Please see earlier podcast Interview with Lars Kroijer Part I – on the importance of Global Diversification
And my earlier book review of Lars Kroijer’s Investing Demystified.
In this discussion with author Lars Kroijer we talk about the main assumption of his book Investing Demystified – which I happen to completely endorse – which is that ‘beating the market’ lies somewhere between highly unlikely and impossible. The goal for individuals should be, instead, to earn market returns. Common behaviors that most investors do, like
1. Paying extra management fees to an active portfolio manager, or
2. Stock picking yourself in order to ‘beat the market’
is a fool’s game, and will ultimately prove unnecessarily costly.
Later in the interview I asked Kroijer to describe his earlier book, Money Mavericks.
Lars: Everyone’s got sort of their angle. My angle is really to start with asking a question of the investor, which is; do you have edge? Are you able to beat the markets? I don’t even make that call for you but I try to illustrate it is incredibly hard to have edge, and that most people have no shot in hell whatsoever of attaining it. Incidentally, that means that people like you are I are not necessarily hypocrites because it’s entirely consistent with our former lives to say we worked in the financial markets; we’ve bought and sold products, and as well informed as anyone. So if we didn’t have edge, edge doesn’t exist.
You could say I’m a hedge-fund manager, and I sold edge for a living, and I certainly thought I had it. But that doesn’t mean that most people, or even that many people have it. I start with the premise in this book of saying do you have it. Then I go on to explain it’s really bloody hard to have it. If you don’t have it, which most people don’t, what should you do?
Essentially, this is a book written for my mom. It kind of is. You wouldn’t believe, but as a former hedge-fund manager, every time I talk to my mom, who’s a retired schoolteacher, she’d always say which stock should I buy. I’d say mom, you could buy an index. And she’s like no, no. Then she’d say stuff like Dansker bonds have done so well, I should be buying it. And I’d be like no, don’t do that. She’s certainly not alone in that position.
Michael: I completely agree with you, and when I think about how your book lays out four simple rules, starting with the one that you should be exposed to the broadest, most global index portfolio, and I have not done that, in terms of I am US-centric and small-caps centric, so I don’t have the broadest exposure. On the other hand, there is no gap between what you advocate, in terms of can you beat the market, and the way in which I invest, which is always I assume from the get-go ‑‑ and this is why that part of it resonated with me ‑‑ so clearly I, like you, say you can’t beat the market. The goal should not be to beat the market. The goal is to expose yourself to the appropriate allocation to risky markets, appropriate to your own personal situation. And then get the market return.
Lars: You want to capture the equity-risk premium.
Michael: The entire finance-marketing machine is about can you beat the market. Beating the market is a complete fool’s game. I think it’s particularly interesting, the other reason I wanted to talk to you, is because you’ve worked in the hedge-fund world, you’ve been a hedge-fund manager, an advisor to hedge funds. I worked on Wall Street. I founded my own fund, and it’s all about that theory that you can, in a sense, have an edge in the market. Yet, the more you know about how it actually works, the more extremely bright people, with the highest powered computing power and the most cutting-edge ideas ‑‑ and you think about the power they had, and we had, and the chances of any retail investor or in fact any of those investors themselves beating the market, or as you say, having edge, is just impossible.
Lars: Add to that they’re at a huge cost disadvantage, informational disadvantage, analytical disadvantage. It’s so unlikely, and this is why always start with you’ve got to convince people they can’t. That’s actually probably the toughest thing. You’re fighting not only against conventional wisdom, but you’re also fighting this almost innate thing we have, that you somehow have to actively do something. You somehow have to pick Google or whatever.
You have to have a view, and you’re smart, you’re educated, doing something to improve your retirement income, or whatever you’re doing. What you and I are advocating is essentially do nothing. Admit you can’t. I think that rubs a lot of people the wrong way.
Michael: You need to bring humility to the situation. I cannot do better than the market. I can do the market but I can’t do better. It’s a very hard, humble approach, but in my opinion and in your opinion it’s the correct approach.
Lars: Yeah. And I also think we’re extremely guilty of selective memory. We remember our winners. That adds to the feeling. It’s a bit like when you ask guys whether they’re an above-average driver. 90% will say they’re above average.
If you ask stock pickers whether they do better than average, 90% of stock pickers would say yes, even more than that. I think there’s a lot of that, a huge degree of selective memory. It’s a shame because I think it really hurts people in the long run.
Michael: It makes conversations along the lines of what you mentioned with your mother conversations with me and other friends and retail investors in stocks ‑‑ hey, I’ve got this great new stock. I’m such a bummer when I talk to them because I say really? I don’t know what to say.
Lars: The alternative is to say you don’t know what you’re talking about, which is not an all together pleasant thing to say. It’s not how you make friends. Certainly not when you’re moving to a new town, like you did.
Michael: I’ve written about this on my site before, but essentially when somebody talks about individual stocks, to me what I’m hearing is I went to Vegas. I put money on 32 and 17 on the roulette wheel. Look how I did. I just don’t know how to respond to that. That’s fabulous, you hit 17 once. I don’t know what to say.
