Does experience trading the markets provide an actual trading edge? Surely an investor who’s seen many bull and bear markets has an advantage compared to a novice just starting out in the field. The beginner is an alpha source for seasoned traders as the former pays their “tuition” associated with learning how to trade. The counterargument, using efficient markets logic, suggests that if a great number of portfolio managers (PMs) have significant experience, then the performance benefits of experience become arbitraged away as prices quickly incorporate the collective wisdom of the pros and experts.
Fund marketers ignore the efficient markets logic and advertise portfolio manager experience because it’s very convincing to most customers. I’ve traded asset classes for about 20 years. I’ve experienced two major and several minor bear markets, and seen a variety of bull markets. When I assess my current trading edges, I admit I’ve started putting “experience” as an edge – although at times with a question mark behind it.
Studies show that manager tenure and experience has little impact on mutual fund performance.1 I’ll speculate that the constraints associated with mutual fund portfolio management greatly inhibit the use of experience as an edge. Prospectus limitations on what securities can be purchased and the requirement to stick with an established investment discipline limit the flexibility to use experience to add value. Career risk can also drastically alter a PM’s personal risk-return profile, inhibiting the use of experience to benefit clients.
Seasoned relationship managers and investment advisors can be highly valuable to their clients since they draw on experience to help a client weigh the pros and cons of making a decision – especially in stressful moments. Of course, their job is not about adding alpha, although many claim they can. Just because a person has 20 to 30 years in the industry doesn’t mean they automatically have an “experience edge” that translates into superior performance. Many PMs are not intentional in how they learn from their experience. They’re lazy.
As an asset class trader, free to shift to any asset class and any investment style at any time, experience can become an impactful trading edge. Intentionally developing an “experience trading edge” requires a carefully planned personal mastery process. Much like a training program used by elite athletes, this mastery process is used to successfully play the asset class trading “meta-game” to better assess what approach works best at a particular moment in time. The mastery process is never-ending and consists of learning, practicing, recording results, reflecting and incorporating feedback to get better. To ignore the process is a huge missed opportunity to get better at this game, and perhaps develop an “experience” trading edge.
Without a thoughtful personal mastery process, a PM is likely a laggard in the asset class trading game. They selectively remember past victories. They incorrectly associate past cause and effect. They fight the last battle. They forget past excesses, past capitulations and all the moments they sat in too much cash.
Much thought and perspective is required to learn lessons from actual results and history to assess what will do well in the future. There’s a lot of randomness in the results that can easily cause you to draw the wrong conclusions. Since trading asset classes allows for flexibility to go anywhere and use any technique to add value, experience can play a larger role in generating attractive returns. For example, simply avoiding asset classes that are experiencing secular bear markets can add lots of value.
Asset Class Trading Mastery Activities
Since the stakes are enormous, trading securities is an ultracompetitive arena where successful traders must constantly adapt to thrive. Striving for mastery – indeed, enjoying the process of slowly grinding your way up the mastery curve and devoting a lifetime to improvement – is a must for those who want to be good at this game.
The key is to be highly intentional about the mastery process, and you can start by reading about it. George Leonard’s book Mastery: The Keys to Success and Long-Term Fulfillment is a nice primer on mastery. Here’s an article on nine steps to trading mastery, and another on seven essential steps to moving from analyst to PM.
Below are six essential activities that help me strive for asset class trading mastery.
- Keep Track of Personal Portfolio Performance
No matter what the activity, keeping track of results must be done to maximize the opportunity to improve. This is especially the case when there’s high variability in the results, such as in sports betting and trading the markets. Tracking personal performance furnishes the data needed to find improvements and provides an essential test-bed to evaluate your decision-making ability in the face of uncertainty.
I’m surprised by how few investment professionals keep careful track of their personal portfolio performance. Even among analysts seeking to become portfolio managers, it seems that few want to make this effort. PMs may rightfully claim that their professional portfolio performance is already being tracked, but there are unique characteristics associated with the personal portfolio that make tracking especially important for asset class trading.
The personal portfolio has only one customer (you) and one portfolio manager (you). Interests are completely aligned and you can’t blame anyone else for poor performance. The personal portfolio also survives the various job and life changes throughout a career and the wide variety of ever-changing constraints that you’ll face.
Non-professional individual investors must keep track of performance if they want to improve.
