Confession time: I never got into that “must-watch” show "The Wire."
Maybe the first episode was just too slow for me. Maybe I had a hard time getting interested in the characters. I have no idea to this day. Hey, everyone’s different.
But what got me to finally get through the entire pilot episode (on my third attempt), was a friend of mine. He suggested I look at it as a show where organizations and institutions have reached what is known as an institutional imperative.
That’s where an organization exists to continue existing, with its core purpose long-forgotten.
The institutional imperative is why our educational and healthcare sectors have seen the fastest growth in administrative jobs, rather than front-line teachers and doctors. The organization is expanding to meet the needs of the organization, as the old bureaucratic slogan goes.
Somewhere along the line, end-users are still there and still important. But not to all people in the organization. They’re thinking about their specific department. And how to grow their department to increase their own prestige.
Companies that grow bloated bureaucracies are the same way.
Cutting out middle management and streamlining operations can lead to huge value creation for shareholders. It’s something to look for in a potential investment, particularly when new management is brought in.
Companies that adhere to their imperative for too long will find it too difficult to make necessary and painful changes down the line. It may even cause a seemingly invulnerable company to go belly-up.
The problem with institutional imperative is that it’s far broader than the institution. It also comes down to the thinking behind it. And usually, that thinking is done by an expert.
Look, experts are great. I have a great and honest mechanic, and rely on their expertise to keep my car running. I talk with other investors, and tend to weigh their advice based on their past success.
Experts are only smart in one area, however. Yet we tend to assume a far wider pretense of knowledge. My mechanic might not have knowledge of your model of car. A great investor might have a horrendous personal life.
In other words, outside their area of expertise, experts are dumb. And that area is small.
Consider this: Some of the smartest minds in finance started a fund called Long Term Capital Management in the mid-1990s. How smart? Nobel-prize winning smart.
It had a few great years following a well-known options pricing model and looking for price mismatches in the bond market.
But they became a victim of their own success. The models could only predict past behavior, not future ones. The fund imploded in 1998. It required a bailout to deal with the trillion-dollar portfolio they had built up to 40-to-1 leverage.
But they, too, had an institutional imperative to use their models and formulas into increasingly esoteric investments to find better returns. They ended up owning illiquid Russian bonds right as the Ruskies decided to stop paying. The models that worked for U.S. government bonds didn’t work for a country that had just emerged from decades of communism and had limited trading history.
Look, in some places we’re the expert.
But some humility grants perspective. I know that I don’t know about a lot of things. That’s why I consider myself an idiot at most things. In most areas, that’s a statement of fact, not an insult.
Recognizing where you’re an idiot will allow you to avoid those to focus on your strengths. And keep your ego in check. Pride goeth before the fall, and what is pride but a false sense of expertise?
Out of what I do know, investing and the stock market are the area where I’d consider a modest level of expertise.
But even there, the market is going to throw curve balls that I won’t recognize. By sticking to that small area of what I do know, I build and grow an advantage.
For instance, when it comes to investing I can’t compete with high-frequency traders. No humans can! They’re computer programs designed to do one thing in a fraction of a second each time.
Since I can’t compete with that, what I can do is work to build a long-term track record instead. That’s where I see the real value. That’s particularly true in a world increasingly dominated by short-term thinking and automation. It’s where the interest isn’t going that creates a smaller playing field to potentially dominate.
In investing, I find I get a lot of value out of finding areas where the experts are dumb. One trait I follow is that I tend to run a concentrated investment portfolio. It goes against traditional investment advice set by those pesky experts.
But running a concentrated portfolio and running it well lead to far better returns over time than buying, holding, and accumulating dozens of positions. If you’re going to do that, just buy a market index.
If you’re looking to beat the market, you have to act differently. I was buying shares of quality companies in late December when the markets were avoiding their traditional holiday cheer. That was after months of taking profits, collecting dividends, and otherwise sitting on my hands in the middle half of last year. Sometimes the best active investors are pretty darn inactive.
Find where you’re competitive. Find where you’re the relative expert. If it’s an odd intersection, it’s far easier to dominate at any one thing. If your skillset matches many others, acquire more skills. Ideally, ones that compliment what you already know, but in a different industry where such a combination is rare.
So consider the experts. But know when they’re outside their area of expertise. That’s what gives you an edge.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.
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