How Probabilities are Expressed Can Impact Our Investment Decision Making

Imagine you are in a team meeting discussing a potential investment with three colleagues, you ask them how probable it is that your investment thesis for a particular position comes to fruition, each of them states that they see it as ‘likely’.  In an alternate universe, you are in the same situation the only difference being the responses from your colleagues – on this occasion they each say ‘60%’.  Does your colleagues’ shift from a verbal to numeric expression of probability impact your confidence in the investment decision?  A new paper from Robert Mislavsky and Celia Gaertig contends that it would – their research suggests that when we are given numeric probability forecasts we average them and when given verbal forecasts we count them.  A succession of ‘sixty percents’ leads you to a 60% average, whereas a similar number of ‘likely’ responses sees your own view become ‘very likely’.

We often talk in probabilistic terms without realising it – when we state something is ‘likely’ or ‘very likely’ we are expressing some form of view on the probability of an occurrence, although it is admittedly a vague one.  Research around this area has typically focused on the comparison and translation of verbal probability expressions into numeric ones, and vice-versa – when we say something is unlikely, what probability do we actually mean?   As Mislavsky and Gaertig note in their paper, verbal probabilities have the benefit of being clear in their direction (you can tell if it is positive or negative) but suffer from imprecision, whereas numeric probabilities are specific but the direction is not always clear (whether a 45% probability is positive depends on the context).

Mislavsky and Gaertig’s research develops the thinking around this subject by moving on from identifying specific differences between individual verbal and numeric probability expressions, and showing that there is a material change in outcome when we combine a number of verbal probabilities, compared to when we combine a selection of numeric probabilities.  Their research incorporates a range of experiments (7 in total) wherein participants were required to make a decision or predict an outcome after receiving one or two expert forecasts – these forecasts were either both numeric or both verbal.

For example, in their second study, participants were provided with some details about a company and asked to judge how likely it was that its share price would be higher in a year’s time.  Some participants received expert guidance from advisers in numeric form and some from advisers in verbal form.  The results of this study – which were consistent with all the experiments carried out in the research –  was that “participants became more likely to make extreme forecasts as they saw additional advisor forecasts in the verbal condition but less likely to do so in the numeric condition”.  We can see this in the chart below:


The predictions of the participants clearly became more extreme when they received an additional verbal forecast but not when an additional numeric forecast was provided.  By ‘extreme forecast’ the authors mean when a participant’s forecast is in excess of that given by either adviser.  Similar results were observed when the study moved from looking at a hypothetical stock price, to predictions of Major League Baseball games with probabilities given by genuine experts.

There is clear evidence from the study that the verbal probabilities lead to a counting process, whereas numeric probabilities are averaged. There are good reasons for both approaches – counting works on the basis that each adviser is providing new information, whereas averaging is prudent if we assume each forecast is founded on the same information.  There is no requirement, however, to associate the different expressions of probability with different processes for their combination – two 60% forecasts could just as easily be driven by different information as two ‘likelys’.  So what is happening?

The authors conclude the paper by reviewing and largely discounting a range of potential explanations (I would urge everyone to read the paper directly).  My best guess of the cause of the phenomenon would be a combination of some of the factors mentioned by the authors, in particular how individuals are liable to perceive numeric and verbal probabilities in different fashions.  Numeric forecasts feel precise and objective, and more consistent with an ‘outside view’ driven by the base rate or reference class – more likely to contain all relevant information.  Contrastingly, verbal probabilities seem personal and subjective, more akin to an ‘inside view’ where an individual providing a forecast will be doing so based on their own unique knowledge or perspective – therefore an additive approach can seem justified.

This idea is pure speculation about which the authors are sceptical, however, whilst the drivers of this contrasting approach to combining probabilities are uncertain; the results, from this initial study at least, are clear, and there is an important lesson for investors to heed.  It is crucial to consider not only the type of guidance and advice we are receive when informing a decision, but how it is being expressed.  This is relevant whether it relates to an individual’s decision using a range of external information sources, or a team based decision making process where we are seeking to synthesise the insights of a number of individuals into a single view.

Mislavsky, R., & Gaertig, C. (2019). Combining Probability Forecasts: 60% and 60% Is 60%, but Likely and Likely Is Very Likely. Available at SSRN 3454796.

Active Management is Reliant on the ‘Inside View’

I have an investment decision to make.  I need to allocate money to a particular asset class and have to decide whether to use a passive market tracker fund to gain exposure or invest with an active manager.  The odds are not in favour of the active option – over the last decade only 10% of managers in the asset class have outperformed the benchmark – however, I have identified a manager with unsurpassable pedigree in the area, a fantastic performance track record and a robust investment process.  Which option should I choose?

