How to be foxy

Like other phrases of Kipling’s – “the white man’s burden”, “the female of the species...” – this one became embedded in the language and is usually modified to “what do they know of England that only England know”. As such, it is both critical and generic. Critical because, obviously, it hints at a lazy insularity that generates little understanding; generic because the question can be posed about any subject that is substituted for ‘England’.

Thus we can ask: what do they know of investing that only investing know? The implication remains clear. Those that only investing know; those who, for instance, only know of relative strength indicators, price/earnings ratios, or the VIX index of market volatility think they know it all, but actually know little, understand less and worst – much like those who “vapour, fume and brag” in Kipling’s poem – don’t even know how little they know.

Yet that might also be unfair. Some of those that only investing know do know a good deal about their chosen focus. In which case, that prompts another question – now borrowing from Isaiah Berlin, a populariser of philosophy – is it better to be a hedgehog or a fox? The difference, said Berlin in a famous essay from 1953, is that “a fox knows many things but a hedgehog knows one important thing”.

Obviously, the shortcoming of knowing only how to roll into a ball has its limitations; for instance, in the middle of the A31 as a 30-ton ‘artic’ steams towards Mrs Tiggy-Winkle. Meanwhile, by knowing lots of little things, the fox has been smart enough to adapt to the cities where Mr Reynard can make a handsome living out of the dustbins of London’s middle classes.

In investing terms, this contest between hedgehogs and foxes boils down to the contention that it is better to know a little about a lot (the fox) than it is to know a lot about a little (the hedgehog). Is it better to see everything about investing through the focus of just one big thing – say, ‘value investing’. Or is it better to connect up lots of little things. And, if it’s the latter, then what’s the most important stuff to know?

Cue a feature about the best investment books that aren’t actually about investment. These are the books that can give you a crash course in acquiring the foxy skills; skills that are at once investing underlay – the hardcore that goes down to support the investing acumen laid on top – and that help supply the flexibility that permits investors to adapt to changing circumstances, to make sense of the unfamiliar. Read and understand these books, is our contention, and you will know of investing that there is much more to it than just investing. But that will no longer be a worry. On the contrary, it will be a challenge to be welcomed.

Before we deal with the nine chosen books that come under four headings, let’s also set out the ground rules on forbidden subjects. Clearly books directly about investing are out – you won’t see Benjamin Graham’s The Intelligent Investor on the list. Nor will you see books about finance, accountancy, economics, business or individual industries. Vital though they are, here they’re taboo. The chosen nine – plus six worthy substitutes (see table) – cover subjects that are as close as we are allowed to creep.They are grouped under four headings all of which relate to skills and understanding that, if acquired, should make anyone a better investor.

Dealing with numbers

It may be remarkable how much you can know about investing while knowing almost nothing about mathematics – much like life, really. Nevertheless, it’s useful if your maths extends to a bit more than basic numeracy.

For instance, it helps to know that the ubiquitous ‘alpha’ and ‘beta’ that investors talk about perennially in connection with excess returns and the volatility of share prices are simply components of a basic linear equation that quantify how a straight line runs through horizontal and vertical co-ordinates. Or, if you dabble in traded options, then it’s interesting to know that the Black-Scholes options-pricing model, which transformed the world of finance, was derived from a piece of calculus that was used to quantify the rate at which heat passes through a metal casing.

And the great merit of Mathematics for the Nonmathematician is that it uses lots of words to help with the descriptive explanation of why these and other branches of mathematics are the way they are; why mathematical reasoning is how it is; how the grammar and syntax of equations is logical; how Euclidean geometry is held together by consistent axioms and so on up to the calculus and beyond. Sure, the book is getting long in the tooth – it was published in 1967 and Professor Kline, who spent most of his academic career at New York University, died in 1992 – but it has stood the test of time, which is probably why it is still in print.

The penultimate chapter of Professor Kline’s book deals with probability theory but, for more explanation of that and other branches of statistics that are vital for understanding investment, readers should go to The Cartoon Guide to Statistics. There are ‘Cartoon Guides’ to many subjects and one of the joint authors of the statistics edition, Larry Gonick, a maths graduate of Harvard University as well as the cartoonist, has made a good living contributing to his full share.

