Trying to find investment ideas is a difficult process. Finding an idea might be easy, but justifying the investment and putting it through a rigorous process of due diligence where you subject yourself to questions that look to remove any elements of confirmation bias is difficult, especially considering the psychological elements of this process.
Over the course of his career, renowned value investor Mohnish Pabrai (Trades, Portfolio) has tried to streamline his investment process as much as possible to remove any biases and to ensure he does not repeat the same mistakes he has made in the past.
It may be hard to believe, but one of the best processes Pabrai has discovered on this quest is speed. In a recent talk at Google, Pabrai said an investment opportunity should only be considered if it hits you over the head immediately. If not, it is best to move on. He believes this is the right course of action because “spending time on [researching] companies is likely to make me bias.” As an example, he shared a story about Charlie Munger (Trades, Portfolio):
“A few years back, I had dinner at Charlie Munger's house with a small group of people. He posed the question to the group; he said that the Capital Group, a few years back, had set up a best ideas fund. They had asked each of their portfolio managers to give one stock, their highest-conviction idea, and then they created a best ideas fund, which was taking one pick from each of the managers. Charlie went on to say that this fund did not do well, it underperformed its benchmark and the S&P 500. He was asking the group why this was.
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They tried setting up the best ideas fund multiple times, and each time it failed. He said, 'Before I answer the question why it failed, I want to give you a story from my days at Harvard Law School.' He said that sometimes when they had classes at Harvard Law, the professor would bring up a case where the facts were such where it wasn’t obvious which side was in the right. Then they would divide the class into two halves randomly. One half would argue for the defendant, and the other would argue against the defendant. The two sides went off and studied the facts and made their arguments. After all of that was done, when they surveyed the entire class, overwhelmingly the students who had argued for the motion believed strongly that they were right, and the people who had argued against the motion believe strongly that they were right. Before they had studied the facts, they did not have a leaning one way or the other. Charlie said the best ideas fund was simply a fund full of ideas which managers had spent the most time on, the ideas they were most excited about.”
This emotional bias holds investors back. The ideas you spend the most time on are likely to be your highest-conviction plays purely for the reason you know more about them than anything else, but that does not keep you from being wrong.
Pabrai's solution to this problem is a series of psychological "hacks" to remove any element of bias. He explains:
“The first hack is being aware. Just being aware of these facts is a huge advantage. So being aware of the fact that we have a lot of biases, and our mind can play games and tricks on us. Being aware of that and being rational. Charlie Munger often says that he isn’t successful because he’s smart, he’s successful because he’s rational. Another approach is to be fluent in the other side of the argument. If you are going to be long a stock, it’s probably worth putting together a thesis of why you should go short. That will force your brain to think about things that it does not normally want to think about.”
You can watch the full presentation below.Ă‚
