Jamie: [00:05] Hello everyone, and welcome to another episode of Hedge Fund Huddle. This is the award winning podcast that takes a microscope behind the curtain of how hedge funds operate and why they continue to dominate the investing world, well, at least a few of them do. Now, for those of you listeners, you'll know that this is episode two in a series that we're doing on the psychology of trading. Last episode, we focussed on the right mental approach to investing, getting in the right mindset, understanding your own mindset in order to optimise your trading approach. Now, today, we're doing something slightly different where we're going to be talking about using performance data, individuals’ performance data to analyse how to better execute trades in terms of timing, what sort of markets you are better in and what biases you may have that you didn't know that you had. Now we'll be referring to something called behavioural alpha, which essentially points out the difference between being skilful and being lucky. Believe it or not, I know this from personal experience. There are a lot of fund managers out there who still don't know the difference between the two and claim a lot of luck as their own skill. Anyway, enough about me. Let's get to our guests and to discuss this topic, we're going to welcome back the formidable Dr Richard Peterson of Market Psych fame, third time appearing on the podcast, a set of steak knives coming away. And we are welcoming for the first time founder and chief exec of Essentia Analytics, Clare Flynn Levy, thank you very much for joining us, guys.
Richard: [01:38] Yeah. Super excited.
Clare: [01:39] It's great to be here.
Jamie: [01:41] Now, Richard, we know a lot about you, but, Clare, if we could just start with you, we'd love a bit of a two minute intro about yourself, because I think your background is really important to framing this conversation. And then perhaps you can finish with what Essentia does so brilliantly.
Clare: [01:53] I knew I wanted to be a fund manager from a really young age. That's weird, now, in retrospect, now that I have kids that are almost the age that I was when I thought I wanted to be a fund manager. I think that's weird, but I did and that's probably because I grew up in the 80s near Greenwich, Connecticut which has since become a fund management capital of the world. But I made a beeline for that occupation and Wall Street right out of university. I went to Columbia in New York. So, I had access to jobs and internships at a time that was pre-Internet for the most part, pre mobile, definitely a different time. Nonetheless, we were able to function without these things. We did business and we had internships. I ended up working first for Gabelli Funds, which still exists in Rye, New York, and then at Kitter Peabody in equity research, as an intern. But that got me my start. I ended up doing my third year out of four in a US degree at the London School of Economics and fell in love with London. And I knew when I was applying for jobs after I graduated that I wanted to work on Wall Street, and I was doing all the milk round interviews for investment banking, but I really wanted to be on the buy side. I knew that because I had been interning and doing jobs throughout university there. And I happened to write a letter to a woman called Nicola Horlick, who some of you, depends on how old you are. You may or may not remember, but she was extremely well known in the UK long only fund management market in the late 90s. Like, you know, celeb of that market. And she had been to my school. So, she was on the alumni list. And so, I wrote to her and asked her for a job basically as a trainee fund manager. And she gave it to me. So, I moved to London. I joined Morgan Grenfell Asset Management, which is where she was. That was at the time a subsidiary of Deutsche Asset Management. But there was a scandal that happened in the bank in the asset management firm during that time that caused a lot of drama in the papers. And those people who were around in the industry back then will know what I'm talking about when I say the Peter Young affair. At any rate, when you're a young person and you know this drama is happening all around you if you have the right attitude, if you're the sort of person that is up for responsibility, just, you know, I'm going to do the best damn job I, you know, making photocopies ever. That was literally the approach that I was taking because I had been sort of raised to be like that, I guess. And I ended up becoming a resident tech expert during the internet bubble when things were going really, really well. You know, tech stocks were going through the roof. So, I was in the right place at the right time. But going to your point about the difference between luck and skill, when the market turns and you had 9/11 happen, the market turned very dramatically at the end of 2000 and early 01. And it stayed in this state where what I had been doing to make money wasn't working anymore. And by then I had launched a long, short fund. So, I left Deutsche or Morgan Grenfell at the end of 2000 to launch a long, short European tech fund called Avocet Capital, and it was an $85 million launch.
Jamie: [05:43] How did you raise? How did you raise the money for that?
