Podcast Summary
Survivorship Bias in Investing and Business: Being aware of survivorship bias can help investors and businesses avoid focusing too much on past successes and consider potential risks to make informed decisions
The focus on successful individuals and businesses can lead to a skewed perception of reality, a phenomenon known as survivorship bias. This bias can also impact the investment world, leading us to overlook potential risks and focus too much on past successes. Principal Asset Management, with its global perspective and local insights, aims to identify compelling investing opportunities by considering both successes and failures. Meanwhile, in the world of business, it's essential to manage expectations and be aware of survivorship bias when making decisions. Simon Henriksen, an expert on this topic from First State Investments, can provide further insights on this important concept.
Survivorship Bias in Finance: Ignoring Historical Catastrophes: Survivorship bias can skew our perception of success in finance, focusing on winners while ignoring failures. Historical events like the Russian equity markets before the 1917 Revolution remind us of the importance of remembering risks and potential catastrophes.
Survivorship bias can significantly impact our perception of success in various fields, including finance. We often focus on successful celebrities or investments as the norm, ignoring the fact that there are many who didn't make it. For instance, in finance, while developed markets like the US or UK may have performed well in the long term, we should not forget about countries that didn't fare as well. Similarly, when evaluating fund managers, it's essential to distinguish between luck and ability. The person who looks like a genius may just be lucky. One of the most striking examples of survivorship bias can be found in the Russian equity markets before the 1917 Revolution. Despite strong performance in the years leading up to the Revolution, the markets were wiped out when the communists took over and expropriated all equity holders. This event highlights the importance of remembering historical catastrophes and the risks they pose, even if they seem unlikely to occur. Moreover, the issue of survivorship bias may be exacerbated by institutional memory loss and unrealistic assumptions based on massaged data. While it's natural to assume that a successful outcome was the result of a good decision, it's crucial to remember that past performance is not always indicative of future results and to protect against potential risks.
Survivorship Bias: Unknown Unknowns in Investing: Survivorship bias can lead to a skewed view of historical returns and underestimation of risk. Diversification, long-term perspective, studying economic history, and understanding unknown unknowns can help mitigate this risk.
Survivorship bias, or the effect of only observing companies or assets that have survived over time, can lead to a misrepresentation of historical returns and an underestimation of true risk. This concept is different from tail risks and black swan events, which are known unknowns or risks we're aware of but uncertain about their occurrence. Survivorship bias, however, is an unknown unknown - a risk we didn't even know existed until we looked back in history. For instance, if an investor in the early 1900s had invested in Russia, a major power at the time, they would have been heavily exposed to a catastrophic event when the market closed down. Protecting against such unknown unknowns is challenging, but having a diverse portfolio with various risk drivers and a long-term perspective can help mitigate the risks. Additionally, studying economic history can provide valuable insights into past market conditions and help us better understand the potential impact of unknown unknowns on our investments. The popular 60/40 portfolio of equities and bonds, which has performed well in recent decades due to unique market conditions, may not be as effective in protecting against survivorship bias and other unknown unknowns.
Historical relationship between bonds and equities: During economic instability, both bonds and equities have often behaved as risk assets, rather than offsets. Institutional memory and focus on historical precedent are vital for diversified portfolios and economic success.
The historical relationship between bonds and equities has not always been negative, as many believe. For most of the last 400 years, during times of war and other economic instability, both bonds and equities have behaved like risk assets, rather than serving as effective offsets. This is particularly important to remember in the context of emerging markets, where strong institutions are crucial for the success of both sovereigns and corporations. Institutional memory and a focus on historical precedent are essential for building a well-diversified portfolio. The importance of institutions extends beyond just the financial realm and is a significant factor in the economic success of countries. As we look to the future, understanding this historical context will be crucial for navigating potential structural changes in the global economy, such as those brought about by political shifts like Trump's presidency or Brexit. Ignoring these factors can lead to concentration risk and potentially missed opportunities.
Historical market performance is no guarantee for future success: Investors should be aware of emerging market risks and potential shifts in developed market dynamics
Historical performance of assets in developed markets, such as the US, does not guarantee continued success, and investors should be aware of emerging market risks that have traditionally been associated with less developed economies. The strength of institutions and rule of law, once considered reliable anchors for high sovereign ratings in developed markets, are now under question due to rising populism. Emerging market investors have historically been more concerned about developed market risks than vice versa, and it's important to remember that the past 100 years of US exceptionalism in capitalism may not continue indefinitely. The French Revolution and other historical events serve as reminders that there have been significant discrepancies in asset performance among different countries and regions throughout history. While the US has outperformed in real and nominal terms over the last century, it's important to remember that there was only one winner in the global power dynamics of that time. Therefore, investors should not blindly assume that the past will repeat itself and should be prepared for potential risks and shifts in market dynamics.
Considering historical events and their impact on capital markets: Prepare for potential risks by considering historical events and their impact on capital markets, reassess unrealistic return assumptions, and be skeptical of 'this time is different' arguments.
It's crucial to consider historical events, such as political revolutions, hyperinflation, currency mismanagement, and potential wars, and their impact on capital markets when managing a portfolio. While it's unlikely that such events will occur, it's beneficial to mentally prepare for various scenarios and assess potential risks. The speaker also discussed the perspective of economist Thomas Piketty, who argues that the last 50 years have been an anomaly in terms of income equality and that history generally shows that high earners accumulate most of the wealth. The speaker also emphasized the importance of reevaluating unrealistic return assumptions, especially for pension funds, and considering the historical context of asset returns. They also expressed skepticism towards the argument that "this time is different" and that economic and political cycles tend to repeat themselves.
History is written by the winners, with untold stories that could impact our understanding of historical trends.: Remember that history can be biased and incomplete, and important lessons may be hidden in untold stories. Stay curious and manage expectations.
History, while often seen as a guide for understanding current events, can be subject to survivorship bias and incomplete records. The speaker, Simon Henriksen from First State Investments, emphasized that history is written by the winners and that there may be many untold stories of expropriated assets or lost records that could significantly impact our understanding of historical trends. He also noted that we are currently living in a relatively peaceful time, but warned against complacency and emphasized the importance of managing expectations. The concept of survivorship bias, which refers to the tendency to focus on what survived rather than what didn't, is particularly relevant when considering the end of the world, equity market performance, or mutual fund returns. While it may be tempting to dismiss the importance of history or focus solely on current trends, it's crucial to remember that history has a way of flattering the winners and that there may be important lessons hidden in the stories that have been lost to time.
Understanding the origins of financial assets and events is crucial but challenging: Despite the importance of learning from history, definitive answers about the origins of certain financial assets and events remain elusive. Institutional memory about governance and structure may be fading, and the idea that yields don't always move inversely to bond prices adds to the complexity.
There is a lack of clear understanding about the origins of certain financial assets and events, which makes it challenging to draw definitive lessons from history. Simon emphasized that we don't have a definitive answer to which sovereigns created which assets or which companies have failed. He also noted that institutional memory about the importance of governance and structure may be fading. While there may be a historical document that could change our perspective on markets and finance, it remains elusive. Another intriguing point raised during the conversation was the idea that yields don't necessarily move inversely to prices in bond markets. Overall, the discussion underscored the importance of continuing to explore and question assumptions about financial markets. For those interested in delving deeper into finance and Wall Street, be sure to check out the new Money Stuff podcast featuring Matt Levine and Katie Greifeld.
