Probabilities vs. Absolutes

Joe: I’m excited to welcome our guest today, Ted Seides. I first met Ted a few years ago at an event for the Alliance. We’ve always had exciting and thought provoking conversations, so I’m thrilled to have him on the show today. A bit about his background: Ted is the founder of Capital Allocators, LLC, as well as the host of a hugely successful podcast, “Capital Allocators.” He’s the author of the widely praised, So You Want To Start a Hedge Fund?, and the soon to be released Capital Allocators: How the World’s Elite Money Managers Lead and Invest. Ted is also on the Advisory Council here at the Alliance for Decision Education. So welcome Ted and I would love for the audience to hear in your own words what you do and also what your journey here has been like. Would you paint that picture for us?

Ted: Sure. Well, thanks, Joe. It’s really a pleasure to share this space with you. Well, what I do today is a public version of what I’ve done for, call it 20, 25 years. And that is, I spend my time talking to what we’ll call capital allocators or they’re really often chief investment officers of large pools of capital like endowments and foundations and pension funds. And then I spent a chunk of time talking to money managers about the strategies they pursue and what’s happening in the markets. For most of my career, I started out of undergrad working for the person who’s become the most famous in this field, a guy named David Swensen, who for the last 30-something years now has managed Yale University’s endowment and created really a novel model for how a lot of university endowments and foundations invest their capital. And I worked for David for five years helping manage Yale University’s assets. I went to business school. I spent a couple of years directly investing, picking stocks and a little bit in private equity. And then I spent 14 years as the co-Chief Investment Officer of an investment fund that invested in hedge fund strategies and that went through 2015. And then the last three and a half years, a big chunk of my time has just been spent on this podcast, talking to people who were in similar or are in similar roles and what they’re doing today and how they’re, how they’re going about it.

Joe: Ah, that’s fascinating and very helpful. You mentioned a few things there that our audience may not be as familiar with. One of the terms you used was a hedge fund. Could you just describe what that is and how it’s different or similar to the investment funds that people might typically think of?

Ted: Sure. I think there’s a notion in investing of traditional strategies and alternative strategies. And the traditional strategies are generally thought of as stock funds and bond funds, so people who are buying stocks in the market or buying bonds. A hedge fund is a little bit different in that it’s really an investment strategy more than just owning a stock or a bond. And there’s lots and lots of different types of hedge funds. But one thing to think about is that something, or there’s a notion at least, that something is hedged. So there’s a risk that you’re reducing. So, one example that you might think about is, or probably the oldest example, it’s a little less popular these days, but we used to talk a lot about: you could buy the stock of Coca-Cola if you thought more and more people were planning to drink soda. But you could also think of a strategy where you felt like you knew something that was very special that was happening in Coca-Cola. Maybe they were ahead of the curve in flavored waters compared to all their competitors. And you really weren’t interested in betting on soda. But you wanted to bet on that particular execution of the company in this new product. So one thing you could think about doing is you could buy Coke and at the same time you could sell Pepsi. And so you’re taking away a lot of things that you’d benefit from normally in Coke stock. So for example, GDP growth, the growth of beverage consumption generally. And instead you’re hedging that out. So you’re taking out the market risk, you’re taking out maybe consumer product risk, and you’re really only trying to make a bet on the particular execution of Coke relative to Pepsi. So that’s just one simple example of the type of a strategy that a hedge fund might pursue.

Joe: Okay, so that’s helpful because one of the things that is interesting to me about the industry that you work in and [that] I think a lot of our listeners would find interesting is just the significance of the decisions, the weight of them, in terms of the kind of things people normally think about when they’re making financial decisions. So I just wanted to drill in a little bit on that. And so then the next thing is, so you’re entrusting someone to make investment decisions in the range of a hundred million to $500 million for you. What are you advising people or what are you hearing from capital allocators that they’re looking for with regard to either the dispositions or the skills that these managers have? What are they paying attention to?

