First published in the Daily Maverick 168 weekly newspaper.

I recently had insight into how I treat money when I was kicking myself for not investing (disposable cash that I don’t have) in bitcoin. A good friend of mine recently quadrupled a sizable sum of money by investing in bitcoin and ethereum and at the time (early February) advised that I invest too. I didn’t. But I stopped being so hard on myself when I realised that if I had the chance again I probably still wouldn’t – I’m too risk-averse. My strategy is slow and steady wins the race. Boring, I know.

Investors like Housel have been applying human behaviour to investing for decades and the practice has a certain following. At a recent behavioural summit hosted by Nedbank, a presentation on behavioural science in investing caught my attention. I’ve always wondered how it was that some investment managers have consistently avoided fallen angels like Tongaat, EOH and Steinhoff. After all, they are looking at the same numbers and company reports as everyone else.

Listening to William Pattisson, cofounder of and portfolio manager at UK investment firm Ardevora, I realised there is other valuable data out there for the observant – human behaviour, particularly that of the CEO.

Pattisson and the other Ardevora cofounder, Jeremy Lang, have developed a methodology for picking stocks that requires an understanding of how three groups of people interact: CEOs, financial analysts and investors. CEOs, says Pattisson, are prone to overconfidence, while sell-side analysts (who make buy, hold and sell recommendations) are prone to under-reaction, being overconfident about their forecasting ability and resistant to information that contradicts their views. And investors – large and small – are prone to over-reaction, drawing black-and-white conclusions from a narrow range of information. The stock market crash in March 2020 is an obvious example – and provided a massive buying opportunity for those who saw through the fear.

Most people obsess about the opportunity before they look at the risk. This can lead to one becoming emotionally “invested” in the opportunity and thus unable to quantify the risks. At Ardevora the partners look at the risk first. If it looks risky they don’t even think about the reward.

This reminds me of an investment manager I know who won’t invest in Naspers or Prosus because of the Chinese regulatory risk around Tencent. The risk makes him willing to forgo the reward.

Risky business

CEOs by their nature are prone to risky behaviour. That’s because the type of person who runs a large listed company is self-confident and doesn’t like being told they are wrong. Asher Bohbot, Peter Staude, Markus Jooste? While these characteristics may be useful in getting to the top, once there the characteristics that make a good CEO include being able to listen, accepting you can be wrong and be able to change.

If the natural tendency of a CEO is to take risks, compounded by a remuneration system that is focused on short-term payoffs and driven by a licence to go for growth from shareholders, then it is not surprising that Ardevora’s portfolios are constructed by rejecting stocks rather than by choosing them.

But I couldn’t help wondering, then, how one finds growth opportunities when risk is removed from the equation. Watch out for companies where management has lost credibility and so shareholders won’t allow risky decision-taking, says Pattisson. Or look for companies where growth is unusually easy (the pharmaceutical companies in the 1960s and 1970s, or chocolate in the 2020s), or the growth runway is unusually long. Sometimes the obvious is not obvious and some companies can surprise analysts for a long time.

An example is French company Hermès, a 200-year-old firm with its roots in saddlery. Today it’s a powerful business, controlled by a family with a long-term view, deep and complicated supply chains and effective marketing machinery.

Combine that with aspirational products and growing global affluence and you have a company with an unusually long runway that has been overlooked by many analysts, he says.

Will fortune favour the brave?

It goes without saying that there are not a lot of these companies out there. What there are, particularly now, are companies that are recovering in value. Pattisson asks whether you are brave enough to buy other people’s anxiety. The trauma of the Covid-19 crisis has devastated stocks. Will this trauma remain? When you are in the depths of a traumatic event it is very hard to gauge objectively where the balance of risk and reward is.

Changing management behaviour is worth watching too. While giant companies like Marriott will survive by virtue of deep pockets, the companies that have faced their challenges and adjusted their strategies are interesting. Take French car company Renault, which has lurched from one bailout to the next for years and is unloved by investors. It has a new CEO, has sharpened its strategy and is focused on cutting debt.

Which reminds me why I love the investment world. It’s not just shares, companies and investments that fascinate me – it’s the people. DM168

This story first appeared in our weekly Daily Maverick 168 newspaper which is available for free to Pick n Pay Smart Shoppers at these Pick n Pay stores.