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In this brilliant article, Kris talks about the importance of trying to "shorten the feedback loop"?
How does a fundamental manager "shorten the feedback loop"?
I don't do anything that looks like "fundamental investing" but I couldn't stop thinking about the problem...
1/10 https://twitter.com/KrisAbdelmessih/status/1333930524272975872
How does a fundamental manager "shorten the feedback loop"?
I don't do anything that looks like "fundamental investing" but I couldn't stop thinking about the problem...
1/10 https://twitter.com/KrisAbdelmessih/status/1333930524272975872
I think of the returns from "fundamental investing" coming from two sources...
1. Risk Premium - The tendency of risky assets to be relatively cheap vs their expected cashflows. This leads them to "carry" more than they would if their real cashflows were riskless
2/10
1. Risk Premium - The tendency of risky assets to be relatively cheap vs their expected cashflows. This leads them to "carry" more than they would if their real cashflows were riskless
2/10
2. Mispricing - For behavioural/structural reasons, some assets are under/over-priced vs a reasonable estimate of their ex-ante "fair value".
On average, we expect them to converge towards fair value over some long time horizon.
This is "alpha" in fundamental investing
3/10
On average, we expect them to converge towards fair value over some long time horizon.
This is "alpha" in fundamental investing
3/10
As @KrisAbdelmessih explains, it's hard to tell if you have any skill in this mispricing game because the "time to convergence" ("the feedback loop") is soooo long.
So most of us avoid the game most of the time because we can.
Easier games available. Too hard basket.
4/10
So most of us avoid the game most of the time because we can.
Easier games available. Too hard basket.
4/10
In some domains, it is easy to see how you might shorten a long feedback loop.
If I want to predict the winner of the English Premier League I can get good shorter feedback from my predictions vs the outcomes of individual matches.
5/10
If I want to predict the winner of the English Premier League I can get good shorter feedback from my predictions vs the outcomes of individual matches.
5/10
I can get even shorter feedback by looking at the rate of goal scoring within a game.
I can get different feedback from *other factors which are highly correlated with match result*, such as "shots on goal", or "number of corners".
6/10
I can get different feedback from *other factors which are highly correlated with match result*, such as "shots on goal", or "number of corners".
6/10
It is hard to find analogs in trading convergence on fundamental asset mispricing.
If we lower the time period we're looking at we tend to simply observe noise.
In investing, there are no easily-idenitiable "matches" for us to test our ability against.
7/10
If we lower the time period we're looking at we tend to simply observe noise.
In investing, there are no easily-idenitiable "matches" for us to test our ability against.
7/10
And the market tends to be so efficient that any fast-converging factor we can identify will only be *very noisily related* to our objective (long-run expected convergence.)
In investing, our "corners" and "shots on goal" are only very weakly correlated to our result.
8/10
In investing, our "corners" and "shots on goal" are only very weakly correlated to our result.
8/10
I tend to avoid these games for these reasons - and because I can.
There are easier games to play: risk premia and quicker flow-based mispricings.
But I'm interested in how a good fundamental investor would try to navigate the challenge of "shortening the feedback loop".
9/10
There are easier games to play: risk premia and quicker flow-based mispricings.
But I'm interested in how a good fundamental investor would try to navigate the challenge of "shortening the feedback loop".
9/10
If you are a fundamental manager you don't have the option of the "Too Hard Basket"
How do you approach this?
10/10
How do you approach this?
10/10
