Dispassionate objectivity is itself a passion, for the real and for the truth - Abraham H. Maslow
In Daniel Kahneman’s outstanding book Thinking Fast and Slow, the Nobel Prize-winning psychologist describes two modes of thinking. System one is fast, intuitive and driven more by emotion and passion. System two is slower, deliberative and more logical.
Kahneman provides numerous examples of how behavioral bias affects both systems, even though system two appears to entail dispassionately stepping back and following a more thoughtful and logical approach. It is even more surprising that Kahneman found system one to be more influential, in that it guides and – often problematically – steers system two.
Because of the complexity of predicting future investment performance, it is important to gather as much information as possible and to use rigorous empirical techniques to process it. Without passion, it is unlikely that analysts will be motivated to gather enough to tilt the odds in their favor. It is only then that a dispassionate approach to defining the process and ultimately generating a forecast can materially improve results.
One essential element that is often overlooked in the process of making investment decisions is communicating both the research conclusion and the rationale behind it. Most research analysts simply provide their ranks and forecasts, but processes that are objective and systematic – that is, those that rely primarily on Kahneman’s system two – can provide greater insights into what is really driving the forecast. The purpose of research is to promote timely and impactful hiring and firing decisions, and decision-makers are more likely to gain conviction and act appropriately if they fully understand how the objective elements drive the view, rather than simply relying on an analyst’s intuition.
THE PASSION PLAY
Motivation and drive, which are most frequently associated with passion, will help all aspects of the manager research process. What’s more, both sides of the data-gathering process – hard data such as returns and holdings, and the softer qualitatively rated elements – stand to benefit from intense motivation.
A robust research process is based on establishing the relationships between individual components and future performance. Leading research organizations have systematically studied many of these relationships, and evaluating individuals such as portfolio managers and research analysts is arguably the best predictor of a product’s future performance. Analysts therefore spend significant amounts of time gathering information about individuals. Some of these elements are obvious, including experience, education and details about how an individual’s full track record was generated. Other elements are more qualitative, although analysts often seek to capture these in a quantitative manner that facilitates comparison. Since the more qualitative elements generally have to be discovered through direct interviews, highly motivated analysts often prepare better and obtain a more complete picture.
Timing is critical too: Only after processes have been developed and refined in the light of the appropriate evidence should they steer analysts. Quick, tactical decisions are best when they are driven by intuition and feeling, but only once strategy and the research process have been defined deliberatively and methodically.
While passion drives and motivates, dispassion illuminates the path and ultimately the destination.
The term ‘sounding board’ refers to an informal mechanism in which an individual or group provides feedback to someone presenting ideas. At Russell Investments, for example, the sounding board is one of the most important mechanisms in the manager research process, promoting dispassionate analysis and usually resulting in better decisions. It is a chaired meeting, attended by both senior and junior professionals, in which a sponsoring analyst can present the rationale for a product upgrade. Attendees prepare by reviewing all the relevant qualitative and quantitative information in both a standard, summarized form and other supporting documents. Senior participants take their role seriously, asking questions drawn from their knowledge of the general research approach, other similar manager products and the product itself. The ultimate goal is to promote excellent synthesis, or more simply, the proper weighing up of all the inputs.
THINK SLOW, ACT FAST
In the end, harnessing passion within a dispassionate process in this way leads to optimal outcomes. Intuitive, passionate thinking alone often results in suboptimal decisions based on anchoring to narrow beliefs. Slowing down when refining processes and making individual forecasts promotes the requisite rigor and agility.
Mark Thurston is a founder and partner at consultancy firm Alpha Signal. He was previously head of equity manager research at Russell Investments, where he worked for 25 years.