If you’re an individual investor, create a spreadsheet listing all investment accounts you control, including 401(k) accounts where investment options are probably limited. Don’t select a subset of accounts, such as a trading account only. You must include all accounts because it’s just too easy to hedge decisions made in one account with actions in another.
Each month, add up gains (or losses), cash inflows and outflows for all accounts, then sum and calculate monthly performance for the entire portfolio. You’ll eventually use monthly performance measures to calculate portfolio volatility and drawdowns as important measures of risks taken.
Next, identify a personal benchmark using Vanguard mutual funds or ETFs. A simple benchmark is a combination of the Vanguard Total World Stock ETF (Symbol: VT) and Vanguard Total Bond Market ETF (Symbol: BND), with the split determined by your risk tolerance. You can also create a next-level custom diversified benchmark with various smart-beta ETFs. Take time to carefully think about and establish your personal benchmark. A portfolio of low-cost index funds is tough to beat on a risk-adjusted basis.
There are many important factors that go into the decision of a personal benchmark. A young investor may choose an all-equity portfolio. Someone in mid-life may want to add bonds. A business owner with lots of exposure to the economy may want to own mostly bonds. The idea is to design an appropriate portfolio accounting for your personal situation that you’d be comfortable holding for the next 10 years. Investors outside the U.S. have different considerations and index fund investment options, and may have a very different benchmark.
The benchmark can rightfully change down the line as you get older, but don’t worry about that now. It’s very important that you establish the benchmark up front. If not, human nature may lead you to pick the most favorable benchmark with actual performance data in hand, which might cause you to miss important lessons. For instance, if you thought an 80:20 benchmark split between equities and bonds was appropriate, and your actual volatility levels are half of this benchmark’s volatility, you’ll be tempted to use a 40:60 portfolio as a benchmark after the fact, without critically thinking about how cash drag may be affecting your portfolio.
As time goes on, you’ll be able to develop a picture of your portfolio performance versus the benchmark. You can use these results to guide the search for trading improvements, reassess your risk-tolerance or benchmark, or ultimately realize that this game is not for you. No matter what the results, you’ll be a much better investor or trader down the line by tracking your performance, and you’ll have a much better understanding of yourself and what investment approach works best for you.
There’s always a bit of nuance when examining performance numbers, depending on what question is being asked. For professional PMs, it may seem your professional track record will do, and indeed it’s highly useful for providing feedback to get better over time. However, it’s likely the portfolio focuses on just one asset class, so it won’t measure your ability to trade asset classes. When you leave the firm, or the portfolio is shut down due to business considerations, then the track record is gone unless you incorporate it into your long-term records. Often a PM does not have complete control of portfolio decisions. The portfolio may be co-managed, or there might be supervisors, clients and analysts who influence decisions.
There’s no doubt analyzing the professional performance track record is useful, but there are additional benefits of tracking personal results. The personal track record is a reflection of your decision making only. Yes, there may be constraints associated with your job that greatly restrict what you can do in the personal portfolio. Working within the constraints may be challenging, but you can learn a lot by tackling this problem thoughtfully.
For PMs focused on a single asset class, the professional track record is not very useful in getting better at trading asset classes. If you happen to professionally manage a portfolio that can go anywhere among all asset classes, then it’s still useful to keep track of both personal and professional portfolio performance. I’ve kept track of both performance records for almost 17 years, and longer for my personal portfolio. Even though both of my portfolios have much flexibility, they also have contrasting constraints that allow me to learn from analyzing both portfolios.
What to do with a personal track record?
Once you have the personal track record, what can you do with it? An analyst may be satisfied with developing trade ideas, and monitoring the success of these ideas. But this sort of analysis misses much of what’s required to be an excellent PM. Total portfolio performance provides the feedback required to get better at putting everything together and to assess the many subtle ways you can hurt and improve performance.
The first is cash drag. Cash drag is ignored when evaluating individual trades because it doesn’t factor into the typical trade statistics. Only portfolio performance provides the information required to assess whether cash levels are consistently high over time due to inattention, psychological reasons, bonus-hedging, waiting for the inevitable correction or the lack of trade ideas. If you’re subtly reducing exposure when nervous about a market correction, then this view is probably seeping into the professionally managed portfolio also.
The second is position sizing, which is so important in successful portfolio management. Betting too little on a high-conviction trade can be just as painful as a losing trade. Nothing is more frustrating than making a lot of good calls during the year, but not having it translate into a year with superior net-of-fee performance. Analyzing the position sizing used in past trades can greatly improve performance, especially if you’re typically timid or tend to inch into even the high-conviction trades. That’s important information you need to know about yourself.
