The preceding posting concerned “the illusion of certainty”the research puzzle | The phrase was borrowed from John Hempton. that facilitates the sale of many investment products and services. It manifests itself in a number of ways, some subtle, some not so subtle, as those making the pitch offer “a stylized version of the investment world” and what the future is likely to be.
Given the appetite for the illusion among the investing masses, a portfolio manager who is seen to wear the cloak of greatness has an easy time conjuring up a winning story. Bill Gross would be one that could fall into that category (and he is good at talking his portfolio at timesthe research puzzle | This is a look at “the card player” from 2009.), but his latest commentary casts the cloak aside and reveals the illusion.PIMCO | It is entitled, “A Man in the Mirror,” and it’s a must read.
In short, Gross raises doubt about his numbers and those of other investment legends “that purport to show how much better an individual or a firm has been than the competition.” As for greatness, “I must tell you, after 40 rather successful years, I still don’t know if I or PIMCO qualifies.”
You can say that it’s false modesty, but his point is cogent and almost never broached in investment discussions. That is, that we may have just been through “the most attractive epoch” to manage money, one fueled by a great credit expansion (and a succession of Federal Reserve puts). When — if — it changes will be the real test of greatness of a manager, Gross believes.
It is a remarkable commentary. Gross pokes fun at his own image, for one thing, and also highlights PIMCO’s ability to sell volatility and earn carry as keys to its success, the emphasis probably a surprise to many of its investors and their advisors. But, most importantly, he questions our assumptions about expertise in the financial markets.
A day before his piece came out, I had read a seminal paper by Daniel Kahneman and Gary Klein called “Conditions for Intuitive Expertise.”fiddlemath | I know nothing about this site other than that’s where I found the PDF available. The authors come from different points of view to ask the questions: “What are the activities in which skilled intuitive judgment develops with experience? What are the activities in which experience is more likely to produce overconfidence than genuine skill?”
Klein is a scholar of naturalistic decision making (NDM) and Kahneman is famous for his study of heuristics and biases (HB). Their bodies of work seem to be at odds, and the paper effectively summarizes the points of difference and agreement.I have to say I love to see things like this, where disparate points of view are examined carefully and with respect. Rare. Where the NDM canon sees the ability to develop expertise, Kahneman talks of the “illusion of validity” (speaking of illusions), for “the unjustified sense of confidence” that often manifests itself in those with experience, without regard to whether the situation warrants it.
The common ground for the authors is that the degree to which expertise can be relied upon depends on the nature of the environment for decision making. In their eyes, investment professionals face a hard reality: “Long-term forecasting must fail because large-scale historical developments are too complex to be forecast. The task is simply impossible.” That plus overconfidence spells trouble, as the markets are one of those “wicked environments” where feedback is misleading, luck plays a huge role, and plenty of new errors are there for the making.
Perhaps we could learn from those in other fields whom Klein has found to show consistent skill. They “typically resist requests to make judgments about matters that fall outside their area of competence.” (That doesn’t happen much in the investment arena.) And: “People in professions marked by standard methods, clear feedback, and direct consequences for error appear to appreciate the boundaries of their expertise.” Our profession doesn’t have those characteristics, yet all too often we don’t acknowledge or heed the boundaries that exist.
As purported mavens of the market, we operate in a wicked environment, one that fools us and allows us to fool others as to its reality, intentionally or unintentionally.The authors offer ideas of how to deal with the disconnects, some of which I have written about before. Gross would have us think that an even more wicked environment might face us in the future, that what we have experienced of late is as good (or as easy) as it gets.
Whether or not that is the case, the words of these three men, two academics and a practitioner, argue for a clear-eyed view of the nature of expertise. The environment demands it.