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How Investing is Like Tennis
Plus May Market Report

John Gorlow | Jun 16, 2018

I was a competitive tennis player in high school. For that I can thank my father, who learned to play on the red clay courts in Brooklyn and taught me what he knew. I watched him parlay above-average skills into quite an extraordinary game by learning the fundamentals and playing regular doubles matches with skilled competitors. My own game evolved from his example. So did my approach to investing. More on that after a quick look at May markets.

May Market Report

The S&P 500 Index posted a 2.41% return in May after adding 0.38% in April. These back-to-back gains reversed the negative runs of minus -2.54% in March and minus -3.69% in February, leaving YTD returns for the index at 2.02%. Despite the recent increase in volatility, the trailing twelve-month return for the index remains above the historical average at 14.38%.

The S&P Small Cap 600 Index continued to move higher, returning 6.46% for the month after returning 1.03% in April and 2.04% in March. For the three-month period, the Small Cap benchmark returned 9.75% versus a measly 0.19% for the S&P 500. YTD and trailing twelve-month returns for the Small Cap index climbed to a healthy 8.17% and 22.72%, respectfully.

International Developed Markets remained volatile, giving back -1.9% in May, leaving YTD returns for the index in the red by negative -1.69%. For the trailing twelve months, the International category added 8.33%, in line with historical returns. International Small Caps also reversed course in May, returning negative -0.71%, leaving a YTD return slightly in the black at 0.30%. For the trailing twelve months, International Small Caps returned a solid 14.2%.

Emerging Markets ended the period on a four-month losing streak, returning negative -3.54% in May, and dragging the YTD return to negative -2.42%. The one-year return is 14.03% and the trailing two-year annualized return is a robust 20.53%.

To recap, Global Equity returns are barely in the black YTD and down about -1% for the trailing three-month. But for the trailing twelve-months, Global Equities returned a solid 11.84%, which is above average.

U.S. Real Estate Securities (REITs)continued a positive streak, returning 3.98% in May after adding 1.48% in April and 3.88% in March. International REITs fell short in May, returning negative -1.17% after climbing in March and April.

Fixed Income: The 10-year U.S. Treasury Bond traded as high as 3.13% (the highest since 2011), but closed the month at 2.87%, down from last month's 2.95%
Commodities: Oil continued to move higher for most of the month, passing $72 per barrel, but then closed much lower, at $66.93. Gold was down for the month, closing at $1,303.00 from$1,316.10 for April. The Bloomberg Commodity Total Return Index added 1.42% in May after returning 2.58% in April, bringing its twelve-month return to a healthy 11%.

Don’t Try to be a Pro

It’s tennis season again, always my favorite sports season of the year. Last week I watched Rafael Nadal plow down his opponents to win his 11th French Open title. Nadal’s game was described as a “complete performance, a complete demolition, brutal, breathtaking and brilliant.”

The rest of us will never approach that level. But that doesn’t mean you can’t turn above-average skills into a polished game and winning streak. This point is made with hilarious insight in one of my favorite books about tennis. It’s called Extraordinary Tennis for the Ordinary Player by Simon Ramo, Ph.D. (He earned two doctorates at Caltech, one in Physics and one in Electrical Engineering.) Published in 1970, the tone is witty and wry. The language is dated but the lessons aren’t.

Mr. Ramo, himself an above-average tennis player, observes that “People think there is only one game called ‘tennis.’ Actually, there are two...Most tennis players have no business playing one of them. They cannot do it well, and they lose some of their happiness by trying. But it is worse than this. What they actually do is play one game while thinking they are playing the other. It is like being a cat while thinking you are a dog.” 

He goes on to describe the difference between ordinary and pro tennis. The chief distinction being that ordinary players try to imitate pros but end up being “undistinguished, of average capacity, a little dull to watch, more commonplace than inspired.”

Pro tennis is a singles match in which the first serve is ferocious, the second serve easier but generally inside the lines. Pros warmup. They don’t get distracted. In contrast, ordinary players chat, warm up half-heartedly, casually hit balls out of bounds, and after many misses say, “Let’s get started, first serve in.” The first few games are really “just an extended warm-up period.”

How many investors think they are big dogs, imagining they are capable of playing a pro game and beating the benchmarks? Maybe you were once one of them. How many “Let’s get started” moments have you had, thinking, “This time I’ve got it, I’ve seen how it’s done.”

Let’s say in this case the “pros” are active investment advisors who promise to up your game. In every tennis game, there’s a 50% chance of losing. In investing, the loss rate is much higher. Over the five-year period ending December 2017, 85% of active investment managers underperformed ordinary index benchmarks. Similarly, over the fifteen-year investment horizon, 92% of active managers failed to beat their indexes.

And yet hope springs eternal. Some investors fare better than others…some advisors wallop the benchmarks. We can be that person, or find that person! Ramo dissects that idea as he describes individual players in a doubles game: “Let’s assume that though these players vary, they share mediocrity.” They all make different mistakes. When mistakes are randomized, the point is to capitalize on the errors of others, and ultimately, to make fewer of them yourself.

That’s a heck of a strategy for winning: don’t make more mistakes than the other guy. Many investors also believe, perhaps unconsciously, that they can make up for past mistakes. They carry on like tennis players, making “botches” (“you have to lose the ball in an inexcusable way”) or “sons of botches,” which Ramo describes as a lost point set up by your previous botch. Sons of botches are often more costly, as they compound a loss. A lot of misplaced blame is involved as the original botch is overlooked. The parallel to investing is to choose another strategy or investment advisor, because that last one was awful!

Then there’s the triple fault. Tongue-in-cheek, Ramo writes: “Serving is…the only chance you ever get as a player to lose the point absolutely and all by yourself, without any help from a partner or opponent. ”The triple fault stems from three faulty actions: the first “cannonball ace, which fails miserably very, very often,” the second “safe serve” which is totally expected unless the receiver is both “mediocre and senile,” and bingo, the third fault: the hard hit returning the easy serve, thereby losing the point. The real fault, says Ramo, is with the easy server. 

The point is, it’s very difficult to win by doing what you think you should do, rather than relying on the fundamentals. But “Darned if you are going to give up membership in the pro circuit to enter the circle of the average or ordinary,” Ramo writes. The desire to be superior may explain why so many investors forfeit billions of dollars on sketchy schemes that promise unbelievable returns. Who wants to be ordinary?

Inside Ramo’s laugh-filled book is solid advice for learning the real pillars of the game and thinking methodically while on the court. In investing, of course, the pillars of the game are index investing paired with a passively managed long-term buy-and-hold strategy. It’s what we do at Cardiff Park Advisors.

Turns out the average investor can beat the pros by learning and then sticking to the fundamentals of success. It might not be as exciting as an investment game filled with sons of botches and triple faults, but a well-diversified indexed portfolio will produce superior results over time.

Sticking to fundamentals means we keep getting better at what we do. As for me, I’m going to find more time to improve my tennis game. I saw online that Simon Ramo wrote another book on the topic, called Tennis by Machiavelli (1984). I’m going to track it down. It’s got to be good.


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