waypoints 161 + 163 - biases duology

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Eliminating Investor Biases

Waypoints Release 161 and 163October / November 2012

In this Way po int – original ly issue d in tw o p arts, we g rap p le with six c om m on inv estor b iases:

Availability Bias: Giving higher priority to ideas we think of at all or think of first.

Substituting Questions: When faced with a difficult question, we instead find a related but simplerquestion that we can answer, but does not address the real, difficult question.

Affective Error: Emotional caring that can lead to delusion and falling victim to herd mentality.

Representativeness Error: Mistakenly applying patterns.

Search Satisfaction: The tendency to stop searching once one big discovery is made.

Commission Bias: A tendency toward action rather than inaction.

Brynne Thompson, CFA

[email protected]

Pip [email protected]

David Bujnowsk

[email protected]

Dan Sigler

[email protected]

Artist: Eric Hopkins, Waypoin



Waypoints 161.0Release 161 + 163 October / November 2012

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Version 161.0 2012 copyright Coburn Ventures. www.coburnventures.com

What exactly is Coburn Ventures?What we really do for a living is to understand as much about “change” as we are able. We combine

anything we have learned about change over the past 12+ years with our domain expertise in globa

technology, telecom and media markets as the foundation of all we do. We specifically look fo

monumen ta l change and see it happening continually in the world – though the assumption we see

humans – and investors as a subset of humans – living with is generally that incremental change is the

type of change that usually occurs when change occurs at all.

Our investment philosophy is as follows: look for positive and negative monumental changes around

which we are able to develop high conviction. The underlying presumption is as follows: When a

‘change’ event occurs, the inherent value of an enterprise may immediately change as well – though i

is hard to get ones arms around or calculate just how much. The investment community, however, may

require a period of years to truly comprehend – and correctly value – the shift that has occurred as a

result of the change event.

If we are able to generate high conviction and clarity about specific changes we will be able to invest

now and be rewarded as the broad investment community comes to appreciate and adjust to the

new inherent value of the enterprise over time.

As a compass for our activity, we developed a methodology called The C ha ng e Func t ion . The Cha nge

Function is a framework for determining whether or not a change will ac tually occur: Will a new produc

or technology get adopted? Will there be new ideas about how to use technology? Will a proposed

industry restructuring be successful? And so on.

The C ha ng e Func t ion simply says that a ‘change’ really equates to a ‘change of habits’. We believe

the change of habits is extremely difficult. Habits are only changed when the immediate level of “crisis”– on a scale ranging from total indifference to flat-out crisis – outweighs the total perceived pain of

adopting a potential new habit that promises a solution to the “crisis”. This is a fanc y way of saying tha

the condition for change is that it becomes more painful not to change than the perceived pain in

changing.

So what we do is study change and apply both what we know and our own mental models to deciphe

the likely direction of the global technology, telecom and media markets.

None of all of that is a business but rather hopefully a foundation for business opportunities.

Coburn Ventures is named “Ventures” as a reference to multiple ac tivities as opposed to indicating we

are in the venture capital industry. We intend to pursue a series of advisory opportunities ac ross time a

aimed at helping provide increased clarity and conviction for our clients as they go about making

dec isions in the markets in which we specialize. Waypoints is intended as one of those services.

Waypo in ts will include applications of our philosophy as building blocks for our bottom up analysis of

companies and stocks. If you are a current subscriber, thank you for joining us on the journey and if you

are contemplating joining we would love to have you along as we go.




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SIX INVESTOR BIASES TO VANQUISH!The s ign i fic an t prob lem s we fac e c anno t be so lved at the sam e leve l o f th ink ing w e w ere at

when we c rea ted them…”

-A lbe rt Einstein

This may sound odd but…

One of my favorite things about being an investor is how difficult it can be!

There is never really a clear cut “answer”.

There isn’t a way to know I’m going to “win”.

It’s pretty objectively clear when I’m possibly “wrong”.

It’s a very, very human undertaking.

With human limitations.

And human mistakes.

But, bec ause of all that, there is always a chance to improve, to see something just slightly more

clearly, and to test out new thinking another day.

That’s what this Waypoints series is about:

Putt ing al l the hum an l im i tat ion a nd m istake s

in our investme nt proce ss und er the m icrosc op e

to see w hat we see .

We’ll do it by looking at common investor biases…human cognitive errors…which, if we fall victim to,

can lead to a repeat cycle of poor dec ision making, limited thinking, and wasted time,

but if we can start to be aware of, to handle, and manage, will lead to less tracking error, more insight,

and deeper conviction.

Much has been superbly written about investor biases and decision-making biases with a seemingly

implicit idea that they are easy to overcome, but there is little or no prac tical action to employ to work

on vanquishing these biases from my life!

The who le po int of th is piec e

is to share ide as and tac t ic s for eliminat ing investor de c ision-m ak ing b iases.

We’ll cover six biases in all, in two Waypoints pieces.




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Our methods may not match up 100% with what will work with you and your own investment process,

but I hope these ideas can apply to some degree for any investor aiming to improve results from

decision-making, and at a minimum serve to inspire ideas specific to your team, your process and your

culture.

With that, here are three biases that we’ve been exploring, and a few of the tactics that we have either

folded into the fabric of our process or that we are experimenting with or recently brainstormed. For

more of our thoughts on our method we will happily send our 70-page piece on our investment

philosophy and process.

I hope this helps spark some thinking for your own work.

…brynne

“When yo u im prove a l it tle eac h da y, eventua l ly big th ings

occu r…

Not tomo rrow, not the next da y, bu t eventua l ly a b ig

ga in is m ad e.

Don’ t loo k for the big, quic k imp rove m ent. See k

the sm al l im provem ent one da y at a t im e.

Tha t’s the o nly w a y it

ha p pe ns – an d wh en it ha p pe ns, it lasts…”

… John Woode n




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BIAS #1: AVAILABILITY BIASWhat is availability bias?

The availability bias prioritizes ideas and examples that come to mind first and gives

those ideas and examples a higher probability of occuring or being right. Availability

bias includes recency bias, which is the simpler idea that ideas thought of mostrecently carry the highest priority.

Your mind says: if I can even THINK of it, it must be likely, or at least important!

Example:

I no t ic e I ma y have “h igher co nv ic t ion” in a c om pa ny be c ause I just d id a round of work on tha t

c om pa ny or I sim p ly spe nt m ore tim e wi th tha t ma nag em ent team or work ing on tha t com pa ny.

It “fi lls” m ore o f m y bra in!

“While o ur thinking c olors a ll ou r exp erien c e, m ore often than no t our thoug hts tend to be less than

co mp le te ly ac c u ra te . Usua lly the y a re m erely uninform ed p riva te op in ions, rea c t ions and p rejudice s

ba sed on l im ited knowledg e and in f luenc ed pr im ar ily b y our pa st c ond it ion ing .

Al l the sam e, when no t rec og n ized as such and nam ed , our th ink ing c an prevent us from see ing c learl y

in the p resent m om ent . We g et c aug ht up in a th inking w e know w hat w e a re see ing a nd fee ling , and in

p ro jec t ing our jud gm ents our onto eve ryth ing w e see off a ha irline trig ge r. Just b eing fam ilia r wi th th is

de ep ly en t renc hed pa t te rn and wa tch ing i t as it hap pe ns ca n lea d to g rea te r non -judg me n ta l

rec ep t iv it y and a cc ep tanc e…”

Jon Kab a t-Zinn

THE PROBLEM AVAILABILITY BIAS PRESENTS:

DISTORTION OF CONVICTION LEVEL




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What tactics might help offset Availability Bias?

#1: USE DATA TO JOG THINKING ABOUT ALL COMPANIES IN THEPORTFOLIO

When it comes to portfolio management, we put controls in plac e aimed to jog our memory for EAC H

company in the portfolio and each candidate in the portfolio, instead of relying on what thoughts

happen to be coming up for us individually or which events happened recently.

In other words, we re-contextualize information into our wide pool of data before taking any action.

To incorporate this portfolio management tool with the whole team of analysts, we use an “integrated

decision engine” that reminds us of changes in estimates, our base conviction level, share price

movements and expected range of outcomes, as a few examples. As a team we review this sheet of

data together, and it helps neutralize c oming to a meeting with an idea that I’m particularly jazzed

about one day without looking at it in CONTEXT with our entire portfolio.

Pip’s Ad d :

A co mm en t ab ou t teamw ork :

We c onside r invest ing the u l t im ate tea m a c t iv ity be c ause a w el l-func t ioned , supe rb ly co mm unic a t ing

tea m c om m it ted to e xc e l lenc e a s a group wi ll a c t in a w ay to ha lf mo st eve ry b ias. Tea m m em be rs –

im p ly ing t rust – w ill loo k out for one a not her who m igh t b e o n the v erge of a c t ing b a sed on a b ia s.

