When Being Right Becomes More Important Than Making Money

Why investment management should be about evidence, not emotion.

I have increasingly found myself wondering whether some investors are no longer simply concerned about the valuations of artificial intelligence-related businesses. Are they actually hoping these companies fail?

It’s a provocative question, and I certainly wouldn’t presume to know the motivations of individual fund managers. But after several years of extraordinary performance from a relatively small number of technology companies, I do wonder whether there is a growing temptation among those who have avoided them to want the market to prove them right.

And that raises a much broader question about investment management.

Are we making investment decisions based on the opportunities and risks in front of us, or are we becoming emotionally attached to decisions we’ve already made?

The uncomfortable success of AI

There are entirely legitimate reasons to question the extraordinary performance of AI-related businesses. Valuations are demanding in parts of the market. Capital expenditure commitments are enormous. The economic returns on some AI investments remain uncertain, while US equity indices have become increasingly concentrated in a relatively small number of companies.

None of these concerns should be dismissed.

But neither should the remarkable earnings growth delivered by several of the businesses leading the market.

Recent Goldman Sachs commentary has highlighted the extraordinary concentration of US equity market leadership. Yet an important distinction is that much of this concentration is supported by the earnings power of the underlying companies.

That doesn’t mean valuations are justified indefinitely. It means the debate requires more than simply declaring that something has risen too far. There is a difference between recognising an investment risk and becoming emotionally invested in that risk materialising.

An investor can quite reasonably conclude that Nvidia, for example, is too expensive for their portfolio. But if the company continues to deliver exceptional earnings growth, shouldn’t that investor remain willing to revisit their assumptions?

Or do they find themselves waiting, perhaps even hoping, for the share price to collapse and vindicate their original judgement?

That’s where conviction can become dangerous.

At some point, wanting to be proved right can become more important than recognising what is actually happening.

The active versus passive dilemma

I think this is particularly relevant to active fund management, and multi-manager investing in particular.

The sustained dominance of a relatively small number of US technology businesses has created an uncomfortable environment for many active managers.

Market-capitalisation-weighted indices naturally develop larger exposures to companies whose share prices outperform. An active manager who deliberately holds less of these businesses must generate sufficient outperformance elsewhere to compensate. That can be extremely difficult when market leadership remains concentrated.

For multi-managers, the challenge can be even more complicated. A portfolio containing several individually well-regarded active funds can still end up consistently underweight the very companies driving index returns.

And when those companies continue to outperform, the temptation to question the sustainability of their success inevitably increases.

Imagine having spent several years explaining why certain technology businesses are overvalued, why their earnings are unsustainable, or why investors should look elsewhere.

Each subsequent period of outperformance creates another uncomfortable comparison with a passive index fund.

Eventually, there is a risk of looking less for evidence that might challenge the original investment decision and more for the event that will finally validate it.

A significant AI correction could provide precisely that opportunity. Suddenly, years of avoiding the sector might appear justified.

But would that really demonstrate superior investment management?

Not necessarily.

A correction following years of substantial gains does not automatically invalidate those gains, nor does it prove that avoiding the investment throughout was the correct decision.

Being right eventually is not necessarily the same as making the right investment decisions along the way.

Of course, this cuts both ways.

An active manager shouldn’t be criticised simply for refusing to follow an increasingly concentrated index. Maintaining diversification, questioning valuations and managing downside risk are entirely legitimate responsibilities.

And passive investing isn’t without risk. As the largest companies become an increasingly significant proportion of an index, investors can find themselves taking considerably more concentrated positions than they might appreciate.

The point isn’t that active management is superior to passive, or vice versa. It’s that neither should become an ideology.

Both are tools available to investors. Both have advantages and limitations. Our responsibility is to use them appropriately rather than become emotionally attached to one approach.

When conviction becomes stubbornness

One of the most dangerous things an investment manager can do is become too attached to their own decisions.

