Some nice stuff I am reading, watching, and observing at the start of this weekend…
Beware of Charismatic CEOs
Guy Spier’s The Education Of A Value Investor is a book that reads like having a friendly conversation with a wise friend. It’s one of those very few books where the authenticity is reflected on each page and you can tell that every word has come out straight from the heart.
One of the most important things required for long term investing success, as I have learnt so far, is following a sound investment process. According to Guy, a sound process is a robust set of rules that makes our investment decisions smarter and less vulnerable to the distortions of our irrational brains.
Guy has developed eight such rules to bring an analytical rigour to his process. Here is one rule which made a lot of sense to me and cleared my dilemma about the need to talk to the management. He writes –
…my own experience is that close contact with management is is more likely to be detrimental to my investment returns. The trouble is, senior managers—particularly CEOs—tend to be highly skilled salespeople. No matter how their business is performing, they have a gift for making the listener feel optimistic about the company’s prospects…But this gift of the gab doesn’t necessarily make them a dependable source of information…This isn’t to say that CEOs, CFOs, and other top executives are malicious or immoral…They may be skewing information subconsciously, without any bad intent. But it doesn’t matter. Knowing my own rational limitations, I’d prefer not to expose myself to this potentially distorting influence.
If I want to assess the quality of the management, I’d rather do it in a detached and impersonal way by studying the annual reports and other public data, along with news stories.
So the rule is: Beware of CEOs and other top management, no matter how charismatic, persuasive, and amiable they seem.
And of course there are always some exceptions to every rule. Spier writes –
Exceptions to the rule: Berkshire’s chairman and CEO, Warren E. Buffett, and a small but growing minority of CEOs (at companies like Fairfax Financial, Leucadia National Corporation, and Markel Insurance) who take seriously the idea of sharing what they would like to know if they were in their shareholders’ shoes.
Meeting with management can seriously distort your view and mess up with your mind. Do that only if you’re confident about your ability to keep your mind insulated from a host of biases (Liking, Authority etc.) coming from the charismatic personality of the CEO.
Smart People are Often Crazy
We often treat history as being linear, forgetting that things could have been different in an alternative universe. Biographies, as Paul Graham writes in a short, powerful post, play a role in creating this linearity in our minds…
Because biographies of famous scientists tend to edit out their mistakes, we underestimate the degree of risk they were willing to take. And because anything a famous scientist did that wasn’t a mistake has probably now become the conventional wisdom, those choices don’t seem risky either.
Biographies of Newton, for example, understandably focus more on physics than alchemy or theology. The impression we get is that his unerring judgment led him straight to truths no one else had noticed. How to explain all the time he spent on alchemy and theology? Well, smart people are often kind of crazy.
The Brains Behind Behavioral Science
You can easily change people’s behavior while ignoring the brain, just as you can perfectly write software without knowing anything about a computer’s hardware. But are we so sure that knowing what the brain does isn’t important for behavioral scientists? Can neuroscience improve behavioral science? And what is the risk of failing to keep up with the latest developments in neuroscience? This post has some answers.
Psychologists and behavioral economists struggle to explain why people are biased. For example, the planning fallacy may result from our tendency for optimism and overconfidence. Similarly, confirmation bias is a combination of overconfidence and optimism bias, anchoring (overreliance on information encountered early in a process), and even cognitive dissonance (discomfort with new information that contradicts existing beliefs). But none of these additional behavioral concepts explain why people reject information that contradicts their beliefs.
As Owen D. Jones, a professor at Vanderbilt University Law School, recently observed, explaining one cognitive bias with another is like “saying that rain is caused by a rainstorm.” What causes these biases? The truth is that behavioral scientists have no definite answers—but neuroscientists might.
Sports and Brain
When most of us consider learning and intelligence, we think of activities such as adding numbers, remembering names, writing poetry, or learning a new language. But most of us underappreciate the role that learning a new sport plays in developing our brains, as this post suggests…
Regular exercise changes the brain with studies in animals showing that running and other types of physical activities increase the number of new brain cells created in parts of the brain that are integral to memory and thinking. But the impacts of learning on one of the most primal portions of the brain have been surprisingly underappreciated, both scientifically and outside the lab.
Expiring vs. Long-Term Knowledge
Sherlock Holmes told his accomplice Watson in A Study in Scarlet –
I consider that a man’s brain originally is like a little empty attic, and you have to stock it with such furniture as you choose. A fool takes in all the lumber of every sort that he comes across, so that the knowledge which might be useful to him gets crowded out, or at best is jumbled up with a lot of other things so that he has a difficulty in laying his hands upon it.
Holmes added –
Now the skillful workman is very careful indeed as to what he takes into his brain-attic. he will have nothing but the tools which may help him in doing his work, but of these he has a large assortment, and all in the most perfect order. It is a mistake to think that that little room has elastic walls and can distend to any extent. Depend upon it there comes a time when for every addition of knowledge you forget something that you knew before. It is of the highest importance, therefore, not to have useless facts elbowing out the useful ones.
Morgan Housel does a great job explaining what you should stock in your brain attic (long-term knowledge), and what you should just ignore (expiring knowledge)…
Expiring knowledge catches more attention than it should, for two reasons. One, there’s a lot of it, eager to buzz our short attention spans. Two, we chase it down, anxious to squeeze out insight before it loses relevance.
Long-term knowledge is harder to notice because it’s buried in books rather than blasted in headlines. But its benefit is huge. It’s not just that long-term knowledge rarely expires, letting you accumulate it over time. It’s that compounds over time. Expiring knowledge tells you what happened; long-term knowledge tells you why something happened and is likely to happen again. That “why” can translate and interact with stuff you know about other topics, which is where the compounding comes in.
Add to this something similar I wrote a couple of years back in my post on a guide to reading for investors.
Investing and Conscience
It seems logical that so-called ethical investing comes at a cost. If an investor restricts the universe of shares he is willing to buy for good moral reasons, he is likely to miss out on some stellar opportunities. But what if those lower returns are actually a desirable consequence of environmental, social and governance policies, rather than an unhappy side-effect of investing with a conscience?
So not only should conscientious investors be resigned to accepting lower returns, they should arguably welcome them as evidence that their morality is having a concrete impact. But I’ll leave the final word on the issue to Asness: “Frankly, it sucks that the virtuous have to accept a lower expected return to do good, and perhaps sucks even more that they have to accept the sinful getting a higher one. Well, embrace the suck, as without it there is no effect on the world, no good deed done at all.”
Investing’s Three Magic Words
Confucius said that real knowledge is knowing the extent of one’s ignorance. Aristotle and Socrates said the same thing. Is it a skill that can be taught or learned? It probably can, if you have enough of a stake riding on the outcome.
Some people are extraordinarily good at knowing the limits of their knowledge, because they have to be.
As Charlie Munger said, “Think of somebody who’s been a professional tightrope walker for 20 years – and has survived. He couldn’t survive as a tightrope walker for 20 years unless he knows exactly what he knows and what he doesn’t know. He’s worked so hard at it, because he knows if he gets it wrong he won’t survive. The survivors know. Knowing what you don’t know is more useful than being brilliant.”
James Altucher stresses on the same point in this post where he writes about the three magic words for investing your money.