What Happens When Markets As We Know Them Cease to Exist

SPEAKER_1 (0:00)

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Tracy Alloway (0:25)

Thank you Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. My normal co-host, Joe Weisenthal, is away this episode, but don't worry, I've found the perfect replacement.

It is Bloomberg reporter, Sid Verma.

Sid Verma (0:40)

Hi there.

Tracy Alloway (0:41)

So, Sid, you're filling in for Joe today. That means that we get to talk about whatever we want basically, right?

Sid Verma (0:47)

Definitely. I mean, yeah, let's be postmodern and talk about anything.

Tracy Alloway (0:51)

All right, so speaking of postmodernism, I have a complaint, and it's a grievance of mine, which is, you know, whenever people tell you that you should pursue your dreams.

Sid Verma (1:03)

Oh, you're talking about the positivity industrial complex that runs America.

Tracy Alloway (1:11)

I wasn't quite talking about that. But you know, if you want to be an actress, you should try to be an actress. That's like the classic one. Or if you want to be an astronaut, you should try to be an astronaut. And then you always hear these big success stories from all these people, right?

Sid Verma (1:25)

Of course, it's awful.

Tracy Alloway (1:26)

There's a word for it, though, right?

Sid Verma (1:28)

I believe in managing expectations.

So I wish that I fail. And then if I succeed, I'm pleasantly surprised.

Tracy Alloway (1:38)

OK, but the fact that we focus on all these celebrities who have succeeded in life, and they're sort of our base standard, there's a concept that we use for that, and it's called survivorship bias, right? And that's basically the mistake we make that by concentrating on the people or things that survived some certain process or situation, that that's kind of like the norm, right? Just because they did it, they're there.

Sid Verma (2:05)

Of course, yeah. Losers don't matter. That's how the whole world is framed.

Tracy Alloway (2:10)

Winners write history is also a classic example. OK, so believe it or not, that concept can also be applied to the markets.

Sid Verma (2:19)

Yeah, I guess create a destruction of capitalism is another way of putting it.

I'm trying to be really alpha male here. And I'm going to ask Simon, why does it matter? You know, survival of the fittest, destruction of capitalism. Why is this a problem? That's what I'm going to be doing.

Tracy Alloway (2:38)

Well, you just gave away our guest. We have the perfect person here with us to talk about survivorship.

It's Simon Henrickson. He works on the multi-asset team of First State Investments, and he has authored a fantastic paper all about this topic.

Sid Verma (2:53)

Awesome.

Tracy Alloway (2:54)

Should we bring him on?

Sid Verma (2:54)

Definitely.

Tracy Alloway (2:55)

You already gazumped me.

Sid Verma (2:57)

I skimped you.

Tracy Alloway (3:08)

All right, Simon, thank you so much for joining us today.

Simon Hinrichsen (3:10)

Thank you for having me.

Tracy Alloway (3:12)

So, I used that example about us focusing on successful celebrities as the sort of baseline norm. Do you think that's the right way of looking at survivorship bias?

Simon Hinrichsen (3:24)

I think it's a pretty good way of looking at it. In finance, you often hear things like equities are going to do better in the long run. And there are certain managers and fund managers who are celebrated for their ability to beat the market.

Well, oftentimes, what we miss are these really, really big events that either destroy whole markets or, as you say, sometimes people are just lucky. So if we look at equities over the long term, well, what people often mean is that the US or the UK's equity markets or developed markets have done really well.

But what they don't necessarily mean are all the countries that didn't make it. Now, if we talk about fund managers, well, imagine that you have a hundred people where you gave them money and each had to try to beat the market. Inevitably, at some point, you're going to have someone who's going to look like a genius, but someone is always going to end up looking like that. It's just chance. And it's really important not to conflate luck with ability, but it's also really important to be able to distinguish are we actually falling for the survivorship bias when we look at investments, and does that mean that you have massive concentration risk in your portfolio? Right.