By Clive McDonnell
LABELS such as “value investor,” personified by Warren Buffett who describes his holding period as “forever” or the “bond king” Bill Gross who made billions during the bond bull market are familiar to investors. Even for such legendary investors, finding value in equities and bonds have become challenging in recent years. Perhaps, it is time for an investor to consider alternative approaches that have a better chance of succeeding in the coming years.
As we explored the alternatives, we zeroed in on the importance of diversification in getting more accurate answers to the outlook for markets, as exemplified by Victorian statistician Francois Galton. Galton was one of the first to observe the power of diversity in generating accurate answers to hard-to-answer questions — he labeled this the “wisdom of crowds.” His breakthrough came when he was attending a village fair and observed a game of guessing the weight of an ox. While individual guesses of the ox’s weight varied widely, the accuracy increased significantly when he averaged the guesses of the crowd. The average of the diverse estimates of the crowd was superior to that of the individual.
In recent years, a growing body of academic research has shown that diversity in decision-making creates better investment outcomes. This is reflected in our own performance since 2012 when we started to incorporate this body of research into our own process. A key challenge for investment firms is to find individuals who are able to perform the investment equivalent of thinking “outside the box.” While this concept is easy to describe, it is a challenge to find individuals who truly fit the description, the so-called “T-shaped” expert.
The consultancy McKinsey popularized the search for “T-shaped” consultants in the 1980s. They were described as individuals who have specialized knowledge — the vertical element of the “T” — but also have a wider understanding and perspective — the horizontal element of the “T.”
The “T-shaped” investor captures the diversity that an investment team needs to search for when hiring. Such individuals add to the diversity and create better investment outcomes.
The importance diversity plays in investment outcomes was observed in January 2018 when a collapse in diversity had a dramatic effect on markets.
The surge in US stocks in late 2017 and early 2018 following the announcements of US tax reform led to a drop in diversity, or the range of views on the outlook for the market.
In effect, everyone became bullish on equities and, when this combined with the late-January 2018 surge in bond yields, we had a catalyst for a market correction. While diversity has since returned to markets, the February correction exemplifies the importance of a range of diverse views on the outlook for markets to bring about balance. Without the multiplicity of views, the market becomes unbalanced and at risk of a sudden change once a catalyst emerges to break up the narrow range of outlooks.
However, for diverse views to thrive and “T-shaped” investors to succeed, we need a wide variety of informational inputs. This is achieved by operating an open platform so that members of an investment committee have access to a broad spectrum of views on the market. These sources can include traditional investment bank research, independent research providers, asset management firms, as well as information generated by big data available from Google Trends or trending themes on social media.
Big data, for instance, can provide insight on the frequency at which people search for terms such as ‘growth’ or “recession,” as well as trending themes on social media such as the popularity of multi-player games. These insights can bring added diversity to decision making on whether it is time to switch from bonds to equities, or adding the stock of a company that is benefiting from a surge in popularity of an online game to a conviction list.
“T-shaped” investors know how to tap into these diverse sources of information to make investment decisions even when it is outside their core area of knowledge.
At Standard Chartered, we have consciously strived to incorporate this diversity when making investment decisions, believing that group of diverse “T-shaped” investment professionals can reach better investment decisions. The combination of these varied views has shown to produce an investment outcome that is unbiased and, as we have seen since we started applying this approach in 2012, profitable for our clients.
Clive McDonnell is head of equity strategy at Standard Chartered Private Bank.
By Clive McDonnell