Successful investing has to be pure art or pure science

By | CYH

Increasingly, I think successful investing has to be either pure art or pure science.

If you haven’t know already, index investing is a scientific method because all the stocks in the index are picked by a set of mathematical rules. And this pure scientific method is able to beat majority professional fund managers and retail investors alike.

Another scientific approach is to do quantitative methods such as factors to form a portfolio of stocks. This eliminates the need of using one’s subjective judgement and biases to pick out investments.

There have been enough evidence that this simple approach can do better than the index; not every year but over a long period of time. One example is that by using the size factor, an equal-weighted S&P 500 ETF can beat the original S&P 500 ETF that is market-weighted.

The art of investing is about making judgement calls that may or may not be based on numbers. For example, the quality of a business or the management cannot be quantified.

But discerning investors who practise the art of investing do not buy based on stories alone. They also do valuations and analyse financial statements. Some may even engage in drawing trend-lines on stock price charts.

I am afraid that the competition in the stock market has increased and it is no longer sufficient to do table-top analyses – most investors see the same financial statements, financial metrics and information available on the internet. You may argued that the views may differ even though the access to information is the same. But I would say that you can definitely find many investors sharing the same view as you because the market is just so big. The information gap among investors has narrowed and that makes returns harder to get even if you have done a lot of analyses.

You need to go more extreme in the art side – dig information that is not available to most. That said, it is not about possessing insider information because it is illegal, but to find public information that has not been surfaced yet. It could be a product you noticed that is flying off the shelf but the revenue growth will not be reported until the end of the quarter or year. It is the ‘scuttlebutt’ investing that Phil Fisher talked about. The institutions have access to the management but you can be on the ground kicking the tyres. Naturally your edge is found in the consumer space or business-to-business products/services related to your work.

Thus, I believe successful investing has now been pushed to the extreme ends – pure art or science. And it is very hard to play in the middle now.

You either win by obtaining true informational edge (pure art) and/or you win by utilising unbiased large datasets (pure science).

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