In active investing, the word “edge” is often used. For about four years, I worked as an institutional allocator, meeting and studying investment managers, evaluating their strategies and capabilities. “What is your edge?” That is a popular question that allocators are trained to ask, and investment managers are trained to answer.

To this popular question, I have heard many popular answers:

• “My edge is that I have worked X number of years under a famous hedge fund manager”;
• or, “I have spent Y number of years in the ABC industry so I have built an unparalleled network of connections”;
• or, “I manage both a private book and a public book and these private investments gave me special insights into public companies”;
• or, “I used to manage a sector-focused team with Z number of analysts under me so I have a track record of running my own show”;

And the list goes on and on.

Not only are their stories compelling but so are their resumes. Almost all investment managers studied at prestigious universities and have worked for blue-blood institutions. Can’t be better.

“Good Students”

A few weeks ago, I had a chat with a Managing Director of an asset management firm. Talking about the capabilities of the MD’s research team, the MD thought about it for a second and said, “They are just good students.”

Also recently, I had the privilege to sit down with a former Chief Investment Officer of a university endowment. We shared the observation that high-performing investment analysts, collectively as a group, do not have a great track record of launching successful investment funds — with “success” defined by investment results, not fundraising results. That CIO then made a comment on these high-performing analysts, “They are just good students.”

“Conventional Edge”

Here, I propose a term called “conventional edge,” and I define it as follows: A set of advantages possessed by an investor that are also possessed by many other investors. Let me expand on this a little bit.

When I was in business school, I learned that most active investment managers have failed to outperform the general stock market. Later, when I worked as an institutional allocator, I saw with my own eyes that, over the long run, nearly every professional investor has failed to produce a net-of-fees investment result that can match that of the S&P 500.

Investment managers are highly educated and well trained. Most of them work extremely hard. They share similar goals of discovering mispriced opportunities so as to make a profit from them. Think about this dynamic. Close your eyes for a second. What do you see? Extreme competitiveness!

In such an environment, individuals’ conventional advantages get neutralized — you are good at doing ABC, I am good at doing ABC too; you learned to do XYZ, I know how to do XYZ as well; the edge you think you possess, a large number of other investors have that too. Collectively, almost no one’s advantages really count.

It is like throwing 100 Muhammad Alis into a boxing ring. For any spectator watching such a game, no spectator will be able to tell on a consistent basis which Muhammad Ali will win. And, for such a game, there are almost no consistent winners. The result is certain. And certainly, we see this kind of result in reality.

Good students are good because they have the best transcripts, the best presentations, the best resumes. They excel because they know how to work in a way that can get teachers to issue them the highest scores, and get bosses to issue them the highest job ratings. For “good students,” it is paramount that they minimize the chance of producing something that will be laughed at — because that is what bad students do, what bad employees do.

So, the idea of “conventional edge” comes in handy here. It captures the dynamic that exists in the investing industry today. It is not that these people are not talented, but that their edges are too conventional. They are too conventional because there are too many people who also share something similar if not identical. Almost everyone is a “good student.” And it becomes a big problem for everyone. Everyone is “good.” Few can be “better than others” in a material way that allows one to get ahead of the rest on a sustainable basis.

Unconventional

In his book Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, David Swensen wrote the following:

“Even with adequate numbers of high quality personnel, active management strategies demand un-institutional behavior from institutions, creating a paradox few successfully unravel. Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.”

Some 60 years before Swensen wrote the above, John Maynard Keynes wrote the following:

“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

Careful readers would have noticed that in the title of Swensen’s book, there appears the word “unconventional.” That book was first published in 2000.

Careful readers probably have also observed this phenomenon — as I called out in a blog piece I wrote earlier this year (link) — most institutional investors today have studied the “Yale Model” and many of them are trying to follow the same approach. And I wrote in that blog piece: “The model has been so widely imitated that at this point, everyone knows how to do what to do, everyone is doing pretty much the same thing, so as a result, institutional investing has become more competitive than ever.”

Ironically, what was unconventional 24 years ago is conventional today. The quality of being unconventional then contributed to Swensen’s success. The quality of being conventional today seals the fate of imitators’ results: Mediocrity!

What is unconventional at one time can become conventional at a later time. One cannot achieve an edge by just imitating what was unconventional before — by doing so, one is likely to get a “conventional edge” and, unfortunately but almost certainly, a lot of mediocrity.

And that, naturally, brings me to the next point.

Cannot Be Taught

In my 2021 reflection (link), I wrote: “Investing can be learned but cannot be taught. Any tactic that is systematically taught has probably already been arbitraged away.” Over time, I have increasingly come to believe that successful active investing cannot be systematically taught.

Think about these three cases:

• If successful active investing can be systematically taught, why do we not see any academic institution with a great track record of producing investors who can produce superior investment results on a consistent basis?
• If there is indeed a “Holy Grail” in active investing and can be identified exactly and described precisely, why are there countless books written on investing? One book would be enough!
• If there is some “secret sauce” to successful active investing that can be passed on through generations, why do we not see any “family dynasties” among active investors?

In most fields, we have “family dynasties” of generations of a family excelling in a specific endeavor. In medicine, we have the Mayo Family. In politics, we have the Kennedy Family. In music, we have the Bach Family. In banking, we have the Rothschild Family.

In active investing… I don’t know even one!

Ask yourself: Do you know any highly successful active investors whose children are also extremely successful in producing superior investment results?

If loving parents cannot teach successful investing to their children (who also share similar genetics), I am not sure any other mechanism can allow successful investing to be taught to a person!

That is why I say: Successful investing cannot be systematically taught. Conventional edge, it is largely copy and paste. For “real edge,” you have to figure it out yourself.

“Real Edge”

What constitutes “real edge” then? I think about this question often. My best answer, as of now, is the following:

• Passion
• Discipline
• Pattern recognition
• First-principle thinking
• Mental strength

Being unconventional is simply an output of exercising the above qualities.

Being conventional is the opposite of the above qualities: “It’s just a job”; “Let’s copy that guy’s method”; “I am feeling so bad watching other people’s portfolios going up; I must buy this same set of stocks now so I can feel better!”

Conclusion

Perhaps, real edge in investing cannot be described and narrated. Or, at least, real edge in investing simply cannot be taught.

Real edge comes from oneself, not from one imitating others.

In early 2020, I predicted in advance oil prices would turn negative. I shared with other investors my prediction. Some people laughed at my idea, calling it stupid and ridiculous.

Over 2,000 years ago, back in ancient China, two philosophers had already recognized something.

Zhuangzi: There must first be a true person, before there can be true knowledge. (庄子：先有真人再有真知。)

Laozi: When a superior person hears of the Way, they diligently practice it. When an average person hears of the Way, they sometimes keep it and sometimes lose it. When a foolish person hears of the Way, they laugh loudly at it. If they did not laugh, it would not be the Way. (老子：上士闻道，勤而行之。中士闻道，若存若亡。下士闻道，大笑之。不笑不足以为道。)

Real insights, in the eyes of the average, look stupid, wrong and laughable — or these would not be real insights in the first place. Wait, isn’t that what Swensen wrote and I quoted above?

Throughout millennia, from the East to the West, true knowledge, real edge, share the same origin.

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