Creating Unique Investment Strategies

I took a car service home from Newark airport at 1 a.m. this week after a tiring but fun west-coast trip. I’d just met with 15 very impressive teams—advisors, RIAs, etc—to discuss markets and investment strategies. It struck me that it must be very difficult for advisors–who are constantly bombarded by portfolio managers like me representing investment strategies–to find managers and strategies that are truly unique and therefore worth their time to consider.

I was thinking about this challenge on the way home, and because I was still on west coast time, I had energy to talk to my driver David and thank god I did. It turns out that he had only been driving for 2 years, and only because a double hip replacement had ended his several decades long career as a master furniture craftsman and woodworker. Here is a desk he made.

david table

His lifelong passion has been creativity. I’ve read a lot and written a bit on this topic, and think it is crucial for active management and for life in general. David was clearly an expert, someone who hadn’t just read about creativity, but lived it.

He outlined what he felt were the essential aspects of a creative life. Creativity is play, he told me. Play is like dancing. The best play happens when you don’t give a damn about convention, or about what other people think. Play is most delightful, he said, when it combines random different elements. When you tinker for fun, surprising results ensue. The scientific method, he said, is bullshit. Most major discoveries are accidents: the results of tinkering and play. Mixing things which don’t seem to make sense and which may make you look or feel silly in the short-run. Most people, David said, operate within a conventional set of rules or norms, the pre-established.

“The mind is the result of the known; it is the result of the past, which is the accumulation of time; and is it possible for such a mind to be free from the known without effort so that it can discover something original?”

What excites me most is finding something new. An original insight, a creative combination, and unexpected result. I am always chasing these moments. This is very hard to do in the world of finance and asset management, where themes, strategies and opinions tend to coalesce. The hunt for alpha is in many ways the hunt to free oneself from the markets conditioning. Perhaps true alpha requires redefining many taken-for-granted market concepts.

In investing, you want to do something that no one else is doing (or very few others are doing). But not just because there is no one else is doing it, but also because it makes sense to do. Value has worked historically because it is a clean way to buy stuff that others dislike. The best value stocks have a few other attributes as well (as Seth Klarman put it, you want to have a contrarian streak and a calculator).

But now everyone likes value. The “value tilts” which are introduced into portfolios in smart beta or similar strategies aren’t the real McCoy. Value should hurt!! It doesn’t hurt to buy a fundamental index. If it doesn’t hurt, it should at least scare you. Scare you because the stocks look terrible, because they’ve done badly, or because buying a particular basket of stocks introduces the career risk that we must accept if we are to own unique portfolios. Contrarian value strikes me as creative. Value tilts may have been once, but do not seem to be anymore.

Obstacles

Robert Shiller said something which nails this point exactly:  “[I]f you swim with the current, you will be thinking the same things as everyone else. You have to recognize that your own thoughts are not your own thoughts. They kind of filtered and percolated in from other people. It all seems like my own common sense, but it’s just what everybody is saying now.”

That is a scary, powerful, and often accurate notion: your thoughts are not your thoughts. How to undo this mess? Jiddu Krishnamurti would say that to do so you must free your mind from all conditioning.

 “When the mind is free from all conditioning, then you will find that there comes the creativity of reality, of God, or what you will, and it is only such a mind, a mind which is constantly experiencing this creativity, that can bring about a different outlook, different values, a different world.”

[You] must have immense patience to find out what is true. Most of us are impatient to get on, to find a result, to achieve a success, a goal, a certain state of happiness, or to experience something to which the mind can cling. But what is needed, I think, is a patience and a perseverance to seek without an end.

Seeking without end, that’s just play! A true understanding of self will also be required, otherwise you’ll be more likely to cave from outside pressures.

And so it is important to understand oneself, is it not? Self-knowledge is the beginning of wisdom. Self-knowledge is not according to some psychologist, book, or philosopher but it is to know oneself as one is from moment to moment. Do you understand? To know oneself is to observe what one thinks, how one feels, not just superficially, but to be deeply aware of what is without condemnation, without judgment, without evaluation or comparison. Try it and you will see how extraordinarily difficult it is for a mind that has been trained for centuries to compare, to condemn, to judge, to evaluate, to stop that whole process and simply to observe what is; but unless this takes place, not only at the superficial level, but right through the whole content of consciousness, there can be no delving into the profundity of the mind…creativity is something that comes into being only when the mind is in a state of no effort.

I often hear people say that they are influenced by their “priors,” which is a fancy word for thought-habits. I am guilty, too. I tend to seek out data which further supports my core investment believes (in factors like value, momentum, capital allocation, etc).

The best way to shed priors? I’m still trying to figure that out. I have found that conditioning is stripped away on a walk in the woods, or in the shower, or in the middle of the night. In certain moments like these, everything sometimes feels like a farce, a hoax, and with everything so exposed we can re-evaluate things on a blank slate.

David would say, just play! Operate outside established rules.

What might that mean in investing? For quants, it might mean that you forget about the “fundamental law of asset management” proposed by Grinold and Kahn. Perhaps high information ratios are not sacrosanct. Perhaps a more differentiated, concentrated application of investing factors is better. I wrote recently about buybacks as a factor: it turns out you don’t want a broad exposure (say several hundred stocks) to that factor but instead to a fairly concentrated subgroup: companies who are repurchasing significant amounts of their shares, not just a few percent[i].

I read a book recently called Waking Up to the Dark that is a little wonky, but is also compelling. It talks about waking up at odd hours. Meditating. Taking walks in the dark.

So I took a long walk in the dark the other night which 1) made my wife (and maybe some of you) think I was a weirdo and 2) created an incredible mental clarity and about five new ideas. I had never just walked in the pitch dark before. I had never considered it. A few years ago I would have said it was dumb. But it was was pretty great. If something appears stupid, or weird, or silly, it may mean that you are on to something.

***

At the end of my drive home, David said he has one day off a week and would love if I came by his house to talk about books and eat and drink wine. No surprise he is an expert cook. He proposed salad with what he calls “Greek Goddess” dressing, his playful take on green goddess dressing that uses tzatziki, along with some intricate sounding smoked ribs, made in a smoker he built, and a side of spicy coleslaw with sweet raisins. And some Malbec. How friggin good does that sound?

It is rare to meet someone whose life is driven by creative play, but each time I do I am reminded how important it is to keep an open mind, try different things, and try to deliver high quality results that only you or your firm could deliver in the first place. Creativity is the uninhibited expression of self. Thank you to David for reminding me of this truth.

 

 

Note: if any of this strikes you as worth thinking about more, I suggest you watch the third episode of Netflix’s fan-friggin-tastic new show “Chef’s Table.” The episode profiles chef Francis Mallmann who may embody all this more than anyone I’ve come across. It is a jarring and amazing hour of television.

[i] For the quanty folks, this strategy may never look appealing because the IR will be lower due to lower breadth, but doesn’t it make a lot more sense that the high conviction buyback programs, say 10% plus, would be a more effective signal than low conviction ones?