#2: INTENTIONALLY CHOOSE MY INPUTS: AWARENESS OF WHAT I

“LEARN” THROUGH OSMOSIS

What “air” am I b rea th ing ?

When I first joined Coburn Ventures 6+ years ago, one of Pip’s first direc tives was to stop watching any

CNBC. This was not a wholesale rejection of CNBC, but it was a rejection of what he thought CNBC

would bring into our culture that didn’t fit at all with our spec ific investment process.

In other words, if CNBC was in my “air”, and I was so used to it because I was coming from a big sell-side

firm that blasted CNBC 24/7 on the trading floor, it was important that we remove that input from my

“air” and intentionally choose new inputs that better matched our process.




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Over the years I’ve noticed that there is much more to go on just becoming aware of what my inputs

are:

If I’m in an airport I inevitably succomb to watching headlines scrolling on omnipresent TV monitors…,

and wait, wasn’t I rattling off some thinking about the possibility for a double-dip recession the other

day? And wait, was the source of that thought really just a 20 character rolling headline from an airport

CNN monitor? Oh my….

I call this one HEADLINE OSMOSIS. It happens for me with web browsing, when pulling up a web

homepage, or scanning Facebook…all of these are inputs in my “air”.

So it’s helpful for me to continually ask myself throughout the day while reading, researching, web

searching:

Does th is input m a ke the g ra d e? Is i t wh a t I wa nt in m y b ra in?

Doe s it sup p o rt the inve stm ent proc e ss I b e l ie ve in?

Does th is input lea d m e into b iased th ink ing , or help m e a vo id i t?

Exa m p le : ANC HORING a nd ENTRY PO INT DATA

Wha t DATA d o yo u c hoo se to exam ine e very d a y or every we ek for your por t fo l io?

We b e l ieve the d ata w e ta ke in WILL af fec t w h ic h b ia ses w e fa l l in to .

M INI-TACTIC:

We w a nt to inc lud e d a ta tha t wi ll keep us a s far a w a y f rom ANCHORING a s p o ssible, so w e

d on ’ t inc lud e en try p ric e p oints ANYWHERE on the inve stm en t she ets our group rev iew s

weekly .

Anc hor ing is a sec ond c ousin to a va ila b ilit y b ias, in w h ic h the d a ta a b out w ha t our ent ry p o in t

wa s c ou ld g i ve tha t p iece o f d a ta h ighe r w e igh t in ou r dec ision -ma k ing tha n w e w an t .

Pip’s Ad d :

We ha ve long c onside red da ta on e nt ry po in ts inc red ib ly eg o-ce n t ric in tha t the m a rke t do esn ’ t c are

one iota a b out O UR entry po int or whe the r w e ha ve p a p er ga ins or losses. So w e w on’ t trac k it ! The b est

w ay to a vo id one ’s p ap er pro f it or loss f rom im p ac t ing a c t ion is to fo rge t w hether you have a pa pe r

g a in o r loss to b e g in w ith!

Next, after identifying and cleaning out what’s in your “air”, there is the FUN part of choosing what type

of air you want to be in!




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Looking at all the sources of information we have today and saying “WHAT MAKES THE GRADE?” What

of this plentitude of information do I ac tually WANT in my head? Which newspapers, blogs, writers, TV

shows, books, investors and thinkers do I think are GOOD ENOUGH to LET IN?

THE GOAL: KEEP OUT NOISE, LET IN SIGNAL!

This way I am cultivating my own curriculum as best as I am able and with as much awareness and

insight as I can muster…so that I am actively evaluating what I’m spending my time reading or who I’m

talking to, which trips to make, which gatherings to go to, based on this constant question:

Does th is input ma ke the grad e? Wil l i t exp and m y thinking? Wil l i t ke ep m e from fal ling into c om m on

biases?

Recognizing that I WILL experience availability bias, am I at least

filling my brain with inputs that will help me?

Do m y inp uts he lp m e ide nt ify SIGNA L from no ise?

We consider that our job is to effectively and efficiently detect the relatively small amount of signal th

exists inside the tremendous pool of data which for our purposes is largely noise. If we are unintention

about our inputs, and unaware of what we are recklessly letting into our brain through osmosis, th

Availability Bias is more and more likely to seep into our investment work, increasing the tracking erbetween our business thesis and “reality”.




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But, if after a few days of looking around and thinking about what might be in my air, and then thinking

about what noise I want to vanquish from my air, and what signal I want IN my air, I experience

increased peace of mind and clearer thinking about my investments!

I love this type of projec t, as it helps me consider that I am not victim to my environment (not

completely, I surely do realize that my brain is not capable of filtering out “noise” as strongly as I wish!),

and that I’m less likely to fall into a herd mentality from headline osmosis, and that I’m on a path to

wisdom instead of squelching my learning and limiting my growth by actively CHOOSING my inputs.

#3: ASK QUESTIONS IN MY INVESTMENT PROCESS TO DEVELOP

AWARENESS OF AVAILABILITY BIAS:

What ideas and concepts and stories are coming to the forefront of my mind, simplybecause it is what I am exposing myself to, or what my life experience has been?

Example:

I c ould th ink m ost suc c essfu l tec hno log y c om p a nies a re b a sed in Silic on Va lley, be c a use I have m a ny

expe rienc es of a na lyzing suc c essfu l Silic on Va lley-ba sed tec hno log y c om p a nies.

It m ay be som eth ing tha t sim p le .

Am I coming up with in an investment thesis that is too heavily weighted toward MYexperience rather than what might be closer to reality?




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Example:

I live in Manhattan. Almost everything I consume is either delivered to my doorstep or available to me

within a three block radius.

This is no t a “no rma l” c on sum er expe rien c e! Not a t a ll!

If I walk around thinking my experience and my life represent the norm, my conviction will be skewed

toward companies and investments that relate to my life experience but may not reflect the reality of

consumption for most of the world.

Pip’s Ad d :

There is noth ing a t a ll w rong in sta rt ing w ith a n id ea tha t or ig ina ted from m y ow n exp er ienc e so long a s

there a re e noug h fo llow on step s of resea rc h tha t c om ba t a ny suc h b ias th roug h a de f ined proc ess.

In our c a se w e a l low nea rly a nyth ing in to the top of o ur investm ent funne l know ing tha t a ny id ea m ust

g o th roug h a t lea st eight round s of suc c essfu l inve st ig at ion b efo re a c tua lly g ett ing in the p ort fo lio…

plen ty o f opp or tun ity to co m ba t mo st any b ia s.

BIAS #2:

SUBSTITUTING QUESTIONSWhat is Substituting Questions?

Substituting Questions is a heuristics (shortcut) or bias that Dan Kahneman lays out in Thinking, Fast &

Slow. He calls it Substituting Questions and it involves our tendency to devolve and create a simpler

question to answer when the *real* question is too challenging.

Dan Kahneman c laims we do it all the time and don’t even realize we’re doing it:

“ I propo se a sim p le a c c oun t o f how w e g enera te intu it ive o p in ions on c om plex

m a tters. I f a sa t isfac tory a nswe r to a ha rd q ue st ion is no t foun d q uick ly , System 1 (his

n ic kna m e to d esc ribe a pa rt of our m ind ’s th ink ing) w i ll find a re la ted que st ion that is

e a sier and w ill a nswer it.”

What’s an example?

Here’s how Kahneman describes it:




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“The ta rge t que stion is the a ssessm ent y ou intend to p rod uc e. The he uristic q ue stion is the sim ple r

que st ion that yo u a nswe r instead .

Here are some examples:

Ta rget q uestion : How hap py are you wi th your life these da ys?

To a nsw er th is q uest ion, I wo uld w a nt to exp lore m a ny ve ry d ee p q uest ions and issues in m y l ife : w ha t is

the q ua lity of m y relat ionship s? Am I d evo ted to m y w ork? Wha t is the sta te o f my p hysic a l hea lth? Do I

trea t o thers w el l? These a re a ll big q uest ions tha t p rov id e a n inp ut to a nsw er ing the rea l ta rge t q uest ion

a roun d ha p p iness. But e a c h q uest ion is d if f ic u lt to a nsw er wi thout rea l exam ina t ion . What ’ s a n e a sier

w ay to byp ass go ing through the em ot ions tha t suc h a n invest iga t ion c ou ld b ring up ? Create a sim p le

q uest ion tha t o nly requ ires a sim p le, surfac e a nsw er. Suc h a q uest ion m ig ht b e:

Heuristic qu estion: What is m y mo od righ t no w ?

Ta rget q uestion : This w om a n is runn ing for the p rim a ry. How fa r will she g o in p ol it ics?

