Wednesday, February 29, 2012

Jeremy Grantham's 4Q 2011 Letter

From the latest quarterly letter by Jeremy Grantham:

Grantham's 4Q 2011 Letter

"To be at all effective investing as an individual, it is utterly imperative that you know your limitations as well as your strengths and weaknesses. If you can be patient and ignore the crowd, you will likely win. But to imagine you can, and to then adopt a flawed approach that allows you to be seduced or intimidated by the crowd into jumping in late or getting out early is to guarantee a pure disaster. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely MUST NOT manage your own money. There are no Investors Anonymous meetings to attend."

Later he adds...

"On the other hand, if you have patience, a decent pain threshold, an ability to withstand herd mentality, perhaps one credit of college level math, and a reputation for common sense, then go for it. In my opinion, you hold enough cards and will beat most professionals (which is sadly, but realistically, a relatively modest hurdle) and may even do very well indeed."

Understanding more than a little bit about business certainly helps. Otherwise, investing well requires an even temperament, discipline, patience, and awareness of one's limits more so than sheer brainpower.

If it was mostly about brains, Isaac Newton and John Meriwether (founder of Long-Term Capital Management) would have had more investing success.

Isaac Newton, The Investor

Clearly investing success isn't primarily about having superior intellect. Smart people are not at all immune from doing very dumb things when it comes to putting capital at risk.

"A lot of people with high IQs are terrible investors because they've got terrible temperaments." - Charlie Munger in Kiplinger's

Long-Term Capital Management (LTCM)* back in 1998, the first of many more recent debacles, serves as a good modern example among many:

"...the hedge fund known as 'Long-Term Capital Management' recently collapsed, through overconfidence in its highly leveraged methods, despite I.Q's of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a speech to the Foundation Financial Officers Group

In both of these spectacular investing failures**, Isaac Newton's and John Meriwether's LTCM, there was no shortage of IQ. Yet, obviously, some of the other necessary characteristics of investing success weren't there.

"A money manager with an IQ of 160 and thinks it's 180 will kill you...Going with a money manager with an IQ of 130 who thinks its 125 could serve you well." - Charlie Munger in San Francisco Business Times

The aspects of human nature that leads to costly misjudgments hasn't changed since Newton was wiped out a little less than 300 years ago.

It certainly doesn't hurt to have some awareness of what causes even relatively smart and informed investors to go off the rails.

Adam

Related posts:
Munger on LTCM and Overconfidence
When Genius Failed...Again

* Actually, not so long-term. Could a more perfectly wrong name have been chosen? It lasted all of four years before it needed to be bailed out to prevent a more widespread financial markets collapse. So the poor judgment of one highly leveraged fund had created serious monetary and systemic implications. 
** These two failures are very different, of course. Newton's folly hurt only himself. Merriwether lost money for others while threatening the stability of the global financial system. In fact, as these two articles point out, Merriwether has lost money for investors more than once:
John Meriwether, the Wile E. Coyote of Hedge Funds 
Meriwether: Fool Me Once, Shame On You. Fool Me Twice, Shame on Me
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