Contributed by: Shivani Chopra, CFA
The Delhi chapter of the Indian Association of Investment Professionals (IAIP) organized a speaker event titled,” Why Smart Investors Do Dumb Things” on March 18, 2017.The event was delivered by Mr. Puneet Khurana who is a renowned investor and educator. The focus of the event was to discuss in details the most common errors investors make and what makes such smart people do really dumb things.
The session started with a discussion of how the society has evolved by the collective efforts of some smart people who came together and led to some tremendous achievements which have changed the world for good (e.g. Google, Manhattan project, Bell Las etc.). But unfortunately, the same record is not replicated when it comes to investing domain and the speaker referred to the records of hedge funds and funds of funds to put across the point (e.g. LTCM, etc.). He discussed three key differences between other organizations and a team of investors and what are the key differences in two types of human collections and endeavors. He explained that there are primarily three differences:
1. Measurable Goals
2. Feedback Loops
3. Checks and Balances
The absence of factors mentioned above in individual decision making at the investment firms accentuates the impact of individual quirks in decision making. For this very reason, the first and foremost reason for errors is the human misjudgement, and hence the speaker went on to explain the science behind the human misjudgement. He compared investing to Keynesian newspaper beauty contest where the decisions are not objective but also based on the subjectivity of masses and how in investing the decisions of masses can become influential in the final outcome. Hence the investing activity becomes not only an individual pursuit but also an endeavour of understanding the wisdom and follies of masses.
The lesson started with the understanding of Biology and Human evolution and how the various parts of brain got developed providing a survival advantage. The explanation of the role of the amygdala, sensory cortex, thalamus, hypothalamus, etc. was discussed and provided a context of the physiology of decision making and what caused the brain to go into the freeze, fight or flight mode.
From here on Mr. Khurana explained the critical errors which he has suffered or observed and explained few of the key human biases that lead to errors. The key biases he discussed were Overconfidence, Rigidity of thoughts process, Activity bias, Hard Work Fallacy, Once Bitten twice shy error, Recent event Bias, Confirmation Bias, Anchoring Bias and Romantic Lovers Bias.
The speaker went on to give a detailed explanation of all these biases and how it specifically interacts with investing decisions. He was candid in providing examples from his own life where the mistakes caused him to make investing errors.
Mr. Puneet Khurana, referring to Charles D Ellis’ tennis analogy, compared investing to the game of amateur tennis where reduction of errors is a tremendous edge.
Moving forward, he then explained errors beyond the human psychology and in the realm of investing. The speaker continued with a disclaimer that the list is not comprehensive but what in his understanding are the most crucial ones. He divided the majority of errors into the following categories:
1. Errors in Behavior (which he discussed above)
2. Choosing the wrong battleground
3. Errors of omission
4. Errors of commission
5. Error of risk assessment
6. Errors of Portfolio Management
7. Errors of Execution
Each of these errors was then explained in great detail with examples of companies and examples from his observations across many investors, his students and his own errors too. In short, it encapsulated a large amount of learning from the personal investments journey of the speaker.
After this, he then went on to give examples of how Checklist development has dramatically led to a reduction of errors. But then he gave a very interesting perspective that error reduction is a significant edge and takes an investor in the above average league, but it’s not enough to take the investor into the “TOP” league. After all the ship can reduce all the errors by staying on the deck, but that’s not what it is meant for.
The second part of the success equation in investing is “Insight Generation”.
He referred to the work of Gary Klein to substantiate his assertion. He then went on to explain how different investors can generate insights during their practice and have pattern recognition that leads them to shift the odds in their favor. In fact, for all the errors of omission and commission discussed, some outliers generate special insights in one or two areas, and shift the odds in favor and make money. He then went on to explain his areas of insights over a decade-long practice, where he has been able to develop patterns and shift the odds in his favor.
It was a 3.5-hour long session but was so gripping that none of the participants agreed to the breaks in between despite the offers. It was filled with real life cases and amazing insights for all the investors.