I c ou ld e xp lo re her v iew s, her bac kground , ask ab out he r to o thers who have exper ienc e wo rk ing wi th

her. All w hic h w ould req uire som e t ime , som e w ork and som e thinking . Instea d , I c ould sa y:

Heuristic q uestion : Do es th is w om a n “look” like a p ol it ic a l winner? …

(Ma ny sug g est this is m ost vo te s ONLY b a sis for de c ision -ma king on p ol it ica l c a nd id a te s!)

… the m enta l shotg un m a kes it ea sy to g ene rate q uic k answ ers to d if f ic u lt q uest ions w itho ut

im p osing m uc h ha rd w ork on yo ur la zy System 2”

Now, let’s transfer this over to investing:

Target question:Should I buy shares of Apple?

Ca n q uic kly turn into: w ha t d a ta c a n te l l m e ho w A p p le ’ s b usiness is p erform ing rig ht now or in the ne xt

th ree m onths so I d on ’ t have to und erstand m ore ab out the c om pe t it ive env i ronm ent or ha ve a v iew

on ho w users th ink o f Ap p le ’s p rod uc ts or wha t a b i lity ma nag em ent ha s to ha nd le the b ig soc ie ta l

c ha ng es c om ing th ei r w a y, or in othe r w ords:

Heuristic question: Will Apple make the next quarter?

Here are a few more examples:

Target question: Does this company have a NODE #3 sustainable competitive advantage?

Heuristic question: What is this company’s market share?

Target question: Will Microsoft succeed with the Surface Tablet?




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Heuristic question: How do its specs line up c ompared to the iPad?

THE PROBLEM SUBSTITUTING QUESTION PRESENTS:

STUCK IN SMALL AND LIMITED THINKING!

IF the REAL question can’t be answered, or at least, I can’t answer it, that is OK! All it means is my

conviction is going to be lower and THAT it is important to know and not be delusional about!

What tactics might help offset Substituting Questions?

#1: DEVELOP “UNKNOWABLE” BURNING QUESTIONS This tactic is about keeping our minds open and our questions big, AND to bec ome comfortable in

it being OK that we don’t know everything, that we’re human, and complex questions ARE difficult to

process cleanly!

The more comfortable we can become sitting in this uncertainty, the less likely are minds are to

push down into small and limited thinking.

Here’s one tactic I consider is helping us move along this path: “unknowable” burning questions:

We generate a “pre-determined game plan” well before taking a position that includes the

following:

-A stated business thesis

-3-5 Statements suggesting where we think the thesis will be WRONG after the fact

-3-5 “Burning” Questions core to affecting our conviction in the thesis

-Relevant operating model metrics

-A 1 year share price chart

The portion of this tool that I think is most helpful to Substituting Questions is our “Burning Questions”.

At the surface, they may look like “typical” maintenance-research questions, and some of them are.

But we have a core philosophy to generating these questions that is reflected in probably 50% of

them: the questions may well be completely UNKNOWABLE. Even if we allocated the next year to

“answering” these questions, we would not get there.

Here are a few examples:

ARM:

Wha t w ill ARM d o w ith its e xc e ssive b usiness suc c e ss?

Ba ng & Olufsen:

Wha t w a s it tha t c onv inc ed Ap p le to sel l B&O p rod uc ts? How susta ina b le is the relat ionship ?




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Goog le :

Is Go og le ma ngem en t a c tua lly be c om ing m ore e f fec t ive?

MOBILE + DISPLAY: Wha t a re t hese tw o seg m ents co ntrib ut ing to Go og le ’ s ove ra ll grow th? Wha t

tren d - line d oe s th is lea ve c ore d esktop sea rc h on ?

WW. Grainge r:

How ofte n d o o rd ers g o unf i lled w hen a c lient shop s a t a m om & p op ? Do G ra ing er ’s 350k SKUs

rea lly m ake a d i ffe renc e?

Me rc ad o Lib re :

CO MPETITIVE ADVANTAG E: Why e xac t ly d o users c hoo se to p urc ha se som ething on M erca d o’ s

p la t fo rm ra the r than a c om p et ing o ne? Mo re inventory … bet te r pr ic es … bet te r user expe rienc e?

So wh y ha ve “Unkno wa ble” Burning Que st ions?

Two reasons:

1) If we limited ourselves to Burning Questions that we THOUGHT we “COULD” answer, we would

only think of simple, likely mediocre, likely completely unhelpful and unfurthering questions!!

Instead, we want to pinpoint what the key question is, no matter if it is unknowable or not! We

do NOT wish to squelch our thinking, but to expand our thinking about what might truly matter.

2) Second, and maybe even more important, is:

Questions tha t we “th ink” m ay be “unknow ab le” toda y m ay not be in the nea r fu tu re !

We have SO much more access to data and information of a ll sorts today. If we don’t train

ourselves to think of big questions, we won’t see the big ANSWERS in the data and information

staring us in the face.

By allowing and encouraging unknowable burning questions, we are attempting to develop more and

more patience resting with and grappling with the uncertainty that is inherent in investing, for not

having immediate answers, for understanding that there is tremendous learning in coming up with the

question in the first place. This requires some patience in our culture, and apprec iation for learning and

studying without having to SHRINK limited thinking down to c reate a sub-par “answer”…. I consider that

sub-par answers can be as damaging as WRONG answers.

Pip ’s Sto ry:

One d a y a b o ut six yea rs a g o I w a s runn ing on the street s of Plea sa ntvi lle, NY. As I w a s just p a ssing the

intersec t ion o f Bed ford Roa d a nd Whee ler Ave nue it struc k me like lig htn ing . I rea lized tha t I ha d a a

de ep ha b i t o f c ond it ion ing m y q uest ion ing to que st ions tha t I thoug ht I c ou ld g et a nswe rs to a s

op po sed to the que st ions tha t m at te red m ost ! I grew exc i ted a s I rea lized it w ou ld b e no w

ove rcomab le .




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#2: REMIND OURSELVES THAT A THESIS IS NOT REALITYA business thesis is really just an idea or thought that exists in one’s head. It is an abstraction! It is a

HYPOTHESIS only. It is not reality.

So we aim to remind ourselves that a thesis is not rea lity: it is just our best effort at coming up with our

model that is as close to rea lity as possible, is a tac tic for RESTING in the unknowable.

The idea here as it relates to combatting Substituting Questions is simply that the more we can rest in this

thought that we do not and cannot KNOW reality, the less resistance we are going to have to handling

very difficult questions to which we do not have an immediate answer. Any defensiveness I have about

my thesis can be tossed aside if I admit to or recognize that my thesis is inadequate by its very nature.

We think that oftentimes folks get confused that the thoughts in their head ARE reality as opposed to a

**thought about** reality! When you hear someone say "what is really going on is..." it is often times to

look out! We develop thoughts that are skinnied down version that we hope explain reality in a useful

way but our mental models will never be the same as rea lity!

They are nonetheless potentially very useful so long as we are aware of the tracking error between the

thought and reality. We find that realizing this difference can help generate humility immediately.

From that point we c an b e free to rec og nize our me ntal mo de l (e.g. Investm ent thesis) ca n be a lway s

imp roved up on .

So each day that is our task: generate a better investment thesis that has less tracking error with the real

world.

Pip’s Ad d :

By bu ild ing in the expe c ta t ion o f “im p rov em ent” into o ur p roc ess w el l b eyo nd ta king a p osit ion ( in fac t ,

expe c t ing “ im provem ent” fo rever) , we a re a c c ep t ing a nd revea ling the inad eq uac y of our th ink ing

system a tica lly!

“We ll, you c a n’ t a dm it THAT!”

Why no t?! It ’ s true!

The q ue stion than kful ly isn’ t wh ethe r our thinking is p erfec t be c a use it isn’ t!

The q uest ion is w heth er our th inking a nd p hilosop hy a nd p roc ess c a n a llow us to system a t ic a lly m a ke

m one y! Perfec t ion is not a req uirem ent b ut the p rete nsion of p erfec t th inking w ill a lm ost c erta in ly result

in fo olhea rty d efe nsiven ess a nd losing c lient ’ s m one y.




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#3: VANQUISH URGENCY TO “DO”: TO TAKE A POSITION, TO MAKE

A TRADE, TO HAVE AN ANSWER The more urgency there is to DO or to be addicted to simple, easily accessible but FALSE TRUTHS…

the more likely we are to oversimplify to come up with a simple question and potentially sub-par answer

instead of waiting, not doing or acting, until the right question and answer are with us. This will be

different for every culture and match differently with every investment process.

It is my impression that many of us individuals in the investment world have a tad of brashness or

machismo in us in that we love to have an answer for everything, it seems to be one common way to

pick out pecking order in our chosen field : the brashest, loudest answer wins! Well, maybe not!

But, we’re only human. We do NOT have answers for everything, if we think we do, we’re probably

falling into the “substituting questions” bias. As a further aid, it has helped us, we think, to indicate our

conviction level in various opinions from “high conviction” to “low conviction”.