Clare: [05:47] I raised the money with two backers introducing me to their networks, one of whom was Mike Lynch, the CEO of Autonomy, who recently sadly passed away in the yacht disaster in Italy. But he was the CEO of Autonomy at the time. We were a big shareholder in it. I got to know him through that, and he and I shared a view that the European tech market was very inefficient and that there's a lot of opportunity. And because I knew all the CEOs, because Morgan Grenfell was a big shareholder in all of these companies, I should have an information advantage. Not an illegal one, but one, nonetheless. And so that was our pitch and he and another guy took me around the market, and we raised money from fund to funds, which is what existed at that time. You know, that was the main investor fund of funds, family offices and high net worth individuals. And you really didn't have institutional money in the same way that you do in alternatives today. But an $85 million launch was a big launch back then, which is kind of wild now to think about. Anyway, I was in a good place, but then the market turned and it's like, now what do I do? What I have been doing isn't getting me the same results. Is it me? Is it luck? Is it skill? Like, is there something I can control here that I should be doing better because I'm that type of person that will tell them I want to continuously improve, show me what it is I'm not doing well, and I'll try and do better. But nobody could show me that. They could show me my performance and say, well, it's not been great. It wasn't terrible, but it was like I was running very hard to stay in one place. And, thinking that I'll just consume more information. I just need to work harder. That will help. And there's plenty of science now that shows that the marginal there's a point of decreasing marginal returns when it comes to consumption of information and data about a particular thing. So that's not the right answer. But I wanted somebody to say, all right, well, if we take a step back and understand that my job is to make decisions, that's what a fund manager's job is. Outsourced decision making, basically about money. So, if that's what my job is, there's only a certain number of types of decision that I make picking decisions, sizing decisions, entry timing decisions and so on. So can't somebody just analyse all my past decision behaviour and tell me which ones am I good at and which ones do I screw up. And I've read about behavioural bias. I don't doubt I'm biased. Can somebody just tell me what. Show me, me doing it and then tell me how I can fix it. And that did not exist at the time.
Jamie: [08:37] I mean, it's fascinating to me that it wasn't that long ago that looking at what you've just described, people would just say, here are my past three years of performance. And so much of that could just be your bullish tech stocks versus some other sector. You know, it could just be like a lucky call. And yet at the end of that conversation it's like, oh you've got great numbers. Here's $100 million. And I know we're getting to this with Essentia, but this is what Essentia really tries to do, is cut through the noise and say no, no, no, no. You've got great numbers but just look at your positioning. Like 80% of this was just you being bullish. If we actually see how much skill was involved, I can really tell you how good you are as a portfolio manager. So, do you want to just talk a little bit about that?
Clare: [09:19] It's the difference between looking at the outcome and using that to judge whether a good job has been done. And it's like on some level they're paying you for performance. So, you perform well. You did a good job right. Well maybe a good job was done incidental to you. So, what role did you play in it? And if you knew what role you play in it, you could optimise for that and make your own life easier in the process by not doing the stuff that isn't contributing to it. But in order to do that, you need to be doing analysis at the decision level. And that means that at the trade level. Fund managers make lots of decisions that don't result in trades. Right. So, there's a lot of decisions that are not being captured by trade data, but a lot of decisions are. So, everybody's got their daily holdings data or their daily trade data, and if you just start with that and do analysis on, we call them investment episodes. But the game tape of each one of the positions that you've held in the portfolio over its life and analysis of what did the winning games have in common and what did the losing games have in common? And then if you zoom in on the constituent parts of the of the game, you know, the picking decision, the entry timing decision, the rate at which you build your positions, the adding and trimming decisions you make in during the life of the position, the rate at which you get out, when you get out, those things. You pick your sport, but it's the analogy, it's the same thing. It's like strokes of a tennis racquet. And not everybody is great at every single stroke. But you're not going to win if you're only good at serving. I mean, I suppose it's possible to statistically, but it's not going to happen. So, you need to know first of all which things you are good at, which things you are not good at and try to optimise. And when you do that sort of analysis from bottom up, you have way more data points to work with. And so that means that you can start looking at stats that are like batting and slugging, the stats that people refer to as those two things I would say hit rate and how often are you getting it right. Meaning, you know, no matter if you're benchmarked, if you're not benchmarked, whatever your measure of right should be in P&L terms. What percentage of the time are you achieving that positive contribution? It would be over 50%. But actually, the majority of fund managers have hit rates under 50%. It's not about being right all the time, or even more often than not, although ideally you would be the key is what people will refer to as a slugging stat, but it's not really. It's a payoff ratio. And what it's looking at is the average P&L on your winners divided by the average P&L on your losers, or the P&L of your average winner, divided by the PNL of your average loser. So, when you're right, are you more right than you're wrong when you're wrong? That's the key. And that's where you can see which stocks went up. Could be a matter of luck. But somebody who is good at running winners and at cutting losers and keeping that ratio well over 100%, ideally even over 200%. That's a skilled portfolio manager. And it becomes very evident.
