Crystal-ball investing: speculation leads to losses

By Julie Macleod-Henderson, head of retail investment for Foord Asset Management in KwaZulu-Natal.

Crystal ballThe term “crystal-ball investing” appropriately invokes images of smoke and mirrors, charlatanism and faux clairvoyance.  None of these has any place in investment practice.

It’s important to distinguish between “investment” and “speculation”. Investment has a long-term perspective, the eventual outcome of which is almost certain, whereas speculation has a short-term perspective and an inherently uncertain outcome.

While both modes of activity are forward looking, speculation often involves guesswork, conjecture and an absence of convincing evidence, whereas investment is grounded in a pragmatic assessment of the facts and a rigorous evaluation of the probable scenarios established by the factual background.

The “crystal ball” myth might manifest more readily in the asset-allocation process.  Whether or not to have exposure to one industry or another is partly a function of future economic conditions. With perfect foresight (that perennial impossibility), an investor might know if a good thing will keep getting better, or a bad thing worse. Moreover, such perfect foresight might also indicate turning points: when a good thing turns bad, or a bad thing turns good.

Perfect foresight is moot

The very danger of crystal-ball investing is that it seeks to divine an advantageous future akin to the products of perfect foresight. This is naïvely inappropriate. The identification of advantageous outcomes can only be predicated on what is known, what has been experienced, and the probabilities of particular outcomes. More particularly, essential in the assessment of future scenarios is a meticulous consideration of the risks of being wrong, the consequences thereof, and the measures necessary to mitigate and manage such risk.

Some might argue that certain investment managers are more “intuitive” than others in their assessment of future scenarios, but this should hardly be construed as support for the “crystal-ball investing” mindset.

Intuition is nothing more than the ability of the human brain to process vast quantities of information quickly; it also draws on previous experience to contextualise information. As with any method of prognosis, it is also not foolproof – nor does it claim to be. But as luck seems to improve with practice, so intuition might improve with experience.

Moreover, the notion of investing being predicated on a “trend” is anathema. Momentum in and of itself is not a successful investment strategy. Time and again, through all manner of investment cycles and over the fullness of a long-term investment horizon, the practice of buying undervalued assets and selling them when they are priced well above their fair value, prevails. It is the discipline of, often, acquiring that which might appear out of favour and selling that which is favoured.

If anything, a successful long-term investment philosophy eschews trends. Without doubt, investing successfully takes good judgement – the better your judgement, the more successful you will be as an investor. The fact that good judgement is in short supply among market participants leads to market inefficiency and volatility. This increases opportunities for those with longer time horizons and better judgement of the probabilities of a range of future outcomes.

In conclusion, crystal-ball investing is neither an art nor a science. In investing, there is no scope for the triumph of hope over experience. Rather, investing involves a rational and pragmatic assessment of the facts, combined with a sensible and regular re-assessment of those facts and the probability-weighted assumptions underpinning future scenarios. Alpha is not earned by optimistic guesswork, but by relentless analysis and risk management.

Established in 1981, Foord Asset Management offers a premium investment-management service to long-term investors in investment funds and tailor-made portfolios.

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