Sam Sivarajan is a speaker, independent wealth management consultant and author of three books on investing and decision-making.
In the world of personal fitness, new products and shiny gadgets are constantly flooding the market. Yet, they are just variations of a few basic movements: push, pull and cardio exercises. While workouts can get complicated, the core principles of human physiology remain the same.
The world of investing is no different. Despite the myriad of mutual funds and ETFs, and the emergence of new asset classes, the fundamental principles of investing haven’t changed: buy low, sell high; diversify across asset classes and geographies; prioritize consistency over timing, etc. Here, complexity doesn’t equate to better returns.
Howard Marks, a renowned portfolio manager, regularly publishes investment memos. In one, he emphasized the power of simplicity and consistency, telling the story of David VanBenschoten, who managed the General Mills pension fund. Over 14 years, David’s fund never ranked above the 27th percentile or below the 47th percentile in annual returns. Yet, his fund ended up in the fourth percentile overall for that period, outperforming 96 per cent of other funds. This success came not from aiming for top performance each year, but from avoiding large losses and maintaining steady, above-average returns.
Karl Weick’s analysis of the Pittsburgh Steelers in the 1970s underscores a similar point. The Steelers won 98 per cent of their games against weaker teams using a simple game plan, but their success rate dropped to 50 per cent against stronger teams, where more complex strategies were needed.
This shows that consistently executing a straightforward plan can lead to extraordinary success in most situations – the Steelers won four Super Bowls in this period.
The recent experience of the Canada Pension Plan Investment Board illustrates the potential dangers of taking a more complex approach. Since 2006, the CPPIB shifted from a simple, low-cost index-based strategy to a complex, actively managed approach. This change increased staffing to more than 2,100 today from roughly 150 employees in 2006, and costs soared to $3.5-billion from $36-million. Despite these efforts, the CPPIB’s performance lagged those of a simple, passive investment strategy.
Over an 18-year period, the CPPIB’s active management strategy resulted in a negative annualized return of 0.1 per cent relative to its benchmark, amounting to a $42.7-billion loss. While the fund achieved an annualized 7.7-per-cent return, the reference portfolio – a composite of global equity and bond indexes – earned 7.8 per cent annually. This underperformance highlights how complexity can introduce unnecessary costs and risks that outweigh potential benefits.
Andrew Coyne points out that the CPPIB’s experience is not unique. Many actively managed funds underperform their benchmarks, especially after fees. The CPPIB’s transformation into a “giant hedge fund” involved stock picking, board seats and investing in alternative assets such as real estate and private equity. These efforts increased the fund’s complexity and costs without delivering better returns.
The Pareto principle, or the 80/20 rule, asserts that 80 per cent of results come from 20 per cent of the effort. In investing, focusing on core factors, such as making consistent contributions, minimizing costs and diversifying, can help achieve most goals.
Research by Victor De Miguel and colleagues showed that a simple equal-weighted portfolio often outperforms more complex strategies that are based on mean-variance optimization. (The optimization approach suggests that one can, through analysis and calculation, identify a portfolio that maximizes returns for any given level of risk.)
Even Harry Markowitz, the Nobel-prizing winning father of mean-variance optimization, admitted to not following his own advice. He said that he split his investments equally between stocks and bonds rather than following the complex approach for which he won his Nobel Prize.
When it comes to investing, it’s crucial to establish goals, time horizons and risk appetite at the outset. While these factors differ for institutional investors – like the CPPIB – compared with individual investors, Leonardo da Vinci’s motto is worth keeping in mind: “Simplicity is the ultimate sophistication.”
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