Executive Chairman, Fusion Group
Phil Goodwin reflects on some of the reasons for making poor investment decisions, and considers the power of gut instinct in investment decision-making.
In the investment business, sometimes you make a bad decision. A bad decision is one which (a) loses you money and (b) when you look back at it, makes you think “We should have known that this would go wrong”.
Note that, defined this way, bad decisions are not inevitable: it should be possible to run an investment business without them (there are always going to be decisions which lose you money, but there is no inevitability about the regret that you “should have known”). So, why do bad decisions occur?
The point I want to make is this: we always in some sense know that we are making a bad decision, even as we make it. A bad decision always, in our experience, has one or more of the following elements:
- The investment executive or team is trying to do something other than make a good investment decision. For example, they are trying to impress the boss; or trying to prove something in the marketplace; or achieving an internal target; or supporting a friend or a worthy cause; or proving to investors that we can execute a certain investment mandate; or gaining experience in a new area; or responding to investor criticism that we are not backing certain kinds of investment which that investor regards as “hot”.
- The executive or team is following a strong market trend, and applying accepted market thinking. Wily and well-trained investment professionals will never admit to buying an asset “because it is going up”, for example. But the reality is that this kind of thinking underlies a great number of investment decisions (perhaps the majority) – the fancy analysis and data come post-hoc.
- There is pressure for “consistency”. As in: “if we approved such-and-such a deal, then we should also do this one”. This pressure ignores the particularity of investment decisions, and the likelihood that when we say one deal is “like” another, we are either ignoring or giving insufficient weight to a factor which may prove to be critical in the outcome.
- Somebody has worked very hard on a deal, done a lot of work and spent a lot of money on due diligence, and the work is presented beautifully. The decision to approve the deal is in effect a round of applause for the executives involved, and/or an unwillingness to shoulder the broken deal costs.
Whichever of these has triggered the pressure to do the deal, there is in our experience as professional investors, ALWAYS SOMEONE IN THE ROOM WHO KNOWS WE SHOULD SAY “NO”.
Every well-run Investment Committee knows this. Its main purpose is, or should be, to create an environment in which that person can speak up and be heard. This is often misunderstood: the common lay understanding of an Investment Committee’s role is that it should be staffed by experienced investment professionals, whose main role is to scrutinise executives’ investment thinking and appraisal, and catch them out if they make a mistake.
Not so: experienced decision-makers know that it is very difficult to catch out a competent investment executive: he or she always has more information than you do, and has spent longer thinking about the case. If you can catch him out, he shouldn’t be on the team in the first place. There is no denying the value of experience on an Investment Committee, but their role there is to train and nurture the executives to “think like an investor”, and in particular to recognise a bad decision when it is forming in the room, and have the intellectual tools and character to denounce it as such.