Please, No More Success Stories

Last Saturday’s Globe and Mail featured a story about one Mike Henderson, a retired university professor who has enjoyed staggeringly good returns over the last decade. While chumps who invested in a Canadian index fund settled for a 72% total return over the last ten years, Mr. Henderson shot the lights out with a 305% windfall.

How did he reach investing nirvana? With a “blazingly simple, must-have portfolio” of seven carefully selected stocks. “I basically sat down and thought, what is absolutely essential to our society, and who provides those essentials?” says Mr. Henderson.

I don’t want to take cheap shots at this gentleman, and I don’t begrudge him his investment success. This isn’t personal. But I do think there is a danger in stories like this. The clear implication is that if you just follow the same strategy, you too can beat the market. I’m not buying it.

A keen grasp of the obvious

So many investing success stories begin with the premise that picking winning stocks is just common sense. Big line at the Tim Hortons drive-thru every day? Then it must be a great company. The population is getting older? Buy health-care stocks. Governments pouring trillions into public projects to stimulate the economy? Invest in infrastructure. In the case of Mr. Henderson, it was just a matter of identifying “what is essential to our society.”

The problem here isn’t that these observations are wrong: it’s that they’re glaringly obvious. It’s what Larry Swedroe calls confusing information with knowledge: “Ask yourself: ‘Am I the only one who knows this information?’ If the answer is no, the market has already incorporated that information into prices — and the information can’t be exploited.”

Does Mr. Henderson truly believe that identifying good companies in key economic sectors is a unique insight? Funny how it didn’t occur to the 96.7% of Canadian equity fund managers who failed to beat the market benchmark over the last five years.

Some essentials are non-essential

A solid investment strategy can be clearly defined and consistently applied, and Mr. Henderson’s fails on both counts. The idea described as “blazingly simple” is, in fact, stunningly arbitrary.

Using his “essential” criteria, he decided that modern capitalism runs on pipelines, banks and railroads. Then he loaded up on seven stocks in these sectors: Fortis, Enbridge, TransCanada, TD Bank, RBC, CN Railway and CP Railway.

I’m curious why pipelines made the cut, but not the oil and gas producers that fill those pipes. Why are railroads essential to society, but not cars or airplanes? Why banks, but not insurance companies? And where are the companies that produce our food, build our homes, or make the medicines that save our lives?

The fact is that Mr. Henderson took a hugely concentrated bet on three sectors and he got lucky. His portfolio is hopelessly undiversified, and a serious problem with one or two of his companies would have blown him to bits. To suggest other investors can learn from his “strategy”  is ridiculous. There is no strategy.

“All my stocks were winners except the losers”

All of this would be reason enough to cancel the parade, but it gets better. Near the end of the article we learn that, “The Essentials Portfolio has been the core of Mr. Henderson’s retirement fund for years, but it’s not all he owns.” He’s also had “some success” with income trusts, and he has a “gambling account.”

So Mr. Henderson used his keen insight to identify seven stocks that would go on to beat the market over the next decade. But he also invested in a lot of other stocks that didn’t beat the market. (“Some success” is an investing euphemism for “very little success.”) Of course, we don’t know what those losers were, or what blazingly simple criteria he used to select them. Do you think it’s possible that our market-beating genius is using some selective reporting here?

It’s so easy to be seduced by stories like this. Who wouldn’t want to be profiled in the media as an investment czar who picked all the big winners?  No one wants to read about the guy who is broadly diversified, keeps his costs low, accepts that he’s not smarter than the market, and accepts a tracking error of 0.5% — geez, I’m falling asleep just writing this sentence.

Wake me up in 30 years so I can check my portfolio.