In a world where investors are increasingly being encouraged to react and trade (typically not for their benefit), doing nothing can often prove to be sage investment advice. In a recent paper, Hendrik Bessembinder analysed the performance of “do nothing” portfolios, and shows that even if we are doing very little, the results we achieve will be heavily influenced by the small choices we make.

To run his analysis, Bessembinder created a series of “do nothing” portfolios from the constituents of the S&P 500 at the end of each year from 1970.  The portfolios are “do nothing” as there are no trades after the portfolio is formed, apart from dividend reinvestment. If a stock is delisted, the proceeds are held in cash for the remainder of the period.  The underlying idea is to understand what would happen if we simply bought a selection of stocks on a certain day and then ‘left them in the drawer’. It is not quite a “do nothing” approach, but it gets pretty close.

I don’t want to simply repeat the findings of Bessembinder’s paper, and I would recommend reading it directly, but I thought I would draw out what I thought were the most interesting aspects of the results:

Rebalancing Matters

Over the full 55 year sample, an equally weighted “do nothing” portfolio (holding all available stocks at the same position size) grew from $1 to $678, while a value weighted approach (the typical index market cap structure) grew to only $361. This is a huge advantage for an equal weighted over a market cap strategy. Bessembinder suggests that this could be due to a ‘small cap effect’ boosting returns for the equal weighted approach. While this might explain some of the difference, I am doubtful that this is responsible for the entire gap – the underlying constituents are S&P 500 companies, so nothing is genuinely ‘small’. I think the differential is more likely due to rebalancing.

In the example above, the portfolios are not quite “do nothing” as they are rebalanced back to target weights at the end of each year. The impact of rebalancing is far more significant for an equal weighted approach where target allocations are fixed, unlike market cap where they move with performance. The paper also shows the impact of extending the rebalancing window to only every ten years. Here the gap between the returns of the equal weighted portfolio and the market cap portfolio collapses – the end value of equal weight is $387 and for market cap $342.

It appears that a substantial portion of the return advantage for an equal weighted “do nothing” approach came from a premium attributable to harvesting the volatility of the underlying assets over time. That is selling down stocks after periods of outperformance and vice-versa. Of course, a rebalancing effect does not only stem from an equally weighted portfolio, it comes from any strategy where the weightings of the holdings are not linked to the underlying price of the assets – equal weighting is simply one example.

Even when we wish to take a hands off approach to our investment strategy, there are seemingly innocuous decisions that can have a profound impact on outcomes.

The Two Types of Market Timing

I write frequently about the futility of market timing. I don’t think that people can predict the short-term movements of financial markets, and I wish they wouldn’t try. There is, however, another type of market timing that is far less deliberate, but can be even more influential – our starting point.

Although not a direct angle of the paper, Bessembinder’s work does show how the apparent efficacy of any given strategy is heavily dependent on the period over which we observe its returns.  One of the approaches analysed is simply to buy the largest stock in the index and then “do nothing”.  The fortunes of this admittedly extreme method depend entirely on when you start.

If you did nothing but owned Microsoft from 1999 you would have lost 33% over the subsequent decade, but if you had applied the same strategy in 2016 you would have held Apple and gained 1,046% over the next ten years.  

There are two important takeaways from this (aside from – please don’t invest your entire portfolio in a single stock). First, is that our investment outcomes will be influenced by the point in time when we invest – this will apply to a single stock or a highly diversified 60/40 portfolio. A great deal of this will be down to chance. Second, the more concentrated your investment strategy, the more beholden you become to the point in time you invest, because as concentration increases, so does the range of outcomes. Being diversified mitigates, but does not remove, timing risk.

The Concentration Conundrum

You may recall Hendrik Bessembinder from his previous paper which looked at how concentrated equity market returns were over time – just 46 firms accounted for over half of the $91trn in net wealth created over the course of a century, and the median buy and hold return across individual stocks was negative. When contrasted with Bessembinder’s new paper, this creates something of a puzzle.

His research on concentrated stock market returns implicitly supports taking a diversified, market cap-based approach to equity investing – this ensures that you have an increasing exposure to the companies that matter over time. This new paper, however, highlights the positive impact of an equal weighted approach, which benefits from harvesting a rebalancing premium from volatile equity markets, explicitly cutting the winners and bringing them back to their initial size.  

