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Cognitive diversity’s key role in decision-making – with Ted Seides

Decision-making may remain undertaught as a subject and yet, as podcast guest Ted Seides points out, plenty of cost-effective and straightforward techniques exist to help people improve the quality of their decisions

26/04/2021

Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

“If you have never suffered from confirmation bias, you are not in the investment business” – and, in one line, Ted Seides cuts to the heart of what investors need to understand about behavioural finance. As human beings we can never hope to eradicate all the biases that tens of thousands of years of evolution have hot-wired into our brains – all we can do is look to put in place processes designed to counter them.

Confirmation bias – where people specifically seek out information that supports their current view on a question or decision – is one of a number of instinctive biases investors constantly need to beware. When Seides recently appeared on The Value Perspective podcast, therefore, we asked how the investor, author and financial podcast host par excellence might guard against it.

 

“If someone suffers from that regularly – and from another bias, overconfidence – it is very hard to imagine they are going to be successful investors at the end of the day although there are processes you can put in place,” he replies – before quickly adding much of what he is about to say stems from podcast conversations of his own with previous guests on The Value Perspective Annie Duke and Michael Mauboussin.

“It all starts with the structure of the decision-making unit itself,” Seides continues. “There is much research to shows the optimal decision-making unit is four to six people – not four to six decision-makers but a group of four to six that is together trying to figure out the authentic truth. One or two people in a room are unlikely to bring enough opinions to unearth all that needs to be unearthed while 10 is probably not a good idea.

“So that is important but the structure of the group also matters. If, say, you have a very strong leader, who likes expressing their own opinion before asking for other people’s, they are never going to see true independence of thought. That is because it is likely other members of the team will instinctively just want to agree with the leader – but there are ways you could think about organising those meetings.

Cognitive safety

“Maybe, for example the most junior person speaks first and expresses their opinion – although these meetings also need to be cognitively safe. After all, if people disagree with the leader of the group but then get punished for it – either implicitly or explicitly – they are not going to be willing to express their divergent opinions in the future. To reach good decisions, you want everybody feeling able to speak up.”

According to Seides, research also suggests building cognitive diversity into a group is “inordinately helpful”. “I am not talking about social diversity here but cognitive diversity – people who think in different ways,” he explains. “Some ways to achieve that are easy –  so social diversity and cognitive diversity do appear to be highly correlated. People of different races and genders often have very different experiences in their life.

“Specifically in the context of optimal decision-making, however, you are looking to build in cognitive diversity so, in addition, there are methods like personality tests. Introverts and extroverts think differently, for example, and, if you took a Myers-Briggs test, say, each of the factors indicates something where people will think and process information differently.”

It is all very well assembling a group of people who are naturally inclined to think differently from each other but little will be achieved if they cannot agree on anything. “A key vector here is something called the ‘rationality quotient’,” says Seides. “People who are highly rational in their beliefs are very good in decision-making groups because they will not immediately dismiss someone else’s view because of their own biases.”

Premortem analysis

The “most actionable decision-making tool” Seides has picked up from his Capital Allocators podcast conversations is from cognitive psychologist Gary Klein, creator of the ‘premortem’ analysis, which also cropped up in Better decisions – with Michael Mauboussin. “We all do post-mortems to try and improve our processes,” says Seides, “but Gary looked at doing this before rather than after something goes wrong.

“He created a simple 15 or 20-minute meeting with a very rigorous structure so that, when you are ready to make a decision, you can gather your decision-making group and put yourself in the frame of mind of, not ‘What do we think might go wrong?’, but ‘OK, it is three years from today and this decision has not worked. Now let’s go around the room and ask each person – why did it fail?’

“It is not that doing a premortem will necessarily change the decision – just that it has this incredible ability to reduce overconfidence and unearth possible outcomes that might not have come up in what can be a very momentum-driven process. When you are doing more and more work and developing your thesis – and so starting to risk encountering confirmation bias – it is very easy just to let that freight train roll ...

“What the premortem analysis does is address the question of how you get all these people on your team to be able to think a little bit differently about what might go wrong with whatever it is they are working on and just allow that to enter into the decision-making process. It has proven very effective at helping teams to make better decisions.”

As Michael Mauboussin has pointed out on The Value Perspective podcast, the whole subject of decision-making remains undertaught, even in masters programmes and at business schools. Nevertheless, techniques such as the premortem – along with the application of base rates and tracking your decisions – are powerful yet cost-effective and easily adopted ways to help people improve the quality of their decisions.

Author

Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

I joined Schroders in January 2017 as a member of the Global Value Investment team. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet I was a member of the Customs Solution Group at HOLT Credit Suisse.  

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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