Winning the Loser's Game

In the last post, I said that the selling decision matters more than the buying decision. For those who haven't read the earlier post, it might be a good idea to do so, before you read this one. Click, The Art of Selling - Preview to read the earlier post.

So, why does the selling decision matter? By the time you finish reading this post, I hope to convince you about why selling matters more than buying.

Charlie Ellis has written a seminal book called Winning the Loser’s Game. The book is essentially a treatise on why active management is a Loser’s game and why investors must resort to an Index fund as their primary vehicle of choice. The book, originally published in the calendar year 1998, when Index Investing (not to be confused with investing in Mutual Fund schemes managed by Active managers), wasn’t the rage that it is today.

The fundamental premise that he posits in the book can be summarised as follows:

The investment management business should be a profession, but it is not, it is a business.
The reason for this is that professional money managers believe they can beat the index - this is a false belief.
The belief that active managers can beat the market is based on two assumptions:
- (1) liquidity offered in the stock market is an advantage, and
- (2) institutional investing is a Winner's Game.

The investing landscape in the Indian stock market has changed over the last two decades. The most significant change is that institutional investors have become, and will continue to be, the dominant feature of their own environment. Institutional dominance has converted market liquidity from a source of profits to a source of costs, and this is the main reason behind the transformation of money management to a Loser's Game.

The following is extracted from the book. The author uses tennis as an analogy for his thesis. Essentially, what he correctly points out is: (replace the word tennis in the text below with investing for it to make sense in)

Simon Ramo identified the crucial difference between a Winner's Game and a Loser's Game in his excellent book on playing strategy, Extraordinary Tennis for the Ordinary Tennis Player.
Over a period of many years, he observed that tennis was not one game but two. The first game is the one that is being played by the professionals. The second game is being played by the rest of us.
Although players in both games use the same equipment, dress, rules and scoring, and conform to the same etiquette and customs, the basic natures of the two games are almost entirely different.
After extensive scientific and statistical analysis, Dr. Ramo summed it up this way: Professionals win points; amateurs lose points. Professional tennis players stroke the ball with strong, well-aimed shots, through long and often exciting rallies, until one player can drive the ball just beyond the reach of his opponent. These splendid players seldom made errors. Expert tennis is what Simon Rana calls a Winner's Game.
Because the ultimate outcome is determined by the actions of the winner. In such a game, the victor is the one who wins more points than the opponent. The winner hit more winners than the loser.
Amateur tennis, Ramo found, is almost entirely different. Brilliant shots, long and exciting rallies, and seemingly miraculous recoveries are few. The ball is fairly often hit into the net or out of bounds, and double faults at service are not uncommon. As a result, the amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points.
As a scientist and statistician, Dr. Ramo gathered data to test his hypothesis. And he did it brilliantly. Instead of keeping conventional game scores "Love," "Fifteen All," "Thirty-Fifteen," etc.-Ramo simply counted points won versus points lost.
And here is what he found. In expert tennis, about 80 percent of the points are won; in amateur tennis, about 80 percent of the points are lost.
Professional tennis is a Winner's Game, the outcome is determined by the activities of the winner—and amateur tennis is a Loser's Game the eventual outcome is determined by the activities of the loser.
The two games are, in their fundamental characteristic, not at all the same. They are opposites.
From this discovery of the two kinds of tennis, Dr. Ramo builds a complete strategy by which ordinary tennis players can win games, sets and matches again and again by following the simple stratagem of losing less, and letting the opponent defeat himself.
The trouble with Winner's Games is that they tend to self-destruct because they attract too much attention and too many players, all of whom want to win.
But in the short run, the rushing in of more and more players seeking to win expands the apparent reward. And that's what happened in Wall Street during the 1960s. Riding the tide of a bull market, institutional investors got such splendid rates of return in equities that more and more money was turned over to them, particularly in mutual funds and pension funds which fuelled the continuation of their own bull market. Institutional investing was a Winner's Game, and the winners knew that by playing it faster, they would increase the rate of winnings. But, a basic change occurred in the investment environment; the market came to be dominated by the institutions.
In just ten years, the market activities of the investing institutions have gone from only 30 percent of total public transactions to a whopping 70 percent. And that has made all the difference. No longer are the "New Breed on Wall Street" in the minority; they are now the majority.
The professional money manager isn't competing any longer with amateurs who are out of touch with the market; now he competes with other experts.

Stated differently, in the professional game, the outcome will depend on the skill set of the winner and in the amateurs game, the activities of the loser decide the outcome. In reality, when the game is being played, there is no distinction of which game who is playing - everyone is playing against everyone without knowing whether the person on the ‘other side’ (from whom we are buying or to whom we are selling), is an amateur or a professional?

Since there is no concrete distinction between who is a professional and who is an amateur, investing outcomes are decided by the activities of the loser. As a result, investing becomes a ‘loser’s game’.

For those who want to win the stock market game, here are a few things that he has hinted at in the book:

Be sure you are playing your own game. In the stock market each participant is playing a different game. We should define our time horizon BEFORE we invest.
Give the other person on the ‘other side’ as many opportunities as possible to make mistakes. In other words, be patient. The correct strategy should be to lose less, instead of trying to win more.
Keep it simple. Make fewer and perhaps better investment decisions.
Take the time and effort to make accurate selling decisions, since the buying decision process is extremely competitive. Almost all the information in the investment management business is oriented towards the purchase decisions. The competition in making purchase decisions is too good. It's too hard to outperform the other fellow in buying. Concentrate on selling instead.
Keep the emotions out of the investing process. This is one of the most difficult things to do.

I’ll try to address the rhetorical question: ‘Who is on the Other Side’, in the next post.

Click here to go back to The Art of Selling - Index

To view this post in your browser or to share it click Winning the Loser's Game