Supported by Greenhaven Road Capital, finding value off the beaten path.
Barry Ritholtz interviewed John Montgomery of Bridgeway Capital Managment and it was fantastic. Episodes like this are why I love podcasts. I knew nothing of Montgomery but got to spend an hour learning from him.
Behavioral finance lightbulbs. Montgomery’s first behavioral finance insight occurred when he was at Harvard Business School
“I was in one particular class where we were studying a quantitative method of investing and at the end of the class the professor stepped back from the blackboard, kind of tugged on his beard and asked, ‘Who thinks that when you get out of school and go to Wall Street you’ll beat this record?’
“This was a pretty fine record. It wasn’t just beating the market, it was doing quite well. Well, eighty percent of the hands in the class went up… I thought, if this is a microcosm of Wall Street five years from now, then using quantitative methods should help get you on the other side of that investment, which should have some advantages.”
“The iron rule of life,” says Charlie Munger, “is that only twenty percent of people can be in the top fifth.” However, some people can stay there. When Ritholtz brings up the idea that most people think they’re above average drivers Montgomery points out the nuance with this idea.
“Well, with respect to driving I’ve never had a chargeable accident. I’ve never had a moving traffic violation. I always go back to the statistics and the logic. Evidence-based investing is what we do.”
Reversion to the mean is real, but Montgomery says, “You want to differentiate when things do and don’t regress to the mean. Is there skill or just luck in driving?” Michael Mauboussin’s book, The Success Equation is about this idea. If clean driving records persist year to year, then driving is more skill than luck. Baseball bull-pens, wrote Joe Peta, tend to mean revert. “Value investing,” said Cliff Asness, “is highly related to mean reversion, they’re almost synonyms.” The Madden Jinx? Probably mean reversion too.
Scratch your itch. Success when starting from scratch takes a lot of stick-to-it-ness. Often that means working on things important to you.
“I love service industries and anytime I experience service that’s subpar I think there’s a market opportunity there; restaurant, hotel, anywhere. If you’re doing a lousy job of providing service you’re inviting competition in.”
“I was an investor in a couple of mutual funds, setting up an IRA and thinking, ‘You should be able to do better than this.'”
“I had a dozen ideas about how to improve that industry.”
See it to believe it. Montgomery took a year off to study markets, models, and making money before beginning Bridgeway. This wasn’t his idea.
“I had a model for that. There was a mayor of Houston at the time, Bob Lanier. Each time he switched careers he took a year off to study the heck out of the next thing that he was doing. He was very thoughtful about it and I thought that was a fascinating idea.”
Evidence. Montgomery admits, “I’m a quant,” and comes back to evidence-based ideas throughout. Ritholtz needs to get this guy to EBI. For example, derivatives are not a deity.
“The models are built by people and there’s a very strong human component to that. The models are only as good as the modeling process you’ve got.”
And before presenting an idea:
“We have this thing called ‘Confessing your Biases.'”
The base rates of marriage.
“I got married at twenty-one and the statistics on that are not great. The statistics would say wait a while, get more life experience, but it was awesome for me.”
Ritholtz asked, “What led you away from cap weighted?” Montgomery answered:
Every year and a half Montgomery spends a quarter tracking his time to see if his commitments align with his goals.
“I wish there was a Mint.com for my time because it’s a real pain to do.”
Montgomery studied the great depression during his year off.
“If you want the granddaddy of downturns you go back to that period….the specifics of risks have changed but the nature of risk itself has been around a long time and you can learn a lot.”
“I convinced myself from that; be prepared for the inevitable downturn, it’s behavioral, and it’s incredibly difficult to time.”
Stewardship for screening stakeholders. Getting the right people involved helps a lot. It’s the ounce of prevention pound of cure mindset. Bridgeway does this.
“Stewardship is a pretty great screening tool. If you put at one end of the spectrum ‘Greed’ and a lot of the things the finance industry is criticized for and at the other end ‘Generosity’ and making a difference in life. It’s pretty great to say, ‘If you want to make seven figures and are about generating personal wealth you won’t come to Bridgeway.'”
Scott Norton is pursuing “stakeholder capitalism.” Ben Falk was a stakeholder in Sam Hinkie‘s process. But any cause of demand can be a stakeholder; spouses, health, and additions all count too. Early alignment of these is a powerful force.
The behavior gap. Two-thirds!
“This is my biggest sore spot professionally…we have not solved the problem of the behavior gap… the natural tendency of human beings to buy more as thing are going up and fear when things go poorly.”
“Over last fifteen years – on one of our more aggressive funds – the returns to investors is two-thirds of the total return.”
Two-thirds! That’s incredible. How is it that people who are motivated enough to seek out Bridgeway funds aren’t motivated enough to seek out mistakes? Dan Egan had this advice: “If you’re excited about what you’re investing in you should worry. If you’re doing something boring or standard you’re going to stick with it.”
Hire well to argue well.
“We all know that you don’t want to hire a bunch of yes people – but there is tremendous psychological pressure to hire people that look and feel and think just like you.”
“You want to associate with people you trust. Who do you trust? People that look just like you. That’s a formula for disaster.”
“We’re trying to intentionally hire people that don’t agree with us. People who have a different view into things.”
“Some people will say, ‘Do you know that this other team member doesn’t agree with you on XYZ?’ I’m like, ‘Yes, and that’s a good thing.'”
This goes by different names but it’s the same spirit. Larry Kochard calls it “diversity of thought.” Charles Koch calls it “challenge culture.” Hinkie wrote to “tolerate counterarguments.” Ray Dalio calls it “thoughtful disagreement.” Matt Wallaert said: “The thing I love about Oregon is that you can vehemently disagree about something and still come to dinner on Friday night.”
But as noted in Egan’s post and Montgomery’s quotes, this isn’t easy.
Books. Montgomery suggested three books.
The Bible. “Great mapping for life in general but especially finance.”
Daring Greatly. “As a research guy this research is just fascinating.”
The Honest Truth about Dishonesty. “Anybody who is in science or research should read some chapters in this book. We all think because we’re doing numbers and statistics we’re objective but this book would say ‘Not so much and if you think you don’t have that problem it’s going to creep in more not less.'”
Thanks for reading.
Montgomery inspired some digging into marriage rates and I think his base rate for the expected length of marriage shouldn’t be based on his age so much as his education. I guess that’s the point of data. Precision doesn’t always mean accuracy. Life doesn’t fit in spreadsheet cells.