My beachside reading on the recent winter trip to Australia was the excellent “The Undoing Project” by Michael Lewis.
Obviously when it comes to Michael Lewis expectations are high, both for the quality of the writing and depth of the research behind it. This is no exception. Some of the specific elements are familiar but Lewis does great job of weaving the intellectual content of the Kahneman/Tversky collaboration into a compelling story about their lives and the contemporary history of the time. Which are plenty interesting in their own right. I’d say the only negative points would be an oddly-placed chapter at the start which rehashes many of the ideas from MoneyBall (it was interesting, just seemed oddly placed relative to the rest of the book) and the slight lack of compete chronological sense of order that comes with the style of hopping around and pursuing digressions. It probably makes the book more readable, to be honest, but I found myself having to go back and review sections to get the full Kahneman/Tversky timeline over the years straight in my mind.
Some of the key behavioural science insights of Kahneman and Tversky that Lewis covers and articulates so well include the following.
Kahneman and Tversky understood that the errors the mind made offered you at least a partial insight into the mechanism behind decision making. A bit like optical illusions offering an insight into the workings of vision.
“Features of similarity” Comparing two objects: the mind tends to make a list of features, count up and compare the features that two objects have in common, in particular one object with reference to the other. for example Tel Aviv is frequently thought to be like NYC but NYC is not thought to be like Tel Aviv. NYC has more noticeable features than Tel Aviv. An absence of a feature is also a feature. “Similarity increases with the addition of common features, or the absence of distinctive features.
Transitivity in decision making. transitivity violated if someone picks tea over coffee, coffee over hot chocolate and then turns around and picks hot chocolate over tea. The features of similarity model helps explain why people will violate transitivity in this way. The context in which a choice is presented affects the choice. When presented with a choice people aren’t assessing each object on a linear scale and evaluating relative to some representative model of ideality, they are essentially counting up features they notice. but the context in which a choice is presented can have a big effect on the features that are noticeable. for examples two Americans meeting in NY vs meeting in Togo. “The similarity of objects is modified by the way in which they are classified”.
First heuristic – representativeness. When people make judgements they compare whatever they are judging to some model in their minds. How closely do the approaching clouds represent my mental model of a storm? How closely does Jeremy Lin represent my model of an NBA basketball player? It’s why players with Man Boobs don’t get selected in the NBA. It’s not that the rule of thumb is always wrong – in many ways it can work quite well. But when it does go wrong it does so in systematic ways.
Second heuristuc – availability. the more easily you can recall a scenario to mind the more “available” it is, and the more probably we find it to be. For example words starting with K vs words with K as the third letter. Again can often work well. But not in situations where misleading examples come easily to mind.
People predict by making up stories
People predict very little and explain everything
People live under uncertainty whether they like it or not
People believe they can tell the future if they work hard enough
People accept any explanation as long as it fits the facts
The handwriting was on the wall, it was just the ink that was invisible.
Man is a deterministic device thrown into a probabilistic universe
Theory of regret – emotion linked to “coming close and failing”. it skewed decisions where people are faced between a sure thing and a gamble. regret is associated with acts that modify the status quo. The pain is greater when a bad decision led to a modification of the status quo vs one that led to a retention of the status quo. Regret is closely linked to responsibility – the more control you felt you had.
Anticipation of regret is actually as powerful as regret itself. We look at a decision and anticipate the regret we might feel. Often we do not experience actual regret as it is too difficult to be sure of the counterfactual.
This all contravened expected utility theory (which was a central part of some economic models of how individuals made decisions). Expected utility theory wasn’t just wrong, it couldn’t defend against contradictions. The Allais paradox was a good example that violated utility theory. it basically had two examples framed at different probability levels but with the same utility tradeoff underlying both of them, people chose differently depending on the framing of medium odds vs long odds.
A greater sensitivity to negative outcomes – a heightened sensitivity to pain was helpful for survival. A happy species endowed with infinite appreciation of pleasures and low sensitivity to pain would probably not survive the evolutionary battle.
Prospect theory – people approach risk very differently when it comes to losses rather than gains. risk seeking in the domain of losses and risk averse in the domain of gains. people respond to changes rather than absolute levels. but changes vs some reference point, some representation of the status quo. In experiments this is usually clearly definable, in the real world, not so much.
