Warren Buffett, who claims that high IQ and investment success are not correlated, suggests a trade: swap 20 IQ points for a better temperament. Again the Sage of Omaha challenges a shibboleth, and again the challenge will be dismissed as ‘Warren being Warren’. Yet Ben Graham, too, has declared that “the main point is to have the right general principles and the character to stick to them.”
Seth Klarman of Baupost poses a pithy first filter for value investors:
“Ultimately, value investing needs to fit your character. If you’re predisposed to be patient … appreciate the idea of buying bargains, you’re likely to be good at it. If you have a need for action, if you want to be involved in new and exciting technological breakthroughs … you’re not a value investor, and you shouldn’t be one.”
Answers to two questions might help develop such simple filters into operational ones:
- Which characteristics of temperament inhibit or enhance investment success? A decisive temperament is crucial in much investing but is only tested under pressure. John Meriwether of Long-Term Capital Management (in)famously had it until confronted by two Nobel Prize–winners with stratospheric IQs.
- How do these characteristics vary across asset classes, investment styles, and strategies? The temperament needed for success in long-only equity management is likely almost orthogonal to that needed for short-biased management. The former tend to be positive and optimistic; the latter, sceptical and pessimistic.
The Oxford English Dictionary defines temperament as “a person’s nature especially as it permanently affects their behaviour; from the Latin ‘temperamentum’, correct mixture”. What, then, are the “correct mixtures” for investors?
Temperament, being unmeasurable, is likely to be ignored, yet in politics, war, and sport its importance has long been recognised. Franklin D. Roosevelt was described somewhat positively as having a “first class temperament and a second class mind” (Walter Lippmann, qtd. in Different Class 2009). The temperament to craft stable coalitions, not raw intellect, was the key to his success. Leon Trotsky’s temperament was ideally suited to the post-revolutionary chaos in which he transformed a rabble into the fearful Red Army, but was ill-suited to the (relative) order that later prevailed. While the strong functional parallels between investing and warfare (low signal-to-noise ratios, a mix of strategy and tactics, and, as Napoleon well knew, immodest doses of luck) are well known, of potentially greater value are the temperamental parallels implicit in Norman Dixon’s On the Psychology of Military Incompetence.
Successful investors are likely to be overweight a number of the following traits:
- A paradoxical blend of arrogance, to discover and arbitrage opportunities ahead of the market, and humility, to simultaneously be sceptical about those discoveries.
- A commitment to ‘knowing thyself’. For instance, recognising that previously justified contrarianism had degenerated into unjustified stubbornness.
- The ability to make effective decisions under uncertainty, ambiguity, and pressure. A temperament that seeks comfort and stability will likely be ill-suited to investing.
- The confidence to encourage and absorb dissent yet to know when to act. Almost all organised human endeavours have at their core a paradigm of broadly agreed beliefs, stylised facts, and patterns of thought that impose a uniformity of views. Ideas that challenge the paradigm tend to be ignored, not absorbed: Markowitz’s thesis was not rated as genuine economics, while Akerlof’s ground-breaking Lemons paper on the pricing impact of information asymmetry was twice rejected. Both eventually won Nobel prizes.
- The wisdom to know when to cooperate, a rare trait in a culture that imbues competition with religious status. Much (but not all) investment information is ‘non-rival’, whereby its value increases through sharing, as evident in open-source ventures. Yet by temperament, training, and incentives, many are antithetical to sharing. One study engaged students in a game where participants do better by cooperating. 60% of general students cooperated while only 40% of economics students did.
- The self-control to value patience, and so resist the short-term imperative and its eternal concomitant, being busy.
- A willingness to question and be curious, traits lacking in many boards that oversee other people’s money. After being embedded in US pension funds, the anthropologists O’Barr and Conley reported “a surprising lack of interest in questioning and surprisingly little interest in considering alternatives”.
Isaiah Berlin bequeathed a crude but useful typology of people: hedgehogs view the world through the lens of a single defining, and usually substantial, idea; foxes view it through multiple lenses. Both types are needed in investing, but we are over-populated with hedgehogs who better fit compartmentalised corporate structures and are more fecund. We need more foxes, people with broader perspectives willing to trespass — a notion coined by Albert Hirschman — into foreign fields. No investment organisation would hire a sociologist; yet Winslow Jones, who created the first ever hedge fund, was one. One of the best analysts of Jim Chanos, a famous short-seller, is an art historian. “She had no formal business school training. She was so good because she was very intellectually curious. She was never afraid to ask why ... This is almost something that you can’t train.” The Bank of England showed similar courage in seeking insights on complexity from a theoretical biologist, recognising that markets behave more like evolving, adaptive non-stationary biological systems than physical engineering systems.
Cultural change is needed to recognise, support, and reward foxes, who tend to be spurned by tribal hedgehogs as soft-headed dilettantes. To Charlie Munger, having different mental models is the most important thing in investing, because they expose new opportunities and drive a dialectic of risk. Investment organisations should seek more people with 'contrary imaginations', as the psychologist Liam Hudson phrases it: people with exceptional intelligence in alternative but meaningful ways; people with intelligence about the humanities, especially history and psychology, the disciplines that underlie and drive markets; people with emotional intelligence to direct and manage others; and people with organizational intelligence to get things done.
The latter are rare, because our training idealises companies as rational profit maximisers populated by homo economicus. The anthropologist and investment banker Karen Ho paints a more realistic picture: “Capitalist organisations are not simply motivated by … profit or governed by rational actors. They are sociocultural organisations with complex contradictory world views.” Getting things done in such organisations requires a temperament different to that required in ideal ones. The investment industry should adopt a strategy of ‘mental and temperamental heterogeneity’. That will require another Buffett-style trade: swap much of the prized but value-detracting ‘comfort’ for the much-avoided but value-enhancing ‘courage’.
Dr Jack Gray is a Director at the Paul Woolley Centre for Capital Market Dysfunctionality, Faculty of Business, University of Technology, Sydney, and was recently voted one of the Top 10 most influential academics in the world for institutional investing. For a full list of references or an expanded version of the paper contact jackgray08@live.com.au.