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‘Sorry’ should not be the hardest word for investors

Investment mistakes can be tough to identify but that should not stop professional investors from trying, from learning from those errors they do make or from acknowledging to their clients that they happened

02/07/2019

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Elton John may have famously sung how ‘Sorry’ seems to be the hardest word yet it turns out being able to express regret in a meaningful way can significantly benefit businesses and their processes.

That, at least, is one of the arguments in Kathryn Schulz’s 2010 book Being Wrong: Adventures in the Margin of Error, which offers up the US medical system as an instructive example.

Schulz cites an arresting estimate from the Institute of Medicine that between 690,000 and 748,000 patients are affected by medical errors each year in the US, with between 44,000 and 98,000 dying as a result.

Even if you take the lower of those two figures, she points out, that is the equivalent of one fully-loaded 747 crashing every three days, killing everyone on board.

If that ever happened in reality, the commercial aviation industry would of course be swiftly shut down so how, you might wonder, is something similar allowed to continue in the US medical system?

Not a reason to avoid medical help

The first and most obvious factor is that, while you can always choose not to fly, when you need medical treatment, you need it – so there will always be a stream of patients through the doors of hospitals and doctors’ practices.

A second, less obvious, consideration, however, stems from what happens in the aftermath of a medical error.

In many cases, human beings – and legal systems – being what they are, there will be some sort of cover-up or, at the very least, no acknowledgement an error was made. That is clearly bad news for any affected patient but it is arguably worse for future patients who end up suffering because the original error was not addressed.

Or to put it another way: “If you don’t acknowledge that mistakes occurred, you’ll never eliminate the likelihood that they'll occur again.”

Interestingly, this quote in Being Wrong is from the CEO of a large US hospital, the Beth Israel Deaconess Medical Centre in Boston, which around the start of this century instigated a policy of publicly apologising for its mistakes.

In doing so, reports Schultz,  the hospital significantly improved its accident rates and reduced the amount of money it was spending fighting lawsuits.

And while she offers no numbers for that particular hospital, Schultz does note that the University of Michigan medical system saw its annual legal fees drop from $3m (£2.35m) to $1m after it implemented an ‘apologise and explain’ programme.

With such processes, Schultz writes, these medical organisations “try to imagine every possible reason a mistake could occur, they prevent as many of them as possible, and they conduct exhaustive post-mortems on the ones that slip through. By embracing error as inevitable, these industries are better able to anticipate mistakes, prevent them and respond appropriately when those prevention efforts fail”.

What's this got to do with investment?

And that paragraph leads us nicely to investment and the process we follow, here on The Value Perspective.

We too try to imagine every possible reason a mistake could occur; we have a checklist to prevent as many of them as possible; and while, given the earlier medical context, “post-mortems” feels a strong analogy, when mistakes do slip through, we certainly work hard to understand why and to ensure they do not happen again.

For there is no denying errors are as inevitable for investment professionals as they are for their counterparts in medicine.

As we have discussed in articles such as Horse sense, value investing is about keeping on the right side of the averages – a statement that implicitly acknowledges that any portfolio of today will contain a number of mistakes of tomorrow.

Fund managers do not know what those are, of course – if they did know where their errors were, presumably they would no longer hold them.

That said, the great majority of professional investors remain remarkably coy about holding up their hand to any mistakes they made in the past either. Yet surely only by admitting fallibility can you improve as an investor and deliver better bottom-line performance for your clients?

Here on The Value Perspective, we do have a culture of acknowledging we make mistakes and – because there is a good chance you are now thinking, ‘Go on then, name one’ – we will offer the name of Debenhams.

At one point, we were among the UK retailer’s largest shareholders but eventually it went to zero.

And while we were not among its largest holders when Debenhams breathed its last, that does not mean it was not a mistake.

We've made some errors

You can read a more extensive analysis of another of our errors in The investment decision that haunts us most but the reality of financial markets is it can be very difficult to know what a mistake is.

That is because, as we discuss in more detail in our recent chat with author and retired poker player Annie Duke, we live in a probabilistic world – that is to say, it is very rare that a decision has a single possible outcome.

If you work as a surgeon and you remove the wrong kidney, say, then that is demonstrably and unarguably an error.

It is impossible to defend that whereas, in investment, when we buy a stock and it goes up, that could well be down to luck or to good judgement or to a bit of both.

And, of course, the inverse is also true. Maybe the stock we bought went down because we made a mistake – or maybe we were the victims of an extremely unlikely yet extremely unfortunate outcome.

What matters is having a consistent, objective and repeatable process so we can be confident that, if we took the same course of action 100 times, say, things would have worked out for us maybe 60 times.

Furthermore, even if investment mistakes can be tough to identify, that should not stop us from trying, from learning from those we do make or – hard as Elton sung it is – from acknowledging to our investors that they happened.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick 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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