[ARCHIVES] Michael Mauboussin: Attributes of a Good Investment Process

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Michael Mauboussin is considered an expert in the field of behavioral finance and has some famous books on the topic including, Think Twice: Harnessing the Power of Counterintuition and More More Than You Know: Finding Financial Wisdom in Unconventional Places.

September 28, 2005 Michael Mauboussin: Attributes of a Good Investment Process; The Critical Role of Decision Making

Michael Mauboussin: The T Theory

  • The best in all probabilistic fields
    • Focus on process versus outcome
    • Always try to have the odds in their favor
    • Understand the role of time
  • The best have more in common with one another than they do with the average participant in their field

Michael Mauboussin: Process versus Outcome

  • In any probabilistic situation, you must develop a disciplined and economic process
  • You must recognize that even an excellent process will yield bad results some of the time
  • The investment community-largely reflecting incentives-now seems too focused on outcomes and not enough on process

Michael Mauboussin process vs outcome

Any time you make a bet with the best of it, where the odds are in your favor, you have earned something on that bet, whether you actually win or lose the bet. By the same token, when you make a bet with the worst of it, where the odds are not in your favor, you have lost something, whether you actually win or lose the bet.

David Sklansky, The Theory of Poker, 4th ed.

(Henderson, NV: Two Plus Two Publishing, 1999), 10.

Any individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.

Robert Rubin

Harvard Commencement Address, 2001

Michael Mauboussin: Odds In Your Favor

  • Asset prices reflect a set of expectations
  • Investors must understand those expectations
  • Expectations are analogous to the odds—and the goal of the process is finding mispricings
  • Perhaps the single greatest error in the investment business is a failure to distinguish between knowledge of a company’s fundamentals and the expectations implied by the price

The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory . . . This may sound elementary, and many players may think that they are following this principle, but few actually do. Under this mindset, everything but the odds fades from view. There is no such thing as “liking” a horse to win a race, only an attractive discrepancy between his chances and his price.

Steven Crist, “Crist on Value,” in Beyer, et al., Bet with the Best

(New York: Daily Racing Form Press, 2001), 64

I defined variant perception as holding a well-founded view that was meaningfully different from the market consensus . . . Understanding market expectation was at least as important as, and often different from, the fundamental knowledge.

Michael Steinhardt, No Bull: My Life in and Out of Markets

(New York: John Wiley & Sons, 2001), 129.

Michael Mauboussin: The Role of Time

  • Because investing is about probabilities, the short-term does not distinguish between good and poor processes
  • A quality process has a long-term focus
  • The investment community’s short-term focus is costly, and undermines a quality long-term process

Over a long season the luck evens out, and skill shines through. But in a series of three out of five, or even four out of seven, anything can happen. In a five-game series, the worst team in baseball will beat the best about 15 percent of the time. Baseball science may still give a team a slight edge, but that edge is overwhelmed by chance.

Michael Lewis, Moneyball: The Art of Winning an Unfair Game

(New York: W.W. Norton & Company, 2003), 274.

See full Power Point here.

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