Finally, analyzing portfolio-level results can help you find the best trading style and discipline to suit your psychological tendencies. It takes a particular psychology to be a trend-follower and perhaps a completely different personality to be an effective deep value investor. There’s no right answer, but bad things happen when there’s a mismatch of psychology and trading style. How is a new experimental trading approach incorporated into the portfolio? How do you position the portfolio when you have no great ideas or the market seems to be in late-cycle mode? Total portfolio performance tracking is key to getting this right over time.
- Keep a Yearly Notebook Documenting All Major Decisions
Trading and investing is all about making decisions in the face of uncertainty. You need to cultivate this skill, and you need data to improve this process. The most successful trades often occur when the fundamentals are hazy at best. As a human being, it’s just too easy to rewrite history, forget details and add justifications for a trade after the fact with the benefit of hindsight. To get the most out of yourself, and to best enhance the experience edge, you need to document as much information as possible at the time of major portfolio buy and sell decisions. This is required for both professional and personally managed portfolios because it’s very difficult to get better without this information.
Don’t worry about minor trades and small portfolio shifts. You want to document large position changes, new trade ideas, investment philosophy shifts, major sell decisions and benchmark changes throughout time. You can use this data to search for improvements.
You also need to truthfully document all moments when emotions are seeping into decisions. Just document it all, and later you’ll be able to pick up on themes associated with how your emotions may be negatively influencing decisions. Do you tend to chase what’s worked in the past? Do you have the tendency to capitulate on trades due to negative price action or a contrary news item? Do you tend to hedge exposure too much? Did you give up too soon on a trading strategy? Did you hang on too long? Self-awareness around these issues and developing mitigation measures are crucial for trading success.
If trading is automated, then in principal you can go back and reconstruct why trades were made. Failures are “by design” in this case. However, record design modifications made to the algorithms along with motivations for the change. Over the years, there can be many lessons learned from analyzing these decisions because there are still many ways human nature can subtly affect the implementation of mechanical trading systems.
I have over 20 years of notebooks documenting as much as possible about my personal and professional trading decisions. These notes can also be useful when assessing a question that’s relevant for today’s market. Before betting on the dollar in 2014, I went back and reviewed all my major currency bets to search for lessons.
- Develop a Lessons-Learned Process
Feedback is so essential for getting better. Every high-performance organization has a lessons-learned process. With performance tracking and information about why trades and investments are made, we now have the data to support continuous portfolio manager growth. Each year, I go through a personal and professional portfolio lessons-learned process. For some, this may seem as tedious as shopping for auto insurance, but to me, this is a treasure hunt for new skills development that’s just as interesting as hunting for new trade opportunities.
I immediately examine mistakes to find new lessons on how to get better. Randomness in results must obviously be accounted for when analyzing performance and the success of individual trades. For this reason, I also review results over a variety of longer-term periods such as 3, 5 and even 10 years. Analyze the results across other dimensions, such as by trading strategy, asset class, illiquid investments, etc. Another focus for me is position sizing, which seems to be the never-ending question when evaluating results.
There are always constraints for both the professional and personal portfolio. Acknowledge the constraints, and factor them into the analysis. In a given year, perhaps you had no time to devote to the personal portfolio. Perhaps you’re highly constrained with your investment choices. Finding ways to work within constraints can help with the skills development process.
- Learn About Human History and from Highly Successful Fund Managers
I don’t know how you can get good at this game if you don’t enjoy reading about the markets and human history. With respect to the markets, grab any book that interests you or consult the many “favorite book lists” associated with famous investors and hedge fund managers.
As an expert in the field, I tend to get the most out of books written by successful investors, traders and fund managers. Anything written by my top 10 thought leaders in the industry is a great starting point. Recently I enjoyed Sam Zell’s book Am I Being Too Subtle, which led me to the autobiography of William Zeckendorf. The latter book provides one take on the history of real estate development from the 1930s to the 1960s, providing a perspective of what worked back then, and what caused investors to lose it all. Both books provide perspective on private real estate investing spanning nine decades.
