A Flying Knee

For fans of mixed-martial arts and who watch the UFC like us, this is an exciting weekend. The biggest fight of the year, for the lightweight championship between Khabib Nurmagomedov and Justin Gaethje will be taking place (in fact by the time you read this, the result of that fight should be decided). When we were watching the promo for that fight on YouTube, we were suggested we watch another video which featured the most exciting fight from last year. That fight, featuring Ben Askren taking on Jorge Masvidal, was exciting not because it was for a championship or for anything of any importance, it was exciting because it featured the fastest knockout in UFC history. You can watch it here; it lasts less than 5 seconds. Now, we know what you’re thinking, “Pratyush has finally lost his mind and is going completely off topic on an investment blog”, but we promise there’s an important message about investing, just bear with us.

To understand this message, it’s important you know a bit about the fight. Jorge Masvidal had just come off an exciting win against a young prospect, and was looking to add to his highlight-reel. Askren, a wrestling prodigy, had just entered the promotion and had talked a lot of “smack” about how he would dominate all his opponents. Now, if you watch the video, you can see that as the fight starts, Masvidal (in the red shorts), is relaxed against the cage while Askren advances in a typical fighting stance. However very quickly, Masvidal moves off the cage, circles around, and launches into a flying knee. Askren, seeing this, does what any wrestler does, dives towards his opponents legs in order to bring him to the ground. Now unfortunately for Askren, Masvidal perfectly times the knee and it lands square in his opponents face, rendering him unconscious and the recipient of the fastest KO in UFC history. In the aftermath of this fight, Ben Askren was mocked mercilessly, partly because he is a known troll himself, but mostly because of his decision to duck down and expose his face to counter a flying knee. The sofa-sports fans went crazy and lambasted Askren for this. However, in a well-articulated post-fight interview, Askren defended his technique and made some very valid points when he said he would do the same thing again had he had the chance to re-do the fight. For one, flying knees are notoriously difficult to pull off as they are quite a feat of athleticism, and generating enough force to do any damage, let alone a knockout, is no easy task. Second, had Masvidal missed, even just by a few centimetres, Ben Askren would have been able to take him down and use his elite wrestling to control the fight (as he had in his 19 undefeated fights before this). It seems that the fans had made a common mental model mistake, which was to judge the quality of the decision by the outcome. Had this fight been able to play out over and over again, it’s quite likely that Askren strategy would have worked a high percentage of the time, it just so happens that, this time, it didn’t.  

We see the mental mistake of judging often in the investing world where investors and market participants will judge their decision making processes by the outcome. Invest and the market goes up, you’re a genius. Invest and the market goes down, you are a complete fool. Don’t invest and the market falls, pat yourself on the back, invest and the stock falls 20% you kick yourself. This kind of thinking has been quite rife in a year like this when markets went from a disastrous spiral to a euphoric high all in a matter of months. In March this year, a lot of savvy investors took a very defensive posture to the market. Not panicking, but raising some cash, investing in recession proof businesses, and getting out of businesses that looked permanently flawed (now ~10 months into the pandemic and seeing airlines lose more and more money every day, Buffett’s decision to sell his airline stocks is looking smarter and smarter). In hindsight, given the market bull-run these all look like bad decisions. But, were they really? The world was a very uncertain place, we didn’t know how many people the virus would kill, and how long we’d all have to be hunkered down. The odds were not necessarily on humanity’s side, and like most crises it was more likely that the market could have formed a much lower bottom had the Fed not stepped in when it did. Given the odds, could a defensive decision really be such a terrible one? If you judge the decision by how far the markets have come since then, then you would say it was a bad decision. But in reality, the decision making process to go defensive, was not actually a bad one. In 2008, for example, it would have been a very good decision as markets continued to fall after the initial bottom in March 2008 and then again in July 2008.

Hang on you might say, ‘”weren’t you recommending clients deploy cash in March this year?” Ah very good, dear reader, we certainly were. But what we weren’t saying was spend it all. At a certain point the panic got a bit too much and we started seeing signs of a bottom, and knew it would be a reasonable time to deploy some cash, we did not know it was the bottom. All in all, while we think this was a good decision, if we were to judge the decision based on the outcome, it would actually be rated a very mediocre decision, as the market rallied so much in hindsight we should have told our clients to spend it all.

Annie Duke, in her book “Thinking in Bets” (one of the best books on decision making we’ve ever read) explains that life is like Poker and not like Chess. Chess has no hidden information and requires very little luck, whereas Poker has heaps of unknowns and luck can play a huge role. Life and markets (but aren’t markets life?!) are very much like this. We don’t have all the information and cannot know the outcome, but all we can do is try to make the best decisions possible given the information we do have at hand.

Let us give you a personal example of how we fall in the trap of judging our decision by the outcome. In April, we had recommended our clients purchase a payment-related stock that has since gone on a tear (10x from the March bottom, 4x from our recommendation point). Before the September mini-meltdown in the market, we noticed that this position was becoming an unusually large part of our client’s portfolio. Given that the valuation had run above what we would think was reasonable value, and the exposure to the overall portfolio, we recommended clients trip 20% of the position. We also told them to put in orders to buy back the 20%, at a lower level. But lo-and-behold the stock never reached that level and instead accelerated to a brand new-high. We kicked ourselves for this for a few days. Upon reflection we noticed the decision making process wasn’t too bad, it was a prudent decision, and we actually got within a whisker of buying back the shares at a lower level (as the stock did correct significantly). It just wasn’t meant to be. This prudent decision making was actually a huge winner for us in Jan and Feb this year where we moved to de-levered a number of client portfolios (not because we knew global lockdowns were coming, just because we generally don’t like leverage) and raise cash for some liabilities we knew our clients had to fund. It just so happens, this time luck was on our side, and we went into March and April with a lot of firepower. Again, had the virus somehow not gone beyond China, this decision might have looked too conservative in hindsight.

As most people understand, but often fail to internalize is that we cannot control outcomes. Outcomes often are driven by forces outside our control. Not being able to recognize this truth leads investors to make some very poor decisions, i.e. selling when their thesis is still intact, not investing in a generally outperforming fund because it’s going through a period of underperformance, or doubting themselves when something hasn’t gone quite right. In the end no matter how good your process, you’re bound to get a few things dead wrong, and that result is not an indictment of your process. Now, we’re certainly not saying that processes can’t be flawed, but rather the point is that even solid processes can lead to bad outcomes.

We hope this helps you reframe your thinking when it comes to judging yours or other people’s decision making. Further, we hope this also prepares you a bit better for bad outcomes, because unfortunately, no matter what you do, we will eventually catch a flying knee to the face. Happy Investing!