Friday, November 14, 2014

Interesting Article on Non-Emotional Investing

CFA Institute Magazine printed an interview with C. Thomas Howard, director of Athena Investment Services.  He has an extreme style of investment, meant to eliminate all emotional biases.  Some of his ideas are definitely outside the mainstream.  He makes a good argument that the Prudent Man Rule, and even modern portfolio theory itself, are, in some ways, the institutionalization of emotion-driven investing, so that even our ethical and academic frameworks are damaging to optimal investing.

I think he makes some great points, and has some challenging ideas about how to invest wisely.

In the end, the problem comes down to the fact that optimal investing is hopelessly bound up with uncertainty on many levels.  We can never cleanly separate temporary and permanent changes, losses from mistaken tactics and losses from volatility, etc.  So, while the best long term investment needs to be unconcerned with volatility, there will always be the possibility, at the nadir of volatility that is likely to be mean-reverting, that it is actually only the beginning of the consequences of a very poor or very unlucky position.  That includes tactics as broad as having a diversified exposure to the global productive economy.  And, that problem is multiplied many times over when your portfolio is under the management of a 3rd party.

Even when a portfolio does well, it can be for reasons that are unclear.  For instance, the Athena Pure portfolio has gained an average annual return of 25% over 12 years. Howard attributes this to his non-emotional, behavioral finance approach.  But, it just so happens that part of his theory regarding this approach is that he prefers firms with high levels of debt and large dividends.  How much of his gains have come from behavioral finance insights, and how much has come from the happenstance that this profile might do very well in a context of falling interest rates?  (I haven't researched the fund's holdings.)

Here is the link (pdf).  An interesting article, with food for thought, and several good ideas, in any case.


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  2. Hhmmm, I've not heard of this approach before, or this manager.
    Dividends is a fairly standard position - the market often does seem to slightly downrate firms that start paying divi's - perhaps because they feel it's a signal that the firm has gone ex-growth. He sees it a s a sign that the firm has confidence in their ability to pay it going forward. They're both right I suppose - Buffett doesn't pay dividends because he feels he can invest that money at outsized returns ( and also for tax reasons I believe) but invests mostly in firms that do.
    He also likes forward analyst earnings estimates that are growing ( I think that's what he says) - again fairly standard but then again you'd expect that sort of info to be fully in the price.
    And then he likes debt - that's kind of out there - his reasoning is that the lender will have full confidence in the firms' ability to pay - I guess there's something in that but I wonder if it's one of those fat tail things - where you'll occasionally take a big hit.
    He likes price:sales ratios as they are less easy to manipulate - revenues that is - again I think there's some truth in that although misstiming of revenues does happen (Tesco in the UK recently). And then he has a minimum revenue level that takes out the micro-caps.
    Overall it seems almost too simplistic or even naïve, but then again I sometimes think that these simple, heuristic approaches are often highly effective. I might try and register to see their holdings and see if they are firms that I also like by my criteria.

    1. Yeah. His criteria of having a dividend but very low stockholders equity would seem to select for firms that are highly leveraged, but not in distress. That probably means firms with mature and stable revenue and high fixed assets. The combination probably is a peculiar selection for cyclically defensive firms that are sensitive to interest rates, and leveraged to boot. I wonder if he will be able to keep up the performance in a new context.

  3. If the Athena style works, the market will figure out...a lot sooner than over 12 years...

    My guess is he has been lucky...flip a coin and it will come up heads four times in a row one eighth of the time.

    Also, many managers report returns on accounts under management...meaning that accounts that left are not in the mix.....

    I do like divvie stocks...