The rise of ETFs is threatening active investment firms. The ETFs are powered using technology, data analysis and consistent algorithm decision making. The active managers are under challenge. Some are waiting for the passive investment (ETFs) industry to show some vulnerability while others are investing on technology and people.
I would like to provide my opinions on how can active investment management can challenge passive investment industry. I believe, it is by challenging the status quo of people working in the investment industry. 'The times they are a changin', and it is time to re-think and re-define the role of industrialized analysts in the post-industrial and digital world. In my opinion, the following types of analyst will thrive in the post-modern world:
Symbolic Analysts
Essentialist Analysts
Antifragile Analysts
Post-conventional Analysts
All opinions/views are my own.
A. Symbolic Analysts
Symbolic analyst, first introduced by Robert Reich in the book: “The Work of Nations: Preparing Ourselves for 21st century’, in general “solve, identify, and broker problems by manipulating symbols.” In other words, the symbolic analyst is someone who is a problem identifier, a problem solver, or an innovator who can visualize new uses of existing technologies.
Routine production and routine service jobs are evaluated based on number of hours worked or amount of goods/products generated.
While, on the other hand symbolic analysts are post-modern and post-industrial workers. Symbolic analysts enjoy more fluidity and freedom in their work than those in traditional white-collar occupations such as professionals or corporate middle managers, who can be tied into strict and controlling organizational hierarchies. Symbolic analysts are vulnerable to falling income if the quality and relevance of their work fades or if their creative ideas run out.
He described that the symbolic analysts have these four basic skills:
i. Abstraction
The capacity for abstraction – for discovering patterns and meanings - is the very essence of symbolic analysis, in which reality must be simplified so that it can be understood and manipulated in new ways. The symbolic analyst wields equations, formulae, analogies, models, constructs, categories, and metaphors in order to create possibilities for reinterpreting, and then rearranging, the chaos of data that are already swirling around us.
ii. System Thinking
It carries abstraction a step further. To discover new opportunities, one must be capable of seeing the whole. The symbolic analyst must constantly try to discern larger causes, consequences, and relationships. Problems can usually be redefined according to where you look in a broad system of forces, variables, and outcomes, and unexpected relationships and potential solutions can be discovered by examining this larger terrain.
iii. Experimentation
In order to learn the higher forms of abstraction and system thinking, one must learn to experiment. Exploring a city on your own rather than following a prescribed tour may take you far afield - you may even get lost. But there is no better way to learn the layout or see the city from many different points of view. The habits and methods of experimentation are critical in the new economy, where technologies, tastes, and markets are in constant flux.
iv. Collaboration
Symbolic analysts typically work in teams - sharing the problems and solutions in a somewhat more sophisticated version of a child's play group. Symbolic analysts spend much of their time communicating concepts - through oral presentations, reports, designs, memoranda, layouts, scripts and projections - and then seeking a consensus to go forward with the plan.
While the traditional analysts are busy following the orders, reacting to news, watching Warren Buffet’s videos, attending team building seminars and fearing ETFs , symbolic analysts are discovering patterns; finding causes, consequences and relationships; learning new tools, languages and technologies; exploring new ways of doing traditional activities; and collaborating with people with shared motivation.
B. Essentialist Analysts
Humans cannot compete against technology regarding computation, reacting to information, focusing on everything at once, thinking probabilistically and ability to be non-biased all the time. For that reason, analysts should embrace essentialism and should focus most of their efforts on value-additive activities.
The part is borrowed from Greg McKeown. I would highly recommend reading 'Essentialism: the disciplined pursuit of less' by Greg McKeown. If you do not have time, you could always rely on the following notes.
What is the core mindset of essentialist analyst?
Individual Choices: Essentialist analyst could choose how to spend their energy and time.
The Prevalence of Noise: They believe that almost everything is noise, and a very few things are exceptionally valuable. They take time to remove noise.
The Reality of Trade-offs: They understand that they can’t have it all or do it all. They ask the honest question 'what is the most important thing to do?'.
Why non-essentialism is everywhere?
There are too many choices.
There is too much social pressure.
People have idea that 'they can have it all'.
What steps are taken by essentialist analyst to develop this framework?
Explore and Evaluate: Discerning the trivial many from vital few.
Eliminate: Cutting out the trivial many.
Execute: Removing obstacles & making execution effortless.
I. Exploration
The essentialist analysts have these six fundamental attributes that differentiates them in this category:
1. Power of choice
It would be intuitive to assume that everyone has power of choice. But in 1960s scientist discovered the concept of learned helplessness in humans and animals. It was discovered by Seligman & Maier through an experiment in 1965.
"Learned helplessness is behaviour exhibited by a subject after enduring repeated aversive stimuli beyond their control. It was initially thought to be caused from the subject's acceptance of their powerlessness: discontinuing attempts to escape or avoid the aversive stimulus, even when such alternatives are unambiguously presented. Upon exhibiting such behaviour, the subject was said to have acquired learned helplessness."
