On the signal and the noise
Professional investors today face a very different challenge than Ben Graham in the 1930s. During the Great Depression when Graham developed the tenets of modern security analysis his major issue was a lack of data and information about the companies he wanted to investigate. There were hardly any disclosures in the financial statements of the companies and no computers to crunch number (not that there were too many numbers to crunch in the first place). Today, we are flooded by information and data to such a degree that we often suffer from information overload and have a hard time separating the wheat from the chaff.
I don’t want to focus here on the techniques to limit and manage information flow in our daily work but instead emphasise that the information we receive during a typical day tends to be of vastly different quality. Being able to quickly identify valuable information from random noise is the first step to overcoming information overload. In my view investment professionals should focus on the top of the information pyramid and then work their way downwards.
The highest quality information: wisdom
Some information endures the test of time and is valuable independent of the current market conditions. I am talking here about fundamental insights into investments like the concept of “margin of safety” or different behavioural biases like “loss aversion”. More often than not this kind of wisdom is qualitative in nature and almost philosophical, which is exactly why it is so versatile yet often ignored by investors, particularly those with less experience. New pieces of wisdom are rare to find, but if you do find them hold on to it for dear life, they might well save a portfolio one day.
Ironically, wisdom is not what you find discussed on Twitter or CNBC because due to its timeless nature it does not lend itself well to the attention-grabbing formats of these media. Even in newspapers, this kind of timeless information is hard to find. If you want to find wisdom, I recommend reading some of the investment greats like Ben Graham, Seth Klarman or Howard Marks. Some bloggers and journalists also focus on the enduring principles of investments like Jason Zweig at the Wall Street Journal.
And of course, there is academic research, which may not always amount to much wisdom, but the hit ratio of finding wisdom there is certainly higher than anywhere else in the investment media or in the “thought leadership pieces” of many asset managers and investment banks. Good places to go are SSRN and the CFA Institute Research Foundation, which publishes a series of books, papers, webinars etc. each year that stand the test of time (disclosure: I am on the board of trustees of the research foundation and have helped publish some of these reports).
Relevant investment information
On step below is information and data that is relevant but typically expires very quickly. Quarterly corporate earnings or central bank policy decisions are typical examples of this kind of information. This is what most professional investors focus on in their daily jobs. Of course, the crucial question is to figure out what information is relevant. Here is a simple rule of thumb that I follow: just look for the breaking news on Bloomberg TV or CNBC. By now, financial media is in such a stiff competition for the attention of the viewer that they seem to have a “news alert” on almost anything. In fact, they don’t, but they are not far off. In my experience, if you only pay attention to breaking news alerts you will automatically get the one to three most important pieces of information each day. Everything else hardly ever matters.
However, there are two pitfalls that many professional investors fall into when dealing with relevant information. First, they focus exclusively on this kind of information and never venture outside their comfort zone and deal with the pieces of wisdom mentioned above or with information from other fields of inquiry that could inform their investment decisions (see next section). This means that they are never going to be able to identify underlying investment principles and “the big picture”. As a result, these investors are in danger of changing their investment approach too often or reacting to short-term developments at the cost of long-term performance.
The second pitfall is that many investors hold on to this information for too long. It might sound impressive if you can recite the dividend yields of every listed infrastructure company in the UK or the quarterly earnings of HSBC for the last five years, but it is irrelevant and does not improve your investment performance. News like quarterly earnings are incorporated into market prices within hours and days. After that a dividend announcement or an earnings announcement has lost all its practical value except for portfolio managers to signal their “deep knowledge” of a market.
Peripheral information
Remember that financial markets are millions of people around the world trading with each other. In order to understand financial markets, you must understand what motivates these human beings. This means that seemingly unrelated information from fields, such as psychology, politics, history, and even entertainment and sports can influence market sentiment and investment behaviour.
During the Eurozone debt crisis, it was fascinating to see how different the debt crisis was perceived inside the Eurozone compared to the Anglo-Saxon world. Anglo-Saxon investors were commonly much more pessimistic about the Eurozone and its ability to stem the debt crisis in Greece and other countries than European were. As it turned out, European were right and while they certainly did not solve the Eurozone debt crisis for good, they made sure that nothing blows up either, which in turn created fantastic investment opportunities in government bonds in peripheral countries in the Eurozone. A lack of understanding about the goals and motivations of Eurozone policy makers prevented British and American investors from accurately assessing the developments back then, just like it seems to prevent many Brits from accurately assessing the EUs actions in the ongoing Brexit negotiations today. Of course, the fault is mutual. European often do not understand the Brits because they know too little about British history, politics or other factors that influence the decisions taken in this country.
My advice for professional investors is thus to gather information in these peripheral fields. Read newspapers in different countries and follow information sources with a different political tilt. Ideally, one should live in different countries for some time to broaden one’s horizons but that may not always be practicable. I think a good investor is someone who has become a student of humanity and tries to understand humans without prejudice in all the colours, shapes and beliefs they come on this earth.
Entertainment
Having fun at work is an important component to keep me going, so I enjoy finding out about quirky developments in markets or the world in general. Is it useful? No. But it recharges my batteries before I dive into the next set of quarterly earnings…
Noise
Everything else that I have not mentioned so far, I consider noise.
My information pyramid
Source: Fidante Capital.