Structure shapes behaviour, and behaviour shapes outcomes.

The structure of a market shapes what investors see. When a small group of companies leads the returns, those companies attract attention and capital. The funds that own them rise in the rankings, while portfolios built differently appear to fall behind. A performance table shows winners and laggards, but it also reflects the particular conditions of that moment.

Every market cycle has a story. A group of companies captures investors’ imagination. Their earnings grow, their share prices rise, and the story begins to feel inevitable. Yet market structure changes. Leadership broadens or narrows, and different businesses, sectors and investment styles come into favour. A long-term investment process must be built with that change in mind.

When a story feels most convincing, investors are often most tempted to join in. They look at the funds that have done best, assume the results reflect superior skill, and move money towards them. But part of what they are buying may be exposure to conditions that have already been unusually favourable. By the time a trend feels safe, considerable optimism may already be reflected in prices.

When a narrow group of companies leads the market, the best-performing funds often share the same risks. They may own different companies, but their returns depend on similar expectations being met. If those expectations prove too optimistic, or market leadership changes, they can fall together.

Today’s leaders may continue to prosper, but their future returns still depend on the price paid and the expectations built into it. We cannot consistently identify when leadership will change or which investments will benefit next. Trying to trade each turn can leave an investor buying yesterday’s winner and selling tomorrow’s opportunity.

That uncertainty is precisely what a durable investment process should handle. It should define the portfolio’s sources of return, how managers are selected and what evidence would justify a change. It should also allow for periods when sound decisions trail the prevailing market. Those periods are among the conditions the process was built to survive.

Consider manager selection. We choose a manager because we understand their philosophy, believe in their ability and value their conviction. Then the market favours a different approach, and we question the very qualities we selected. If a manager must resemble the current winners to retain our confidence, we have given them little room to practise their discipline.

As short-term performance pressure builds, investors may feel compelled to move away from their stated beliefs. A portfolio built to meet long-term needs can become a response to the latest performance table.

There is a contradiction in that shift. We say we invest for the long term partly because we cannot consistently call the turns in market cycles. Yet when the current cycle makes us uncomfortable, we change our process to resemble its recent winners. In trying to avoid short-term disappointment, we remove the features intended to make the portfolio durable.

Chasing winners after prices rise, then abandoning them after prices fall, reverses the behaviour a disciplined process should support. If we build a portfolio around the latest story and judge it by short periods of relative performance, we create pressure to change course.

If we diversify across different sources of return, select managers for clear reasons, understand when the strategy may lag and decide in advance what would justify a change, we give our long-term approach a better chance to work.

Good investments and sound decisions will sometimes look disappointing next to the most fashionable part of the market. We cannot harvest long-term returns while demanding that every holding win in every short-term cycle.

Your investment goal and process provide the structure for the decisions you make along the way. When markets test that structure, examine the evidence carefully and remember why you built it.

Preserve the structure of your decision-making.

 

Written by Marius Kilian