Trust The Process

There are 2 activities in my life that bring me as much joy as they do frustration…watching Arsenal and Investing.

To succeed in either activity requires patience, diligence, commitment, analysis, practice, and consistency in execution. Both demand an absolute dedication to your craft to have the privilege of trying to achieve success, but neither offers any guarantee.

Both activities offer countless lessons about human behaviour…our discomfort with randomness, probability, and an unpredictable future…our inability to control our emotions both in good and bad times.

Both are narrative driven where the outcome dictates the public discourse as opposed to the underlying numbers and facts. This outcome bias makes us demand action and change when doing nothing is probably the best of action. But why is this?

Human attention tends to be drawn towards two things – salience and availability. Salience is where something is particularly noticeable (often due to some emotional resonance), and availability is how easily something comes to mind (typically because it is recent). The lure of the day-to-day gyrations of football and financial markets is strong.

Unfortunately, it is not only an issue of attention, but importance. We are prone to hugely overweight the relevance of what is happening in the moment, as Daniel Kahneman noted: “Nothing in life is as important as you think it is, while you are thinking about it.”

In the general sense this is not irrational human behaviour.

If something is happening or changing in the current instant, then it can make absolute sense to focus on it and deal with it immediately. Fire the manager, sell that stock! Do something! Because to not do so would be too uncomfortable. We’re not wired that way as humans.

Taking the time to accurately calculate the probability of whether that movement you spotted on the savannah is actually the head of a lion was probably not a smart strategy for our ancestors. Those who stopped and pondered got eaten.

The issue is that rationality is context dependent. What is good for human survival is often terrible for a long-term football project or investment portfolio.

The problems that stem from this behavioural wiring are twofold. First, we are likely to neglect information that is genuinely important in favour of what we are currently experiencing.

Second, we are almost certain to make compounding errors as we get stuck in the cycle of continually reacting to the next set of salient and available information, or what we might instead call the prevailing narrative.

That most football fans and investors are caught in this behaviourally satisfying but return-eroding loop is reflected in the lack of introspection or reflection around past decisions and opinions.

Nobody looks back at all the predictions that were made a year or two ago because it would be embarrassing to acknowledge how wrong we were and how attentively we focused on matters that were either irrelevant or unpredictable.

It is better for everyone if we all just keep looking forward.

Nobody wants to be rational. It’s not fun for pundits and rival fans to admit that you can be a good football team and not win trophies…just like clients don’t want their investment manager telling them that you can be a good investor and still lose money…not because your process is flawed, but because the outcome is never within your control due to extenuating factors.

Both fields give me endless joy because there is always something to learn and analyse. Both deeply frustrate me because of how shallow the conversation around them tends to be.

Football pundits want to talk about “the right way to celebrate”, rival fans want to banter. Investment pundits want to tell you why the market ended up 2% lower today, clients want to talk about this months’ performance.

Never-ending conversations that lack context.

He Ate The Computer

I think another reason why I love both football and investing so much is that if you care enough to look, both provide solace in the numbers. The numbers don’t lie and are a true reflection of the quality of your process over the long-term.

The concept of Expected Goals (xG) in football offers a neat way to think about the game and your team beyond your desired outcome, and I think the same thought process should be applied to investing when assessing performance.

Let’s break it down into simpler terms to see how understanding these concepts can give us better insights into both soccer and investing.

Imagine you’re watching a soccer match. Every time a player shoots at the goal, you instinctively feel whether it was a close call or a long shot. What xG does is put a number to that feeling, rating each shot based on how likely it was to lead to a goal.

It considers things like how far the shot was taken from, what angle, and even how the ball was passed to the shooter. So why should you care?

  • Fair Play: It helps us see if a team is actually playing well but just unlucky, or if they’re really not as good as the score suggests.
  • Strategy Insights: It shows whether a team is good at creating (and taking) real scoring chances.
  • Better Debates: It gives fans and analysts a solid way to discuss a team’s performance beyond just the scoreline.

So how should we apply this to investing? How do we determine if a fund or investment manager is skilled or just lucky?

Imagine your investment portfolio is like managing a football team. Each player on the team represents a different asset in your portfolio, such as stocks, bonds, or REIT’s.

Just as a football team aims to win matches, your portfolio aims to achieve a certain return, or “score goals”, against its benchmark, which is like the opponent team.

  • Setting Expectations (Benchmarking): First, just as you would evaluate a football team’s expected performance against various opponents, you assess your portfolio’s expected performance against a benchmark. This could be outperforming a stock index like the S&P 500, or inflation by 5% or more. This benchmark is like the average team your football team should be expected to compete with or beat.
  • Measuring Actual Performance: Throughout the investment period, you track how well each asset (player) performs. Are they contributing to your portfolio’s overall goal of outperforming the benchmark? This is akin to watching how each player performs in matches, scoring goals, defending well, or setting up plays.
  • Providing Context: Now we are not simply concerned about how well our portfolio did over the last quarter or year, but rather if it is constructed in a manner that can deliver sustainable results for as long as possible. If your portfolio consistently outperforms the benchmark, then a bad quarter or year is not something to lose sleep over.

“The game that I want to play is acknowledging how ridiculously powerful compounding is and therefore increasing the odds that I will be able to stick around long enough for compounding to work. That’s the game that I want to play. And it might look conservative, but to me, it’s actually the opposite.” – Morgan Housel

What the above quote from Morgan Housel teaches us about wealth creation is that your concern as an investor shouldn’t be, “what is the highest return that I can get this quarter/year”, rather it should be, “what return can I sustain for the longest period of time?”.

If you’re investing for 30 years, the biggest gains are going to come in the last couple of years. That’s how the math of compounding works. It just gets exponentially higher as time goes on.

So to me, the number one thing that I want to do, and I think this is true for a lot of investors, is just maximize my endurance, maximize my durability as an investor.

Compound interest sees its biggest value in the later years of compounding so your goal should be to never allow short-term events to stop compounding from working in your favor.

How to Manage

  1. Team Selection (Investment Selection): Just as a manager selects players for a match based on their skills and the opponent’s weaknesses, you choose investments that have the potential to outperform the benchmark. This might involve picking stocks with strong growth prospects or bonds with solid yields.
  1. Formation and Strategy (Asset Allocation): In football, a team’s formation and strategy can be crucial to winning matches. Similarly, how you allocate your assets—how much you invest in stocks versus bonds, for example—can significantly impact your portfolio’s performance. Adjusting your asset allocation based on market conditions or your financial goals is like a football coach adjusting the team’s formation during the season to capitalize on the team’s strengths.
  1. Review and Adjust: Just as a football coach reviews match performances and adjusts the team lineup, formation, or strategy as needed, regularly review your portfolio’s performance. If certain investments aren’t contributing to outperforming the benchmark (they’re not “scoring goals” or are constantly injured), it might be time to replace them with ones that might.

By applying the concept of Expected Goals (xG) to your investment portfolio, you’re effectively taking on the role of a football team manager—strategically selecting and managing your “players” (investments) to outperform the “opponent” (benchmark), aiming for the best possible outcome based on the resources and conditions at hand.

Success is not measured on external factors beyond your control. Success is measured by how well you are allocating and managing your resources compared to your peers and internal expectations. All you can do is what you can do.

Extra Time

Just as xG has given soccer fans and analysts a new way to look at the game, applying a similar concept to investing will change how we judge investment managers.

By separating luck from skill, we can make more informed decisions, whether cheering for our favorite team or choosing where to invest our money.

It’s a complex idea, made simple, to help us appreciate the games we love and make smarter choices in the investment world.

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