laws-of-fund-management
The Hindsight Law of Fund Management
Simulated systems with 20-20 hindsight never seem to have the same foresight

Only God and Fox News commentators know exactly what the future holds. Mere mortals have to rely on the past. And so we try and predict the future by what we think we have learned from the past. Hence the expression, “There is no such thing as history, merely historians.” In theory, pat-terns in history can somehow help us to predict what will happen in the future. In Funds Management, some people have taken this a step – or rather a mile – further down the road.

The theory goes something like this. Opinion is free, but facts (i.e. statistics) are sacred. Every-thing worth knowing (apart from the results of next week’s EuroMillions numbers, dog and horse winners and football results) is hidden in past statistics and numbers. These numbers form patterns that identify trends. All you need is a better model than the next person, and you too can interpret the future from the past. Opinion can be left to the idle chatter of economists and other morons. Just read the tea leaves, charts, candlesticks, heat spots, trends or algorithms properly -and you too will have the key to future riches.

This explains the proliferation of investment models that use past statistics. All these models have amazing hindsight predictive capabilities. Few, unfortunately have the same good outcomes when they are applied to the real world with our money. 20-20 Hindsight regrettably is always better than the foresight of such models. The exceptions to this rule (you know who you are) are of course immensely rich!


The Differential Law of Fund Management
Systems don’t know why they make money. Discretionary managers know why they lose money

This law represents one of the interminable debates in funds management. The question
is: are humans better at managing money than machines? Of course, the machines are also made by humans, so in some respects the argument is self-defeating.

As Descartes said to me only the other day: Cognito ergo sum. I think, therefore I am. This excludes a large majority of the human race, including – and maybe in particular – Arsenal fans. To those to whom the dictum does apply, it means that those whose investment decisions are based on the human mind and its ability to interpret what is going on in markets, are able to explain both why they made money and why they lost it. Strangely, amnesia always seems to set in when people are asked to explain the losses. Amazingly, verbosity sets in when people are asked to explain the gains.

Machines, black boxes, mathematical models, algorithms and other non-human investment ap-proaches, tend to follow market data or patterns. Based on past experience, they try and predict the future. Some smart machines and models even claim to be able to learn from current activity so as to not repeat mistakes of the past. These mechanical approaches may not be capable of being in a state of Cognito ergo sum. They do think, but they are not yet what some philosophers would call conscious of themselves. Sometimes these machines make money and sometimes they lose money. They don’t talk about it. Only humans do that. Unless of course you believe in Hal from 2001: A Space Odyssey, or machines from Star Wars. In which case my poor sister in Nigeria needs your money…


The Ultimate Law for Fund Managers
There’s always an index your track record can beat

When I originally wrote these laws some time back in ancient history, I stopped at Law No. 13. I naively imagined that I had created a sort of 13 principles of faith. But after observing the absurd behavior of financial markets and its participants, I decided to add a few more.

All fund managers compare themselves to some index or other. The Law of Simulated Returns states every fund manager can comfortably beat this index when not actually investing real money. Some fund managers even beat the index when investing real money. All of them, like the rest of humanity, need something to beat most of the time. That is why when the track record vacillates, they need to change the index against which they are measuring themselves. After all, why would anyone want to invest with a manager who can’t beat an index?

I would go further, and boldly state that most managers do not beat their indices over time. In other words, most people are actually investing with sub-par managers most of the time. However, it makes us all feel better if we are with the winners. So losers often change the index so they look like winners. If you then stay with them, they are winners – and guess who the loser is!


The Contrarian Law of Fund Management
Good opinion is not influenced by the view of lemmings

It’s not that the crowd gets it wrong. They just get carried away by the mass of other lemmings doing the same thing. Ergo, they must be right.

Blind enthusiasm is no substitute for brains. The psychology of the crowd overtakes the reality, and takes markets both too high and too low.

One of the smartest managers I know (let’s call him Hugh Hendry of Eclectica to safeguard his anonymity) never follows the herd, and never reads the views of juvenile scribblers. He takes his own counsel from his own observations, and draws his own conclusions. This is true contrarian thinking. Hugh is one of the very few great managers out there who operate this way. It’s not easy. It can be lonely going in the opposite direction of the lemmings.

Another manager like this is Richard Edwards. Richard has applied chaos theory to markets, which allows him to observe the lemmings in action. By following the behaviour of the crowd, he is often able to accurately see where markets are getting compressed and may soon break out.

He predicts when and what to buy, and has been remarkably accurate in his predictions. He writes a narrative, but only in order to put the findings into an economic context for those of us that like reading stories. This should not be seen in itself as an explanation of market behaviour. Richard is telling us what will happen, not why?