Alt Investments
Diane Harrison Principal & Owner Panegyric Marketing January 18, 2013
Editorâs Note: Here Diane Harrison outlines her perspective on why some elements of Darwinâs theory of evolution translate to the investment world. For example, as strategies like managed futures become more common, they demonstrate how successful organisms, or strategies, are rewarded over time. And in investment, she says, as with life, change is the only certainty.
Opinions are the authorâs but Family Wealth Report is grateful for the right to publish them, and welcomes reader responses.
Itâs 2013: a new year, an opportunity to start a fresh YTD performance chart, and a chance to climb a little further out of the 2012 hole in which a fair amount of the alternative investment world wallowed. January is often a time when investors and managers forge resolutions to do better â take stock of portfolios, review what seems to be working and what seems to be off, and implement a course of action for the coming year.
Fiscal cliff avoidance aside, the alternative landscape appears littered with potential pitfalls, pratfalls, and protracted performance slumps. Some of us might feel that a trip to the Galapagos Islands would be more enjoyable than diving into the fiscal waters of 2013, so it could be interesting to filter this viewpoint with a little evolutionary context courtesy of Charles Darwin.
There are many proponents and opponents of Darwinâs theory, engaging in a lively debate that has spanned more than a century. The theory goes something like this:
Darwin's general theory presumes the development of life from non-life and stresses a purelynaturalistic (undirected) "descent with modification." That is, complex creatures evolve from moresimplistic ancestors naturally over time. In a nutshell, as random genetic mutations occur within anorganism's genetic code, the beneficial mutations are preserved because they aid survival - a processknown as "natural selection." Natural selection acts to preserve and accumulate minor advantageousgenetic mutations. Over time, beneficial mutations pass on to the next generation and the result is anentirely different organism (not just a variation of the original, but an entirely different creature). (Source: darwins-theory-of-evolution.com).
Certain elements of the theory seem more likely to be true than false, particularly as applied to financial elements. Letâs examine five of these.
Time is a good thing. So, if one assumes that complex creatures evolve from more simplistic ancestors naturally over time, being an investor who has been around longer could mean having gained an ability to judge what is singular and what is systemic in the markets â in other words, an ability to separate the melodies from market noise. Investment managers with longevity have learned a thing or two about getting it right. Investors who have been in the market longer have also presumably learned both from their mistakes and have gotten better at identifying good choices. Ageism in alternatives means having been at it long enough to know what "it" is.
It pays not to follow the herd. According to Darwin, beneficial mutations are preserved because they aid survival. For investment managers, it literally pays to be a standout. Beneficial mutations in the investment world are the leaders, the outliers in the north-by-northeast quadrant of the efficient frontier. If they are considered beneficial, it is because they achieve performance results without taking on excessive risk in so doing. Managers who care about attracting investors are always seeking to improve their relationship with the top left quartile of the risk/reward chart. Those possessing the ability to land there and stay there are the ones who, by being better, dare the rest to follow.
Natural selection rewards the organism with a higher rate of survival. The theory goes on to postulate that natural selection acts to preserve and accumulate minor advantageous genetic mutations. If we consider the investor to be the organism, aligning interests with the talent that occupies the "beneficial mutation categories" of alternative investing leads to an elevated form of life, or perhaps a fully-funded investment mandate. Less desirable species (or investments) ultimately cease to exist in favor of more desirable ones. This part of the evolution process is often in a push/pull relationship when applied to investment management. As a good alternative idea/manager/investment vehicle attracts greater numbers of followers, the ability to continue to perform at the same or higher levels of performance erodes, and other opportunities arise to take its place. One could blame greediness or complacency on the manager who fails to stave off this competition, but perhaps itâs the natural selection process in action.
Being a little bit right a lot of the time sure beats being wrong one or two mega-times. This piece of natural selection is perhaps the most recognized commonality in the alternative investing world. In the long run, if an investment manager fails to control the downside, there isnât much of an ability to last long enough to capture the upside. For investors, swinging for the fences when making investment decisions is likely to result in knocking oneself right out of the game before having amassed enough of an investment cushion to be able to take on high-risk investments. The "stay rich" mentality of slow and steady progression through all market cycles and strong risk management practices to protect against the unforeseen happenings is the investment version of natural selection that very few alternative managers or investors care to argue against.
You canât forecast a change, but change is a constant. While Warren Buffett may have been able to get away with the now-quaint "buy and hold" strategy, the markets have proven that the âbuy it and forget about itâ ship has sailed and isnât coming back. Most people would also agree that market timers, both on the buy and the sell side, are doomed to eventual failure.
While the natural selection argument is likely to continue indefinitely on into the future, with heated defenders both for and against Darwin, there is no argument about the inevitability of change. Complacency is the enemy of Darwinists, and should be of investors. Being too comfortable in deciding on a singular course of action will, over time, lead to an erosion of effectiveness in investment planning. Long-term survival in both the physical and the investment world requires vigilance, constant learning, and adaptation. As 2013 unfolds, the markets will provide undeniable opportunities and risks for both managers and investors. Those with the adaptive skills to survive will emerge fitter, smarter, and financially resilient.
