The Value Perspective Podcast episode – with Simon Evan-Cook
The Value Perspective Podcast episode – with Simon Evan-Cook
Juan Torres Rodriguez (JTR) and Andrew Williams (AW)
Hi, everyone. On The Value Perspective podcast today, we are absolutely delighted to have Simon Evan-Cook, who is a multi-asset fund-of-funds manager with over 25 years’ experience in financial services. He began his career with Fidelity before going on to Rothschild Asset Management and then Gartmore. In 2006, he joined Premier Asset Management, where he built his reputation as the senior member of the firm’s award-winning multi-asset team. The latest chapter in his career began earlier this year, when he joined boutique listed fund business Downing Fund Managers. Simon, who is also a columnist and blogs regularly on his website, Never Mind the Silver Bullets, describes his day job as one that depends on good decision-making and solving complex problems. He also realises these insights are useful in the real world so he is committed to going deeper into the world of tough problems – and that is exactly what he shares on his blog. In this episode, Juan and I enjoy delving into the decision-making styles of Han Solo and C-3PO, overcoming ‘lazy averages’, learning how ‘systems thinking’ can help you solve Christmas and much, much more. This podcast is recorded remotely and so the sound quality is not as perfect as it could be. For that we apologise but we are confident it should not spoil a cracking conversation. We hope you enjoy it ...
Chapter headings for Simon Evan-Cook on The Value Perspective Podcast
Please click on the link below to jump straight to a chapter
- Simon Evan-Cook, welcome ...
- Buckets of certainty
- Han Solo v C-3PO
- Thinking in probabilities
- Countering personal bias
- Waking up to ‘lazy averages’
- How to solve Christmas
- Book recommendations and one big mistake
JTR: Simon Evan-Cook – welcome to the 50th episode of The Value Perspective podcast. It is a pleasure to have you here. How are you?
SEC: I am good, thanks. I had no idea this was number 50. I am glad I did not know because I think I would have been nervous beforehand! I feel a lot of pressure now! But I am very happy to be here. Thank you.
JTR: For those who may not know you, please could you briefly introduce yourself?
SEC: Sure. Obviously the challenge there is the word ‘briefly’, but I will give it a go. As you say, my name is Simon Evan-Cook. I am a fund-of-funds investor, which means I buy the funds of other investors. So I do not analyse equities or bonds – I analyse people who buy equities and bonds – in fact, if I ever give you a recommendation to buy a specific equity or a specific bond, you should instantly ignore it because that is not what I do. My expertise is understanding whether somebody is a good investor or not.
So, over the years, I have managed to cobble that together into funds of funds that have done well, won awards and taken a lot of money. Most recently, I joined a company called Downing, where I am in the process of setting up – so I am looking for seed capital for funds of funds currently, but I also have some white-labelled funds running. But all of this is based on understanding what other people do and creating funds that are hopefully resilient and hopefully will be successful for the holders over the long term.
JTR: You have left out the fact you run a very interesting blog – something that, as bloggers ourselves, is very important to us. Could you tell us all about that?
SEC: Absolutely. If I had given you the full version of my history, writing has permeated through what I have done ever since I graduated from university in 1996. I was never particularly good at writing but, over the years, I realised that actually I loved it. I really enjoyed writing and so my career has been interwoven with writing over that time. At the moment that has two outlets. I write a column called The Fund of Funds Insider for Citywire, where you can see some of my more financial based writings, more investing stuff.
But I also found that, over the years, in trying to become a better investor, I read and learned so much stuff – so much stuff about investing but also so much about other stuff, which then helped me with investing. There were loads of offcuts from that – loads of learnings and loads of information, which was really useful in other parts of life. And it was all just going to waste so I wanted to start a blog that looked at all the stuff I had learned and then tried to apply that in the wider world.
So it is not specifically an investment blog – I might have mentioned investment sometimes – but it looks at what I have learned in becoming a better investor and how you can use that in everyday life to solve problems. I suppose ‘problem solving’ is another way of saying ‘decision making’. So, if you wanted to have a look at that blog, it is called Nevermindthesilverbullets.com and it is specifically a journey through the world of problems – trying to solve problems and how can you get better at solving problems?
JTR: In one or your blogs, on why the site is called Silver Bullets, you wrote it was because it is trying to offer easy answers to very complex problems – is that correct?
SEC: It is actually completely wrong! It is called ‘Never Mind the Silver Bullets’ because one of the things that winds me up constantly through life is how we are always trying to find really simple answers to complex solutions when, quite often, there is no simple answer to that complex problem available. The trouble is, though, because we humans are so drawn to silver bullets ... Googled ‘silver bullets’ and you will find there is a silver bullet solution for everything – or, more accurately, you will find that actually X is no silver bullet for Y because those problems just cannot be solved by something simple. So my crusade is trying to rally against people trying to use overly simple answers to solve what are amazingly complicated problems.
A really good way of looking at the world of problems is, if you imagine those puzzle books you can buy in airport lounges, which have all these different puzzles, if you pick up one of those from someone’s lounge or in a waiting room, the ones that have been completed are the really simple puzzles. And that is where we are – the stuff that could be solved by one break or one simple silver bullet has been solved or completed long ago. So what you are left with is the equivalent of a used puzzle book where only the hardest puzzles are left. And those need more complex answers – maybe they need more than one person to think about it; or they need you to have learned different subjects to understand them; or they have five, six, seven, eight different answers, which all masquerade as one simple answer.
So that is the crusade I am on with Never Mind the Silver Bullets – it is trying to say to people, just forget trying to find one simple answer. Forget, say, voting in Donald Trump to solve all your problems because a lot of people saw him as a silver bullet to solve all of America’s problems – but clearly that is not going to solve all the problems. But that is a very good example of how people think one thing can solve this nest of problems.
