Why you cannot see the investment Woodford for the trees

Why you cannot see the investment Woodford for the trees

Neil Woodford was fêted by pundits as a star manager for years. He was even touted as a guru of sorts. He could do no wrong. Until he did. Shooting stars fall to earth as dust.

Is there such a thing as a star fund manager? Or a basketball player with a hot hand? Although populist myth says there is, this does not make it true.

This blog is not all about Neil Woodford or Hargreaves Lansdown. If you need more on those topics, the internet is awash with them. To make a point, Mr Woodford is included.

Does Neil Woodford suffer from hubris? This is the personality trait of extreme pride and dangerous overconfidence combined with arrogance. You can make up your own mind. After hubris comes nemesis.

Patricia Demauro

Patricia is not a fund manager, but perhaps she should have been.

Patricia had a hot hand. After getting bored playing the slot machines, the New Jersey grandmother tried her luck at the craps table. It was May 2009, and the venue was Atlantic City’s Borgota Hotel, Casino and Spa.

A complete rookie at craps, Patricia did not know the rules, the terms or even the odds. Yet she achieved something out of this world, refuting all mathematical and probabilities logic.

The point of craps is to avoid scoring seven with a pair of dice. The casino understands mathematics, statistics and probability. The game cannot escape scientific fundamentals. The outlier is simple luck.

Patricia rolled her dice for four hours and eighteen minutes, a total of 154 continuous rolls. She never scored a seven.

The statistical odds of doing that is one in 1.56 trillion. So rare, it is a world record. Getting struck by lightning is a mere one in a million.

How much skill is needed to play craps? Put two dice in one hand and roll them in the pit. This has to be seen as low on the skill continuum. Even the casino calls it a game of chance. The House knows that with a pair of dice, a seven is the most likely statistical outcome. It normally averages only eight rolls before the player is out.

The previous longest time recorded was in 1989, and the highest number of rolls before 2009 was 147 in 2005. They do not come around often.

Was it her skill? Did she know something others did not? Was Patricia a visionary? No, she got lucky.

The 1,000 game to become a super-rich guru

Some of you will have played a fundraising game at a charity event. Often called heads or tails, each guest bets an equal sum to play. You all stand up and put your hands either on your head or behind your back. A two-sided coin is flipped by the compere. In no time at all a winner is standing on stage sharing their bounty.

Do the other guests hail this person as a sage and then hero-worship them? Usually not.

Now imagine there are 1,000 very good and well-known professional fund managers (in reality there are many, many more than this). In predicting (guessing) how the UK markets will perform in the following 12 months, 500 predict markets will rise, and 500 claim markets will fall.

The markets go up. The 500 fund managers who guessed ‘rise’ make the same bet again. Half are unlucky, but half are right. There are now 250 ‘correct’ fund managers. Same event in year three. 125 fund managers got things ‘right’ three years in a row. Wow! They must be good.

Do this for ten years on a 50/50 guess split and how many are left standing? One. Imagine if this fund manager had a good following and self-publicised to good effect. Each year the number of followers, advocates and investors would grow. In the final few years, growth would be steep.

The newspapers, television and radio would be covering them. Investors would be piling in. Surely the fund manager had a special gift, a hot hand in the markets. No, they simply rode their uncontrolled luck and chance.

One in seven billion

There are over seven billion people living on earth. Some are too young to invest, and some are too poor. But it still leaves a lot of other people. When you invest, you think you need to be smarter than all these other unknown (to you) investors.

Those are tough odds, so why not allow an investment expert to do it for you. They will have much more experience, knowledge and skill, surely. Huge rooms in wealth management firms that circle the globe full of super-intelligent young people, with multiple computer screens and data delivered in less than a second.

Let’s face it, you do not want common or ‘garden’ returns, you are paying to beat the returns other people can get. This is where the belief system sets in. Beautiful charts of historical benchmark-beating performance. Your chosen fund house is the best of breed of course.

Asset Risk Consultants (an independent research company) records the real performance of 97 fund managers on an ongoing basis. Based on the law of statistics, at any given time (and let us exclude forever) some of the 97 fund managers will be winning, some will be losing, and the rest will be treading water.

Is it a rational behaviour to believe that one single person can perform better than all the other 96, year after year on a consistent basis? How could this happen in the world of probability? Especially when all of the other fund managers are also striving to win and outperform and have access to the same information at the same time.

If the only news and information that you get is from one of the 97, how will you ever know what you are missing out on?

The Icarus effect

Icarus was the son of Daedalus who built the Labyrinth for King Minos and was later imprisoned.

Daedalus wanted to escape from Crete with his son Icarus and crafted two sets of wings made of wax and feathers.

Before escaping Icarus was warned by his father not to fly too high (near the sun) nor too low (near the sea). The sun’s heat would melt the wax on the wings and Icarus would fall to his death. Flying too low near the sea would make the feathers wet, with the same deadly outcome. Icarus was warned of hubris by Daedalus.

It didn’t end well for Icarus, who defied his father’s wise words and flew giddily upwards towards the sun. Icarus fell and drowned after the wax melted.

When it comes to investing, the extreme highs and the extreme lows are best avoided.

Be careful what you wish for

Be careful you are not left alone in the dark if you really want your investment portfolio manager to ‘shoot the lights out’.

Beware of cults

The cult of the fund manager should be avoided. Be a thinker, not a follower. Global market returns are usually positive without the expensive intervention of guru fund managers.

Spread your holdings and diversify. Keep costs and expenses as low as you can. Avoid frequent buying and selling. Do not buy on trend or fashion.

If you want some level-headed conversations about investing based on science and evidence, contact one of our chartered financial planners today.

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