In James Montier’s investment classic “Value Investing: Tools & Techniques for Intelligent Investment”, he recalls an experiment undertaken by two scientists (Eisenberg & Lieberman) in 2004. As part of the experiment, the subject was asked to player a computer game with two other individuals (at another location) that involved throwing a ball back and forth between the three individuals; however, what the participant didn’t know was that the other two “players” were really just computer controlled.
When the game first started, the players tossed the ball back and forth between all three individuals; however, after a period of time, the two computer controlled players would start excluding the third player (the test subject), and toss it back and forth between each other. When Eisenberg and Lieberman looked at the brain imaging of the participant while this was going on, they discovered that this social exclusion generated activity in the anterior cingulate cortex and the insula; the interesting thing is that these two areas are also activated when an individual feels real physical pain. In the words of Mr. Montier, it’s “like having your arm broken on a regular basis – not fun!”
JOB RISK
For investment managers at hedge funds and mutual funds, the world is constantly looking at short term results (look how Bruce Berkowitz’s assets under management noise-dived in 2011, despite winning manager of the decade from Morningstar in 2010); for them, standing out from the crowd comes with the added risk of losing one’s job (or billions of AUM), and the pain/anxiety that comes with it. For example, in The Economist from the week of February 4th, there is an article that discusses the 3-year loan offering from the ECB to banks, and the effect that this has had on certain securities such as sovereign debt. One particular paragraph jumped out at me (bold added for emphasis):
“Yet the headline number of €489 billion and the promise of a second (potentially larger) three-year auction later this month have been enough to turn sentiment around – especially as non-bank investors had started 2012 short of euro-zone government paper. Before the end of the year “everybody was underweight Italy because they were worried about being fired for being long”, says the head of capital markets at one large investment bank. “Now the job risk has shifted to being underinvested in Italy.”
This is akin to the historical "No one gets fired for buying IBM stock" way of thinking, and is best captured by John Maynard Keynes: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally”.
THE INSTITUTIONAL IMPERATIVE
Warren Buffett talked about this phenomenon and how it relates to corporate executives in his 1989 letter to shareholders:
“In business school, I was given no hint of the imperative's existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn't so. Instead, rationality frequently wilts when the institutional imperative comes into play.
For example: (1) As if governed by Newton's First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.”
As always, when a group of investors are acting irrational for one reason or another, the intelligent investor should be on the hunt for opportunity. Just like with a company, investors should look at themselves and honestly answer the key question: what is my competitive advantage? Many people fool themselves by thinking that they know more than the market, when in many cases they are blinded by the biases that affect us all.
In reality, one of the biggest advantage for the individual investor is the fact that they aren’t at the whim of clients, and don’t need to adjust their investment strategy to meet short term hurdles. While many investors profess this belief, Seth Klarman’s words are representative of the reality: “The temptation of making a fast buck is great, and many investors find it difficult to fight the crowd”.
Being contrarian isn’t easy, and focusing on the long term as the ticker flies by on the bottom of the TV screen (over and over and over again) is difficult as well; that partly explains why the majority of individuals can’t resist the temptation to trade in and out of stocks, usually at exactly the wrong time.
THE GREATEST REWARD
For investors looking to achieve long term financial success, the teachings of Buffett, Munger, Fisher, and Graham are bountiful; the hard part is sticking to the strategy when the sky is falling or the good times can't stop rolling. Many investment professionals can’t go against the herd (in a big way) for fear of losing clients or their job; for the individual investor, this is an opportunity that can lead to a lifetime of tremendous financial success. In the words of Sir John Templeton, “to buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward”.
When the game first started, the players tossed the ball back and forth between all three individuals; however, after a period of time, the two computer controlled players would start excluding the third player (the test subject), and toss it back and forth between each other. When Eisenberg and Lieberman looked at the brain imaging of the participant while this was going on, they discovered that this social exclusion generated activity in the anterior cingulate cortex and the insula; the interesting thing is that these two areas are also activated when an individual feels real physical pain. In the words of Mr. Montier, it’s “like having your arm broken on a regular basis – not fun!”
JOB RISK
For investment managers at hedge funds and mutual funds, the world is constantly looking at short term results (look how Bruce Berkowitz’s assets under management noise-dived in 2011, despite winning manager of the decade from Morningstar in 2010); for them, standing out from the crowd comes with the added risk of losing one’s job (or billions of AUM), and the pain/anxiety that comes with it. For example, in The Economist from the week of February 4th, there is an article that discusses the 3-year loan offering from the ECB to banks, and the effect that this has had on certain securities such as sovereign debt. One particular paragraph jumped out at me (bold added for emphasis):
“Yet the headline number of €489 billion and the promise of a second (potentially larger) three-year auction later this month have been enough to turn sentiment around – especially as non-bank investors had started 2012 short of euro-zone government paper. Before the end of the year “everybody was underweight Italy because they were worried about being fired for being long”, says the head of capital markets at one large investment bank. “Now the job risk has shifted to being underinvested in Italy.”
This is akin to the historical "No one gets fired for buying IBM stock" way of thinking, and is best captured by John Maynard Keynes: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally”.
THE INSTITUTIONAL IMPERATIVE
Warren Buffett talked about this phenomenon and how it relates to corporate executives in his 1989 letter to shareholders:
“In business school, I was given no hint of the imperative's existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn't so. Instead, rationality frequently wilts when the institutional imperative comes into play.
For example: (1) As if governed by Newton's First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.”
As always, when a group of investors are acting irrational for one reason or another, the intelligent investor should be on the hunt for opportunity. Just like with a company, investors should look at themselves and honestly answer the key question: what is my competitive advantage? Many people fool themselves by thinking that they know more than the market, when in many cases they are blinded by the biases that affect us all.
In reality, one of the biggest advantage for the individual investor is the fact that they aren’t at the whim of clients, and don’t need to adjust their investment strategy to meet short term hurdles. While many investors profess this belief, Seth Klarman’s words are representative of the reality: “The temptation of making a fast buck is great, and many investors find it difficult to fight the crowd”.
Being contrarian isn’t easy, and focusing on the long term as the ticker flies by on the bottom of the TV screen (over and over and over again) is difficult as well; that partly explains why the majority of individuals can’t resist the temptation to trade in and out of stocks, usually at exactly the wrong time.
THE GREATEST REWARD
For investors looking to achieve long term financial success, the teachings of Buffett, Munger, Fisher, and Graham are bountiful; the hard part is sticking to the strategy when the sky is falling or the good times can't stop rolling. Many investment professionals can’t go against the herd (in a big way) for fear of losing clients or their job; for the individual investor, this is an opportunity that can lead to a lifetime of tremendous financial success. In the words of Sir John Templeton, “to buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward”.
