◀ Back
Accept Decline
 The Power of Story

The Power of Story

Unlike the universal laws that govern physics, investment is messy and complex.

In a recent essay, Santa Fe economist Brian Arthur challenges economists to describe the world in more than algebraic terms. He believes they should extend their vocabulary (and minds) to include verbs, alongside their highly prized nouns, to allow the underlying processes, context and organic nature of complex systems to be described in full technicolour.

Arthur’s argument is well founded, and applies to the investment industry as much as any other economic realm.

As it stretches to reduce all things to a model, classical economic theory uses quantifiable nouns (amounts, levels and rates) as a base language. The resulting models – inspired by the robustness of physics – ideally deliver clarity and “scientific” logic, but often at a cost. A single-minded approach to narrative effectively sieves what it cannot quantify, and in so doing, easily skips over the natural disorder of people and processes that live behind the numbers. 

Unlike the universal laws that govern physics, economies are messy and complex. Humans simply do not behave in the predictable fashion of atoms and neutrons. And herein lies the limitation of a solitarily, algebraic perspective of the world, a perspective that abstracts people and their unique behaviours and motivations, and reduces them to symbolic quantities for comparison and theorisation. 

Algebra and the language of nouns

The investment industry has long faced pressure to forego the mess of narrative and embrace the purity of algebra and the language of nouns. Efficient Market Hypothesis, Modern Portfolio Theory2 and the Capital Asset Pricing Formula3 are just some of the popular Newtonian laws4 of the finance classroom, while sharp-edged nuggets – Active Share, Tracking Error, Information ratio, Sharpe ratio  – constitute the industry’s trusty algebra.

To complicate matters further, unlike in economics – where there is often agreement on the definition of key nouns – in our industry Risk, arguably the most important noun, has taken on a multitude of definitions. In its most dangerous form it is abstracted, quantified and expressed in relation to another algebraic symbol. Unfortunately it is rarely defined as absolute loss against absolute wealth.

There’s a case to be made that our industry prefers the simplicity of ratios for the simple reason that they travel well. Stories, on the other hand, take time and effort to translate across a throng of intermediaries. Comparatively, there is far less friction in the language of ratios, ratings and rankings: What’s the portfolio P/E? What’s the active share? What’s the tracking error? What’s the ESG score? How big is the investment team? Unfortunately, the quantified answers to these questions quietly sieve out people, their history and culture, and their motivations. 

A Darwinian approach

It doesn’t travel as readily, but at Stewart Investors our philosophy has long favoured a Darwinian approach to understanding the quality of people, franchise and financials, and to debating the future.

In On the Origin of Species, Darwin took some 480 pages and roughly 120,000 words to articulate his theory of evolution. His work treated biology as a science where verbs and adjectives bring our gloriously complex world to life. Similarly, our philosophy and culture embrace the context, actions, motives and stories behind the numbers, because we believe human nuance informs long-term returns. Put another way: numbers, ratios and rankings are backward looking, but money is made, and most importantly protected, by looking forward. Successfully allocating capital into a largely unknowable future requires embracing and truly valuing the unquantifiable nouns our industry has trouble pinning down.

Quality is an emergent property. It is never static. Any attempt to reduce it to a simple ratio or statistic is, in our view, not only inappropriate, but also dangerous for one’s capital. Ratios sterilize the magic, organic, complex nature of businesses. When this approach is taken, as it so often is, our favourite topics (enduring qualities like culture, purpose and passion) are supplanted by numerators and denominators that are largely meaningless to anyone trying to understand a company’s ability to protect and grow capital over a decade or longer.

Unquantifiable factors

Indeed, our view is that the unquantifiable factors are what enable high-quality companies to enjoy success far beyond the time periods that traditional economic and financial theory seek to quantify.

For example, an Indian Consumer company and an Australian healthcare company, have been held across our funds for close to two decades. With innovative and often unique long-term cultures, these businesses have nurtured world-class franchises and generated 30%5 (GBP) and 21%6 (GBP) returns a year7 while also making the world a better place, we believe, by improving the health and well-being of people around the globe.

We’ve found some of the most attractive investment opportunities arise when a company changes management. In these situations, historic ratios become even more meaningless. We build our conviction by talking to people and lining their vision of the future up against comparable franchises and cultures across the globe. A small team of geographic and sector generalists is an important resource in this type of pattern recognition.