JTR: That is incredibly interesting. How long have you been writing the blog for?
SEC: I have been writing the blog for three years or so but I have been thinking about it, well, forever – I think everybody’s always thinking about how to solve these problems because they are problems that are about complicated things. That might be markets – and, obviously, we will talk about that later on – but it is about complex systems. And we will talk about systems later as well but that could be anything from markets to economies. But it could be your garden, it could be your body, it could be the company you work for, the team you are playing for or root for – all these things are complex systems.
So it is thinking about that and how can you make decisions or solve problems about these highly complex structures? But, hopefully in a simple, approachable kind of way because, if there is one thing I have discovered in writing this blog, it is the word ‘complexity’ is incredibly off-putting – who wants to read about complexity, right? So I try to find interesting ways to talk about this – to use analogies that might be more appropriate to people’s lived experience rather than dry academic language, which is where a lot of this stuff comes from.
AW: I came to your blog after we met last year and I think you have definitely achieved that. I think it is fantastic and I love the metaphors and analogies you manage to get into explaining lots of these complex systems or decision-making so I would encourage people to take a look. One big thread that runs through the blog is decision-making – and, of course, you are now on a podcast about decision-making – so I guess that is a good place for us to start. One line I read in one of your blogs really jumped out at me, which is when you said: “Our emotion programming is not suited for the modern world but overriding it often fails too.” What do you mean by that?
SEC: For millennia – certainly for centuries – humans have been making decisions the same way, which is to use their emotions. And that has obviously worked brilliantly for years – take it back to the days when we were all living in caves and that instinctive emotional decision-making made a lot of sense. It was designed by evolution, over generation after generation after generation – the best way to make decisions meant that you survived. So we have this incredible brain that is designed to keep us alive – we are programmed to keep ourselves alive long enough to breed and then long enough, hopefully, to bring up your kids once you have bred. And that is really what your genes are driving you to achieve.
So we have been programmed to do this – but the trouble is, the world has changed enormously over the last 50, 100, 200, 300 years. And so we are left with this incredible brain but it is perhaps not as well suited for modern life as it was before. It is designed so that, if you are out in the open and you are hunting, if you have a bad sensation there might be a tiger around, there is not really a big cost to running off. On the other hand, there might be a really big cost to not running off – a tiger then devours you. Obviously now, though, we are not faced necessarily with those risks every day.
Clearly, we are talking about finance here and a lot of those decision-making systems can be gamed or hacked. You talk a lot about behavioural biases and heuristics – how these instincts can lead us to make bad decisions, particularly in the financial world. And when you look at, for example, just the process of buying double-glazing or, as I recently did, buying some wardrobes, you know you can be ‘hacked’ – there are salespeople out there who know what your biases are. They know, for example, if they say a wardrobe should cost you £30,000 but, hey, today it is going to cost you £20,000 as a special deal, then they have ‘anchored’ you at a high level and they are now gaming you and making you feel like you have got a bargain. Even if the wardrobe is actually only worth £1,000, you feel – because you are imagining £30,000 – that it is a bargain.
Again, you talk a lot about ‘system one’ and ‘system two’ thinking – where your emotional brain is known as ‘system one’ and your more rational, decision-making brain, which can override that, is ‘system two’. Now, system one is a super powerful computer that does amazing things and amazing calculations – you know, if I was to throw a ball 30 feet up in the air for you, you would be able to run underneath and catch it. If you asked your rational brain to try and calculate the relevant trajectories and speeds, it would take weeks, if not months, to do so – you just cannot do it. So that part of the brain is incredibly powerful.
Obviously, the rational brain is not as powerful and, sometimes, what I am rallying against a little bit is the feeling that maybe we have gone a little bit too far in arguing the rational brain is king and we should always listen to it. Actually, sometimes your instincts are right – sometimes in a financial decision, you just have a bad feeling about a person and perhaps you should listen to that bad feeling.
And you see that in markets as well with buying and selling – sometimes it is right to panic. So, for example, if you were in a super high growth fund in 2020, when the pandemic hit, if it dropped 30% and you panicked and you sold, that turned out to be the wrong decision. This year, if your super high growth fund dropped 30% and you said, this time, I have learned my lesson – I am going to override that feeling of panic and hang on to it, then it dropped another 30%. So, at the moment, you may be sitting on a 60%-plus loss because you did not panic. Sometimes rational does not work and we need to build that into our decision-making.
AW: There is a lot to unpack there.
SEC: It comes down to what I call the ‘buckets of certainty’. It is about how, again, as humans, when we make decisions, we tend to think in absolutes. Let’s say you wanted to start a business – you either think the business is going to be a success and you do it; or the business is going to be a failure and therefore you do not do it. Now, I call those two extremes ‘buckets of certainty’ because, if you put it into numerical terms, you have 100% success in one and 0% in the other one.
In real life, though – particularly when you are trying to predict the future or trying to work out what is going to happen – those two things almost never happen. So the ‘hack’ is – never ever, ever put anything in either one of those buckets. So, even if you are super-bullish that you are about to start this business and you think it cannot possibly fail, I would just encourage you to put it in the ‘99%’ bucket. Of those two buckets of 100% and 0%, let’s say there are 99 buckets between them – you can put it in any of them. Still, if you are a super-bullish, optimistic person and you were talking to me, I would say, right, just take it out of the 100% bucket and put it in the 99% bucket because, as soon as you do that – as soon as you stop using the two buckets at the end, you then have to use two buckets rather than one.
