Dr. Raife Giovinazzo Discusses Research on Investors' Mistakes

so they are doing something right there. Uh. He has a fascinating background, and you'll hear about both his academic background at Princeton and the University of Chicago working for two of the giants in the world of behavioral economics, Danny Kahneman and Richard Thaylor. How's that for a pair

of advisors. Uh. And he spent his entire your career working in that space, trying to figure out how to apply the knowledge and the wisdom that those gentlemen and others have created in the field of of behavioral finance to the world of investing. I think you will find this to be an absolutely fascinating conversation. I know I enjoyed it a great deal. So with no further ado, my conversation with Raife Jovinazzo. I'm Barry Ridhults. You're listening

to Masters in Business on Bloomberg Radio. My special guest today is Dr Raith Jovinazzo. He is responsible for managing the Fuller and Failor behavioral small cap equity strategy at the firm Fuller and Failor. He has a fascinating background. Previously, he was researcher and co portfolio manager with black Rocks Scientific Active Equity Group. He has a BA in sociology from Princeton and an m b a PhD from the

Booth School of Business at University of Chicago. But his advisors were Danny Khanoman at Princeton and Richard Taylor at Chicago. So I expect this to be a fascinating conversation. Dr Raef Gina Venazzo, welcome to Bloomberg. Thank you very much. So let's start with your advisors. That's pretty elite group of people to work within your career. Kneman is your undergraduate advisor and Failor as your m b A and PhD advisor. That's some serious intellectual firepower. They are smart folks.

I was lucky, you know, I took a class by Knoman on decision making. I loved it, asked him to be my thesis advisor. The funny thing is, at that point in time, I didn't understand that he was a giant in his field. I knew he was very smart. Obviously, in the course of doing my research, I realized I'm talking to the number one expert in this subject matter. Uh.

And then he actually connected me ultimately with Taylor. He said, I called him up about five years after I've been working as a strategy consultant and said, I want to go back and I want to combine study of business with the study of psychology. And he said, well, you need to go study under my best friend, Dick Taylor the University of Chicago. How crazy is that? Well so, so, during the time these folks were advising you, you had an appreciation of how unbelievably fortunate you are. I did,

you know. And that's a nice thing, you know, it's a great thing. Let me talk up my alma made to the University of Chicago. There's so many noble prize winners there, you know, I mean, ironically, I don't know if you knew this fact. On my dissertation committee were both Taylor and Fama, which is the only time that's ever happened. And you know that, to my knowledge, that those two have been on the same and they're golfing buddies. Yeah, they get along much much better than people think they

do well. Philosophically, they're completely the opposite sides of the universe. And yet I would disagree actually, and that they both strongly believe in paying attention to evidence. Let's look at the data, and that is it's actually a big unifying approach as opposed to we'll just look, we'll have a theory about what should work, if we don't actually care if it actually happens in the real world. So they start with the data, but they end up in very

different places. They have different interpretations of the data. That's certainly true to say the least. So the other question that comes to mind is how do you go from sociology, which is definitely not a moneyed um economic slash business oriented coursework to write in the mix of finance and asset management. What made you decide sociology leads to NBA. So it happens that at Princeton the most flexible major was sociology and I actually only took five sociology classes

as a quote sociology major. Uh. To be honest, I'm was never were very well trained in the discipline of sociology, but it allowed me to take all sorts of social science classes. And I think at the time I was really searching for this understanding that it's more than just economics. There is something that matters about how people think, how

people behave, what are norms? And so I think it was a very natural transition to where I ultimately ended up even at Princeton, to really being focused on this decision making, which is an intersection of psychology and economics. So so you come out of Princeton, you spend five years doing some consulting work. Uh, you end up going to Chicago. What was that four years NBA PhD? I wish it was only four. So the NBA is two years, and then it's another three or four years on top

of that. You know what's ironic is I told my wife when I joined the PhD program, Oh, I think I'll be able to do it in three years. It turns out nobody does it in three years, and almost nobody does it in four years. And so I was the norm. I did it in five years. It's kind of funny that meets the standard planning biases that I was about to bring that up exactly. The planning talks about that all the time. When they when they started working on an economics textbook, he said, well, you know,

we're smarter than most of those other guys. This will only take us. And he said we were off by a factor of ten x, which is exactly I did the same thing. You know, what he says is people use an internal model the forecast. They think about their own personal situation, and they downweight the external model of forecasting, which would be what happened to everybody else. So I felt like, look, I've been here two years, I've taken some PhD classes. I know what I'm doing. I have

a focused area. I should be able to do it quickly. Yeah, I mean, listen, how hard is a trade war? It's not. It's not that difficult. That is the classic planning fallacy right there. It is. So, so you get your PhD and your m b A. And what's your first job out of out of B school slash PhD school. Yeah, so the PhD program is trying to train researchers fundamentally UH, and at the time I actually thought I wanted to, if possible, go into an academic position, but it was

