Investing or Speculating

The WSJ ran a story in the Money & Investing sectrion, Bond Investors Turn to Cash. They note,

Investors are cashing out of bonds but remain hesitant to plunge into stocks, preferring instead to buy money-market mutual funds despite their low returns. The surprise move highlights persistent investor anxiety with equities even as stock indexes reach new highs. Investors withdrew an estimated $43 billion from taxable bond mutual funds last month, the largest-ever monthly outflow, according to the Investment Company Institute… Many observers expected to see those flows turn to funds tracking U.S. stocks. But in a twist, the main beneficiary of the rush out of bonds has been money-market funds, which are cash-like investments that appeal to safety-minded investors.

As an aside, the article goes on to say that $6.3 billion came out of U.S. stock funds in June, but $7 billion back in during the first two weeks of July.

The fact that dollars allocated to bonds which see the limited risk/reward in the fixed income markets are not jumping into equities should not be viewed surprisingly, and in fact, is probably a good thing. When investors begin to reach for returns in other asset classes because they can’t get the required returns in their desired asset class that is cause for concern. What is happening now is proper risk management, rather than frothy speculation.

Speaking of speculation, the CFA Institute ran an interesting “Twitter Forum” with some leading experts on the differentiation between Investing and Speculating. For literally centuries, the world’s leading investment thinkers have struggled to articulate the difference between “investing” and ”speculating.” Although not a mission to set the standard, the Forum was a thought provoking discussion by a panel of investment practitioners as part of the Future of Finance project at CFA Institute. The panel was moderated by the content director at CFA Institute, Jason Voss, CFA, and the panelists include former Ewing Marion Kauffman Foundation CIO Harold Bradley; investment consultant and blogger Tom Brakke, CFA; Marret Private Wealth President Margaret Franklin, CFA, a former chair of the Board of Governors of CFA Institute; and Legg Mason Investment Counsel chief investment strategist Robert Hagstrom, CFA.

The following are a few of our notes from the rather long discussion with attribution to the tweeter.

Robert Hagstrom

Ben Graham said the difference between investment and speculation is a matter of “intent.” When you put money to work in the market, what is your intent? If your intent is to profit from the change in prices caused by an anticipated change in the behavior of the participants in the market, you are speculating. If your intent is to increase your capital by the growth in the value or the return of your asset you are investing.

Tom Brakke

The “institutional imperative” and “career risk” have led the investment business into a world of relativity, so the degree of speculation ebbs and flows as risks taken are judged in light of what others are doing. Most asset owners chase relative performance and most asset managers use relative valuation more than absolute. Resting your process on comparative measures too often serves as a cover for decision making and an anchor for behavior. When everything is relative, it’s easy to lose situational awareness.

Jason Voss

I valued assets both absolutely and relatively as a check on valuation. An analyst asked me once, “So which one wins when there is a disagreement?” I responded that the absolute valuation wins because it is independent of what everyone else thinks. The caveat, of course, is that certainly we are all vulnerable to our own delusions, projections, and mistakes.

Marg Franklin

In my world, investing is predicated on thoughtful, comprehensive and reasonable analysis of the securities you are purchasing and the portfolio being created against the return you expect to receive – which can come in myriad forms: interest, dividends, capital appreciation. Speculation, in contrast, is based on conjecture rather than fact-based analysis – “greater fool” comes to mind unless it is insider trading. Either case, it is fraught with more risk.

Jason A. Voss

Criterion used so far by panelists and our audience:
* Differences in expected sources of return. Investors expect more of their return from cash flows over time and are less price sensitive. Whereas speculators expect changes in price as their primary source of return.

* Differences in willingness to take on risk. Investors are described as more risk sensitive, engaging in higher levels of due diligence to mitigate risks. Whereas, speculators are described as more willing to take on risk. This is supported by the above description, too, as speculators forgo cash flows from an investment (risk mitigator) for price appreciation.

* Differences in strategy’s time horizon. Investors are more long-term, speculators short-term.

Robert Hagstrom

I agree with Marg when she says the pressure of “relative” performance is an immense problem and likely, in my opinion, invites short-term actions (perhaps speculative in nature) to stay in the game. The other problem we have is that because there is no generally agreed upon definition between investing and speculation is that the media (TV in particular) are weaving back and forth between what I perceive to be investment thoughts and speculative thoughts in the same segment without even realizing they are doing so. In turn, the viewer is getting mixed messages as to what actions are investing (intended to achieve long-term results) and speculation (intended to achieve short-term results).

If we can come to some general agreement of what is investing and what is speculation, would the next logical step to begin identifying what strategies are speculative and what strategies are investing so individuals and advisors would have a clear understanding of when they were investing and when they were speculating.
For example, is buying and selling securities based on changes in sentiment an investment strategy or a speculative stragegy? Is technical analysis an investment strategy or a speculative strategy? I am not sure I know. Is buying or selling securities based upon monthly changes in unemployment figures or quarterly GDP results investing or speculation?

Harold Bradley

Having watched behaviors of professional investors for way too many years, I believe that the focus on risk management has RAISED and not LOWERED the level of speculation. “Hedge” is equated with more return for less risk as the narrative. If I invest in Europe but hire managers to hedge my currency, is that investment diversification with a speculative kicker? I would say so.

Robert Hagstrom

I obviously think there is a critial need to define the differenes between investing and speculation and in doing so we will do a great service to individuals who allocate part of their savings to the capital market. As I said earlier, I believe this objective will go a long way towards re-etablishing a higher level of trust between individuals and the financial industry which we know is sorely lacking.

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