Thursday, January 19th, 2012
point counterpoint

In celebration of the new year, I’m looking at some big ideas.  The first was “the haircut,”the research puzzle | For new readers, these arrows in postings are used to provide additional information about linked material. which focused on the damaging but standard practice of using expected returns as the foundation for much investment planning.

The implementation of that idea would involve significant financial sacrifice, as institutions and individuals would be required to make hard choices to meet the new, more conservative plans.  It’s the right thing to do, but it would be painful.  Conversely, there are many improvements to investment decision making that don’t involve that kind of trauma.  All that’s needed is the will to do things better.

That’s the case with the need to hear both sides of a story before making an informed decision.  “Well, well,” you might say, “We always do that.”  I beg to differ.

I’ve seen many different parts of the investment business in my time and it’s a business of advocacy, not of balance.  From the street corner advisor to the master of the universe, the purveyor of investment ideas does not give the other side of the story unless pressed (sometimes hard).  It’s just not in their DNA.

Therefore, the buyers of investment products need to seek out those other opinions aggressively and to eliminate the structural impediments to good decision making.  Largely it’s a matter of design and leadership.  You can tell right away the nature of the decision processes at an organization by simple observation of how information is arrayed for consideration and what is left out.  Often there is no standard way of evaluating ideas in an evenhanded fashion and the whims of the person in charge dictate the flow of information.

A simple but very productive alternative can be summed up in two words:  point counterpoint.  What if the decisions you were involved in systematically included an advocate and that famous character, the devil’s advocate, appointed to forcefully and effectively argue the other side of the question?

Implementing such interactions in the decision process is not hard, it just requires a bit of structure and management commitment.  There are well-known hedge funds that have adopted similar approaches, inviting an analyst with a bullish scenario to debate one that is bearish.Kynikos Associates | Jim Chanos, for example, arranges meetings with Street analysts that have buy recommendations on his short positions in order to see what his firm might have missed.  Such approaches are much less common than you might think and the natural in-house contrarians at firms are often ostracized rather than effectively used to explore the range of possibilities.

In another realm, consider a member of an investment committee at a pension plan or foundation.  When ideas are presented to that person — new asset class exposures, new investment vehicles, new managers to hire — they usually come with recommendations from the consultant and the staff members.  What are the weaknesses and alternatives?  Is the range of possibilities really explored?  Is the idea presented fully and fairly in a way that will lead to a truly informed decision?  Most often not.  The committee ends up being a rubber stamp a very high percentage of the time because the decision process is structured in a way that ensures it.

There are simple ways to offset those tendencies, but everything starts with a willingness and an inclination to seek out differing points of view.  I was struck by a tweet the other day from one voice in cyberspace to another, “You are a great counterpoint to my oft bearish instincts.  What are your thoughts on China GDP numbers?”Twitter | The author, @hedgefundinvest, is an anonymous professional investor.  There is a seeker, unafraid to admit that his own perspective is narrow and looking for other insight wherever it might be found.

That is the essence of good decision making.