So, which is better?

It is important to note that the samples used for the two papers are different – his work on concentration incorporates a far greater number of companies assessed over a longer horizon. Although this means that the results of the two studies are not directly comparable, that distinction also brings us to the answer – it depends. The consequence of running winners rather than rebalancing is dependent on the prevailing environment. If performance over an extended spell is skewed towards a select group of large winners allowing concentration to build can pay-off, if this is not the case, the rebalancing effect can win out.

We cannot, however, know in advance if future returns will be concentrated and which companies will be responsible for that concentration. What we do know is that rebalancing and concentration are about trade-offs: rebalancing works because it prevents concentration from building, while a market cap approach works because it allows concentration to develop. The “right” amount of concentration is unknowable in advance, but the more concentrated your approach, the wider the range of outcomes you need to be prepared for.

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Although not its express purpose, Bessembinder’s research is a timely reminder that there is no investing strategy that really constitutes “doing nothing”. Whether it is the precise approach to rebalancing we adopt, when we start investing or the particular index we select there are always choices that we need to make, and these will be consequential.

It is important to be deliberate when doing nothing.  

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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).

I have never been a strong believer in the notion that a fund manager should invest their clients’ assets ‘as if it were their own money’. It is a neat heuristic that I am not sure works consistently in practice. The reality is that there is likely to be a gap between a fund manager’s personal and professional investments, and that difference can tell us a lot about an investor and the environment they operate within.

If we assume consistent objectives, why would a professional investor run their own portfolio in a manner that is different from their clients’? Primarily, because the constraints are distinct. By this, I don’t mean formal aspects such as the range of available assets or fees (although these do matter), but rather the informal restrictions that shape investor behaviour and decision-making. Constraints have a huge impact on investment outcomes but are typically ignored or hidden.

Let’s say a fund manager runs their own portfolio and also a fund for a large asset manager; the goal of both is to generate a 3% real return over 10 years. Why might the approaches be different?

Career risk: The most obvious driver is the spectre of career risk. Professional investors are optimising for two things: delivering on the objectives of their fund over time and keeping their job while they attempt it. Three years of underperformance doesn’t matter for a fund manager’s personal portfolio, but it could matter a great deal for their career. The influence of this factor will depend heavily on the individual.

Keeping their clients invested: While managing career risk may seem like a rational but somewhat self-serving endeavour, there is a closely related behaviour whereby a fund manager adopts a different approach for their clients in an effort to keep them invested. There is no point in having a great investment strategy that nobody can stick with. An investment approach that can deliver 15% annualised over 10 years, but will at some point underperform by 30% over three years, could be ideal for their personal portfolio; it is just that their fund might not have many assets left at the end of the 10 years. Professional investors should seek to run money in a way that keeps clients invested (for the right reasons).

Team over individual: Most professional investors work in teams. The investment process adopted and decisions made are the result of interactions within that group, rather than a reflection of one individual’s ideas. When a fund manager invests for themselves, they can pay attention to, or ignore, their colleagues as much as they wish. It is reasonable to assume that we will overweight the value of our own opinions.

Living through outcomes: Nobody has to live through the short-run outcomes of their personal investments; we can check our portfolios as infrequently as we like. When fund managers make decisions professionally, however, they have to experience those outcomes on a daily basis and are subject to constant scrutiny. Even if they have a resolute belief that an underperforming investment idea will work over the long run, this conviction might be tempered if they have to justify it to a committee every quarter. The emotional toll can be heavy and one that many people would rather avoid.

Managing for the collective: When a fund manager makes investment decisions for their own portfolio, they are doing so with ‘perfect’ knowledge of the person they are investing for and to whom they are accountable. That is entirely different when those decisions are being made for a sizeable, largely unknown and diverse group of people. Managing for the collective is different from running money according to your own personal circumstances and views.

Norms and conventions: Personal portfolios are unseen, so there is absolute freedom to take decisions that may seem odd, anomalous or imprudent relative to industry conventions. This could lead to value-creating liberation or some unmitigated disasters (which clients may be spared)

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It is easy to assume that the constraints creating a gap between how a professional investor runs their own money and their funds are negative for clients – as if they are receiving an impaired version of a ‘pure’ investment strategy. I don’t think this is always the case. While some constraints can be an impediment, others can serve as an effective limit on sometimes erratic or self-centred individual behaviour.

