Meeting A Market Wizard
Last month, I had the privilege of meeting legendary investor Larry Hite.
Larry was born into a lower middle-class family, had a major learning disability, did poorly in school, and was completely blind in one eye and half blind in the other. In his own words, “I was not handsome. I was not athletic. Whatever I did, I sucked at it badly.”
In 1981, after dabbling as a music promoter, actor, and screenwriter, Hite founded Mint Investments. Mint was a true pioneer, eschewing human judgement and instead basing its investment decisions on a purely systematic, rules-based approach rooted in statistical analysis.
By 1988, Mint registered average annual compounded returns of over 30%. In its best year, Mint registered a gain of 60% (1987, the year of the stock market crash), and in its worst year, it produced a gain of 13%. By 1990, Mint was the biggest hedge fund in the world, with a record-breaking $1 billion under management.
When it awarded Larry the Lifetime Achievement Award, Hedge Fund Magazine wrote:
“Larry Hite has dedicated the last 30 years of his life to the pursuit of robust statistical programs and systems capable of generating consistent, attractive risk/reward relationships across a broad spectrum of markets and environments and has inspired a generation of commodity trading advisers and systematic hedge fund managers.”
Although Hite began his investing career in the early 1980s, his philosophy of markets and approach to investing are remarkably similar to our own, which are summarized below.
Failure: A Foundation for Success
Hite maintains that his early failures were instrumental in his eventual success. He believes that accepting that failure is sometimes inevitable led him to develop an investment strategy that would limit losses.
In his book, The Rule, he wrote:
“I believe the success I’ve had arrived because I always expected to fail big. Solution? I engineered my actions so that a failure could not kill me. I won because I expected to lose. Failure became my advantage. Once you understand your potential for failure – that is, there are times you can’t win – you know when to fold your cards and move on to the next. You will do this more quickly than others who stay in the game too long, hanging on and hoping that their losing bet will turn around.”
It’s Not All About Being Right
Many investors focus on being right as much as possible – on maximizing their ratio of winning vs. losing investments. On its face, this seems like a good idea – all else being equal, if you win more than 50% of the time, then over time you will make money.
Hite takes a different approach. Whereas he has no issue with trying to be right as often as possible, he is far more focused on maximizing the average magnitude of his winning positions relative to that of his unsuccessful ones, asserting that:
“Becoming wealthy and successful isn’t simply about being right all the time. It’s about how much you win when you are right as well as how much you lose when you are wrong…. The Mint trading system did not prioritize being right all the time. We prioritized not losing a lot when we lost but winning big when we won. But as a result, we were frequently wrong. We understood and expected this and taught our clients the wisdom too.”
Risk: A No Fooling Around Game
Hite places a greater emphasis on risk management than on generating profits, claiming that mistakes regarding risk can lead to catastrophic results. He asserts that, “Risk is a no fooling around game; it does not allow for mistakes. If you do not manage the risk, eventually it will carry you out.”
His approach to investing clearly reflects his respect for risk. Specifically, Hite divulges that “We approach markets backwards. The first thing we ask is not what we can make, but how much we can lose. We play a defensive game.”
One of my favorite anecdotes regarding risk is Hite’s reflection on a conversation he had with one of the world’s largest coffee traders, who asked, “Larry, how can you know more about coffee than me? I am the largest trader in the world. I know where the boats are; I know the ministers.” Larry responded, “You are right. I don’t know anything about coffee. In fact, I don’t even drink it.” The coffee mogul then inquired, “How do you trade it then?”, to which Larry answered, “I just look at the risk.”
Five years later, Larry heard that this magnate lost $100 million in the coffee market. Upon reflection, Hite states, “You know something? He does know more about coffee than I do. But the point is, he didn’t look at the risk.”
Market Predictions, Storytelling, & Good Copywriters
Larry is skeptical that anyone can predict markets. He in no way bases his approach to investing on making predictions, which he believes is an exercise in futility. In his own words:
“I respect the sheer intelligence and devotion of economists who have attempted to develop a unifying theory of market dynamics. But I don’t believe any such theory will hold up to scrutiny in the real world of money on the line. When you start believing you have remarkable market predicting powers, you get into trouble every single time.”
Hite is also critical of Wall Street research reports, claiming that they possess little investment value and are designed to exploit people’s natural tendencies to listen to entertaining narratives, stating:
“Stories began at the dawn of human society to entertain and instruct the next generation. We are wired to learn from well told stories. And unfortunately, Wall Street preys off our basic human weakness to want stories.”
