There is a mantra in the world of marketing that applies just as effectively to most endeavors. Keep it simple, Stupid (K.I.S.S.). Meaning don’t overcomplicate things. If possible, use simple words rather than complex sounding jargon. Believe it or not, studies show that people perceive you to be smarter when you use simple words that they can understand. (No, the most recent US election wasn’t one of those studies.)
Unfortunately, we like to complicate things that needn’t be. Take, for instance, a decision one of my students was analyzing. His stated objective was to get and stay fit by being physically active every day. The activity he chose to achieve this objective was running. The problem is, sometimes he couldn’t complete a full run, because the tide would come in, thereby cutting off his route and shortening the intended course. His decision log was dedicated to solving the problem of unexpected tidal interruptions. He knew that he could simply look up the timing of our tides and be done with it, but given how easy and obvious that solution was, and yet he wasn’t doing it, it was clear the problem wasn’t tidal. Perhaps on those days when the tide is cutting his run short, subconsciously that’s exactly what he wants. Instead of him facing the fact that he is to blame, he deflects to nature, making it easier to deal with his failure.
The flaw in his decision making process occurred in step 2, defining the states. Recall, states are those factors that affect our ability to achieve our objectives, but which we don’t control. For instance, he enjoys being social and competing against his peers. If he had taken the time to define these states, it’s very likely he would have chosen intramural soccer, tennis or basketball to achieve his goal. Instead, he opted for the one that immediately came to mind when thinking about a physical exercise people do to get in shape. Here’s the fascinating part. When we dissected his decision with a proper analysis, the correct course of action was obvious to the entire class. However, his instinctive reaction was to push back by adding the additional criteria of “discipline” to his objective. You see, the obvious answer, to play a number of different physical sports that incorporate social and competitive aspects in order to get and stay in shape, was so simple, he had a hard time accepting it. “Not everything should be easy,” he said. “There’s something to be said for doing things that are difficult, and challenging.” The irony of his statement was lost on him.
You see, he had avoided the cognitive strain (hard work) required to select the action(s) that provided the greatest odds for achieving the outcome he desired. As a result, he opted for an action that provided low odds of success, but provided the appearance of hard work. Of course, it’s not easy to find the time to play a team sport, no matter how much you enjoy it and it’s also difficult to play that sport well. In other words, what he had defined as an easy task wasn’t actually easy, it was just enjoyable. That enjoyment is what increased the odds of him actually doing the hard work in order to achieve the outcome he desires.
We do the same thing in this business. Truth is, we are actually incentivized to overcomplicate things. After all, how can we rationalize charging 2/20 for tasks that are easy to achieve? Let’s imagine for a moment, you are a long only equity fund manager. You have dozens of analysts who hold calls with managers, gather info and maintain a database on dozens of companies. You fly around to conferences, subscribe to research and have fancy offices to hold meetings. As a result, you deliver 400 basis points of alpha above the S&P 500 for many years. You feel terrific and investors reward you for a job well done.
There’s another guy. He runs a program based on just a few factors, out of his garage. He has discovered that small caps tend to outperform over time, that trading less often delivers a higher probability of better, more consistent returns, and that it is easier to predict which sector will underperform all the others in a given year than it is to predict which sector will outperform all others. So, he follows a rather simple investment approach. As it turns out, simply by avoiding the worst performing of the nine sub-sectors in the Russell 2000, distributing his investment equally across the other 8 sub-sectors and holding that position for the year, he has been able to outperform the S&P 500 by an average of 450 basis points over the last 20 years, all with less volatility in the return stream.. He doesn't attend any conferences, fly around the country meeting with managers or have to deal with the distractions of a complex business structure. Investors have shown little interest in his strategy.
We do the same thing when it comes to the research process. For some reason, we seem to believe that gathering more information and data is somehow directly correlated to being better informed and making better decisions. It’s not. Just as my student would have been better served had he taken the time to properly define the states before diving in to consider his different options, investors would do themselves a great service if they first identified what represents signal and what is merely noise as it relates to a company’s stock price, and the factors that affect their expectations.
