Loss avoidance in investing involves more than math, because psychological traps abound—even for high-profile investment managers.
In its Q4 2017 letter to shareholders, Brookfield Asset Management says that “the single greatest way to dig ourselves out of mistakes is to be patient with investments and, in most cases, double down.”
We winced at this comment, since we’d identified doubling down as a common investment mistake in an article from September 2014 (see “8 common investment mistakes”).
The reason to dislike doubling down is the arbitrary nature of the inherent goal, which is to break even. A clear psychological effect is at play when the investor’s aim is to avoid being branded a loser.
If an investment’s value drops by half, its value must eventually double to break even. If you double down at the bottom (i.e., double the number of shares owned), the investment must bounce back by only 50% to break even. Suddenly, the investment sounds more reasonable—but the reasoning is a lot like self-bargaining.
Expanding on its strategy, the Brookfield team says doubling down is “the best way to recover losses, although it requires conviction as well as availability of the necessary capital. This is particularly important when we have acquired a good business, but our timing was poor.”
Brookfield goes on to say that patience is key to turning around an investment. In other words, given unlimited time, you can always be a winner—an unexpected and trite sentiment from executives managing more than $275 billion in assets. With the team’s purported experience, resources, investment contacts and opportunities, investors are justified in questioning whether a losing investment is the best use of funds.
While there’s something to be said for patience, why throw good money after bad? In addition to investment psychology, other considerations are likely at play that also have a psychological component. Brookfield and its publicly traded subsidiaries are story stocks, with investors attracted to management and the tale it tells, as much as they are to the base investment fundamentals.
Brookfield’s story is one of amassing capital heft and intellectual experience, with a global reach that exceeds others in the private equity space. The firm can therefore enter into deals that others can’t consider, and scoop up bargains in distressed assets or markets.
The flip side is that Brookfield is, arguably, such a capital-raising behemoth that it’s under pressure to invest in ideas regardless of whether they’re prime opportunities. Brookfield investors want their new money invested, not sitting idle. And Brookfield wants to collect management fees on the invested assets sooner rather than later.
Given that the merits of Brookfield’s investment moat are debatable, the firm’s overarching story is key. The story allows Brookfield entities to trade at premiums to their market peers, and could encourage investors to ignore attributes that normally result in a discount, such as an overly complicated corporate structure.
Average investors must admit their mistakes to only themselves. A large firm has more at stake: by admitting fault, its story could take a hit, along with its premium valuation.
Investors might understand a management firm burying a mistake and perhaps waiting it out, all while appealing to strategy. Indeed, a figurative doubling down can create an investing aura and thus a tangible advantage, should others believe in it. What’s concerning is if a firm goes the next step and literally doubles down on a weak investment with new investors’ money.
Having too much money to invest can be a drawback, especially if managers have grown at a substantial rate and reached a size where meaningful growth is difficult. Add in global competitors nipping at their heels, and past investment returns might be difficult to replicate. Investors might be wise to give greater thought to doubling down on investments in such firms.