There is no blanket answer as to whether a gap between personal and professional investment is positive or negative; it is simply important to understand whether it exists and why.

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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).

As we are currently in the midst of a wonderful summer of sport, I was considering writing a post about the factors which make some sports boring to watch and others exciting.* I am not, however, brave enough to put my head above the parapet on that subject quite yet. Instead, I decided to write about some vivid human behaviours that arise when we are watching the World Cup, all of which should feel very familiar to investors:

– Extrapolation: We can’t help but believe that what has happened in the past will continue into the future.

All it takes is one England victory and we are immediately checking our wall chart / bracket (delete based on age / location) to see who we will be playing in the final. 

– Momentum matters: Positive or negative progress can become self-perpetuating and an incredibly powerful force.

The wretched hydration breaks and their impact on World Cup games are a great example of how vital momentum is in many walks of life, and how significant interrupting it can be.

– We are overconfident: We all think we are better than we are.

We know more about what England’s starting XI and optimal tactical approach should be than their manager who has deep knowledge of the players and has won nine major trophies in nearly 17 years. 

– Emotions dominate everything: The judgments we make are often overwhelmed by how we feel.

As Paul Slovic highlighted when discussing the affect heuristic – when we feel emotional about something we lose sight of any nuance or reasonable perspective about it. We will see this in stark contrast when people react to England being knocked out (if, indeed, they are).

– Selective perception: We see everything through our own, partial lens.

If a player on your team suffers a potential foul in the area, then it is a certain penalty; if your team commits exactly the same offence at the other end it is absolutely not a penalty, and probably a dive.

– Narrative fallacy: Where there is randomness and chaos, we see compelling stories.

There will be some wonderful stories throughout this World Cup, and many of them will involve far more luck and fortune than anyone will be willing to acknowledge.  

– Halo effect / attribution error: We neglect the role of systems or chance, and focus on the impact of individuals.

We don’t want World Cup wins to be about teams, rather we want to put success or failure down to identifiable, individual agency – whether it is Mbappe driving France towards another title, or Ronaldo being responsible for Portugal’s lacklustre start. 

– Incentives matter: Most decisions are driven by the incentives of those who hold the power.

See: FIFA.

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Sometimes it is hard to get across behavioural investing concepts amidst the complexity of financial markets, but all of the same issues occur in sport and will be vividly apparent during the 104 games of the World Cup. Keep an eye out.

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* As a sneak peek, exciting sports (in my opinion) have high and persistent levels of jeopardy, but more on that another time.

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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).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

There has been plenty of talk about elevated levels of market uncertainty this year, but until very recently equities have been contradicting this notion. When markets are exhibiting pronounced levels of dispersion driven by a singular theme – in this case AI – it is a sign of conviction rather than doubt. Yet the extreme moves we have witnessed seem like an exaggeration of the level of confidence anyone can have about how the future unfolds.

There are many excellent examples of the intense equity market dispersion that has occurred. It might be the crushing outperformance of momentum versus quality stocks, TSMC holding a substantially higher weight in emerging market indices than India, or more than 50% of the Korean market being made up by two companies. It seems fair to say that the AI trade has been running extremely hot.

The problem with the ferocity of the move in names within the AI eco-system is that it seems misaligned with the vast number of unanswered questions about the longer term impact of AI on markets and the economy.

Here are a few that spring to mind that I don’t have confident answers to, and I doubt anyone does:

– What level of ROI are companies seeing from AI implementation?

– What levels of ROI are companies hoping to deliver in the future from an AI rollout?

– How much are companies willing to pay for tokens when subsidies are reduced?

– What is the moat on an LLM? How do they ‘sustain’ high margins if their only edge is time to market?

– If AI is to be genuinely transformative, why were the corporate users of AI being left behind in the rally?

There are many more questions without clear resolution, and the dramatic level of market dispersion seems at odds with the profound uncertainties ahead.

This is not to say that the most bullish base case is wrong, rather that the probability of it occurring is not 100%.