Granted, there are many versions of the ‘Statistics made Simple’ text book and the Cartoon Guide is not necessarily better than some others. Like so many, it knocks up against the problem that much about statistics – like most maths really – is intrinsically difficult, so it needs effort and practice to understand. Yet because statistics is almost as much a visual study as a mathematical one then using lots of cartoons helps intuitive understanding. Simultaneously, it’s good that the authors don’t shy away from the equations and the mathematical notation that underlie the graphs.

Dealing with technology

Not a million miles from The Cartoon Guide to Statistics in terms of presentation is The Way Things Work Now. Instead of a geeky statistician and his resolutely non-mathematical girlfriend this book has colour drawings of cave men and anthropomorphic woolly mammoths. Between them they explain the basics of physics as they apply to the machines that power the 21st century – from door locks to smart phones.

Some readers may recall buying the original version of the book in the late 1980s to explain to their children how the world worked then. Now they can buy the updated version – it was published in 2016 – for their grandchildren, but it does a job for adults, too – up to a point, that is. Like so many ‘how to’ books, if you already know the subject, you can pick it apart. Yet if you feel the need for a more grown-up approach, you can always turn to the ‘For Dummies’ series published by John Wiley, which includes books on almost any scientific subject you care to mention. ‘For Dummies’ will almost certainly fill the gaps on chemistry and biology that The Way Things Work Now leaves unplugged, though their art work is hardly up to the standard offered by Dorling Kindersley, which publishes the latter.

Dealing with human nature

Writing in The Intelligent Investor – the book we said we wouldn’t mention – Benjamin Graham told us that “the investor’s chief problem – even his worst enemy – is likely to be himself”. However, know human nature and we know ourselves and thereby we overcome and, in the process, become better investors. Or, at least, that’s the theory. As good a place to start with this notion is the spooks’ handbook, The Psychology of Intelligence Analysis, written for employees of America’s Central Intelligence Agency by one of their own, Richards Heuer, a CIA veteran of 45 years.

The book’s chief merit is that it avoids most of the dreadful writing that populates textbooks about the pseudo-sciences, thus making an important subject accessible. It keeps it simple with sections on our mental machinery, tools for thinking and explaining cognitive biases. True, the book is very much second hand, putting into layman’s language what detailed studies by behavioural psychologists put into jargon, and it’s all the better for that.

Besides, it might just as well have been written for investment analysts as for intelligence analysts. Indeed, take the following quote: “The intelligence analyst’s function might be described as transcending the limits of incomplete information through the exercise of analytical judgment”. Substitute ‘investment’ for ‘intelligence’ and you have the perfect description of the function of investors when they are assessing a proposition. Work through the book in that frame of mind, making the necessary substitutions, and it becomes an insightful guide.

And if you want to consult one of Mr Heuer’s main sources, you can dip into – to give it its full title – Judgement under uncertainty: Heuristics and biases. This is a collection of 30 or so academic studies that show the way that people use mental rules of thumb – heuristics – to deal with complex and uncertain situations. “Heuristics are quite useful, but sometimes,” warn the chief editors, Amos Tversky and Daniel Kahneman, with understatement, “they lead to severe and systematic errors.”

Much of the problem is that people are useless at dealing with statistics and are overly influenced by anecdote. Or, as the editors say more formally: “The fundamental notion of statistics is evidently not part of people’s repertoire of intuition.” Thus people consistently allow their intuition to lead them to the wrong conclusions – to become overconfident, especially if they are dealing with a subject they think they know; to see connections where statistically they are unlikely to exist; to imagine they have control where, really, they are playing with chance.

Linked to almost all of this is the difficulty of making good forecasts. Yet investing can’t exist without forecasting. After all, when anyone buys a stock, he or she is, in effect, forecasting that its price will rise. Poor at forecasting though they are, people can get better with practice, by keeping an open mind and by mastering a few skills. At least, that’s what we are told in Superforecasting: The Art and Science of Prediction by Philip Tetlock and Dan Gardner.

The main man here is Mr Tetlock, a psychology professor at the University of Pennsylvania, who is best known for establishing The Good Judgement Project. The project – a collaboration of mostly academics – was set up in 2011 and easily won a forecasting competition organised by the US government’s intelligence bureaucracy to address the lamentable performance of America’s spooks in failing to understand the danger posed by Al-Qaeda or the subsequent mayhem in Afghanistan and Iraq.