BIAS #3: AFFECTIVE ERRORWhat is Affective Error?




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Affective Error is emotional caring that typically leads to a higher level of delusion in

otherwise objective analysis. Affective Error provides a shortcut by coming up with an

emotional “story” about a company, a management team, or even a thesis.

Because we are HUMAN and emotions RESONATE and stick with us, we are particularly drawn to ideas

that are soaked in emotion.

It happens largely without our awareness.

It is hugely facilitated by “stories”, as stories are easier for us to remember and the emotions stick with us

I suspec t that Affec tive Error is actually one of the most prevalent biases in our industry. The universe ofpossible public equity investments is HUGE. We gravitate to methods that offer shortcuts. There’s nothing

wrong with that.

The problem is that in our industry we seem to have amped up the cuteness and casualness of this

shortcut.

Companies are reduced to nicknames and then down to ticker symbols, ticker symbols are reduced

down to yet another nickname for the ticker. Female CEO’s are referred to by their first name. Male

CEO’s are referred to by their last name. “Investors” walk around talking about management

“tone”…it’s endless.

We are looking for shortcuts and Affective Error injec ts emotion – so its easy for our mind to hold onto –

but replaces rea l thinking.

Because of that, Affective Error is one of the errors that is HIGHLY likely to lead us into HERDING and

GROUP THINK:

Our “stories” become COMMON STORIES and then are suddenly espoused as the COMMON WISDOM…

“Stories” are mainstream, short-run, popular currency on Wall St. but thinking and analysis is the currency

of business analysts who couldn’t care less about affective error and being popular in or driving “herd”

thinking. Consequently, we have outlawed the phrase “story” in favor of “investment opportunity”.


Attraction to Overcoming Odds or Massive Dreams of Success Turnarounds can be incredibly attrac tive and lure us in with drama and the potential for overcoming

huge obstacles. It can be attrac tive to imagine a “story” of incredible against-all-odds turnaround, but

mostly, we are caught up in the emotion of the “story”, and then miss all the practical challenges that

are required, or the incredibly complex nature of the turnaround.

Rooting for Underdogs




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It’s very human to just really want a c ompany or management team or product to SUCCEED. Success is

great. Rooting for success seems absolutely harmless, and it many ways it is…but if it’s a company that I

am supposed to be analysing as clearly as possible – to be able to SEE how close or far away my thesis

is from reality, then “rooting for” CLOUDS that judgment.

Any “Rooting” At All!

Pip ’s Sto ry:

The te c h sc en e in the 1990’s w a s filled w ith tra d e show p rom ot ion a l item s like g olf shirts, ba g s, mu g s,

pe ns. One d ay in 1997 I c a m e ho m e a nd I th rew ALL m y g i fted prom ot iona l item s aw a y, inc lud ing a

w hite w ith red c ol la r and trim Luc ent g ol f shirt a s w el l as a b urnt o ra ng e Cisc o g ol f shirt .

GONE!

These i tem s ha d zero, zero p la c e in m y life o f b eing a n a na lyst . They m igh t o nly sw a y m e into a n

unwa nted e m ot iona l sta te .

I ha ve c om e to m ore ea sily sep a ra te m y ad m ira t ion fo r lea d ers or cul tures or prod uc ts from m y task to

a na lyze using o ur sp ec if ic inve stm en t ph iloso p hy.

Being a Part Of The Facebook IPO Roadshow was a striking example of what it seemed like was an emotional pull to

“be a part of” something. How many hours were wasted on having to come to an opinion on

Fac ebook, maybe even as an excuse to go see “Zuck”?

THE PROBLEM AFFECTIVE ERROR PRESENTS:

INSTEAD OF SEEING REALITY CLEARLY,WE BECOME ATTACHED TO A “STORY”;

INCREASED LIKELIHOOD OF HERDING AND GROUP THINK

What tactics might help offset Affective Error?

#1: USE CLEAR COMMUNICATION THAT DIFFERENTIATES EMOTIONS

VS. THINKING

One of the most useful things to note about Affective Error is that it most easily disappears when we are

forced to present our THINKING about a company or management team instead of our EMOTIONS.




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The easiest way to do this?

Dema nd th ink ing a nd o u tlaw em ot ion -spe ak !

To get more specific:

#2: CUT OUT EMOTION WORDS!

Question:

If you are a portfolio manager and your analyst communicates the following sentence to you, what doyou do ?

“I’m c om fortab le wi th the qua rter /e st im ates/ c onsensus”

Answer:

How could you REALLY take a high conviction action after being offered this so-called “thinking”?

What I’m “c om fortab le” with ma y b e hug ely di f ferent than w hat Pip is “co m fortab le” wi th or what Dave

is “co m fortab le” wi th.

And if Dave or Dan or I were ever to come to Pip with “thinking” that is actually only reflecting our

emotions about the question, Pip has no magic emotion translator to translate my level of comfort into

what it means for HIS comfort.

Eliiminating emotion words can have the profound impact of taking away the subjective uncertainty

embedded in our communication. It is very NORMAL to walk around with emotions, and the power in

analysis comes in separating and seeing clearly what is emotion and what is real thought.

Good news:

Emotions are generated from thoughts. We might get “scared” because we THINK there is a prowler in

our house!

Further good news:

While we can’t interfact at an emotional level bec ause my idea of “comfort” and Pip’s can be distinct,we can interface effectively at the logic level!

So when we hear “emotion-speak” we can ask “what is the thought that is generating that feeling?”

“I a m c om fortab le w ith the p osit ion size…”

“What is the tho ught b eh ind tha t “ fee l ing” o f c om fort?”

“I th ink the m a na ge m ent is c a p a b le o f hand ling th is p rod uc t tra nsit ion.”




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“Oh , we ll I fu lly d isa gree so I am not c om fortab le a t a ll!”

#3: USE FULL COMPANY NAMES AND MANAGEMENT NAMES

Around the Facebook IPO we heard a lot of folks talking about “Zuck”.

“I’m go ing to see “Zuc k”.”

“Rea l ly? Nea t!”

An outside observer might actually be thinking, wait, is that guy FRIENDS with Mark Zuckerberg??

Using a nickname c onnotes “knowing”.

(Ge orge W. Bush w a s g rea t at d ol ing o ut nicknam es, pa rt ly p erhap s a s a p ra c t ic e o f disa rm ing . It ’s the

sam e fo r inve sto rs! O nly w e’ re d ea ling w ith a c tua l inve stm en ts, no t p erson a l o r p o lit ica l rela tionships!)

Using the FULL name reminds our brain that we do not KNOW this person or their character, AND that we

wish to take our craft seriously…not to treat it as a “game”.

It is SO incredibly easy for certain CEO’s, take Steve J obs as an easy example, to turn into personas.

Once a CEO has become a persona there is an emotional story about WHO this person REALLY is.

If I buy into that, I walk around thinking I KNOW this person. I consider them too often as “awesome” or

“terrible”.

When I implicitly decide I KNOW this person, I could start to have higher conviction that I KNOW what

decisions this person will make.

Tha t is delusional thinking.

One last trap to point out is how much faster this process happens for women CEOs: Most female CEO’s

are suddenly refered to by their first names “Carly”, “Meg”, and now “Marissa”. Perhaps because they

are anomolies to the pattern, we are even more likely to have to c reate a personae for them that can

lead us astray in assessing their management ability. They “don’t compute” with the typica l pattern, sowe create a shortcut for our brain to ma ke them compute.

#4: CUT OUT TICKER SYMBOLS AND COMPANY NICKNAMES

This is another variation on the idea of using full names instead of shortcuts or nick names that carry a

“story” with them. Open Wave one day became “Open Grave” – there’s a lot of bias inherent in that




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nickname! One of my favorite used to be the traders calling Synopsys, ticker SNPS “Snaps”. Its seemingly

harmless, and fun, but it still takes me away from considering the COMPANY I am working on. It’s not a

ticker symbol, its not a nickname, it’s a COMPANY that I’m considering for investment. Unless we are

referring specifically to the ticker symbol of the equity we NEVER substitute a ticker symbol for a

company name and we don’t use playful company nicknames. If we act casually our thought is that

our thinking will drift away from serious and crisp thinking.

Similarly, we don’t say the company or stock is “acting weird” or “hairy” or talk about management’s

mood. We consider these traps to really thinking through what may or may not be important investing o

trading questions. We don’t say “what “names” do you like?”“Names? You mean companies?”

By cutting out ticker symbols and company nicknames we won’t confuse security price analysis with

fundamental analysis.

We won’t confuse the connotations implicit in company nicknames with the REALITY of what that

company is about or how it is performing.

#5: DEVELOP AN AWARENESS OF MY AFFECTATIONS!

