The Music of Investment Genres and Processes

Is your investment process jazz or classical?

There are other possibilities, of course, but let’s stick with those.  At a basic level, jazz is improvisational.  The “chart” is just a melody and some chord changes (and maybe lyrics).  In contrast, classical music comes with a “score” where almost everything is laid out and strict adherence to it is the goal.

In some cases, there is a blending of the two styles, when a jazzy sound is coupled with a defined arrangement (at times including some improvised solos).  Much big band music falls into that category.  And works by George Gershwin, Duke Ellington, Stan Kenton, and Gunther Schuller, among others, were fully orchestrated but clearly had their roots in jazz.

Investment process

Let’s go back to the notion that the two approaches are mutually exclusive — one rule-based and the other working off of a general framework that is elastic in its implementation.

Which is closest to your investment process?

Or, if you are responsible for allocating assets to investment managers, which category does each of the managers you choose go into?  Are they playing jazz or classical?

Most descriptions of process sound like classical music.  For example, asset managers often brag that what they do is consistent and repeatable — and that phrase is often echoed in response by allocators when they are asked to evaluate those managers.  Similarly, advisory firms want to make things sound structured and logical.  The message:  “We can play this music over and over, and make it pleasing for you every time.”

In classical music, with everything apparently laid out in the score, there are still matters of interpretation, so one rendition of a famous work can sound different than another, resulting in collectors sometimes owning several recorded versions — and having an opinion about which is best.  Tempo is one of the biggest differentiators among the variations.  (To wit, Leonard Bernstein’s famous comments about Glenn Gould’s highly unusual take on a Brahms concerto.)

In the same way, even a process that is promoted as fixed has degrees of variability involved, sometimes inconsequential in the scheme of things but often more significant than advertised.  Finding and sizing that variability is an important task for those doing due diligence.

Just as improvisation in music is risky business — whether you are playing on your own or trying to react to the surprises that your bandmates introduce into the mix — improvisation in investment is too.  That’s why stories of consistency resonate with allocators.

Change

Speaking of risky business, the investment markets are interlocking complex adaptive systems, so change comes with the territory, making a classical mindset less tenable over the long term than it appears.  A brief clip from an appearance by Brad Jacobs on Shane Parrish’s Knowledge Project podcast describes the problem.  (The whole interview is here.)

Yet change is hard.  Long-time fans can get frustrated if they go to a concert and large parts of it consist of new material or deep cuts instead of the golden oldies.  Billy Joel hasn’t had that problem, since he only recently released his first new song in a couple of decades.  Not to worry, the crowds still show up to see him.

The familiar is comfortable.  When a 69-year-old is playing air guitar in an arena, he wants his idol to do the solo just like he did on the album a half-century before.

It’s like that with investing too; we are suspicious of change in a process, even though changes in process are necessary to stay in contact with the environment over time.

Flat-out improvisation is frowned upon by most, unless such eclecticism has resulted in admirable returns.  (In that case, investors often see performance, infer process, and go along for the ride.)  But a run of ill-advised flyers that crash and burn sours investors on extemporaneous forays.

People

While it’s generally best to have a mix of different kinds of people involved in an investment process (to provide balance and avoid the trap of a uniform perspective), mixing those who have a jazz mindset with others who have a classical one can be a challenge.

Feeling the environment and adjusting quickly to surprises is not at all like executing according to a well-defined plan, so problems develop when there’s a lack of clarity in approach.  There are natural frictions of that type that are to be expected, but sometimes a fault line develops from them that causes more serious issues.  (A benefit of ethnographic due diligence is the opportunity to ask insightful questions that surface those kinds of disconnects.)  There will always be relative strengths and weaknesses — and differences of opinion — among an investment team.  The question is whether they can still come together as an ensemble in satisfying ways.

Genres

A common theme between music and investment is an obsession with genres.  There is an inherent need to draw lines between categories — and to decide who is best in each.

This year, 94 Grammys were awarded in eleven genres, several of which have multiple categories.  But those groupings have changed considerably over time, as a historical list of current and former categories demonstrates.