In his typically blunt and straightforward manner, he adds, “When you start following slick reports filled with predictions, you’re just finding out who has good copywriters.”
A Computer Can’t Get Up on The Wrong Side of the Bed in the Morning
Larry was a pioneer in his exclusive reliance on a data-driven, systematic approach, using statistical analysis of historical data to develop trading rules, which are the basis of his investment decisions. When he launched Mint Investments in 1981, his goal was “to create a scientific trading system that would remove human emotion from buying and selling decisions and rely instead on a purely statistical approach built on pre-set rules.”
Hite draws a parallel between his approach to investing and that used by Billy Beane, former general manager of the Oakland As and protagonist of the well-known book (and subsequent movie) Moneyball. Despite having one of the smallest budgets in major league baseball, the As made the playoffs eight times between 1999 and 2014. Beane used sabermetrics (the mathematical and statistical analysis of baseball records) to make what he refers to as “rational objective decisions in a business where everybody was making subjective decisions.”
Hite asserts that a great deal of his success is attributable to his reliance on purely quantitative investment processes. He pulls no punches in expressing his preference for systematic, rules-based investment methodologies over those predicated on human judgement and subjectivity. Hite contends that “a computer can’t get up on the wrong side of the bed in the morning.” He elaborates:
"Numbers are not as exciting or sexy as stories you hear screamed across financial channels by pretty people, but numbers will make you wealthier if you use them the right way……If you build simulations, you’re seeing mathematical evidence, probabilities, odds, risks. There’s no wishy washy in there. You want to be very definite in what and how and when and why you are doing something. My complete edge is that before I do anything, I know exactly how much I am betting, I know exactly why I am betting it. I know exactly when I am going to get out of that bet.”
Buy and Hold: Not A Panacea
Larry is somewhat critical of the passive, buy and hold approach followed by the vast majority of investment firms. In this school of thought, investors should do nothing when prices drop. The idea is not to pay attention to fluctuations in the market, but rather to wait it out, because over time, the stock market always rises, and you always do well. He states:
“Yes, you might do well with a buy and hold strategy. But you also may have to endure booms and busts and potentially major losses for lengthy periods – losses many people may not be able to tolerate. If you had money in the S&P 500 in the early 50s and withdrew it in the early 1970s, your buy and hold strategy would have worked brilliantly because the market was soaring when you exited. But what if you didn’t want (or need) to take it out until April of 1982? You would have been heartbroken because the S&P had dropped dramatically.”
In no way does Hite suggest that buy and hold investing is patently “wrong”. However, he cautions against investing 100% of your portfolio in any one approach, insisting that there is no single investment methodology that works every time and that investors should diversify across styles.
Markets Don’t Change Because People Don’t Change
Hite does not believe that markets are efficient, and thinks that this lack of efficiency creates investment opportunities. He writes, “I have noticed that everyone who has ever told me that the markets are efficient is poor.” Moreover, he insists that markets will never be completely efficient, declaring that:
“Human nature – that is, our still primitive lizard brains – drives financial markets. Our longings, greed, fear, ambitions, and creativity build the driving forces of supply, demand, trends, booms, busts now and throughout history and always will. I would soon come to know that efficient markets don’t exist and never will for as long as humans are playing the game with greed and fear in a tug of war.”
Imitation is the Sincerest Form of Flattery
Like Hite, at Outcome we do not believe that markets are completely efficient (If we did, we would not be in business!).
We are also “Larry-like” in terms of our strict adherence to systematic, rules-based approaches based on statistical analysis and machine-learning. To wit, one of our mottoes is “In God We Trust. All others bring data.”
In addition, we share Hite’s reverence for risk, and are at least as focused on managing risk and limiting losses in hostile markets as we are on generating gains in favorable environments.
We also share Hite’s belief that a buy and hold approach is not a panacea that is suitable for 100% of investors’ portfolios. To this end, our Global Tactical Asset Allocation strategy has successfully shifted its portfolio through various market regimes to enable our clients to participate in rising markets while protecting them from large losses in the hostile environments of Q4/2018 and March of 2020.
Lastly, we share Larry’s skepticism that anyone can consistently or accurately predict markets. Rather than assume what markets will do, we “listen” to them (albeit algorithmically) and position our portfolios accordingly.
Standing on the shoulders of giants such as Larry Hite has enabled the Outcome strategies to deliver superior risk-adjusted returns for our clients. We salute and thank him for his contributions and inspiration.
The YouTube audio recording of my interview with Larry Hite is available here: https://youtu.be/jDMYnAxpyRw