- Frank Byrd, CFA
Sheep Following Lemmings
Amen of the Week:
“We all have to fight to maintain our unique style and taste in a world that would have us conform.”
- Ralph Lauren Fashion designer
There are wise crowds. There are mad crowds. Which one is your money following?
Many assume that buying an “efficient” mix of index funds reflects the wisdom of the crowd. I disagree. Owning what academics refer to as the Market Portfolio comes closer to following a mad crowd than a wise crowd. A long history of academic literature has chronicled that crowds, under the proper conditions, can be incredibly wise. One popular example involves a classroom of students guessing the number of jellybeans in a large jar. As it turns out, the average guess comes closer to the precise number of jellybeans than the guess of any individual student.*
However, for this experiment to work, certain conditions must hold, including: The students must be diverse, independent (no asking their neighbor’s opinion), decentralized (no committees formed to vote for blocks of students), and have the proper incentives.** Think about it. Is this how modern financial markets operate? Certainly not. Capital is allocated today by institutional investors. Most of this capital is run by white males in their 30’s and 40’s living in two cities (New York and Boston). We graduated from the same few schools, read the same few publications, and dress the same way. Does this sound diverse to you?
Further, the structure of the investment management industry is highly centralized. Clients' investment decisions are typically made by advisers, who outsource decisions to portfolio managers, who depend on analysts, who rely on front line sources for their perspective. Does this sound decentralized? Not at all. This ultimately retards independence and warps incentives. Imagine if only a select few students in the classroom were allowed to cast votes for the number of jellybeans. Under that scenario, the crowd’s guess would be inferior.
This is why Fielder remains skeptical of the “efficient” portfolios espoused by so many. I have no idea whether financial markets will be higher or lower five years from now. Who wants their life’s savings invested in something with that kind of uncertainty? Not me. Owning “the market”, as I see it, is akin to sheep chasing lemmings over a cliff. Fielder prefers a focused, value-based approach – one that follows a wise crowd, not a mad one.
Yours in the Field,
Frank Byrd, CFA
*Repeating this experiment over time, the crowd decisively beats the guessing skills of even the smartest individual bean-counter in the class.
**This list is a combination of conditions espoused by James Surowiecki (The Wisdom of Crowds, 2004) and Scott Page (The Difference, 2007).
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