Jamie: [12:43] Okay. Now that particular process you're talking about, I'd love to dive into a bit more. Unless Richard, you wanted to jump in now?
Richard: [12:49] Well, I had a question for Clare about this because this is really interesting. So, when you have a hit, you know, sometimes they talk about, say, in poker your hit rate might be 40%, but you have the higher expected value overall, right? So, your gamble is likely to pay off more. And I was curious, when you look at investors, do you find that there are some that have these lower hit rates. So, they're lower accuracy, but they have these really big returns. So, you invested in Nvidia or Amazon in the early days everything else was useless. But that one return was huge. And you know, there's this famous story with Benjamin Graham that Warren Buffett has told at times that what really made his returns so good, Benjamin Graham, was that he invested in Geico, which didn't actually fit his model in the first place. Geico didn't fit all the financial metrics, but he knew a guy on the board. He got involved and he said, wow, this company could really be something much bigger. And then he helped turn around Geico. So of course, Benjamin Graham being the Columbia professor that tutored Buffett and helped Buffett get his start as a value investor. So, sometimes there are these funny stories, you know, we see somebody doing so well from just a few concentrated positions. And I hear about fund managers like this occasionally, and I meet them at conferences. And I'm just wondering, do you see them, and do you see these funny niches like that in your data where there's people with unconventional approaches who really are the outliers but then do really well overall?
Clare: [14:13] I mean, I definitely see people with unconventional approaches. And, every strategy is different. So having a strong understanding of what it is that you're actually good at and that your approach is delivering, that is obviously very important. But I don't really like to see the sorts of portfolios where there's like one stock, then like Nvidia has been the entire performance, like that's not really a good look. You want there to be a handful of those. And it could be that there are far more losers than there are winners. So, we see hit rates. I'd say they span like at the low end 35%, at the high end 65%. But the average is like around 46 or so percent. And so, you have some people who will have a high hit rate, low payoff approach. And you kind of think of it in personality terms too, like there's some people who prefer to take the lower risk on being right or wrong, but they're not going to go for it.
Richard: Are they may be letting their winners run a bit, so that's why you can be 46%, but still.
Clare: Well, and this is it. So, you can have a low hit rate. But if your payoff is high, so, if it's over 100% it needs to be over 100%. But with hedge fund managers, often really good managers will have a hit rate that's under 50%, but a payoff that is 285% or 300%, meaning their average winner is winning three times as much as the average loser is losing. So, when they're right, they're super right on average. And when they're wrong, they're only a little bit wrong and they're good. It's basically because they'll have ones that they've deemed are worth letting run, that they let run. And then they have ones that they have nipped in the bud before they get too painful. And they're not always perfectly right, but that is a good legitimate way to make money.
Jamie: [16:17] I have a real life story of what happened to me, which is on this topic, which might be a good example. I remember the stock. It was ING and it was going through a rights issue. This is basically a Benelux bank assurance stock, and I remember it was trading around, I don't know, €6 a share or something. And we'd done all our work, and it was going to be eight. But during this rights issue it was ticking down every day, six, five and a half, five and a quarter. And I was like very nervous about what was going on. And then one day you could just tell the stock was under pressure. And I was like, I'm wrong. I don't know what I'm doing. One day it popped up 5%. And I remember, there was I won't mention his name. There was another PM at the firm, and I was like, Thank God, I can sell some. And he just wrote back, he's buying more. And it was just the difference. And this guy is an amazing trader. And when he said that it just made so much sense, I was like, that's why he is fantastically good at this job. Because when you go no, no, no, now it's turned. And then me being, you know, a bit of a scaredy cat. I was just thrilled that I didn't have to have as much risk on because I got a good day. And just in that moment, I just saw the difference between me, a kind of decent trader, I guess, and someone who was really brilliant. Anyway, I just thought that was an interesting example because I still remember it so well.
