Taleb’s writing sits in the heart of many parts of the economy today, especially the active vs. passive debate. Markowitz would tell us that the only reason for taking risk is that we must be compensated for it. Further, if we are taking risk with an active manager that is likely to produce more tracking error to the benchmark, we must be compensated for that extra volatility.
To bring this into our discussion, Markowitz would have been advising you that 10 years into working with Sir John Templeton, you should have fired him. Why? Markowitz and others that adhere to his folly weren’t compensated for the risk you were taking with him. Even at the point that he broke ahead of the S&P 500 in 1969, you still hadn’t been compensated for the higher level of tracking error to get the similar return to the index and that was 14 years in. Based on the psychology of investors today, you could only hope to still be employed. These are all arguments to look smart or win an argument. Templeton won, his investors won, and anyone that needed all the data to prove they would be compensated missed out.
For readers that are bothered by using the S&P 500 Index, instead of a global index like the MSCI World Index, we did this because the MSCI World didn’t incept until 1970. Remember that even today, 63 percent of this index is U.S. stocks. Though we don’t have the data, it’s not a bad guess to believe that U.S. stocks were an even larger outsized portion of global market indexes in 1954. Despite this, here is Templeton’s track record against the MSCI World, since 1970.
This looks much better to the Markowitz crowd as it looks like you’re more highly compensated out of the gate against a better respective benchmark. However, what goes hidden in this snapshot is that Sir John Templeton’s investors underperformed this index by 35 percent cumulatively from 1980 to 1989. This must have been a very frustrating time for Templeton’s investors.
“Charlie and I would much rather earn a lumpy 15 percent over time than a smooth 12 percent.” – Warren Buffett
We as investors believe, as Taleb and Buffett do, that the point is to win. A 15 percent return is what Buffett wanted, even if it was lumpy. He didn’t say he’d take it only if his tracking error was 25 percent or less, or greater than the 12 percent return. Next week we will unpack this further through the Sequoia Fund, Buffett and the circumstances of the late 1960’s.
Cole Smead, CFA, is managing director and portfolio manager at Smead Capital Management.