Invest your client’s stake in process, not sizzle

This spring, the previously unthinkable happened: Toyota (Japan) Motor Corp. surpassed General Motors Corp. of Detroit as the world’s biggest automobile manufacturer.
When we read this, we couldn’t remember any Toyota advertisement — in sharp contrast with several memorable ads for GM cars.
Who among us has not lusted after the Northstar System after seeing a Cadillac ad? Who among us has the foggiest notion of what it is?
For GM trucks, the metal stamp proclaims: “We Are Professional Grade.”
But what profession are they talking about?
Lawyers? Dentists?
The Pontiac division asserts: “We build excitement!” We commend Pontiac for its refreshing candor, admitting that it focuses on the sizzle rather than the steak.
One reason for building “excitement” is that it is easy to convey in an ad.
Start with pulsating rock music. Add an attractive passenger with an adoring gaze.
Top if off with the car zipping through amazingly beautiful and challenging terrain, accompanied by a hedge clause telling you that this is actually a professional driver on a closed course, and not something you are supposed to emulate.
But of course the purpose of the ad is to create in you an immediate desire to emulate. The unstated message is that if you buy this car, energetic rock music will accompany your every move, attractive people will find you worthy of adoring gazes, and your life will be more exciting and fulfilling.
Selling excitement
As it is in autos, so it is in the investment world. Advertisements sell financial products by conveying excitement, not safety, reliability or a rational process.
Major investment firms advertise short-term, world-beating returns, while others show supposed retirees snowboarding or kayaking down rapids. The ads don’t sell you on having enough money to live on when you turn 90 but on taking the one bold stroke that allows you to remain young and live like the people in the ad.
If you aren’t selling excitement, the creative process for ads gets a little dodgy. Volvo is up to the challenge, conveying its message of safety, showing cars filled with mannequins slamming into a wall in spectacular crash tests or, with a softer touch, showing parents protectively watching their toddler in a car seat through the rearview mirror.
Toyota’s strong point, though, is reliability, not the most visual of virtues. Just as a matter of logic, it is hard to demonstrate the absence of a negative.
Is it supposed to show a car door slamming 5,000 times with no rattle developing?
Toyota’s reliability is the result of its manufacturing process, of a thousand small correct decisions, not a single, bold decision.
Process, though, usually isn’t inherently interesting.
An old joke tells of two auto executives, Japanese and American, whose plane crashes in enemy territory. Their captors grant them one last wish before they are executed.
The Japanese executive asks to give his lecture on manufacturing processes one last time; the American asks to die first so he doesn’t have to listen to the lecture again.
This isn’t about nationality (many of those Toyotas are made in the United States with U.S. workers, after all) but about focus. Focus on process risks boredom and, unlike the goal of most ads, generally doesn’t arouse positive emotions.
Advertisers can generate the emotion of excitement relatively quickly, so excitement is perfect in a world of short attention spans and 30-second TV spots.
Similar to auto manufacturing, wise investing is the result of many small decisions. We try to identify areas within our client portfolios where probabilities favor one course of action over another, and act accordingly, taking no action unless we think that we can identify an edge.
Each small advantage, in itself, isn’t particularly interesting, nor is it ever a sure thing, just a probability. If you have a coin that comes up heads 60% of the time, it makes sense to bet on heads, but you would be foolish to bet the farm on the next flip of the coin.
The winning strategy is continually to bet relatively small amounts on heads — remunerative but not particularly exciting, even if you add a pulsating sound track.
Making bold strokes in the investment business may be exciting, but it tends to be dangerous. Deciding you like biotechnology stocks and putting half the portfolio in them is exciting and easy to communicate but ultimately probably destructive.
Managers at the top of the performance heap in any given quarter or year are very often taking these chances that other managers think are unwise. Their risk taking, while exciting, can devastate the portfolio.
So we are resigned to conduct our profession in a way we think is consistent with our fiduciary duties but which will never generate a great TV ad.
We take solace, however, that in the auto industry, reality does matter. Unexciting, process-oriented Toyota is the winner.
William Berg is founder and president of Sigma Investment Management Co. in Portland, Ore. This article appeared initially in the firm’s newsletter.