Ted: Yeah. I mean, it is a very multifaceted, complex decision process. Among the things they pay attention to are the people. And there’s a lot of alliteration. So when does the three P’s: People, Process, and Performance. There’s a lot of others. It’s cute, but it encompasses a lot. They absolutely look at the people and they’re really looking for people whose incentives and alignment are consistent with the goals that the particular CIO or the allocator is trying to accomplish. They’re looking for a certain type of competitive advantage that those people have in their personality. They might be looking for a certain type of even temperament to what can be kind of bumpy markets, as the case may be. There’s lots of different criteria. You hear words like integrity and consistency a lot. And that’s true of the leader and it’s also true of the team and the team dynamics and how does the team work together, and how do they communicate with each other, and how do they make good decisions? Then you get into a whole layer of their investment process: what do they believe about the opportunities they’re pursuing? How do they find their ideas? How do they make decisions? How did those decisions turn into a portfolio and results? And then people will spend time trying to understand what are their expectations for the future in terms of performance? How might the past be similar or different from what that will look like going forward? And all of these decision points can vary across different types of strategies as well. Like what the most important features are can change quite a bit.

Joe: So you mentioned decisions a couple of times there, not surprised I’m going to follow up a little on those. When people are evaluating them about their decision-making or their decision quality, what are the skills or what are the behaviors that you notice people paying attention to or looking for?

Ted: I think it’s very similar to what we described at the Alliance to sound decision processes. So you’re looking for people who gather the right amount of information, clearly qualitative what the ‘right’ amount means. But sometimes they get stuck in analysis paralysis. Sometimes they don’t gather all the information they should. You’re looking for people who are cognizant of all or as many behavioral biases as they can be and seek to mitigate those through their process. Confirmation bias is the one that comes up the most in the investment world, meaning that if someone’s trying to make a decision about, ‘I want to buy Coca-Cola,’ I might want to look at consumption trends and I might only be focused on the good markets for Coca-Cola and not try to figure out, well, where might my thesis would be wrong? So people who are cognizant of that and design into their process. And then when you have teams, you have to pay careful attention to how information gets brought up the food chain from the person, maybe at the ground level, doing the research to maybe a sector head or to a portfolio manager and how they process that information and try to make sure they’re eliciting all the opinions that they can that go into making a good group decision process at the end of the day.

Joe: I’m curious how much of the edge that you think one firm might have versus another is related to the way they process information, the norms they have around making decisions, recognizing and resisting biases, thinking in probabilities, those sorts of things versus that they’ve actually identified a strategy or an insight about the market that is distinct and gives them a competitive edge. How would you allocate where most of the advantage is at this point?

Ted: Yeah. Well, I know you’re going to be talking to Michael Mauboussin if you haven’t already on the show, and he has this wonderful acronym he uses called B.A.I.T. where B is behavioral, A is analytical, I is informational, and T is technical. All of those are aspects of what can create an advantage in public market investing. Behavioral is a funny one in that everyone can go out and just buy an index fund. And maybe do pretty well. And so what really happens is that behavior hurts people more than it creates an advantage over people, because the index fund you buy doesn’t have any behavioral flaws in it. So most of the advantages that you see tend to be either analytical, meaning someone’s raw horsepower is just better than other investors. And often as you alluded to something particular in their expertise or an inefficiency they’re pursuing. The behavioral challenges allow those to get expressed in returns. And if they don’t get around conducting themselves in a way that’s conducive to making good decisions, they’ll just be hurt. It’s not that they’re going to be as advantaged over other people because unlike in a lot of other fields, in investing, the lay person can do quite well, the average is quite well. You can’t go to an untrained, mediocre, not knowledgeable surgeon and expect to have a good outcome. So investing is quite different in that way.

Joe: What are the mistakes that you typically see around either the allocator or manager decisions that are not what you would describe as behavioral?