As soon as you put it the 99% bucket, you can say, right, what is in the corresponding 1% bucket? Why might the business not succeed? If you are a super-bullish person, you might just say, well, if I got hit by a bus, it would not succeed. And you can say, OK – but what if you got ill? Or what if you broke a leg? Or what if you are relying on a certain customer and that customer gets hit by a bus or that customer changes their mind? And suddenly, you are starting to think, actually, that is not a 1% chance of failure? Maybe that is a 10% chance of failure? Then you start to look at other things and think about, well, what if there is a recession? What if there is another pandemic? That is something a lot of people would not have considered five years ago – they will now – but as we now know, it is something they should have considered.
JTR: When we try to express things in terms of uncertainty – and, as you say, nothing is 100% or zero – people start to think you are a pessimist. I tend to tell them I am not pessimistic, I am paranoid – there is a difference! A paranoid person knows that something could go wrong – they do not expect something will go wrong but they can understand that it could. Do you feel the same way?
SEC: I absolutely do. I think being a great investor involves all sorts of paradoxes – for example, being ‘flexibly dogmatic’ is a paradox. But, in terms of what you are saying, Juan what I think you need to be is either an ‘optimistic pessimist’ or a ‘pessimistic optimist’. If you are just a pessimist or an optimist, you are likely to struggle. If you are an optimist, the key skill to learn is temporarily pulling yourself back and just saying, right, I love this idea but what could go wrong?
Now, you can either do that personally by learning to do that as a skill, or you can partner up with someone who is a pessimist. I quite like meeting fund teams where, for example, you have someone who is a real optimist and maybe they have teamed up with someone who is a short-seller. Short-sellers can be quite optimistic but they are going to be optimistic that a company is going to fall apart and fail, and they are going to make a lot of money from disaster happening. But if you have those two people together, that is quite a useful combination for how people think about things.
AW: We love talking about all this sort of stuff but there was another line – and I promise this podcast will not just become me quoting bits of your blog back to you – but this resonated with me. You wrote: “Many investors (and most of our leaders) have read the book on Bayesian decision-making, swallowed it whole, and now worship it as religion. In other words they have – ironically – used it as an excuse to stop thinking.” Can we just unpack that? Can this go too far?
SEC: There is certainly a case that it can go too far and actually, when you stand back and look at society currently, I think it has gone too far. When I have written about these two systems – system one and system two – and the kind of animal brain versus the human brain, I have reference C-3PO and Han Solo from the Star Wars movies. And in The Empire Strikes Back – which, as everyone knows, is the very best Star Wars movie! – there is a brilliant scene where these two types of thinking are represented perfectly by these two characters and they come together and clash.
What happens is, the Millennium Falcon is being chased by these fighters and this big star destroyer and lasers are blasting all around it. And Han Solo has to try and get away and he discovers he is just about to enter an asteroid field. At that point, he thinks this is a great idea but C-3PO, who as the name suggests is a robot, tries to hold him back by telling him the odds of successfully navigating an asteroid field – and I have written them down – are ‘approximately 3,720 to 1’.
That is a really useful example of Bayesian thinking where you put a probability on something and it just slows things down. Whereas Han Solo is very much an instinctive decision-maker who follows his gut and he is about to do this potentially very stupid thing. So you have C-3PO stopping and saying, well, these are crazy long odds for doing that so don’t do it – at which point, Han Solo says, ‘Never tell me the odds’. And he flies into the asteroid field anyway.
So when you unpack that, I meet a lot of fund managers who are a bit like Han Solo and operate in a way where they just go, this is a great company, this is a great idea, I am just going to go and buy. That is it. I also meet a lot of fund managers who are just like C-3PO, where they will analyse and analyse and they will just purely go on the data. And they will try as hard as they can to get rid of any gut instinct. Now, why it does not work is because, if you are the Han Solo character and you defy those odds of 3,720 to 1 and you get blown up – well, what were you expecting? That was obviously a really stupid thing to do.
So it is right to stop yourself and say, I need to think about this – but I think our world has gone too far in listening to the C-3POs. And by that, I mean academics quite often fit into the C-3PO camp. I think a lot of senior decision-makers – particularly if you are relying on accounts or an Excel spreadsheet to make a decision – tend to go to the C-3PO way. So you also need to say to C-3PO, hang on – let’s look at what you are saying here as well because those odds you have just quoted at me, what are they based on?
Let’s unpack your 3,720 to 1 because what data have you used to calculate that? First of all, is there survivorship bias? Or quite the opposite, actually – I mean, who has records of whether a ship has actually successfully navigated an asteroid field or not? Those records would not exist – because why would you have a record of whether you successfully navigated it or not? You might have a record of ships that got blown up so those odds might be wrong for that. But also, how big is the spaceship you are flying? Is it a really big spaceship that could get smashed quite easily? Or is it a little fighter that might be able to manoeuvre around? How fast is it travelling? And this is before you even get on to the question of how good is the pilot actually flying that spaceship?
All of these things are variables – and I have no way of knowing whether they are all included in C-3PO’s odds or not. And – spoiler alert! – Han Solo does survive. So either he was one of those unbelievably lucky guys who are the one in 3,720. Or he was actually a skilled pilot flying a very navigable ship, who actually made the right decision because the alternative was being blown up. After all, what are the odds of actually surviving a fight with a star destroyer? You didn’t mention that. So all of these things can put you off making the right decision because you get caught up in statistics – and quite often those statistics are wrong.
JTR: Have you come across The Scout Mindset by Julia Galef? It is a short book and I really recommend it. She brings up Mr Spock and, while I cannot say I am as big a fan of Star Trek as I am of Star Wars, I do know he strives to avoid human biases and emotions and be more logical and computer-like. Anyway, Galef watches the whole series, measures all his predictions against the eventual outcomes – and Spock got it wrong. A lot!
