Simple But Not Easy: a second edition of a cult investment classic
A new edition of Richard Oldfield’s popular guide to investment continues to fly the flag for active management and the value style
Simple But Not Easy by veteran fund manager Richard Oldfield has achieved something like cult status since it was first published in 2007. Distilling a lifetime’s investment experience at a series of established funds and the author’s own, the book offers hard-won advice on what investors can realistically hope to achieve, and the many ways they can sabotage their own efforts.
A second edition was published late last year. I missed the first edition and am late to the second, which includes a substantial afterword considering how the investment landscape has changed over the past 15 years. I’m glad I finally got round to seeing what the fuss was about. It’s one of the most interesting finance books I’ve read, best categorised, perhaps, as fitting into the rather small genre of what might be called investment wisdom literature, bearing comparison with John Kay’s The Long and the Short of It and Mihir Desai’s The Wisdom of Finance. This is a longish review, but it only touches on the contents of a book rich with insight and packed with — often amusing — vignettes from the author’s career. In the acknowledgements Oldfield says he wrote it because he enjoys writing, and it shows: the author’s love of language shines through.
The value of equities
The book’s disarming tone is established from the outset with a lengthy opening chapter cataloguing Oldfield’s ‘howlers’, the mistakes and formative experiences that have helped shaped his investment worldview. He goes so far as to agree with sceptics that the ‘industry as a whole does nothing useful’, but with the critical proviso that the statement must be interpreted as a truism rather than a dismissal. In developed markets dominated by funds it logically follows that, over time, half of managers will outperform the index and half will underperform.
And though wary of what the industry can claim for itself, Simple But Not Easy is no manifesto for passive investing. Oldfield believes good active managers can beat the market more often than not, and that they are not as hard to find as the pessimists assume. The returns even the best managers can secure beyond the market return may be modest, but over the years those gains compound, and give portfolios an edge over the mass of passive products.
He thinks one very simple, but very important, thing good managers can do is to insist on the long-term value of equities. Quite simply, since modern markets emerged in the 1850s equities have generated a real annual return of around 6%, well beyond any other asset class. It’s easy to lose sight of that during the market’s frequent periods of volatility (as, indeed, at the time of writing this review). As Oldfield puts it in one of the book’s many memorable images: ‘Rather like reputations, which are built up over many years and can be lost in a trice, markets seem to stagger determinedly though haphazardly up an infinite staircase and to throw themselves precipitously down a flight or two from time to time — never more precipitously than in 2020, though the speed at which they afterwards climbed the staircase has been exceptional.’
But the facts don’t lie. Investors with the resources and temperament to ride out turbulent times should have a significant long-term stake in equities — around 80 to 90%. For Oldfield alternative assets are primary of use as psychological ballast during particularly scary bear markets, assuaging the investor’s perennial temptation to move out stocks just before they — inevitably — rise again. He likes a colleague’s adage that ‘equities are life, bonds are death’, but doesn’t quite go along with it. Bonds have proven their worth in certain market conditions (though not today’s). He doesn’t like hedge funds, which he considers much too expensive and too hard to pick in advance of good performance, and is sceptical about private equity for the same reasons. He acknowledges his aversion to bitcoin may be generational, but finds it hard to discern what merit investors of any age might find in cryptocurrencies. But he does like gold, which has mercurial qualities that make it an effective diversifier. It may be hard to locate any pattern in the yellow metal’s performance, but that is the point: it simply seems to float free in a world of its own beyond equities, bonds, cash, or property. Gold should be part of every portfolio ‘as a long-term investment, to be tucked away, not fussed over’.
Keeping faith with active funds
Turning to the active versus passive debate Oldfield is sympathetic to the many investors who put most or all of their money into index funds. He rather likes a ‘Rip Van Winkle’ approach allowing the value of passive investments to accumulate quietly in expectation that good times will outweigh the bad.
