A common characteristic of successful people and organisations is an ability to recognise and quickly learn from their mistakes. UK Equity Income Fund Manager Chris Murphy shares the lessons he has learned from an eventful career.
In their day, John Maynard Keynes and Irving Fisher were celebrated economists and investors. Both lost heavily during the 1929 Wall Street Crash. But whereas Keynes’ place in history is firmly established, save a few, avid disciples, little is remembered of Fisher. If he is referenced at all, it is for pronouncing that stock markets had reached “a permanently high plateau” right before the crash.
In part, this may have something to do with how they responded to their mistakes. Keynes learned from his and changed his investment strategy to focus on quality companies rather than trying to predict the ups and down of business cycles. Fisher, by contrast, stubbornly kept to his failing strategy – relying on leverage and economic forecasts – and lost his fortune, dying in poverty.1
What shapes the behaviour deployed to achieve success depends on how failure is perceived
No-one ever learns from getting it right first time. In his book Black Box Thinking, British author and journalist Matthew Syed demonstrated recurrent themes and trends tend to explain success or failure among individuals, teams and companies. What shapes the behaviour deployed to achieve success depends on how failure is perceived. See it as a threat and we deny ourselves of what he calls “the precious learning opportunity” behind every mistake.
“In a complex world, one’s intelligent capacity is not enough,” Syed argued. “One has to be willing to learn, to create a dynamic process of change.”2
To extract the most value from a mistake, an obvious but difficult step is to take responsibility for that mistake. This isn’t always as straightforward as it seems.
Take fund management, where there is a share price reaction. On the surface, it is a blunt way of seeing the evidence in that you buy something and it’s worth considerably less the next day. Nevertheless, ego often gets in the way. It is far easier to fall back on what Syed calls “self-justifying behaviours” – primarily blaming someone or something else.
History is littered with examples of this. The pools, for example, used to be the way families bet on football results. Littlewoods, the UK’s biggest pools operator, had the opportunity to bid for and run the National Lottery, but felt its brand was so powerful it didn’t need to. Its demise from being a household name to irrelevance was rapid, an all too common occurrence for many previously successful brands in the internet age.
As fund managers, we always ask whether we are set up for things to go wrong
The pace of change and disruption has accelerated since the start of this century, a trend that could be amplified by COVID-19. As fund managers, we always ask whether we are set up for things to go wrong. Is the fund inappropriately balanced for difficult periods? Or is it exposed to over-leveraged businesses?
Asking the right questions is central to extracting the most value from any mistake: in the second world war, the Royal Air Force looked at where they were seeing damage in returning planes. They decided to reinforce those areas. However, it made no difference. They asked the wrong question. They missed a crucial bias. They should have asked about the planes that weren’t coming back, not just the ones that survived. When they looked more closely and factored this analysis in, more planes returned.
Sharing information is also critical. This only truly happens in an environment where people are rewarded – or at least not punished – for doing so. Rather than seeing mistakes purely in black-and-white terms to assess blame, it may be better to think of how to continuously challenge the investment thesis. Being motivated to investigate what is really happening is especially crucial now because the market environment is changing so fast. It is tough to predict what the world is going to look like on the other side, but we can get closer to being right by having the right framework to challenge ourselves.
To survive, companies need to spot emerging threats
Finally, it is important to react when the story changes. To survive, companies need to spot emerging threats. At Tesco, Terry Leahy built up a fantastic business. But it can be all too easy to believe your own press. In meetings, Leahy talked endlessly about the company’s successes, but failed to recognise the growth of Aldi and Lidl in the UK following the global financial crisis.
Tesco’s management lacked humility and objectivity. They failed to cut costs. They treated their suppliers poorly. They simply were not prepared for the competition.
At the time, we didn’t sell out of our Tesco position early enough, and this harsh lesson would impact subsequent investment decisions. We didn’t ask the right questions. Mistakes can be the result of one of two things, and sometimes both: the stock you buy and how much you buy of it. Not all companies and investments have the same amount of risk over time, and it is important to realise that. If the risk increases, sizing the position appropriately allows for a quicker escape route if anything goes wrong.
Learning from the Tesco experience influenced the team’s decision to sell a one per cent holding in a major advertising company. The business had attractive attributes, including a good understanding of the digital changes in its industry and an increasing dividend yield. However, it became increasingly clear company executives were not making enough progress, and we exited the position in February 2018, two months before a company announcement of a board-level investigation caused share prices to fall. We were able to limit the performance cost to our portfolio.
Asking the right questions can also lead to opportunities, even during a crisis. One of the main conversations among colleagues recently is around what happens if we are all at home for longer. For example, how do people spend their money? The obvious answer might be shopping online, but they also might save more. In Asia, as more people have been shocked by the pandemic, maybe they are going to want to buy more life insurance. The discussions about what happens during a lockdown have helped us to increase our exposures to some financial services companies, which have so far proved resilient.
The hardest part of fund management is knowing when to go against the herd and when to fall into line
The hardest part of fund management is knowing when to go against the herd and when to fall into line; when to trust your instincts and when to challenge your own perceived wisdom. If I have learned anything in my career, it is that managing these tensions requires keeping an open mind and having endless curiosity.
It is often said in fund management that all you can hope for is being right more often than being wrong. If that is the case, the ability to learn from your mistakes can replace hope with a more resilient and successful approach.