There Are No Bananafish
This year, our firm has onboarded several new clients with large cash positions, much of which I suggested be reallocated into quality bonds.
In 46 years since 1976, a quality bond index was positive 42 times, and negative only 4.
I gave the same advice to one of my sisters, and one of my best friends from college.
They'd all have been better off not listening to me.
Imagine confronting that clients, and people you love, would have been better off doing the exact opposite of your advice.
And I am an investment professional!
All investors, whether DIY or working with an advisor, will occasionally get disappointed along their journey.
I, too, am disappointed in recent market outcomes. I wish all my recommendations came with guarantees, but instead they come with statistics.
I would give the same advice again.
The reason why we strive to be long-term investors is because the short-term will sometimes, inevitably, deliver unaccommodating results.
Unpack the frustration with an evidence-based lens, and it should be apparent.
It's okay to be disappointed.
On expectation, periods like this won't occur often, but they will occur sometimes.
Downturns do peculiar things to our psyche, but we can limit our emotions to only disappointment, and not let it get worse.
How? Be a market-based investor.
Let the market itself be the biggest driver behind your outcomes. My friend Jay Totten shares it this way:
You either believe that returns come from the market, or you believe that returns come from the manager.
You don't need anyone else, nor should you want anyone else, to manage your money with unfounded, crystal-ball opinions.
Just capture broad market stock and bond returns. Own everything. You will know that whatever the market returns in any given year, your portfolio will return similar.
The opportunity is extraordinary.
While it's okay to be disappointed, it's not okay to be surprised.
When you're not a market-based investor, the person pulling levers on your portfolio can hijack your outcomes. The premise of investing this way, called traditional active management, is trusting a decision-maker to select some parts of the market over others. Active managers believe that market prices are wrong, and that they know what's right. So they pick and choose, and investor outcomes are then driven by these selections rather than the entire market itself.
And sure, it might work out okay. But on expectation, it won't.
Here is how Cathie Wood's ARKK Innovation fund is described on its website:
ARKK is an actively managed Exchange Traded Fund (ETF) that seeks long-term growth of capital by investing...in domestic and foreign equity securities of companies that are relevant to the Fund’s investment theme of disruptive innovation.
Disruptive innovation. Cool. Here is the performance this year:
It's down 59% in basically four months.
How can it be down that much?
Because people like Cathie can deliver disappointing returns, AND surprising returns.
She and her team have the autonomy to make concentrated bets on investor's behalf.
Here are the current top 10 biggest bets in ARKK:
Mind you, I've got nothing wrong with her performance. This is a reasonable outcome if you hire someone to invest this way for you. She had fantastic performance just a couple years before this...also reasonable.
The point is that her returns just don't look anything like the market itself. You don't actually know what you might get.
This is not Cathie's problem. This is Cathie's job.
Investors can debate her investment approach and how she markets her products, but she's not forcing anyone to buy her fund.
Although, she's sure glad when they do:
ARKK manages ~ $12 billion
.75% annual fee per year
$12 billion * .75% ≈ $90 million annual revenue
The fees get paid regardless of performance. We can agree she's not struggling to make ends meet.
FWIW, the global stock market is down only ~ 18% this year, and you can buy it for .06% per year.
There Are No Bananafish
First published in the New Yorker on January 31, 1948 – and again in the Nine Stories collection, JD Salinger's A Perfect Day for a Bananafish is a masterpiece short story.
You get early hints that something is amiss with this character, Seymour. Allusions to mild psychosis, maybe some depression. Then you get distracted by other story elements...many of them playful. The reader sort of forgets about the early hints, and now Seymour's happy and having a great time.
Then he shoots himself in the head and the story is immediately over with no explanation.
It's heavy. And you sort of think back as a reader and realize – of course, there were early hints. But during the read, you lose track.
At one point in the middle of the story, Seymour is on a Florida beach playing with a little girl, Sybil.
Ocean. Sand. Seashells. It's the 1948 New Yorker version of Snoop Doggy Dogg's Corona commercials – we, the reader, want to join them on this beach.
"Sybil," he said. "I'll tell you what we'll do. We'll see if we can catch a bananafish." "A what?" "A bananafish," he said.
Seymour describes what to look for: a normal-looking fish that just happens to eat bananas.
"I don't see any," Sybil said. "That's understandable. Their habits are very peculiar. Very peculiar."
And she's more intrigued. And she keeps looking.
And then she finally tells him that she sees one! And it has six bananas in its mouth.
Sybil is young and impressionable. Seymour is older, and knows how to stir Sybil's interest. Keep looking. Their habits are peculiar. Very peculiar. Keep looking.
And eventually, when Sybil's looking hard enough – and she's frustrated enough, and when she wants to see one badly enough – Sybil sees one.
But Sybil seeing a bananafish is just an outcome that Seymour engineered.
Many of our investment returns are disappointing right now. Investors, especially during downturns, are impressionable. Just like Sybil.
They want to believe things.
I could have avoided this downturn. I should have stayed in cash. We all want to avoid disappointment.
Salespeople, and carnival barkers on financial TV, will steer investors to look for things that aren't there, and tug on our desires to have had better outcomes. Downturns are when markets seem most peculiar, and investors feel compelled to tinker.
These external voices can engineer false belief sets. Just like Seymour.
And they will try to convince us that disappointment could have been sidestepped. But it's flawed logic. Many things could have happened this year. The best portfolio is the one that gives investors the highest probability of future success, not the one that looks perfect looking back from the future.
This was the outcome we got, not the one we had to get.
And the reason that investors are prone to deviating away from their long-term strategy during downturns is the same narrative plot technique that Salinger deploys to make us forget that Seymour showed signs of depression early in the story.
We get complacent. We forget the background. Life goes on. We are at the beach.
It's only been two years since markets were decimated by Covid-19, but discipline was rewarded when they screamed back. For many investors, it had been fairly quiet since then. So with this recent bout of volatility, it might feel like something is wrong.
Nothing is wrong with getting negative returns every once in a while. That's the expectation.
How quickly we forget what long-term investing really looks like.
Markets will occasionally deliver disappointing results.
And maybe not right away – but eventually, if you let traditional active managers lead you away from probabilistic thinking, away from a market-based approach, they will disappoint you, too.
The difference is that you might be bitterly surprised by how much.