But he believes the big long-term shift to passive funds ‘is the product of a doctrine of despair’, an undue pessimism about the capacity of good managers to beat the market, and of investors to find those managers, or pick their own stocks. Blindly following the market does indeed ensure investors won’t miss out on gains from its strongest performers. But he notes that under the bonnet index funds indulge in some extremely odd behaviour. By way of example he highlights the peculiar gyrations of trackers at the onset of the tech crash at the turn of the millennium. In March 2000, on the eve of the collapse, the FTSE index committee replaced nine stalwart securities that had quietly been turning steady profits for many years with a set of high-flying, and as yet unprofitable, tech stocks. When the market turned the value of the new additions plummeted, taking the index with them. Very shortly afterwards the incomers were silently replaced by the very companies they had dislodged, an upheaval that any decent active fund would have avoided. Index funds, Oldfield fears, ‘have the serious disadvantage that they behave as lunatics.’
How, then, should investors pick these good active funds? Oldfield, acknowledging that ‘the investor is always trying to roll a stone uphill because active managers on average underperform’, dedicates perhaps the book’s best chapters to the conundrum.
He doesn’t believe the task has been helped by the increasing tendency of active funds to follow index funds — ‘to cling to the tails of a lunatic’. He laments the concept of ‘active risk’ that emerged when managers started to notice and worry about growing investor scepticism that their funds could beat the market, and began constructing their portfolios to closely follow the index. Oldfield believes such efforts have done ‘more harm to the investment management industry, at least in the UK, than anything else in the last 30 years.’
Indeed index-hugging tends to lead to worse performance than the indices themselves after — still healthy — management fees are factored in. Policing by risk control departments tasked with ensuring portfolios do not diverge too drastically from indices embeds textbook bad practice, leaving managers ‘always chasing their tail’, offloading shares that have just fallen, and buying, shares that have just gone up ‘a formula sure to result in underperformance’.
It also drives talent out of the bigger funds. ‘In the late 1990s,’ Oldfield believes, ‘despite the excitement of the rise in markets, the fund management industry became an enervating place … many clever and highly paid people became demotivated because they were now required not even to try: they were expected to imitate, more or less, the performance of the market index rather than attempt to outperform it significantly.’
The proliferation of indifferent index-hugging funds has at least opened new opportunities for good managers to shine, many of the disillusioned leaving larger companies to set up boutique funds giving them back their preferred stocks, with all of the attendant risks and possibilities. (The reader assumes that Oldfield, who set up his own fund some years ago, is one of them.) He notes, with wry amusement, that what he regards as no more than a return to classic investment principles is now regarded as somewhat exotic, investment consultants filing such ‘Long-Term Long-Only’ funds as an alternative investment class alongside hedge funds and private equity.
For Oldfield, then, good managers are those with the courage to construct portfolios that can differ quite radically from indices. They should ‘have convictions, of the noncriminal sort’ and be ‘able to express in a few sentences what their fundamental beliefs about investment are, and what they are looking for in making investment decisions.’ That doesn’t mean recklessness. The timeless wisdom of diversification still applies to the boldest of stockpickers. But Oldfield believes the virtues of concentration and diversification can be reconciled: there is plenty of evidence that it is possible to diversify a portfolio effectively with no more than 15 stocks. The ideal is a concise, adequately diversified portfolio bearing little resemblance to the index, that bears the stamp of its manager’s investment philosophy.
The composition of a well considered conviction portfolio need not change much. Good choices will reveal themselves over time. Indeed, against a workaholic industry prone to self-defeating hyperactivity Oldfield advocates the virtue of ‘constructive indolence’. He tells of ‘two excellent investment managers’ who during the great bear market of 1973–4 ‘used to pass the time by adopting a raindrop each and betting on which raindrop would reach the bottom of the window first. This was a more sensible way to spend their working hours than gratuitous buying and selling.’
He also has rather counter-intuitive views on the value of past performance: ‘Anyone meeting a Nobel Prize winner is likely to think that the Nobel Prize winner is highly intelligent, and is likely to be right. Anyone meeting an investment manager with an excellent performance record is likely to think that the manager must be good. Not necessarily. It may just have been luck. And even if it was not luck, it may have been the climate of the times, which could be about to change.’