The stark contrast of perspectives underpinning this question is an example of what Kahneman and Tversky would label as the ‘outside view’ versus the ‘inside view’[i].  The outside view in this scenario is that 10% of active managers achieve success in the asset class, and is what we can consider to be our base case or reference class – it provides a statistical framework for informing a decision.  My experience of being impressed by a particular manager is the inside view, which is developed using information specific to my individual case which, as Michael Mauboussin notes, may include “anecdotal evidence and fallacious perceptions”[ii].   We can broadly characterise the outside and inside view informing any decision as having the following features:

Outside View Inside View
Reference Class Personal Experience
Evidence Narrative
Similarity Difference
General Specific
Realism Optimism
History Current

Our general tendency is to focus on the inside view – we adore narratives, tend to believe that our own experiences are exceptional and are overconfident in our abilities.  Use of the inside view is particularly prevalent in the active asset management industry as, of course, it must be – if something does not work on average then it must be forged on the notion of edge, competitive advantage and exceptionalism.

The inside view is also so much more compelling – those wonderful and usually superfluous stories of active managers gaining an advantage by visiting the factory of a target company (it always seems to be a factory) or meeting management are both diverting and persuasive.  The problem is that they do not change the odds; rather they simply encourage us to forget them.  We often think that the additional insights from detailed research are improving our decisions, but in many cases they are simply making us neglect the base rate (whilst erroneously increasing our confidence)[iii].

Returning to the question with which I began this post; if I select the active manager option then I need to support that decision with one of two claims.  I can argue that the base rate is incorrect and therefore the odds are more favourable than they appear – there is something about historical experience which means it is not representative of the future.  Alternatively, I can accept the probabilities but possess such belief in my active manager selection capabilities that I am not concerned by them.  In most cases we don’t actually make either of these arguments explicitly, we simply ignore the outside view and make the case using our inside view – which is usually sufficiently captivating to overwhelm more prosaic considerations.

This is not to suggest that the inside view is of no merit, but rather it should be used only as a complement or adjustment to the outside view. Our starting point should always be a consideration of the reference class or general evidence that frames a particular scenario.  We can then revise this (usually modestly) if we obtain relevant information that is specific to our case.  A failure to follow this approach means that we will consistently make decisions which ‘feel’ right but where the odds are stacked against us.



[ii] Mauboussin, M. J. (2012). Think twice: Harnessing the power of counterintuition. Harvard Business Review Press.



Why Are So Many Fund Managers Men?

Citywire’s 2019 ‘Alpha Female’ study[i] reported that only 10.8% of the fund managers in their global database were women; a figure that has largely flat-lined since its first publication in 2016.  If we disregard the absurd notion that men hold some form of gender based advantage in the skills required to be a successful fund manager, then this represents a staggering anomaly.  There are inevitably deep-rooted societal features* that contribute to such disparities and whilst these are apparent across industries[ii]; there are also features and behaviours specific to asset management – and our perception of what it means to be a talented fund manager – which serve to exacerbate the issue. These must be acknowledged if we are to even begin to remedy the situation.

In her excellent book ‘Invisible Women’[iii] Caroline Criado-Perez highlights the idea of brilliance bias and research showing that “the more a field is culturally understood to require brilliance or raw talent to succeed…the fewer women there will be studying and working in it.”  She goes on to make the case that we struggle to associate women with being “naturally brilliant”. Criado-Perez cites areas where this bias presents a major impediment for women including: maths, physics and science, but this group could easily include active fund management – particularly given our long standing obsession with ‘star’ fund managers.

It is unquestionable that we are often in thrall of successful active managers.  Given how difficult it is for active managers to deliver excess returns; we are prone to laud those that do as possessing some form of exceptional or even innate investment aptitude (even where it may very well be luck). One of the (many) problems with this is that, as Criado-Perez notes, we are more likely to erroneously associate possession of such inherent talent with men.  There is also the complication that nearly all examples of this type of fund manager adulation involves men, which only serves to perpetuate and exaggerate the trope that those truly exceptional individuals able to buck the trends in active management are inevitably male.

Whilst brilliance bias is often focused on opaque and unexplainable characteristics – intangible concepts such as talent – the challenges faced by women seeking to enter the fund management industry are also caused by the wrongful assumption that certain (traditionally male biased) characteristics are associated with fund management skill, and these are often the very characteristics which overwhelm investor decision making.  This idea is eloquently put forward by Tomas Chamorro-Premuzic in his paper (and subsequent book) ‘Why Do So Many Incompetent Men Become Leaders’[iv].  Although about executive management positions rather than fund management roles the parallels are stark, and there is one particular trait which resonates pointedly – overconfidence.

