Investment manager Tom Czitron says you can do all the due diligence in the world but you can never avoid hidden risks such as bad luck.ArtistGNDphotography/iStockPhoto / Getty Images
Tom Czitron is a former portfolio manager with more than four decades of investment experience, particularly in fixed income and asset mix strategy. He is a former lead manager of Royal Bank’s main bond fund.
It is human to make mistakes. I have made and will continue to make them. The following are what I believe are my biggest errors as an investment manager, owing to poor judgment and ego, and what I’ve learned from them.
First mistake: As a rookie, I believed so-called experts. Sometimes I could barely wait until the “expert” left our office before trying to load up on their recommended strategy. After all, this person was being paid a lot of money and had made correct predictions in the past. Of course, it turned out they had made terrible predictions, too. Frequently, they had made a few correct predictions in a row, acquired fame and then proceeded to lose their “hot hand” soon after their client base had grown.
I eventually learned that the current guru usually just benefited from survivor bias and good fortune. Even in a purely random game, some players will do exceedingly well for a period. Mean reversion inevitably sets in. Fortunately, I had older and much wiser bosses who prevented me from losing untold amounts of client money and destroying my career.
The lesson here: Do not rely on self-described experts. Use your reason to assess all analysis. Does the expert’s opinion have a basis in logic? Is their methodology sound? Do they change their views when things change or are they permanent bears or bulls? Most importantly, never have exposures that are too risky as to permanently damage your portfolio if you are wrong.
Second mistake: I had an almost pathological fear of credit losses in my portfolio. I came by it honestly. My first job was as a credit analyst at a rating agency. I absolutely had to be able to assess whether or not an institution would survive. When I was later hired by the old Royal Trust, I was told, only half jokingly, that if one name in our portfolio underwent a credit event, let alone a default, that I would be immediately terminated. In the early 1990s, despite my best efforts in extensive research and analysis, our investment in Olympia and York bonds on the First Canadian Place building still got into trouble. My boss did not fire me. Our performance suffered a bit and we went on from there and soon recouped our relative performance. My worst fear was manifested and it turned out not to be so horrible. I came to realize that credit risk, properly managed, is beneficial and that the occasional bomb in a portfolio is more than offset by the benefits of corporates as long as credit risk and diversification issues are closely watched. Besides, you can do all the due diligence in the world but you can never avoid hidden risks such as bad luck.
Third mistake: My obsession with shorter-term performance numbers. It made me into an unrealistic perfectionist. Every trade needed to work. I wanted to catch every trend and reversal in the market; even shorter term ones. I felt that a year of underperformance would result in my termination and the end of my career. Of course, this was absurd, as many investment managers have subpar long-term performance numbers and have been around for decades. I also began every day with a mental acknowledgment that anything less than my absolute best effort was letting my clients down.
I also realized that active management did not ensure outperformance and that if individual managers did have an advantage, it was fleeting at best. In fact, the underperformance and outperformance of managers over various periods of time were so close to what would be expected from randomness as to be indistinguishable from a gambling game. This meant that even if some managers were superior, they were rare, and their advantage was temporary as their personalities and the markets themselves changed over time. In such a world, I was trying to go undefeated in a game where that was impossible. The truth is, most chief investment officers hire, fire and award bonuses based on blind luck and personal relationships.
What did I learn? Do the best you can. Don’t worry about pleasing more senior people at the firm, many of whom do not really understand the reality of financial markets. Also, there is more to life than outperforming at least half your competitors over a three-month period. The Stoics were right all along: Don’t worry about events out of your control. Fortunately, you can control your reaction to events. The key is to identify your mistakes, correct them and try to avoid similar mistakes in the future.