fascinated by predicting stock returns. I did always wonder a little bit, if you really want to predict stock returns, should you be just studying it? Why not actually try to put it in practice? But primarily I interviewed for academic positions, but as well as a few UH positions in industry as well. I was fortunately I did get a number of job offers. My wife is a Harvard Business School graduate. She's a successful executive, and it was

very hard to to match some of the locations. I had an offer at a Dartmouth actually with Ken French, which was great, but there's no there's that as a tiny town. There's no real positions for no positions for my wife. And I also realized, you know again, I'd like to be closer to actually amending this, so I actually had a conversation with Dick. I had a few

offers in industry. One of them was at Barkley's Global Investors in the Scientific Act of Equity that eventually became Black Rock, which eventually became Black Rock and I've also had an offer, fortunately from Fuller and Failure and Dick said, look, if what you want to do is learn all about the investment process and be involved in everything with that, join our firm. We're a small firm. You will do everything.

If what you want to do is just focus on research, well, if you join a twenty PhD uh staffed research group at Barkley's Global Investors, you can focus on research and since at the time I had been struggling with academia or industry, that seemed like a happy medium. But by the end of my time there, I had already moved over into more of a portfolio management role and realized that's what I wanted to do. So it was a great opportunity to come to Fuller and Taylor five years later.

That's fascinating. Let's let's talk a little bit about behavioral finance. So you you leave Princeton under Danny Kahneman's tutelage and end up with Richard Thaylor, widely known at the University of Chicago, widely known as the father of behavioral finance. What was it like learning at the knee of the master. It's great, you know, one thing that impresses me about both of them is their willingness to actually be challenged

and change their minds. I think they both like me because I was willing to disagree with them, and that's good because if they didn't like that, then things could have been a little bit rocky. I saw you do an interview of Dr Khaman not too long ago, um, and you talk to him about the role of money buying happiness, how much it can and his perspective on that has swung around. Tell us a little bit about that conversation, because I thought you're back and forth with

charming well well in college. He at that point time, back in the late nineties, he was doing a lot of research about experienced happiness as opposed to predicted happiness, and part of that study was an analysis of how

happy does money really make us. We all think it makes us tremendously happy, doesn't make us as happy as we think, And one of his conclusions at the time was that there is a kink in the amount of happiness we experience from money happening defined that kink sorry, meaning that the amount of happiness goes up up up with money up until at the time he said about twenty thousand dollars of income, which then thirty years ago

meant economic security. You're paying for healthcare, and we even even then, you know twenty you know, in a lot of mid nineties, twenty thousand is not a whole lot um. And he set up till twenty thousand, it increases, your happiness increases with money, but after that it's flat. And I was joking with him, actually talked to him about five years after college working in New York making fortunately more than twenty thousand dollars, but not a whole lot more.

And I recalled when I got my first raise, made me a lot happier. That was quite useful. I said, I gotta tell you, this does not match my experience of the idea that money beyond twenty dollars doesn't do anything more for my happiness. And he at the time said, oh, rafe, we got it wrong. Actually, it's not kinked. It's log linear, meaning it gets more and more gradual. How much happiness you get from money, it starts the plateau. The rule

of diminishing returns kicks in. It's but to be precise, a plateau is literally a flat point whereas diminishing returns is the slope is going down. So his point was just it still goes up, but much more slowly goes up, much more slowly, exactly. And so I was just struck by this is a giant in his field. What giant in their field? Have you ever heard say, oh I

made a mistake. Oh I'm changing my mind. Although then in our interview which you witnessed, he said, Rafe, I've now gone back to thinking that it is in fact kinked and there's a permanent plateau where it doesn't get higher. I wonder if that's just a function of longevity and seeing the world from your seventies and eighties as opposed to your thirties and forties, that sort of smile of happiness, you're you're really happy as a young in and then it sort of drops and then peaks again in your

later years. I wonder if that that's relevant, could be. But knowing Dr conom and I bet it's based on some very hard data which I just haven't seen now. The other data on this one point, which I find fascinating. It turns out that once you control for life events

such as divorce, the numbers skew much higher. And if there's a divorce in there, no matter how much money you have, it ends up being miserable or so some economists have have referenced, you know, uh, Dick Taylor has a phrase which is your happiness is the minimum of yours and your spouses happiness. So that makes Amie accordingly that that makes that makes perfect sense. So you're at the University of Chicago with Sailor. Did you ever participate in any of his studies as a subject. I don't

think I did. Actually, you know, the standard psychological experiments usually use a little bit of misdirection, and if they say it's about one thing, but it's really about something slightly different, it makes it a little bit tricky. If you have people who know too much of the psychology to be able to see through what are you really asking about? You would be the ringer at the table

that was wo That would throw it off. And um, let's talk a little bit about blind spot bias, the people's own failure to recognize their own biases, even if they're knowledgeable about biases and other people. That was also discussed with Professor Khaneman. Part of it is our biases are hardwired. They really come deep innately from how we