Of course, I am being a little naïve here. The market conditions we witnessed in recent months had little to do with fundamentals or probabilistic nuance, and much to do with thematic performance chasing driven by an incredibly powerful narrative. Although there has been some respite in recent days, if that environment resumes the danger is that performance pressure eventually drags everyone in.

In times such as these the market becomes starkly binary. The questions are: is the rally justified or not? Is AI in a bubble? Are software company models irrevocably broken?

This is unhelpful and dangerous. The future is messy, complicated and uncertain, that is always the case – even if markets seem to be telling us otherwise. The most important question to answer remains this: am I appropriately diversified given all that I can’t possibly know?

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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).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

I recently read an article about another high-profile ‘star’ fund manager whose performance had been flagging severely. You can probably guess who it was, but that is irrelevant. What matters is the depressingly repetitive pattern of fund managers being lauded as geniuses after a spell of strong returns and dismissed as frauds when gravity brings those returns back to earth. This dramatic shift in sentiment is symptomatic of how most active fund investing works, and it is an almost sure path to failure.

The comments beneath the piece lamenting the latest star fund manager’s downturn were inevitably vitriolic. Here is a sample:

“A has-been definitely proves he is a has-been.”

“Finally exposed.”

“Poor excuses for poor decisions.”

“It was a complete open goal in 2025. Any fool could have made money.”

“Having endured years of presentations from active fund managers, I can confirm that the only real skill they possess is selling snake oil.”

Although I wasn’t surprised by the tone, it did jar with the universally positive perspectives I was sure I had read about this very same fund manager when their relative performance was a little healthier. I looked at the comments responding to a far more positive article from 2021:

“An absolute legend who deserves every penny.”

“Great man – and a great team.”

“Fantastic and fully deserved. May you have many successful years ahead.”

“Great guy. I’m heavily invested. Worth every penny. Those who say he isn’t simply aren’t good at valuing his contribution. Their loss.”

In the space of five years the fund manager has gone from investing genius to greedy and incompetent. I spent years having to justify why I hadn’t invested in this particular manager and was apparently a fool to be missing out on such an obvious winner. Now everyone says they knew all along it wouldn’t last.

Neither of these binary perspectives is true, but they do perfectly represent how most people seem to approach investing in active funds: find the funds that have generated the strongest performance over three to five years, latch onto the narratives that have built up around either the manager or their investment style, and then sit tight for mean reversion to take hold.

It is hard to overstate what a terrible approach to investing this is, yet it is accepted practice across every part of the industry.

All high-conviction actively managed funds will experience prolonged spells of outperformance and underperformance – and by prolonged, I mean years. This is entirely irrespective of whether the manager possesses genuine skill or edge. If a fund is enjoying an unusually strong period of relative returns, it is almost inevitable that leaner times lie ahead, even if the timing is uncertain. Yet each time it happens we act as though we have never witnessed it before.

There is no process, no matter how robust, that works in all environments and at all times.

The endemic performance chasing in the active fund industry is driven by two powerful behaviours: outcome bias and extrapolation. With outcome bias we judge the quality of a process – or a fund manager – purely by the results delivered, which in a noisy system is an incredibly dangerous assumption to make. Extrapolation compounds this. When a fund manager is outperforming, not only is their investing ability considered unimpeachable, we cannot see any end to those high returns.

When a previously high-flying manager begins to struggle, the same outcome bias that gave us such conviction in their acumen now leads us to spot weaknesses in the process. It becomes easy to identify changes in approach and construct plausible-sounding reasons why returns have deteriorated so sharply. The last thing we want is to acknowledge our own failings, or accept that we misjudged the inherent cyclicality of fund manager returns. Instead, we have to build a compelling case for why things outside our control have changed, and why we need to sell.

One of the most frustrating features of this hire-and-fire culture is that we treat each high-profile case as a unique instance with its own particular circumstances. Yet it is the same pattern repeating. It is about our behaviour far more than the capabilities of any individual fund manager.

Few of us readily admit to performance chasing when selecting funds. We always construct persuasive stories justifying our decisions and explaining why historic returns were incidental to the choices we made. It is just a coincidence that, if you know a fund’s past performance, you can almost perfectly predict the outcome of any research carried out on it. It is not merely that we don’t want to admit it – we are genuinely wired to find a good process behind good outcomes, and a flawed one behind poor outcomes.