People also do not respond to probability in a straightforward manner. people will pay dearly for certainty. But they will treat a 90% probability as less likely than that (they do not treat a 90 chance as nine times more likely than a 10 chance). When it comes to small probabilities they do not treat a 4% chance as twice as likely than a 2% chance. if you tell someone one in a billion they treat it more like one in ten thousand – and worry too much about it (and pay more than they ought to rid themselves of that worry).
One consequence of prospect theory is that you should be able to alter the way people approach risk (risk seeking vs risk averse) by presenting problems framed in terms of losses rather than framed in terms of gains.
The endowment effect (Thaler) – people attach a strange amount of extra value to what they own (compared to what they don’t). they fail to make logical trades and switches.
The Undoing Project. The title itself refers to a theory similar to regret: counterfactual emotions, the feelings that spurred peoples’ minds to spin alternative realities. The intensity of emotions of “unrealized reality” were proportional to two things: the desirability of the alternative, and the possibility of the alternative.
Experiences that led to regret and frustration were not always easy to undo. Frustrated people needed to undo some feature of their environment, whereas regretful people needed to undo their own actions. but the basic rules of undoing are the same, they require a more or less plausible path to an alternative state. Imgination wasn’t a flight with limitless possibilities, rather it’s a tool for making sense of a world of unlimited possibilities by limiting them. The imagination obeyed ruled: the rules of undoing. The more items that were required to undo the less likely the mind would undo them. “the more consequences an event has the larger the change that is involved in eliminating the event.” also, an event becomes gradually less changeable the more it recedes in time.
I really enjoyed this fantastic article which featured in the March issue of Harvard Business Review, and explores the Deloitte Business Chemistry model in relation to trying to understand differing work styles and team dynamics. I’d definitely recommend reading the article in full if you haven’t already.
It got me wondering – how might these insights apply to pensions? After all, taking decisions, making progress and enacting change within a DB pension fund involves a huge team effort between trustees, corporate sponsor, in house pensions teams and advisors. In many cases there can be big differences in style and approach between these groups and even individuals within the same group. These differences could derail effective decision making, or they could enhance it.
What is the Deloitte Business Chemistry model?
The Model is based around identifying four different personality styles relevant to teamwork. The purpose of this isn’t to “pigeonhole” individuals but rather to identify a common language that helps everyone understand the differences between them, and appreciate the potential sources of tension (both positive and negative). It also gives some actionable takeaways that you can start thinking about straight away.
I’d encourage you to read the whole article but here is a summary of the four styles:
Pioneers value possibilities, and they spark energy and imagination on their teams. They believe risks are worth taking and that it’s fine to go with your gut. Their focus is big-picture. They’re drawn to bold new ideas and creative approaches.
Guardians value stability, and they bring order and rigor. They’re pragmatic, and they hesitate to embrace risk. Data and facts are baseline requirements for them, and details matter. Guardians think it makes sense to learn from the past.
Drivers value challenge and generate momentum. Getting results and winning count most. Drivers tend to view issues as black-and-white and tackle problems head on, armed with logic and data.
Integrators value connection and draw teams together. Relationships and responsibility to the group are paramount. Integrators tend to believe that most things are relative. They’re diplomatic and focused on gaining consensus.
Source: Harvard Business Review
The challenge in allowing these diverse styles to work together most effectively are the big differences in what energises and alienates each group. For example integrators dislike conflict, but drivers love a solid debate. Also the style in which each group prefers to think and contribute varies greatly: a guardian is likely to want to step through a plan line by line, for a pioneer this might feel quite painful. This has real consequences for situations where differing styles interact.
You’ve probably already recognised elements of your colleagues’ styles in the descriptions above, but what might this mean for running a pension fund?
It’s easy to see how these differing styles might be present around the meeting room of a typical DB pension fund trustee board. Starting with trustees themselves – the connotation of the word “trustee” in English is similar to “guardian” – even though the role of the modern day trustee is much wider than that – and many trustees approach their role with the mindset and style of a guardian (for all the right reasons). They want to see data and facts before taking any decisions that might expose their members to risk, they want to see rigour and convincing arguments in the choices being made in the management of the assets.