We are liable to mistake confidence for competence.  This is especially relevant in the fund management industry where identifying the features that are truly indicative of skill is so difficult that we are likely to rely on how compelling or convincing an individual is.  Chamorro-Premuzic argues that the advantage granted to overconfident individuals presents two challenges for women attempting to attain leadership positions – they are generally perceived as less confident than men and if they do display ‘extra’ confidence we become concerned that they are not conforming to their gender stereotype.

A related concept highlighted by Chamorro-Premuzic is the influence of charisma, another feature which clouds our ability to judge an individual’s aptitude for a given activity – there are few things more dangerous in fund manager selection than a charismatic manager who has been lucky.  Although there is far less research around how gender impacts our perception of charisma, Chamorro-Premuzic argues that there is a circular relationship at play – more leaders are men, leaders are perceived to be charismatic and therefore charisma has come to be considered a male-dominated trait.  He goes on to produce a pertinent quote from Margarita Mayo about our attraction to charisma:

 “The research is clear; when we choose humble and unassuming people as our leaders, the world around us is a better place…Yet instead of these unsung heroes, we appear hardwired to search for superheroes: over-glorifying leaders who exude charisma”.

I could quite easily replace ‘leaders’ with ‘fund managers’ in the above quote and it would prove an appropriate description of the type of fund managers to which we are often drawn.

A report by capital markets think tank New Financial:  ‘Diversity in Portfolio Management’[v] explicitly attempts to identify the barriers to progression for women and those from diverse backgrounds within the asset management industry.  One of the 18 highlighted was the ‘loss of performance continuity through leave of absence’- this is a material concern and one which is directly related to our perception and glorification of star fund managers.  Our false perception of the archetypal successful fund manager as being a supremely talented individual with a unique skill set not only plays into tired gender stereotypes, but also increases the requirement to have named fund managers and avoid extended leaves of absence.  The belief that superior performance must be down to one individual who is constantly poring over the portfolio further raises the hurdle for women, who are more likely to have extended time way from the office due to factors such as maternity leave and the traditional division of childcare responsibilities[vi].  This imperils the ability of a female portfolio manager to develop an undisturbed track record as an individual, which is often valued highly by fund selectors, and seen as a ‘requirement’ for asset management firms to successfully market their funds.

Two other extremely valid issues raised in the report are the lack of meritocracy and the shortage of role models.  The meritocracy obstacle in fund management is caused both by asset management firms valuing the wrong characteristics (such as confidence over competence), and also the self-perpetuating tendency of people to hire individuals who are most like them – the mirrortocracy – if most fund managers are men, this becomes an implicit characteristic / requirement for such positions.  The lack of role models is a related and also pernicious problem (and by no means just relating to gender) – if the vast majority of fund managers are men, there are inevitably few role models with whom people of other groups can easily identify.

The causes of gender imbalance in the asset management industry are deep and structural, and far more complex than I could possibly hope to convey.  The purpose of this post is to highlight how asset management groups and fund buyers can be considered complicit in the under-representation of women in fund management roles because of our desire to identify, extol and sell ‘exceptional’ individuals (unfortunately almost always men) whilst being beguiled by gendered traits such as overconfidence and charisma – which have no proven relationship with the skills required to be a successful fund manager.  Until we start taking substantive steps to improve the situation – such as moving to a team based fund management culture rather than one focused on star individuals – progress in this area will remain glacial.

*These vary across region, there is an admittedly UK / US bias to this article.



[iii] Perez, C. C. (2019). Invisible Women: Exposing Data Bias in a World Designed for Men. Random House.

[iv] Chamorro-Premuzic, T. (2013). Why do so many incompetent men become leaders. Harvard Business Review22.





Your Investment Time Horizon Might Be Shorter Than You Think

I was recently asked by a friend for my opinion on UK assets following the renewed weakness in sterling and the general Brexit induced pessimism surrounding the UK economy.  I am deeply reticent to talk about this type of investment related issue outside of work; primarily because it usually ends up with the person wondering if I really have a job in the investment industry – I don’t know where markets are headed, I don’t have any good stock tips and have no unequivocal opinions on key economic issues.

Although it is inevitably a conversation killer, I instead try to turn to sensible and broad investment principles; on this occasion I said something along the lines of: “It depends on your time horizon, if you are investing for the long-term – like your pension – then buying unloved and undervalued assets can be a good idea, but if you are looking for a short-term trade the risk and uncertainty is extremely high”.   Whilst I think the general point here is sound*, on reflection I made a major behavioural omission, which I think is fairly common when thinking about time horizons.