We’ve all encountered investors who are permanently bullish on a particular market, managers who will defend their favourite funds regardless of performance, or those who seemingly refuse to invest in anything that doesn’t fit their preferred style.

I’ve never understood that approach.

A fund isn’t a football team. You don’t have to support it through thick and thin.

Nor should an investment decision become a matter of personal pride.

There is nothing wrong with having strong convictions. Indeed, managing money requires them.  But conviction should never become stubbornness.

If the evidence changes, our assessment should change.

If a fund manager stops delivering what we expect, we should question their place in the portfolio.

If an investment style becomes more attractive, we should be prepared to embrace it, regardless of our previous preferences.

And if a market we have previously avoided begins offering compelling opportunities, we should be willing to reconsider our position.

That doesn’t necessarily mean our original decision was wrong. It simply means the circumstances have changed.

The same applies to those who have benefited enormously from AI-related investments. There is just as much danger in falling in love with successful technology businesses and assuming their extraordinary performance will continue indefinitely as there is in hoping for their demise.

Neither approach is objective.

Investment management isn’t about defending what you believe. It’s about responding intelligently to the evidence in front of you.

The Qualis approach: investments are tools, not allegiances

This is something I regard as fundamental to our investment philosophy at Qualis.

We don’t believe an investment style should become an allegiance.

We don’t believe a fund manager should be retained simply because we’ve supported them for years.

And we don’t believe an asset class or sector should be permanently favoured because it has historically delivered attractive returns.

Our portfolios incorporate both active and passive investments because we regard them as complementary tools, not competing philosophies.

We can favour growth when we believe the opportunities justify it, while recognising the merits of value investing when conditions are more supportive.

We can invest with exceptional active managers while using passive funds where we believe they offer a more efficient or appropriate solution.

We can reduce exposure to an investment that has performed exceptionally well, just as we can increase exposure to one that has previously disappointed, provided the forward-looking evidence supports the decision.

None of these decisions should be influenced by loyalty, personal preference or a determination to prove that an earlier judgement was correct.

That doesn’t mean constantly changing portfolios or chasing whichever investment has performed best recently.

Quite the opposite.

It means maintaining a disciplined, considered investment process, with the flexibility to respond when the balance of opportunity and risk genuinely changes. There will be occasions when doing nothing is the right decision. Equally, there will be occasions when acting decisively is necessary.

The important thing is understanding why.

We should be prepared to change our positioning without feeling the need to defend what came before it.

The real danger isn’t getting it wrong

I don’t know whether AI-related businesses will continue to dominate equity markets, whether market leadership will broaden into other sectors, or whether we will experience a significant correction.

There are credible arguments for each outcome.

What I do know is that hoping for any particular outcome is no substitute for objective investment analysis.

If AI valuations become unsustainable, we should be prepared to reduce exposure.

If earnings continue to justify those valuations, we should be equally prepared to maintain it.

If opportunities emerge elsewhere, we should be willing to recognise them.

And if our assessment changes, our portfolios should be capable of changing with it.

One question I believe every investment manager should ask themselves regularly is remarkably simple:

If I didn’t already own this investment, or hadn’t previously rejected it, would I make the same decision today?

It is a useful way of challenging whether an investment still deserves its place in a portfolio.

Because ultimately, our responsibility isn’t to prove that we were right yesterday.

It’s to make the most appropriate investment decisions we can for tomorrow.

We won’t always get those decisions right. Nobody does.

But we should never allow pride, loyalty or personal conviction to prevent us from recognising when circumstances have changed.

And perhaps that’s the greatest investment discipline of all.

Markets don’t care about our opinions. Our job is to make sure our opinions don’t get in the way of the evidence.

This article represents the views of GWA Asset Management at the time of publication and is intended for general information only. It does not constitute investment advice or a recommendation to buy or sell any particular investment. The value of investments and any income derived from them can fall as well as rise, and investors may not get back the amount originally invested. Past performance is not a reliable indicator of future returns.