Case in point. One of Bija’s coaching clients had a strategy on that would benefit if FERC (Federal Energy Regulatory Commission) were to approve the Rover natural gas pipeline. It was all called into question when President Trump suddenly pushed aside the Chairman, Democrat Norman Bay, in favor of fellow Commissioner Cheryl LaFleur, and Bay responded by announcing he would step down from the commission on February 3rd. Without Bay, the commission would be left with just 2 commissioners. The problem is, in order for the pipeline to be approved, a quorum is required, but the definition of a quorum is nonexistent. Those who are deeply involved in this sector were suddenly scrambling for clarity on the definition. I read the reports put out by experts in the field. Now I’m used to reading reports written by two handed economists, but these read like they were produced by a Hindu deity. It was clear they had no idea whether or not a binding vote could occur between February 3rd and the time when a new appointee would be approved, and that mattered. If the pipeline wasn’t approved by February 3rd, even a short delay would push off the project launch by at least six months thanks to the protection afforded the endangered northern long-eared bat during its migratory season.
I’m not very familiar with all the intricacies of the pipelines and the regulatory environment, but to be honest, that gave me an edge, because it was little more than a distraction. What was creating the confusion for the experts is that they were using the old political norms, and their experience in the area, to assess the odds of it going through. That is a mistake many are making (see Trump Delivers Clarity).
If it is pro-business, and especially pro-energy, odds are heavily in favor of it going through under this administration. It really is that simple. In the discussions with our client, we focused on the incentives likely to drive Bay’s behavior ahead of his departure and Trump’s ability to define “quorum” should the vote be delayed until after Bay’s departure on February 3rd. Everything else was noise. Period. As our analysis suggested, the pipeline was approved ahead of Bay’s departure. Our client texted me, “Best line so far - ‘can't believe it, Rover just magically gets done - trump just pushing stuff through’”. It’s not magic, it’s a new approach. What was signal is now noise, and vice versa. If you don’t employ the cognitive strain necessary to properly define the states as they actually exist, rather than how you remember them or would like them to be, you will struggle to achieve your objectives, just like my student.
A subscriber shared this feedback after reading Trump Delivers Clarity. “A couple of our people were so angry that they couldn't really get past their own bias. Like him or not, we are in the business of taking risk and making money. So it is not for us to love or hate the guy, it is for us to understand what he will do and position accordingly. We have to live and succeed in the environment that we are in. When a key person at our firm read your article his whole mindset changed from being too upset to putting his personal feelings aside and look more objectively at the market.” Job done.
"While everyone else is scrambling to answer who, what, where and when, Duneier is focused on explaining the 'why'."
For nearly thirty years, Stephen Duneier has applied cognitive science to investment and business management. The result has been the turnaround of numerous institutional trading businesses, career best returns for experienced portfolio managers who have adopted his methods, the development of a $1.25 billion dollar hedge fund and 20.3% average annualized returns as a global macro portfolio manager.
Mr. Duneier teaches graduate courses on Decision Analysis and Behavioral Investing in the College of Engineering at the University of California. His book, AlphaBrain, is due to be published in early 2017 (Wiley & Sons).
Through Bija Advisors' coaching, workshops and publications, he helps the world's most successful and experienced investment managers improve performance by applying proven, proprietary decision-making methods to their own processes.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America, Managing Director in charge of Emerging Markets at AIG International and founding partner of award winning hedge funds, Grant Capital Partners and Bija Capital Management. As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world for more than 20 years on topics including global macro economic themes, how cognitive science can improve performance and the keys to living a more deliberate life. Each is delivered via highly entertaining stories that inevitably lead to further conversation, and ultimately, better results.
His artwork has been featured in international publications and on television programs around the world, is represented by the renowned gallery, Sullivan Goss and earned him more than 60,000 followers across social media. As Commissioner of the League of Professional Educators, Duneier is using cognitive science to alter the landscape of American K-12 education. He received his master's degree in finance and economics from New York University's Stern School of Business.
Bija Advisors LLC In publishing research, Bija Advisors LLC is not soliciting any action based upon it. Bija Advisors LLC’s publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Bija Advisors LLC does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Bija Advisors LLC’s publications only. All forecasts and statements about the future, even if presented as fact, should be treated as judgments, and neither Bija Advisors LLC nor its partners can be held responsible for any failure of those judgments to prove accurate. It should be assumed that, from time to time, Bija Advisors LLC and its partners will hold investments in securities and other positions, in equity, bond, currency and commodities markets, from which they will benefit if the forecasts and judgments about the future presented in this document do prove to be accurate. Bija Advisors LLC is not liable for any loss or damage resulting from the use of its product.
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