When we talk about investment time horizons we often focus on only two discrete points – when we invest and when we plan to disinvest. If I make an investment in my pension today, which I hope to draw upon in 30 years’ time; my time horizon is clear**.  Whilst this is an incredibly important element of any investment decision, our tendency is to focus on the start and the end, and neglect what we might do in the intervening period.

What I should have said in response to my friend’s question on the UK is: “it depends on your time horizon…and even if you have a long-term objective, are you going to be checking the valuation and poring over the news every day?  If so, then your time horizon might be a great deal shorter than you think”.

Even if our circumstances do not change, our behaviour can lead to our realised time horizon for any given investment being materially different to what we may have stated at the outset.  The overwhelming driver of this is how we engage with financial markets – how frequently are we checking our portfolio?  How easily can we trade?  How anxious do daily price fluctuations make us? Are we eagerly watching the financial news?  Are we checking on short-term performance?

Making a long-term investment is not simply investing money with the aim of meeting a temporally distant goal; but understanding the behavioural discipline required to be a long-term investor. Where possible the ‘easiest’ route is simply to disengage from the daily cacophony of market and economic news, and commit to a long-term investment plan.  For many^ this is not feasible and in the constant battle between long-term objectives and short-term behavioural pressures there is typically only one winner.  Unfortunately, for most of us, this means that investing for the long-term is simply making a succession of short-term decisions.

* I am making the very simple point that valuation matters to long-term expected returns.

** Of course, circumstances may dictate a change in your time horizon.

^ This is a particular problem for professional investors.

Why Are So Many Investment Decisions Based on Biased and Contrived Stories?

I recently read Will Storr’s excellent book ‘The Science of Storytelling’[i]; which is an exploration of how our brains process stories and why they are such a fundamental component of human experience.  Whilst it is primarily designed as an aid for writers seeking to better craft their narratives; for me, it also served to underscore the underappreciated but essential role that stories play in financial markets.

Linking storytelling and investments is not a revelatory observation – investors are often lured into a poor decision by a compelling story and no financial bubble in history has been absent some beguiling narrative – however, their importance is hugely understated.  Rather than a susceptibility to stories being a behavioural quirk; the human brain’s reliance on narratives to make sense of the world means that they define much of our investment behaviour.  The noisy, chaotic and unpredictable nature of financial markets is anathema to our mind’s desire for order and clarity; stories reduce our discomfort and allow us to navigate the ever-capricious waters. It seemingly matters not that most of the yarns we spin are works of fiction.

Storytelling in financial markets is always driven by cause and effect.  There are two forms of this – either we predict a cause and effect before the event, or we look to rationalise an effect by defining a particular cause subsequent to the occurrence.  Although we might not always consider them as such both of these scenarios are about creating narratives – Y will happen because of X, or Y has happened because of X.  Investors do this for every conceivable situation – from justifying the hourly change of a stock price to the impact of a fifty-year demographic shift on asset class returns.  Everything must have a cause and effect underpinning the narrative.

In many other circumstances a straight and true line can be drawn between cause and effect – even if something might not be forecastable, it can be understood after the event. We might not be able to foresee a plane crash; but in most cases we have sufficient information to gauge its cause after the incident. Unfortunately, in the random and reflexive world of investment, accurately defining these aspects in either predictions or during a post-mortem is hugely problematic.  We know only too well about the hopelessness of forecasting and observe on a daily basis the myriad competing explanations for even the most irrelevant market or economic change.

If gleaning cause and effect in financial markets is so difficult, why do we spend most of our time talking about it?  As Storr succinctly notes: “Cause and effect is the natural language of the brain. It understands and explains the world.”  The alternative would be to exist in a financial environment defined by randomness and chaos – whilst this may be closer to the reality, it would not make for a comfortable existence.

In addition to the importance of cause and effect for our narrative-driven brains; Storr also highlights how the types of stories we tell are dependent on the mental models that we develop and then seek to defend. This has unquestionable relevance for investors – we all utilise models for interpreting the financial world; these can be structural (I might be a Keynesian economist) or temporary (I might be bullish on equity markets over the next six months). The belief sets that we maintain mean that when we create our stories we do so in a prejudiced fashion; as Storr explains: “Our storytelling brains transform reality’s chaos into a simple narrative of cause and effect that reassures us that our biased models…are virtuous and right”.

The importance of these models to our sense of identity means that much of our tale telling is in the defence of those models. Financial market participants are not coolly and impartially attempting to identify cause and effect; rather we are creating stories that corroborate our views and our beliefs, and often rail against those with conflicting perspectives or opinions. We see this constantly in the varied and often entirely contradictory interpretation of the latest release of economic data. If you understand an individual’s angle, mental model or incentive, then you are likely to have a good idea of the story that they may tell.

