While studying at Cambridge University in 2003 I got a letter from former US secretary of state Henry Kissinger, inviting me to meet him in New York. I naturally embraced the opportunity. I recall walking into his stuffy office overlooking Park Avenue, adorned with literally hundreds of photos of Kissinger standing alongside heads of state and other dignitaries. Given his wealth of experience, I asked what life lessons he would pass on to a 26 year old making his way in the world. A former Harvard academic and long-time geopolitical adviser, Kissinger offered two insights. The first was to publish policy work while I was still young that would resonate through time. The second was to exploit every prospect that was randomly presented rather than trying to execute a long-term grand plan. “All my Harvard peers had these ambitious five-year strategies,” Kissinger recalled in his gravelly baritone. “I just opportunistically capitalised on my openings as and when they materialised.” This logic has important ramifications for investing. I often hear folks say they can get their long-term forecasts right, but not over the short term. Yet statistically, nothing is further from the truth. Read the full column here or AFR subs can click here. Excerpt enclosed:
It is much easier to predict the short term correctly than trying to divine outcomes over many years. This is why the greatest investors in history, like billionaire mathematician Jim Simons, exploit short-term rather than long-dated mispricings where the ex ante probability of being right is higher because there is less scope for external events to perturb profits.
It is also why the oft-claimed distinction between “traders” and “investors” is fallacious. All good traders and investors have a view on where fair value lies and seek to pick up assets trading at levels that deviate from it and which have a strong likelihood of mean-reverting.
Consider two investors with the same talent exploiting the same quantum of mispricing on the same asset. Suppose the reasonable expectation for one is that the mispricing will close in a few hours while the other believes the mispricing will take weeks to normalise. Since uncertainty grows as a function of time, intelligent investors will always take the first trade rather than the second given it has a higher probability-weighted expected return.
And yet I regularly come across individuals who think that those “investors” targeting long-holding periods (ie, most fund managers) are superior to “traders” (like Simons and, in his own way, Kissinger) who relentlessly optimise opportunities over the short run.
An unwitting adherent to Kissinger’s doctrine is the Reserve Bank of Australia. My beloved Martin Place brethren are, to their credit, the first to admit they cannot forecast much, if anything, beyond 12 months despite the army of analysts at their disposal. When the RBA’s board members meet each month, they have to make decisions based on the highly imperfect information they have available to them. As Glenn Stevens used to say, “nowcasting” (figuring out what is happening in the present) is more valuable than guessing about an unknowable future.
When I played rugby for Victorian Schoolboys, our aphorism was “small steps”. Chain those together and the game will look after itself. A similar maxim was adopted on the tennis court: focus on winning each individual point, and the games, sets and match will follow. Think too far ahead, and you can lose sight of the present.