Like kites, do portfolios rise against or with the wind?
For the runners, cyclists or outdoor sportspeople within our readership, a handful of circumstances will almost always result in a proverbial groan: headwinds. That gust of wind that makes turning that corner on the bike or spending the next half of a game with a wind impediment less enjoyable, is unfortunately a part of exercising amongst the elements. Headwinds, as it were, have become known as such a physical inconvenience that they are also a common analogy for when situations in life are met with obstacles that inhibit progress. The counter to a headwind therefore is a tailwind, where benefits and/or privileges fuel our progress, bypassing or simply overcoming the obstacles (or headwinds) that come our way.
If we then take this concept and apply it to a fund manager's portfolio, how many would attribute their performance success to an investing skill or purely an outcome of a bull market? Put another way, did the manager overcome genuine obstacles (a headwind) to achieve success, or were they the beneficiary of a rising market (a tailwind)?
Recent research published by social scientists Dr Gilovich and Dr Davidai in 2016 suggests that people are more likely to both recall and overweight their headwinds more poignantly than those of their tailwinds. Their theory claims that when people benefit from a tailwind, the satisfaction is adapted to quickly and is relatively short-lived, whilst a headwind's dissatisfaction is 'consumed' over a longer-period. Using the sporting analogy at the top of the above paragraph, many can relate to the internal monologue that goes on when a headwind is faced; often, longing for the tailwind. Usually, this monologue does not end until the tailwind is experienced. At which point, a brief sense of relief is felt and the team or individual go about adjusting to the new advantage. Almost without a second thought!
This tendency to recount information in a way that confirms one's view (confirmation bias) that they had more obstacles than benefits has been coined by Gilovich and Davidai as the headwind-tailwind asymmetry. It is suggested that because a headwind is an obstacle that needs to be addressed, whether that be in a career, sport, relationship or an investment context, there is a greater propensity for these events to be etched into our memories. Their very existence can in fact precede critical junctures and choices in our lives. Conversely, a tailwind is a privilege that often goes unseen by its very nature of not necessitating significant effort or attention. It's harder to recount a privileged education, upbringing, career opportunities or investment successes when they were already occurring without requiring effort.
At Spatium, we pride ourselves on having outperformed the benchmark (a headwind) without having a beta in excess of the benchmark, or resorting to leverage or gearing within the fund (an easy 'tailwind' during a rising market environment). Conversely, when the market winds inevitably change, Spatium has had a long-term average of losing only half as much as the benchmark.
When assessing managers, portfolios, or even individual companies, one must be critical: "has this business overcome genuine headwinds, and has the strength, knowledge and processes to do so again in the future"
"has this business simply benefitted from structural tailwinds", such as declining interest rates, or similar paradigm shifts, those of which may be unlikely to be repeated at the same amplitude (or in the case of rising interest rates, potentially work as a headwind) into the future.
In aggregate, one should enjoy just as many tailwinds as headwinds over the years, with the key focus being maximising ones advantage during tailwind periods, and remaining convicted to persevering through intermittent headwinds.
Author: Jesse Moores, Director
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