Article By Alex Gavrish, Etalon Capital Ltd; author of “Story Investing”
About a year ago I read an exciting book by Professor Eric Kandel, a Nobel Prize laureate in medicine and professor at Columbia University. In the book, professor Kandel draws parallels between such seemingly disparate fields of science as brain research and modern art.
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Despite different objectives, there is an important conceptual connection between the two. Scientists reduce complex processes and problems to smaller, simpler components. They do it because it makes it much easier to do the research. For example, to understand brain activity.
Modern artists implement the same principles but approach the problem from an opposite direction. They make us start with “simple” and “reduced” elements of visual representation and make us “move” towards more complex ideas. Picasso destroyed the form. Mark Rothko reduced everything to color. Jackson Pollock integrated chance and accident into painting.
Because of these “techniques” and the biological mechanisms underlying our visual perception, abstract modern art enacts a powerful influence on us: we become more creative and our imagination starts to function better.
It is not hard to draw parallels with the investment world. Quantitative investment managers and factor-based strategies aim to achieve the same. They reduce complex processes, in this case, economy and the stock market, to a simple formula or model.
In a recent paper by investment management firm AQR, researchers performed a quantitative analysis of famous investors: Warren Buffett, George Soros, Peter Lynch. The authors argue that all of these “superstar” investors investing styles have exposure to a range of factors. The implicit idea here is that if we reverse engineered their approach and found these factor exposures we can, without much effort, replicate or achieve similar results.
The problem and the truth are that both “superstar” investors, as well as artists, do not really start from a reduced model. The artists force us to start the perception of art with the help of a reduced model, and their genius lies partially in the ability to create and develop one, but the techniques and the model itself are the means, not an end. Artists themselves do not start from it. And they do not end with it. Otherwise, their paintings would not be worth tens of millions of dollars.
They start from a different place: from their complex and unique vision of the world. From the depth and strength of feelings, they want to share with us. From philosophical, religious or cultural concepts they want us to understand. It is just that modern artists feel it is very hard, if not impossible, to relay their vision except through a reduced and simplified form. But it remains our task to take it as a starting point and work all the way up to deeper understanding.
Recently I watched an interview with Ilya Kabakov, a famous conceptual artist. He was asked if art will save the world. His answer was that it is not art, but the culture that will save the world. By culture, he meant a broader set of higher values. If art is part of such culture then, of course, it will fulfill its mission and role in saving the world. This viewpoint is similar to the main idea of a short book by Leo Tolstoy “What Is Art”. Tolstoy starts the book by changing the question. In order to know what good and bad art is we should ask not so much “What is art?” but more “What the art is for?”
Similarly, it is so with great investors. To learn something from them, we should focus not so much on factors underlying their investments but more on what stands behind these factors. What values do they transmit? What broader life or investment philosophy investors adhere to when investing? What risk management objectives they aim to achieve? What complex reality do they try to react to by making certain investment decisions?
Most would probably agree that markets are efficient to a large extent, but despite this, a small pack of activist investors and hedge fund managers continue to come up with great investment ideas. How is it possible? Why do these opportunities not disappear?
I think the reason is because these managers are good storytellers. Many investors believe that making good investments requires excellent skills in the analysis of financial accounting statements, building complex and detailed valuation models, forecasting future profitability of companies and otherwise analyzing numbers “to death”.
But according to one of the best investment managers of the 20th century, Peter Lynch of Fidelity Investment’s Magellan Fund - which achieved a 29% annual return over thirteen years’ period between 1977 and 1990, good investing is about something else:
“Investing in stocks is an art, not science, and people who’ve been trained to rigidly quantify everything have a big disadvantage”.
When activist investors present their investment thesis to the general public, they not only communicate reduced model consisting of simple facts such as low valuation ratios and recent share price underperformance. They often tell a story: about a struggling business, a corrupt CEO or management team, a restructuring process that failed or is not reflected in the share price yet, a strategy for improving the business and a myriad other types of stories. Just like great artists, activists tell these stories with emotions, with an intrigue, with drama, with conflict, with struggle.
Contrast this with the art world. Mark Rothko, generally identified as an abstract expressionist, did not view himself as one:
“I'm not an abstractionist. I'm not interested in the relationship of color or form or anything else. I'm interested only in expressing basic human emotions: tragedy, ecstasy, doom, and so on.”
