Any point in history, or investment, has a range of possible outcomes


Andrew Williams

Andrew Williams

Investment Director

The more you learn about investing, the more you are aware of the probabilities and risks involved and that nothing is really certain – even in hindsight

 “It is an iron rule of history that what looks inevitable in hindsight was far from obvious at the time.”

The above line, which appears in Yuval Noah Harari’s 2011 book Sapiens: A Brief History of Humankind, may be about history but it could just as easily apply to investment. Both fields are susceptible to what is known as ‘hindsight bias’ – the inclination of human beings to see an event, once it has occurred, as having been wholly predictable, even if there was no chance of that ever really being the case.

We all know people who ‘knew all along’ that Donald Trump would become US president, say, or that Apple would always grow to be one of the world’s most successful companies. The reality, of course, is that every point in history and investment is more like a junction that offers a range of possible outcomes – and what happens is not necessarily what seems most likely based on a rational analysis of all the variables at the time.

To use one of Harari’s example, anyone predicting in 306 AD – the year Constantine became emperor of Rome – that “an esoteric Eastern sect” called Christianity was about to become the Roman state religion would have been “laughed out the room just as you would be today if you were to suggest that, by the year 2050, Hare Krishna would be the state religion of the US”.

Statue of Roman emperor Constantine

Paradoxically, as Harari also notes, this all means the better someone knows a historical period, the harder it is to explain why things happened. “Those who are more deeply informed are much more cognisant of the roads not taken,” he writes – and again this holds true with investing, where the more you know, the more you are aware of the probabilities and risks and that no successful outcome was ever ‘always going to happen’.

To hold that nothing is predictable is not, however, to suggest everything is possible. “Geographical, biological and economic forces create constraints,” Harari writes. “Yet these constraints leave ample room for surprising developments, which do not seem bound by any deterministic laws.” Naturally this disappoints people who would prefer history – and investment – to display a little more in the way of order.

The trouble is, says Harari, there are so many forces at work and their interactions are so complex, that extremely small variations in the strength of the forces and the way they interact can produce hugely different outcomes. In short, history is chaotic and furthermore, according to Harari, it is what is known as a ‘level two’ chaotic system. That’s right – chaos comes in two varieties.

‘Level one’ chaos

‘Level one’ chaos does not react to predictions about it, with the weather being a good example. It may be influenced by many different factors but it is possible to build computer models that take more and more of these into consideration and so produce better and better weather forecasts.

‘Level two’ chaos

‘Level two’ chaos, however, reacts to predictions about it and, as a result, can never be predicted accurately.

Guess what else is a ‘level two’ chaotic system? Markets. Say you develop a computer programme that forecasts with 100% accuracy the price of oil. If oil is trading at £90 a barrel today and your infallible computer forecasts it will go to £100 tomorrow, then investors will rush to buy today so they profit from the predicted rise and oil will hit £100 a barrel today, not tomorrow. And what happens tomorrow? Who knows?

If the world of investment is essentially unpredictable then, what do you do?

Harari tells a great story about two Scottish ministers, Robert Wallace and Alexander Webster, who in 1742 were entrusted with the job of calculating how many ministers were likely to pass away in any given year, with a view to ensuring the ‘Fund for a Provision for the Widows and Children of the Ministers of the Church of Scotland’ had enough money to do what it said on the tin.

Wallace and Webster’s work was informed by a number of recent breakthroughs in the fields of statistics and probability, including Jacob Bernoulli’s ‘law of large numbers’. This codified the principle that, while it might be difficult to predict with any certainty a single event, such as the death of one person, it was possible to predict with great accuracy the outcome of many similar events.

The pair also used actuarial tables published 50 years earlier by Edmond Halley – of comet fame – showing the chances of someone of a certain age dying in a given year. Ultimately, they calculated the fund would have capital of £58,348 in 1765. In fact, when that year arrived, more than two decades later, it stood at £58,347. Today the fund has become a multi-billion-pound company with a simpler name – Scottish Widows.

Whilst past performance is no indicator of future results,  if you have a great deal of information on the outcomes of many similar events, you could stand a better chance of identifying a more probable outcome. As it happens, there is now some 130 years of data showing, on average and over time, a value strategy has outperformed – and qualities that could help value investors continue that run is a focus on long-term averages, on data and on probabilities that can help ensure they do not fall foul of hindsight bias.


Andrew Williams

Andrew Williams

Investment Director

I joined Schroders in 2010 as part of the Investment Communications team focusing on UK equities. In 2014 I moved across to the Value Investment team. Prior to joining Schroders I was an analyst at an independent capital markets research firm. 

Important Information:

The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.

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