And then there is the question of what kind of music belongs in any genre.  Is it really country if it doesn’t have a twang in it?  If so, much of the popular country music of the last few decades would have a hard time qualifying.  And that particular question has been out there for longer than that, as Matt Zeigler recounted in a posting about “The Greatest Award Ever Lit On Fire On Live TV” (lit by Charlie Rich, after John Denver won the Country Music Award for entertainer of the year).  Just this year, Beyoncé’s new album topped the Billboard country chart, following forays by other unlikely crossovers since Ray Charles recorded Modern Sounds in Country and Western Music in 1962.  Cross-fertilization abounds in the music ecosystem, often in unexpected ways.

There is a constant evolution in categories, as musical worlds collide and create new planets and stars.  The most interesting developments often happen at the edges of a genre, where influences from other realms are tapped and combined to create something fresh.  Sometimes those developments amount to new wrinkles; at other times they prompt emergent categories that radically change the music scene.  (There’s often a geographical center for new beginnings; consider Detroit, Seattle, and the Bronx as a few of the many examples.)

Ditto on the investment front.  Categories proliferate, divide, morph, and go from obscure to common (or vice versa).

No one would have won Best General Partner, Secondaries a few years ago.  It wasn’t a thing.  Private credit was only elevated to asset class status by most within the last decade.  Litigation finance?  Pod shops?  Crypto?

And a lot of the old categories that are still around would be greeted by yawns at an investment award show.  Growth at a reasonable price got its own acronym back in the day but it doesn’t seem like anyone talks about it any more.  The traditional categories have gotten boring and aren’t a focus of attention.  Even the active-versus-passive debate has worn thin — the SPIVA numbers barely change no matter what part of the cycle we’re in and passive continues to gain share in liquid strategies.   (Speaking of category malleability, the word “passive” has gotten mushy with indexes that aren’t really passive in the classic sense often being lumped in with ones that are.)

Reinvention

Music and investing are social phenomena, and mimetic desire is a strong force.  As new sounds gain popularity, there is a rush to imitate, just as there is when new investment strategies show good performance and begin to attract assets in size.

The urge to copy is strongest at those times of success, but there is another kind of copying that comes later, after the burst of popularity has faded.  In music, cover songs and tribute albums can unlock new appreciation and meaning.  Musicians across genres have mined the so-called Great American Songbook of the last century to good effect, and there have been jarring and revelatory redoes like Johnny Cash covering “Hurt” by Trent Reznor of Nine Inch Nails.

The reprise of an investment strategy usually lacks the specific attribution that is available in music if a copyrighted work is remade — although some try to claim a tie to Buffett or other gurus for marketing oomph — but such reinventions can put a productive spin on an old notion.  For one thing, they can incorporate adaptations that the originators of the strategies have failed to seize.

Coda

The topic of changing genres brings us back to the subject of changes in investment process.  Because allocators carve up the strategies of the day and judge managers within them, they are concerned with style drift that would take a manager away from the location in the current map of possibilities where they had stationed it.

But the map is always changing and style drift should be expected and, depending on the circumstances, encouraged.  Is the drift merely reflecting transitory changes (movement toward what’s becoming more popular or away from what’s becoming unpopular, only to see it revert), or something that represents a fundamental, sustainable evolution that should be embraced.  It isn’t easy to tell, but style drift shouldn’t automatically be rejected — or embraced.

Process drift, on the other hand, should be expected as a result of continuous improvement efforts.  A consistent and repeatable process is nothing to brag about.  One that gets better year by year ought to be the goal.

When asked about genres, musicians often reply with the saying that “there’s only good music and bad music,” that arbitrary boundaries can get in the way of judging quality.  That’s true in the investment world as well.

Standards and practices and dividing lines don’t stand still.  Appreciating what they are today — and understanding their power as social norms — is essential.  But so is remembering that they aren’t eternal.

 

Issues of categorization and investment process are covered in depth in the Advanced Due Diligence and Manager Selection course.  The process module is also available on a standalone basis in the short course, Analyzing Investment Process.