In this issue:

  • We humans are, quite literally, born to run
  • We’re smart, but have cognitive biases
  • A robust investment process can compensate

My congratulations to those of you who ran the London Marathon earlier this month. Although I do run recreationally, I’ve never run a marathon.

This year, I knew a handful who took part and they universally praised the weather. While many of us might be cursing just how cold this spring has been, the 12-degree high temp on the day provided for ideal distance running conditions.

Just as a keen sailor prays for wind, runners tend to prefer cooler rather than hotter conditions for an obvious reason: they are less likely to overheat, oversweat and thus suffer from dehydration fatigue.

Even at warm temperatures, however, humans are great distance runners. Some would argue the greatest of all. Our ability to sweat from our entire body to keep cool is a huge advantage over those animals which, although faster at a sprint, tend to overheat in practice when running long distances. Bipedalism also provides a long-distance advantage through the relative conservation of energy – i.e. the lower body does essentially all the work rather than the entire body being necessarily engaged.

The only animal that can give humans a long-distance run for the money is the horse, and even then most horses are not up to the endurance challenge, especially under hot weather conditions.

Some evolutionary biologists believe that so-called endurance hunting was absolutely central to the development of homo sapiens. The pattern-recognition and memorisation abilities required to track and ultimately close the distance on large game over long distances favoured superior cognitive abilities and more.

As large game could normally only be brought down by a group working together, endurance hunting also fostered the development of important social skills that formed part of the basis for the primitive but successful hunter-gatherer cultures that would eventually form the first recorded civilisations.

But while humans evolved to be ideal endurance hunters, we didn’t concurrently evolve into great investors. Indeed, as behavioural psychologists Daniel Kahneman, Amos Tversky, Malcolm Gladwell and others have observed, in certain respects our brains remain primitive, in particular when it comes to the risk-return reasoning so central to successful investing.

For those unfamiliar with their work, for which they won the Nobel prize in Economic Science, Kahneman and Tversky discovered that, on average, humans are irrationally risk-averse (or fearful) when it comes to big risks and irrationally risk-friendly (or greedy) when it comes to more trivial matters. In the former case we miss out on big opportunities and in the latter we frequently fritter away small amounts of capital which, over time, can accumulate to large losses.

In a primitive, hunter-gatherer setting the above makes sense. Big risks frequently lead to injury or even death, whereas small risks are necessary to keep one’s belly at least somewhat sated from day to day.

But in the investing world, you want to be as rational as possible. It is OK to take big risks as long as you are not investing more than you can afford to lose and the potential returns are sufficiently attractive. And taking an unknown number of small punts just because they’re small, but don’t necessarily offer sufficiently high returns, is not going to grow one a large pension pot.

The above is especially true when investing over long time horizons. Big risks can be combined into a portfolio that diversifies and therefore lowers the collective risk substantially. The investor with both patience and the willingness to take calculated risk for attractive return is likely to outperform in the end. Just ask Warren Buffett.

It is with this investment philosophy that I designed the Southbank Wealth Advantage investment process. The service is always fully invested, something that might be considered by some to be a risky approach. But it is invested in the most efficiently diversified way possible, using a risk-weighted portfolio optimisation.

At present the portfolio holds a mere 15 companies in those sectors most likely to outperform in the current economic environment. But 15 positions are sufficient to diversify one another due to their low average cross-correlations. Over time, this efficient diversification provides the investor the advantage of remaining fully invested throughout long periods of time, thereby generating large cumulative returns.

The Southbank Wealth Advantage investment process is thus appropriate for longer-term, retirement-oriented portfolios. Hence some readers might be interested to learn that we are currently offering an initial subscription at a discounted price, for a limited time only. If you’d like to learn more about what Southbank Wealth Advantage might be able to do for your pension pot, please click here.

[Capital at risk.]

Until next time,

John Butler
Investment Director, Fortune & Freedom