think about the world. You know, It's funny as the conversation I recently had with Danny that you witnessed, he pointed out, I was making a joke at the research that he started uses this complicated word heuristics that people use a heuristic which is really just a rule of thumb, and I tease them about why don't you call it a rule of thumb, which is an English phrase that

people understand. He he reacted very strongly to that. He also reacted brilliantly to point out that a rule of thumb is a deliberately chosen approximation, but in fact our biases come from unconscious rules of thumb. In fact, he said, rules of thumb is therefore the wrong word because it's it's an unconscious process that makes us quickly jumped to

conclusions that are in fact incorrect. And it's precisely because it is these unconscious processes that make us do this, that make it so hard to overcome our biases, even if we're aware that we should be looking out for them. Let's jump right into that and describe what it's like to build a firm based on known behavioral biases. How is the firm structured and how does it take advantage

of all of these eras that investors make. Yeah, everything we do is based on the study of investor mistakes, and we try to invest on the opposite side of where we think other investors are making those mistakes. Broadly, psychologists have documented dozens of mistakes, but you can group them in two categories. Sometimes people overreact, sometimes people underreact.

The trick, of course, is knowing when they're likely to do one versus the other, and then we try to buy when people have overreacted to bad news, to panicking, or when they're underreacting to good news, and we think that prices are going to go up even further and faster than they realize. So if if you were managing a portfolio at the current portfolio you're running at a different firm, I would say, oh, it looks like Rape is managing those small cap value tilted FAMA French factor portfolio.

But that's not exactly what you're doing, is it. No? Oh, so I would say that the overreaction to bad news is naturally going to find stocks that have bad news. They're gonna be guess what we're likely value strategies value companies, And in fact we run a strategy that is a pure overreaction strategy, and that does look like small value.

Of course, uh by by construction, the strategy that I run is actually a small cap core because it includes this examination of do we think people are under reacting to good news? And therefore it sort of removes the value. Tilton ends up being core portfolio because of that reason, and I just have to reference that. At the failure economent event, I was sitting at the overreaction table and

all the tables had cognitive biases. Instead of table one, table two, table three, it was table confirmation bias, table um, overreaction, et cetera. I found that terribly amusing. So so let's talk a little bit about small cap um. The argument could easily be made that small caps outperform over time because you're taking more risk, you have liquidity risks, they're much less followed by analysts, they're much less known, and and therefore that out performances on a risk adjusted basis

goes away or or does it? What? What are you? What are your thoughts on the so called UH small cap premium? So I think the reality is that some of the small cap premium is truly risk and most of the small cap premium is not risk. But it's both. On a side note, you know, academics often write papers that are either everything's a mistake or everything is rational, but if you talk to them, almost all of them agree it's both. So specifically, let me talk about the

small cap premium. You mentioned liquidity risk. I think that there is some risk of owning things that have less liquidity, that if you need to sell them, they're going to perform worse. Although interesting note, in general, stocks that have lower liquidity actually have a lower beta, they have lower exposure to the market. It appears that when the market panics, people tend to sell their most liquid names. Not exactly so the intuition of oh, when people are desperate, the

least liquid will be terrible. It doesn't do bad on a price scent. In terms of prices. It is of course a challenge if you really do need to sell it, though, makes a lot of sense. So if it's not all risk, where does the rest of the return come from? In small caps? So you mentioned the other issues that there's less followed not a lot of analysts not well known and not well known. So to me, none of those

actually are truly risk. They're sort of a lack of comfort, and I think that's where a lot of the return can come from, in that people don't know about them, and so they're willing, they're unwilling perhaps to to take a gamble on them and invest as much in them. But that really truly isn't risk in the sense of risk to your money. It's just perhaps risk to your psyche. And I would call that kind of risk to your

psyche something that is really more behavioral. And I should add there's there's one other element that I do think really matters, and this is a little bit technical, but if you think about it, once you assume that there are errors in the prices of companies, Naturally, if a company is overvalued, it will be a little bit bigger, if a vent company is undervalued, it will be a

little bit smaller. So as soon as you think that there are any errors, sorting on size is not going to be a very direct way of finding those errors, but it will be correlated with the errors. And so I do think that matters as well, that just beaten up stocks are more likely to be small, just because any any mistake people made would automatically make them a

little bit smaller than they really should have been. The description of of the psychological risk of not being familiar with the names reminds me a little bit of the home country bias that people tend to be wildly overweighted around the world. Wherever you live, you own the companies, you're familiar with, the CEOs, you've seen on local television,

and it creates a very distorted portfolio. You're quite right, And of course, the United States is such a large economy and it's so well diversified, having a home bias in the United States is probably fine. Furthermore, a lot of the largest companies in the United States nowadays they have international operations. You actually are getting exposure. But what's fascinating to me is always you take a small company in Norway, and Norwegian investors are more likely to invest

a predominant amount of their investments in Norwegian stocks. That really doesn't make sense overall, other than the fact that they're so familiar with those It does give them, It does give them psychological comfort, and you know there might be a value to that. But if from purely rational. All I care about is my money and my return standpoint.

