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 persist in attributing some of the brain’s subtler and more complex functions – our feelings – to the heart, anatomical evidence be damned. Equally, stuff that is hard to 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.
We are born with some amazing mental hardware, which is capable of driving sophisticated software developed over our lifetimes. We continuously update our mental software through our experiences, reflections and willingness to keep learning. Events are often so convoluted that it is very difficult to reduce everything to simple cause and effect. However, just because we can’t always rationalise our thought processes doesn’t mean our brains and software aren’t in fact successfully tackling complex, non-linear problems very rationally indeed. Knowing when it’s your brain subliminally solving problems or your “heart” masquerading as your brain is pretty important!
I think about this a lot when it comes to selecting fund managers. There is often very little that separates money managers in terms of their “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 tend to use phrases like, “it’s really simple”. They might say these things on TV or radio shows to much acclaim from the general public, which does not automatically qualify them to navigate the complex vaults of the “probability space” of investment markets, where little is simple or certain. It is no accident that at PortfolioMetrix we are more interested in understanding a manager’s mental software than ticking boxes in a simple scoring matrix.
Why is this relevant? It helps define the interplay between quantitative and qualitative research. It is hard to imagine our firm doing much more on the quantitative side than we already do, and I believe our tools are market-leading. Nevertheless, more than 50% of any decision to invest in a manager tends to be qualitative and relies on subjective interrogation and experience. 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 meetings are looped back into the quants, allowing us to hold the numbers up to the light in a different, more intriguing way. This confluence of rock-hard engineering and subtle instinct is where we aim to add value. By and large, careful analysis of the numbers provides the questions, not the answers. Getting the questions right, as it happens, is pretty important if you are looking for meaningful answers.
We dispute the argument that says, “Yes, manager skill may exist out there, but it’s impossible to identify in advance. In fact, it’s not always evident that great historical performance can be attributed to skill either”. This simply says that historic data has little predictive power. In isolation, we would agree. No-one has developed a spreadsheet algorithm that predicts who tomorrow’s winners will be, but this misses the point completely; we are not seeking a silver bullet or crystal ball. You simply want as much information as possible to produce a well-rounded picture of capability. One needs privileged access to fund managers pre-armed with thorough research, which yields little clues here and there. Before Sherlock Holmes applies his incredible deductive capabilities, he starts with the data – and so should we. Anything else is just sloppy detective work.