On fund managers and poker players

It is skill that differentiates the successful from the unsuccessful players over the long term

Surprisingly, there are striking similarities between successful fund managers and professional poker players.

Competition poker has become the latest global craze - the surge in popularity coincides with the advent of the lipstick camera, that allows viewers at home to see the cards of the players as the hands unfold.

This, and the remarkable sums of money at stake have made poker a popular spectator sport.

Having always been firmly against gambling (to the point where I have never even bought a lottery ticket), I had simply assumed that poker was another means for the statistically challenged to give away their hard earned money to casinos.

To my surprise it turns out that professional poker players are not gamblers.

When playing professional poker, you are not pitted against the casino, but rather against your competitors; so like active fund management, poker is also a zero sum game.

In order to win, good poker players must inflict their profits as losses on their competitors. To do this consistently they have to be more skilled than their fellow players.

Interestingly, like top fund managers, good professional poker players generate significant profits over longer periods, but have mixed results over shorter periods as there is a random element (or luck) to the cards dealt.

It is skill that differentiates the successful from the unsuccessful players over the long term.

The great players can make lucrative careers of poker, simply because they are more skilled than the competitors.

That is why at every World Series of Poker certain players frequently make it to the final table year every year.

A similar trend exists in fund management. Although, over shorter periods of time, even the most successful fund managers underperform the market, they tend to float to the top over a longer time frame.

It is for this reason that we do not advocate the comparison of fund manager performances over short periods of time – a full market cycle would be the minimum period worth considering.

So skill is only evidenced (as in poker) over longer time frames. Relative performance can be random over shorter periods.

The best poker players bet big when they have a high level of conviction in their hand. In this way they limit the losses on poor hands and make good gains on their strong hands.

This type of strategy improves the odds of generating profits through time. To do this successfully, the poker player needs to exercise discipline and patience, as it is tempting to play more hands than one should.

Apparently, the biggest mistake that amateur poker players make is betting too frequently. This is understandable as it is far more exciting to play a hand than to sit on the sidelines.

Similarly, successful fund managers research the ‘bets’ that they make, and take larger active positions when they are most sure of their facts.

By scaling their bets to their conviction levels, they are more effectively managing the risk in their portfolios. We consider effective risk management one of the most crucial elements of investment success.

Another characteristic of a successful poker player is their ability to ‘read’ their opponents. The top players study their opponent’s behaviour, style of play and idiosyncrasies.

By being better able to read their opponents (who often try to bluff or purposefully misrepresent their hand), they improve their odds of a positive pay-off.

Interestingly, some of the most successful poker players hold doctorates in subjects such as psychology, computer science and mathematics. Their numerical skills and insights into human behaviour have bought them success.

Similarly, top fund managers must use their expertise and experience to judge market and company prospects based on incomplete (and sometimes misleading) information, and at the same time deal with the hype, sentiment and emotion that drives markets from time to time.

By being better equipped to make these decisions under uncertainty, top managers are able to differentiate themselves from their peers.

As with fund management, there are countless books about successful, moneymaking poker strategies.

However, the true differentiator may not be that easy to pin down.

The minimum requirement is obviously a disciplined approach that tilts the odds in your favour, but a certain insight at the margin or unquantifiable edge, differentiates the best players from the merely adequate.

This is true also of top fund managers, who require more than experience, a sensible investment philosophy and a disciplined process. They also need to be smarter than their competitors.

Written by Matthew de Wet

itinews.co.za