We're taking a lot of risk with the homebias. It seems that things that investors do that give them comfort don't seem to work to their advantage in the markets. Is that a fair statement. I think that's a very fair broad statement. It matters a little bit exactly how you implement it, of course. But but the idea is, if people are going to pile into something because it makes them feel good, it should cause the returns on that particular feel good strategy to be a little bit lower.

So here's the key question I have about the portfolio you manage. When stocks get thrown out by a large group of investors and they become a little smaller and the price becomes a little lower, how can you identify when it is either a behavioral issue of people overreacting or genuinely decaying fundamentals. So a lot of the Reeds that own malls and and other things they've gotten shell act. Is this a permanent change in society or people over reacting?

Maybe that's not the best example. We could use steam engines and leather belt companies back in the early days of the DAO. But the key question is how can you tell the difference between when something is fundamentally deteriorating on a long term, secular basis versus investors overreaction. Yeah, that of course is the key question. And you know, naturally I could talk for hours and hours about the details of how we implement stuff and just touch the

surface of how we approach it. But here's the broad outline. Our approach is to try to look at queues where we think and other investors are likely to make mistakes here. Some of the cues we use, for example, in the retail space, because we see a lot of overreaction to problems in retail right now, are to say an individual company basis, what are the insiders doing, What is the manage meant doing? Are they buying back shares of their company? Are they selling shares? That's an entry point to say

is there a real problem here? Then we're gonna look at how the investors reacted to the news. In this case, it's pretty easy to understand there's a lot of negative news out there about retail. But then we do also have to do the hard work of digging in and saying, Okay,

what is the real opportunities of this individual firm. Part of our approach is to try to not make an overall description, overall analysis of hair are people overreacting to, you know, mall reads, but instead really look at individual companies and say, how about this particular read. And when you dig into individual companies, of course they have individual

nuances that can make a real difference. Let's talk a little bit about the success your funds has had over the past a half decade prior five years, you've compounded at seventeen percent a year, beating of other small cap funds. So what do you owe this success too, and what are your expectations about this fun going forward. The success is due to our process and that's the key to how we invest. We are trying to spot where other

investors might be biased. Make no doubt, I'm biased, just like every other portfolio manager at Fuller and Taylor, just like you, just like everyone. And it's our process that lets us overcome those biases and find opportunities. And we think that's going to continue working. Obviously, no guarantees. My compliance person would get very mad if I made any kind of guarantees. But what we continue to have very

comfortable with the process. Yeah, we think it makes sense when investing to try to figure out where are other people making a mistake. So, so here's the key arbitrage a way, the alpha question. You guys have carved out a niche in behavior investing, and obviously when you have people like Richard Taylor and Danny Kahneman involved, that gives

you a big edge. But what about other firms recognizing this and coming into the same space and saying, hey, we want to catch some of that behavioral alpha as well. Do you see any are there any competitors and do you see any competitors coming in eventually? Yeah, we see a lot of folks talk about behavioral finance. It's a fun topic. People like to use it to justify what they're doing. But honestly, we have never seen really anybody who's doing exactly what we do. And there's a few

reasons for that. I think one is doing what we do requires not doing a lot of the traditional things that cause bias that makes people uncomfortable. We talked about how people like to do things that leave them comfortable. Omitting some of the steps that people typically do will make people uncomfortable, and really focusing are the way we do just on the mistakes often can make other folks uncomfortable and so they don't do it for that reason.

And as you know, as we talked about in the beginning, these biases are hardwired. So it's not that the investor mistakes are going to go away, but you really need to have a process that's laser focused on finding them to work in the long term. So we we discussed earlier. Um Fama and Failure play golf together their buddies. Um, there's clearly inefficiencies in the market over the short term. Our markets mostly kind of eventually sort of efficient. Like,

how do you think about markets over longer periods of time? Yeah, you know, Fisher Black had a rule that he said markets are efficient probably do a factor of two that prices are within plus or minus two times the correct price. Now you tell me, it's actually pretty reasonable in the scale of things to say that's reasonably efficient. Okay, they're not ten times what they should be. On the other hand, that leads a lot of room for is a giant swing. Yeah,

that's a big swing. So I think it depends on how you think about in defining what would efficiency be the idea that all prices are perfect. I think it is about as ridiculous as thinking all people are perfect, But the idea that they're pretty good it's about as reasonable as thinking that most people are pretty good. But there's a lot of rooms still to find improvements that

that we look out for. So if I had to define the era following the financial crisis, I think most people would look at it as the era of indexing and simultaneously the era of e t f s. The question that comes up over and over again is what does indexing due to price discovery? How does that affect the ability to identify miss pricing. Yeah, so I think that e t f s and indexing have a variety

of impacts. One impact is that there's a bunch of people who used to be analyzing individual securities that aren't anymore. That's gonna make individual prices, as you can imagine, a little bit less efficient. On some level. That makes our job as an active man, you're a little bit easier because you've taken some of the people who used to be analyzing things out of the out of the game.