Does the importance of narratives in how our brain interprets the world mean that investors are condemned to exist in an environment of incessant, often meaningless and always biased storytelling?  To an extent, but it depends on how much we choose to engage. Financial markets provide an unrelenting torrent of outcomes which we can seek to forecast or explain via stories – indeed, much of the industry is fuelled by these precise activities – and whilst the notion of storytelling seems harmless, for investors it is likely to mean over-trading, over-confidence, stress and partiality.  Investors need to be comfortable stepping away (it doesn’t matter what the market did yesterday or why), be willing to say they have no idea what will happen or why it happened; and focus on some robust, evidence based, principles – all supported by a good story, of course.

[i] The Science of Storytelling by Will Storr


When to Ignore a Fund Manager

The active asset management industry is overpopulated and hugely competitive, and, as with any sales activity, delivering the ‘appropriate’ message to prospective and incumbent clients is hugely important.  They are a range of common utterances from active fund managers, which feel as if they are intended to cultivate a certain image or manage client concerns, rather than present a realistic assessment of crucial issues. The types of statements listed below should be disregarded, or at least considered with a liberal dose of scepticism:

“ESG factors have always been at the heart of our investment process”.

“The growth in assets under management has not had a negative impact on our investment approach”

“We have reviewed strategy capacity and increased it by £1bn from our previous estimate”

“There is a bubble in passive strategies”

“Markets are not rewarding fundamental analysis”

“My (asset class / style / factor) is historically cheap”

“My performance has been driven by individual company selection, with no major impact from factor exposures”.

“We rarely use sell-side research”

“Even though half of the team have left to join a new firm we can continue to run an unaltered investment process”

“I spend 95% of my time at my desk on pure investment work”

“My CIO has given me their full support despite the difficult period of performance”

“The merger / acquisition / restructure has not been a distraction”.

“I think that interest rates are going to…”

“The performance fee structure means that we are perfectly aligned with our clients”

“We have an approach that can adapt to different market conditions”

“Having a team of 27 doesn’t hinder our decision making”

“All of our excess returns are from credit selection, being overweight credit risk hasn’t really been a factor”.

“I don’t think we suffer from any biases in our recruitment policy, it just so happens that the best candidates all went to the same universities and look the same”.

Although this post is somewhat tongue-in-cheek, there is an important point at its heart. If all firms and teams present themselves with a similar sheen, then there is a significant cost to being an outlier that is frank about problems, challenges and limitations.  This fosters an environment where openness and transparency are viewed as business risks.

Investment Risk is a Behavioural Phenomenon Not Just a Number

Risk, particularly in finance and investment, is often framed in cold and calculating terms, but such an approach can often lead us to neglect its very human features.  More than simply an absence of certainty*; risk is about our inability to deal with probabilities in a consistent and coherent fashion, and the discomfort caused by the fact that “more things can happen than will happen”**.  How we perceive and experience risk is uniquely personal but at the same time hostage to our common behavioural limitations.

Central to our relationship with risk is how we are feeling at any given time. There is even a formal hypothesis for the role of emotion (or affect) in decision making called ‘Risk as Feelings’, in which George Loewenstein and colleagues argue that emotional reactions often dominate behaviour leading to our decisions diverging markedly anything that might be considered objective or rational[i].  How we feel about something tends to have an overwhelming impact on how we view the probabilities and potential outcomes.  An excellent example of this is psychologist Gerd Gigerenzer’s notion of ‘dread risk’, which he defines as a fear of low probability high consequence events.  Gigerenzer claims that a reluctance to fly following the terrorist attack in New York on September 11th 2001 meant that more Americans lost their lives on the road due to their desire to avoid flying in the following three months than died as a direct result of the horrific attacks[ii].

Whilst dread risk suggests that we often hugely overstate certain low probability, high impact risks, there are other activities where individuals seem to ignore them entirely – for example, driving under the influence of alcohol.  This apparent contradiction is a prime example of the inconsistency of human behaviour.  When it comes to risk, the crucial issues are salience and availability. In Gigerenzer’s example, the emotional impact of the terrorist attacks were both severe and prominent in our thinking, thus the force of the potential outcome engulfed any rational assessment of probability.  Contrastingly, as we start the engine of our car and begin to drive home whilst intoxicated by alcohol are we likely to have any highly emotive examples of the potentially disastrous consequences readily in our mind?

This contradictory treatment of risk has also been evident when observing individual decision making in insurance.  Research has found that people are often underinsured against catastrophe risk – such as floods or earthquakes – even in situations where policies ae subsidized[iii].  Unsurprisingly, the likelihood that you will protect our home from disaster risk is not driven by a rational cognitive assessment of the potential costs, but by how fearful we are of the consequences, or how easily we can recall a similar situation – its availability.  If something hasn’t occurred for a long time or hasn’t recently stirred our emotions, we might simply disregard the risk entirely[iv].  The implications for investors of this type of behaviour are stark.