Sometimes all that is required to squash affec tive bias is the awareness of “oh, Brynne just WANTS this

company to succeed…!” and the portfolio manager or investment team can layer on what they think is

a more objective viewpoint. This is part of how a functional investment team can start to help one

another handle these biases.

Pip ’s Sto ry:

It took about 18 months back in the 1990’s for me to rea lize I had a fondness for turnarounds!

What a terrible way to lose people’s money! I got over it quick!

PART II

THREE (more) INVESTOR BIASES TOVANQUISH!

The s ign i fic an t prob lem s we fac e c anno t be so lved at the sam e leve l o f th ink ing w e w ere at

when we c rea ted them…”

-A lbe rt Einstein




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This is our second in a two-part series on eliminating common dec ision-making biases for investors. In

this piece, we work on representativeness error, search satisfaction and commission bias.

So much has been superbly written about investor biases and dec ision-making biases with a seemingly

implicit idea that they are easy to overcome, but there is little or no prac tical action to employ to work

on vanquishing these biases!

The who le po int of th is piec e

is to share ide as and tac t ic s for eliminat ing investor de c ision-m ak ing b iases.

Our methods may not match up 100% with what will work with you and your own investment proc ess,

but I hope these ideas can apply to some degree for any investor aiming to improve results from

decision-making, and at a minimum serve to inspire ideas specific to your team, your process and your

culture.

With that, here are three biases that we’ve been exploring, and a few of the tactics that we have either

folded into the fabric of our process or that we are experimenting with or recently brainstormed. For

more of our thoughts on our method we will happily send Part I of the biases work and our 70-page

piece on our investment philosophy and process.

I hope this helps spark some thinking for your own work.

…brynne

“When yo u im prove a l it tle eac h da y, eventua l ly big th ings

occu r…

Not tomo rrow, not the next da y, bu t eventua l ly a b ig

ga in is m ad e.

Don’ t loo k for the big, quic k imp rove m ent. See k

the sm al l im provem ent one da y at a t im e.

Tha t’s the o nly w a y it

ha p pe ns – an d wh en it ha p pe ns, it lasts…”

… John Woode n

BIAS #4:

REPRESENTATIVENESS ERROR




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What is representativeness error?

My thinking and analysis is guided by a pattern, but I fail to consider possibilities

that contradict the pattern and thus attribute the “signals” to a pattern where there is

instead an anomoly.


Let me preface these examples, as they aren’t directly from the world of investing, but from the world of

medicine.

…wait…medic ine??

…Yep!!

One of my favorite investing books that on the surfac e has zero to do with investing is How Doctors

Think, by Jerome Groopman. We studied it in a small group at the Sundance Retreat this year. I’m going

to refer to it in this section on representativeness error because I think representativeness error is one of

the most common investor biases that is so, so difficult to tackle: it lies in this gray area between

developing phenomenol skills of PATTERN RECOGNITION and having over-simplified pattern recognition

that isn’t supported by a strong investment process and therefore leads to poor decision making.

When there is a case in which the error or bias is so close to home, so “in the air” I breath, I find it all the

more important to be able to distance myself from it a bit – to look at it from another angle. The book

How Doctors Think helped me do this by diving into the cognitive errors doc tors face, with HUGE

consequences (think: humans dying…vs. a “bad” stock pick for us…now there’s some perspective!) and

how the doctors work through and aim to improve their ability to avoid these errors that have such

disastrous results.

So, here first are the examples of representativeness error from the medical field, a fter which I’ll tie them

to investing.

EXAMPLE #1: APPLYING PATTERNS INCORRECTLY

“ [Dr.] C roskerry to ld m e h ow his eye s ha d f ixed on M c Kinley ’ s trim fra m e a nd his eleg a nt o live

un ifo rm , a nd ho w th e range r’ s p hysique and c h ise led fea tu res rem inde d h im of a young Cl in t Eastwo od

– a ll strong a ssoc ia tions w ith h ea lth a nd vigo r. Yes, there w ere u nusua l asp ec ts to M c Kinley’ s a ng ina ; his

p a in w a s not typ ic a l of c orona ry artery disea se, nor d id th e p hysic a l exam ina t ion a nd te sts p oint to the

hea rt . But, Croskerry e m p ha sized , tha t w a s p rec isely the p oint : “ You have to be p repa red in your mind

fo r the atyp ica l a nd not so q uic kly reassure yoursel f , a nd you r pa t ient , tha t e veryth ing is oka y.” (p 44)

Here, the doc tor thought he saw the typical prototype of a healthy “Clint Eastwood”. Instead, the

patient had a fatal heart problem.




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He missed those symptoms that would have led him down the path to discovering the heart

problem because he took a shortcut: assessing the patients physcial appearance without checking a ll

the boxes that might have led him to come to a completely different conclusion.

To transla te this to investing , rep resenta tivene ss error is wh a t hap p ens whe n we b el ieve we are

see ing a pa ttern, a nd w e m iss the c lea r signa ls that this p a rticu lar ca se d oe s not fi t the p atte rn – it is a n

anomo l y .

We get STUCK in the pattern, instead of helped by it.

A simple example is grouping all companies into a certain industry as the same, or identifying

buc kets of “theme” companies when it is unlikely that all of their businesses really fall into the same

pattern completely.

EXAMPLE #2: BLINDLY FOLLOWING UNEXAMINED PROTOTYPES

An even more prominent problem representativeness error presents is that we take all these

patterns we have “identified” as “truths”, relying on them to the point of error and even lazy thinking.

We use our “teaching” and “training” as our pattern recognition, but we may not realize that we

took this teaching and training as the “truth”, and never thought to question or examine it!

"Why d o yo u st ic k the ne ed le unde r the xipho id?" [Dr. ] Loc k a ske d.

I paused. "Bec ause that was how m y tea c hers taug ht me in m y tra in ing."

"And why do you th ink your teac hers taught you the wa y they d id?" Loc k a sked .

"Bec a use that's the wa y THEY we re tau g ht." (p. 134)

Here, a prototype was left unexamined. A procedure was done the same way over and over again

NOT because it was the best way but because it was “ok” therefore was left completely UNEXAMINED.

He later says:

"The b ig prob lem is that mo st peo ple a ssum e that onc e i t 's [ the proc ed ure] ma de up, i t's ac tual ly

rea l . Espe c ia l ly the p eo ple w ho m ak e i t up them selves. Then they th ink i t ca m e stra igh t from God ."

Here’s where applying this thinking to investment gets really useful….

I don’t think we even have the STARTING POINT of great prototypes!

In fact, the prototypes and industry “thinking” we start with may be massively faulty!

What an awful place to start.




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Unlike medicine and other disciplines, we don’t have many institutional prototypes that a re handed

down. We don’t have a science, that’s for sure, but we also don’t have great thinking on what it means

to be an investor. Only a handful of “great” investors are studied but more often than not “investing”

includes a huge hodge podge of activities, most of which I would argue are about TRADING or

TRANSAC TIONS, and not investing.

I am completely fine with this idea that there isn’t a “science” to investing, but where I do get my

antennae up is when I observe that this lack of thinking opens up a HUGE VACCUUM for others to fill if

we let it.

And who or what fills that vacuum? CNBC, trading blogs, and in general, transaction oriented,

completely temporal, completely unexamined thinking. This means that not only are we grappling with

representativeness error, using prototypes instead of examining our thinking, but we are working withunhelpful prototypes much of the time:

Putting the needle in the xyphoid may not have been the best option, but at least it was a procedure

that worked MOST OF THE TIME.

I can’t say that about many of the prototypes or “rules” of investing.

We accept the common wisdoms (likely herd thinking) of what will happen in the market, We spend time thinking about why the market “acts” this way or that, We have a vague definition of what a “blue chip” company is or, What investing “strategy” “works” for the long term (“buy and hold”, “data point investing”, etc.)

… all mediocre thinking about investing that we leave unexamined at our peril.

This is the w on d erful puzzle of inve sting… wh y it nev er g ets bo ring !

… but it ’s not simp le. Lea ving our “co mm on wisdo m s” unexa m ined, let t ing them be o ur guid ing

“pa tterns” to loo k for, wi l l OVER simp l ify our thinking , lea ding to po or de c ision m a king .

THE PROBLEM REPRESENTATIVENESS BIAS PRESENTS:

OVER-SIMPLIFIED PATTERN ANALYSIS AND UNEXAMINED THINKINGLEADING TO POOR DECISIONS

What tactics might help offset Representativeness

Error?




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#1: WRITE DOWN AN INVESTMENT PHILOSOPHYIf we take this idea that we are working with prototypes that aren’t very useful or very developed (e.g.,

“buy and hold beats the market in the long run”) …

…AND I think that I am working with thinking that is unexamined…

…then the opportunity is to take those prototypes and that unexamined thinking that has been passed

down to me and wrestle with it. One of the best ways I’ve been working with that this year is by working

with Pip writing and revising the Investment Philosophy for the C oburn Ventures Buckeye Fund and for a

new model portfolio, Oakley.