Jerome Bruner, a famous cognitive psychologist, explains that narrative mode of thinking leads to conclusions not about certain absolute truths, but about varying perspectives that can be constructed to make experience comprehensible. By telling stories, we formulate these different perspectives. Pablo Picasso said that “Art is a lie that makes us realize the truth”.
It is not a coincidence that most famous investors are also good writers. Strictly analytical approach to investment management does not provide us tools for dealing with uncertainty. The closed and fixed form of analytics leaves no place for imagination. And without imagination, we are just not capable of fathoming uncertainty, fathoming the future. Isaac Bashevis Singer, Nobel Prize laureate in literature said: “A story to me means a plot where there is some surprise. Because that is how life is - full of surprises”. The same holds true for investing, because companies, markets, and economy by their very nature are social processes. And when there are humans involved, there will always be surprises.
In investing, you cannot escape them. They will arise either because your decision was made with incomplete information or just because that is how life and business are. Whole investment philosophies were developed as an outcome of addressing uncertainty issue. Howard Marks’s The Most Important Thing and Seth Klarman’s Margin of Safety books are bestsellers, among other reasons, because they describe solutions to problems of risk and uncertainty.
Over past decade, exactly at a time of increased popularity of ETFs and passive investing, a great wave of activist investors appeared. It is one thing to work with abstract models and numbers where your personality is hidden behind the “model”. It is a completely different experience to put your personal reputation and perhaps your entire career on the line by making a high-profile investment broadly covered by media.
Nassim Taleb, in his (as always timely) recent book Skin in The Game, provides some interesting perspectives on having “skin in the game”, or “soul in the game”. Taleb argues that many of us are subject to Kant’s universalism. According to him, modernity likes the abstract more than the particular. But at the end of the day we, humans, are local and practical “animals”. The colorful personality of Fat Tony (familiar to us from Taleb’s previous books) is a great example of such local and practical “animal”. As we move more and more into abstract constructs we miss the trees for the forest. In financial markets and economy, this can lead to uncontrolled, undesired or even disastrous results. It seems that many activist investors and hedge funds took on the Fat Tony role in order to bring the system “back to earth”.
Returning to the world of art, one can notice that same processes are ongoing here as well. In the seventies, a group of painters known as School of London went against the ever-increasing popularity of abstract expressionism and returned to figurative painting. Current exhibition All Too Human at Tate Britain showcases this group and related painters, among them Frank Auerbach, Leon Kossoff, Lucian Freud, Francis Bacon, Michael Andrews, David Hockney, Paula Rego, Francis Newton Souza. At the entrance to the first room, the visitor is greeted by Chaim Soutine’s paintings. One might ask what this Jewish-French expressionist painter from twenties has to do with School of London group from seventies, an interval of about half a century? Last year’s exhibition of Soutine’s portraits at the Courtauld Gallery was the first major retrospective of the artist in the United Kingdom in 35 years.
I believe that apart from their commitment to figurative painting and focus on the human figure, the main connection is through the social and world processes both Soutine and School of London painters tried to reflect and question. This questioning aims to refocus and bring us “back to earth”. So that we never forget the world is built by Fat Tonies. By individuals. By personalities. By human beings. Not by corporations. Not by abstract financial models. Not by investing in passively-managed index-based ETFs.
Soutine drew portraits of servants and workers of expensive Parisian hotels in the 1920s. At the time, these workers were pure “abstracts” the businesses and the “system” utilized for obvious purposes. They were nobody both for managers and clients. But through his paintings, Soutine showed to everybody that these individuals are not some “abstract” workers without personality. They are the complete opposite. Behind their simple appearance and low social level, there are deep human beings with infinite, transcendent souls.
The world cannot exist and develop through too much abstract stuff: be it abstract expressionism in art, simplified models for investing, business or government systems built on faceless executives, bureaucrats and corporate slaves without “skin in the game” (to borrow Taleb’s idea again), etc. Humans cannot live with abstract ideas only. And who knows maybe realization of this is the reason Soutine’s retrospective made it to the public after 35 years’ pause.
I believe the same process will be at work forever in all dimensions of our lives, including investing. The more bureaucratic and ignorant large corporations will become, the more start-ups and entrepreneurs will appear. The more fashionable abstract art will become, the more unique figurative (or otherwise balancing) artists will appear. And the more popularity and acceptance passive investing will gain, the more activist investors will show up to counterbalance it. But in the end, it is not the tipping of weighs to one or the other side that will decide the fate of this battle, but our attentiveness, sensitivity, and understanding of the ongoing human versus abstract “rebalancing” process.
