Investing: art or science?
13 March, 2015
I have an enormous advantage over "normal" people when it comes to investing. I work with a bunch of clever investment professionals and run every investment idea past them, review their recommendations and hear the logic and analysis behind each idea.
This peer review process is not infallible — we still occasionally make bad investment decisions — but our calls are a darn sight better than if made by an individual reflecting his or her own biases, experiences and assumptions.
Having worked with investment professionals for more than 25 years, I have come to appreciate how much the unique make-up of every single investor influences market behaviour. Without wanting to offend my industry colleagues, I think it's fair to say that investment professionals are a fairly homogenous lot.
The sort of person who carves a career in the investment industry is typically a self-confident, optimistic and intelligent risk-taker. They know their way around a set of financial accounts and can prepare valuation models in their sleep. They have an enquiring mind, which they need, because the numbers only tell half the story.
But they are still unique individuals and their way of thinking and the way they make decisions will be influenced heavily by their backgrounds, their life experiences, their age and their gender. That can lead to significantly different outcomes.
I can vouch for this, having sat through countless investment meetings and listened to the debate, the questions and different conclusions derived from common information. Everyone can see the data, knows the questions that must be asked and understands the models and techniques that decide if an investment is a buy, sell or a hold.
Yet they will all take a different slant, apply their judgement and, in a group of 10, it is not uncommon for one to conclude Buy and one to conclude Sell...from the same base information. That is how markets function.
Any transaction needs a buyer and seller. The buyer needs to believe he/she is getting good value; the seller needs to feel they have sold well.
But how can this be? We know what represents good value, we know how to calculate a price earnings ratio or complete a discounted cash flow valuation and we know when an investment is priced steeply, relative to its peers or its historical trading average. Yet, at a given price, some investors find value while others don't.
Personal judgement makes investing as much an art as a science. If all it took to invest successfully was to understand the theory and application of mathematical models to select valuable investments, there'd be a lot of wealthy academics and mathematicians out there.
Over time, the 'artistic' element of investing has been explained by behavioural theories (our tendency to think certain ways about risk and return) and by investment style.
In our team we have a mixture of individuals who are value-oriented or growth-oriented, some who have a bigger risk appetite, some who prefer quantitative research while others focus on the qualitative aspects.
We do not try to reach consensus — it would take a long time to build a decent portfolio if we did — but we do heed the opinions of all, paying particular attention to the outliers. This takes time but it removes the human tendency to be too optimistic and fall in love with a good idea. If it can pass the scrutiny of those investors at the opposite end of the spectrum to us — the doubting Thomases — then it really is a good idea.
Most successful investors trust their own judgement. But there is something to be said for considering what others think, particularly if they completely disagree with you. Convince them, and you're onto a winner.