In other words, I now have a method for bumping up against thinking that I took as “the truth” when Ifirst started in the industry or studied for the C FA exam and can now say, “THIS is what I believe”.

Through deep examination I am forced to consider what I truly believe in and whether my processes

are synched p with those beliefs.

One of the great services we think a money manager can provide clients springs from a mentality of a

student's mind that is open to being wrong and learning more. IF I put myself in the position as "final

word", well, when the data arrives disproving my thesis the odds of defensiveness and denial sky-roc ket!

IF I am of a student-mind the new evidence will be properly or approriately weighed and a new

enhanced thesis will evolve.

To be clear, it is EASIER to look for prototypes! It is EASIER to stay comfortable in looking for the patterns

we think we KNOW! This is why we fall into the trap of representativeness error time after time. Keeping a

students mind, and keeping a “work in progress” investment philosophy may be one way to keep yourbrain actively defining what it is you THINK you know, such that you can keep challenging your thinking

with new ideas.

#2: WORK TO REDUCE TRACKING ERROR

“WHAT WE KNOW IS ONLY BASED ON A MODEST LEVEL OF UNDERSTANDING”

This is the most complex but to me, most interesting tac tic to combat representativeness error. It pulls

aga in from that example from Dr. James Lock in How Doctors Think and relates it to the TRACKING

ERROR that we experience as investors as our THESIS can never be REALITY:

Without me giving you too much bac kground, Groopman is writing about Dr. J ames Lock, Chief of

Cardiology at Boston Children’s Hospital. He is a doctor that has to do extremely tricky surgeries, many

times on the hearts of very young children.

He was obsessed with Sherlock Holmes as a child – the deduction and reason that was used for

sleuthing. He compares that to the work he does diagnosing problems in children’s hearts. We can use

the same parallel when thinking about how to research and form a thesis (“diagnosis”) for investments…

Here’s how Loc k talks about bringing “investigation” into his work – what works and what doesn’t:




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“Like his hero Holm es, Jam es Loc k p ond ers the nature and interpretat ion o f ava i lab le evide nc e a nd

tries to ima gine a b etter future.

“ I kee p an o ngo ing tap ,” he sa id , “on how I know w hat I know.”

(THAT is m y fav ori te sen tenc e in the b oo k!)

“Epistemology, the nature of knowing, is key in my field. What we know is based on only a modestlevel of understanding. If you carry that truth around with you, you are instantaneously ready tochallenge what you think you know the minute you see anything that suggests it might not be right.”

Pip ’s Ad d :

To b e o f a stud ent ’ s m ind I p ra c t ic e te lling m ysel f “I real ly d on’ t kno w a nyth ing ab out th is in the g rand

sc hem e of th ings and I have sooo m uch to learn !” unt il I b el ieve tha t wi thout e ver be ing p a ra lyzed b y

the fea r or de fensiven ess of th inking suc h a th ing .

Reminding ourselves that a thesis is not rea lity, it is just our best guess at coming up with our model that is

as close to reality as possible, is a tac tic for RESTING in the unknowable and feeling COMFORTABLE

enough to wade into and rest in “I don’t know the answer here, but I’m not going to fall back on

prototype thinking that isn’t relevant or useful”.

“What we know is ba sed on o n ly a m od est leve l o f understand ing…”

and this coming from a medical doc tor and scientist!

Said another way:

We don’t know all we think we know!

IF as investors we can embrace this humility, we are much more OPEN to that second part of his

statement:

“…you are instan teously read y to c ha l lenge what y ou kno w the m inu te you see anyth ing tha t

sug g ests it migh t not b e right.”

In other words, one of the effec ts of letting the first statement sink in – my thesis is NOT rea lity, and

my understanding is modest anyway, and I WILL ALWAYS HAVE TRACKING ERROR – is that there is much

more openness, and much less defensiveness, to fully exploring, playing with, and seeing what might be

OFF about your diagnosis. Instead of avoiding counter-signals, you will see them immediately AND be

able to act instead of sit and scowl in defensiveness of “your” thesis.

Pip’s Ad d:

A YELLOW FLAG for me is w hen I g o th roug h the p ort fo lio a nd ge t to c om p a ny XYZ a nd I th ink “All’s

f ine the re… No ne ed to sp end t im e o n it…Next….”




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Now I th ink “Whoop s! Go b ac k and THINK ab out tha t c om pa ny!”

BIAS #5:

SEARCH SATISFACTIONWhat is Search Satisfaction?

Search Satisfac tion is a natural cognitive tendency to stop searching, and therefore

stop thinking, when one makes a major finding.





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Many analysts work and work to develop enough conviction to get a company into the portfolio, and

once the company is in and the adrenaline rush is over, there is a “completeness” to the work that can

be completely misleading, an experience of:

“I’ve d one m y wo rk; I have high c onvic t ion in my the sis…”

and , the imp l ic i t prob lem whe re Sea rc h Sat isfac t ion snea ks in:…

“I kno w w hat there is to know .”

THE PROBLEM SEARCH SATISFACTION PRESENTS:

OVER-CONFIDENCEMIS-MATCH BETWEEN PORTFOLIO MANAGER AND ANALYST NEEDS

What tactics might help offset Search Satisfaction?

#1: “ WHERE THE THESIS WILL BE WRONG”

We generate a “pre-determined game plan” well before taking a position that includes the

following:

-A stated business thesis

-3-5 Statements suggesting where we think the thesis will be WRONG after the fact

-3-5 “Burning” Questions core to affecting our conviction in the thesis

-Relevant operating model metrics

-A 1 year share price chart

One of the most effective tools within it is the section of 3-5 statements that detail our thinking on where

we think we are most likely to be WRONG.

Highlighting this sec tion has a number of benefits:

1) It reminds us of our own fallibility – we are going to be wrong some of the time! Instead of

ignoring that or denying it, we can work with it and work to reduce its probability of oc curing.

Part of having a thesis is rec ognizing it is only our best guess. I like Dr. Lock’s quote from How

Doctor’s Think:

“Eve n thoug h m y rea soning is tight, I’m sti ll ma king it up .”




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And this from a doctor who has a science to refer to. Now imagine how much of our thesis have

elements of “making it up” in it!

2) We are reminded that there is not ONE answer to where the thesis will be wrong.

3) We are prompted to keep creatively thinking about HOW our thesis will be wrong. For me, this

type of thinking is inspired by the book we read as a group, The Opposable Mind, by Roger

Martin. Here’s one example:

“Ma stery wi thout or ig ina l ity be c om es rote.

The m aster who neve r tries to th ink in nove l way s ke ep s see ing the sam e p oints of sal ienc e, the sam e

c ausal re lat ionships, and the sam e p rob lem a rc hi tec ture.

Suc h m astery w i ll prod uc e the sam e kind o f resolut ion ev ery t im e, even i f the c ontext de m and s

som ething differen t.

Ma stery wi thou t or ig ina l ity b ec om es a c u l-de -sac .”

Rog er Ma rtin

#2: PIVOTAL QUESTIONS: A CONSTANT LINK BETWEEN THE

PORTFOLIO MANAGER AND THE ANALYSTWe have a newer tactic in our process we call “pivotal questions”. The idea is to identify the 1-2 Pivotal

Questions that, depending on the answers we uncover, would dramatically change our position size.

A Pivotal Question asks:

What inform a tion o r insights WOULD lea d us to tr ip l ing the c urren t p osit ion size?

What informa tion or insigh t wo uld ha ve u s c ut the p osit ion size in ha lf?

Pivotal Questions help tie in the immediacy of the portfolio manager’s job with the analyst that may

be quietly falling into a state of Search Satisfaction, pleased that he did his job by having a company

represented in the portfolio but unattached to the urgency of constantly assessing levels of convictionin each thesis and each position size in the portfolio. By using the questions that tie into **conviction** in

the thesis **vs. other companies in the portfolio** there is a possible awakening to the importance of

constantly assessing what FURTHER question would have our conviction increase or dec rease

significantly? Potentially the process of Pivotal Questions might lead to a more AWAKE experience in

relation to each company/investment ALL the time.




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#3: FRESH EYES“Fresh eyes” is simply rotating in a different analyst -- not to take over “covering” the company -- but to

do one quarterly thesis assessment to provide a different perspective. I love this tac tic because it

highlights that we all have different strengths on our team and may see things differently. In an exercise

like this, we might be able to get some benefit from having another mind thinking through the company

thesis for a few hours.

Pip’s Ad d :

Im p ortant ly , “fresh eye s” is d ep end ent o n the q ua lity of yo ur tea m . If your tea m is rea lly a c ol lec t ion of

ind iv id ua l ego s the “fresh e yes” w ill dev alue into a p ol it ic a l hai rb a ll as op p osed to a refreshing

comp l imen t .

