Re: ZINIFEX..ZFX
A snapshot of a post which I posted on another thread:
Whitney Tilson is a highly successful US money manager, and a student of human behaviour. His recent presentation, entitled Applying Behavioural Finance to Value Investing, draws upon several columns he has written for the likes of the Wall Street Journal, in which he identifies and examines those traits of human nature that turn a seemingly rational investor into a luck-be-a-lady irrational gambler.
Be warned, we are all about to enter a hall of mirrors and may not like what we see.
Tilson believes that investment success requires far more than intelligence, good analytical abilities and proprietary sources of information. Equally important is the ability to overcome the natural human tendencies to be extremely irrational when it comes to money. As Warren Buffet puts it, "Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble investing."
Consider an experiment by the Nobel Prize-winning economist, Vernon Smith, in which a group of participants would trade a dividend-paying stock, the value of which was clearly laid out for them.
Invariably, a bubble would form, with the stock later crashing down to its fundamental value. One might expect that the participants, having suffered terrible losses, would have learned not to speculate. Yet when they gathered for a second session, still the stock would exceed its assigned value, though the bubble would form faster and burst sooner.
The conclusion drawn is that the lesson learnt by investors the first time was not: "don’t speculate", but rather: "sell more quickly once the bubble starts to burst". Of course this doesn’t work either, as few people accurately time the top and everyone tends to head for the exit at the same time.
Says Smith,
"They always report that they’re surprised by how quickly it turns and how hard it is to get out at anything like a favourable price". It is only when the session is run a third time that the stock trades near its fundamental value, if at all.
Tilson suggests that one of the biggest problems facing human investors is that they tend to be overconfident in their view of things. Not just "robustly", but "wildly" overconfident.
It is such irrational overconfidence that Tilson believes gets investors into trouble. Moreover,
it turns out that the more difficult the task (such as predicting the price of a stock), the greater the degree of overconfidence. And professional investors – the so-called experts – are generally even more prone to overconfidence as they have theories and models which they tend to overweight.
Tilson explains overconfidence by suggesting that people generally remember failures very differently from successes.
Successes were due to one’s own wisdom and ability, while failures were due to forces beyond one’s control. Thus people will tend to believe that with a little better luck or fine-tuning, the outcome will be much better next time.
Overtrading is a fine example of overconfidence, Tilson suggests. In a study of 78,000 individual investors at a large US discount broking house during 1991-96, average annual turnover was around 80%. The least active quintile, with an average annual turnover of 1%, scored a 17.5% annual return. The S&P return was 16.9% over the same period.
The most active 20% of investors, with annual turnover of greater than 100%, scored a 10% annual return.
The authors of this study thus concluded that "trading is hazardous to your wealth". And perhaps more thought-provokingly, another study by the same authors showed that investors who switch to on-line trading, hence cutting out the human broker in between, suffer significantly lower returns.
Tilson’s conclusion is that investors have an awful, unshakeable habit of piling into the hottest investment fad at precisely the wrong time. If there’s one thing as certain as death or taxes, says Tilson, it’s that investors will chase performance, almost always to their detriment.
Whereas chasing performance irrationally may be one example of detrimental human behaviour, the real problems start when one considers the other side of the equation – selling. Possibly the hardest thing an investor has to do is to make a decision to sell at a loss.
One’s inability to admit that one may have made the wrong decision is part of the problem. As Tilson suggested, we attribute success to ourselves, but failure to outside forces. Nevertheless, in selling situations, the real demon is the tendency to put one’s head in the sand in the irrationally desperate hope that when one pulls it out again, it will all have been just a bad dream, and the stock is back where it was.
Tilson makes the perfectly rational suggestion that an investor should always step away from their portfolio and consider, "would I buy that stock now?" If the answer is no, then why hold on?
Tilson suggests another extremely sensible exercise (he’s kind of annoying like that). Take your portfolio, and pretend you’ve turned it all into cash.
Now, from a totally fresh position, decide upon the portfolio you would really like to have now. Is it different? Yes? Then why the hell is it?
As Tilson so poignantly points out, keep in mind that a stock doesn’t know that you own it. Its feelings won’t be hurt if you sell it, nor does it feel any obligation to rise to the price at which you bought it so that you can exit with your investment – not to mention your dignity – intact.
Humans don’t only turn into irrational reprobates at the thought of selling at a loss either. An equally unjustifiable opposite is the blind hope that a stock may return to a price where you wished to buy it in the first place, having since moved up. If your rational mind can suggest that a stock is worth buying up to a certain price, then go ahead.
The same philosophy can be applied on the downside. Just because a stock you’ve bought falls in price, it doesn’t mean you must be wrong. Some short term influence may be at play, and the reality is that a dip is an opportunity to buy more at an even better price.
Tilson refers to this as "anchoring". That is the tendency to stubbornly stick to your original evaluation without taking time to step back and review any new information, or objectively analyse any specific force acting upon a stock price.
To recap, the lesson so far is: don’t get swept up into chasing a stock, but don’t be too stubborn to increase a buying price. Don’t be foolish enough to hang on to a stock when it’s fallen, but don’t sell if you still believe in it.
And don’t be overconfident for no good reason. It’s all very simple, isn’t it?
My comments:
I like the part which states "Successes were due to one’s own wisdom and ability (i.e. brilliant price prediction) .......... while failures were due to forces beyond one’s control (i.e. market manipulation by brokers, etc.)
It's not my fault - the dog ate my homework