Even investors who sincerely try to avoid performance chasing find it extraordinarily difficult when it is such a powerful industry norm. Everyone is happy when you sell a struggling fund or buy into one topping the performance charts, despite the evidence suggesting that this is unlikely to be a good idea.

If you want to invest in high-conviction active funds with genuinely differentiated returns, you need to do three things: identify a manager with real skill or edge; be willing to sit through potentially years of underperformance even when you believe in that skill; and develop the ability to distinguish between cyclical underperformance and a genuine deterioration of process. None of these is easy.

The good news is that there is no obligation to do any of it. Index or diversified systematic funds remain a perfectly sensible option and a far better one than investing in high conviction active funds with wholly unreasonable expectations. If you do want to identify skilled, differentiated active managers, it is extraordinarily hard to do well, made significantly harder by a set of very human behaviours. To have a chance of succeeding you need to approach it very differently. Or not do it at all.

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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).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

Whenever we experience a spell in financial markets where high quality bonds lose value at the same time as equities a glut of commentaries appear either announcing the ‘death of the 60/40’, showing rising equity / bond correlations or proclaiming bonds have lost their diversifying properties. While part of this is usually an effort to sell alternatives, there also seems to be a genuine concern that bonds have evolved to develop a new set of characteristics. I find this puzzling – high quality bonds seem to be behaving just as we might expect them to. They are a good diversifier to equities but not a perfect one.

When bonds and equities lose money in unison there is almost always the same explanation – inflation. Bonds can offer strong protection from equity market risk when there is a growth shock (profits fall, but so do interest rates and inflation); they are not, however, a helpful equity diversifier when an inflationary problem arises (yields push higher and Central Banks are unable to cut rates).

This behaviour has always been a feature of how high quality (nominal) bonds act relative to equities in a portfolio. Very little has changed in that regard. All that has happened is that inflationary shocks have become far more common after decades where disinflationary pressure was the dominant trend.

This doesn’t mean that the relationship between equities and bonds doesn’t matter, it is just that it is important not to misdiagnose the problem. The real issue is that through a prolonged spell of subdued inflation, many investors became complacent about the role bonds play in a portfolio – neglecting the scenarios in which they might struggle.

Since we have experienced a succession of inflationary supply shocks through COVID, Russia-Ukraine and now the Iran conflict, these risks are now front and centre in our thinking. This has been coupled with a huge amount of angst about ‘fiscal sustainability’, which for countries who issue bonds only in a currency that they can also print (such as the UK and US) ultimately comes down to a question about future inflation.

These issues have led to bonds getting a very hard time.

It is worth reiterating that high quality bonds are a superior diversifying asset for portfolios where equities are the most prominent risk factor. Equities are a volatile asset class that can generate high long-term real returns, but are acutely vulnerable to weak growth and recessions. Bonds almost certainly diversify this risk better than any other option. This remains true today.

If an investor is considering reducing their allocation to bonds within their portfolio (which unsurprisingly more people seem keen to do at 5% yields than they did at 0%); it should not be because bonds no longer play a valuable role, but rather because they are attaching a higher probability to the occurrence of troublesome inflation.

This is a perfectly sensible view to hold, but we should remain cognisant of our propensity to exaggerate whatever risk is salient or fresh in our minds. The dangers of the availability heuristic notwithstanding, investors should be seeking to create portfolios that are well-balanced and resilient to a range of economic scenarios, including those in which equity and bond correlation is on the rise.

There are supplementary asset class options that might fill the gaps not covered by high quality bonds – inflation linked bonds, commodities and even trend following strategies. These choices are not unreasonable and a case can be made for their use in a diversified portfolio (alongside many other candidates). They all, however, come with weaknesses and require the acceptance of trade-offs (some very significant). Most importantly, none work as consistently well as a diversifier to equities in a growth downturn.

If we are in a world where the incidence of inflation shocks relative to growth shocks rises then we should expect a higher (average) correlation between equities and bonds, and probably some extra term premium (if inflation risk is greater, I want some additional compensation). This might impact portfolio allocation decisions, but I would be wary about our ability to anticipate future economic environments. I would be more confident in predicting that when the next recession arrives, we will all be glad to be holding high quality bonds in our portfolios.

