By Alton Cogert | email@example.com
Not the problem of being mistaken for the more famous quarterback with Tom’s homophonic (sounds the same, but different meaning) last name.
Tom is President of Boston Patriots Insurance Company (BPIC).
He is trying to make sense of financial markets. With a combined ratio of close to 100, BPIC relies on investment income to provide sufficient income and a positive bottom line.
You know the story.
Low rates for longer, but maybe not for too much longer. Equity volatility that seems to come out of nowhere, or perhaps from a tweet. And, investment experts that are convinced they know more than Braidy about investments but, are likely overstating their expertise.
As a so-called investment ‘expert’, I can tell you the search for adequate expertise is an ongoing exercise for me, let alone Mr. Braidy. I am constantly reminded of my grandfather’s advice: “Never get a reputation of a wit, for someday you may only get a 50% rating!” Thus, ‘expert’ is a tag I try to avoid.
But Tom cannot avoid his problem. His company is small, so it cannot afford to employ an investment ‘expert.’ BPIC’s CFO is an expert…in accounting, actuarial and other related disciplines. He has worked hard to develop the best possible investment expertise for BPIC, but other responsibilities certainly get in the way.
So, I dedicate this blog entry to Braidy and all the other Toms at small and large insurers, as well as government risk pools, who may have a similar problem.
Let’s focus on a few (there are many more) of the cognitive biases that are hurting BPIC and, if not correctly dealt with, might get Mr. Braidy sacked. And, be careful, because more than one can occur simultaneously or serially. And, be even more careful, because many of these biases are hardwired into how we humans have evolved. Thus, it is very easy to ignore or not know they are occurring.
Let’s face it, incentives are a huge reason why certain activities get done in a certain way and others are virtually ignored. If BPIC employs an external investment manager, the incentive is based on keeping BPIC’s business. Does the manager gain by doing a world class job for BPIC? Unlikely, unless the management fee increases with better performance, and that sets up BPIC for a manager ready to take on as much risk as possible to get as much compensation as possible virtually all of the time.
Solution: Negotiate a fair management fee, set relevant benchmarks that set a high yet reasonable hurdle and watch the manager like a hawk.
Reluctance to Change Bias :
We tend not to desire change, as maintaining consistency is easier. Perhaps that reluctance is hurting BPIC in exploring new or better ways of looking at the investment process.
If someone does something good for us, we can feel obligated to return the favor.
Solution: Be careful what favors, gifts, ‘free’ analyses, etc, you receive from the investment expert and ask yourself if its value sets you up for this natural human tendency.
If others are doing something, that is something BPIC should seriously consider doing. This bias is incredibly strong and can produce lemming like results.
Solution: Independently think through the advantages and disadvantages of a given action or decision, as if nobody else had ever considered that action.
Pain Avoidance Denial:
We don’t face facts until they become bearable to us. I am reminded of bonds issued by some major banks and their performance during the beginning of the great financial recession of 2008-2009. As bonds of banks like Lehman Brothers and Washington Mutual began trading at unheard of levels for an ‘investment grade’ credit, many insurers heard their managers say, ‘it is not a liquidity problem, so the bank is OK’.
Alas, there were more to these banks than the problems faced by the Bailey Building and Loan. It was all about capital and denying this fact only increased realized investment losses.
Solution: The phrase ‘let’s face facts’ come to mind. Only a disciplined approach can assist in these instances. For example, for a given security you might ask yourself if it would be added to the portfolio today.
Excessive Self-Regard Bias:
Everybody thinks of themselves as above average, but that, of course, is mathematically impossible. We are likely above average in some areas and below average in others.
Solution: The phrase ‘know thyself’ comes to mind. Realize you cannot know everything and that when you are confident of an answer you just might be wrong.
When we think everything will work out well, it means we aren’t properly considering all reasonably possible results. Expecting too much from your investment portfolio without considering downside risk is one way to look at this.
Solution: Consider upside and downside of your decisions about and within the investment process. For a given portfolio, it is vital to consider the upside, downside and everything in between.
When you acquiesce to the expert in the room, as they seem to be the authority.
Solution: Question, question, question and remember that there are no ‘stupid’ questions. Consider the ‘five whys’ technique to get to the bottom of the authority’s reasoning. Remember, you don’t have to be an expert to communicate your concerns and questions successfully.
You just have to know some basic information about the topic and be able to ask the ‘expert’ to explain in clear, understandable language. Just remember what Denzel said in the movie ‘Philadelphia.’
And, these are just of a few of these biases. A good offensive line will not help Tom Braidy improve his investment process and produce consistently strong financial results. But, acknowledging these, and other cognitive biases, in real-time will be essential.
Like Mr. Braidy, is it time for you to work on your game plan for investments?