The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority «go with the flow,» either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other inefficiencies in market pricing, but this is by far the largest. It explains the discrepancy between a remarkably volatile stock market and a remarkably stable GDP growth, together with an equally stable growth in “fair value” for the stock market.

Career risk and the resulting herding it creates are likely to always dominate investing. The short term will always be exaggerated, and the fact that a corporation’s future value stretches far into the future will be ignored.

Career risk is not evenly spread across all investment levels. Career risk is very modest, for example, when you are picking insurance stocks; it is therefore hard to lose your job. It will usually take 4 or 5 years before it becomes reasonably clear that your selections are far from stellar. Picking oil, say, versus insurance is much more visible and therefore more dangerous. Picking cash or «conservatism» against a roaring bull market probably lies beyond the pain threshold of any publicly traded enterprise. It simply cannot take the risk of being seen to be «wrong» about the big picture for 2 or 3 years, along with the associated loss of business. Remember, expensive markets can continue to become obscenely expensive 2 or 3 years later, as Japan and the tech bubble proved. Thus, because asset class selection packs a more deadly punch in the career and business risk game, the great investment opportunities are much more likely to be at the asset class level than at the stock or industry level.

Keynes said in the famous chapter 12 of his General Theory that «the long-term investor, he who most promotes the public interest … will in practice come in for the most criticism whenever investment funds are managed by committees or boards.» He, the long-term investor, will be perceived as «eccentric, unconventional and rash in the eyes of average opinion … and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy.» (Emphasis added.) However, you can apparently survive betting against bull market irrationality if you meet three conditions. First, you must allow a generous Ben Graham-like «margin of safety» and wait for a real outlier before you make a big bet. Second, you must try to stay reasonably diversified. Third, you must never use leverage.

Too big a safety margin and we believe we are leaving too much money on the table; we are probably protecting our job rather than attempting to maximize our clients’ return. Too narrow a safety margin and clients may fire us. I believe this is not good for us or our clients, who tend to rebound into much different portfolios, often, given the circumstances of an extremely mispriced market, at a very inauspicious time. It is, of course, a central dilemma of investing. Of all of the investment issues close to my heart, career risk is in my opinion the most important.

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