Uncertainty should be no barrier to intelligent decisions

Over the course of the last four months or so, here on The Value Perspective, we have run a series of podcasts on the subject of decision-making at times of uncertainty. With the exception of market strategist and author Michael Mauboussin – one of our favourite value thinkers and, frankly, too good an opportunity to miss on this topic – we set out to interview people who have nothing to do with finance in and of itself.

You can see below the links to our seven conversations with this diverse group – which includes explorers, members of the military, a space-tech entrepreneur and a film producer. Uniting all our guests is the need to face uncertainty as part of their day-to-day jobs or projects and it is fitting the line-up is completed by the person who set us thinking about compiling this series – author and retired US poker player, Annie Duke.

• Michael Mauboussin, market strategist and author
• Air Marshal Sir Graham Stacey, senior RAF officer
• Santiago Zapata, film producer
• Dr Nicola Wetherill and Sophie Montagne, ‘Ice Maiden’ Antarctic expedition members
• Captain Marshal Elliott, former army officer
• Sean Sutcliffe, CEO of Oxford Space Systems
• Annie Duke, author and retired poker player

We have written before about our conversations with Duke – on the subjects of probability and decision-making, base rates and countering ‘tilt’ and outcomes and timeframes. For a little variety therefore, we will highlights some thoughts Duke’s 2018 book Thinking in Bets: Making Smarter Decisions when You Don’t Have All the Facts inspired in another of our favourite investors, Oaktree Capital chairman Howard Marks.

Quality and outcome

In his January 2020 letter to Oaktree clients, You Bet!, Marks begins with the first thing he remembers learning at business school – the observation by C Jackson Grayson Jr in his book Decisions Under Uncertainty: Drilling Decisions by Oil and Gas Operators that “you cannot tell the quality of a decision from the outcome”.

Marks goes on to explain Grayson’s point that people make the best decisions they can on the basis of what they know – but the success of those decisions will be heavily influenced by any relevant information that may be missing and also by luck or randomness. “Because of these two factors, well-thought-out decisions may fail, and poor decisions may succeed,” he adds.

“While it might seem counterintuitive, the best decision-maker isn’t necessarily the person with the most successes, but rather the one with the best process and judgment. The two can be far from the same and, especially over a small number of trials, it can be impossible to know who’s who.” From there, Marks goes on to outline his fondness for games of chance, including backgammon, blackjack and poker.

Three dimensions

Looking to create an effective analogy between playing games and investing, he underlines the point that games vary in three “primary dimensions” – hidden information, luck and skill. Thus a good example of “no hidden information, no luck, skill” is chess; “no hidden information, luck, skill” is backgammon; “no hidden information, luck, no skill” is roulette; and “hidden information, luck, skill” is poker.”

From there, Marks makes a number of observations – the first being that, where no skill is involved, the outcome must depend entirely on luck. Even if skill is involved, however, luck can still play a role. Moreover, the presence of luck does not preclude a role for skill. “In fact,” Marks adds, “making intelligent decisions when future events are uncertain is one of the greatest forms of skill.”

That is the subject of both Grayson’s book, which kicked off Mark’s business school education, and Duke’s Thinking in Bets, which we have previously referenced, here on The Value Perspective, in articles such as Learning from the controversial 2015 Super Bowl and How to have no regrets as an investor. It also, of course, lies at the heart of our series of podcasts.

Identify superior propositions

As such, say Marks, of the four games mentioned above, active investing has most in common with poker – and he goes on to observe: “Success in gambling does not go to those who pick winners, but to those with the ability to identify superior propositions. The goal is to find situations where the odds are generous to one side or the other, whether favourite or underdog. In other words, a mispricing.”

To help illustrate two key conclusions, Marks looks back to a couple of episodes from the early part of his career – investors losing money in the late 1960s buying into the so-called ‘Nifty Fifty’, the very best stocks in the US; and his own experience running a high-yield bond fund a decade later and “making good money safely and steadily” out of “the worst public companies in America”.

“Success in investing does not come from buying good things but from buying things well – and it is essential to know the difference,” he emphasises before adding: “It is not a matter of what you buy but what you pay for it.” Or, as we ourselves have argued consistently over the last decade, here on The Value Perspective: “What you pay, not the growth you get, is the biggest driver of future returns.”

Author