Monday, August 24, 2009

Looking for the Right Word

I have no problem with describing Modern Portfolio Theory as science. After all, Markowitz’s work did win a Nobel Prize for Economics, and for that matter, so did Bill Sharpe’s work on the Capital Asset Pricing Model. I believe that investor’s want to pay for science…and all that it implies. Science implies certainty, exactness, facts versus opinion, expertise, proof, and so on. Since investor’s want to buy science, it should be no surprise that investment advisors want to sell science. For four decades now the financial industry has successfully sold strategic asset allocation as science. But now that the problems with MPT are becoming well known, consumers of investment advice need to reevaluate the value proposition of any investment process that claims to be scientific.

I am still looking for the right word to describe active portfolio management where the decision making process is driven by a subjective, qualitative approach to asset allocation. I have described it as “art,” the antithesis of science. In my book, Buy and Hold is Dead (AGAIN), I contrast art with science as saying that art “lies in the eyes of the beholder.” One investor’s interpretation of the economic facts of the day can and will be different from another investor looking at the exact same data set. The experience, judgment, and wisdom that help an investor reach a conclusion are art, I said. The problem being that art conjures up all of the wrong images. Artists are erratic; art is hard to measure and impossible to repeat. If investing is art than it must be about guessing, hunches, flashes, intuition, and other non-sellable attributes.

So this morning I want to suggest active management as a craft. Yes, craftsmen are still artists, but it seems to me that we value craftsmen. If investing is a craft to be learned, then we imagine that it takes skill and not luck. We expect craftsmen to apprentice for years before they practice on their own because a craft takes judgment and experience, in a context that we value and appreciate. So for now on, I think I’ll describe investing as a craft to be learned. While everyone is not an equally good craftsman, we can all agree that the best of them deserve our respect and are worthy of our patronage.