At the same time, I think there are increasingly more swings that happen because people are moving into a utility z et F, and now they're moving into a financials et F, and now they're moving into a smart bay to e t F. And there are a lot of movements that are happening more at the macro level in

terms of individual E t F decision making. And you know, the funny thing is, I mean, I've heard one phrase is a sort of an extreme phrase, that that indexing is communist in the sense of you've trusted everybody else to set the price. You really do have to have confidence that the market is reasonably efficient, that the price that you're buying things is right, And that's not a bad approximation. But I think I do think you can do a little bit better. I'm I'm biased, of course,

because I'm an active manager. I'm pulling this from memory. I believe it was Alliance Bernstein called indexing Marxist, but I'm not positive that was my search piece. Um, but but the same the same issue applies. So here's the counter argument about indexing, and it's a behavioral argument. Uh, humans are irrational. We're not especially good at stock picking, we're not especially disciplined at staying on even if we come up with a quantitative method, we have a tendency

to get caught by narratives and stories. You know, if I just index and forget about it for forty years, I'm better off than getting in my own way. What's the counter to that? From a behavioral perspective, I think you're right that people get in their own way all the time. You know, Dick Taylor's got a phrase. Instead of watching CNBC, you should be watching ESPN. The idea being that tracking how you're doing every day is going

to cause tremendous unhappiness and it's gonna lead to more biases. Actually, we worked with separate note. We worked with one of our academic advisors, Professor Joey Engelberg, who's that U see you c s D. And he's done research that when the market goes down there's more admittances for heart attacks to hospitals around the country. Not surprised it really, it really makes people unhappy. So the set it and forget it I think actually is right. At the individual investor level,

people should set it and forget it. I think there's a role for picking the right active manager as part of your set it and forget it strategy, But it's certainly true that trying to make those individual timing decisions, you're going to be very subject to biases. The The other um favorite example, and I'm trying to remember who brought this up recently, is imagine if you've got your home price quoted every single day, and it would make people crazy. You wouldn't you wouldn't be able to deal

with it. You get a price when either you put up your house for sale or one of your neighbor's house cells, and even then we redid our kitchen, they didn't, etcetera. So what what does the daily price action tell us about investor psychology? Yeah, you know, I'm sure you're aware that no matter what happens in the market, people are always on the news spinning here's why it did what it did. But the reality is, I gotta tell you, as as an academic, we see a lot of movements

that we don't really know why it moved. Here's here's a different way, more technical way of phrasing it. Uh. The academic perspective, more broadly is that most of the price movements that happened in the market are changes in the required return, not changes in cash flows. What that means is it's not that people have a new, updated vision generally about how well the core business is going

to perform. Rather, they've changed their mind and said, oh, I'll accept a little bit lower return, and therefore the price went up, or oh, I'll accept a little bit higher return, so that I demand a little bit higher returns to the price went down. But for you and me, that's equal to the same thing as there's just noise. It just moved for kind of no reason, and as long as you brought up noise, I understand. Professor Khneman is working on a new book on noise. I'm absolutely

fascinated by that. Why is it that we're so compelled to take what appears to be to the educated eye random noise and impose a narrative storyline on that drunkards walk? That ability to very quickly find patterns is crucial to learning. Think about how quickly toddlers learn new words. Think about how quickly kids figure out what the rules of social interaction are. And they do it all by just watching

a few times. Sometimes I'm sure you've seen toddlers might hear a word once and then they start being able to use it. Why because yeah, exactly, of course they figure that out. And why because we're experts at quickly identifying patterns, and that's of course useful from an evolutionary standpoint, but then it trips us up on things that truly are random. We start to see patterns that don't exist, and we interpret that in ways that then can cause bias. So a big part of the way you manage the

portfolio is capitalizing on overreactions. What do we see more of overreactions to the upside based on green and enthusiasm, or overreactions to the downside based on risk aversion and panic. You see both. I think you see a little bit more overreactions to the down side. Now I say that, but I may be biased because we're focused on overreactions

to the downside. That's when we buy. If there's a company that's overhyped, we're not going to buy it, and we do a little bit of long short investing, but for the most part, we're not going to pay attention to those super hype stocks. And so maybe that's why I'm giving a biased answer that it seems people more likely overreact to the downside because that's what we focus on. Can you stick around a little bit. I have a

few more questions to ask you. We have been chatting with Dr rap Jovinazzo of Fuller and Thailor, where he manages the behavioral small cap equity portfolio. If you enjoy this conversation, be sure and check out our podcast extras, where we keep the tape rolling continue to discussing all things behavioral. You can find that at iTunes, overcast, Bloomberg dot com, wherever funer podcasts are sold. We love your comments, feedback and suggestions right to us at m IB podcast

at Bloomberg dot net. You can check out my daily column on Bloomberg View dot com. Follow me on Twitter at rid Halts. I'm Barry rid Halts. You're listening to Masters in Business on Bloomberg Radio. Welcome to the podcast, Ray, Thank you so much for doing this. This is really a fascinating topic that I am, you know, have been enamored for or decades about and offline, we were talking about the problem with our cognitive issues is we evolved

for very different purpose. It's it's I give a presentation where I use via Gra as an example. It's off label. Originally, Viagra was a hypertension and heart disease um products, And as they do when they do these studies, they ask the the subjects any side effects. Yeah, my wife has locked herself in the bathroom and she won't come out. Um. Oh, maybe we have a different use for this product. So um.

