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1/ Time for a little afternoon armchair “philosophy.” Today, I want to talk systematic versus discretionary decisions in investing.
2/ Anecdotally, investors seem to be more comfortable knowing there is a human at the wheel.
3/ Even with systematic models, they want to know a PM has ultimate discretion.
4/ I would argue, however, that any disciplined approach can be systematized. Any deviations, then, must be idiosyncratic by nature.
5/ After all, a consistent reason for deviation could, in turn, be systematized.
6/ So one way of thinking of a discretionary manager is as a systematic manager plus a whole bunch of idiosyncratic deviations.
7/ This implies that the application of discretion must relate to a unique, special, and non-repeatable situations.
8/ To build confidence in a manager’s ability would require a huge number of samples over a variety of market conditions.
9/ Given that markets can move in long, secular cycles (e.g. 35+ years of declining rates), our confidence should be limited.
10/ By contrast, systematic approaches can be tested across a variety of scenarios, time frames, economic conditions, and geographies.
11/ And they can be stress tested and hypothesized about for new, unseen situations.
12/ I’m clearly biased, but a preference for discretion assumes a manager can navigate a truly unique situation.
13/ Given the large number of documented cognitive biases that plague investor decisions, my confidence in discretion is limited.
14/ Particularly since, by definition, there can be no precedence by which to establish expectations.
15/ Fin.