Reading about human history can provide a much broader context for trading and investing in asset classes. You gain insight into what motivates people, how politics and constraints influence what people do and how decisions are made. It allows you to better put yourself in the shoes of decision makers. History books also allow you to gain a much bigger picture about historical cycles, black swan risks and how what is important changes over time. I often like to ask myself how I would structure a portfolio at various moments in history. Most investors now, including myself, have never experienced an inflationary environment. Reading about investing in the 1980s or post-World War I Germany can provide some preparation if inflation one day comes back into play.
Academic articles attempting to make sense of and learn lessons from past historical events are also interesting. One example is Reinhart and Rogoff’s book This Time Is Different which is now a classic that documents and catalogs the impact of bank crises on economies and markets.
A person’s investing career spans only a few generations. What works in one decade may be awful in the next. Reading about history can provide a much broader context for evaluating what’s going on in the markets and adapting to the upcoming decade.
- Adopt a Peak Performance Mindset
I can only touch upon the thousands of “self-help” books written on this very broad subject. Whatever the learning media (books, audio, workshops, retreats, etc.), exploring enlightenment, happiness, spiritual development, goal setting and peak performance in any competitive field will eventually improve your trading. There is no right answer; each person can explore a variety of disciplines, or focus on an area that really touches them.
The latest personal development book I read was Stephen Cope’s The Great Work of Your Life: A Guide for the Journey to Your True Calling. Most successful people read these books and adopt what makes sense to them. In different stages of life, what’s important will change.
Working all the time does not lead to peak performance. Trading the markets successfully requires creativity to generate original ideas. Developing a work-life routine that maximizes creativity is a must. Each trader needs to develop this routine and determine how much time to devote to non-trading activities including exercise, hobbies, family, friends and spiritual development.
Further, each trader must understand their own strengths and weaknesses, and constantly adopt a process of self-discovery. Putting life into perspective can help depersonalize results, which enhances the truth-seeking attitude required to unemotionally search for personal improvements.
- Continuous Skills Development
Tracking your performance, documenting the decisions you make, and using the lessons-learned process help sharpen current trading tools. However, these tools may or may not be adequate 10 years from now, so seek to develop new skills also. Let your interests guide you, or let personal trading constraints nudge you to investigate approaches that fit in with your professional life. If personal trading is disallowed, investigate private real estate investing for example. Developing expertise in new markets will be highly useful over time. I’d much rather have decent tools to use with an asset class experiencing a secular uptrend, than be an expert in an asset class suffering a secular bear market. If the public markets are unattractive, developing an approach to investing in illiquid or new asset classes may be the answer.
We at Merriman are always searching for new trading edges. This is like discovering a new tool that few have. The process takes an enormous amount of creativity. We’re keenly interested in new asset classes to exploit with our existing tools. We also investigate new investment product for trading edges. Successful traders are never satisfied with their current set of tools or security-set to trade.
At this point in my career, I feel that writing this blog is the best way I know to consolidate twenty years of experience and ultimately leap to a next-level ability in asset class trading.
Asset class trading is particularly conducive for using a lifelong mastery process to develop an experience trading edge. The opportunity set is extremely rich and the performance feedback process is naturally very long. The key to developing this edge is to be highly intentional about learning from your own portfolio management experience.
I haven’t mentioned the need for a mentor or coach in the process. There’s no doubt that a good mentor can speed up the mastery process. I’m self-taught. I never had a mentor, but that was okay with me, since I’m comfortable and good at learning on my own. Being the sidekick of a great PM can only get you so far. As soon as possible, test your decision-making abilities with a real portfolio. The above six activities, which must be performed individually, are essential to being a winner at the asset class trading game.
- Porter, G.E. and Trifts, J.W., The Best Mutual Fund Managers: Testing the Impact of Experience Using a Survivorship Bias Free Dataset, J. of Applied Finance, No. 1, 2012.
The content contained within this blog reflects the personal views and opinions of Dennis Tilley, and not necessarily those of Merriman Wealth Management, LLC. This website is for educational and/or entertainment purposes only. Use this information at your own risk, and the content should not be considered legal, tax or investment advice. The views contained in this blog may change at any time without notice, and may be inappropriate for an individual’s investment portfolio. There is no guarantee that securities and/or the techniques mentioned in this blog will make money or enhance risk-adjusted returns. The information contained in this blog may use views, estimates, assumptions, facts and information from other sources that are believed to be accurate and reliable as of the date of each blog entry. The content provided within this blog is the property of Dennis Tilley & Merriman Wealth Management, LLC (“Merriman”). For more details, see the Important Disclosure.