2 February, 2017
Alex Gavrish explains why best investments are just like good stories or movies: with three part structure, important turning points, intrigue, drama, and surprises
Over past few years we have witnessed tremendous growth of shareholder activism. US is a leader in this field. Not a day passes without reports in financial media about new activist investor campaigns or updates on companies in which activists already invested.
Everybody would probably agree that markets are efficient to a large degree. What is amazing is that despite all these efficiencies, a small pack of activist investors and hedge fund managers continue to come up with great investment ideas. How is it possible? Why these opportunities do not disappear?
I think that great investment managers are also good storytellers. Many investors believe that making good investments requires excellent skills in the analysis of financial accounting statements, building complex and detailed valuation models, forecasting future profitability of companies and otherwise analyzing numbers “to death”.
But according to one of the best investment managers of the 20th century, Peter Lynch of Fidelity Investment’s Magellan Fund – which achieved a 29% annual return over thirteen years period between 1977 and 1990, good investing is about something else:
“Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage”
Strictly analytical approach to investment management does not provide us tools for dealing with uncertainty. The closed and fixed form of analytics leaves no place for imagination. And without imagination, we are just not capable of fathoming uncertainty, fathoming the future.
Isaac Bashevis Singer, Nobel Prize laureate in literature said: “A story to me means a plot where there is some surprise. Because that is how life is – full of surprises”. The same holds true for investing, because companies, markets and economy by their very nature are social processes. And when there are humans involved, there will always be surprises.
In investing, you cannot escape them. They will arise either because your decision was made with incomplete information or just because that is how life and business are. Best financial minds put a lot of effort into solving this problem through strictly quantitative or analytical ways. Whole investment philosophies were developed as an outcome of addressing uncertainty issue.
Many successful investors enjoy the success because they were able to develop a methodology and otherwise deal with uncertainty. Howard Marks’ The Most Important Thing and Seth Klarmans’ Margin of Safety books are bestsellers, among other reasons, because they describe solutions to problems of risk and uncertainty.
Peter Lynch is not the only one who expressed the idea that investing is more art than science. What is this art then? What is meant by art in investing? It is possible to learn it? Can it be pursued by everyone or will always remain the privilege of a select few, like painting or music? After all, there is only one Claude Monet. Only one Vincent Van Gogh. Only one Pablo Picasso.
So far, similar dynamics could be noticed in investing. There is only one Warren Buffett. Only one George Soros. Only one Peter Lynch. Can famous investors’ skills be replicated or will this art of excellent investing forever remain a mystery?
In my book Story Investing I argue that best investments are just like good stories or movies: with three part structure, important turning points, intrigue, drama, and surprises. One of the highlights of the approach is the proposal to develop both a historical perspective as well as future narrative for the company and its share price. It is not only a question of providing verbal and common sense explanations of the numbers.
When activist investors communicate their investment thesis to general public, they often tell a story: about a struggling business, a corrupt CEO or management team, a restructuring process that failed or is not reflected in the share price yet, a strategy for improving business and a myriad other types of stories. Activists tell these stories with an intrigue, with drama, with conflict, with struggle, with emotions.
Jerome Bruner, a famous cognitive psychologist, explains that narrative mode of thinking leads to conclusions not about certain absolute truths, but about varying perspectives that can be constructed to make experience comprehensible. By telling stories, we formulate these different perspectives.
It is not a coincidence that most of famous investors are also good writers. A large crowd of investors eagerly anticipates and reads Warren Buffett’s annual letter to shareholders of Berkshire Hathaway. Activist investor Daniel Loeb is well known for his sharp letters to executives of companies who are subject to his activist campaigns. Howard Marks, founder of Oaktree Capital Management, writes regular memo notes to his firm clients and has published book The Most Important Thing which is based on these memos. Peter Cundill, Canadian value investor kept a writing journal during his entire investment management career. And the list can go on and on.
Pablo Picasso said that “Art is a lie that makes us realize truth”. Of course, one should not be carried away into total fantasy with this storytelling: the story should be combined with analytical thinking and should be supported by fundamental valuation. But it is the art of narrative thinking and story composition that will ultimately make a difference.