SEC: I am so glad someone has done that because I was toying with Star Trek as well but I just considered it as not quite as well known or as popular as Star Wars. But yes – that clash between Captain Kirk and Spock was the basis of almost every episode. So often it was Spock saying, well, that is not a logical thing to do – and then Kirk saying, shut up, Spock, I’m going to do it anyway! And then, because we like Han Solo more than C-3PO and we like Captain Kirk more than we like Spock, we end up rooting for that kind of decision-maker. We want the gut decision to be right and we want the geek to be wrong. But the truth is the geek is right a lot of the time – but sometimes they are not and it is that clash.
And to bring it back to your question, Andy, it is about how far is too far and what gets lost? So my concern with how far, if you like, ‘C-3POan’ thinking or how far ‘Spockian’ thinking has gone is – what are you crushing sometimes when you just look at that data? And movies are a great example here. Star Wars is a fantastic movie and it has obviously spawned this giant, multi-billion franchise, but would it get made today? My concern is that C-3POan thinking is so powerful that, when people are deciding whether to greenlight a new movie or not, they are increasingly just saying, show me the numbers. That is why so many sequels are getting made.
It is why, much as I love the Top Gun sequel that has just come out, it is still a sequel – and why almost every trailer I saw when I went to the cinema to see Top Gun was for some kind of reboot or new spin on an old idea. Whereas, if you think of something like The Matrix, which is one my favourite movies, who would make that today? It is based on a philosophy, this strange world that nobody ever heard of, and is going to cost millions and millions and millions to make – nobody would greenlight that because you would have to get past an accountant. You would have to prove to them it would make money – and you cannot prove it will make money. So my concern is this sort of expansive gut-feel is being taken out of all sorts of areas of our life and we are being left with something that might be safe but it is very dry and very boring and does not necessarily create the next amazing experience we are all looking forward to.
AW: We have spent a lot of time talking about movies and it is really interesting. But getting back to how you assess portfolio managers, I think you would agree it is quite important to have a bit of Kirk and a bit of Spock or a bit of C-3PO and a bit of Han Solo in there but what in practice would you say you are looking for?
SEC: What I am taking it back to, I guess, are the buckets of certainties. What I want them to find with this fund manager is they have had a great idea but have they tested that from different angles? Have they thought about the worst-case scenario? So that is one way. Just a simple way is you ask a fund manager what their best idea is or what their base-case view on something is. And then you ask, OK, I have got that – I get what can happen if that goes right and that is really exciting. But what is your worst-case scenario? What is it and what happens in that worst-case scenario?
As an example, I remember speaking to a gold fund manager, going back 10 or 12 years, when we were at the end of the last commodity supercycle and gold had been kind of like what cryptocurrencies have been for the last four or five years – it had been on the front page of every trade or every investment magazine every week. Everyone had been talking about gold, the price of which had pretty much doubled and gone up to about $1,800 in very short order.
That always makes me a little bit contrary and a little bit wary so I was quite sceptical. But I met this gold fund manager, who had bought goldminers, as a lot of gold funds do, and I asked her why I should buy the fund. She talked very coherently about how gold could go from $1,800 to $2,400 to $3,000 – and I could not argue with any of that, right, because I am not a gold expert. But there was no reason – particularly with gold, which is just a lump of metal at the end of the day. I know a lot of people feel very emotional about gold but it does not have a cashflow or anything like that. It is just based on what other people are prepared to pay for it.
And I asked her, what is your worst-case scenario? And I certainly got the impression she was just plucking a figure out of the air. But I think when she talked about her models, with all of these companies, her worst-case was $1,400 – even though the fact was gold had been $900 an ounce just three, four or five years before and, if you went back six, seven years before that, when Gordon Brown sold a load of Bank of England gold, it was $300 an ounce. So you think, well, why are you using $1,400 as a worst-case scenario? What happens if it goes back to $900? Or even to $300? What happens to these companies?
I did not by the fund, thankfully, because that just got me worried about it. But obviously, in very short order, the gold price did fall back again – I think it maybe got to $1,200 or $1,100, so well beneath that ‘worst-case scenario’. And sure enough, those funds had a horrific time after that. So, yes, you have to make sure they are thinking about what could go wrong as well as what could go right. So it is about just questioning from different angles – and, I guess, in tune with what you guys do, valuation is something I pay a lot of attention to because, if they are calculating a value, or what they think a company is worth, then that in itself is just a good exercise. I mean, 99 times out of 100 that guess about what a company is worth will be wrong in some way or another but at least shows that you are thinking about the inputs to them.
JTR: This podcast aims to explore everything to do with probabilities and adopting a probabilistic mindset but we are keenly aware that calculating probabilities is difficult and does not come naturally to many people. Do you have any advice for people who want to get better at thinking in probabilities?
SEC: Absolutely. I think a lot of people get put off by the language, for starters. As soon as we start talking about probabilities, we are immediately going into the world of maths – and not everyone is mathsy. A lot of people will immediately be put off by that. But I think that is a bit of a red herring because calculating the odds of whether, for example, a company is going to survive for five years – you kind of just need to learn to trust your own eyes and ears.
A really good example of how we can be foxed just by our experience – I guess it is a form of anchoring but then you can quite easily overcome that – is a very British thing and it concerns land usage. We are each sat in an office now – I am literally looking out of the window at a concrete building – and a common moan among British people is that ‘everything is being concreted over’. Only a couple of weeks ago I was having this discussion with an uncle who was saying, oh, this place will all be gone and will be concreted over within weeks. If you were to ask a British person, how much of the country is actually concreted over, most people think 47% of Britain is concreted over. Whereas the actual truth is, when you look at the statistics, it is somewhere between 0.1% to 2%, of Britain is actually concreted over.