Managers need to be given time to prove the worth of their strategy. Funds and their clients are too often tempted to change managers just before they run into good performance or performance turns bad. And for Oldfield that long-term good performance is best secured through the value style, which he believes tried-and-tested through ‘the all-powerful, simple, empirical truth that, based on market performance since 1880, if investors pay high price-earnings ratios then on average they get low returns and if they pay low price-earnings ratios, on average they get high returns.’
Value investing has a simple robust logic that ensures it always comes good — in the end. The expected return of an asset rises as its price falls, making a share price that has fallen ‘more interesting than it was before it fell’. What has come down, tends to go up. The mean reasserts itself. It’s a simple insight to articulate, but hard to embrace. We are naturally enthusiastic about things that are doing well and gloomier about those which are doing badly. It takes discipline to pass over high-flying stocks for those that have been overlooked, even when research indicates that those neglected stocks are due for renewal. But the truth is that ‘if the company involved is essentially sound, with scope for improvement, but an unduly low valuation, then in time the value is likely to be realised.’ On average value managers have, over the long term, outperformed growth managers.
Oldfield still holds by that in the book’s afterword, in which he reviews what he wrote back in 2007 in light of the market’s subsequent history. He acknowledges value investing has come under great pressure since then, a period during which — until very recently — growth stocks have surged ahead. But he sticks to the essence of what he said in the first edition, advocating ‘concentrated portfolios managed with individual accountability and no “committeeitis”, and consisting of shares held patiently in companies with basically sound businesses which are at low valuations because of the vagaries of fashion or because something has gone temporarily wrong.’ Writing the afterword last year, when value was still languishing, he believed the tide was about to turn, noting speculative stocks were as overvalued as they were back in 2000 when the tech bubble burst and value reasserted itself. And indeed something like that has happened over the past six months.
He also considers another significant development, the rise and rise of passive investment. As in the first edition he acknowledges the great virtue of index funds — they can’t fail, by definition. In the end active investment has only one selling point, ‘the potential for outperformance, a potential which ultimately has to be realised for it to be worthwhile’. But he retains faith in the capacity of good managers to prove their worth. Indeed, in perhaps the book’s boldest speculation, he ventures that ‘the next ten years could … be a golden decade for active managers’. Since index funds are driven by the performance of a cluster of big stocks — today, Amazon, Apple, Google, Microsoft et al — good active funds, which will hold them in much smaller quantities, if at all, stand to do well if the giants begin to underperform. ‘If this were to go on for a year or two,’ Oldfield suggests, ‘indexers would notice that their index funds were now underperforming active managers disproportionately. Some of them might then hurry back to active management. This would magnify the underperformance of index funds; the hurrying of a few could become the hurtling of a herd.’
Time will tell. Overall, though, Oldfield remains acutely aware that the investment philosophy he advocates is a hard sell, asking much not just of active managers but of their clients as well, who must be prepared to make the effort to find good stock pickers, and summon the discipline to stick with them through thin periods. That’s difficult when money is at stake, and time is finite. As Keynes so memorably put it, in the long run we are all dead.
Oldfield concludes with another encomium to the virtue of patience, noting that ‘the Latin word from which patience is derived is also the root of the word passion, and the biblical meaning of passion is suffering. Unfortunately, investors concentrating on apparently deeply undervalued shares have to have a great capacity for suffering, because there will be many periods in which the thing that they are patiently waiting for takes an awfully long time to happen, and they may suffer a great deal while it is not happening, and have to be pretty passionate about it.’
Not all will be convinced of Oldfield’s case, and he doesn’t expect they will be. I myself, as I’ve expressed elsewhere on this blog, am rather more positive about the merit of passive investment than he might be. But the author’s modesty is perhaps the book’s greatest virtue, making this a thoroughly likeable guide to the nebulous world of fund management, one that the thoughtful investor can read for both profit and pleasure.