Zebras have the same problem as institutional portfolio managers. First, both seek profits. For portfolio managers, above average performance; for zebras, fresh grass. Secondly, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions. Third, both move in herds. They look alike, think alike and stick close together. If you are a zebra, and live in a herd, the key decision you must make is where to stand in relation to the rest of the herd. When you think that conditions are safe, the outside of the herd is the best, for there the grass is fresh, while the middle see only grass which is half-eaten or trampled down. The aggressive zebras, on the outside of the herd, eat much better. On the other hand – or other hoof – there comes a time when lions approach. The outside zebras end up as lion lunch, and the skinny zebras in the middle of the pack may eat less well but they are still alive.
. . . Acorn Fund’s founder, and portfolio manager, Ralph Wanger
We recalled Ralph Wagner’s quote (Acorn Fund) while reading this quip from The Hartford Fund’s Dr. Elesa Zehndorfer article titled “Hardwired to Herd.” She writes:
Legendary investor and CEO of The Baupost Group Seth Klarman once reflected on the powerful evolutionary pull of herding when he noted that it is always easiest to run with the herd; at times, it can take a deep reservoir of courage and conviction to stand apart from it. And he was right. In fact, many legendary investors out there – George Soros, Jim Chanos, Carl Icahn – have all made billions of dollars resisting the urge to run with the herd, instead relying on hard data to make exceptional returns. George Soros once made a $1 billion in just 1 day on September 17th, 1992, shorting the British pound. Chanos, as CEO of Kynikos Associates, made $500 million shorting Enron after concluding that the company was operating fraudulently. At the time, Enron couldn’t have been a more lauded or idolized success story, so by shorting Enron stock, Chanos’s move was hugely contrarian.
She goes on to note:
One of the reasons that Seth Klarman talks about the role of courage is because our brains literally register a kind of neural discomfort when we try to stand apart from the herd. That discomfort might not be something that we consciously acknowledge, but it nevertheless represents a powerful driver of our decisions, leading us to unconsciously opt for a herding-based investing decision. A recent study found, for example, that when people did buck the consensus, brain scans found intense firing in the amygdala and that people go along with the herd not because you want to, but because it hurts not to.
We saw many “outside zebras” gorging themselves on stocks in late-2007 as the D-J Industrial Average (DJIA) made a new all-time high and then registered a Dow Theory “sell signal” in November 2007. Subsequently, those outside zebras ended up as “lion lunch” when the senior index shed an eye-popping 48% over the ensuing 16 months. By March of 2009 many of those outside zebras had moved to the inside of the herd just in time to miss the bottom (we were very bullish). Since those lows more and more zebras ventured back toward the “outside” of the herd driven by performance pressures. I have repeatedly commented that given the immense amount of cash still on the sidelines, as the equity markets continue to rally, the performance pressure, subsequent bonus pressures, and ultimately job pressure become just too great, causing portfolio managers to “pay up” for stocks. And that, ladies and gentlemen, is why the corrections have been relatively short since the November 2012 “lows.” As the Jeremy Grantham writes: