One of the best moments of being a football (soccer) fan is when your team scores from long range. Although a goal built from an intricate passing move is undeniably pleasing, nothing quite beats a 25-yard rocket into the top corner. That’s why when a player finds themselves in space outside of the opposition penalty area the crowd will inevitably encourage an effort on goal with the dull roar of ‘shooot’. This is a mistake. The probability of scoring from distance is poor. It is typically a much better idea to try to work the ball closer to the goal. Shots from distance in football are like short-term investing – it feels right, but the odds of success are terrible. It is much better to do something else.

In his book on the use of data and analytics in football, Ian Graham (who played a major role in the success of Liverpool over recent years) highlighted work that showed while one-third of shots from inside the six-yard box are converted into goals, this falls to just 4% once outside the penalty area. There are several caveats to place around such numbers, but the general point holds –  shooting while being a considerable distance from goal is not usually a great decision.*

Why does this have anything to do with short-term investing? Well, trying to predict how markets might move over any brief time period (1 month, 1 year…) is another activity that we seem inescapably drawn towards despite it having little chance of success and being detrimental to what we are trying to achieve.

But why do we believe that long range shots and short-term investing are better ideas than they really are? Because of the influence of some of our most impactful behavioural foibles:

– We remember the wrong things: Our judgement of probability is inextricably linked to how available something is in our mind. Goals from long range shots don’t seem anywhere near as rare as they are because they are salient and we see them repeated continually, much more so than those that fail to hit the back of the net. Similarly, it is far easier to remember those short-term market calls that we got right, than the many we got wrong.

– We want a near-term fix: We prefer things that are exciting and give us a reward as soon as possible. Long range shots and short-term investing are far more stimulating than their alternatives, both of which require a great deal more patience and are just a little more dull.

– We want to be part of the crowd: Most people in a football crowd will urge the player to take the long shot, why would we not want to be part of this? Likewise, most people in the investment industry want us to engage with short-term market activity, so most of us do. Norms matter.

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There are situations where taking a long shot might be a prudent option. For example, a weaker team playing against a much stronger team my not get that close to their opponent’s goal so an effort from distance is their best chance. Yet even here the the similarities with investing are stark – speculation can only be justified when our objectives are speculative.

The further we are from goal when taking a shot the greater the uncertainty, the more other variables will get in the way and the lower the probability of success.   

The shorter our investing time horizon the greater the uncertainty, the more other variables will get in the way and the lower the probability of success.

Enjoying and encouraging a shot from long distance in football is entirely understandable and perhaps desirable. Football is entertainment – it is about moments and feelings – ignoring what the data tells us is fine, it might even make the game better. Most of us don’t invest for fun and, unless we do, we should avoid the long shot of being short-term.

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* These numbers are a simple representation of what the data tells us. There are a range of other factors that will impact the probability of scoring from various parts of the pitch, such as the relative strength of the teams involved, the player taking the shot, how easy it is to get the ball closer to the goal etc.. Such things are always noisy, but the point about long shots being overrated (from a data if not enjoyment perspective) still stands. There has been a reduction in long range shooting in high level football in recent years no doubt in part due to the increasing use of analytics.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

In the latest episode of Decision Nerds, Paul Richards and I talk with Professor Alex Edmans of London Business School. Alex recently published a book, ‘May Contain Lies’, which discusses our vulnerability to the misuse of evidence, statistics and stories, and how we can get better at deciphering the information that we consume.

Alex talks us through his ‘Ladder of Misinference’, which is a great framework for understanding how we might be mistaken when in receipt of information, and what we can do about it.

As part of the discussion we also cover areas including:

– How to help people move beyond black-and-white thinking and engage with complexity – getting the right mix of data and stories

– Why do bad ideas stick – do you still ‘Power Pose’?

– Changing minds – the power of good questions (there’s a great experiment on pianos and toilets that you can try at home).

– Trading off the short and long-term – why he chose the most critical agent to help him publish his book.

– Understanding neurological carrots and sticks – what happens when we put people in a brain scanner and give them statements they like and don’t?

– The state of debate around ESG and DEI – ideology, identity and pressures to conform.

I hope you enjoy the conversation, which covers a range of subjects that feel increasingly important.

You can listen to the episode in the usual places, or from the link below.

May Contain Lies

In his book on the concept of ergodicity, Luca Dellanna writes of his cousin who was a highly talented skier in his youth, but had a potential future in the sport cut short by a succession of injuries.[i] The lesson that Dellanna draws from this is that it is not the fastest skier that wins the race, but the quickest of those who reach the finish line. The risk of irreversible losses is integral to long-term success. Investors may think that maximising returns is their primary goal, but it isn’t. Survival comes first, and survival comes in several guises.