#4: COMPETITION FOR CAPITAL

The competition for capital is the idea that a portfolio is a Darwinian exercise: there is a survival of the

fittest among the different companies in the portfolio as well as candidates to come into the portfolio.

There is no “completion”!

ALL that inclusion in the portfolio means is that FOR NOW this company won the competition. It does

NOT mean we now KNOW everything!

There is no ability to rest and be “satisfied” if you believe in this perspec tive.

This comes back to the link between the portfolio manager and the analyst where there may be a

mismatch. The portfolio manager may LIVE this experience of “competition for capital” every waking

moment, while the analyst considers his work “done”.

Pip designed the “integrated portfolio decision engine” with the aim to link the work of the analyst and

his needs as portfolio manager much better – just ping us if you’d like to read his CIO Investment Diary

on it.

BIAS #6: COMMISSION BIASWhat is commision bias?

A tendency toward action rather than inac tion.


Unnecessary Trading:




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If I want to do “something” to improve portfolio performance, I may trade more without really having

conviction in the trading while generating unnecessary transaction costs and wasting time.

Moreover, sometimes the thought process put into making a trade fools us into thinking that a question

about our thinking on the **investment** has been “handled”, when actually, the question in terms of

the investment is still sitting there… all I’ve done is make a trade!

At worst the “nervous” energy is put to poor use and a habit develops of one problem leading to an ill-

thought reaction ad infinitum! Ugh!

Diving Into a Research Black Hole:

In an effort to “act” and to “solve” I may generate more and more reasons why I “need” to spend moretime on XYZ Company research report. I may fall into endless hours of digging up fac ts, going to

meetings, listening to conference calls, fooling myself into thinking I am “doing research”, when actually

I am avoiding thinking through what is REALLY the important question to ask that could have my position

size triple or take the position out of the portfolio. Without spending my time addressing those pivotal

questions, I may be merely treading water.

THE PROBLEM COMMISSION BIAS PRESENTS:

WASTED TIME

UNNECESSARY, COSTLY TRANSACTIONS

What tactics might help offset Commission Bias?

#1: No investment positions in IPO’s for the first 6-9 months.

I put this tac tic first because it is the most clear cut: no participation in IPO’s helps us consider that there

is no reason we HAVE to have an opinion on a c ompany JUST BECAUSE it is coming to market. That is a

supplier-centric view dictated by bankers, and as investors, we consider our calories more useful after a

few quarters have gone by.

We might examine a company that is a new IPO but we don’t participate. The IPO process leads to

biased information divulgence by conflicted parties painting a “story”. It is a period filled with emotions

and undue attention for something “now”. A horrible environment for clear decision making.

We take a view that there are plenty of fish in the sea and IF this is interesting now it will also likely be

interesting in nine months.

#2: PICK TWO DAYS OF THE WEEK TO NOT PUT IN TRADES




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We have a guideline that we don’t trade on Mondays and Fridays. This helps put trading in its plac e –

trading is a tool for our portfolio management which has a ~3 year time horizon. This may not be

practical for other strategies, but we might want to consider an even wider rnage of trading

moratorium days throughout the year.

#3: REMOVE TICKER SCREENS FROM WORKSPACE

(or at least turn them off for the hours when I really want to do some investment thinking!)

IF I want to drive up my adrenaline to take action, all I have to do is watch a flickering screen all day.

The movements of ONE DAY of trading could have you incented to take unwanted actions of all sorts.

As we mentioned in the first “Biases” Waypoints – it may be useful to observe what’s “in your air” – whatabout your environment incents you toward useless ac tion? That screen may be one of them…

Pip’s Ad d :

I ha ve n’ t ha d a ticke r sc reen for 7 yea rs a nd I d o n’ t m iss it a b it. Ini t ia lly el im inating the ticke r sc ree n is

like a life long Ne w Yorker c ont em p la t ing m oving som ew here e lse. They m igh t w ond er if it is a c tua lly

p ossib le to exist ou tsid e th eir p e rc ep tion of th e c en te r of the universe. It a c tua lly IS p ossib le! And , I c a n

exist w itho ut tic kers fla shing a t m e a ll d a y!

Pip ’s Sto ry:

Sitt ing a t lunc h in 1994 tw o old er c ol lea g ue s – M ike Sa ssi and Da lla s C orser – reflec te d on the d a ys of a

c oup le ye ars ea rlie r when the y ha d to m ake a spe c ia l t rip a c ross the o f f ic e to c hec k a stoc k pr ic e o nthe o nly quo tron in the off ic e!

They a gree d t ha t they w ere b ette r inve stors then !

But, no o ne sitt ing a ro und the lunc h ta b le DID an ything w ith tha t INSIG HT!

Instea d w e rushed b a c k to our d esks to c hec k how o ur p ersona l list of t ic kers ha d “a c ted ” in the p er iod

of 30 minutes a w a y!

#3: EVALUATE HOW COMPENSATION IMPACTS UNNECESSARY

ACTIONPip decided to spread out “bonus” payments throughout the year instead of having one lump sum at

the end of the year. I noticed a big difference in how this affected me that was distinct from my

previous jobs on teams and in firms that hugely emphasized the end of the year “bonus”: I used to be

distracted by what my bonus might be, and I can say with pretty high conviction that I think the rest of

the team was too! This would result in all sorts of potentially nervous energy and odd behavior, none of

it very productive, insightful or in the spirit of building a business for the long term. When the “number” is

diluted over periodic payments, it’s influence diminsihes, and there is the added benefit of providing

more opportunities for conversation and feedback that may only come up every 12 months otherwise!




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#4: IDENTIFY UNNECESSARY ACTION CREATE TIME DIVIDENDSOne of the benefits of identifying commission bias of all sorts (not just trading), is that it will result in

TIME DIVIDENDS!

So, if I can identify some ac tions that I no longer believe to be helping me grow into a better and

better investor, and then I can STOP those actions, I should have availability to INTENTIONALLY CHOOSE

NEW INPUTS that WILL help me grow!

Some of the activities we have stopped or limited are : daily trades, listening to earnings calls,

blindly accepting meetings with management teams, useless/mindless/insight-less financial modeling,

going to c onferences in which managements control a 20 minute power point presentation and are

rung through 30 min 1:1’s with pre-prepared answers, going to analyst days, listening to analyst days,reading the majority of broker research, particularly on earnings.

The list of activities we have eliminated that do not support our process is enormous. As a result, we

have huge time dividends, and have deployed our time to ac tivities we think are much more useful

toward generating insight.

#5: TIME CONSTRAINTS ON INVESTMENT WORK

We have a eight round proc ess in which we identify EXAC TLY how much time the analysts are

supposed to spend on each level of work. I’ll highlight two major purposes of this tactic:

-The analyst is limited from going down that black hole. This is *especially* valuable for junioranalysts who may have a fear of not answering every question or not covering all the bases.

-Pip, who engages as each round of work is completed, has a framework for how we’re improving

– what I could do in four hours five years ago is VERY limited compared to what I can do now. He can

help us see where we may be wasting time, and we are held accountable if we are continually going

over time. Quickly we become discriminating about what is relevant and what is either noise or trivia.

#6: RETREAT FROM ACTION AT LEAST ONCE A YEAR

This year at the Sundance gathering we experienced 90 minutes of solitude. Yes, solitude. A group of

30+ investors and industry folks all put down our notebooks and smart phones and sat, went for a walk inthe woods or otherwise experienced solitude. It was a further step toward creating more and more

space at the Sundance Retreat that would facilitate an ability for all of us to step back and SEE more

CLEARLY how we are, what we think and “how we know what we know”. From there, we have a MUCH

stronger chance at identifying actions that we consider embedded in our process or crucial to our da ily

lives that are really just wastes of time.

I think that is really what this work on biases is about for us investors, aiming to grow and expand as

investors, but also to be continually assessing where we are simply wasting time, whether it is by falling

into herd mentality thinking that offers nothing for our clients, or limiting our thinking by not allowing




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ourselves to identify the “unknowable” burning question, or by oversimplifying the incredibly complex

questions we are faced with every day to the point where our shortcut question leads us down the

wrong path.

The best thing about being an investor is that there IS no prototype, there IS the opportunity to

continually expand and grow and steep ourselves in complexity, patiently thinking through each piece

of the puzzle until suddenly the puzzle starts to fit together and we think maybe just maybe we are

closer and closer to reducing that tracking error between our “thesis” and “reality” which would lead to

ever better trendline results for our clients. Maybe, as we work to be aware of the biases that are always

going to be with us, we are seeing clearer and clearer.

And the alternative is staying in the same rut as the majority of investors and likely, wasting time on

proc esses that may actually facilitate us falling into common biases. The joy in exploring biases is my

hope that it helps each of us grow instead of unwittingly resting in medioc rity.

