Any avid climber must be deeply anxious while watching the movie, Everest, a true story based on a 1996 expedition to the summit of Mount Everest. This gripping story, from a memoir called Left for Dead: My Journey Home from Everest, follows a climbing team whose journey turned disastrous from dealing with the naturally volatile conditions on Mount Everest.
It hasn’t taken long for business writers and thinkers to draw comparisons with what happened on Mount Everest to what goes on in business. Financial Times Writer, Andrew Hill, in his opinion piece called, “When the stakes are high, dissent is a sign of success,” introduced work by Jennifer Chatman. Her thoughts were published in a new book, What Works, and make us salivate as contrarians. We like to think that investment success comes to those who are willing to be lonely and getting to the top of the mountain has to be one of life’s loneliest endeavors.
Ms. Chatman and her co-authors studied 40,000 climbers from 80 countries that headed to the Nepalese peak of Everest. As the movie Everest highlighted, there is one goal: reach the peak. In the movie, there is a scene where the climbers are still in the city of Katmandu before beginning their trek to base camp. Each climber stated who they were and why they were going to the top. Motivation ranged from doing it for children back home, to conquering the highest peaks on all the continents, to simply summiting the highest mountain on earth.
What can be easily overlooked, according to Chatman, is the understanding of differences in a group with regard to experience. Whatever the reason for ascending Everest, the goal of getting to the top as an overriding goal can often blind you to the risks. Astutely, Andrew Hill in his piece applied the term “groupthink.” This was a factor that proved fatal for many in the 1996 expedition portrayed in the movie. It’s not the seen risks that kill you in business, it’s the unseen risks.
Disagreement as a starting point for the climb
Groupthink can be one of the most damning epidemics in climbing as well as in common stock investing. All investors would like to produce high returns and reach the peak of investing success. Many would argue that it is impossible to outperform the broad index and believe that owning the index is the only way to go. This could be a grave error. Chatman’s work reminds us of Martin Cremers and Anti Petajisto’s work on Active Share, which they jointly published in 2009. Cremers and Petajisto noted in their conclusion:
“There has been a significant shift from active to passive management over the 1990s. Part of this is due to index funds, but an even larger part is due to closet indexers and a general tendency of funds to mimic the holdings of benchmark indexes more closely. Furthermore, about half of all active positions at the fund level cancel out within the mutual fund sector, thus making the aggregate mutual fund positions even less active.”
Since the Cremers and Petajisto study of mutual funds was first published in 2009, indexing has gained even more popularity. As Active Share shows, you have to be willing to differentiate from the index and the consensus of investors around you. It doesn’t mean you will be successful. On the contrary, Active Share demands a willingness to look foolish in the short run.
Clouds on the horizon that may make the climb worse
In the movie Everest, the devastating circumstances surrounding the 1996 climb were compounded by a horrible storm. What bad weather could be on the horizon for U.S. large-cap common stocks? The S&P 500 Index is trading at 17x forward earnings. This is higher than average, but not egregious from a historical standpoint. We at Smead Capital Management would note, however, some anomalies in the broad index and recently addressed this in a piece titled “The Equity Valuation Paradox”.