July 16, 2018 - Win Murry
Win Murray has been a co-manager of the Oakmark Select Fund (OAKLX) since 2013. He also serves as the Director of U.S. Equity Research at Harris Associates. He joined Harris Associates in 2003 as an Equity Analyst after working in investment roles at Colonial Management Associates, Federated Investors and ASB Capital Management. He holds an M.B.A. from Georgia State University (1996) and a B.A. in Russian/East European Studies from the University of North Carolina (1992).
World Cup fever has gripped the population. Many of the matches have been quite close, and a handful have been decided by penalty kicks, in which five players from each team alternate turns shooting the ball from a spot 11 meters in front of the goal, versus a goalkeeper who’s usually unable to react quickly enough to block the shots.
Given that the ball, once kicked from the penalty spot, crosses the goal line 3/10ths of a second later, the goalie has no time to make a decision on how to block the shot by observing its direction. Instead, he typically will leap either to the left or the right when the ball is struck, hoping that he’s guessed correctly and can make the save.
A study done by the Journal of Economic Psychology shows that:
- Goalkeepers who dive to the right at a penalty kick stop the ball 12.6% of the time
- Those who dive to the left stop the ball 14.2% of the time
- Goalies who don’t move have a 33% chance of stopping the ball
Despite this, goalkeepers stay centrally located only 6.3% of the time, choosing to dive for the other 93.7% of kicks. This data seems to match what my eyes told me during the World Cup, as many times the kicker shot straight down the middle (minimizing the unforgiveable risk of missing the goal altogether) while the goalie leapt to one side, vacating the spot where the ball crossed the line.
Why do goalies make the suboptimal decision to act (diving left or right) when the correct decision is inaction (staying put)? According to the study, they do this because it feels better to have missed the ball by leaping somewhere (action) vs. missing the ball by standing still (inaction).
As is often the case when talking about sports statistics and behavioral biases, there are clear parallels here to the investing world. It’s well established that inactivity (“buy and hold”) is an effective investment strategy: the S&P 500 index is up more than 12-fold since 1991 (when we started Oakmark) despite some terrible intervening events (such as the tech bubble, 9/11, and the global financial crisis).
Even better than “buy and hold” is the less catchy “buy growing businesses run by shareholder-friendly management teams priced at a discount to their intrinsic values and hold,” which is the strategy we practice at Oakmark. An investor who purchased the Oakmark Fund at its inception 27 years ago would today have over 25 times their original investment, or more than twice the capital they would have accumulated by investing in the S&P index.
Unfortunately, it’s apparent that investors find the easiest course of action (inactivity) to be extraordinarily difficult to follow. Ned Davis Research found that investors are holding stocks for progressively shorter time periods: eight months in 2016 versus two years in the 1980s and five years in the 1970s.1 Dalbar came out with a study showing that individual investors have cost themselves a crippling 1.5% of annual performance through “voluntary” behaviors, such as “panic selling, excessively exuberant buying and attempts at market timing”.2
Anecdotally, we see this behavior in our own fund flows, with investors pulling money out after periods of poor performance and adding funds after periods of excellent performance. As our long-time investors well know, our Funds produce very idiosyncratic performance. Using the Oakmark Fund as an example again: In the 264 rolling monthly five-year periods through June 30th 2018, the Fund has underperformed the S&P 500 index in 80 of them. Many clients would view five years as a long enough holding period in which to determine whether a strategy is working, yet these clients would’ve come to the wrong conclusion on the Oakmark Fund over 30% of the time. Over the past 27 years, the Fund has more than doubled the market’s return.
Why do investors insist on actively trading despite ample evidence that this behavior hurts returns? To be fair, there are a lot of external pressures to care about short-term news flow and to try to time the market.
Twenty five years ago, investors would often only see the performance of their holdings after receiving their quarterly brokerage statements in the mail. If they wanted to review daily stock price movements, they would need to check the stock quote tables in the next day’s newspaper. Nowadays, quotes are available instantaneously online (including pre- and post-market trading). Twenty four-hour financial news networks fill their programming schedule with talking heads recommending action, telling people that they need to buy or sell stocks based on various earnings or news reports that in our view typically have no substantive impact on the underlying value of the companies in question.
Of course, if CNBC were to be broadcast only for buy-and-hold investors, its ad-supported business model would produce terrible revenues, as the network would probably only have a few hours of weekly original content discussing the long-term intrinsic value of companies, along with many hours of reassurance that the current macro news flow is unimportant in the long run. Instead, their constant exhortations for investors to buy and sell are the equivalent of insisting that goalkeepers need to stop penalty kicks by diving.
Inactivity isn’t a spectator sport, but we believe it remains the optimal strategy.