All makes total sense – we’re dealing with members’ future financial security here in many cases after all – however contrast this with (say) a “driver” in the chairman’s seat: someone brought in to get things moving, passionate about making progress, changing things for the better, making members better off. It becomes easy to see how these differing styles might cause tension.
Let’s add in the corporate sponsor angle – perhaps a pioneer in the CFO or CEO seat. A natural risk taker who doesn’t like to hear the word “no”, drawn to bold and innovative approaches and focused on the big picture. Sound familiar?
Where are the advisors in all of this?
The key advisors to the scheme (actuary, investment consultant, covenant advisor, lawyer) will also contribute to the team dynamic, perhaps significantly so, and might have a variety of styles – and this is one area actually where the model opens up some choice. The trustees can choose their advisors after all and if they are aware of the mix they naturally have around the table, then they might want to select their advisor to complement that. Perhaps an integrator to try and bring people together, or a driver to generate momentum alongside the chair. Perhaps it might even help to have different personalities in the advisors – a guardian to represent and appeal to the guardian types around the table alongside a driver.
Without wanting to generalise excessively, it’s my experience that actuarial-types are likely to often display guardian characteristics to some degree (having said that I do know plenty of pioneer and driver actuaries). In some ways this isn’t surprising: careful study, discipline and logic are what gets you through the exams (and probably attracts many people to the profession). Having guardians among your advisers may be good, but might not be the best choice if the trustee board is already guardian-heavy.
The picture is further complicated in those pension funds that might have significant internal teams involved in the management. Perhaps a bold portfolio manager with pioneering anti-consensus views. There might be an integrator in there, or more guardians.
So the model’s great, but what can we do with it? What actions can we take away in order to help our pensions teams work better together, harnessing the benefits of cognitive diversity rather than experiencing the tensions.
Well, firstly simply having a common language to understand the differing styles within teams I personally find hugely helpful. Being able to depersonalise by saying things like “look, the guardian in me is saying X”, or “the driver in the room would be saying Y” allows teams to lightheartedly explore the differences without things becoming personal or existential, and hopefully without battle lines being drawn.
But there is more than that.
Adjust your style
Once you are aware that you’re a guardian type, craving rigour and logic, working alongside a driver who is committed to progress and getting things done it becomes easier to recognise and adjust your style – perhaps that means going outside your comfort zone to try and get to a decision on a key issue with incomplete data, being happy working with a bit of ambiguity in an area that can’t be pinned down, or being open to new types of solution that don’t necessarily fit into existing modes of thinking. On the flip side the driver might need to be patient in systematically exploring the data behind the decision to appease the guardians, stepping through details like by line when their instinct is to get it done and move on.
Recognise minority styles
Making sure that minority groups are represented and have a voice is really important to be productive and is something that can be influenced – for example it’s possible to verbally acknowledge that a group is guardian-heavy and that they need to try and listen to – and be receptive to the perspective of – the drivers. Rather than playing “devil’s advocate” in challenging ideas, it may be more helpful to “play driver” or guardian. Especially if that isn’t your natural style.
Add to the team carefully
When there’s the opportunity or need to add to the team, the model gives a clear roadmap for exploring the fit between the needs of the team in terms of personality and potential candidates. In particular it highlights the need to bring integrators to the table, and potentially the need to bring more balance to the driver/guardian split.
Get close to your opposites
It’ll often be in one-on-one relationships where the real differences emerge and pain-points become apparent. Knowing how those styles opposite to you will react, what energises them, and how they prefer to work will be really helpful. It might involve getting out of your own comfort zone and adapting your style (as mentioned above), but it must just increase the chance of progress being made.
Beware of cascades
Teams with lopsided composition can be vulnerable to decision making biases such as cascades – where the views of those first to speak become echoed by others and grow into a crescendo until they go unchallenged. The key to addressing this is to consciously “elevate” the minority styles on the team – perhaps making sure they are first to speak when it comes to decision making.
These are just some quick thoughts on how this powerful model could apply to pensions. Do tweet me with your thoughts.
- Hack your own productivity, figure out what works for you
As “knowledge workers” we all carry out a wide variety of different cognitive tasks each day: some are repetitive, some are simple but require a high degree of accuracy, some are creative while others involve problem solving or co-ordination of others. Some involve significant willpower while others may not.