That will comes as a surprise to a lot of people and I guess that is an example of Bayesian thinking. So how could you actually have worked it out for yourself? Well, think about the last time you took a train, say, from London to Edinburgh, or think about the last time you flew in on an aeroplane – when you look out of a window at Britain, it is overwhelmingly green. There are very few spots where it has been concreted over – or, if you are flying in at night, where there are actual lights, we can take that as a proxy. Likewise, on a train, if you are going from London to Edinburgh, for example, you will spend 96% of your time staring out at fields and only about 4% looking at concrete because the train slows down for the grey bits and actually goes faster for the green bits. So there are ways there – you just have to, I guess, stop yourself and think, is this actually right? I need to have context for that.
Something I have just started to do with my kids – which has meant they have really started to hate mealtimes with dad! – are all these little experiments. They will kill me if they ever hear me talking about this! You can practice it yourself but give your kids questions to which there is not an obvious answer. There was a little meme that went around that was a great example of it – just the simple question of, are there more doors or wheels in the world? It went around and then it went a bit viral and everyone was talking and thinking about it – well, it is cars and wheels on cars but actually, within cars, there are wheels but then cars have doors.
People really got into it so I started to come up with other examples. We were sitting in Wagamama’s with my two boys a few weeks ago and I just asked them, in our village, are there more kids or dogs? And you suddenly start to really delve into that question and it is quite fun. You start to look at, actually, everyone has a dog, but some people have two kids. And then you start to look at how many kids are in the local school and how many people we know and you start to piece things together.
The aim is to get something that is ‘roughly right’ – you are never going to get the exact right answer to that. It is ideal, I guess, if you can check or you could phone up. If you are sat in a restaurant, maybe you can say I wonder how many pizzas these guys sell in a week. And then you could try and work that out. And then maybe, at the end, you could even ask the guy who sells the pizzas, how many he sells. But immediately you are bringing in these different ways of thinking and, to bring it back to kids, I think it is so important for us to learn that stuff – but, when you are with your kids, to actually start them training ...
So many exams are about answering something precisely or getting exactly the right answer – I would love to see exams containing an unanswerable question because that would cause so much panic among people who have just narrowly focused on passing but have not learned enough about the wider world. So ask them where the FTSE 100 is going to be in three weeks’ time and then just see them fall apart under the pressure of that. Maybe that is a little bit cruel but that is what life is like – you do not know what it is going to be like.
JTR: One of many great Warren Buffett anecdotes has him sitting in a Washington Post board meeting in the late 1970s or early 1980s when someone makes a presentation on the paper getting into video, based on what the US consumer is spending on home entertainment. Buffett rarely spoke in those meetings but, with a few simple calculations, he showed the presenter’s numbers had to be way-off and killed the idea – but he got to the crux of the matter instantaneously, just by doing the maths, having some anchor points to rely on and knowing how to get there.
SEC: That is such a great example of questioning. I mean, we have become very good at the C-3POs questioning the Han Solos and stopping them but we need to get a lot better at questioning the C-3POs as well. We have seen it with the pandemic – suddenly, we all became statisticians about how this will cause this and it is going to do that. But there is so much data and so much of that data is wrong – in our industry, particularly.
And in what I do in terms of picking fund managers, so much of that data is wrong, that you just have to have a feel for when something is wrong and you really have to say, hang on a minute, how have you got to that? What are you looking at? What has gone into that? And then, quite often, when you start doing that, you can either find out – like Buffett did – that the numbers are just nonsensical. Or, delving within those numbers, you might find opportunities where there is a little gap in that data, where actually that gap is the opportunity. That is where the money lies, for sure.
JTR: That is a great segue into my next question. You said part of your job is to assess fund managers and so I wanted to ask you, what do you glean from meeting a fund manager and looking at the data behind the manager? Also, we know that just being aware we have biases is not enough to overcome those biases, so how do you deal with your own biases when you are meeting people?
SEC: Sure. The answer to the first question – what can you glean from manager meetings rather than just data? – to me is everything. It is so important to what I do. If I could only choose either meeting fund managers or just using the data, I would choose meeting fund managers every single time. Luckily enough for me, you can do both – and I do do both and the data helps one side, and the empathy helps the other.
It is one of my big bugbears. I wade into the ‘active versus passive’ argument a lot and you will find a lot of the information and data on the other side – so the passive arguments – being created by academics. Now, in my experience, the academics have used data and it almost seems to me they have done everything they could possibly do – removed biases, looked at different factors – everything they could possibly do, except actually getting out of their offices and doing something humans could do, which is to speak to other fund managers. And, when you do that, that is an entirely different world.
So these academic studies are always based on data – and, to me, in my world, the question is often posed as ‘Can an individual pick a winning fund manager before they actually start to outperform?’ Obviously, it is quite easy to find a fund manager after they have outperformed but the big thing that is useful is, can you find them before they outperform? So they ask this question and then they talk to the data to try and find out whether you could do it or not – and they invariably say, no, you could not have done that.
But, to me, it seems that is almost like asking, could an unusually dim robot actually find an outperforming manager in advance because, if you only left me with the data, I couldn’t do it either. Because that data has so many flaws in it and, when you go and meet a fund manager ... I mean, one of the obvious flaws in the data might be the manager has left a fund and gone to another one so you have got a completely different fund manager now running that. So that is one data point that has now become wrong because your data set does not tell you it has a completely different manager with a completely different approach.