As Mary Oliver said,

“Tel l me , wha t is it you plan to d o

wi th your one wi ld and prec ious l ife?”

…brynne

…brynne




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NODE #1 SOCIETAL SHIFTS

Here is a very brief snapshot of each of our NODE #0s and NODE #1s monumental societal shifts. Please feel free to

ping us for the more detailed write ups.

NODE #0:

#1) HUMAN POPULATION GROWTH/CHANGE: When human population growth rate is witnessed across a

generation, the unintended consequences are extraordinary and trigger an infinite number of by products that induce

dramatic societal changes. We see these “unintended consequences and by-products” as the root factor behind many

global issues well beyond just “clean/green” tech.

#2) DIGITAL DEMOGRAPHIC REVOLUTION: Society as a whole will adopt new technologies at an accelerating

rate as Digital Natives and Digital Immigrants grow as a percent of the overall population, and have a greater influence

on social and business norms. Digital Natives have grown up with technology (they were born into a PC and Internet

eras), and Digital Immigrants are older but are comfortable using technology to solve a crisis.

#3) GLOBALIZATION: Technology has supported the so-called shrinking of the planet; geography and nationality

have become less of a barrier. Key words that we associate with globalization are *effective*, *expanded sourcing

pool* and *expanded market opportunity*. For example, those who are using or facilitating the expanded global

sourcing pool will benefit while those who do not will face a diminishing competitive advantage.

NODE #1s:

#4) THE DIGITAL FERRYMAN: The concept of the Digital Ferryman has its roots in the Change Function and in

the premise that Analogists and Digital Immigrants have higher total perceived pains of adoption (TPPAs) when it

comes to technology than Digital Natives do. A Digital Ferryman is a product/service or company that takes theuncomfortable Analogist by the hand and helps him migrate to the Digital World.

#5) HYPER PERSONALIZATION: People are getting more accustomed to having their lives more and more exactly

like they would like it and are demanding such. *I want what I want when I want it and where I want it and how I wantit*. We expect individuals to accelerate hyper personalization as it becomes clearer that they have the ability to do so

and that doing so is socially acceptable.

#6) NAKED WITHOUT DATA: We believe: i) society is in an infant stage in its relationship with data; and ii) that

the impact of data usage is far far greater and wider than is understood. In many instances people feel Naked Without

Data. The issues of data presentation, regulation, quality, measurement, analysis, search, mobility, video, data mining,

health care…etc… will all undergo further development, creating numerous business opportunities.

#7) UNCENTRALIZATION: We think that the further development of technology combined with the effects of the

Digital Demographic Revolution will lead to a far greater transparency and *truth* that will demand centralized

organizations to use more and more energy to maintain their centralized status to fight the laws of entropy.

Uncentralization, in turn, leads to wider choice for people who understand their options (and how to use technology to

access those options).




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#8) DYNAMIC MOBILITY: This refers to much more than cell phones and smart phones. The core idea is being

able to do things from anywhere, anytime. Mobility is a subset of freedom, and people have shown that they will go togreat lengths to have freedom. We expect much of the population will enjoy more and more dynamic mobility at an

accelerating pace during the next several years.

#9) ADDICTED TO COMMUNICATION: People are addicted to the experience of being on common ground or

*connected* to one another. Communication is about “action taken towards the experience of oneness” and shares the

root with “community”. It is much wider than just “talking”.

We have seen an incredible expansion in the tools for communication (email, mobile phones, YouTube, SMS,

blogging, FaceBook, Twitter, Second Life, etc.), and we expect to see many many more.

#10) ADDICTED TO VIDEO/IMAGES: We see humans as extraordinarily affected by videos and images. We

believe that the Digital Demographic Revolution will accelerate this circumstance and opportunity as Digital Nativesare training the older impressionable generation to attach even greater meaning to video and image. This goes beyond

screens and YouTube and extends to facelifts (addicted to our self-image).

#11) THE END OF THE ADVERTISING WORLD AS WE KNOW IT: *Advertising* is not dead, but it is

changing. Advertising has been about manipulation and humans don’t like being manipulated; they develop immunity

against manipulation, so new forms of manipulation replace old ones that no longer work. In this context, traditional

advertising agencies are scrambling to acquire new expertise while pretending they understand the new world when

they largely do not.

#12) THE FREE WORLD: This concept refers to a world in which people expect that many of the products/services

that they previously paid for are now free (gratis); for example, music, movies, articles, news services, data services,

travel advice, telephone calls, the internet itself, electrical charging at airports, etc. The advent of the internet has

accelerated this trend.

#13) THE FASTER WORLD: Humans place a value on speed and have for a long time. The Digital Demographic

Revolution accelerates the desire for FASTER; technology facilitates it as well. We expect products and services that

enable the Faster World will provide good business opportunities as will products and services that serve as antidotes to

the Faster World (such as day spas).

#14) “MEANING OF LIFE IS TO BE ENTERTAINED”: We observe that entertainment’s value in society today is

so large that if an alien came to the developed economies of the planet, they might well mistake the purpose of our

planet was to be *entertained*. So, as investors we consider those businesses that will benefit from effectively

injecting entertainment into our lives.

#15) “MEANING OF LIFE IS TO CONSUME AS MUCH AS POSSIBLE”: We observe that humans in many

societies seem to place an ever growing emphasis on the ability to consume as a gauge of their underlying *value* as a

person. In this context, providing others with the *experience* of consuming appears to be a good thing to do.

#16) COMFORT WITH *CHANGE*: Humans are in the process of truly accepting that the world is nothing but

dynamic. We expect the user’s relationship with “change” to grow from passive/victimized toward active/empowered.

#17) THINKING: LINEARLY HOLISTICALLY: We see some signs that individuals and organizations are

more and more accepting of the idea that “everything” is tied together in ways that are very hard to understand. We

suspect that a larger number of individuals and organizations will accept that they must think and act holistically in

order to be more effective. Technologies will be seen as facilitators of effective holistic solutions and lives.




#18) DO MORE WITH LESS: The old way of thinking about Enterprise spending was: “technology is critical tocompeting in the future. IT will save you.” The new way of thinking is: Do More With Less.” We see no signs of a

reversion to the prior “mantra” and we do not expect as such. Public companies have exhibited tendencies of being

addicted to margins and outsourcing is one form of pursuing that addiction. There is a huge and on going opportunityin understanding the “Do More with Less” mantra and then tailoring and selling services and products successfully into

such an environment.

#19) OUTSOURCE IT: Although the concept is hardly new in its effect, the word “outsourcing” has become prominent in the last 2 decades. Today, peer pressure to outsource is immense; keeping fixed costs down is at a

premium; shrinking down to one’s core competency is growing. Those abstracts are manifesting themselves in a still

rapidly growing set of business opportunities.

#20) AGE OF INFORMATION AGE OF INTEGRATION: The Age of Information ended once everyone hadaccess to nearly as much information as they could possibly want and were being bombarded with tremendous amounts

of information they didn’t want at all! Today, there is a tremendous opportunity to help people cope with and then

effectively use all the tools and data that they have easy access to – hence the Age of Integration.

#21) COMPLEX TO SIMPLE: The idea of simplicity in product design, service, promotion and education will all

become growingly important elements in determining product and service winners over time. This is a change –

especially in the tech market – where it seems that over the past 50 years, many new applications were introduced that

added more complexity to an already complex ecosystem.

#22) ITERATIVE OPEN DEVELOPMENT: Culturally we are very early on in what might be a 20 year adoption of

these two idea principles that apply at a minimum to design of products and operation of organizations. Iterative

development is often associated with rapid prototyping, time to market and more laser-like matching to user

requirements in product design. Open development is a related idea that relates to both business models and productdesign.

#23) GRANULARITY: Technology’s on-going ability to supply far more capability, far less expensively and to do soin many new ways and variants. The capability to supply in a fashion that is nimble, cheap, specific, adaptable,

effective, imaginative, personal. This, frankly, has been going on progressively for thousands of years: ingenuity

creates new abilities to supply in ever more dramatic fashions until they are merely expected. Example: the Toys RUs “pop up stores” at Christmas; a 25k library of songs on a chip that fits inside a matchbox.

#24) ROUTING AROUND INSTITUTIONS: A force that combines Granularity – a supply-oriented force – and

Hyper-personalization – a demand-oriented force. End users are increasingly demanding exactly what they want, whenthey want it. And their acumen about how to get “it” by routing around the incumbent “institution” is also rising.

Granularity, meanwhile, is providing end users with new ways to get the service they want such that the old service

provider (i.e. the ‘institution’) may be dis-intermediated. Example: newspapers routed around by the Internet, loca

healthcare system routed around by medical travel.

waypoints 161 + 163 - biases duology

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