Salient, emotive and recent events can overwhelm our perception of risk and the investment decisions we make. It leads us to become complacent during prolonged equity bull markets and fearful in the midst of a bear market.  We can think of this as our erratic perception of risk continually shifting our personal discount rates.

Risk is perhaps the second most commonly used term in financial markets (second only to return). Despite its ubiquity and undoubted importance, it is often not clear what is actually being discussed.  The central debate about risk tends to be around whether it refers to volatility (how variable the price of an investment is) or the permanent loss of capital.  Quantitative strategies often rely on volatility as the central measure of risk for an asset or strategy, whereas more fundamentally driven investors will often claim that risk is the chance of losing money.  Both sides of this argument are right that their preferred measure is related to risk, but wrong to believe that there is any single concept that can encapsulate investment risk.

Let’s assume that we have two portfolios – one of 50 medium sized companies all listed on the stock market and one otherwise identical portfolio of 50 companies, but this time the companies are not listed – therefore their valuations are appraised rather than derived from public trading. Furthermore, the public portfolio can be traded on a daily basis, whereas the private portfolio is locked up for five years.  In essence we are contrasting one public equity portfolio and one private equity portfolio.  If we assume that the underlying positions are indistinguishable does this mean that the portfolios carry the same level of risk?

From a fundamental standpoint the answer must be yes – the overall outcomes will be driven by the underlying performance of the companies, but from a behavioural standpoint this is not the case.  The listed portfolio will suffer far greater price fluctuations than the private portfolio and offers the investor the ability to react to these variations (they can buy and sell); by contrast, the private equity portfolio will report smoother prices for the underlying securities, and the investor will be unable to trade – the less observable price fluctuations the less opportunity for us to react emotionally to them.  The behavioural risk (that we make bad decisions) is significantly greater in the public equity option than the private equity option.  This is by no means a validation of private equity structures, rather an example of how risk is about far more than the underlying characteristics of any asset.

Whilst the role of emotion and behavioural bias makes all types of decision making difficult there is an extra problem when we consider our investments.  Many important life decisions are discrete and made at a single point in time – whilst we will be subject to the behavioural  problems when buying a house, once we have made that decision it is not easy to reverse course – we don’t have to make the same decision over and over again.  For investments the opposite is true – once we make an initial investment decision the flexibility to change course means that we are forced to repeatedly face the same choices, but whilst the fundamental decision might be the same – our biases and emotions are likely to frequently alter how we perceive the risk in the decision.

Financial markets also lure us into being excessively diverted by what we might call ‘secondary risks’ or those that are subordinate to our primary objective.  For example, whilst our primary risk for our investments may be a failure to build a portfolio sufficient to maintain our standard of living throughout retirement, there will be a multitude of secondary risks such as suffering from short-term losses or our portfolio underperforming relative to peers or benchmarks.   We often make decisions to manage or mitigate these secondary risks, even if they jeopardise achieving our primary objective.  It’s not simply that we are thinking about risk in the wrong way, but we are thinking about the wrong risks entirely.

We continually discuss risk solely as it pertains to a particular asset or portfolio as if it is remote from the individual experiencing it – this constitutes a glaring omission.  Risk is about our individual differences, how frequently we check our portfolios, how we are incentivised, the last thing we saw on the news, recent stock market performance and how readily we can recall similar emotive examples – to name just a handful of contributory aspects.  Combining the freedom to trade at any time with our fluid view of risk is a potentially toxic cocktail.  Whilst attempting to manage and control such myriad of factors is a huge challenge for all investors, it is one which should not be ignored.

* There is a theoretical distinction between risk and uncertainty, but they can be considered synonymous for the purposes of this post.

**This is an Elroy Dimson quote.


[i] Loewenstein, G. F., Weber, E. U., Hsee, C. K., & Welch, N. (2001). Risk as feelings. Psychological bulletin127(2), 267.

[ii] Gigerenzer, G. (2004). Dread risk, September 11, and fatal traffic accidents. Psychological science15(4), 286-287.

[iii] Kunreuther, H. (1984). Causes of underinsurance against natural disasters. Geneva Papers on Risk and Insurance, 206-220.

[iv] Kunreuther, H., & Pauly, M. (2015). Insurance decision-making for rare events: the role of emotions (No. w20886). National Bureau of Economic Research.