A lot people in the investment industry have learned helplessness regarding macro economics, Knightian uncertainties and issues that are just beyond their scope. Due to these learned helplessness, professionals are focusing more and more on non-essentials to maintain the perception of their ability.
On the other hand, essentialist analysts are able to discern the essentials from the non-essential and not take part in non-essential activity.
2. Ability to discern
Non-essentialist thinks that everything is essential and views opportunities as basically equal. On the other hand, essentialist thinks that everything is non-essential and distinguishes the vital from trivial many.
3. Ability to create space
They believe that in order to focus, they need to escape to focus. They create space to design, space to concentrate and space to read. The non-essentialist is too busy doing to think and the essentialist is constantly creating space to escape and explore.
4. Ability to look and cut the bullshit
Non-essentialist pays a lot of attention to the loudest voice, hears everything being said and is overwhelmed by all the information.
Essentialist, on the other hand is able to pay attention to the signal in the noise, hears what is not being said and scans to find the essence of the information.
5. They are playful
The non-essentialist thinks that play is trivial and thinks play is an unproductive waste of time. Essentialist knows play is essential and knows play spark exploration.
Play is defined as the activities we do simply for the joy of doing rather than or means to an end. Play has power to significantly improve everything from personal relationships to education to organization's ability to innovate.
6. Ability to select
Non-essentialist says yes to almost every request and opportunity, uses broad and implicit criteria like 'if someone else is doing it, I should do it too'.
While, essentialist is says yes to only the top 10% of opportunities, uses narrow and explicit criteria like 'is this exactly what I am looking for?'.
II. Elimination:
The essentialist analyst have these four following attributes:
1. Essential intent
The non-essentialist has a vague, general vision or mission, has concrete quarterly objective that fail to energize themselves and peers and has a value set but no guiding principles for implementing them.
While, essentialist has a strategy that is concrete and inspirational, has an intent to be meaningful and memorable and makes one decision that eliminates over thousand decisions.
2. Ability to Dare
Non-essentialist says yes to avoid feeling social awkwardness & pressure and almost says yes to everything. While, essentialist dares to say no firmly, resolutely and gracefully. They say yes to the things that really matter.
3. Ability to Un-commit
Non-essentialist asks 'why stop now when I've already invested so much in the project?', thinks 'If i can keep trying, I can make this work" and hates admitting mistakes.
Essentialist asks 'If I weren't already invested in this project, how much would I invest it now'?, thinks 'what would I do with time and money if I pulled the plug now?' and they are comfortable with cutting losses.
Essentialist avoids commitment traps with the following traits:
a. They are beware of the endowment effect. Endowment effect is our tendency to undervalue things we do not own and overvalue things we own;
b. They can pretend that they do not own it yet;
c. Get over the fear of waste, also know as sunk cost fallacy. Individuals commit the sunk cost fallacy when they continue a behaviour or endeavour as a result of previously invested resources (time, money or effort);
d. Instead, admit failure to begin success;
e. Stop trying to force a fit;
f. Get a neutral second opinion.
g. Beware of the status quo bias and is able to apply zero-based budgeting.
h. Get over the fear of missing out.
4. Ability to edit and subtract
Latin word for decision is 'decisio, which means to kill or to cut. Non essentialist thinks that making things better means adding something and they are attached to every word, detail or image.
While, on the other hand essentialist thinks that making things better means subtracting something and eliminating the distracting words, images and details.
III. Execution
The essentialist analyst have these four following attributes:
1. Buffer
The non-essentialist assumes that the best case scenario will happen and act on it and they usually force execution at the last minute.
The essentialist on the other hand, builds buffer for unexpected events. They practice extreme and early preparation.
They conduct proper survey planning through following ways:
1. Risk measuring and controlling.
2. They focus a lot on worst-case scenario.
3. They understand the social, economic and cultural impact of their actions. 4. They invest to reduce risk & strengthen extreme and social resilience.
2. Progress
The non-essentialist starts with big goals and goes for the flashiest wins.
The essentialist on the other hand, starts lean and gets big results. They learn from mistakes and celebrate small acts of progress.
3. Flow
The non-essentialist tries to execute essential by force and allows non-essential to be the default.
The essentialist on the other hand, designs a routine that enshrines them. They make the execution of essential almost effortless and seamless.
They make it look easy by:
1. Right routine. 2. overhaul their triggers.
3. Create new triggers.
4. Do the most difficult things first.
5. Mix up their routines.
6. Tackle their routine one by one.
4. Focus
The non-essentialist's mind is always spinning out about the past or the future, thinks about what was important yesterday and tomorrow and worries about the future and stresses about the past.
