10-12-2013, 07:10 PM
Chapter 3: The Institutional Performance Derby: The Client Is The Loser
Chapter 3 describes the weaknesses and negative effects of institutional investing. Noting that “institutional investors dominate the financial markets,” author Klarman argues that “[u]nderstanding their behavior is helpful in understanding why certain securities are overvalued while others are bargain priced and may enable investors to identify areas of potential opportunity.”
He then runs down some of the well-known weaknesses associated with managing vast sums of other people’s money: a preference for growing the amount of funds under management that necessarily reduces long-term performance, groupthink, short-term focus, and reliance on relative rather than absolute performance.
My favorite part of the chapter was this:
This is an important distinction that I never really thought about in so direct a manner. I think I probably think about the value of my prospects in more relative than absolute terms. Not that finding the “relatively” best investments is in itself any small feat, but I’ll have to give more thought to where each investment stands in absolute terms as well.
The chapter is rounded out with a discussion about how many institutional investors have abandoned fundamental stock analysis entirely and with a detailed take-down of indexing as a strategy. Klarman makes some of the better-known arguments against indexing, concluding that “indexing will turn out to be just another Wall Street fad.” I think he may have missed the mark pretty widely there, but nonetheless, some good notions in this chapter.
Chapter 3 describes the weaknesses and negative effects of institutional investing. Noting that “institutional investors dominate the financial markets,” author Klarman argues that “[u]nderstanding their behavior is helpful in understanding why certain securities are overvalued while others are bargain priced and may enable investors to identify areas of potential opportunity.”
He then runs down some of the well-known weaknesses associated with managing vast sums of other people’s money: a preference for growing the amount of funds under management that necessarily reduces long-term performance, groupthink, short-term focus, and reliance on relative rather than absolute performance.
My favorite part of the chapter was this:
Quote:Remaining fully invested at all times certainly simplifies the investment task. The investor simply chooses the best available investments. Relative attractiveness becomes the only investment yardstick; no absolute standard is to be met.
* * * * *
Absolute-performance-oriented investors, by contrast, will buy only when investments meet absolute standards of value. They will choose to be fully invested only when available opportunities are both sufficient in number and compelling in attractiveness, preferring to remain less than fully invested when both conditions are not met. In investing, there are times when the best thing to do is nothing at all. Yet institutional money managers are unlikely to adopt this alternative unless most of their competitors are similarly inclined.
This is an important distinction that I never really thought about in so direct a manner. I think I probably think about the value of my prospects in more relative than absolute terms. Not that finding the “relatively” best investments is in itself any small feat, but I’ll have to give more thought to where each investment stands in absolute terms as well.
The chapter is rounded out with a discussion about how many institutional investors have abandoned fundamental stock analysis entirely and with a detailed take-down of indexing as a strategy. Klarman makes some of the better-known arguments against indexing, concluding that “indexing will turn out to be just another Wall Street fad.” I think he may have missed the mark pretty widely there, but nonetheless, some good notions in this chapter.