The Cricket World Cup, Outcome Bias and Outrageous Fortune (Or How A Wicked Deflection Can Change Everything)

Given how unfathomable the game of cricket is for the uninitiated (and initiated) I am at pains to reference such a wonderfully convoluted activity; however, sometimes sport offers up such vivid examples of our behavioural biases in action that it proves irresistible subject matter. This was the case on Sunday when England won the Cricket World Cup for the first time.  Rest assured this post is more about our behavioural absurdities, than it is about cricket.

Before Sunday, the Cricket World Cup had been held 11 times beginning in 1975 and running every four years (approximately).  Despite being one of the pre-eminent teams, England had never won the tournament, but had finished runners-up on three occasions.  The 2015 World Cup saw a particularly dispiriting and ignominious exit for the England team, which brought about an overhaul of their approach to the game and an ambitious four-year plan to win the trophy when the competition returned to home shores in 2019.

England did indeed win the 2019 Cricket World Cup after overcoming New Zealand in Sunday’s final, but it is unlikely that this would have happened were it not for an outrageous slice of good fortune.  Without going into any unnecessary detail – very late in the game a ball took a wicked deflection off an England batsman after being thrown by a New Zealand player, which resulted in England being gifted extra runs through nothing but sheer chance. Absent this incident England would probably not have lifted the trophy.  Whilst all sport is to an extent defined by luck and randomness, it is worth highlighting that every ex-professional cricketer I have heard discuss this incident has said that they have never seen such a thing happen before. For it to transpire in such a pivotal match at such an important stage of the game is delightfully ridiculous.

It is not fair to say that England were lucky to win the World Cup – there was a great deal of skill that got them to the position to win the competition at all – rather they would have been unlikely to do so without the assistance of an unprecedented freak occurrence.

Following England’s victory, the immediate and persuasive narrative around England’s victory has been:

  • The meticulous four-year plan to transform the game was an incredible success.
  • The team fully justified their pre-tournament favourites tag.
  • The players were able to handle the pressure of a World Cup final.
  • The team proved their ability to win on a difficult pitch*.

These points all have a level of validity, but England probably only won the game because of a once-in-a-lifetime piece of luck – what if everything had been the same, but that outrageous deflection had not occurred? What would the prevailing narrative had been then?

  • England’s four-year plan failed as they lose yet another final.
  • The team didn’t live up to their billing as pre-tournament favourites.
  • They didn’t cope with the pressure of a World Cup Final.
  • The team can only win on ‘easy’ pitches.

The bounce of a ball not only changed the result of a cricket tournament and the lives of the England players, it transformed our perception of everything that led to that victory.  Clearly this is an absurd situation, the assessment of a detailed four-year plan cannot hinge on the random deflection of a ball; but this is the very nature of outcome bias – we take the result and then work back, viewing everything through the lens of that outcome.  Taking such an approach in activities where there is luck and randomness involved is hopelessly flawed.  We seem to operate with a binary narrative switch, which will flick between two entirely contradictory rationales depending on the result.

In my experience outcome bias is one of our most intractable failings, trying to persuade anybody to look past the result and consider the quality of the process underpinning it is nigh on impossible – you often look foolish even suggesting it.  Once the result is in, the narrative is fixed.

So why does the Cricket World Cup matter to investors?  Most sports are dominated by skill but punctuated with doses of luck – in many cases outcomes are actually a reasonable proxy for the quality of a process; for investment the reverse is true – it is luck and randomness with a smattering of skill.  This means we should be even more leery of outcomes alone telling us anything meaningful, but if anything, we are more reliant – performance frames and overwhelms virtually all investment activity and decision making. We are obsessed by the name on the trophy, and care far too little about how it got there.

*Sorry, this is jargon and unnecessary detail.  Certain cricket pitches are harder to bat on and England were accused earlier in the tournament of being only suited to playing on easier pitches.

What Will Investors Be Saying in Ten Years’ Time?

Despite it being most investors’ favourite pastime, we are terrible at forecasting; what we are much better at is talking about events that have happened as if they were inevitable.  If a certain path has been taken it is difficult for us to believe that any other routes were ever feasible or even available.  Whilst this creeping determinism or hindsight bias seems somewhat harmless, it is a damaging trait, which perpetuates outcome bias and leads us to believe that any past decisions made that were contrary to what actually occurred were foolhardy.  Diversification rarely looks sensible after the event – why didn’t you just own the best performing assets?

Having said that it is a serious issue for investors, I will now lurch toward frivolity.  If we go forward ten years, which outcomes will we be claiming were obvious ten years prior?  Some of the hypothetical comments below are more credible than others – I will let you decide which:

–  ‘Value investing was so depressed and had underperformed for the best part of a decade – a recovery was inevitable’

–  ‘US equities were the most richly valued major equity market by some distance, they were due a period of low returns and relative underperformance’

– ‘ The expected returns from a traditional 60/40 portfolio became so low it was simple common sense to increase exposure to alternative strategies, including hedge funds’

– ‘The US tech giants were expensive and facing severe regulatory scrutiny – their time in the sun ended a decade ago.”

