The Illusion of Control
During these past few weeks, I’ve been thinking a lot about how little of our lives are in our control. From the time we’re conceived, very little of what makes us, well “us”, is actually up to “us”. Like most of the world, I was quite saddened by the events in Afghanistan this week, but it caused me to reflect on what my chances of success would have been had I been born in that country. I would wager that my chances would be in low double digits or perhaps in the single digits. You can conclude this with a quick mental exercise – without googling, try and name a famous non-political Afghani. I think you’ll find it to be tough – and just FYI Malala is Pakistani. The reason here is not that a plethora of talented hardworking Afghanis don’t exist. It’s just that the political and economic conditions in the country makes it near impossible for someone to break out of the environment. I often reflect on how luck has already played such a huge role in my life. My own home country of India is rife with poverty, and at the time of my birth in 1987, slightly more than 50% of the population lived under the poverty line. It was basically a coin flip of a chance that meant I ended up above the line, and several more coin flips for me to be born into an upper-middle class family.
Now, this post is not meant to be a chicken-soup-for-the-soul type, but rather to draw observations on how the illusion of control can impact investing. So, to start the illusion of control is the tendency for people to think that they have more control over events than they do. Through this lens, we tend to overestimate our impact on our successes and underestimate them on our failures, while ignoring luck as a factor all together. Let’s take a simple example, say you played the lottery and in one scenario, you picked the numbers and the second you let a random number generator pick them for you. Let’s assume you won in both – which one would you be happier/prouder about? I’m guessing the former, even though the odds were the exact same.
There are several examples that I’ve come across in the investing world where I think this bias comes into play. For example:
The illusion of macro: Lately, we’ve heard a lot about inflation, the fed tapering, stretched valuation, etc etc etc. The reality is there have only been three macro events over the last 20 years that have made a lasting impact on markets. The dot com crash in the early 2000s, the 2008 subprime crisis, and the 2020 covid pandemic. Nothing else has really mattered. Thus, trying to think through macro and planning for it gives you the illusion of control, without actually giving you control.
A 50/50 hit rate: Over a long-enough market cycle, even the best investors have only a 50% hit rate on their stocks.[1] This implies that despite strong analytical skills, there’s a strong element of luck within stock picking even for the industry’s best. What really sets these top investors apart is what they do with their winners and what they do with their losers (hint: they ramp up their winners and cut their losers).
A different type of virus: In 2020, investors in tech were deemed to be geniuses as the pandemic forced us indoors and online. Now, granted the move-to-online trends already existed but almost no one expected the 2020 acceleration. Yet, those investors took a lot of credit for very strong portfolio performances. But I wonder, what if it had been a different type of virus? What if instead we instead faced a computer virus (or broad scale hack) that crippled online infrastructure? You could imagine we’d be speaking of a very different narrative. Ironically, tech investors have been lambasted this year as their holdings lap tough comps. My point is neither the assumption of genius or stupidity is correct - luck played a big part here.
The very visible hand: The last two months have been brutal for Chinese stocks given government action. While there were signs that some of this regulation was coming, most investors were still left quite blindsided (and before anyone says it was investors who didn’t know anything about China – it was mostly Chinese investors who bore the brunt of the drawdowns). Government action is very much out of the control of China investors, but now that the actions have been unveiled investors have to make tough choices about getting out or doubling down. For what it's worth, I do think it might be safer now to invest in China than it ever has been considering the government has shown its hand, so the “luck” factor has been taken out of the game to a certain extent.
Now the question becomes how we practically use this understanding of the illusion of control to make better decisions (I will caveat that this is hard because being cognizant of your biases does not imply you can control them). Here are some of the ways I try to control over-indexing successes.
When it’s too easy to make money: In Jan/Feb 2021, we saw client portfolios gaining almost every day. This isn’t normal, and when it’s too easy to make money, I try to be quite quick to attribute this to external forces rather than my own “genius.” I’ll be honest though, while we took some money off the table, we didn’t take nearly enough off.
Trying for too-many home runs: When evaluating funds, we often see that success is driven by tail events (one or two positions that really went gangbusters). However, these ‘home-runs’ are hard to come by. So, when we see a fund manager who just absolutely nailed it on a stock go and try and build a huge position in another (because they feel that they can replicate the success), we get a bit wary. You saw this, after 2008 when investors who called the financial crisis, had mediocre results on their future bets. John Paulson on gold, David Einhorn on his Tesla short, etc.
Actively look for luck: Every time we make significant gains in an investment, we try to think through what part of it was luck and what part of it was our thesis being right. In early 2020 when Afterpay crossed $120, we thought a 12x move in just a few months was a bit too lucky and started to trim the position (it did to as high as $150 though). Similarly, when speaking to fund managers we ask them what their “luckiest” investment was, and if they can’t think of one, they might be letting hubris get the best out of them.
Not stressing about errors of commission: This is a tough one, but when I have an investment go bad, I try not to dwell on it (although I do fail at this from time to time). Just as I try not to over index “genius” when things go well, I try not to over index “stupidity” when things go badly. Anyway, to succeed in this business you’re going to be cognizant of the fact that you will have several stinkers in your portfolio overtime.
Both in my investing life and my personal life, I do my best to focus on what I can control – the effort I put into my work and relationships, discipline with my schedule and daily tasks, and my communication with all the stakeholders in my business and my life. After all, if the last 1.5 years of the pandemic have taught me anything, is that a significant chunk of how my life pans out, is really beyond my control.
I hope this blog post helped you ‘let go’ of the perception of control in your life ever so slightly. Thanks for reading, and happy investing.
[1] Research presented by Lee Freeman-Shor in “The Art of Investing”