Finding individual ways to maximise our own productivity can be hugely helpful – I firmly believe that the productivity of knowledge workers can easily vary by a factor of 4 or 5 times depending on various factors and circumstances, and some of these are quite simple to understand and change.
Things like choosing which tasks to take on at different points in the day, selecting the appropriate space to work in (working from home being great for some tasks, bad for others), harnessing and using your willpower most effectively and balancing requirements to meet and consult with others with working individually. Creating focus on what’s important (rather than simply urgent), and avoiding cognitive switching.
I was influenced in a lot of this thinking by Charles Duhigg‘s excellent book Smarter, Faster better which I discussed in more detail here. Mitesh Sheth also wrote up this excellent list of productivity hacks, which I contributed to.
2. Approach the world as it is, not as you’d like it to be
2016 was a year of surprises and shocks at a macro political level. Some of the events that took place challenged the world views of people – including myself. The result of the EU referendum left many people – myself included- feeling more than a little frustrated and angry.
One positive I take from this is the opportunity it presents to acquire really valuable wisdom and experience – for those people open enough to be able to move past the frustration and approach the world as it is.
The reality is, disruptive events will create both opportunities and challenges. Spending time fighting the way the world is probably isn’t the best use of precious resources of mental energy and focus.
3. Understand the Building Blocks of Change
Changing habits at work is hard. Rolling out new systems and processes and changing old ones. It’s so vital to keep operating efficiently, but the extra burden to individuals of change in the short term will also be resisted.
This great blog by Mckinsey helped me greatly in my understanding of the 4 key requirements for workplace change:
- An understand of why change is necessary
- The capability to make the change
- The alignment of incentives and rewards
- Role modelling by senior and influential individuals
There is a lot of overlap here with takeaways of books such as Nudge and Inside the Nudge Unit. All fascinating and really powerful stuff if you can find ways to implement day to day. It feels like behavioural insights are rightly having more and more impact on policy & decisions across organisations as knowledge and appreciation of the field grows. Great to see this happening and I look forward to more insights in 2017.
4. Beware the Narrative Fallacy
The hearing and telling of stories is fundamental to who we are as humans. It’s hard-wired into us. It’s part of how we understand and make sense of an uncertain world. It was the way our ancient ancestors explained things to each other and kept children away from danger. We are fundamentally inclined to believe convincing stories.
But there’s a problem, far too often in today’s world stories are constructed that ascribe too great a role to intrinsic characteristics such as talent and too little to luck. Stories dwell on the one thing that worked, ignoring the many that didn’t. Stories can easily make us fall prey to the availability or representative bias, skewing our decision making systematically in unhelpful ways.
Making effective decisions therefore, involves getting beyond stories into data, asking the right questions, and seeking evidence (where it can be found). Testing theories, rejecting hypotheses, trying to assess against a counterfactual and learning as much from the trials that didn’t work as those that did.
2016 was the fifth year-end that I’ve been a part of the team at Redington. As we close one year and start a new one it’s a great opportunity to say thankyou to all my fantastic colleagues who genuinely keep life interesting and make it worth getting up for work each morning – which is what really matters, isn’t it? Here’s to a great 2017 and beyond.
As a big cycling fan I have read before about Dave Brailsford’s famous “marginal gains” approach, so I was looking forward to the evening. I found it very enjoyable, and felt he shared some really insightful points that have massive relevance in a lot of other facets of life. Including:
- Belief in the ability to achieve a goal has to come first. After that its about mapping the route in absolute detail, and making small steps that take you incrementally closer. (DB cited Jason Queally’s 1km time trial victory on the opening day of the Sydney 2000 olympics as the moment when Team GB cycling began to believe olympic golds were achievable, after decades of underperformance).
- Culture is more than words written on a wall, it has to run deep. If done properly, culture can be what helps resolve the argument between two mechanics at 11.30 the night before a race.
- Win first, then build a culture around it.
- Take the problem to the person – moaning to others in a team can be corrosive, be upfront.
- Success is based on building winning behaviours AND removing losing behaviours. The latter can actually be more important, as there can be a corrosively negative impact on a team of losing behaviours (vocal moaning etc).