The question that comes up time and again with all these biases and all these cognitive issues was the human mind or has the human mind evolved for very different purposes than we we are currently using them? Yeah? We were evolved in an environment where there were is not a news media that were not graphs and charts that we had to interpret, where there was no Excel, no

financial statements. We were designed for very rapid decisions of you here rustling in the bushes, You better get out of the way quickly because it might be a linn Not. How do I plan a twenty year investment in a power plant? That's not what we're designed for. And so we end up applying our cognitive skill set to a bunch of issues that we really are not built for. Yeah, let me let me give you an example which I think will be illustrative. Maybe I'm biased because it was

the research I did with Dr Khneman at Princeton. I began trying to do research on how do we come up with the shortlist from which we make a decision, because the research on decision making is all about choices, and in the process of trying to answer this question of how do we come up with the shortlist, realize the answer is we don't come up with a short list.

In fact, we're sort of hardwired to instantly jump to the answer that what we're doing is something which in cognitive psychology is often called problem solving as opposed to choosing. But it's precisely because we want to instantly get to the final answer that we're very lousy at making choices when we have a range of choices that we need to think carefully about. You know, it's funny funny you say that. I um years ago on a trading desk, someone would bring an idea to me and very often

that piece of junk. And I eventually learned that that reaction is, hey, maybe there's an overreaction on everybody's perspective, because when someone brings you I was a fan of Apple. When the iPod not iPhone iPod first came out, every person I showed that stock to same reaction a piece of junk company going out of business, the stock a six for one split ago on a two for one split of for that I want to say it was fifteen with thirteen in cash, and that reaction of junk.

That's that immediate response. As opposed to Professor Koneman, we call its system to where you're actually thinking through. You know, here's a funny fact related to that mediate emotional reaction. Our ability to know whether we like someone operates far faster than our ability to remember any fact about them. We know whether we like that person before we can remember their name, because that is what, if you think about it, we're built to be able to make very

rapid is that person a friend? Or do I need to run away decisions? But it can really trip us up when analyzing something abstract like a stock that we've got decades to invest in or not invest in. That's not a good system to be able to make us a decision in milliseconds, even though from a evolutionary standpoint was quite useful back when we were cavemen cave women. That that same here's an instantaneous reaction which has a

purpose in in keeping you alive. Ps. The people who did not have that, that's that particular hard wire, well none of their progeny around think they got eaten by the right. They were literally people's lunch, all right, So I only have you for a limited amount of time. Uh, let's jump to some of our favorite questions that we ask all of our guests. What's the most important thing

people don't know about you or your background? I think the important thing to me that maybe people don't know given the focus on behavioral finance that we have, is my father is a retired professor of accounting, so I'm actually one of those geeks who likes analyzing financial statements as well. It's not pure psychology. Sometimes people think it's all about psychology, but what we do is a combination of finance and psychology. And honestly, it's the finance that's

more important than the psychology. But the psychological combination and addition sort of changes the flavor of everything, gives it a different dimension. Dimension around now is when I ask people who they're early mentors were. But we know at least two of your mentors, Danny Khneman and Richard Faylor. Any other mentors you want to share. That's those are two pretty good names to drop. They're pretty good. They're

pretty good. My father was a mentor. Of course, I did a lot of consulting work work for him in his consulting business when I was in high school and college, and that was some useful training as well. So let's talk about investors who influenced your approach to put in capital at risk. Yeah, I've been obviously tremendously influenced by all of the research and behavioral finance. There are patterns to people's mistakes and therefore their patterns for investing that

make a difference. Uh. And if you follow those patterns, you can earn higher returns. And uh, let's talk about books. This is everybody's favorite question. What are some of your favorite books, be they fiction, nonfiction, investing, add or not. That's a hard one. I've got a lot of favorite books. Um, I do think you know. I have to give a

plug for Thinking Fast and Slow by Daniel Conoman. It's incredibly comprehensive and that can also read is a little bit slow and dense, but you really learn a tremendous amount from reading it. I learned a lot of that at the Feet of the Master. But I think for people who haven't had that lucky experience, it's it's a great book for learning. It's wonderful, and if you read the whole thing once sitting, it's dense. The first half of it really flies. Yeah, you know other other books

that I have enjoyed. I'm a big science fiction and fantasy fan. Um. I don't mean to tell us some of your favorite you know. I've got a bunch of The King Killer Chronicles are one. I'm really hoping Patrick Rothlist will hurry up and write that third book. I don't know if you've read that. Yeah, I loved the books the Game of Thrones. Obviously that's quite popular now. I wish George R. R. Martin would go ahead and finish those book as well. Uh, those are something, you know.