Despite all the noise, bonds are behaving in just the way we should expect them to. It is probably fair to say that in an era of low inflation and falling yields investors didn’t make their portfolios sufficiently resilient to scenarios where bonds don’t complement equities as effectively. Yet this is the fault of investors, not the bonds. Making some adjustments to portfolios because of this oversight seems prudent, writing off bonds for performing in a perfectly predictable way far less so.

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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).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

Remarkably, it has been over a year since our last Decision Nerds podcast, but I am delighted to say that we are able to fill that yawning void in your life by releasing a new episode.

Inspired by one of the reasons for the pod’s absence, this episode looks at the problem of communication in the investment industry and why it is so difficult to do well. We cover:

– The curse of knowledge: Why explaining something you know to someone who doesn’t is so difficult.

– The dual audience problem: How to communicate to different people with different levels of knowledge in the same audience.

– The role of affect: How people react to communications is often dominated by how they feel (what we might call affect); considering the emotional impact of communication is often neglected.

As a bonus, you can also hear why I may never again read the detailed feedback on my own presentations.

You can listen here, and the episode is also available in the usual spots.

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This is not a piece about banal AI-written investment content, it is an exploration of why a reliance on AI kills the benefits of writing for both reader and author.

When I realise that I am reading a piece of writing that was AI-generated my heart sinks a little. In part this is because of the frustrating style it adopts with its incessant use of antithetical parallelism – “this is not just X, it is Y”. Yet there is something more important than this tedious rhetorical-tic: AI investment content strips all of the value and purpose out of the act of writing and reading.

Most investment writing (apart from generic, turn the handle market commentaries) should be thought of as a process which benefits both reader and author. The reader gets to understand the voice and views of the author, while the author can write as a way of shaping and developing their own thought processes.

If investment writing is just the result of a few prompts, it lacks any original thought and fails to represent the author’s voice. Rather it is simply the output of a predictive system that has no stake in what it generates.

For the author, high quality writing should never be merely an exercise in creating some form of content. Of course, writers are trying to communicate something, but the path to arriving at that communication is as important as the message itself. The process of writing involves exploration, reflection and refinement – all of this is lost if we simply rely on AI.

This loss is most pernicious for those with less experience or without true domain expertise. The process of writing to communicate is also an invaluable form of learning. When the answer is simply to ask an AI model to assume this responsibility for us, not only do we sacrifice the opportunity for slow, deliberative learning, but we also do not have the means or knowledge to question whatever answer AI provides. Writing is about so much more than the output.

Even if we do think only in terms of the end product, the loss from AI-reliance is pronounced. Readers know nothing about the person that (they think) might have written something. They have no sense of their voice, nor can they even provide feedback or challenge to the author, because it is not the author’s work.

Successful investment writing comes largely from a relationship of trust between reader and author that builds over time. As readers, we pay attention to the words and opinions of someone we might have followed for years, and we make judgements about the quality of views offered based on that trust. In a world where AI investment writing dominates, there is no trust, just an absence of it.

While the process of writing informs and enlightens both reader and author, writing can also act as a useful signal of expertise, effort and care. The friction that exists because good investment writing is difficult and complex evaporates when AI can churn out passable flannel in a few seconds.

It is possible to argue that the genuine, higher quality writing will shine through amidst the barrage of generic babble, but it will become increasingly difficult to find amongst the maelstrom of AI generated pieces.

AI writing will also inevitably get better and seem more authentic, so it will become harder to spot than it is now. This will not be a positive development.  As the quality of AI writing improves, the loss from our increasing reliance on it will become more pronounced. As more people turn to it, more of us will lose the benefits that stem from authentic, human writing.

There are, of course, aspects of the process of writing where AI can be incredibly helpful such as researching, fact checking (sometimes) and proof reading. It is also useful in producing the generic work that I imagine no human enjoys having to create, but in writing, and in general, we really need to start being very clear about what AI is good for and where its presence comes with a significant cost.

