Sorting is one of the first things we teach children – put the green colours together, the circle shapes together, and so on. Comparing objects with similar and dissimilar characteristics is a foundational life skill. Classification helps us to quickly organise information, understand complex systems and make decisions.
Naturally, classification is also prevalent in the investment industry. Indeed, a paper by Blue Mountain Capital Management’s Michael Mauboussin explored how the investment world makes comparisons. More specifically, Mr Mauboussin shows how professional analysts and investors do a poor job comparing companies. He concludes that: “Comparing, essential to effective decision-making, comes naturally to humans. But our basic approach of relying on analogy can limit our ability to compare effectively. In particular, we fail to incorporate sufficient breadth and depth into our comparisons, and we can be easily swayed by the presentation of information or the allocation of our attention.”
Why might this be? Let’s consider how the industry is set up. Fund managers often employ in-house ‘buy-side’ analysts who cover entire sectors (eg, healthcare) and outsource third-party ‘sell-side’ analysts who cover specific sub-sectors (eg medical devices). The buy-side analyst provides breadth of research while the sell-side analyst provides depth.