Superforecasting describes the forecasting techniques that enabled The Good Judgement Project to do better than spooks armed with classified information. Essentially, the project’s edge – and, by association, good forecasting – distilled down to using some simple skills, which, here at Investors Chronicle, we discussed about 18 months ago (‘See into the Future’, Investors Chronicle, 13 January 2017). Explaining these skills forms the core of Professor Tetlock’s Superforecasting book, but, in essence, they fall under four headings:

●  Outlook – keep an open mind; learn to be comfortable with doubt; avoid jumping to conclusions; be aware of ‘confirmatory bias’.

●  Thinking style – tackle tasks sensibly and efficiently; set priorities logically and sift evidence assiduously.

●  Forecasting methods – consider multiple points of view; become adept at dealing with ‘shades of maybe’.

●  Getting stuck in – success comes from practice, practice then more practice.

The Righteous Mind comes with the sub-heading, Why good people are divided by religion and politics. That signals that the book is something of a bridge between the study of ourselves – dealing with human nature – and our attempts to grapple with what’s happening in the world today in the next section.

It touches on areas found in both Psychology of Intelligence Analysis and Superforecasting and, indeed, its author, Jonathan Haidt, is a former colleague of Superforecasting’s Philip Tetlock. However, its chief aim is to supply a psychological explanation for the widening divisions in the developed world between, say, liberals and conservatives, Democrats and Republicans, Remainers and Leavers, or – more contentiously – ‘inclusionists’ and ‘exclusionists’, citizens of Nowhere and citizens of Somewhere. You get the idea.

According to Professor Haidt, the side of this divide on which we line up depends upon our position in a moral matrix that, for instance, trades off between loyalty (to a group) and betrayal, authority and subversion, care and harm, fairness and cheating. It’s less about genetics and more about ‘group think’. So, to use the book’s acronym, those of us who are born ‘weird’ – that’s western, educated, industrialised, rich and democratic – will find that our intuitive responses are skewed in one direction, favouring care and fairness, but also subversion and betrayal.

But liberals, socialists, leftists and democrats beware. According to Professor Haidt, conservatives come with a built-in advantage because, perhaps surprisingly, they are equipped with more of these moral triggers than the other lot with whom they share little more than a mutual antipathy that goes beyond comprehension. In the long run that means they form stronger groups – and win.

Dealing with the world

Even if reading Professor Haidt’s book will do little to change polarised positions, it should help investors understand the world as it is. They should also be helped if they slot today’s events and – more important – its trends into the grand scheme of things. Not that there necessarily are schemes, but there may be. At least, it is widely known that Marx – Karl, not Groucho – believed that history repeated itself first as tragedy then as farce; the American poet, Ezra Pound, reckoned that history was “a broken bundle of mirrors”; while the Spanish/American philosopher George Santayana warned that “those who cannot remember the past are condemned to repeat it”.

Best, therefore, to grasp the grand sweep of the past, for which task The Lessons of History, from the husband-and-wife writing team of Will and Ariel Durrant, does an admirable job in 100 pages flat. By way of testimony, Ray Dalio, the billionaire founder of hedge fund Bridgewater Associates and one of the smartest investors on the planet, swears by The Lesson of History as a quick-and-easy guide through the shifting currents of contemporary events. That’s understandable because the book offers an instant scan on the big themes – for example, morals and history, religion and history, economics and history – and does it with clarity. Sure, it’s oversimplified and is appreciated more by conservatives than by liberals, but it comes with some great soundbites that – like it or not – you’ll find yourself repeating to interpret market-moving events that, before your instant education, hit you as clod loads of confusion layered upon complication then covered by obscurity.

Last – and probably least – it might be useful to have readily available lots of facts about the world as it is – its countries, their economies, politics and demography. For that, we return to the CIA and its annual handbook, The CIA World Factbook. If you want, you can actually buy this, though the CIA’s website offers a free PDF download and – especially useful – it comes as an app for tablets and smart phones. That accessibility probably gives the CIA factbook the edge over better-known – and paid-for – rivals such as Whitaker’s and The Economist’s Pocket World in Figures.

True, any of those three will offer lots of knowledge about England – well, about the United Kingdom – but you have now moved beyond that. In pursuit of foxy skills and the virtue of knowing a little about a lot you will be able to distinguish knowledge from facts and you’ll understand that there is much more to knowing about investing than just knowing about investing.