Winning the Loser's Game by Charles D. Ellis

Key Takeaways

Part of the problem is that investors make mistakes. But they are not alone. As investment professionals, we need to recognize that much of the real fault lies not with our clients but with ourselves—the unhappy consequence of three major systemic errors. Fortunately, we can—and so should—make changes to help ensure investing is, both for our client investors and for ourselves, truly a winners’ game. For all its amazing complexity, the field of investment management really has only two major parts. One is the profession—doing what is best for investment clients—and the other is the business— doing what is best for investment managers ...Today, investment management differs from many other professions in one most unfortunate way: We are losing the struggle to put our professional values and responsibilities first and our business objectives second. We can stop losing the struggle if we redefine our mission to emphasize the investment counseling values of our profession—and our understanding of investors and investing—to help clients focus on playing the investment game that they can win and that is worth winning. Fortunately, what is good for our professional fulfillment can, in the long run, be good for business
Three errors of the investment profession
1. Falsely Defining Our Mission - "beating the market" is the wrong definition and in today's more competitive landscape, is hardly possible in the long-run. With wide spread of information, markets have become more efficient.
  - Inherent risk - the “losers” underperform the market by twice as much as the “winners” outperform
  - By simply removing two biases in the “data” as conventionally presented— backdating and survivor bias—the apparent record on managers monitored by consultants often shifts down from “better-than-the-market” appearances to “below-the-market” realities.
  - Most investors have not yet caught on to the fact that they would be better off if they put most of, if not all, their investments in low-cost index funds or index-matching exchange-traded funds
  - Because investors can get virtually guaranteed market returns through index funds for less than 10 bps, what they really “buy” when retaining active managers is risk-adjusted incremental returns. Calibrated as a percentage of risk-adjusted incremental returns, investment management fees are not low; they are high.
  - Successful counselors will help each client understand the risks of investing, set realistic investment objectives, be realistic about saving and spending, select the appropriate asset classes, allocate their assets appropriately, and most importantly, not overreact to market highs or lows
2. Incorrectly Ordering Our Priorities - have allowed the values of our profession to become increasingly dominated by the economics of our business.
  - Investment management a great business with great margins and growth potentials. As these companies grow, their focus shifts more to profit generation for themselves
3. Dropping Rigorous Counseling - many investment firms have veered away from offering sound and consistent investment advice. Clients need help understanding the long-term and intermediate prospects for different kinds of investments - risk, volatility and return
  - Investment organizations that are shifting from product-centric to service-centric strategies report highly favorable professional and business results.
Increasing the fit of investment service to the longterm objectives of each investor—moving from caveat emptor “product” sales to more durable, shared-understanding service relationships— would increase the duration or “loyalty” and thereby the economic value of client–manager relationships
Simon Ramo identified the crucial difference between a Winner's Game and a Loser's Game in his excellent book on playing strategy, Extraordinary Tennis for the Ordinary Player. After extensive scientific and statistical analysis, Dr. Ramo summed it up this way: Professionals win points, amateurs lose points
As Ramo instructs us in his book, the strategy for winning in a loser's game is to lose less. Avoid trying too hard. By keeping the ball in play, give the opponent as many opportunities as possible to make mistakes and blunder his, way to defeat. In brief, by losing less become the victor.
The trouble with Winner's Games is that they tend to self-destruct because they attract too much attention and too many players – all of whom want to win. That's why gold rushes finish ugly. But, in the short run, the rushing in of more and more players seeking to win expands the apparent reward.
For those who are determined to try to win the Loser's Game, however, there are a few specific things they might consider:
1. Be sure you are playing your own game. Know your policies very well and play according to them all the time.
2. Keep it simple. Make fewer but better investment decisions
3. Concentrate on your defenses. Most of your time should be spent on selling decisions, not buying.
4. Don't take it personally

What I got out of it

I think Charlie Munger's wise words sums this up nicely - "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying, `It’s the strong swimmers who drown.'"

Faced with information that contradicts what they believe, human beings tend to respond in one of two ways. Some will assimilate the information, changing it so they can ignore the new knowledge and hold on to their former beliefs; and others will accept the validity of the new information. Instead of changing the meaning of the new data to fit their old concept of reality, they adjust their perception of reality to accommodate the information and then they put it to use. Psychologists advise us that the more important the old concept of reality is to a person – the more important it is to his sense of self-esteem and sense of inner worth – the more tenaciously he will hold on to the old concept and the more insistently he will assimilate, ignore or reject new evidence that conflicts with his old and familiar concept of the world. This behavior is particularly common among very bright people because they can so easily develop and articulate self-persuasive logic to justify the conclusions they want to keep
Major errors in reasoning and exposition are rarely found in the logical development of this analysis, but instead lie within the premise itself. The investment management business (it should be a profession but is not) is built upon a simple and basic belief: Professional money managers can beat the market. That premise appears to be false.
It appears that the costs of active management are going up and that the rewards from active management are going down
There are many other Loser's Games. Some, like institutional investing, used to be Winner's Games in the past, but have changed with the passage of time into Loser's Games
In plain language, the manager who intends to deliver net returns 20% better than the market must earn a gross return before fees and transactions costs (liquidity tolls) that is more than 40% better than the market. If this sounds absurd, the same equation can be solved to show that the active manager must beat the market gross by 22% just to come out even with the market net.
Only a sucker backs a "winner" in the Loser's Game

Summary