Ted: All of these things blend together, so I’m not quite sure I would separate them. But the biggest one that you see a lot is overconfidence. And I guess that’s behavioral, but it also has to do with information in that someone could sort of fall in love with a manager and get pretty confident that that manager will do well in the future. Oftentimes, because among other things, they’ve perceived them do quite well in the past. And they stop the process of gathering more information that might do one of two things. One, it might change their mind about the manager, but more often it does a better job in reducing that confidence of better calibrating expectations for the likely path of results, maybe it’s more volatile than they appreciate. And it allows them therefore to behave better as investors and not get kind of scared away if things don’t go on a smooth path. So I think that’s one example. The one that the other one that comes up through the data with great consistency in all of investing is that people chase performance. Meaning that whether it’s a stock or a fund, investors tend to buy into things after an abnormally good period of performance. And then they tend to sell out after a period of abnormally bad performance. Now that’s known and yet it still happens, which lets you believe it’s behavioral. And I’ve seen that in a bunch of different ways. And one is that people try to articulate what their hypothesis is about an investment and what the risks are. And if some of the risks play out, it may still be consistent with the thesis, but they can ascribe it to saying, Oh no, no, we made a mistake. See, that was bigger than we thought it was. And so I’ve seen examples where people will bail out of investments that aren’t working  primarily because they’re not working and not because of a proper perception of what might happen in the future.

Joe: Have you seen, or maybe you’ve experienced this yourself, people that have identified overconfidence as a problem that’s affecting them and then deployed some kind of strategy or change in their behavior that has helped to mitigate it?

Ted: Yeah. There’s, there’s lots of examples of that. There’s a whole set of risk tools that investors might employ right when they’re at the cusp of making a decision, but they haven’t finalized it yet. So those include things like the premortem analysis, which is probably the most effective as far as I understand. And the idea is that commonly, if somebody makes an investment and it goes badly, at the end of that, they might conduct a post-mortem analysis and say, “Okay, what went wrong and how might we be able to use that information to make better decisions in the future?” The premortem tries to invert the timing of that because once you’re doing the post-mortem it’s already too late, the body’s already dead. This was really created and popularized by Gary Klein, who’s a cognitive psychologist and he initially did it with fighter pilots. If you can find a process that’s relatively straightforward, and he describes it extremely well, then you can try to unearth things imagining that your plan or your decision has gone wrong and then try to figure out what might’ve caused it to go wrong. It does two things. One is it brings up lots of different other possibilities, other things that could play out. And that it also effectively reduces the overconfidence of a group. That’s the most powerful one. I know you hear things about red teams and blue teams, which is effectively the same thing as a team-based devil’s advocate, or even as simple with one person as a pro and a con list that forces someone to think about the things that could go wrong.

Joe: When you think about the lessons that you’ve learned in thinking about money management and allocators and the decisions they make, what are the lessons that you’ve taken into and incorporated in your own life about decision-making that aren’t necessarily in your professional space? Are there things that have transferred over?

Ted: Well, in some ways everything does. If there’s one big lesson for me, it’s never too late to learn and grow because this whole science of decision-making that we’re working on at the Alliance was new to me only a couple of years ago. And I did go through a long part of my career in process of making decisions. And I could look back and say, some of those were pretty thoughtful and others weren’t both professionally and personally. But some of the biggest decisions that I made in my life we’re not from good decision processes. And it’s pretty clear to me that that was the case. Now some of them had pretty good outcomes and some had pretty bad outcomes. But really learning that you can go about a process that increases your probability of making good decisions is so new. I mean, for me, it really started when I read Thinking in Bets just a couple of years ago. And so the biggest lesson for me is that it’s never too late.

Joe: Yeah, I’m with you. That’s part of why we created this podcast for the adults. Part of it’s just to raise awareness about the fact that there are skills that you can improve for process, as you’re saying, as opposed to looking at everything based on the outcomes of our decisions. And part of it is because it’s not gonna happen for us in school. Most of us have finished our formal schooling. And so if we’re going to learn these ideas, we’re going to learn them by reading books like yours and Annie’s and Michael’s, and listening to people talk about their own experience with these skills. We’ve mentioned a couple of tools. I would think of them as behaviors, things like the premortem, or thinking probabilistically. Sometimes we talk about dispositions. And you mentioned temperament earlier. Could you talk about if there’s been any change in your own disposition or temperament or what you notice seems to lead to successful decision-making for individuals or organizations when it comes to that?

