Monday, May 30, 2022

Stock Picking: The Game Within The Game

It is important to understand the game you’re actually playing in all endeavors. In stock picking among other areas of active investment many times the game that is being played is not the one that is at first perceived. It is also not always the one commonly believed or advertised to be being played. 

Goldman Sachs is on the other side of grandma's trade. Grandma and her investment club might have been putting in some pretty good research, but they’re very unlikely to outperform the models and information advantage a firm like Goldman Sachs will have. 

As general investors selecting exposure to the market when we evaluate Goldman Sachs, we evaluate them against the market. That is the correct benchmark for a potential or current investor as that is the central question: Am I better off investing with this particular active stock picker or is there another that can do a better job including using a passive index fund? Perhaps more appropriately and completely the question really is: Is the performance Goldman Sachs delivered appropriate for the risk taken, and could I have achieved as good or better results with as much or even less risk? 

That is the game we are playing when we choose investment in a fund manager, but that is not the game that Goldman Sachs, a fund manager, is playing. Goldman Sachs is not trying to beat the market per se. Goldman Sachs and more precisely specific fund managers within the large organization that is Goldman Sachs are trying to beat grandma and her investment club along with all the other relatively novice investors in the market. 

Personally as a wealth manager I am trying to help clients reach financial goals by investing so that their risk-adjusted return is appropriate for them. That is the game I am trying to play--rather than trying to beat the market, I am trying to match their risk/return exposure to their goals. That might mean using a Goldman Sachs fund if I think it is the best option in that specific area. 

Yet clients often don't want to play that game. In wealth management one of the more frustrating things to deal with is competing against mythical portfolios that clients think exist. An example of which might be when a client is told stories at the country club or down at the barbershop about how great someone else’s portfolio is performing. 

It is very difficult to compete against a phantom. Floyd in the barbershop is probably not doing as well as he claims. In fact it is very likely Floyd is under performing the competition because the competition for Floyd is Goldman Sachs among others. 

For Floyd to feel good with his investments, he only has to compare himself to those decisions he happens to remember along with hypothetical investments he did or did not choose to make. Floyd’s benchmark is cash and imagination. 

For Goldman Sachs to succeed they specifically have to beat most of the Floyds out there and only loosely do they need to keep up with the market. In the long run they probably don’t stand a chance against the market but in the long run that’s not who they really are competing against. 

For those of us who want to be investors with Goldman Sachs, the proper benchmark to compare them to is the market. But the bottom line for Goldman Sachs is a benchmark against Floyd, and Floyd never stood a chance. 





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