Just a few examples of half-baked thinking include (A): over-reliance on a particular mathematical or statistical model – the Achilles’ Heel of some ‘experts’. (B): inference wildly beyond what the data allows – a favourite pastime in parts of the media and (C): delegation of important decisions to others without engaging in the process - a standard ploy of politicians, but a trap that can catch us all.
Not only are all three in evidence with the pandemic, but also they have important implications for investment. Problem (A) has long bedevilled decision making in finance. Banks and hedge funds are prone to the lure of abstract modelling, a tradition whose Achilles’ Heel rose to prominence in modern times with the Long-Term Capital Management affair, but there have been many sequels. Summarising uncertainty by simple risk measures still seems irresistible to some financial institutions, revealing both an under-appreciation of the intricacies of data distributions, and the nature of uncertainty itself.
Over-simplification leads to speculative armchair investing, an almost-certain recipe for future regret rather than returns.
Problem (B) is exacerbated by a section of the financial community’s desire for the strapline, missing critical nuances in the process. One consequence is an analogue in the domain of investment to Gresham’s Law in the realm of money – bad money (thought) drives out good, a trend that has seen some excellent analysts abandon our industry in recent years. In the process, we lose those best able to provide context. Over-simplification leads to speculative armchair investing, an almost-certain recipe for future regret rather than returns. Too many investment tales ignore the aphorism attributed to Einstein – everything should be made as simple as possible, but no simpler.
Problem (C) is rooted in an education system where imagination has become subservient to process. As a result, we switch off our own individual creativity and insight. One consequence is that, often when we invest, the real risk lies not with the proposed investments themselves but in our own lethargy, entrusting any thought to others, or worse still, to machines. Often, we are not even aware we have switched off our most valuable neurons. Again, it is perhaps worth committing Einstein’s observation to memory – the intuitive mind is a sacred gift, and the rational mind a faithful servant.
Of course, these themes go further than the investment world. In any complex system, linear thinking is naïve at best, and potentially disastrous at worst. In terms of the environmental challenges we face, for example, Professor James Lovelock summed it up perfectly - dynamic, self-regulating systems defy a logical explanation that uses step-by-step arguments. I shall have a closer look at this in my next post, when I shall re-think the E in ESG. For the moment, next time you are about to make an investment decision, make sure you have your full brain engaged. Otherwise, it might just be better to follow Lady Macbeth’s advice to her husband - you lack the season of all natures, sleep. Roughly translated – sleep on it, and think again.
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The blog does not aim to give investment advice, but is designed to afford relevant longer-term context to investors, encouraging a broad perspective where uncertainty is high and a spirit of learning is important. The views expressed are those of the author, not those of Investec.