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Beware Medical and Money Management ‘Groupthink’

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Helping Doctors Understand Peer Comparisons

By J. Wayne Firebaugh CPA, CFP® CMP™

By Dr. David E. Marcinko MBA, CMP™

Source: http://www.CertifiedMedicalPlanner.org

More than a few mutual, hedge and endowment fund managers have noted that they commonly compare their endowment and portfolio allocations to those of peer institutions and that as a result, allocations are often similar to the “average” as reported by one or more surveys/consulting firms.

One interviewed endowment fund manager expanded this thought by presciently noting that expecting materially different performance with substantially the same allocation is unreasonable. It is anecdotally interesting to wonder whether any “seminal” study “proving” the importance of asset allocation could have even had a substantially different conclusion. It seems likely that the pensions and funds surveyed in these types of studies have very similar allocations given the human tendency to measure one-self against peers and to use peers for guidance.

This is a truism in medicine as well as the financial services sector.

Understanding Peer Comparisons

Although peer comparisons can be useful in evaluating your portfolio, or your hospital or medical practice’s own processes, groupthink can be highly contagious and dangerous.

For historical example, in the first quarter of 2000, net flows into equity mutual funds were $140.4 billion as compared to net inflows of $187.7 billion for all of 1999. February’s equity fund inflows were a staggering $55.6 billion, the record for single month investments. For all of 1999, total net mutual fund investments were $169.8 billion[1] meaning that investors “rebalanced” out of asset classes such as bonds just in time for the market’s March 24, 2000 peak (as measured by the S&P 500).

Of course, physicians and investors are not immune to poor decision making in upward trending markets. In 2001, investors withdrew a then-record amount of $30 billion[2] in September, presumably in response to the September 11th terrorist attacks. These investors managed to skillfully “rebalance” their ways out of markets that declined approximately 11.5% during the first several trading sessions after the market reopened, only to reach September 10th levels again after only 19 trading days. In 2002, investors revealed their relentless pursuit of self-destruction when they withdrew a net $27.7 billion from equity funds[3] just before the S&P 500’s 29.9% 2003 growth.

Amateurs versus Professionals [is there such a thing?]

Although it is easy to dismiss the travails of mutual fund investors as representing only the performance of amateurs, it is important to remember that institutions are not automatically immune by virtue of being managed by investment professionals.

For example, in the 1960s and early 1970s, common wisdom stipulated that portfolios include the Nifty Fifty stocks that were viewed to be complete companies.  These stocks were considered “one-decision” stocks for which the only decision was how much to buy. Even institutions got caught up in purchasing such current corporate stalwarts as Joe Schlitz Brewing, Simplicity Patterns, and Louisiana Home & Exploration.  Collective market groupthink pushed these stocks to such prices that Price Earnings ratios routinely exceeded 50 [nothing in the internet age]. Subsequent disappointing performance of this strategy only revealed that common wisdom is often neither common nor wisdom.

The Bear Sterns Example

Recall that The New York Times reported on June 21, 2007, that Bear Stearns had managed to forestall the demise of the Bear Stearns High Grade Structured Credit Strategies and the related Enhanced Leveraged Fund.  The two funds held mortgage-backed debt securities of almost $2 billion many of which were in the sub-prime market.  To compound the problem, the funds borrowed much of the money used to purchase these securities.  The firms who had provided the loans to make these purchases represented some of the smartest names on Wall Street, including JP Morgan, Goldman Sachs, Bank of America, Merrill Lynch, and Deutsche Bank.[4]  Despite its efforts Bear Stearns had to inform investors less than a week later on June 27 that these two funds had collapsed. The subsequent fate of these firms, and the history of the past two years, need not be repeated to appreciate that the king surely had no clothes.

Assessment

What broader message lies in this post relative to such medical initiatives as P4P, various clinical quality improvement endeavors and benchmarks, hospital peer-review, PROs, Medicare compliance, etc?  

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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References


[1]   2001 Fact Book, Investment Company Institute.

[2]   Id.

[3]   2003 Fact Book, Investment Company Institute.

[4]    Bajaj, Vikas and Creswell, Julie. “Bear Stearns Staves off Collapse of 2 Hedge Funds.” New York Times, June 21, 2007.

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2 Responses

  1. Financial groupthink is like the medical standard of care.
    It reduces liability for practitioners.

    Charles

    Like

  2. LINEAR Thinking

    A lot of things in nature, and thus in investing, are not linear. A past trend may or may not persist into the future. Events don’t happen in a vacuum; they are observed, studied and capitalized on — which in the case of investing may preclude a company’s future from resembling its past. As I write this, I think of successful companies whose achievements attracted competition, which then marginalized them.

    Some things are inherently nonlinear, their behavior reminiscent of a pendulum’s: The further they swing in one direction, the harder they’ll go in the opposite direction. It is very dangerous to default to linearity with such nonlinear phenomena, as the more confident we become in the swing (the more linearity we observe), the closer we are to the pendulum’s reversing course.

    Price-earnings ratios often follow a pendulum behavior. If you look at high-quality dividend-paying stocks — the Coca-Colas and Procter & Gambles of the world — they are now changing hands at more than 20 times earnings. Their recent performance has driven linear thinkers to pile into them, expecting more of the same in the future. Don’t! These stocks were beneficiaries of a swing in the P/E pendulum as it went from low to average and then to above-average levels.

    Pattern recognition is an important contributor to success in investing. Mark Twain once said that history doesn’t repeat itself, but it rhymes. If you can identify a rhyme (that is, see a pattern) relating to the current situation, then you can develop a framework to analyze and forecast it.

    But, what if the current situation is very different — if it doesn’t rhyme with anything in the past? This is where the ability to draw parallels becomes helpful. It allows you to overlay rhymes (patterns) from other companies, industries or even fields. Building analogous frameworks is a cure for linear thinking; it helps us see nonlinearity and facilitates the creation of nonlinear mental models.

    Vitaliy Katsenelson CFA

    Like

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