What
are the common errors made by investment managers and how can they overcome
them?
The errors identified by behavioral economists like loss aversion, representative bias, and so forth have a common problem - which is lack of awareness on how we think. The world presents you many experiences. That may be anything - like a 3% decline in index, the death of Hugo Chavez in Venezuela, which acts as a stimulus for you. And most of us immediately refer to our knowledge and memory of similar events. What happens then is your model will be right only so much as that previous memory and knowledge was correct. Ideally, you should interrupt this process. You have to think how this situation can be different from the past situation.
You can overcome such errors by keeping a dairy in which you note the major decisions taken by you. For instance, Venezuela has relationship with Cuba, which is the declared enemy of United States since 60 years. His death doesn’t change that equation with US. You might have an opinion on that but as an investor you won’t buy it. If you note it in a diary you get a much wider feedback mechanism. If you note 100 decisions and keep seeing that diary on a quarterly basis you can evaluate your decisions. That is one way to eliminate bias because you have documented it.
The second thing you can do is to begin documenting your mental models. For instance, ‘low hanging fruit’ is a common term you hear in business. That’s not really an analysis. It’s a quick mental model to evaluate something. But literally there are hundreds of these terms which we commonly use. It works great if you do it with an investment partner and see where you are making mistakes and where it succeeds.
The third thing is meditation. Meditation is the ability of regaining control of your consciousness with a mental practice and discipline.
According to you, how important is the role of luck in investing?
I would consider luck as failure. The diary which I was describing earlier is important in this context. Suppose a stock you believed in went up because of your estimates. But it’s meaningless if it didn’t go up for the reasons you had thought it would. That’s what separates luck from skill. So the diary is important to help you note down the reasons for your actions which will help you identify your mistakes.
As an investment manage how did you deal with information overload?
I’m still working on that one. It’s a big problem. Meditation helps you to see the world in a less biased way. I had to do meditation for this very reason. After a while in my career, I recognized this problem of dealing with so much information. Meditation helped me identify things that were relevant.
With experience, you begin to recognize what kind of stories worked well. The third and easiest so far is to let your ignorance guide your process. By process I mean how you digest your information. When you begin your career every story you encounter is new to you. You have to slowly but surely read all those stories and let your ignorance guide you. You will recognize that every headline you read is only slightly different from others. You have to identify the slightly more nuanced change in every story. I’ll use the example of oil. I began my career as an oil analyst. So when oil fell to $55 recently, I didn’t have to read many articles to figure out the reasons because I was able to reference my knowledge.
Investors tend to chase returns while selecting a fund to invest. What would be your advice to them?
It is a really hard problem. Daniel Kahneman, the godfather of behavioral economist, identified two forms of thinking – system 1 and system 2. System 1 is flight or fight. Return chasing is a form of flight or fight. It’s instinctual and herd behavior. The system 2 thinking is deliberate. You have to gain awareness of why you are doing what you are doing. Individual investors don’t spend time doing this so the best way is to consult a financial advisor.
Who is your idol in the world of investments?
I used to follow Warren Buffet. I also like Van Duyn Dodge and E. Morris Cox. I also admire another investor Shelby Davis which happened to be the founder of the firm I ended up working with. He exited just a year and a half after I joined his firm. Ray Dalio of Bridgewater Associates is another admirable investor.
Do you still follow an investment guru? Does following an investment guru help?
You have to be responsible for your choices. Some people will read sell side research from brokerage firms and financial institutions and they will buy the stocks without really engaging in their own deliberate process. That may work but it creates two problems. One is more severe than the other. It eliminates your ability to learn anything. It makes you dependent forever on somebody else’s reasoning. So there’s no way for you to improve. It may only help you in the short run.
You have to accept that you can lose money if you take your own investment decisions. If you fail and if you are thoughtful about why you failed you’ll get better and better.
The second problem in following someone is that you are shying away from responsibility. You can’t learn if you blindly follow Warren Buffet. At a professional level, I can’t say to my client that we are sorry because our funds didn’t perform well this year because we followed the sell side research which was at fault.
Your favorite investment book?
I liked the book ‘Intelligent Investor’ and ‘Securities Analyses’ written by Benjamin Graham and David Dodd. Both books are timeless.
Your advice to budding fund managers
Aspire to be you. Getting to know who you are as a human being is important to succeed. It sounds simple but it is hard. It is valuable because if you have identified weaknesses, you have solutions. If you are ignorant about something, get information about it.
If not a fund manager you would have been...
I wanted to work in the record industry. Music was my first meditation when I was young. I wanted to work for a music talent scouting firm. I thought it would be great to get paid to listen to music. It didn’t happen and here I am.