- Successful teams don’t have to be harmonious, but its imperative to have complete alignment around the team goal.
Great insights that I believe can be applied to almost any collaborative situation in life
UK pension funds have been through a hell of a ride over the last 10 years, and more. changes in regulation, longevity, interest rates, equity markets and the changing fortunes of sponsoring companies have all contributed to making the UK pension industry a tricky place. But are the lessons learnt relevant to other investors, particularly Sovereign Wealth Funds in the current climate?
- Why having an over-arching objective helps set investment strategy
- Incorporate future expected cashflows (in & out) into investment decision making
- Risk managing a portfolio which experiences large outfows has unique challenges
- Tracking liquidity of the portfolio is a key metric
- Recognising the cashflow properties of assets is important
- Why having an over-arching objective helps set investment strategy
This is the first of our recently-published investment principles, so needless to say we think its pretty fundamental. If anything, it might sound obvious but all too frequently we hear of funds looking at exotic or niche investments or managers that may be interesting (and may be perfectly good investments) but are inconsistent with the objectives (either on grounds of return, risk, or liquidity). Simply testing each new idea, asset or manager against the test “does it move us closer to our objective” makes life massively easier (and can simplify governance), If each incremental decision aligns itself with the objectives then it makes it a very transparent decision making process.
Going further, an overarching objective allows for the setting of an investment policy framework – which is very powerful for effective decision making. There is a reason why professional scrabble players always arrange their letters in alphabetical order: because patterns emerge more easily when you look at things in a consistent way. Having an investment framework is exactly the same, specifically it has the following benefits:
- Avoids knee jerk decision making (which can be sub optimal) ;
- Avoids “flavour-of-the-month” decision making;
- Makes decisions more transparent and accountable.
2. Incorporating future expected cashflows in and out is essential to setting investment strategy
Pension funds are generally subject to significant inflows (sponsor contributions) and outflows (benefit payments) through their life cycle. A projection model that can succesfully take these into account, and allow for them to be varied or updated is essential to understand where the fund is “aiming” for. Without this, the fund may unnecessarily be taking too much investment risk, or conversely may be locking itself into failure to meet objectives. It also allows the ability to set more realistic goals, sometimes given cashflow constraints a certain funding goal may just not be really achievable given likely asset returns.
3. Risk managing a portfolio which experiences large outfows has unique challenges
At some point in their life cycle all defined-benefit pension funds will become net cashflow-negative. Many already have. This presents a challenging risk to deal with, that has become known in some quarters as “sequencing risk”. Put simply, the challenge here is that if the fund experiences a particularly negative investment return, followed by the need to make a large payment out, this can be very detrimental to ability to achieve its long-term return goals. The existence of this risk makes precise risk management all the more important. Risk measures like required-return-at-risk can really help.
4. Tracking liquidity of the portfolio is a key metric
Illiquid assets can be a fantastic investment, and it is often said that one advantage a pension fund has when investing is it’s long-term horizon which may enable it to commit capital over a long period of time, and earn a higher return. Some assets are very clearly illiquid (eg private equity), and some are very clearly liquid (government bonds or large-cap equity). However many assets and strategies now sit in a very wide spectrum of semi-liquidity. As a pension fund you want to know that when you need it the liquidity in your portfolio is there – and to ensure this it helps to dive a little deeper into the liquidity level of the components of the portfolio, categorizing a broad swathe of the portfolios as “alternatives” for example can be particularly unhelpful, as parts of this could be very liquid and parts illiquid. Much more helpful to categorize asset classes according to their liquidity, and track the overall liquidity layers in the portfolio as a key KPI.
5. Recognising the cashflow properties of assets is important
A second basis on which to categorize assets, that is more helpful than the standard equities/bonds/alternatives categorization is the extent to which the assets’ return is linked to a contractual payment stream or not. For example a bond provides contractual cashflows (absent default), whereas equities are principally dependent on changes in the market value for their return. Understanding the contractual cashflow properties also helps manage the liquidity of the portfolio correctly.
combining these last two points gives a 2×2 matrix, which we believe is a more helpful way of categorizing assets that conventional definitions. This was designed to reflect the characteristics (liquidity and cashflow) that matter most to pension funds, but this applies equally to many other investors who have requirements for liquidity and cashflow.