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Investment Discipline—Narrowband & Broadband

In Perspective

Unio's "In Perspective" short-form series covers the Unio team's views on topics ranging from investing to business to economics.  

 

Investment Discipline—Narrowband & Broadband

John Allison

The thin copper wire that probably still connects your telephone is a narrowband wire. The thick cable (or thin, but capacious, fiber optic wires) that carry most of the Internet are broadband wires. Narrowband can only carry a fraction of the voice and data that broadband can—the difference between a straw and a water main.

For telephone calls, a narrowband copper wire does the job just as a straw is adequate for a glass of lemonade. But for the piles of data streaming through the Internet, you must have broadband—just as a city must have water mains.

Although I suspect you have never heard of investing described this way, one can categorize investors as being narrowband or broadband:

  • A deep-value investor who looks for investments that sell at 50% of their intrinsic value and sells them when they reach 100%, fits the description of a narrowband investor.
  • An investor who looks at multiple factors—perhaps including, but necessarily limited to, value—to make an investment purchase (and then at multiple factors to sell that investment) would better fit the description of a broadband investor.

I have listed below a few features that characterize one or the other—as well as features that are common to both:

Narrowband_Broadband_investor

NARROWBAND INVESTORS—THE EXCLUSIONISTS

The benefit of the narrowband investor is not focus, per se, but exclusion. The narrowband investor excludes every item, every company, that doesn’t stand out when he points his intense flashlight at it. I mentioned the deep-value investor. He excludes almost everything except his obsession with finding investments selling at the proverbial 50 cents on the dollar. So does the investor who says “I look for big cap growth stocks” or “I look for small-cap value” or "I look for Asia emerging markets securities.” In fact, in the past, endowments and pension funds often looked for investment managers who operated on exclusive pieces of turf, hoping that one would cover enough overall investment turf to emerge a winner.

BROADBAND INVESTORS—THE INCLUSIONISTS

The benefit of the broadband investor is precisely that he includes much more than the narrowbander. If the narrowbander carries a flashlight, the broadbander carries a floodlight. His floodlight is still intense and focused. It’s just that it illuminates many more investment ideas at once—across geographies, industries, and so on. The benefit of broad illumination is that the broadbander can put together a portfolio with different relationships among the securities he holds (and therefore different risk/return outcomes). In recent years, shrewd asset allocators have begun to appreciate having in their stable broadband investors who can cover bigger swaths of investment turf.

IS THE MANAGER-PICKING MODEL LOOKING FOR A CHANGE?

Narrowband investors will always exist and be the more numerous. It is just easier to pick one area in investing and exclude everything else. However, it is getting harder and harder for asset allocators to successfully put together a collage of narrowband investors. That is why there is appeal in finding the broadband investor: he puts together a lot of investment territory for the manager-picker. It may well be that the landscape will slowly change from the current model, where asset allocators hire lots of single-purpose investors, to a hybrid of fewer managers—a few single-purpose and more large-territory broadband managers. 

— John A. Allison