I like a lot of those, uh classics in the in that in that realm, if they're kind of fun. Any other science fiction authors float your boat? You know? I really like Werner Vinge. I don't know if you're familiar with him, the science fiction author. He's got a neat book called Rainbows End, which is trying to imagine sort of a near future where there's a tremendous use of artificial intelligence, and what does the economy look like?

Which I think is pretty smart. It's got some other good books fire on the Deep that deals with artificial intelligence. I think it's kind of neat, quite interesting. That's a good list. Tell us what you're most excited about today, like these days? What what really do you find fascinating? You know, I never stopped being fascinated by investing and by behavioral finance. I know it seems odd, but that's part of what makes it so easy to do what I'm doing, is that there's always new wrinkles in the

kinds of mistakes that people make. I also like to apply it to myself and say, what which of these mistakes am I making? And how can I try to correct that? So it's a perpetual passion. It's endlessly fascinating, there's no there's no doubt about that. Given that you work in portfolio management, what do you see as the

next major shifts that are going to take place? Yeah? Well, one shift clearly is increasing use of passive investments, and how does that fit with active you know, I think it's no surprise there's some reasonable arguments in more efficient spaces, maybe in large cap to to consider passive. We think in inefficient spaces like small cap, really doesn't make sense to be passive. But but that continual trend is clearly

going to be happening. I think a second trend that's going on is how do we incorporate all of the information and what's the role of artificial intelligence in trying to use be used for predicting returns. On that note, I have a little bit of a different perspective than a lot of people people. I think artificial intelligence is obviously incredibly powerful, but it needs a tremendous amount of feedback.

If you think about it, if you want to build an AI system to do minute to minute or second to second trading, there's a tremendous amount of feedback that's going to be very powerful. If you're trying to predict five year returns, well over a twenty five year period, you only have five data points. There is no way to build an artificial intelligence just feed it the data and let it figure things out. That's not gonna work. But I'm sure that a lot a lot of people

are gonna try. So tell us about a time you failed and what you learned from the experience. Well, I have what I think is a rather amusing investment failure story. Um So, during the original Internet bubble around late late nineties, you know, there was somebody put out a report that said Amazon dot Com is going to double in the next year. And I just said, this is ridiculous. No, you can't predict that a stock is going to double. This,

this is crazy. Henry Blodget. That was a very famous piece he put out at Oppenheimer, I want to say, and then eventually moved over to Merrill Lynch and things won't arrive from them exactly. So I decided, you know what I'm gonna I'm gonna short this in my personal portfolio.

At the time, I had about twenty five thousand dollars in savings, and I decided I was going to put on a five thousand dollar position on the theory of well, if this actually does double in a year and I lose five thousand dollars, I can handle that in the in the short term, and in the long term, I hope that I'm going to have a lot more savings. And you know, this won't this won't break my lifetime earnings.

I'm not gonna be bankrupt forever. Well, first of all, I couldn't borrow the shares for three weeks because lots of people were trying to short the Internet stocks at that point in time, during which time the price went up. Brilliant me said, oh this is great, even better, even better time to short to short this stock. Finally I put on the position, and by the way, instead of doubling in one year, the price then went to double at that original call in another two weeks. It was

like a month and a half or two months. It was crazy fast. At which point in time, now I have a position which is closer to ten thousand dollars short, uh, in which case, now if this doubles again and I lose ten thousand dollars, now I'm starting to have some problems. Unsurprisingly, I was working as a strategy consultant at that time, but I was spending a lot of time watching the daily that minute to minute price movements of Amazon dot Com. While I got to feel emotionally what it feels like

to be losing money and worried about things. UH. At one point in time, I decided, as it keep kept going the wrong, wake up, going up, up, up, g I need to reduce this position. I did something complicated just because it had taken three weeks to borrow the shares, and that I shorted against the box, so I actually bought seven I bought seventy five shares while still being short hundred and fifty shares. This was the massive amounts

of money. I was covered half of the covered half of the position, and I think this is really an impressive accomplishment. Frankly, because I was doing this sort of panicked decision during the day, I managed to close this position. I e by the seventy five shares at literally the high point of the day, and then as during the day, it then started to drop for the first time, and I thought, what am I doing? This is crazy. I'm not supposed to be. This was my whole thesis and

now it's not working. So I undid a portion of that uh at and I managed to both buy at the high of the day and sell at the low of the day in the same day, which I think is a rare accomplishment. And I learned an important little fact. By the way, the published prices are only four round lots of hundred shares. And because I was trading at seventy five shares they're not quoted prices, and in fact managed to sell below the low of the days for

my seventy five shares. You know, eventually I held onto the position for years, and eventually the position kind of came positive and consistent with every behavioral bias. Once I was able to declare victory of okay, I've no longer lost money, then I closed out the position. But longer term, look how well Amazon has done. I would the better trade was close out the position and then go long exactly if you term, If you look longer term, they've

been one of the successful ones. There was a lot of insanity during during the financial crisis, but I, in my naivete at that time twenty plus years ago, picked one of the wrong things to bet against. So that bet was fundamentally wrong. But but I'll tell you I felt at the time I did have the wisdom to know I'm gonna learn something here. I've learned a lot. That is one of the formative investment experiences for me about knowing about proper position sizing, knowing when to take risks.

