Guy Spier: «Invert, always Invert»

A column by Guy Spier, Aquamarine Capital and Author of «The Education of a Value Investor», about his investment philosophy.

I did not invent that phrase. I first heard it from Charlie Munger, the brilliant and polymath Vice Chairman of Berkshire Hathaway (BRK.A 303000 -0.37%) who himself was quoting Carl Jacobi, a 19th Century German-Jewish mathematician and philosopher.

The way I apply this idea in investing is like this: Totally ignore the vagaries of the market.  Forget completely the raft of unanswerable questions about 2015 – the ones that the pundits will continue to drone on about endlessly: Will inflation kick in? Will the US$ be stronger or weaker? Will equities have a good year or a bad year?

Instead, I prefer to focus on myself. Starting of with the humble realization that in addition to being utterly unable to predict the future,  I am also stuck with an irrational brain that is unequal to the enormous task of untangling the complexities of the market.

I do not think that this my fault though. Each human brain operates on around 25 watts of power. That’s less than the lightbulb above my head, to to mention some of the super-computers around.  Our brains are simply not designed to make us good investors. Instead, they evolved over millions of years to make us good hunter-gatherers in the wild. By contrast, the financial markets are only around a few hundred years old. Hardly enough time for humans to adapt.

So instead of trying to predict where the good investments are going to be, I prefer to focus on my own habits. To uncover and to understand my own, all too human irrationalities and failings. My claim to you is that if I can become better than the other market participants at managing myself, then I will end up making better decisions and doing a little better. Over time, in spite of my irrationalities, this should result in market beating returns. Over the last 17 years, it has.

So far, so good. But what does this means for me in practical terms?

First, are some behavioral rules to reduce my capacity to act irrationally.  I do not participate in IPO’s or enter into any other situation where an investment is being sold to me. Because financial markets are populated by far to many brilliant salespeople who are quite capable of turning my brain to mush when it comes to dispassionate analysis.

And because of first conclusion bias – that I am most likely to believe the first thing that comes into my brain, I am very careful about sequencing what I read, making sure that I start with the least biased and most well researched materials. I will begin company reports and filings and may never even reach the brokers’ research reports – who often have an axe to grind.

And if I decide to act on an investment idea, I won’t trade when the market is open, because the market sends so many signals that are designed to mess with my brain and make me want to trade to frequently, generating unnecessary frictional costs.  Rather, by entering the trades after-hours, I will reduce reactive thinking and preserve my capacity clearly and deliberately before making a move.

These are behavioral rules, but I will also work on my day to day physical realities. This means having no investment analysts in house, and having two rooms in my office: one for busy work – with a computer and a telephone, and another designed just for thinking: a library, with no electronic equipment at all – just books, which is where I should seek to spend most of my time. Because the physical environment exerts a huge influence on the quality of our investment decisions.

Of course, the biggest change for me in this regard came when, five years ago, I left the crazy vortex of New York to create my own Omaha in Zurich. This town, like Omaha, has a unique combination of great infrastructure while also being calm and distraction – free.  An ideal environment for good decision making.

Now many other market participants will not do these things.  And some might even decry them as ludicrous. Do they guarantee market beating returns for 2015 and beyond? Of course not. But I am certain that they will meaningfully tilt the playing field in my direction, and make it just a little more likely that I will generate Alpha for my investors.

To apply Munger and Jacobi, the path to good results in 2015 is to invert the problem: Stop trying to do something about the irrationality of the market, and start doing more work on my own irrationality.