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Sunday, January 6, 2008

Great Investor theory

Yesterday, while reading some comments on the net about Benazir Bhutto’s ghastly but all-too-predictable fate, I came across references to something called the Great Man theory of history. This theory seeks to explain the events of history primarily as the result of the actions of a handful of ‘great men’ (and women, obviously). According to the Great Man theory, if certain individuals had not existed or had acted differently, then history would have taken an entirely different course than what it eventually took.

To take an obvious example, think of how India’s independence struggle would have differed if Mahatma Gandhi hadn’t existed or whether the Second World War would have happened at all had Adolf Hitler died in the First World War. There was a time when this was the predominant view of how history takes the course that it does. I remember that when I was studying in class four in school, each chapter of my history text book was a brief biography of a king or an emperor or someone like that.

Of course, school textbooks often lag behind leading edge academic views by a wide margin and in fact, the Great Men theory has been out of favour for many decades now. Nowadays, I believe that historians like to trace out broad economic and social changes and how those impact the lives of people. However, personally, I can’t quite bring myself to believe that individuals are irrelevant.

People’s actions matter. Leadership matters. There are individuals who act at crucial points in history and are able to influence events. It is true that they can only act within the constraints of broader historical forces but that isn’t quite the same thing.

But what does all this have to do with making money out of your investments? Well, this whole individuals-Vs-trends argument is actually a useful way of understanding investment management. In investment management, there is what I could name the ‘Great Investor’ theory. The Great Investor theory posits that there are investors (or investment managers) who can wring profits out of any kind of a market and in the middle of any kind of trend. The opposite is the notion that by and large, investment portfolios follow the fate of the broader Markets and trends.

A bad investor can do much worse than the trend but even a good investor can’t do much better for too long.

Eventually, the trends win out and the Great Investor turns out to be just someone whose luck worked better than others. Which of the two is correct? Are there great investors? Or are they all just riding trends that anyone could have ridden? I think it’s self-evident that the truth must lie somewhere in between.

The mass of people just ride the trend but there is a progressively smaller number of people who are progressively better investors. At one end of this continuum there may be individuals who qualify as great investors. Maybe.

However, when the trends and the general direction of the Economy are as they are in India for the last five years, then there is another risk -that of too many people concluding that they are great investors!

The fact is that almost all investors have earned Great Investor-type returns by doing nothing but follow the trends and it might be useful to recognise and remember this while making investment decisions.

The author is CEO, Value Research


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