Above Average Returns and Non-Average Behavior

Large non-random outperformance in investing requires uncommon behavior. This article describes the difficulty and one way to deal with it.

The basic issue is this: expecting different investment results than the majority of people while behaving the same as the majority is nonsense. And if it still happens, then it’s random and not attributable to alpha.

Doing behavior that is uncommon is not sufficient to achieve outperformance. It is not about behaving differently for the sake of itself. Rather the successful behavior will be one that is not commonly done. But not all uncommon behaviors will lead to superior performance. Probably only very few of the uncommon behaviors will lead to superior performance, while almost all will not. In mathematical language: it is a necessary requirement but not a sufficient one.

What exactly this non-average behavior is varies depending on the investment style. But it will be there somewhere for every very successful investment manager (sucessful as judged by continued outperformance over many years in good and in bad markets).

For example, have you ever watched CNBC and they interviewed a highly successful manager? When asked a question, they sometimes blandly say, that they don’t know and don’t care, but that they can answer another question and they can make money by answering that other question. They simply spend their times on other questions than the majority of people.

Another example of possible non-average behaviors could be the time spent in days analyzing per investment. It can range from 5 days up to probably multiple months for a single investment for Warren Buffet. Another example could be the time spent on analyzing the upside of an investment versus the time spent on the downside. Making sure the downside is limited might be more important than the upside in many investment styles, but many people enjoy thinking about the positive aspects more than thinking about negative outcomes. Another example could be the emotional state of mind when doing the research, being actually interested in how the company works like a curious scientist versus doing the work to make money and have a career. The scientific mind will probably be more objective, because he or she is just figuring out the world without a connection to his life, while the money and career focus has much background thinking related the effects of a good or bad investment decision on one’s life, which is probably emotionally loaded for most people. And if a person is emotionally involved in making investment decisions, it is probably not helpful.

If we only look at larger outperformances, let’s say 2% and more above average per year for a period of 10 or more years, then only a very small percentage of the investment managers achieve it. It’s likely well below 0.5% percent of all managers or even much less.

That means that almost all other investment managers you meet, they cannot help you in achieving these results, as they cannot do it themselves. And yet they make up the vast majority of all investment professionals and are regarded as authorities in the field, as long as their performance is not meaningful below average. They will tell you how they do it, which is average behavior, and if you follow it, you will simply also do average behavior and this does not help at all. Of course, there are parts to what they do, that you can learn from, like many technical skills. But there are is also the mindset and how to behave and feel or not-to-feel in different situations, which is picked up and automatically imitated mostly unconsciously. For example, have you ever seen a 2 year old baby in total rage? Sadly, I have in a grocery mall. One parent was with the child and also exploded in rage within seconds as a reaction to the child. Babies don’t simply start with such behavior unless they picked it up from somehwere (hint: the parent). And it may be the same with you when exposed to other investment professionals. And whether their behavior is conductive to superior outperformance or not, you may very well start to imitate them unconsciously after a while.

This poses a serious challenge for almost all individuals, as most operate in an environment with ordinary people who all do more or less average behavior. Being the only one, or almost the only one, who goes against the heard and stands alone is for almost all people not normal behavior. For most people it is simply psychologically impossible to stand alone while almost everyone else behaves differently and he/she is aware of that. Especially, when the other people are senior employees and are in charge of one’s continued employment. Or can you imagine your boss being afraid of your portfolio exposure and you just completely shutting him up, because you trust your skills, and you don’t think about it afterwards? You will probably think about it and the more you think about it, the more you will see his point and the more likely you are to go along with him this time and in the future, regardless whether it is helpful for outperformance nor not.

Even worse: when applying for a job, the person who exhibits non-average behavior conductive to superior outperformance could easily be rejected because of exactly that. The person interviewing does not know what to do with this behavior. If the interviewer could identify this uncommon behavior as helpful in achieving alpha, then they would probably start doing it themselves. But that would imply, that they themselves would become above-average investment managers. That is true for they least amount of people, and because they are not above-average investment managers, they will also reject the behavior of above-average managers, unless they see past track records that they can use as a guide for judging the other person’s skills.

However, if a person manages to make a proven track record, he or she can become very self-confident and stop caring what other people say.

A way to mitigate this issue would be to only deal with other exceptional individuals (who have proven track records of outperformance) and restricting contact to average people in the field of work as much as possible. Unfortunately, almost no one has a choice in that matter. There is a book on how people are able to think differently and do so despite social pressure: Iconoclast: A Neuroscientist Reveals How to Think Differently by Gregory Berns

Still not convinced? Then read the books of and interviews with highly successful investment managers and then compare their advice to what most investment managers do.


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