Wednesday, April 18th, 2012
a cognitive net

In The Checklist Manifesto, Atul Gawande extols the virtues of checklists and says, “They provide a kind of cognitive net.”

As I examined in the previous posting in this series,the research puzzle | This PDF is an index of the postings. that net can catch errors in simple processes and it can prevent failure in more complex ones.  How might checklists be applied in the investment world?

Gawande has a section in the book about investors, including Guy Spier, Mohnish Pabrai, and a third that wished to remain anonymous.  (The author dubbed him “Cook.”)  Pabrai described a process in which he searches widely for ideas to consider, a mode from which he shifts when he finds one that seems worthy of consideration.  Then he starts to dig very deeply and if it seems promising, his excitement builds and he goes into “greed mode.”  Spier calls it “cocaine brain.”  The behavioral instincts kick in and start working against you.  That’s when they have found checklists to be of great value:  They keep you grounded and focused and attentive to the possibilities, good and bad.

These are not checklists that get run through in minutes, but ones that are meant to ensure that the investigative process is thorough and that the critical errors that tend to be made are mitigated to the extent possible.  Unlike flying an airplane or building a building, these checklists are designed to increase your chances of success, not avoid failure altogether.  The markets don’t allow you the opportunity to approach perfection, but you can get better.

Each of the investment managers included in the book is a value investor.  Can those that approach the challenge of investing from different angles also benefit from the use of checklists?  Well, strange bedfellows that they may be, traders that look at the technical patterns of an investment rather than its fundamental worth have also been known to use checklists.  And at its core, quantitative investment — be it via the old fashioned monthly rebalancing variety or today’s algorithms that operate in nanoseconds — is an automation of checklists.  But such systematic approaches are relatively rare elsewhere; investment decision makers like it up on the high wire of decision making, with no cognitive net.

The experience of the three value investors have made them checklist evangelists, but “they have found takers slow to come.”  Even at Cook’s firm, if he’s not involved in a decision, checklists don’t get used.  In a business where investors follow each other into positions, they tend not to copy successful methods.  Gawande saw the same thing in his own field of medicine, where a safe surgery checklist demonstrated remarkable results, but was slow to be adopted.  Had a drug or medical device shown the same efficacy, he noted, doctors would be all over it.

Gawande hits the nail on the head:  “It somehow feels beneath us to use a checklist, an embarrassment.  It runs counter to deeply held beliefs about how the truly great among us — those we aspire to be — handle situations of high stakes and complexity.  The truly great are daring.  They improvise.  They do not have protocols and checklists.”

And when we put a group of them together in an investment organization, what kind of process do we get?  For starters, probably one that upon close inspection doesn’t resemble the pictures of processthe research puzzle | This posting, about “picturing process,” struck a chord with a number of firms that have wrestled with this problem. in the marketing pitch book.  There’s not as much structure there as you would expect.  Could there be a better way?

Tommorrow:  This five-part series ends with thoughts about discipline and creativity in investment process.