Think Differently, Deeply, and Better.
On average, you will be average.
The market is consensus thinking. Performing above average means being different. Simply being different doesn’t define success. Success means understanding what it takes to not only think differently but understand when consensus thinking is wrong and executing and implementing those choices effectively.
Doing better (generating superior returns with less overall risk) is difficult. Understanding “what’s really going on” is not a simple formula. It requires different, deeper, and better thinking.
Beating the Averages
Think in layers.
Artificial intelligence’s effectiveness is from different layers of algorithms. As the layers build and learn from each other, the overall output is more meaningful and relevant. This “layered thinking” enables deep learning and unique insights from what was initially ignorant computer code.
Similarly, layered thinking is required to understand any problem more deeply and gain greater insights to form a unique perspective. In financial markets, the initial layer of thinking is the market consensus. Thinking differently requires different layers of analysis and perspective. In other words, different and better thinking comes in layers.
Market participants are well informed, intelligent, and more often highly computerized. Better thinking requires an edge – what tool or capability gives you an insight that others don’t possess?
The Edge
What makes the difference? Identifying those factors that make a difference, understanding the range of outcomes and their probabilities, recognizing what consensus is and how the key factors you’ve identified may be different – and how that will change over time. Obviously, a challenge that goes beyond simple formulas and easy answers.
The combination of understanding what is necessary and sufficient to make a difference is critical to understanding and developing an investment edge. While certain factors must be present, they may not make the difference. It is the combination of all factors in a complex relationship that impacts an outcome. This is the source of superior investment decisions.
Predicting the Future
Investment success is predicting the future. The Efficient Market theory says that prices reflect all readily available information. So, in theory, no one should have an investing edge.
This is nonsense.
Knowing the present and recent past completely might inform decisions, but that is not what defines a successful investment decision. Readily available quantitative information cannot be a source of superior investment performance because it cannot predict the future.
Better performance comes from understanding what information is significant and how it influences an outcome in the future. Also, the qualitative aspects of the company, its management, strategic positioning, and dynamic competitive environment influence the future value of any investment substantially – yet this cannot be predicted quantitatively. This is a value judgment and is subjected to significant discretion.
None of the factors that make a difference can be determined with certainty, measured empirically, or processed with a simple algorithm. Judgment and insight form the most effective parameters and distinctive thinking. Investing is complex, dynamic, and competitive. It is challenging to be distinctive and successful.
Approaches vary – some use unique discretion like Warren Buffett, others use strict algorithms, like James Simons, some combine quantitative analysis with occasional discretion like DE Shaw and others use technology, data science, machine learning, and distributed computing to inform investment decisions, such as Two Sigma.
Arcadia embraces Two Sigma’s approach and aspires to use endless curiosity, effective learning, data science, and engineering to develop transformative investment strategies and make bold investment decisions that produce superior results.
The point is that there is no single solution, but thoroughness, thoughtfulness, and empirical proof are the common characteristics of all these outstanding investors.
Being Different – and Uncomfortable
Being different is the only way to be distinctive and superior. But, along with that comes a willingness to be wrong. Since you are predicting the future, one cannot get it right all the time – or even most of the time. Successful investing means getting things right a little bit more than getting them wrong. This can produce spectacular results, but only if one is willing to be wrong.
Great investment strategies begin with discomfort. Since you are thinking differently, perhaps there is simply something wrong with your thinking. Most investment professionals talk about how to be right, but there is a strong possibility you will be wrong.
Since superior performance goes against consensus thinking, it is uncomfortable. Often, the consensus is right. An active investor is trying to be right, but one cannot be right without running the risk of being wrong. Even well-honed algorithms that have been extensively tested and have performed well still operate in a dynamic environment, and what has worked previously may not be valid any longer.
Sometimes the key variables and the weights of those variables need to change given new conditions. Layered deep thinking also needs dynamic revision. Sometimes the revisions are late. But this is the only sustainable way to superior performance – a willingness to be wrong produces an ability to be right and outperform consensus thinking.
Things Change
Recent events can test anyone’s systematic thinking or layered thought process. Understanding inflation, interest rates, economic growth, and related factors such as energy prices, supply chain disruptions, and other uncertain and unpredictable events ranging from weather to war, make the most systematic thoughtful approaches, bewildering and confusing. Factoring all this in can be mind-boggling and useless.
We can’t know much about the short-term because of such dramatic changes, the market moves with emotional reactions and human behavior. As much as analysis and thoughtfulness help see an overall trend, understanding what’s going on can be challenging. Even effective and accurate algorithms can produce losing results because of so many confounding variables and factors suddenly being more influential.
Investment strategies that withstand volatility and are independent of market conditions will win more often. It is unknown if things will get better or worse. Equally unknowable is how much of that volatility is priced into the market.
Enabling underlying performance to be independent of the market will withstand this volatility and profit disproportionately once the market corrects. While a “mark to market” may be depressing in the short term, investments that produce steady income and return independent of market conditions, and profit from volatility whether the market is up or down, are superior.
Risk Matters
Returns matter, but also the risk assumed to generate that return. Current events are full of stories of various investment funds going bust that outperformed the market several years prior. One can make a big bet, leverage highly, and let market momentum carry you to CNBC fame and glory. Unfortunately, when the music stops, there are no chairs, and you are out of business.
There’s a significant difference between an investment strategy and a business that invests. Businesses manage risk and intend to be around for the long term. Hyper-glorified short-term performance should be ignored. Withstanding market volatility from market cycles will continue to prove to be a far superior strategy.
It might not make headlines, but it is returns adjusted for risk that matter. The long-term matters. Layered, complicated thinking, discipline, and rigor make all the difference. There is no shortcut.
Despite all this, you still have only slightly more winners than losers. But that will make all the difference.
Different and Better
Depart from the investment crowd, focus on the factors that are necessary and, in combination, sufficient to make a difference, sustain performance and manage risk.
It’s not easy or obvious, but it is superior.