– ‘With yields so low it is amazing that investors still held so much duration in their portfolios’

– ‘The vast flows into passive strategies were always going to highlight the flaws in cap-weighted indices, particularly in fixed income markets’

– ‘The Japanification of all major developed market economies was inescapable’

– ‘The return of inflation in major developed market economies was inescapable’

– ‘The long awaited stock pickers’ market finally arrived!’

Of course, we will actually be saying a host of different things – because the investment world is simply too complex, random and reflexive for us to make predictions with any level of confidence.  Taking this into account by making prudent and humble investment decisions now, will mean that some of these choices may seem illogical to our future self – but that is a price worth paying.

The Placebo Effect in Investment

The placebo effect is both fascinating and real, with compelling evidence of its impact in both a medical and marketing context.  Whilst it is in these areas that discussion around placebos tends to focus; the notion that something can make us feel better, even if there is no logical reason for it do so, seems relevant to much investment activity.

The definition of the ‘placebo effect’ from Google is as follows:

“A beneficial effect produced by a placebo drug or treatment, which cannot be attributed to the properties of the placebo itself, and must therefore be due to the patient’s belief in that treatment”.

We can reframe this slightly and create an ‘investment placebo’:

“A beneficial effect felt by an investor by a certain investment activity, which is unlikely to be attributed to the properties of the action itself, and must therefore be due the investor’s belief in that activity”.

What kind of activities might be captured by the above definition (not a definitive list):

– Short-term trading / market timing.

– Trading on macro-economic news.

– Performance chasing in active mutual funds.

The idea of an investment placebo is somewhat distinct from that which is widely discussed in medicine[i] or marketing[ii] – the activity or treatment undertaken in investment is not designed to be inert, rather on average such activities are likely to have a negligible or, indeed, negative impact.  Furthermore, placebos in other areas can actually deliver positive end outcomes – patients can experience improved health following such treatments and consumers get greater enjoyment from drinking a more expensive wine.  In investments, these ineffective activities do not assist in us meeting our end objectives, but simply make us feel better at the time they are administered.

But why do certain investment actions make us feel better, even when there is limited evidence that they will have a positive impact on our long-run outcomes? There are a multitude of factors at play here, but one interesting notion is the idea of an action bias, the phenomenon where in certain situations opting for action over inaction is heavily favoured. As an example of this, a group of psychologists studied the behaviour of goalkeepers during penalty kicks in football (soccer) and found that goalkeepers tend to jump left or right in order to save the penalty, wherein the optimal strategy is to stay in the middle of the goal[iii].

The researchers in the study argue that the tendency of the goalkeepers to dive in a certain direction is because the norm is for action, and their experience of a bad outcome (conceding a goal from the penalty kick) would be worse if they had ignored the norm and simply stood in the centre of the goal.  It would appear as if they did not take any action to prevent the bad outcome.

Now, I think there is a problem with this study – it argues that the best decision for a goalkeeper is not to move (they would save more penalties if they stood stock-still).  This is, however, founded upon the assumption that the penalty taker has not decided to kick the ball into the centre of the goal after seeing the goalkeeper move first.  In fact it is common for high quality penalty takers to wait for the goalkeeper to move and then strike the ball.

Even with this caveat*, the study makes a valid point about behavioural norms and how, in certain situations, we will view the simple act of doing something more favourably than doing nothing, despite there often being no compelling evidence that such activity will be beneficial to us.

In the investment industry, it seems irrefutable that there is a preference for action over inaction – amidst the incessant newsflow, erratic price fluctuations and obsession with the latest headline risk, the urge to do something can be irresistible – what if I miss out?  What if things go wrong and I have done nothing? How can I just sit here when all of this is happening? What will clients think?

The stress and anxiety created by such an environment mean that actions of questionable validity (on average) can prove a powerful short-term ameliorative – making changes based on what is happening now will likely feel good, for a time. The problem is they will often come at a long-term cost.

* Never let reality get in the way of an academic reference.


[ii] Shiv, B., Carmon, Z., & Ariely, D. (2005). Placebo effects of marketing actions: Consumers may get what they pay for. Journal of marketing Research42(4), 383-393.

[iii] Bar-Eli, M., Azar, O. H., Ritov, I., Keidar-Levin, Y., & Schein, G. (2007). Action bias among elite soccer goalkeepers: The case of penalty kicks. Journal of economic psychology28(5), 606-621.