The essentialist's mind is focused on the present, tunes in to what is imp. right now and enjoys the moment.
C. Antifragile Analysts
This part is borrowed from Nassim Nicholas Taleb. Antifragility is defined as:
“Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure, risk, and uncertainty. Yet, in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.”
Taleb provides examples to explain the three: Fragile, Robust, and Antifragile.
Damocles, who dines with a sword dangling over his head, is fragile. A small stress to the string holding the sword will kill him.
The Phoenix, which dies and is reborn from its ashes, is robust. It always returns to the same state when suffering a massive stressor.
But the Hydra demonstrates Antifragility. When one head is cut off, two grow back.
Here are some of the characteristics of antifragile analyst:
1. Antifragile analysts do not worry about maintaining perception or having a code of appearance. They are authentic and they are ready to feel the storm when their work or output deteriorates.
2. They are ready to learn from their mistakes. They also understand that without putting themselves in vulnerable position, they cannot grow. They believe in trial and error and are ready to learn from their mistakes and get stronger.
3. They do not try to fit into something they are not.
Taleb uses the “Procrustean Bed” story to demonstrate how people create harm by reducing variations. Procrustes would capture travelers and put them in his bed, stretching them on a rack if they were too short for it or chopping off their extremities if they were too tall. When a person destroy variations to fit a model, they do similar harm.
4. They avoid being a turkey. “The turkey problem” is how one can imagine a turkey raised and fed from birth, becoming more sure every day that it will continue to be well fed and taken care of, based on its past evidence, right up until Thanksgiving.
5. They are probabilistic in nature. Although they are very rationale being, they embrace randomness and chance in their decision making and interpretations. Taleb provides a paradox to explain importance of randomness.
A donkey equally hungry and thirsty stuck between a bale of hay and water will die of starvation and thirst, unable to make a decision between the two. However, a random nudge in one direction will solve the problem for him. Randomness can help with decision making and becoming unstuck, but when we try to reduce it, we lose that beneficial stressor.
6. They prepare for adversity when they are at the top of their game or are in control.
7. They challenge themselves continuously and surround themselves with the strongest.
8. They are conscious of green lumber fallacy and teleological fallacy.
9. They embrace optionality and create many opportunities for themselves.
10. They are linear as well as lateral thinkers.
D. Post-conventional Analysts
In Investment Management, to be successful you have to be right as well you have to be contrarian.
Symbolic, Essentialist and Antifragile analysts could learn how to be right through their approach to research and analysis. But to be contrarian, they need to be 'Postconventional'.
"Postconventional morality, a concept developed largely by psychologist Lawrence Kohlberg, identifies the ethical reasoning of moral actors who make decisions based on rights, values, duties, or principles that are (or could be) universalizable. This means that the principles are separable from the authorities or persons who hold them, they are open for debate and generally agreeable to individuals who seek to live in a fair and just society, and they withstand tests of logical comprehensiveness. Postconventional morality, as distinguished from postconventional moral reasoning alone, also includes principled moral behaviour, or moral action."
Kohlberg's Theory of Moral Development
Level 1. Pre-conventional Morality
Stage 1: Obedience and Punishment
The earliest stage of moral development is especially common in young children, but adults are also capable of expressing this type of reasoning. At this stage, children see rules as fixed and absolute. Obeying the rules is important because it is a means to avoid punishment.
Stage 2: Individualism and Exchange
At this stage of moral development, children account for individual points of view and judge actions based on how they serve individual needs. In the Heinz dilemma, children argued that the best course of action was the choice that best-served Heinz’s needs. Reciprocity is possible, but only if it serves one's own interests.
Level 2. Conventional Morality
Stage 3: Interpersonal Relationship
Often referred to as the "good boy-good girl" orientation, this stage of moral development is focused on living up to social expectations and roles. There is an emphasis on conformity, being "nice," and consideration of how choices influence relationships.
Stage 4: Maintaining Social Order
At this stage of moral development, people begin to consider society as a whole when making judgments. The focus is on maintaining law and order by following the rules, doing one’s duty and respecting authority.
Level 3. Post-Conventional Morality
Stage 5: Social Contracts and Individual Rights
At this stage, people begin to account for the differing values, opinions and beliefs of other people. Rules of law are important for maintaining a society, but members of the society should agree upon these standards..
Stage 6: Universal Principles
Kolhberg’s final level of moral reasoning is based upon universal ethical principles and abstract reasoning. At this stage, people follow these internalized principles of justice, even if they conflict with laws and rules.
For example, the importance of principles in Ray Dalio's style of management. Here is the summary of the book principles: https://inside.bwater.com/publications/principles_excerpt
"If your time to you is worth savin' Then you better start swimmin’ or you’ll sink like a stone For the times they are a-changin'’"
Bob Dylan
