“[We] have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.”
– Warren Buffett
In most endeavours in life, we get more reward for more stepping up in grade. A middling player in the AFL makes more money than the best player in the Adelaide local league. A triple back somersault with a half twist is going to score higher than a pin drop at the Olympics, no matter how well the latter is executed.
Many people think the same thing applies to investing. It is an intellectual exercise and many of us are drawn towards solving highly complicated problems. When is the next recession going to hit? Are house prices going to rise or fall? What’s going to happen to the Aussie dollar over the next six months, 12 months or five years? Which technologies are going to thrive over the next 20 years and which are going to fall by the wayside? Will electric cars replace the combustion engine? Is global warming going to upend the insurance industry as we know it?
These are all fascinating questions, ones I love reading about, learning about and arguing with friends and family. When it comes to investing my clients’ money, though, I tread a path as far from these complicated issues as possible.
The reasons are several fold.
First, let’s assume that these questions are complicated but answerable. Who is going to be better at solving them? Our small funds management business based in Sydney, with a bunch of computers bought from the local JB Hi-Fi (ASX:JBH), or the world’s biggest hedge funds armed with the most powerful computers and mathematicians? The answer to that is straightforward.
Second, I have severe doubts that many of these questions are actually solvable. Of all the pundits asked to proffer their opinions on the Australian dollar at the start of this year, I don’t remember one forecasting that it would rise, yet the Aussie has rallied since January.
In March this year a computer, armed with Google’s artificial intelligence, beat the world’s best player of the Chinese game Go. A computer beating the best human at this game, with many more combinations and permutations than chess, is a big deal. But it also shows why we are no chance of predicting the future direction of the economy or exchange rates. Sure, Go is a complicated game, but it’s nothing compared with a world that has more than 7 billion players each making their own moves every day.
Finally, and most importantly, I don’t get paid any more for playing in the big leagues.
Focus on simplicity
Our Australian Shares Fund has returned more than 14 per cent a year since inception seven years ago. Most of that has come from “jumping over one-foot hurdles”, in the words of the world’s greatest investor.
Researching a stock will often take a Forager analyst weeks and the full research runs to dozens of pages. But the last thing an analyst must do before putting the idea forward is summarise it in less than a page. If they can’t do that, the idea won’t make it into the portfolio.
One advantage of this focus on simplicity is that if forces us to be patient. A complicated idea can become simple if you wait around long enough.
One of the largest investments in our international fund is an Austrian business called Kapsch TrafficCom (WBAG:KTCG), listed on the Vienna stock exchange.
The company’s tolling technology is used on most Australian toll roads and the tag in your car is likely to have been manufactured by Kapsch. It has recently won contracts for the Sydney Harbour Bridge, the Golden Gate Bridge in San Francisco and most of New York’s bridges and tunnels.
This one is a fascinating business with healthy prospects, but working out how much money it will be making in 10 years’ time is a complicated problem. Will it keep winning new contracts? Will it reinvest the profits sensibly? In a world where every car has GPS and is connected to the internet, will we even need Kapsch’s tolling systems?
We don’t have the answers to those questions. But in January last year the share price had halved from its peak to less than €20. At that price, the thesis was a simple one. In Austria and a number of eastern European counties, Kapsch has long-term contracts where it collects a percentage of toll revenue rather than an upfront payment. Our calculations suggested the present value of these annuity streams was worth more than the share price at the time. You were getting the complicated future for free. A low enough price makes for a very simple idea.
Granted, it doesn’t draw much of a crowd at parties. “This company has a piece of technology that is going to change the world” is a more interesting topic of conversation than “I bought company XYZ because its market value is only half the amount of cash it has in the bank”. But my clients don’t care. Their money is the same colour as everyone else’s.
This article was first published in the Australian Financial Review.
12 thoughts on “Complex Investing Doesn’t Pay”
James Carlisle at II said the Australian dollar was more likely to go up than down last year and we sold the USD we had.
Glad to hear there was one. Having known James for many years, I’m guessing he would recognise it was 50/50!
Hi Craig, As Steve has suggested, I don’t try to pick currency movements, so if I did say that then it would have been by accident (so apologies if I gave the wrong impression at any point but I’m glad it worked out).
Never listen to ‘experts’ proffering opinions on where currencies are headed, is my advice, especially not in the short term and especially not me!
There are all these prognostications about what the future will bring. And what one should invest in or not.