Lars: This is conventional wisdom because to most other people that person will sound smart and educated. They will say here’s why I found this brilliant stock and here’s why it’s going to do great. Most people in the room will consider that person really smart, educated, and someone who’s got it. They’ll sound clever about something we all care about, namely our savings. And you think if I could only have that, I’d want that. It’s tough to go against that.
This is why I think the biggest part of this book is if I could get people to question that. Maybe even accept they can’t beat the market. Then that would be the greatest accomplishment. I think a lot of the rest follows. I haven’t come up with any particularly brilliant theory here. It’s sort of academic theory implemented in the real world and that’s pretty straightforward.
Michael: It cuts against the grain of what I call on my site “Financial Infotainment Industrial Complex,” which is there’s a lot of people invested in the idea that markets can be beaten, that individual investors can play a role.
Lars: Think of how many people would lose their jobs?
Michael: Yeah, it’s an entire machine around this idea. It’s very hard to fight against that. It’s very boring to fight against that. I joked about it in my review; your book is purposefully hey, I have some boring news for you. Here’s the way to get the returns on the market and sleep better at night.
Lars: I sort of compared going to the dentist. You really ought to do it once in a while and think about it. I completely agree with you. I mentioned in the book ‑‑ when I thought about writing this book, it was one of these things that slowly took form, but there’s this ad up for one of these direct-trading platform websites. And there was a guy who was embraced by a very attractive, scantily dressed woman. He was wearing Top Gun sunglasses, with a fighter jet in the background. It said something like “Take control of your stock market picks.”
I thought fuck; are you kidding me? Really? Whoever falls for that, I’d love to sell them something.
Michael: Oh yeah, they’d be a great mark.
Lars: You also hear a lot about the quick trading sort of high-turnover platforms. It’s something like 85-90% of the people on there will lose money. You have a lot of these companies, their clients, 85-90% will lose money.
It’s almost akin to gambling. You can argue is it gambling, which is a regulated industry in a lot of countries, for good reason, because it costs you a lot of money. And I think certain parts of this circus is the same. But it’s very tough to regulate, and I’m not saying you should. But it could cost a lot of people a lot of money.
Michael: I have not read [Kroijer’s previous book] Money Mavericks but give me a preview so when I do read it, what am I going to get?
Lars: It’s a very different book. Money Mavericks is essentially the book of how someone with my background, a regular kid from Denmark ends up starting and running a hedge fund in London, and all the trials and tribulations, humiliations and all that you go through in that process. I thought when I wrote it lots of things have been written about hedge funds, and a lot of it’s wrong. Namely this whole idea that we’ll all drive Ferraris and date Playboy Bunnies and do lots of cocaine.
I thought very little was written from a first-hand perspective, someone who’s actually set up a fund and gone through the fund raising and trying to put together a team. And the humbling failures, and successes, so I thought let me try to write that. I did. I found myself enjoying the process of writing it, which I guess was part of the reason I did it. But then it got published, and it ended up doing really well.
I was actually kind of pleased about that because I thought it’s very nonsensationalist. We didn’t make billions, we didn’t lose billions. No one defrauded us and we didn’t defraud anyone. So those are the four things you normally think about when you think of hedge funds.
Michael: If you’re trying to sell books, yes.
Lars: Yeah, so this is none of that. It’s just a story of some guy starting a hedge fund, how it all worked out, all the little anecdotes. I was really pleased that resonated. In fact, the best feedback I got was from people in the industry who were like yeah, that’s exactly what it was like. I’m sure you would appreciate it because you’d have lived a lot of it. Begging for money.
Michael: No, that’s my second [imaginary] book. My first [imaginary] book is personal finance. My second book is gonna be that experience, your books in reverse.
Lars: I think you’d enjoy it. That resonates with a lot of people, including what you also would’ve experienced, this whole undertone of anyone can start a hedge fund; I’m going to quit my job and raise 50 million dollars. I’m going to build a track record and then raise another couple of hundred million. Then I’m going to be rich and happy. The number of times I’ve heard some version of that makes me want to puke. When you’re actually doing it you realize how incredibly hard it is.
Michael: Very stressful.
Lars: It impacts your health, your life, your family, all of that. Then that’s before you try to make or lose money.
Michael: You actually have to do it, get a return that people are happy with, and they’re happy to stick with you. Does your fund exist still?
Lars: No, it’s just my own money. I had incredibly fortuitous timing. I returned all capital in early ’08. But no skill, it was for mainly my own reasons, sanity, health, and family. I’ve been lucky.
Michael: As we always say better lucky than good. That’s more important.
Lars: For me there was a big part of that. I thought let’s quit while you’re ahead. To be honest, I have yet to wake up one day where I miss it. I get to wake up one morning where I wish I was heading to Mayfair to turn on to Bloomberg and be at it.
Please see related book review on Investing Demystified by Lars Kroijer
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