Ted: Well, the framing of it of course, is that we are inclined to make better decisions when we’re calm, for lack of a better saying, or not emotionally charged. And it’s really that awareness and the awareness for me of when am I in a situation where I’m angry, frustrated, tired, worried, afraid, excited, all the things that could kind of raise your emotions, so that you’re less likely to make a good decision. And then knowing yourself to know in all of those possible emotional states, which ones affect you the most? So for example, for me, I make the worst decisions when I’m in a place of scarcity and fear. If I am super excited and positive, I actually tend to make quite good decisions. And that wasn’t hard for me to think through and realize. And so I just need to interpret that, internalize it, and recognize, when I’m in a situation where I’m feeling afraid or worried, that I need to have a pretty sound process in front of me so that any decision I make in those periods of time is more likely to be a better decision than it might otherwise be. And those are individual decisions and it gets even harder, as we touched on, when you’re in groups. Because it’s hard for groups to communicate effectively. It’s hard for groups to bring out the best of the individuals as it relates to making a good decision. So there’s lots of tools that Annie and others have created to do that, but it’s hard. So I think the first piece is really just becoming aware of what effectively the science is. How is this supposed to work so that you can have a sound decision making process? And then practice it.

Joe: So I have a couple of questions there. One is just, what do you mean by a situation where you’re experiencing scarcity?

Ted: So, it might be, what I was thinking about was money. If I’m in a situation where I might make a decision, or certainly have in the past, that was more driven by money than money being one of a number of factors that should have factored into the decision because I was worried or I thought it was important to have more money at that point in time. That’s what I mean by scarcity.

Joe: Okay. And it sounds to me like you’re saying, when you have situations like that, you prefer then to have some kind of process that you’re accustomed to using so that your anxiety or your sense of scarcity or your fear is not overriding your better practices. What do you mean by that? What kind of process might you use?

Ted: Well, some of it’s pretty straightforward and simple. So one is bringing other people into my decision. Other trusted people into the decision. So if I am coming from a place of fear, others that I trust might not be in that same emotional state and just running a decision by some other people might get them to help me think it through. So that’s a big one for me because for whatever reason I was growing up in this male world with the wrong belief that I needed to figure everything out on my own. So I was inclined to make decisions without talking to anybody else. Well, again, this is really looking back because I wasn’t aware as much of what sound decision-making processes look like. So I could look back and say, most of those really poor decisions I made big and small came from times when I wasn’t in a great state of mind to be making a decision.

Joe: One of the things we talk about quite a bit with the students and the educators that we are collaborating with is when they get into thinking about a decision, clarifying their values or their goals. And when you think about the people that you’re going back to, do they have to share your values or goals or do they just have to know yours and because they care about your wellbeing, are trying to help you maximize yours?

Ted: It’s definitely the latter and I’m almost chuckling inside as you’re saying it, because I’m not so sure that the people I go to to help me with decisions, even think about the notion of a decision group the way I do. So they don’t have to have the same values and goals. They just need to be able to work through the decision I’m trying to make and understand where I might fall short in making good decisions.

Joe: One of the other areas that’s come up a lot recently and I think it’s connected to creativity and how we’ve under-emphasized that in education is the importance of just generating more alternatives. Trying to think about possible ways that things could go. When you talk to your trusted decision partners, how much of a role are they playing in helping you come up with new alternatives or ideas and how much are you laying out to them here are the things I’m picking between her deciding between?