Richard: [17:37] There's the cautionary tales as well, where a lot of the rogue traders end up being those guys that when it's ticking lower, they're buying a bit more. And some of them can become very successful. There's the story of Jon Corzine, who ran MF Global before that was the governor of New Jersey. So, Jon Corzine had this career. If you look at his trading history, where on the trading desk, he would be given extra risk at times because he would be about to blow out and they would increase his risk limits. He would then win that. The markets would turn, he'd win. And then he got a reputation as being a guy who really knew how to stick to his guns and take good risks. But then with MF Global, similar situation, too much leverage, but no one was there to backstop him. Eventually that risk became too big and then the whole firm blew up. And so sometimes, these guys, like, you can do well for decades, but sometimes that strategy will come back and haunt you. So, very tricky.
Jamie: [18:35] Well, I think this is what's really interesting about Clare's work because, I mean, I worked at a pod shop. And, you know, one thing about a pod shop is basically capital gets allocated to whoever who's hot at the time. I mean, in a way, you're not just trading stocks, you're trading people as well. Like if someone's on a hot streak, give them more. But with what you're saying, Clare, if someone had showed extreme skill in trading stocks and was having a bad performance, I would probably give them more capital because you know that at some point their luck's going to change. I mean tell me if I'm wrong. But I do remember it was more simplistic than that. I just remember if you're on a hot streak, you got more capital. And if you weren't doing well, it was taken away. But I think with what you do at Essentia, you know, is like a second derivative. It's like, okay, well, are they losing money because it's bad luck, or is it because they're just really doing poor stock selection?
Clare: [19:24] You know, are they doing something differently or is it just about the stocks right now are not in favour.
Jamie: [19:30] Clare, I had a wider question for you and I'd love your opinion as well Richard. The very short question is - is this the hardest market ever to be trading? And let's just stick with equities for now. The bigger question is, Clare, you're in this unique position of being a long only fund manager and a long short equity fund manager. It's like for people listening who know they want to be investor. Clare, they're you, a few years ago, should we say, I won't say how many. Is it a better market right now to be in long only. Is it a better market to going long short? I mean, I'm thrilled I'm not in the long short equity market right now because it just looks so hard. So, I'm just interested in what kind of market you think we're in now. You know was it just easier back then, five, ten years ago? What are your thoughts?
Clare: [20:14] I mean I definitely think it was easier. It was easier back then just because you could still have an advantage by being smarter or better connected than the other.
Jamie: [20:25] But yet still, these hedge funds are putting up such great numbers.
Clare: [20:29] Well, now what's happening is that it's optimisation what the hedge funds have done. Well, the pod shops in particular have done well is optimise and they really are. The way I see it, it's like cows in a professional dairy where you get slotted in and they milk you. And as soon as you stop producing the flow of milk that's expected, they unplug you and they put a different cow in there. And that's literally what they're doing and they're paying you very handsomely for your milk. So. Great. As long as they're doing that and you don't mind the stress of it all, and the relatively short tenure that can ensue. Fine. But they are doing a certain amount of analysis to figure out when is the milk running out and is he done? You know, just like a manager of a football or U.S. soccer team would be looking at, you know, how's that guy running? Oh, his stats are starting to deteriorate. I think we better take him off. They're doing a lot of that. But it is very much risk and performance based. It's coming at it from the point of view of the team manager or CEO who is allocating the risk. So, it's not designed to help the manager, help the cow make more milk. It's designed to tell you when the cows stop making milk. And that is a bit of a conundrum for the cow. My analogies are all over the place.
Richard: [22:02] No, I love it. I mean, comparing hedge fund managers to cows is great. I've never heard of portfolio manager as a cow. I like it
Clare: [22:08] I mean, they're getting very, very clever about optimising and that's only going to continue. I mean, the long only world is far behind on it. But you can see it starting to happen. In some of the products that are creeping up, whether it's on the ETF side or otherwise in hedge fund land where it's the human computer hybrid that sort of spectrum of quant and human. It's finding itself. It's not so much of a barbell as it used to be.
Jamie: [22:40] And what I was going to ask as a follow up and maybe to you as well Richard, is a lot of the mechanics of the markets have changed. Passive investing has obviously had a big pickup there over the past ten years. ETFs, algos, there's a lot more noise in the markets. But ultimately when it comes to human psychology, are we still the same people now that we were 10-20 years ago in terms of people still buy and sell on greed and fear, they are still the ultimate drivers and maybe it's changed in the way that retail investing is making a difference in the market. But so, Clare and Richard, I would love your opinions on that.
