The Independent Market Observer

The Science and Art of Investing

Posted by Anu Gaggar, CFA, FRM

This entry was posted on Sep 24, 2021 10:00:00 AM

and tagged Commentary

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Both science and art are essential to strategic investing, according to Commonwealth’s Anu Gaggar.“There is an art to science, and a science in art; the two are not enemies, but different aspects of the whole.” Isaac Asimov

Is cooking an art or a science? If I have the ingredients for a recipe and follow the directions to a T, we would classify the process as a science, right? Anyone who follows the recipe and uses the same ingredients should be able to produce a dish that tastes exactly the same. When I follow the same recipe multiple times, my dish should taste the same every single time. Yet the connoisseur chefs among my readers know this theory could not be further from the truth.

How about when we apply this concept to investing? Based on the way investing buffs talk about financial analysis, ratios, spreadsheets, and technical graphs—all concepts that lend themselves to precision—investment analysis seems to be categorized as a science. Most investment professionals pursue degrees and educations in learning the theoretical frameworks of investing. Why, then, do their investing outcomes differ? Why did Long-Term Capital Management, the famed hedge fund run by a dream team of the best minds of Wall Street, academia, and the government, fail in 1998? Perhaps it was because investing requires “the passion of the scientist and the precision of the artist,” to borrow a well-known saying of writer Vladimir Nabokov. Applying one without the other may not result in long-term success or a repeatable investment process.

The Science

Let’s look at how Commonwealth’s Investment Management team invests client portfolios. We follow strategic asset allocation models that have long track records and are rooted in academic research. Our investment philosophy focuses on the long term, so it’s important for us to identify managers with a similar approach. Furthermore, managers must do what they say they do. We start with a quantitative screening process to narrow our universe of fund managers. Each search results in a unique screen based on the asset class and model at hand, and these screens typically capture several metrics for positioning, risk, and performance.

I’ve intentionally mentioned performance last. We believe performance is an outcome of a process—and should be used as a tool to test the robustness and consistency of the underlying process. We aren’t necessarily looking for the absolute best-performing manager; instead, we want to find the best manager to perform within a portfolio concept. We employ quantitative metrics for ongoing due diligence of the managers on the platform. All in all, the scientific element constitutes about 15 percent to 20 percent of our overall process.

The Art

Once armed with scientific knowledge, our Investment Management team focuses on the qualitative component of evaluating managers. In this step, which is where we often spend the bulk of our time, we evaluate the five Ps—people, process, philosophy, performance, and positioning. This evaluation entails understanding a manager’s philosophy and process and, most important, the people running the show. Philosophy is important as it helps us picture the colors of the manager’s stripes, while process is where the rubber hits the road. We want to have a solid understanding of the people tasked with running a strategy, as they are the cogwheels that keep the machine running.

Last, but certainly not least, we consider positioning. Before we make any decisions, we return to the quantitative part of our process, to identify how adding a manager to the portfolio may affect the exposures, performance, and risk, relative to the other managers we use across asset classes. This step is akin to piecing together a jigsaw puzzle. There is no magic formula or secret sauce to what we do here. Our process marries the best of quantitative and qualitative analysis by combining the science and the art of both. Our ability to consistently apply our process depends on having the right balance of scientists and artists on our team. And this balance is what helps us act as prudent stewards of client assets.

A Blended Approach

Thus, the science of investing gives us the road map to get from point A to point B of our financial goals. The art of investing deals with the uneven terrain and roadblocks that we encounter on this journey, while helping us identify the blind spots, or the unknown unknowns. The key takeaway is that investors need to use the functions of the left brain to deal with the scientific aspects of investing, such as areas that can be learned through experience or training with a fair degree of precision.

Investors should also leverage the right side of the brain to account for the creative, imaginative, intuitive, and behavioral aspects of investing. Although some people are gifted with a balance of left and right cognitive abilities, many of us need to enlist the help of other professionals to fill the gaps in our skills sets and be our partners in our financial journeys.

Commonwealth’s Investment Management team strives to be the partner doing just that for our advisors. We help manage their clients’ portfolios with an institutionalized, repeatable, and transparent process, while providing advisors with the time, scale, and capacity to run their practice.

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