Investment Performance IS Dollars of Future Wealth — Moneyball!
The Law of Causality is the Law of Identity in action. If an investor’s primary investment objective is to live the one life they have with confidence, investment success or failure must be measured by looking into the future, not back into the past.
The corollary to this is the traditional industry refrain, “past performance does not guarantee future results.” Quite true, and another essential step up the conceptual ladder is to respect the uncertainty of the future. However, this is ignored by traditional industry “best practices” because it might render their economic and market forecasters to be irrelevant.
The objective alternative to subjective forecasts is quantitative analysis. At Poetic Justice Capital Management, we combine the timing of an investor’s cash flows objectives with 1000 potential lifetimes of random simulations. Each outcome, for any investment strategy, is then calculated using the most reliable, historical capital market assumptions available.
For GM Billy Beane of the Oakland Athletics baseball club, this meant replacing members of his scouting department with SABRmetrics. It measures the actual game performance that an individual player can control, compiles the data, and organizes it into a useful structure. In epistemology (theory of knowledge) this is called logic — evidence, causality, and context.
Known famously as Moneyball, the 2002 Oakland A’s revolutionized the game after winning the AL West with the lowest payroll in baseball. At the time, his methods were reviled by his scouting department and mocked by baseball industry experts. Yet Moneyball won the day for the same reason that a former Army Chief of Staff once said to his Generals, “if you don’t like change, you’re going to like irrelevance a lot less.”
Traditional baseball metrics like Batting Average and RBI’s were replaced with On Base Percentage, and supported by the subsets — strikeouts, home runs, and walks. Like a batter cannot control the position of the fielders, or their choices and skills, an investment manager cannot control the price mechanism inherent to liquid capital markets.
Paradoxically, if financial industry “scouts” could predict markets and discover mispriced securities, and do it consistently, their outperformance would not mean more dollars of future wealth! The Law of Causality (life happens) demonstrates that the timing of cash flows and sequence of returns has a greater impact on an investor’s long-term success or failure than the sacred industry “best practices” of asset allocation, manager selection, and market timing.
Another traditional bromide is “days out of the market,” and its used to keep clients invested and “stay the course” lest they miss the top ten days of market performance. Yet, does anyone ask, what happens if you miss the bottom ten days of a market free-fall? We do.
At Poetic Justice Capital, our exposure to risk assets is predicated on objectively measured investor confidence. Accordingly, our new performance benchmark is meeting and exceeding our client’s defined goals for dollars of future wealth. That is the performance standard, not historical industry benchmarks.
In addition, because our primary purpose is for our clients to live the one life they have with confidence, this defines fiduciary responsibility better than any government regulation.