Richard: [23:20] I think you can see as in the dotcom era, there are the lottery stocks where there's a lot of retail activity. And then there's the more institutional passive investor type stocks where you have the portfolios of thousands of stocks in an individual fund. But on the retail side, there's definitely the same greed and fear dynamics. And that's what we see in the media a lot in GameStop, AMC, it could be uranium stocks, it could be lithium stocks, whatever. There are bubbles here and they're popping up as retail moves its attention. So that's interesting. And sometimes that does overlap with the institutions like in the case of GameStop where the target is the institutions. But then on the institutional side, you've got the professional analysts and all their nice tools and data analytics, and they are competing for a very small slice of alpha. It's getting smaller over time. A few of them have migrated over towards the retail trying to take advantage of the anomalies on the retail side, which is quite interesting as well. But markets are always adapting, right? So, things are changing. But the fundamental, as you pointed out, fundamentally there's greed and fear. It can be in little bubbles here and there. It could be in crypto. It could be in AI, quantum computing. Recently, space stocks were up 20% in the first week of January. So, there's all these funny little pops here and there.
Clare: [24:36] Humans, our brains have not evolved at the same rate as the market.
Jamie: [24:41] That's exactly the point I was getting to is that the machines we're building are just evolving far quicker than us. And it's an interesting sort of contradiction, I guess that's happening.
Clare: [24:51] I've teenage sons and that's a perfect reminder of how some things don't change. What do they want to do? Trade stocks on their mobile phone or gamble. You know, there's an urge to gamble. There's an urge to make money. It's greed and excitement and dopamine. And now the technology's evolved to optimise your money going to the pocket of the provider. So, you have generations of not fully mature minds that are being exposed in the same way that it ever was to these vices, gambling and whatever else. And as a result, we may have learned a lot of lessons and don't day trade and all of that stuff. But that doesn't mean that humanity has. Not at all.
Richard: [25:44] I think there's less of a pretence of seriousness now, like meme stocks, you know, fartcoin. These are just things that there's no belief that there's any fundamental value to any of these. It's purely gambling. And this could be even look at Melaye and his rug pull from the Argentina Libra. These things, it's really becoming quite brazen where there's YouTube videos on how to orchestrate a rug pull in crypto. And so, it's quite interesting. I do think that will lead to probably some regulatory changes in maybe a few years, but certainly the markets have changed, and definitely the participants who are just out there for a quick buck. Zero day options is another example. I think they're half of all options, volume now is zero day options. So, it's really interesting how markets are evolving to appease to that gambling instinct.
Jamie: [26:32] I remember someone once explaining the stock market as an anomaly in the sense that it's one of the only playing fields where the absolute best in the world are playing right alongside the biggest amateurs in the world. I mean, yeah, you don't get me against Rafael Nadal on a tennis court, but you do in the stock market and it's difficult because you want to play a game where you know your opponent and in this game you don't really. And that's why, Clare and I, we spoke before this podcast before it's like, well, just bottom up investing even sort of work anymore because back in the day I had this, I could hang my hat on valuation. I knew that at some point the stock would be worth $56 a share or something because I'd done the work, and I don't mind if it goes down to 30. I know it'll get there eventually. But then you get to a stage where, well, we're all marked on performance. And if I don't make a return within three months, then I'm going to be in trouble. I may have to cut that position or six months or 12 months. So, I don't have the time anymore to wait for the stock to correct. So anyway, I just find it interesting that that dynamic exists.
Richard: [27:42] There is that short term impulse in the milk cow industry or whatever, the portfolio manager industry as well and that's similar to retail where you've got that short term mindset. But I think when you look at the really long term, the success of people who've done well over time, it is the Warren Buffett's, the George Soros, the people who've owned stocks for, well George Soros didn't do this, but people who have had positions for many years and had a long term belief or a narrative that drives what they're doing because that allows you to survive some of the ups and downs like you were describing with ING, for example, if you had that belief, this is the right story. It allows you to survive some of the news driven ups and downs or the retail investors getting involved if you know that something isn't worth it. The challenge is like with GameStop or AMC when the retail investors get involved and it changes the story because the company sells stock and suddenly now it is capitalised. Now it's not going bankrupt. It changes the narrative. Obviously, markets are complicated, like we're all competing against each other and there's only a few percent who are actually making out on top.
