Investment Analysts, Sunk By Deepwater Horizon

Flawed Analysis

“BP has a systemic problem with its culture that runs deep.”

There are unlikely to be any readers of this article unaware of the disaster surrounding BP in 2010 when their Gulf of Mexico based oil drilling rig Deepwater Horizon lived up to its name in dramatic and tragic circumstances. Since then many people have pointed fingers and made accusations but the quote above, by Hersch Shefrin, comes from his book, Ending the Management Illusion, based on an analysis of the behavioral flaws apparent in BP’s management, and written two years before the disaster at the Macondo Prospect.

Yet while Shefrin was able to identify the potential problems at BP ahead of the game not only did this not alert investors to the dangers of investing in BP it also failed to jolt oil sector analysts into any kind of action at all. And, frankly, if analysts can’t tell the difference between an oil major taking excessive safety risks and one that isn’t, what the hell’s the point of them?

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HONTI #3: Don’t Fear Volatility

Rule #3: Don’t worry about short-term price trends, turn off the portfolio tracker.

Risk

"The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances"; Ben Graham, The Intelligent Investor

Imagine if you could pick up the paper every morning and riffle through the pages until you get to the property section where, half way down the third column, you could find the current price of your own home. Imagine further that this price was set by a bunch of people you’ve never met making apparently random bets based on a combination of intuition, centralised economic statistics, a bunch of robots programmed by people with the social skills of a twig and, a couple of times a year, the real price achieved by one of your neighbours actually selling.

Welcome to the world of asset price volatility.

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Plan To Invest As Shares Fall

When stock markets dive into a pit of despondency, the prices of shares fall fast, as they are treated less like claims on a business and more like lottery tickets. In investors’ heads, the little switch marked ‘Risk’ flicks over – and at such times, investors seem to forget company valuations to focus on anything from the oil price to politics.

When we’re worrying more more about how the Italian Prime Minister is going pay for his next bout of bunga bunga than whether Tesco can maintain its earnings record, there’s something seriously awry. Yet these are excellent times to be a contrarian investor.

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Dread Risk: Investing Outside the Goldfish Bowl

Goldfish Don't Have Defensive Moats

To argue that many investors and all markets are like goldfish, continually forgetting the recent past as soon as they swim around the corner of their cute seaweed festooned castle, is to do our piscine friends a disservice: goldfish have a memory span of up to three months. Investors sometimes struggle to be consistent for three hours consecutively.

It often seems like people have a switch in their heads marked “Risk”. While this is in the “OFF” position they’ll happily fill their boots with any old rubbish stock as long as enough other people are buying it. Yet as soon as life’s rich uncertainty rears its ugly head the switch gets set to “ON” and they head for cover behind the seaweed in the hope that their tiny castle can protect them. Memo to markets: risk is always with us, no matter how bad your memory – and castles in goldfish bowls don't have defensive moats.

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Triumph of the Pessimists

Bad Stuff Happens

Given that markets are pursuing their favourite pastime of bouncing up and down like a manic depressive doing the Hokie Cokie on a Space Hopper, investors might be forgiven for wondering what they should do next. Fortunately the world is full of people offering sage advice. Unfortunately none of it is very useful, at least where 20:20 foresight is concerned.

The underlying lesson is, perhaps, an odd one.  We should invert the normal mindset of the average investor, who's an inveterate, if rather foolish, optimist, and proceed on the basis that something is always about to go badly wrong.   After all, it nearly always is.

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The Proper Etiquette for Market Panics

Don’t Eat Soup With a Fish Knife

When we’re operating in situations we’re not entirely sure about we follow a simple rule of thumb: we copy what other people are doing. So if we’re attending a fancy dinner with a place setting of sporks and splayds we’ll probably do whatever the people next to us are doing, in an attempt to look as though we understand the proper etiquette.

Which works beautifully as long as someone knows what to do, but can be disastrous if no one has a clue. Which is all the explanation we need to understand why, currently, investors are trying to eat soup with a fish knife.

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HONTI #2: Hindsight’s Not So Wonderful

Rule #2: Don't forget the past, get yourself some feedback.

Feedback

"Those who cannot remember the past are doomed to repeat it"; George Santayana, The Life of Reason

The second most dangerous trap any investor can fall into is the “I knew it was going to happen” syndrome: the remarkable ability of people to decide that they can predict the future, but only after that future has already happened: an exercise in futility were it not so damaging to investment prospects. This isn’t just a problem for amateur investors either: studies of investment bankers, for instance, show that those bankers least affected get the best returns: and vice versa¹. Overcoming this wilful amnesia is critical to improving investment results.

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Jam Today – Tyranny Tomorrow?

Tyranny of Choice

One of the most famous experiments in social science published this century was on jam, or at least the impact of having more or less types of jam to choose from. This research, by Sheena Iyengar and Mark Lepper, in When Choice is Demotivating: Can One Desire Too Much of a Good Thing, suggested that consumers are often paralysed by choice.

By extrapolating from what was originally a pretty limited study researchers have created a whole new industry out of reducing the number of options for people to select from. Of course, that leads to the next tricky question – which is who decides what should be available, and to whom?

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