We have our brains and our hearts, the former being a complex organ capable of learning, computing and remembering, whilst the latter is simply there to pump blood around our bodies. Nevertheless, we humans persist in attributing some of the brain’s subtler and more complex functions – our feelings – to the heart, anatomical evidence be damned!
It’s OK though, because we all understand each other when we talk about our hearts. Equally, stuff that is hard to clearly rationalise or articulate, we put down to intuition or instinct. We all know what we “mean” by instinct but, as it happens, we do not (verifiably) have any sixth sense and apparent “instinct” is in fact learned.
What we do have is some amazing mental hardware that is capable of driving sophisticated software, which does not sadly come pre-loaded at birth. It is left to us to develop it through our experiences, reflections and willingness to keep learning. The world and what happens within it may be so convoluted that it is often very difficult to reduce everything to linear cause and effect.
However, just because we can’t rationalise things precisely doesn’t mean our brains and software aren’t in fact processing complex problems very rationally. The challenge is how to know when it’s your brain subliminally solving problems or your “heart” masquerading as your brain!
I think about this a lot when it comes to investing. There is often very little that separates money managers in terms of their education and “hard skills”, but some are just better than others at getting it right. Those who pretend (or believe) that the world is really, really simple and deterministic tend to use phrases like, “it’s really simple”; they typically say these things on radio shows, where their talents are best put to use with the general public and they ideally should not be allowed to navigate (with other people’s money) the subtle and shifting landscapes that exist in probability space, where nothing is simple or certain.
It is no accident then that when selecting managers, we are more interested in understanding their internal mental software than ticking boxes in a simple scoring matrix.
Why is this relevant? It helps define the boundaries between the quantitative and qualitative manger research. I have often said that it would be hard to imagine our being able to do much more on the quantitative side and I believe our tools are market-leading; nevertheless, more than 50 per cent of any decision to invest in a manager is qualitative.
But the boundary between quants and quals is blurred; the quants’ investigations provide rich inputs to the face-to-face engagements, allowing us to extract so much more than if we hadn’t crunched the numbers. The insights from the manager meetings are looped back into the quants, allowing us to hold the numbers up to the light in a different way, turn it around slightly and see the problem from a new, perhaps more subjective angle. This confluence of rock-hard engineering and subtle instinct is where we aim to add value.
In a sense, this is the rebuttal to the argument that says, “Yes, skill may exist out there, but it’s near impossible to identify ex ante. In fact, it’s not always evident ex post that great performance can be attributed to skill”.
What this really means is that it is very difficult to prove that the numbers (history) have any real predictive powers in isolation. In other words, no-one has developed a spreadsheet algorithm that predicts who tomorrow’s winners will be. This misses the point; we are not seeking a silver bullet or crystal ball. What we seek is as much information as possible to produce a well-rounded picture of capability. In order to do this, one needs privileged access to (patient) managers, not just a data provider with a simple analytics package.