CFA Institute

Editor's Comment: Trying Too HardAuthor(s): Dean WilliamsSource: Financial Analysts Journal, Vol. 40, No. 2 (Mar. - Apr., 1984), p. 7Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478725 .

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Editor's Commen

Trying Too Hard

As investment professionals, we may be try- ing too hard. More than that, no matter how hard we try, we may not be as important to the results as we think we are. It seems reasonable that increasingly detailed security analysis would lead to better investment results. Ex- perience causes us to doubt it, though. Com- plexity isn't necessarily pointless, but in our profession, simplicity has its place, too. Maybe even a place of honor.

The reason for dwelling on the virtues of simple investment approaches is that com- plicated ones, which can't be explained sim- ply, may be disguising a more basic problem. They may not work. Mastery often expresses itself in simplicity.

Much of the analytical theory we've developed assumes that financial relationships are rational and economic events predictable. What we've found instead is one surprise after another. It's possible that we've assumed ra- tional behavior where none exists. If so, much of the back-testing, modeling and forecasting we do would seem to be on shaky ground.

One principle that accepts surprise instead of trying to outwit it is regression to the mean. Its message to investors is this: Expect most companies to have an average future, and act accordingly when their share prices assume otherwise. Something usually happens to keep both good news and bad news from go- ing on forever.

Two qualities of mind also offer help. They are consistency and what in Zen is called "Beginner's Mind." Great long-term invest- ment records share little in common except the discipline, fidelity and consistency applied to

attain them. "Beginner's Mind" helps an ex- pert remain as open to new ideas as a beginner.

Most of us are organized to stand under a waterfall of information and then to bet against others who stand under the same waterfall. A simpler approach, and one that probably stands a better chance of working, is to measure relative value instead of trying to make sense out of the waterfall. Buy what's cheap today and let others deal with the odds against predicting the future.

Benjamin Graham was skeptical of anyone's ability to discover information unknown to the market or to forecast future earnings. His view of portfolio management was buying a diver- sified list of statistically cheap stocks. He once said, "I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activitiy, say, 40 years ago when our textbook Graham and Dodd was first published. But the situation has changed a good deal since then. In the old days any well- trained analyst could do a good professional job of selecting undervalued issues through detailed studies. But in light of the enormous amount of research now being carried on, I doubt that in most cases such extensive efforts will generate sufficiently superior returns to justify their costs."

He may have been asking us: "Do you think you might be trying too hard?"

-Dean Williams Batterymarch Financial Management Boston

FINANCIAL ANALYSTS JOURNAL / MARCH-APRIL 1984 O 7

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