One of the premises behind the Investment Masters Class is the belief that investing is far more art than it is science. Whether it is an art or science has implications as to how one should approach investing, what one should study and the necessary skills for success.
This paper will draw together many of the tutorial topics included in the Investment Masters Class [including 'Art or Science', 'Education and Smarts', 'Invert always Invert', 'Rear-view mirror', 'Keeping Stock Valuations simple', 'Investment Factors', 'Investing Instinct'. 'Stock Market Magic Formula'].
"Investing is more art than science" Howard Marks
Science is associated with consistent, independent and timeless outcomes. Science can be studied in a textbook, applied in an experiment and deliver an expected result. If investing were a science, in theory, you should be able to buy an investing textbook, apply the knowledge and achieve excellent returns. There would be an investment formula you could apply to achieve results. Unfortunately, there are no magic formulas or formulaic textbooks that guarantee success.
"If there was one formula, one way to do it, we'd all be zillionaires" Paul Tudor Jones
If investing were a science it's likely that investors with the highest IQ would outperform. You would expect investors that attended pre-eminent business schools to be the finest. The fact that the majority of professional money managers do have highly regarded education qualifications and under-perform the market indices, suggests finance courses don't correlate well with performance. In fact, I'd be prepared to wager there is no statistically significant correlation between, say those holding a CFA or Applied Finance qualification and those that don't, and their respective investment performance.
"Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ. " Warren Buffett
Building more detailed and complex investment models doesn't ensure investment success either. There is no relationship between the detail or complexity of an analysts model and the likelihood of investment success. In fact the Investment Masters tend to keep valuations simple and instead take the time to think about the key factors that impact a common stock's performance. A much more fruitful exercise than building a 2,000+ line spreadsheet model.
“Keep it simple. Your thesis should be on the back of a postcard if it’s right.” Bruce Berkowitz
Relying on the science of formulas such as 'Value at Risk' as opposed to a common sense assessment of risk has blown up plenty of investment funds.
"Things like Gaussian curves and Value at Risk (VAR) were some of the dumbest ideas ever put forward" Charlie Munger
Understanding the efficient market hypothesis and the capital asset pricing model hasn't secured a place for any investor in the ranks of the Investment Masters. Most of the Investment Masters are critical of such theories.
"The elegance of the efficient market theory is at odds with the reality of how the financial markets operate" Seth Klarman
So if investing isn't a science, is it an art? What is Art? Most of the Investment Masters do consider investing more art than science.
Art can be defined as the 'expression or application of human creative skill and imagination'. The ability for an investment manager to consider alternative outcomes, to connect disparate information, to step away from the crowd, and to imagine and contemplate business performance are prerequisites for investment success.
So how do you study art? If you were to study classic art you would likely start by studying the great masters - Picasso, Renoir, Van Gogh, Monet and the like. You would explore their work, style and techniques. You would contemplate their thought processes, the times in which they lived and their creative progression. It's unlikely you would spend time studying the physical process of painting or the composition of the paint.
Investing is no different. To become a successful investor it pays to start learning from the Investment Masters. How do/did they operate, their psychological considerations and the common themes behind their success.
Art involves creativity and imagination and is associated with the right-side of the brain. This is the side that also deals with ideas and intuition.
These are functions commonly cited by the Investment Masters as prerequisites for investment success. Examples include the ability to create unique investment theses and to imagine alternative investment scenarios and the implications for a stock or market.
"Creativity and independence of thought are the essence of the hedge-fund craft” Paul Singer
“We put great emphasis on a consistent investment process that demands enormous creativity, energetic sourcing, outside-the-box thinking, intellectual honesty, and vibrant debate” Seth Klarman
"I always tried to balance risk aversion with some measure of creativity" John Neff
The ability to stand against the crowd is a key ingredient for investment success. It also requires creativity ..
"From our empirical observations, it seems that some members of our species are immune to this call of the herd. They can go left when the rest of the tribe goes towards the right. Their attitude isn’t influenced by the behaviour of the tribe. Their genetic code seems to not have the “tribal gene”. It’s difficult to evaluate what percentage of humans have this particularity but it’s a minority. And it’s probably those who eventually become creators (artists, scientists, writers, entrepreneurs, etc), as the act of creation requires the capacity to make something new and to forge a new path different from others. To create is to go where there was nothing before. Creating is the antonym of following." Francois Rochon
“It’s imperative to be creative because a stock currently is selling at a price that the average investor thinks is the right price, so you have to come to a decision that that price is wrong and that the stock deserves to sell at a higher price for some reason. That reasoning is creative thinking because other people aren’t thinking that way because if other people were thinking that way, the stock would be at a higher price. Every idea is a creative idea.” Ed Wachenheim
The ability to subconsciously connect seemingly unrelated pieces of information to provide an insight is a right-brain function. As is the intuition that comes from years of time in the market.
