The essence of a sound investment strategy

01 August 2018

By Jim Roberts, Chairman of the Verbatim Investment Committee

Every day the media reminds us that our world is a risky place.  The US president is a loose cannon, the British government is in chaos, Brexit looms and all-out trade war is in the offing.  As if that were not enough, we’re all going to fry because of climate change. Populism, terrorism, nuclear proliferation, online fraud are just some of the issues that serve to boost our uncertainty.

Yet in reality, we humans are better fed, better educated, healthier, live longer and are less likely to encounter a war than at any other time in human existence. Why then do we often focus on negative aspects, rather than enjoy our vastly improved status?

It seems that there are reasons why we tend to see things in a bad light, especially when actual conditions are better than in the past.  This is explained in a recent paper in Science Magazine, “Prevalence-induced concept change in human judgment.”   Studies conducted by a group of American psychological researchers reveal that our brains have a natural tendency to normalise interpretation of phenomena.  In plain English, when things improve, we don’t notice.  So, if large threats recede, we don’t feel any less threatened because we have recalibrated our thinking and upgraded lesser threats into larger ones.  Our score on the satisfaction-dissatisfaction spectrum tends not to move, despite the changes going on around us.  Sadly, it seems that evolution has not equipped our brains with the facility to hold constant the criteria on which we judge either the world or our position in it.

This has big implications for investment managers.  We like to think that we make judgments based on economic or mathematical criteria, which by their very nature are absolutes; but we are almost certainly wrong.  Take volatility, for example.  When can a day's movement in the market be classified as volatile? The answer to this question will always be context-related, not absolute.  When volatility is low, the threshold of high volatility falls, and vice versa.  Similarly, this applies to the classification of a potential investment stock as ‘cheap’ or ‘expensive’.  

As humans, we are simply not very good at assessing such mathematical phenomena. Loss aversion, anchoring, overconfidence, confirmation bias and now prevalence-induced concept change all have the scope to lead us to make systemic errors, whilst simultaneously permitting us to retain our confidence that we are behaving rationally.  

So in my view, the essence of a sound investment strategy is a systematic asset allocation based on a rational long-term strategy linked to well-formulated objectives, coupled with a fund manager selected for their insight, experience and data-driven stock selection processes. 

This, in a nutshell, is what the Verbatim investment process provides.  So cheer up! We may not have won the World Cup, but we had a ball!

Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use.