Ted: Yeah, it’s very situational and can vary. I think that most of the time when I’m reaching out to people it is a combination of both. So I’m trying to think of a recent example in my head so that it’s pretty straightforward. I’ll give you a really easy recent example, which is in my little business now, I’ve been thinking about whether and when to hire a virtual administrative assistant. And so, one of the processes to go through is the normal, ‘let me think of a premortem. What could go wrong?’ That’s really going to have to do more with: have I communicated with them the right way? I need to think through. I need to think through what tasks am I assigning to them? When it comes to – should I hire that role to begin with? – there are two people that I’ve gone to. One of whom has a fair amount of experience in building a lean organization and could say things like, well, what do you actually want them to do? And you have a couple of people working with you now, could those people do it or do you need more? That’s more actionable than, “Oh, let me, think of a different way or a different model.” It’s a fairly simple decision and a simple decision process. So I think that’s just a really, really easy example of something I would call a fairly low cost, low impact decision, easily reversible. But you can still talk to one or two people who have been through it and they can kind of help you frame it the right way so that when it comes time to pull the trigger on that, you’d have that much more confidence that at least you’re going about it the right way.

Joe: I like that example too, because it’s at the edge of something that’s been on my mind recently. I think Ralph Keeney was the one that brought it up. But this idea of are you, are you treating decisions like problems to be resolved or situations that have come up that you’re now thinking through what’s the best way to go here? Or are you actively prospecting for decision opportunities? Things that you could do that would alter the trajectory that your situation is currently on because you went looking for a thing that you could change. I don’t know if that’s something that you’ve given much thought to, but at first I guess, is it? And then I’ll follow up if it’s one way or the other.

Ted: So I wouldn’t say I have in those words, but there is a variation of the theme that sounds very, very familiar, which is sort of this notion that – and I’ve talked to Annie about recently and she really spells out beautifully in How to Decide – of when do you want to spend your effort making a thorough decision? And when are decisions not as important? And sometimes the decisions that look like they’re important aren’t. And vice versa. So I have in the sense that there are a couple of bigger things that I think about that could change the inflection of say how I’m spending my time, or how a business grows, or something like that. And I would say that when those things get confusing is when I remember, there’s a framework for a decision process, let me see if I can bring that in and that can help. The ones where I’ve seen it more often, is something that Annie talks about in her book, and ever since I’ve seen it all the time, which is that there is sometimes [where] people get stuck on decisions that don’t seem that consequential. So as an example, my wife most recently has a leased car that’s coming off and she has really struggled to decide which car she’s going to get. Until I said to her, you realize this is between two cars. And the reason you’re struggling is because – Annie describes it as like a vacation in London or Paris – it’s because they’re so similar relative to all the other cars that you’re going to be fine either way. So just flip a coin. And so something that felt like it was going to be so consequential to her because she’s going to be in a car a lot, driving kids around and all these kinds of things, you realize actually, no, that’s not a decision you want to spend a lot of time on.

Joe: Yeah, I think that’s one of the more fascinating things in her newest book, this idea of speeding up. Either because the both alternatives are good enough and you’re not going to be in bad shape either way [or] the other question – is it reversible? You mentioned a lease as opposed to a purchase there for example, and I don’t want to get into that at the end of our time together. But that feels to me like another place where you’re going to be able to change your decision reasonably soon and it’s not going to have such a big downside. So it’s more like a one-way two-way door than a one-way door. We always ask guests toward the end, when you think about one thing, if you could hand the next generation of all Americans, every student that’s in middle school or high school right now across the country, some knowledge or some skill related to decision-making that they would then be able to have for the rest of their life, what jumps out to you? What’s the one you’d be like, all right, this is the one I’d like to give to everybody?

Ted: The one that jumps out at me the most is the idea that more things can happen than will happen. It is one of the many things in the notion of thinking about the world and probabilities and not absolutes. And it comes to mind for me because I see it in my kids all the time. We have kids ranging from age 11 to 17 and they – particularly teenagers, maybe teenage girls – get very fixated on something that is going to happen, particularly if it’s not so positive. And it’s hard to do as a parent, but it would be great if they innately understood that what they’re thinking might happen might actually be probable, greater than 50%, but that lots of things can happen, and many of the things that can happen in almost any situation are not things you can predict. So that’s the one that I have found in some instances gives a lot of peace of mind in tougher situations. And if nothing else, allows you to be open to exploring the world and all the amazing opportunities and things that can happen and surprises in ways that really foster learning and growth.