From a capital protection perspective, our clients have not been invested in many companies commonly perceived as high quality (high ROEs, no debt, smooth earnings growth) because we weren’t comfortable with supposedly unquantifiable “squishy stuff” like culture, time horizon and alignment. Many of the large Chinese internet companies fall into this category. With large addressable markets, attractive margins and sky-high returns on capital, they tick all the quantitative boxes. However, the algebra can be meaningless in an environment where the rules of the game can change overnight for companies that are misaligned with the Chinese Communist Party’s ambitions for China.

Focus on Quality

Our focus on quality and people leads us to embrace stories and narrative. Our investment reports often have sections that run for pages without mentioning many numbers. Anyone observing our investment debates would hopefully also notice how much time we spend deep in the weeds, focusing on the key determinants of quality: culture, values and behaviours.

This is also true for how we think about and incorporate ESG and sustainability into our analysis: we find it impossible to separate our consideration of these things from discussions about quality. We believe our industry’s desire to create new “quantifiable nouns” threatens to replace the living, dynamic nature of companies, and their people, with colour-coded algebra. In fact, our view is that the long list of AAA-rated ESG companies that fail to meet our quality and sustainability requirements reflects the imperative data providers have to force others to see companies through their kaleidoscope of ill-defined, templated, quality.

As with the companies we seek out, independence of thought and the ability to zig when others zag carries the cost of being different. But our view is that long-term success often comes from a willingness to be different.

We also believe, based on past experience and performance as much as anything else, that Stewart Investors’ unconventional comfort in prose over numbers – along with our preference for debating the future over quantifying the past – will continue to result in unconventional portfolios capable of delivering attractive long-term returns to our clients.

Doug Ledingham
October 2021

Some companies presented in this article have been selected as companies that make a contribution to healthcare and are held in the Stewart Investors Sustainable Funds Group strategies as at December 30, 2020. Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of those companies. Companies mentioned herein may or may not form part of the holdings of Stewart Investors. This stock information does not constitute any offer or inducement to enter into any investment activity nor is it a recommendation to purchase or sell any security.

Certain statements, estimates, and projections in this document may be forward-looking statements. These forward-looking statements are based upon Stewart Investors’ current assumptions and beliefs, in light of currently available information, but involve known and unknown risks and uncertainties. Actual actions or results may differ materially from those discussed. Readers are cautioned not to place undue reliance on these forward-looking statements. There is no certainty that current conditions will last, and Stewart Investors undertakes no obligation to correct, revise or update information herein, whether as a result of new information, future events or otherwise.

Footnotes

  1. W. Brian Arthur, Santa Fe Institute; Economics in Nouns and Verbs

  2. Modern Portfolio Theory is a practical method for selecting investments in order to maximize their overall returns within an acceptable level of risk, Investopedia - https://www.investopedia.com/terms/m/modernportfoliotheory.asp

  3. The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital, Investopedia - https://www.investopedia.com/terms/c/capm.asp

  4. Newton's laws of motion are three laws that describe the relationship between the motion of an object and the forces acting on it.

  5. Source FactSet: Marico annualised (total) return over 20 years (including dividends), up to 30/09/2021 – market price

  6. Source FactSet: CSL annualised (total) return over 20 years (including dividends), up to 30/09/2021 – market price

  7. Past performance is not indicative of future performance. This information is provided for illustrative purposes and does not constitute any offer or inducement to enter into any investment activity.

Investment terms

View our list of investment terms to help you understand the terminology within this document.

Subscribe to our updates

To get regular updates and content from Stewart Investors, please register here.

Important information

This material is for general information purposes only. It does not constitute investment or financial advice and does not take into account any specific investment objectives, financial situation or needs. This is not an offer to provide asset management services, is not a recommendation or an offer or solicitation to buy, hold or sell any security or to execute any agreement for portfolio management or investment advisory services and this material has not been prepared in connection with any such offer. Before making any investment decision you should conduct your own due diligence and consider your individual investment needs, objectives and financial situation and read the relevant offering documents for details including the risk factors disclosure. Any person who acts upon, or changes their investment position in reliance on, the information contained in these materials does so entirely at their own risk.

We have taken reasonable care to ensure that this material is accurate, current, and complete and fit for its intended purpose and audience as at the date of publication but the information contained in the material may be subject to change thereafter without notice. No assurance is given or liability accepted regarding the accuracy, validity or completeness of this material.