Diversifying Disaster

The most obvious case of the survival imperative is in the avoidance of catastrophic losses. These tend to stem from some form of concentration but are often complemented by leverage and complexity.  Although this might seem a simple risk to mitigate it is not, primarily because it is easy to be negligent about how susceptible to concentration we are. Just because a portfolio looks diversified – it holds lots of stocks, funds or asset classes – doesn’t mean it is.

Although diversification can be critical to survival, investors don’t really like it. When we diversify it says that we are uncertain about the future rather than confident, it also means that – after the fact – our portfolio has always performed worse than it might have done. Why didn’t we hold more of the asset that produced the strongest returns?

The danger of this is that we have only ‘line-item diversification’ – we hold a long list of names in the portfolio because it is deemed to be the prudent thing to do, but they are all exposed to very similar risks. When we do this we are prioritising return maximisation over survival, which is an incredibly dangerous approach.

Wrong on Average

One of the primary causes of survival neglect is looking at the wrong type of average. Investors can be susceptible to thinking about the average return of an asset class at a group level (XYZ hedge fund category has produced a 7.8% return over the past decade), but really we should care at least as much about the individual paths taken by the funds within that grouping (5% of the funds in XYZ hedge fund category lost more than 50%). The second piece of information feels more important than the first.

Humans can think in this way. When we buy home insurance, we (hopefully) don’t spend too much time considering the average loss experienced by all home insurance buyers (we know insurance companies should make a profit), we instead focus on the consequences of a bad outcome in our own personal experience.  Of course, as investors we cannot make decisions based on the worst possible result, but with any decision we make we must consider the potential adverse paths it might leads us down and whether we can survive them.

Salient Survivors

What investors really want is to identify investment strategies that survive and generate stellar returns. How do we go about finding these? Often by looking at individuals and teams that have achieved just that.

Although survivorship bias seems to be one of the most high-profile behavioural foibles that we encounter, this awareness doesn’t seem to provide much protection against it. High risk, highly fragile investment strategies – whether they be complex, leveraged hedge funds or concentrated equity portfolios – are constantly lauded when they produce extraordinary returns with rarely a mention of the many, many other similar strategies that were carrying similar risks but failed to survive.

Why is it so easy to fall into this trap? In part because of the salience of high-profile survivors – they become incredibly prominent and identifiable, far more so than the long, unmemorable list of those that no longer exist (notwithstanding the select group of notable failures) – but also because of our difficulty in accepting the consequences of high risk and good fortune. The successful survivors have inevitably enjoyed incredible luck, but it is our tendency to ascribe those outcomes to agency and skill rather than a dice roll.   

Surviving Ourselves

It is very easy to think about investment survival purely in terms of avoiding disastrous outcomes from the assets themselves, but although this is critical it is far from the only relevant aspect.  As important are the decisions we make through the life of an investment.

Any investment is only as good as our ability not to make bad choices while we own it.  

Poor decisions at the wrong time – selling at a market trough or following a prolonged spell of underperformance – is another survival problem. It doesn’t matter if the asset recovers from its difficulties if we have acted to crystallise the losses through our own actions.

The challenge is that it is incredibly tough to avoid such mistakes. When a fund is going through a poor spell of performance, we will desperately want to sell it and move on. And the longer the trend persists, the stronger the urge will become. The narratives will be overwhelming and the emotional toll heavy.

Every investor overestimates their aptitude for making smart decisions in the face of poor returns, yet every investment will go through spells of disappointing performance. Few of us seem prepared for this painful reality.   

To benefit from the power of compounding returns over the long-term, we need to survive the temptation to make poor decisions along the way.

Surviving our Environment

The lessons about the challenges of dealing with our own behaviour applies to private and professional investors alike, but for professional investors not only do they have to worry about themselves, they have to worry about their environment. This means not only considering their own behaviour, but also the decision making of their clients and their employer.  It is no good making a great investment decision if you might lose your assets or job before it comes to fruition.

Imagine you are a fund manager responsible for asset allocation decisions and happen upon a (functioning) crystal ball that means that you are sure that a particular asset class will generate the highest returns over the next decade. Would it make sense to own as much of the asset as you can within the parameters of the portfolio you are running? No, it wouldn’t, because the path will matter. You need to survive for the next ten years – what if the asset class that will win over the decade underperforms significantly for the next three years? Do you still have a job?

For a professional investor there is a requirement to make decisions where they can survive the weakest link in the chain. It might be their investments; it might be their own psychology, or it might be their environment.

For any investor to be successful there must be an alignment between their investment approach and the environment in which they make investment decisions. If there is conflict, the environment will win.

There is often a lot of cynicism about fund managers running ‘closet trackers’ or making decisions that seem to be designed for managing their own career risk. While such choices might not look compelling from an investment perspective, it is a rational activity for an individual looking to survive their environment.  

How to Survive

Long-term investing has many benefits, but to enjoy them we need to find a way of reaching the long-term. All investors need to think as much about surviving as they do about performance.  

[i] Ergodicity, Luca Dellanna

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).