That dataset will also be missing data – so one of the things I will ask fund managers is, are you invested in your own product? Are you heavily invested in your own fund? And the answer I get to that is instructive. So I will overwhelmingly invest with fund managers who have a lot of their own personal wealth invested into their own funds because it aligns their interests with what I am doing – I want to know that they are thinking about decisions and risks as if it is their own money. But that data point quite often does not appear.
I get the sense people are trying to address that – they are trying to get that data point to exist. But even when that data point does exist – let’s say, for whatever reason, fund managers have to start declaring whether they are invested or not – £1m could be borderline irrelevant. It could be ‘pocket change’ to some managers whereas, with a younger fund manager, £1m will be everything they possibly own. They are very different things so the data set can be wrong as well or missing stuff.
All of that is important but, for me, the really important stuff is trying to push fund managers and asking them questions. So I really like it when a fund manager is very honest with you, when they talk about their mistakes, when they are really open about what went wrong and they talk about that stock that blew up on them – that tells me that is potentially a relationship that is going to work, that they are learning from their mistakes, they are going to be open with you.
How on earth do you get that into a spreadsheet? And, therefore, I know that is not appearing in academic studies. So, to me, you absolutely have to get details from meeting fund managers and it is a challenge I throw down to the fund management industry – that we all need to get a lot better at putting out the kind of information that I get to see. So being able to see a fund manager talk and being able to see the whites of their eyes. How does he talk about the stock that went wrong? How does she talk about stock that went right? All of those details that enable a retail investor to be able to get a feel for the human being they are actually investing with – because if I was to do the job now but I did not have the access I have, it would be really hard to get that kind of feeling. And after all of that, Juan, I have completely forgotten your second question!
JTR: It was about dealing with your own biases when you are meeting fund managers. Some fund managers take the view the people who get to the top of a company are very good at sales and indeed selling themselves. There is nothing wrong with that but there is a chance you get biased by what that person is saying. So how do you deal with that you personally?
SEC: Funnily enough, because I have just started at the new place, I am making a few changes. Nothing too radical but there are improvements, definitely, on what I was doing before. And one thing I have started doing is specifically addressing emotional elements of investing. We are all people so you could come out of a meeting with a feeling you really liked someone but that does not mean they are going to be a great fund manager. It could just be chemistry. I mean, we all like some people on meeting them and we dislike other people. So now, there is a specific section in my analysis whereby I say, I have come out of the meeting and I hated that person or I really liked them. Then it is noted down so you have acknowledged the fact you have a feeling about this fund manager, for better or worse. At least when it is out there, you know that bias is there?
AW: That is really interesting. When you were talking there – and, again putting it into the Han Solo/C-3PO framework – I was thinking that, by meeting people, you are introducing those biases the Han Solo or more powerful ‘system one’ part of the brain can easily latch on to. So even just writing that down or being aware of it is helpful – that while everything else about a meeting actually told me something else, there is just something about that particular individual.
SEC: Yes. A piece of paper is a powerful thing, right? Pulling something out of your head and putting it down is always a good idea.
AW: Moving forward slightly, when you have gone through that process and picked a fund manager, something we talk about a lot on this podcast is how you learn from your past decisions and how outcomes can be a really lousy teacher – especially in investment and even more so with short timeframes. So how did you learn the right lessons over time?
SEC: I am hopefully still getting better but it is about being able to separate luck from skill – and that is an incredibly hard thing to do. We were just talking about a piece of paper and that is at least part of the answer. I have something thrillingly called an ‘investment criteria sheet’ and, when I am buying a fund, I write down all sorts of facts about that on it. There is all sorts of data on the sheet – about how big the fund is, how many stocks the fund manager said they were going to hold, how big the fund manager thinks it could get.
So there are all these data points down in there but I also write down my expectations and, if you like, almost my hopes and dreams for the fund. So, if it is a value fund, for instance, I will write down that I expect this fund to win when value types of investments are winning – but, also, I expect it to underperform, perhaps, when growth types of investments are winning.
So it is about making sure I am ready for what it should be doing because then, when it underperforms and there is a good reason for underperforming, you have got it written down – and you think, OK, that is what I said was going to happen and that is what is happening. So the fact this fund is struggling now is as it should be – so don’t worry. Or conversely, if a fund is struggling when it should not be, then that is a point to suddenly start asking questions and worry about what is going on with that fund.
I would say that is such an important thing in investing but also in all aspects of life – just to write down your expectations of something because it is so easy for it to creep or for you to fall in love with that investment. And, because I am dealing with people, if you really like the fund manager and they are doing something different – say they are changing the fund from value to quality growth and then high growth – it is possible for that to creep over time and it is never doing you any favours. So, yes, just trying to anchor yourself on what you expected is really important.
JTR: You have referred in the past to the term ‘lazy averages’. Could you define what you mean by that and how do you think about these in terms of management or manager selection?
SEC: Sure. So a ‘lazy average’ is what I was accusing C-3PO of earlier – he has basically just said the average ship cannot survive an asteroid field. And again, there are all those problems I mentioned where, actually, when you look at that data, there are all these little bits and pieces that are irregular and do not fit with that. That is what I am talking about.
And the ultimate lazy average that affects our industry is, again, that active-passive thing. So there is a lot of talk about how the ‘average fund manager’ cannot beat the market – on the grounds that the average fund manager is the market and, when you take into account their charges, then they are going to underperform collectively by the amount of those charges are. Now, you will hear slightly different variations on that but that is the basic thrust of the passive argument.
I have got a lot of respect for investors, who just say, I have got enough time – I cannot be dealing with the trouble of picking a fund manager – so, fine, I will go with a passive. I have no issue with that whatsoever. The issue I do have is with what I called in a Citywire article that caused a bit of a storm – ‘passive zealots’. And they are the people who wallop you: if you do anything different to buying an index fund, they think you are a complete idiot – like you have not taken this ‘mathematical proof’ on board. But that is a lazy average because, when you look at what the average is, it is filled with flaws and exceptions.
