yacht on ocean

21 Nov 2017

Investing – why risk is required for reward

The discipline to press on when things are painful, and to execute on what’s right in front of you is a trait that carries over to accomplishing anything difficult in life and to being a successful investor as well.

US Navy Seals

Get comfortable being uncomfortable.

The theory behind the US Navy SEALs' saying is that if you can be comfortable being uncomfortable, you'll be prepared to handle whatever situation comes along in your own life.

The Navy SEAL saying applies not only to the extreme physical conditions they endure but also the situations. During their rigorous training, SEALs go through what's called "surf torture." The process involves everyone linking arms and laying down in the frigid ocean until the body reaches early stages of hypothermia. They do this daily before taking on whatever other tasks are required of them.


The point is for them to stay focused on what they need to accomplish, despite how uncomfortable they feel.


Every great investment hurts

I had the privilege of attending the recent and outstanding Investec Wealth Forum, which was held in both Cape Town and Johannesburg. It had an impressive line-up of speakers, including Sunil Thakor from Sands Capital Asset Management and Dave Iben from Kopernik Global Investors, two of Investec Wealth & Investment's World Axis suite of funds’ global equity money managers.


My key takeaway from listening to Dave Iben, the “Top Performing Global Equity Manager, 2016”, in particular, was that his strategy has worked so successfully over time because it acts against human nature. In other words, it is often counterintuitive. His strategy systematically sells stocks in countries with high valuations to purchase stocks in countries with extremely depressed valuations.


Many investors would find it difficult to divest of shares that have treated them so well for the past 10 years, to purchase stocks in countries that are embroiled in war or economic turmoil, but not Dave. 

Watch a panel discussion recording

Leading global investment managers Sunil Thakor and Dave Iben talk about growth vs value investing and where they see opportunities in a turbulent world.

The point is that every great investment is born from decisions that were harder than they appeared to an outsider. There are few exceptions to this. Investors have a fascination with no-brainers, obvious decisions, and easy money.


Also read: Predictability – might be boring, but it works


A critical part of investing is distinguishing what looks easy in hindsight from what feels easy right now. They are different beasts, opposites even.


This is more than hindsight bias, where everything in history books seems obvious. It’s about the forward-looking risk-reward trade-off (which is devilishly hard to quantify) actually manifesting in whether you go to bed asking yourself “What the hell am I doing?” before making an investment.


Easy decisions are rarely viewed as ‘no-brainers’ in hindsight and vice versa.


Finding above-average investments requires either being smarter than others, or being willing to endure more discomfort and uncertainty than others. 

It’s natural to focus on the former because the industry is full of people who are either very smart or think they are. But most edges are found in the latter, specifically because the “I’m-really-smart” edge generally gets competed into the ground. 


Where there’s consistent performance there’s usually intelligence. But there’s almost always a willingness to make more painful decisions than competitors.

Matrix of investment decisions
'Dare To Be Great'

In Howard Marks' memo to Oaktree clients in 2006, entitled Dare to Be Great, he conceptualises the above situation as a simple two-by-two matrix of investment decisions. 

That matrix, above, shows you obviously don’t make money if you’re wrong (conventional or unconventional behaviour coupled with unfavourable outcomes), but what most people don’t realise is that you also don’t make money if you’re right in consensus (conventional behaviour coupled with favourable outcomes).


Returns [or alpha] get arbitraged away.


The only way you make money is by being right in non-consensus (unconventional behaviour coupled with favourable outcomes). Which is really hard.


Take Warren Buffett’s 2008 investments in several banks. Looks easy in hindsight – cheap! Good companies! But Buffett made his offers in the same week PIMCO CEO Mohamed El-Erian told his wife to take out as much cash from the ATM as she could because the odds were so high that the banking system would collapse.

Patrick Duggan
Patrick Duggan, Wealth & Investment

'You are kidding yourself if you think being greedy when others are fearful is as easy as saying it during a bull market!'

The point is that risk is required for reward, but risk isn’t just quantified in spreadsheets. It’s measured by the acceptance of doubt, and a willingness to make decisions that don’t make sense to many others, specifically because the gap between your check and consensus is where outperformance lives.


In the most competitive markets, it’s where any results live.



Investing well, like any significant endeavour requires some level of discomfort to succeed.


The importance of developing the discipline to press on when things are painful, and to execute on what’s right in front of you is a trait that carries over to accomplishing anything difficult in life and to being a successful investor as well.


With investing, the “discomfort” tends to come from two areas:


  1. Paying attention to the fundamentals (i.e., the “boring” stuff) which is required to minimise errors.  “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” – Paul Samuelson, economist and Nobel Prize laureate; and
  2. Being different from other investors. "The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd." – Warren Buffett 


So get comfortable being uncomfortable.

About the author

Patrick Duggan

Patrick Duggan

Wealth manager: Investec Wealth & Investment

Patrick is a senior private client wealth manager with Investec Wealth & Investment, specialising in providing holistic investment planning advice to some of South Africa’s high net worth and ultra-high net worth individuals, families and their associated entities.

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