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Behavioral Matters:
Insights from the application of Behavioral Finance
Issue 20 – June 15, 2010
Behavioral Matters is a series of essays on the application of Behavioral
Finance written specifically for professional investors and portfolio
managers.
Processing Success
But over time more thoughtful decision-making will lead to better
overall results, and more thoughtful decision-making can be
encouraged by evaluating decisions on how well they were made
rather than on the outcome.
Robert Rubin, Harvard University commencement address, 2001
Managers should love their process, not the stocks they hold: This is
the wisdom handed down by great investors over the ages. The more
defined and effective the process, and the more it is adhered to, the
better and more repeatable the decisions. Yet evidence suggests that
process is not implemented to the same degree that it is talked about.
This essay discusses the nature of mistakes and how to avoid them by
using a checklist.
Mistakes Happen
The nature of errors in professional decision-making was pondered by
philosophers Samuel Gorovitz and Alasdair MacIntyre. 1 Ignorance and
ineptitude were the primary reasons for mistakes, according to their
theory. Ignorance refers to decisions made without benefit of pertinent
knowledge, whereas ineptitude concerns not using all the knowledge
available—that is, poor discipline.
It turns out that we are much more tolerant toward mistakes of the
first type than the second. In practice, managers are not expected to
anticipate every market correction, but they are expected to follow
their process when making investment decisions. Perhaps ferreting out
ineptitude is an unconscious motivation behind the intense probing by
clients and their consultants in the aftermath of poor performance.
It’s Complicated
Knowing more makes us smarter and, at the same time, makes
managing what we know ever more difficult. Physician and Harvard
Professor Atul Gawande, who has studied highly skilled decisionmaking under stress, points out: “Know-how and sophistication have
increased remarkably across almost all our realms of endeavor, and as
a result so has our struggle to deliver on them.” 2 Expert investment
coach Lawrence Evans puts a finer point on this topic: “I have studied
experts in a number of areas—race car drivers, surgeons, marketing
professionals, portfolio managers, and the like. They are all smart, yet
they often succumb to the inexorable infiltration of complexity
compounded by innovation.”3
Evans and his team of coaches work exclusively with portfolio
managers, and they regularly see practice fall short of intent. “These
often truly brilliant managers know their process and can explain them
very articulately, but they don’t always follow them as they go about
their typical day,” Evans explains. A major reason for poor adherence
to process, he says, is due to the process itself: “It’s often a
conceptual model of how decisions should be made rather than simple
steps that can be followed.”4 Inconsistent or underwhelming
performance is the cost borne when intention and action differ.
Steps to Success
Decision-making processes are being strengthened dramatically in
many professions with the help of a simple tool—the checklist. Prosaic
as they might seem, these pithy lists are helping professionals improve
their performance in all manner of skilled activity from saving lives to
protecting fortunes. Pilots have long used checklists. They understand
that the complexity associated with flying can lead to mistakes, and
even minor errors must be avoided. Surgeons around the world
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increasingly use checklists to reduce manageable errors. As Dr.
Gawande explains, checklists are needed because “[y]ou see
increasing mistakes … in almost any endeavor requiring mastery of
complexity and of large amounts of knowledge.” 5 Simple, wellconceived lists enable top professionals to more consistently deliver
their best results, according to a study he and fellow researchers
completed for the World Health Organization.
Professional investors are also improving their performance with
checklists. Lawrence Evans finds that the majority of his clients
embrace checklists as they complete his intense coaching experience.
According to Evans, “Conviction is a powerful reason for buying or
owning a share … but results improve when you know why you have
the conviction. It’s why I recommend a conviction checklist. The
purpose of it is to be consciously aware of why you are making this
decision [buy, sell, or hold] and also to consider how you are feeling at
the moment it’s being made.”6 Evans believes that faithfully jotting
down reasons for conviction as decisions are being made is one of the
best ways to learn about your real investment process. And this
feedback can go right back into strengthening process and decisionmaking.
Less Downside, More Upside
Avoiding mistakes of ineptitude is just one way process improves
performance. Assuring that each decision reflects, or is compared to,
the rigor you’ve set for yourself is the way process enables managers
to build a stronger floor to their investing. In explaining how checklists
strengthen processes, Atul Gawande suggests: “They provide a kind of
cognitive net. They catch mental flaws inherent in all of us, flaws of
memory and attention and thoroughness.” 7
Equally important is the fact that process can enable managers to
invoke their intuition and creative thinking more powerfully. Extreme
situations sometimes require innovative solutions. Piloting through
uncharted waters has historically been the exclusive domain of the
most senior decision maker—the portfolio manager. Unfortunately,
being left to one’s own mental abilities at such moments can
compound rather than resolve problems. The stress experienced
during extreme moments limits creativity or can be just plain
debilitating.
A more robust approach for confronting a crisis, while smack in its
midst, is to follow your process. That entails developing a crisis
management process before it’s needed. It involves thinking broadly
through what information you’ll need, from whom, and what authority
each person will have to act; and codifying all this information into a
series of steps that can spring into action when needed. It can be your
“When the *?#! hits the fan” checklist. The purpose is to cause you to
pause, stay objective, and get the facts available to do your best when
you might be feeling your worst.
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Conclusion
Delivering consistent performance requires more than skill and
intuition. Coach Evans offers this keen observation: “Let’s not forget
that while intellectual superiority can help investing, it’s always
trumped by superior processes. In fact, behind every legendary
investor, you’ll find a checklist that is ruthlessly followed.”8
The challenge is to go beyond believing that process is important and
to make it part of your daily reality. Clear and observable process,
with or without checklists, enables you to make decisions in line with
intentions, guides creative problem solving, and supports more
effective learning. The alternative might find you delivering results that
are, well, listless.
Notes
1. Samuel Gorovitz and Alasdair MacIntyre, “Toward a Theory of
Medical Fallibility,” Journal of Medicine and Philosophy 1, no. 1 (1976).
2. Atul A. Gawande, The Checklist Manifesto (New York: Henry Holt,
2009).
3. Lawrence Evans, Oxygen Coaching, Ltd., exclusive interview with
Cabot Research LLC, May 28, 2010. Learn more about Oxygen
Coaching
at
http://investing.
businessweek.com/research/stocks/private/snapshot.asp?privcapId=1
04484229.
4. Ibid.
5. Gawande, The Checklist Manifesto.
6. Evans, interview with Cabot Research, May 28, 2010.
7. Gawande, The Checklist Manifesto.
8. Evans, interview with Cabot Research, May 28, 2010.
Further Reading
Dr. Sunil Eappen, Chief of Anesthesiology, Massachusetts Eye and Ear
Infirmary, exclusive interview with Cabot Research LLC, June 8, 2010.
(The MEEI introduced surgical checklists throughout their hospital on
June 7, 2010, under the leadership of Dr. Eappen.)
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