For one thing, in the UK, for example, the data is quite often built on the UK All Companies sector. So you will have the funds in the UK All Companies sector and then that is turned back so that all of those fund managers basically make up the UK market – they are the investors. But again – a bit like the concreted-over bits in the UK – those fund managers only make up 2.5% of the market. So it is perfectly possible that the average manager within that small pool could beat the UK index over a particular time period – and sure enough, over the 10 years from 2010 to 2020, they did beat it by a long way.
Also, within that, when you look at the data, you find that some of the exceptions there – Warren Buffett is someone you mentioned, and yourselves within your value fund there – when you find these exceptions, those are the things you should be studying. They are quite often fantastic managers – like Warren Buffett, like Anthony Bolton, like some of the greats from the past. So that is where I learned my trade was not just looking at the average but looking at: who are the people who cheated this average? Who are the five out of 100 funds who have for 20 or 30 years just thrashed the benchmark? What is it they are doing? Can you find what it is they are doing? Can you learn from that? And can you find other people who are doing the same thing?
So my answer to the question of whether you can find good fund managers before they outperform is: find ones who have just done that. Find a fantastic fund manager, learn how they operate and then find someone else who is doing that, question them and, at the very least, make sure they are doing something that can be done over and over again and they are not doing something that is impossible to replicate.
So, yes, ‘lazy averages’ entirely annoy me. And they must annoy you guys as well, right? Because you are all judged by them – and, again, how long do you compare performance over? Is it one year? Is it five years? Is it 10 years? As value investors, you could look terrible over one year but still look great over 10 years? So the data, again, is so flawed.
AW: The key point there, I think, is to find something that is repeatable. That is what we try to do in our process. That is the key. If you can find something you can genuinely repeat over time, then that can get you on the right side of the possibilities over the long term.
SEC: Yes – and, ultimately, it still comes down to probabilities. There is no point in me investing with fund managers, who I think are trying to do something that is impossible. And, to me, ‘impossible’ is trying to predict where inflation is going to be in three years’ time, say, or where, because of that, interest rates – and they then base the entire fund on that one prediction. There you are predicting something that is impossible – so do not try and do impossible things.
What you guys do and what some growth investors do as well is possible. I think it is possible for talented, hard-working, experienced individuals to decide whether a company is good-value or not, or whether a company is going to keep growing – maybe not every single time but by enough that, if you buy 40 of these companies, then 30 of them will be good and 10 of them will not be good but, on balance, it will be enough to beat the market. So absolutely – keep doing repeatable stuff. Do not do impossible stuff.
AW: I am going to switch gears slightly. You wrote a wonderful blog called Solving Christmas: How to Make it Better Next Year. I must admit, I have encouraged everyone to read this before next Christmas because it is definitely going to improved mine! And it has also got me onto a book I am reading at the moment – but it would be great if you could introduce our listeners to the concept of ‘systems thinking’ and how it applies to decision-making.
SEC: For me, it is like that moment at the end of The Matrix, when Neo finally discovers how to think like the Matrix and he can almost see the source code of the whole thing. Systems thinking, for me, is almost being able to do that – seeing the ‘source code’ of life, just seeing how stuff works. And the reason that is so powerful is because it means you can take something from one domain and use that experience in another domain.
So, for example, gardening is so rich with amazing metaphors and potential for learning that you can use in investing. That is how I talk about how I am investing, when I am managing funds. A lot of people think investing is bit like being a fighter pilot – that it is about making sharp, jerky moves and being in complete control of everything. I think it is a lot more like gardening, however – it is about a very slow-moving portfolio and, if some bits are not working, you should replace those parts. Over time, though, it is going to move – there are cycles within that, you can see growth, you can see bits falling away, you can see some parts working, some not. Gardening is a perfect metaphor for that.
So systems thinking allows you to take all this stuff from one domain to another – but specifically, when I was talking about Christmas, Christmas is a system. This is what some people do not realise. You can tell if something is a complex system because it will have three common features – the first being the ‘elements’, the sort of things you quite often see. Within Christmas, that might be the people who are involved, the presents you are buying, the Christmas tree, the movies you are going to watch, the food you are going to eat – so all of these elements we associate with Christmas. And because those things are the most visual and the most obvious, those are what we tend to concentrate most of our time on.
But the second feature of a system is there are interrelationships between those elements. So your body is a system, right? And there is an interrelationship between your brain and your heart or between your stomach and your brain and they are sending messages to each other, back and forth, and they interreact. So that is just two parts of your body and there is a relationship between them.
With Christmas – I mean, you just take the nightmare of who do you invite? Which family members do you have over? Do you mix families or do you try and do it separately. Why that is complicated is, if you have just got two elements – let’s just say it is two people – then there is just one relationship between two people. Every time you add just one more person to that equation, however, the number of relationships grows exponentially.
That just suddenly makes it so much more complex – and that is before you consider each of those people’s relationship with the other elements. How do they get on with the food you are planning? Is there a vegan coming along, which means you cannot cook the turkey? Is there someone who cannot be put near alcohol because they do something crazy every time they get near the Cointreau? So there is so much more complexity. That is just interrelations and you can already how systems are so hard to predict, right? And a market is a system where you have millions of people interacting with each other. It is hard enough to understand a million people before you then try and work out how they are all interacting.
The third thing you have to consider about a system is it will have an objective. So you will be a system and you will have an objective. Your objectives as a human might be to make money, to be happy, to achieve a certain bucket list but one of the things that is always common is that system will want to survive – whether that is a human or a dog or a cat, naturally they want to survive. And the same holds true with an organisation. I love the story of the Bank of International Settlements, which is a system. That was founded in 1931, I think, and it is still going today. It is doing something different now to then so they find ways of surviving.
