Learn to avoid common investing myths

February 13, 2014 02:34 PM
Blog first appeared in DanCollinsReport on Sept. 2, 2013

Over the past couple of weeks we ran a series of posts by Michael Dever defining the 20 investment myths he highlighted in his book; Jackass Investing: Don’t Do it Profit From it.

The myths ranged from the obvious long equity world standards of “buy and hold investing” and “Don’t time the markets” to some of the stubborn biases against futures trading.

Dever included several insightful and amusing anecdotes regarding the irrationality of traditional investments and flawed analysis. My favorite — one I have heard before — is how people would not invest with his commodity fund because commodities are risky.

But the most compelling part of the book shows the carnage caused by subscribing to the orthodoxy of many of these myths.

I have my own anecdote in this regard and it explains part of the problem. It even produced a guffaw from investment guru Jim Rogers when I told it to him while interviewing him for his book Hot Commodities.

I told him how in an interview with an emerging commodity trading advisor (CTA) who was having some early success with a short-term stock program trading the E-mini S&P 500 that I asked the manager whether he thought his program was robust enough to apply it to a diversified group of futures markets, including physical commodities. The emerging manager  told me that he would never trade anything as risky as soybeans. This from someone trading the S&P 500 and not only trading it but managing other peoples’ money.

This highlights the problem. Most brokers (and bankers for that matter) are not interested in diversification — it is just a word they use in a sales pitch — they are interested in having product to sell. In the early 2000s the E-mini S&Ps grew so much in popularity that it broke through the niche world of futures markets and became mainstream. This meant it could be marketed and sold to a broader audience and brokers and managers moved in to fill the void. Hence, folks who were uncomfortable with commodity futures because what they heard and what they were told, were comfortable with the E-minis because everyone was trading them and they jumped to the erroneous conclusion that they were safer.

In the run-up to the financial crisis there were many institutions invested in various forms of mortgage backed securities, collateralized debt obligations (CDOs) and other new-fangled and popular investment products who were restricted from trading futures. Think of that: they would not invest in a low volatility CTA but were involved with credit default swaps! Worse yet rating agencies gave these products AAA ratings. Talk about mass hysteria.

It is not a surprise that someone can be ignorant enough to believe the S&PS are less risky than soybeans but it was troubling that someone managing other peoples’ money in the futures world could be this ignorant.

I mentioned this to Rogers because he was pushing the benefits of investing in commodities back in 2005 and pointed out that it is a lot easier for a retail investor to learn the fundamentals and trade commodity markets than equities. He was annoyed with the Wall Street analysts who were always ready to push a stock to buy on the fundamentals in the commodity markets. For stock guys, the bull market in commodities meant they needed to find the right commodity related stock. His point — like many of Dever’s — was obvious yet controversial because of conventional wisdom. If you think gold is going up, don’t look for the right mining stock, buy gold. Sounds simple enough but thousands of investors at the time were looking for the right mining stock to buy simply because the thought gold was going up. Or the right energy firm to buy because they thought crude would rally. I recalled that conversation with Rogers a few years later when a major South American copper mining firm went into bankruptcy in the middle of the one of the greatest copper rallies of all-time. I recall thinking about how many investors must have been wiped out and how many of them probably only invested in the firm because they correctly believed that copper would rally.

What is great about <em>Jackass Investing </em>is its dependence on logic. Why do investments work and why they don't. What drives profits? If you take nothing else from the book but the importance of not automatically subscribing to the conventional wisdom of the day, it would be well worth the read.

The most important point Dever explains is the concept of return drivers. To be truly diversified, you need to be invested in products that have different returns drivers.

Managed futures is so compelling because high volatility and price dislocation, things that hurt many different asset classes, are environments where trend followers tend to thrive in.

I recall Salem Abraham, founder of Abraham Trading, explain this several years ago. The simple point he made shortly after managed futures was the only asset class to produce returns — and they were extraordinary returns — in 2008, is that so much of what people invested in was dependent on a strong economy and a stable credit market.

What you need is something that can produce returns in relatively normal periods but more importantly have a strategy that produces strong returns that are driven by disruptive events that tend to have a detrimental effect on most other investments.

I noted in my introductions that the first group of myths related to general long equity investment propaganda; the second group of myths related to the stubborn failure to recognize the value in trend following; the third group related to biases against futures trading in general and the fourth group explained why return drivers need to replace asset classes as a means to diversify and points out that by doing so you can achieve a “free lunch.”

One last myth slayed.


About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.