"Creativity is the power to connect the seemingly unconnected." William Plomer
“Intuition, whether positive or negative, is quite another matter. It is a vital component of my art.” Peter Cundill
“Being an investor and running a fund requires you to be part financial analyst, part accountant, part financier, part social scientist, part philosopher. You have to tie the right brain and the left brain together. If there’s an edge to be had, it’s in understanding the different components of the analytical process or the selection process. Understanding there’s an element of creativity, emotion, analytics and intuition. Maybe the thing we call intuition is the ability to tie all those things together” Dan Loeb
Conversely, the left-side of the brain deals with the 'science' functions. These functions - logic, verbal reasoning, mathematics, linear thinking, factuality - commonly get investors into trouble.
For example, making the assumption recent trends will continue into the future [looking in the rear-view mirror], investing according to a strict formula and considering only the observable facts without seeking further information or disconfirming evidence are key investment pitfalls. Focussing too much on the numbers at the expense of the big picture is another common investment mistake.
"Computers and their endless databases cause investors to focus on the past. More than ever before, people are looking backward into the future." Shelby Davis
Most business school curriculums are focussed on learning and testing utilizing the left-side of the brain. It's much easier.
"Testing is best suited for left-brain-dominant students. It's much easier to test for sequential thinking and problem solving, recall, etc., than for right-brain attributes. For example, how do you test for intuition or artistry? So economics has become largely quantitative. Of course, modern portfolio theory (MPT) is the ultimate in the application of mathematics to what really is a soft science. So even though MPT is an important part of the CFA program and the curriculum in most graduate business schools Buffett and I consider it almost laughable. Yet it continues as core curriculum because that's what teachers have been taught to teach, and it's hard for this battleship to change direction. In a recent New York Times edition, Bob Schiller, with whom l've had communications, wrote that behavioural economics is the new frontier. Even though it's gaining currency at Harvard, Yale, and a number of other leading schools, it's going to be difficult to institutionalise because it's so intuitive. So l would love for schools to teach right-brain thinking and applications as well, but it won't be easy to quantifiably integrate it into the curriculum." Frank Martin
It's no surprise that many of the Investment Masters have backgrounds or experiences in areas associated with the right-side of the brain. For example, Leon Levy, George Soros, Paul Singer and Peter Lynch studied psychology. Michael Steinhardt majored in sociology. John Burbank, Glen Greenberg and Bruce Kovner spent time as a teacher while Stanley Druckenmiller wanted to be an English Professor. Chuck Akre obtained a BA in English Literature. Paul Tudor Jones learnt more in journalistic studies than business school while Warren Buffett has said if he wasn't an investor he'd like to be a journalist.
"In college, except for the obligatory courses, I avoided science, math, and accounting all the normal preparations for business. I was on the arts side of school, and along with the usual history, psychology, and political science, I also studied metaphysics, epistemology, logic, religion, and the philosophy of the ancient Greeks. As I look back on it now, it's obvious that studying history and philosophy was much better preparation for the stock market than, say, studying statistics. Investing in stocks is an art, not a science, and people who've been trained to rigidly quantify everything have a big disadvantage." Peter Lynch
Julian Robertson took time off to write a novel in New Zealand. The study of Japanese [and Lao Tsu] were instrumental in shaping Howard Mark's investment philosophy. Peter Lynch and Jim Rogers both studied philosophy while David Abrams majored in history. James Dinan credits his liberal arts studies as most valuable. Meditation, a form of engaging the right side of the brain, has been instrumental to Ray Dalio's success.
"I think yoga and meditation are good for your brain and good for your body. They help you think more clearly, improve your memory, and help you become a more balanced, self-aware person. And I think those are all really important things that make a good investor" Dan Loeb
To help avoid the pitfalls of relying too much on the left-side of the brain, some common tools used by the Investment Masters include checklists and inverting.
Checklists developed with reference to realised investment mistakes help overcome common missteps by ensuring key items are not overlooked.
“I’m a great believer in solving hard problems by using a checklist. You need to get all the likely and unlikely answers before you; otherwise it’s easy to miss something important.” Charlie Munger
Inversion helps engage the right side of the brain by introducing unfamiliar concepts. Some of the classic artistic masters would turn their paintings upside down to find fault in them. So to, the Investment Masters turn an investment thesis upside down to identify faults.
“Once a person has an idea, we then start whacking at it. We invert the concept. Instead of trying to prove a person’s idea, we try to kill it, and if we can’t kill it then the person is onto something. Whether it is my own idea or someone else’s, that is the process we go through.” Bruce Berkowitz
Successful investing requires more than an excel spreadsheet. It requires thoughtfulness, intuition, creativity and an edge. It amazes me that the majority of business schools focus on theories that practitioners with long track records of investment success consider ineffectual.
I meet lots of graduates with formal finance qualifications who know nothing of Warren Buffett or Peter Lynch, know zero financial history and have spent no time learning about human psychology.
The world's greatest investor Warren Buffett considers the efficient market hypothesis garbage. Yet, most business schools study the hypothesis not the master. In contrast, the Investment Masters Class focuses on the lessons of the Investment Masters.