And one of the lessons that I have too is when you see something that looks crazy. I'll tell you, I think bitcoin looks crazy. You're very, very wary of shorting it. I think the Canes quote was the market can remain irrational a lot longer than you can remain solvent, to say the to say the very least. Um, what do you do for fun? What do you do outside of the office, either to relax, or to stay physically fit,

or or just for left Yeah. The two of the hobbies of mine is one I coach my kids in sports, which is one nice thing actually about being on the West Coast is because and being on market hours actually get out of work, start at some insane hour in the morning, but get out of work in time to actually go coach a baseball practice or soccer practice. Markets close at one o'clock. You can be home by the time they're back from so I'm not leaving at one o'clock, but but I can. I can make a five thirty

baseball practice, so that's good. Uh. Second thing that I do is I love board games. I mean, I'm a super geek, so UH play a lot of board games. Actually make tried making some board games for my friends. I mean, I'm I'm I'm ultra geek. What what board games do you like? Uh, you know, I like a lot of the board games that have been quite popular. Um. I like a game, you know, Ticket to Ride is a simple game, but it's pretty good. Another game that we have played a bunch this is is something called

Scithe that's a little bit of a war game. It's a little bit stranger. Um. Just to give you an idea, I owned about two hundred board games. So asking me to pick my favorite, that's that's kind of tough. See, that's the most important thing. People don't know about your background. Uh. And I assume you've seen the game Night the movie

you know, it's funny, it's my wife and exactly. So my wife and I try to go to that on a date a couple of weeks ago after it's been out, I think a month, and every movie theater we went to had been sold out, so we up watching a different movie. So it's still on our list. The weird thing is these movies come and go so quickly these days, in theaters for two weeks and then and then they're going. But the good news is now we can watch any of them on demand. Right. You might want to think

about shorting Netflix, which continues to go higher. That that would be the other side of ill be honest, I don't understand Netflix. They're hemorrhage in cash. They just did a billion and a half dollar financing to acquire more content. Yeah, exactly, I don't get them, but I have learned. Yeah, I'm not going to short that right. Yeah that sometimes you don't want to get in front of the runaway locomotive.

Let let somebody else be the hero. And and our last two questions, what sort of career advice would you give a millennial or recent college graduate who came to you and said, I'm thinking about a career in asset management. So let me give you some general career advice that I think is very important for young people, and then

I'll give some specific advice for asset management. My general advice to people is, you hear these phrases do what you love, and I think the correct phrasing is do something you love, the distinction being don't ask yourself what's the thing I love the most of all in life, because it's gonna be probably something that has no commercial value. I love playing video games the most in life, or for me, it's seriously considered. Because I love board games,

maybe I should become a board game designer. And one of the best decisions I ever made was, I'll have that be a hobby. I can spend some time doing this for fun, but I should actually pick a job that I also love, but not try to figure out what's the thing that's absolute most fun. So that's that's my advice. To pick something you love and enjoy, but don't try to pick the thing you love the most, uh, unless you're lucky enough to have it be something that's

highly lucrative. The second advice is specific to asset management, is I just think there's a tremendous power and maybe this is my bias from having come from uh some affirm that specializes in behavioral finance, there's tremendous power to understanding.

Are you in a realm where you need to sort of figure out where other people are making mistakes, which I would say is true in markets like the stock market, or are you in a realm where what matters is are you making the mistake, in which case you've got to do the financial analysis. Well, So the distinction I would sort of make is I've never heard of behavioral private equity. If you're the only person bidding, if you're the only person bidding on a company, you just got

to do the analysis right. You want to focus on financial knowledge. If you're competing with lots and lots of other folks, then I think being an expert on what are the mistakes other people are gonna make that's going to be more important. So it's good to go which area you're trying to focus on and get an expertise that matches that area. And a final question, tell us something you know about investing today that you wish you knew twenty years ago. Well, I already told you that

story I wish I knew, don't know. It's it's be aware of betting against extreme hype because it can go It can go the wrong way much longer than you would expect. We have been speaking with Dr Raife Jovinazzo of Fuller and Thailor. If you enjoy this conversation, be sure and look up an Inch or down an Inch on Apple iTunes when you can see any of the other two hundred such conversations we've had previously. We love your comments, feedback and suggestions right to us at m

IB podcast at Bloomberg dot Net. I would be remiss if I did not thank our crack staff who helps put together these conversations each week. Taylor Riggs is our producer, Booker m Medina Parwanner is our audio engineer. Slash producer Michael Batnick is our head of research. I'm Barry Ritolts. You've been listening to Masters in Business on Bloomberg Radio ex