My reasoning for being heavily invested with a fairly diverse portfolio is a fairly simple one. Investing in the productive economy seems most likely to result in a long term retention of capital and to produce a passive income.
Cash and bonds are also frequently touted but tool me they suffer terribly in times of high inflation.
I regard a diverse share portfolio as being generally risk averse in a big picture kind of way.
With that as a starting premise the exercise then becomes how to tweak that to get above index returns, based on what a business does rather than macro or micro economy issues. Or try to pick winners in future trends or technologies.
“Sure, Go is a complicated game, but it’s nothing compared with a world that has more than 7 billion players each making their own moves every day”.
And even if you could solve it…..would it make prudent financial sense after spending the amount of money required to do so…..
I am currently living in the Czech Republic. Guess which company has been operating the truck toll technology on all (yes, all) Czech freeways since 2007? And guess which company to this day gets all its contracts expended automatically as it is the only one with the required technology?
Hi Martin, thanks. The Czech contract is a very good one for Kapsch but it has just been extended for three years and there’s a decent chance they lose it at some point. It’s one of the complexities with this business, working out what they will keep and and what margin down the track, but all the signs are they can win at least as many as they lose. Keep your eye on it for us!
They get paid a (relatively) fixed fee to operate that Czech truck tolling system (they only get a fraction of the revenues from the roads). It’s standard for a national operatorship like this one – and Poland and Austria – for the winner to get something like a three year contract initially plus a few multi-year rollovers. It’s technically difficult for someone else to come in and operate the Kapsch system. The Czech Governement had the opportunity to put this back out to tender in 2016, but they would have needed to get the ball rolling a few years ago and didn’t. That explains the recent three-year rollover. We’re pretty sure the country will tender for a brand new system to be delivered by 2019, in fact we suspect they’ll be obliged to under EU rules. And we doubt Kapsch will win it (this existing contract has been a bit of a political hot potato). We’re not counting on any value in that contract from 2019 on.
Another tangential comment by me: it’s important to understand the difference between machine complexity and human complexity. Go is a game that has been hard for computers to match top human players because the large board combined with concepts like “space” and “encirclement” are easy for humans to intuit, whilst requiring a high level of programming sophistication combined with hardware brute-force for a computer to “understand”.
A world with seven billion players is indeed far too complex for any modern computer to have any hope of “understanding”, but the patterns and predictability of such a massive number of moving parts makes understanding their collective behaviour relatively easy for a smart, experienced, detached, independent, erudite human participant.
The reason that people are usually so awful at beating the market is that so few of us can lay claim to those five adjectives.
The carbon vs. silicon contest is essentially one of efficiency vs brute force. Top chess grandmasters can evaluate no more than 10-15 positions per second, whereas computers normally evaluate around 300 million positions per second. Nevertheless, in most positions there is no appreciable difference in the quality of moves chosen.
In markets, where the enormous number of moving parts quickly overwhelm even the best computers’ brute force calculation “skills”, the efficiency of thought vs code will come through.
I’m not familiar with Go, but I suspect comparisons between games like Chess and markets, are seriously flawed. Chess may be complex, but it is calculable. Markets are complex, adaptive systems, so they are not predictable with any certainty (they are not calculable, in a mechanistic, or Newtonian, sense).
This is where the human ability to make judgements (or as you say, to intuit) comes in. I suspect the advantage of judgement, is that it can simplify the complex, but especially that it can provide answers to the unknowable. If our judgements involve many moving parts, and thus deal with high levels of complexity, then we are perhaps losing the key advantage that intuition may of offer.
The question is, will computers ever be able to intuit?
Contrary to popular belief, chess is not just about calculation. Computers started passing the Turing Test (https://en.wikipedia.org/wiki/Turing_test) in chess in 1997 when Garry Kasparov accused IBM of cheating because he couldn’t believe that Deep Blue could make a very human looking positional pawn sacrifice.
Modern chess computers play such “intuitive” moves all the time these days.
Watching conversations between chatterbots is also a little unnerving because they do seem to exhibit rudimentary intuition.
Nevertheless, I don’t believe that current silicon chip architecture will ever allow true intuition in computers.
Future generations of chips are likely to sacrifice the unfailing accuracy that is currently associated with silicon thought for a massive increase in processing power. When this happens, I think that Moore’s law will get blown away, and we will start to see the first signs of true sentience in machines.