Investment writing should have a clear purpose and one that is more than simply attempting to communicate a certain message as quickly as possible. For many authors it will be a way of thinking through messy, subjective and complicated problems. While readers want to hear the trusted voice of a writer and understand what they are thinking and why.

All of the meaningful elements of investment writing are human, and most of these have very little to do with the simple production of content. As we increasingly rely on AI, we risk losing the manifold benefits that come from the process of writing and reading.

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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).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

Although equity markets have thus far proved remarkably resilient in the face of geopolitical and economic risks, it is hard not to argue that we are in an environment of heightened uncertainty. Dispersion within equity markets has been extreme, asset prices are moving dramatically on a single tweet, and there is a daily torrent of erratic news flow. This is clearly a difficult backdrop for investors. Perhaps its most worrisome feature is the temptation to do two things we really shouldn’t.

What are these two things?

• Timing market movements.

• Concentrating our portfolios.

These are both usually bad ideas, but they are particularly pernicious in febrile financial markets. Unfortunately, our desire to undertake such actions seems to be strongest at the worst possible moments.

Time to Time

It seems odd that a reaction to rising market uncertainty is an increasing desire to predict how the market will move, but this is inescapably the case. We have an inherent discomfort with ambiguity, and by investing as if we know the future it can give us a sense of control. We can’t bear to sit and let markets happen to us.

To add to this, we are also loss averse. When people talk of market uncertainty what they really mean is that investors are worried that the chances of losing money are increasing. This is why most market timing behaviour is an attempt to get out of risky assets before a major fall, and then get back in at just the right time.

Trying to invest in such a fashion is a sure route to bad outcomes. Not only is the chance of us getting the initial timing correct incredibly low, but even if we are right we then need to keep making similar decisions. Getting in, and back out again. And what about next time? Do we try to repeat the trick every time we feel that markets are at a precarious point?

We have an incredibly strong instinct to act and to do ‘stuff’ – don’t just sit there, markets are moving! For investors that often means trying to make predictions about what happens next. While the urge to do this can feel irresistible, it flies in the face of the evidence about what is likely to work for us over time.

Lacking in Concentration

It is not just the temptation to trade and predict that arises during periods of heightened volatility and unpredictability – we are also likely to become more concentrated in our portfolios. If we see wide levels of dispersion across stocks, styles, asset classes or sectors, our instinct is to think: “Why am I owning these laggards? Why shouldn’t I focus on the winners?”

This is another form of market prediction, but in a different guise. When we see major performance dispersion in areas of the market (such as energy and software recently), and the compelling stories that are used to explain it, we can’t help but extrapolate. If this trend is going to go on forever, then all we need to do is focus on the right parts of the market.

Losing sight of the principles underpinning prudent diversification is a dangerous game, and can be extremely punitive in choppy markets where dispersion is wide. The cost of not holding certain assets or areas of the market can be heavy if we end up on the wrong side, which at some point we inevitably will.

The idea that diversification is a free lunch has always been a naive one, because it ignores the behavioural element. Being diversified means owning things that are performing poorly and that, in certain environments, we should expect to perform poorly. It is incredibly difficult for investors to embrace this idea – we just want to hold the good things that have been working.

Although I have framed market timing and concentration as distinct activities, they are – in essence – both a form of overconfidence in our ability to predict the future. It’s not that investors are gaining confidence as markets become ever more tricky to anticipate; it is rather that the sense of anxiety stemming from rising volatility makes us behave in ways that appear as if our confidence is on the rise.

Attempting to engage in more difficult activities as a reaction to a feeling that conditions are becoming increasingly challenging is an odd and costly path, but a very human one.

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The sense that markets are unusually uncertain is the time when behavioural discipline matters most, but also when we are highly likely to abandon it. Market timing and portfolio concentration feel right, but really they are just the easy options that make us feel good, while being very unlikely to work.

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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).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

It is easy to think about the merits of any asset class as based entirely on its financial return prospects, but what if an asset provides a different benefit – what if it makes us feel good? Are we then happy to accept a lower financial return? A forthcoming paper by Elroy Dimson, Kuntara Pukthuanthong and Blair Vorsatz seeks to answer this question by appraising the investment performance of collectibles such as classic cars, art, wine and stamps. They find evidence of lower financial returns for assets with a positive emotional value. This has broader implications for our investors than simply the world of violins and carpets.

