November 19, 2013

It is well known in the industry that investment research is an integral part of a strong investment process and management company.  Any in-depth consultant or client meeting will involve a long and complicated discussion about research.   This is of course of utmost importance to good investment decisions.

However, there is another key ingredient in the investment process, and one that isn’t as often explicitly discussed.  This is the art and science of decision making.  Investing is a practical discipline and not a theoretical one, and our thinking is not an end in itself, and must lead to action.  How does a company produce excellent research but also understand the need to nurture and protect an environment that promotes effective decision making?

Below are a few of our observations on decision making and creating an environment conducive to effective decision making.

It is very easy to see the extremes of the investment world – between being too lax about the seriousness of buying stocks, and being so obsessed by discovering further information that one can never act on the idea.  In the first camp would be a floor trader who is constantly buying and selling and barely stops to consider all the decisions they make.  In the second camp is the research analyst who writes incredibly in-depth reports but never brings themselves to buy or a sell.  Obviously this analyst will not last in the industry, while the trader can become addicted to trading, or immune to restraint, blind to the risks they take.  Understand that investing is about being conservative, disciplined, consistent and diligent, but also that one has to act when the opportunities arise.

For many people, making a decision gets more difficult the more research one does.  If it is a difficult decision, it only gets more so as you adds to the pros and the cons.  If you start leaning towards the pros, you can’t help but review all the cons, and vice versa as you start leaning towards the cons.  You almost inevitably become trapped in the middle.  The best solution is not to constantly seek out all the facts but to boil down the information to the key points.  Focus your research on what matters, and make a decision based on this.

On culture, we are strong believers that a stressful culture is the anathema of clear-headed investment.  Stress drives adrenaline which helps in “fight or flight” situations, such as battle, stock or commodity trading exchange floors, and parliamentary debates.  It can raise your game for a short period of time.  But after an extended period of time, stress clouds judgement.  A high stress environment is effective for some situations, but buy-side long-term investment decision making is not one of these.  The best long-term decisions will be made with a calm mind.

We also think that an increased number of players involved in decisions can lead to problems of communication, and of personalities and politics.  There are many good large teams of investors but do not underestimate the difficulty in achieving this.  It is very rare that a committee will deliver consistent, sensible and differentiated decisions.  For these reasons, the investment team at Kennox will remain small and nimble.

As you would expect with a subject as complex as investing, there is no one right answer.  There is a balance to be found and compromises to be made.  At Kennox, we try to understand the difficulties and intricacies of decision making, and cultivate an environment where we can achieve the most efficient decisions, and hence, results.

Authorised and regulated by the Financial Conduct Authority (FRN: 475658)
The Company is based in Scotland, UK with the above registered address (Registered Number: SC302037).

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