To the extent this material contains any expression of opinion or forward-looking statements, such opinions and statements are based on assumptions, matters and sources believed to be true and reliable at the time of publication only. This material reflects the views of the individual writers only. Those views may change, may not prove to be valid and may not reflect the views of everyone at First Sentier Investors.

Past performance is not indicative of future performance. All investment involves risks and the value of investments and the income from them may go down as well as up and you may not get back your original investment. Actual outcomes or results may differ materially from those discussed. Readers must not place undue reliance on forward-looking statements as there is no certainty that conditions current at the time of publication will continue.

References to specific securities (if any) are included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. Any securities referenced may or may not form part of the holdings of First Sentier Investors' portfolios at a certain point in time, and the holdings may change over time.

References to comparative benchmarks or indices (if any) are for illustrative and comparison purposes only, may not be available for direct investment, are unmanaged, assume reinvestment of income, and have limitations when used for comparison or other purposes because they may have volatility, credit, or other material characteristics (such as number and types of securities) that are different from the funds managed by First Sentier Investors.

Selling restrictions

Not all products are available in all jurisdictions.

This material is neither directed at nor intended to be accessed by persons resident in, or citizens of any country, or types or categories of individual where to allow such access would be unlawful or where it would require any registration, filing, application for any licence or approval or other steps to be taken by First Sentier Investors in order to comply with local laws or regulatory requirements in such country.

This material is intended for ‘professional clients’ (as defined by the UK Financial Conduct Authority, or under MiFID II), ‘wholesale clients’ (as defined under the Corporations Act 2001 (Cth) or Financial Markets Conduct Act 2013 (New Zealand) and ‘professional’ and ‘institutional’ investors as may be defined in the jurisdiction in which the material is received, including Hong Kong, Singapore and the United States, and should not be relied upon by or be passed to other persons.

The First Sentier Investors funds referenced in these materials are not registered for sale in the United States and this document is not an offer for sale of funds to US persons (as such term is used in Regulation S promulgated under the 1933 Act). Fund-specific information has been provided to illustrate First Sentier Investors’ expertise in the strategy. Differences between fund-specific constraints or fees and those of a similarly managed mandate would affect performance results.

About First Sentier Investors

References to ‘we’, ‘us’ or ‘our’ are references to First Sentier Investors, a global asset management business which is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG). Our investment team operates under the trading name of Stewart Investors which is part of the First Sentier Investors Group.

This material may not be copied or reproduced in whole or in part, and in any form or by any means circulated without the prior written consent of First Sentier Investors.

We communicate and conduct business through different legal entities in different locations. This material is communicated in:

  • Australia and New Zealand by First Sentier Investors (Australia) IM Ltd, authorised and regulated in Australia by the Australian Securities and Investments Commission (AFSL 289017; ABN 89 114 194311)
  • the European Economic Area by First Sentier Investors (Ireland) Limited, authorised and regulated in Ireland by the Central Bank of Ireland (CBI ref no. C182306; Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland; Company no. 629188).
  • Hong Kong by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. First Sentier Investors and Stewart Investors are business names of First Sentier Investors (Hong Kong) Limited.
  • Singapore by First Sentier Investors (Singapore) (Company no. 196900420D) and this advertisement or material has not been reviewed by the Monetary Authority of Singapore. First Sentier Investors (registration number 53236800B) and Stewart Investors (registration number 53310114W) are business divisions of First Sentier Investors (Singapore).
  • Japan by First Sentier Investors (Japan) Limited, authorised and regulated by the Financial Service Agency (Director of Kanto Local Finance Bureau (Registered Financial Institutions) No.2611).
  • the United Kingdom by First Sentier Investors (UK) Funds Limited, authorised and regulated by the Financial Conduct Authority (FCA ref no. 143359;  Registered office: Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB; Company no. 2294743).
  • the United States by First Sentier Investors (US) LLC, authorised and regulated by the Securities Exchange Commission (RIA 801-93167).
  • other jurisdictions, where this document may lawfully be issued, by First Sentier Investors International IM Limited, authorised and regulated in the UK by the Financial Conduct Authority (FCA ref no. 122512; Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB; Company no. SC079063).

To the extent permitted by law, MUFG and its subsidiaries are not liable for any loss or damage as a result of reliance on any statement or information contained in this document. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment products referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.

© First Sentier Investors Group