The limitations around the data on collectibles means the methodology applied for the study is complex – it is not straightforward to calculate a Sharpe ratio for English 18^th century furniture – but I will describe the approach in simple terms. The researchers compared the returns of 13 collectible asset class categories over up to 110 years to a risk-appropriate portfolio of liquid securities. They were seeking to answer the question – how does the performance of collectibles compare to traditional, liquid market portfolios of equivalent risk? *

And the answer was that the collectibles underperformed by an average of 2.5% per annum. The researchers contend that while the liquid asset portfolio has only a financial return element, the collectibles have a non-financial return – what they call an ‘emotional yield’ – which is the reason for the performance gap.

What the authors define as an emotional yield is some emotional benefit that is derived from owning the asset. They define this as private enjoyment and social signalling. If I own a valuable painting, there is some utility from the fact that I enjoy looking at it, and from what other people think it says about me that I own it.

If an asset brings us some form of pleasure or enjoyment, then we require a lower financial return from holding it.

Although the methodology underpinning the paper is complex and necessarily imperfect, the idea that the emotional impact of an asset has an influence on its returns is a compelling one. How we feel has a huge impact on our decision making and judgement, but is incredibly difficult to either acknowledge or measure. It seems perfectly aligned with human behaviour – and indeed rational – that if we have two assets, one in which owning it makes us feel good and one where ownership generates no emotional benefit, we will be content with a lower financial return from the one which is more affecting.**

One unanswered question is the extent to which investors know that they are receiving a lower return. With assets such as collectibles, deriving high quality returns data is inevitably difficult, and there is no reasonable way for anyone to compare performance to a ‘risk equivalent’ portfolio of liquid assets. It would be interesting to explore whether investors would be willing to explicitly makes this type of trade-off.

The Wider Implications of Emotional Yield

While the paper focuses on the world of collectibles, the notion that the presence of an emotional yield impacts our required return has potentially broader ramifications. The authors touch upon – but do not explore in detail – the potential for the concept to be meaningful for ESG investors. If we believe our investments are doing good, that makes us feel good, and therefore we benefit from a positive emotional yield and may accept lower returns.

This seems plausible although the level of emotional yield we might derive from holding an asset, must be related to the strength of emotions elicited. For tangible assets – such as jewellery or coins – this can be incredibly strong, as we have full ownership and can hold, see and feel an object. Information about partial ownership of a company and the ESG-related activities it is undertaking is far less salient. To generate an emotional yield, investors need to be made to feel something.

We have discussed only the potential for a positive emotional yield, but what about the opposite situation? Do investors require a higher return for assets that take an emotional toll? Those that make us feel bad for owning them. As with ESG, it is fair to question the emotion that can be generated by simply owning stocks and bond which can often feel abstract. Even taking this into account, however, it would seem reasonable that we want to be compensated for holding assets that make us feel discomfort or some level of guilt. It is perhaps an idea that can be applied to value investing more generally given the negative sentiment that is likely to surround anything falling into that categorisation.***

One other important implication that the authors highlight about the impact of the existence of an emotional yield – on collectibles in particular – is the potential limitations of tokenisation. By their analysis investors owning collectibles achieve a lower return which is offset by the positive emotional impact of full ownership. If a collectible is tokenised and ownership is fractional, an investor bears the cost of the lower financial return, but without the emotional yield. I don’t get to enjoy the painting hanging on my wall, but I might well pay for it.

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One of the most glaring omissions in all discussion on financial markets and investor behaviour is the role that emotions play. When it is discussed, it is generally focused on the negative behavioural implications of fear and greed, and how they lead to poor decisions. This new paper applies a different lens and makes a strong case that how an asset makes us feel when we own it might just impact the returns we are happy to make. 

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* There is a lot of complexity in the methodology which might not make for enjoyable reading in a 1000-word blog post. Please do read the full paper for details.

** When I refer to emotion here, I am talking specially about how holding the asset makes us feel, not the emotions that price fluctuations might provoke. 

*** In a way, we can think of the higher returns required for owning more volatile assets being a form of emotional yield. We want recompense for the stress and anxiety of ownership.

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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).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.