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“Out of the box” Thinkers Dominate Finance

05 January, 2010
Being away from Mumbai’s manic stock market for even a week can do you a power of good. That was my first coherent thought during my Christmas vacation. Towards the end of my vacation, two extensions of this idea struck me with force. The first is that the most powerful concepts in Finance come from outside Finance. The second is that a disproportionate number of legendary investors live outside the main global financial centres.
 
Let me start with the first concept. Over the last 20 years almost all the ideas that have revolutionised Finance have come from outside the discipline. It started when two psychologists, Amos Tversky and Daniel Kahnenan, teamed up in the 1970s to articulate the whole set of concepts that we now call “Behavioural Finance”. Tversky and Kahneman explained how our fears, our greed, our prejudices and even our self-confidence leads to flawed decision-making at the level of the individual and inefficient markets at the macro level. These market inefficiencies in turn generate profit making opportunities.
 
Then, around seven a years ago, a book called “Fooled by Randomness” became popular among mathematicians. It was written by Nassim Taleb and despite being published in 2001, very few people in the world of Equities had heard about it until 2007. As it turned out, Taleb’s warnings in “Fooled by…” about the high impact of what appear to be low probability events were prescient – financial markets collapsed in 2008 unable to deal with the plight of the US mortgage market. Taleb’s central point is that the traditional notion of Finance as a rational and quantitative discipline has been overdone. As a result, he says, we no longer appreciate the importance of what we think are low probability events despite the fact that these events can impact our investment returns far more than the “base case” scenarios that our investment analysis focuses on.
 
My hunch is that in the years to come the most powerful insights in Finance will come from sociologists. In the published works of superstar economist/sociologist Steven Levitt (of “Freakonomics” fame), you can see how powerful the insights provided by the intersection of statistics, economics and sociology can be (eg. if you incentivise teachers on the basis of their students’ marks, the teachers will help their students cheat).
 
As we wait for the Indian Steven Levitt to emerge, my discussions with Indian sociologists suggest that the biggest stock price movements over the next decade will be caused by three inter-connected developments: (a) the relentless rise of small town and semi-urban India – cities like Indore, Nasik, Jabalpur, Mangalore, etc.; (b) the tendency among Indian women across a range of socio-economic classes to delay marriage and thereby change the spending patterns that companies take for granted; and (c) the increasing economic and political assertiveness of formerly impoverished groups of people. Two authors whose travelogues vividly capture these trends are Pankaj Mishra (“Butter chicken in Ludhiana”) and V.S.Naipual (whose “India: A million mutinies now”, written in the late 1980s, captures the spirit of the last twenty years beautifully).
 
That brings me to the other revelation I had whilst on holiday – the most successful investors tend not to live in the main global financial centres. Warren Buffet lives in Nebraska. Bill Gross, the Warren Buffet of bond investment, lives in California. In India, some of the best fund managers live in Chennai, not Mumbai.  In the UK, a disproportionate number of star fund managers live in Edinburgh, not London. Whilst cities like London, NY City and Mumbai have their share of star fund managers, the outstanding abilities of fund managers living away from these financial hubs is striking. So how can we explain this? I am sure advances in communication helps these investors stay connected with markets, I think their success lies in not getting sucked into the daily gossip, noise and rumours that characterise financial markets. As one of my Edinburgh-based client says, “I really don’t care what happens to this stock’s price tomorrow, next week or next month. What I do care about is whether the underlying investment hypothesis on which I invested has been impacted due to changes within or without the company.” Given that this client manages funds running into tens of billions of dollars, if he can stay away from staring at stock prices every day, maybe it might do all of us some good to obsess less about stock prices in 2010.
 

 


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“Out of the box” Thinkers Dominate Finance

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