And Christmas has an objective too. Now, sometimes that objective drives you without your knowing it and sometimes you can drive the objective – but the advice I was giving is, always, with any system, to start out by defining the objective. I know we were talking about this before the podcast, Andy, but you have to think – what is it that you actually want from Christmas? And, if you do not think about that, you can end up with Christmas being your boss, basically.
So with Christmas, clearly you want it to be merry, right? But you have got to define the next level of elements that will make it merry for you. It might be that you want a break from work – if so, you need to make sure that is one of your aims. Or it might be that you want to make your kids happy – and, if so, you need to make that one of your aims. Or it might be that you want to have a wild time – and, if so, you need to make that one of your aims as well.
So they are quite hard to solve but, if you do not get all of these sub-objectives right, Christmas will not be merry. If you end up doing everything, for example, then you will not have a break and you are going to be worn out and you end up frazzled. So you then need to make sure you build in time where you go for a walk or you spend time reading a book or you watch a movie with the kids. And that ticks your ‘Have a break’ box or, to make the kids happy, you make sure you build in time to go and see Father Christmas or whatever it might be. You have to make sure that all of these things then feed up.
AW: Simon, this has been an absolutely fantastic conversation – we have thoroughly enjoyed it. Now, before we let you go, we ask all our guests two closing signature questions – the first of which is for a book recommendation for our listeners.
SEC: I am a fund-of-funds manager and, for funds of funds, the best book you can read is Team of Teams by Stanley McChrystal. This book goes back to about 2010 and it is about how McChrystal, who was a US Army general basically retooled the US military – from what was turning into an almost Soviet-style system where it was top-down command and control and you do as you’re told, you don’t interact and you don’t share information between teams.
Yet, during that time period, they were having rings run round them by the Taliban, who were operating in a much more fluid and complex way. By the time the US would turn up to try and raid a house where they thought a Taliban member was hiding, they would be long gone because they were well ahead of them. So McChrystal had to really change the military so that they started working in a much more fluid way. They started sharing information, the soldiers started respecting the analysts and the analysts started respecting the guys who were kitting everyone out. And he changed all that and the results were very good from doing that.
Now, why that appeals to me as a fund-of-funds manager is my ethos in running funds is that is what I am trying to do. I do not think that I personally, as an investor, have all the answers you need, which is why I love running funds of funds. I get to speak with experts like you and I get to invest with experts like you and I get to put you all together in this one fund. And so I have this hive-like brain operating where you are out picking stocks that are the best value stocks and I have someone else who is picking the best growth stocks and you are all very good at it and different things all work at different times.
For me, then, it is about standing back and respecting that and leaving you guys to do your job – just making sure you are all working as you should be. Whereas I think a lot of my peer group and my competitors tend to operate in a more Soviet-style model of working from the top down and trying to time value, time growth, get rid of the value manager, buy the growth manager and so on. I think that is a very dangerous and hard way to do things and that is why I love that book.
AW: That is a great recommendation – we’ll be sure to check it out and put a link in the show notes as well. Finally, could you give an example of a past decision you have made – investment, personal or otherwise – that had a poor outcome that was down to poor process rather than poor bad luck?
SEC: Yes, sure. You mentioned this one beforehand, so I have had time to think about it – and it is a really good question because no-one wants to admit mistakes they have made. But it was a mistake that I and the team I was with at the time made very publicly – so there is no hiding from it anyway. It was down to, I think, a flaw in our process and it speaks to what I was just talking about – how top-down investing is a very difficult and potentially dangerous way.
Investing from the bottom-up is, for me, the way forward because, back in 2007, I believe, our team decided to go heavily underweight US equities. Now, we did this for what we thought were the right reasons, which were that, when you looked at the valuation of the US equity market, it was horrendously expensive compared with Europe and the UK. So we were operating a value-based but still a top-down approach and we went underweight US equities. And we stayed underweight US equities, despite the fact US equities then outperformed from 2007, 2008, 2009, 2010, 2011, 2012 ...! In the end, we just carried on staying underweight US equities for about 15 years, I think, in a period when US equities just shot the lights out.
Now the mistake was, well, lazy averages for a start – because when you look at a market, you really have to take into account it is made up of different stocks. And there are big stocks within that and the US versus UK is obviously very pertinent at the moment – but we had an opportunity to correct that. Going back maybe to 2010 or 2011, I remember thinking, actually, in the last four years, the world has changed – because, don’t forget, the iPhone came out at that time and that was when we started to get comfortable with Google. It was clear these were going to be huge companies but we were still tied to the fact we had made this decision.
Emotionally speaking, we told everyone we thought US equities were too expensive but, actually, there was a genuine growth reason rather than the value reason why we should have done that – so we should have changed it at that point and then we had to wear 10 years of uncomfortable regional pain. Luckily for us, we did get the bottom-up right and we had amazing fund managers in Asia, Europe and the UK, who just did a fantastic job with alpha and beating their own markets that we were still able to beat the peer group and outperform. But that that is the learning for me – the process changes to completely forget about the top-down and just rely on you guys, basically, the fund managers, finding great stocks for us. Leaving you to it.
JTR: Simon, thank you very much for your time. This was fascinating. I think you should launch podcast!
SEC: One thing at a time, Juan!
JTR: Thank you.
Juan Torres Rodriguez
Fund Manager, Equity Value
I joined Schroders in January 2017 as a member of the Global Value Investment team and manage Emerging Market Value. 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.
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 and hold a Economics and Politics degree.
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, Tom Biddle and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
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