Joe: That’s great. Thanks, Ted. Thanks for that insight. And then for our listeners, the adults who are paying attention to this and thinking, I wish I had had this when I was in school, which I often think to myself, what’s the one book that you would say, look, this is on your priority list. This is the book you should go out and read next about decision-making and how to improve yours.

Ted: Yeah. So I am torn between two. But they’re the same author, so, and this is biased. In fact, this is why I’m working with you on the Alliance. They’re Annie’s two most recent books. Thinking in Bets opened my eyes to the notion that there are ways that you can improve your decision-making process. And then what she did in How to Decide is formalize it into a structure. I can’t say that I’ve taken How to Decide and gone through the exercises and I now structure all my decisions this way, I don’t. But there are plenty of times where I take a step back and say, oh, this is a decision. Let me go through this in the decision process, because in most of my life, certainly my professional career, there was a pretty clear line between what was the decision and what wasn’t. If I was investing money, we were making investment decisions and other things just happened. Now that I’m not in that business as much, everything is a decision, but it’s not so much a decision. And so to be able to have this set of tools and apply it at times, as you mentioned, where it can have a big impact and then even to think about, oh, could it have an impact? It’s just been incredible. It’s been incredible learning for me. You’ll hear of Daniel Kahneman’s Thinking Fast and Slow, which is a fantastic book in how you think and the problems that we have in making decisions less actionable, whereas Annie’s I found the most actionable of any books I’ve read. So those are the two I’m a little torn as to which one. I’m sure she would want me to say How to Decide now because it’s hotter and newer. But I’m not sure.

Joe: Yeah, I share the sentiment. Blown away by both of them. Really privileged to have her as a friend and to have had an opportunity to read them and talk with her depth about them. I’d love to be back in the classroom and assigning them. And I assume that if we had to pick right now between one of your books, you tell us to go get Capital Allocators?

Ted: Yeah. Well, it’s not out yet, but yes, the pre-sales are available. They’re very, very different books.

Joe: Available and going like crazy. I understand it’s been flying off.

Ted: It’s been great. Yeah. I know, I don’t know what’s happening. They’re very different books. You know, one of them was really a set of lessons I had learned in case studies about what happens when hedge fund managers start new businesses. It’s a very niche. This one’s much, much broader. Really talks about some fundamental tools. In fact, we’ve talked a lot about it, but there’s a whole chapter on decision-making. That was my attempt to distill the lessons that I learned from Annie and Michael Mauboussin and Gary Klein who have all been guests on the podcast. And so it’s about a third really about investing, a third a set of tools that any leaders need. And the last third is a bunch of great quotes, both life lessons and investment lessons. So it’s a really fun bucket. It’s the book after doing 150 episodes of the podcast that I couldn’t remember the things I had learned anymore in my head. And so, you know, COVID hit and I found I had some time to try to start distilling some of those lessons. So it’s really the book I wanted to have on my desk as a reference manual. So we’ll see, hopefully other people find it the same.

Joe: I think people are clearly interested in doing the same. I can’t wait to read it. I went and ordered a copy when the presale was announced and just started laughing when I saw on Twitter how it blew up, you know. It became a number one bestseller when it’s not even available yet. It’s absolutely not. So congratulations on that. That’s fantastic.

Ted: Thanks Joe. I really appreciate it.

Joe: And thank you for taking the time to talk with us today. I always enjoy chatting with you and I just wanted to get you on the podcast and let people hear some of the ways you think about all the space and especially cause it’s in it’s lessons from an industry that most of us don’t ever get to participate in. It’s not something we would be able to glean insights from without things like your book and your podcast, so really appreciate it Ted. Thank you!

Ted: Thank you, Joe.