Clare: [28:43] You have to make sure that what you're getting paid to do the dairies, you know how the dairy is paying the cow is aligned with how the cow makes milk. Because I agree with you. Fundamental stock picking does still work. If you can take a long term view and withstand volatility without getting your money pulled, but you work for a pod shop, you cannot do that. You know that's not how the dairy pays. So, you better get to know how you make money and how your personality aligns with the way you want to make investment returns and then find money that understands that and that is prepared to be aligned with it, because otherwise, statistically, it's just you're not going to succeed.
Jamie: [29:27] So, Clare, if we can let's talk a little bit about more about Essentia in particular about the cows themselves. So, if you have a client, a long only fund or a hedge fund, can you just walk us through the kind of conversations you have? Are you finding that more and more people are coming to you because they're really keen on finding out this behaviour alpha versus just more general alpha and just a little bit more about the conversations you're having right now.
Clare: [29:55] Well, we are definitely getting an increase in people coming to us, mostly that's being driven just by insecurity of AUM where performance hasn't lived up to expectations. And there are cheaper alternatives. And passive funds are a possibility, it becomes existential. And so ideally, we have clients who don't wait until they're in an existential crisis to call us because it takes time to improve. First you got to go and do all the tests and get all the x rays and scans and whatever. And then the doctor sits down with you and tells you about, here's what this data is saying. And in our case, what we do is, that sort of analysis is on your trading history. And we look at it from lots of different angles, just like we're doing an MRI. And then we sit down with you, and we say, so here's what it's showing. The big difference is it's not then therefore you have cancer. You're going to know, it's over for you or whatever. We're not making a diagnosis on the length of your life. What we're saying is here's where we can see real evidence of skill. You're really good at this. And here's where we can see room for improvement. And pretty much everybody's going to have something where there's some room for improvement. And then it is a conversation. They might say, well What? How? I'm not sure I believe you. Why are you saying that? All right. Well, let's drill down. Let's look at, like, every single time. So, take an example. A manager who has had a tendency to hold on to their winners for too long. I mean you think of people having a tendency to hold on to their losers for too long. But sometimes people have a tendency to hold on to their winners for too long, meaning that they turn into losers. They round trip and somebody who shows up as having that behaviour, in our analysis, we can sit down with them and they might say well, I'm a long term investor. You can't. You're telling me that my alpha generation peaks out after three months? Like, how could that be? I invest on a one year view. We work with a lot of long onlys as well who are way longer term than this but doesn't really matter. You know, pick your numbers. If the data isn't reflecting the reality is that person knows it, you know their sense of what is going on. If it's at odds and they want to understand why, and they want to make sure that they really believe it. And so, you have to be able to drill down and look at every single time this has ever happened. And the data doesn't lie like the way we've built this. It's like, you know, airtight.
Jamie: [32:42] I should also say there are white papers published on your website which, there have been real scientific studies into your work really yielding results. So, for anyone who's listening, essentia-analytics.com and go and read some of the white papers. They're really interesting reading.
Clare: [32:59] No, there's a good one on there about this alpha decay is what we call it. So, it's about the fact that when you buy a stock, you have an information advantage that has a limited life. You know there's going to be a point where it runs out of juice. At best the alpha stops accumulating and it just sort of flattens out and it doesn't do any harm. But if that's the case, it's important to find that point where the slope of the line starts to flatten out, because that's when you want to be recycling that capital back into new ideas that are earlier in that journey. But sometimes people have a round trip where they make a lot of money. You get caught up in the endowment effect. You overvalue the stock because you know it so well and you know the management and we get very invested emotionally in these stories as well as financially. And when something's made you a lot of money, it's easy to stop applying the same scrutiny to it as something that is losing you money. And so, you don't really necessarily notice when the cracks start forming and the price starts to peter out. And before you know it, it's had a massive profits warning, and you just lost all the gains. You feel like a total idiot. So, what we found in the research is that managers do generate plenty of alpha on that first half. It's about avoiding the second half and the round trip. So, what we can do is if we detect that in somebody's behaviour and we can see that historically this would have been the right point. The example I was thinking of is a hedge fund manager who for him, it's five months. And it's to do with how his strategy works and the focus it has on results, but earnings results. But the point is five months. And if a stock isn't working or it is working, but it's running out of steam and they have questions, you know, the first question is how long has this been in the portfolio? Oh, five months. Okay. Doesn't mean we always cut everything at five months. But what essentia software does is, it pings them a list once a month of here are the stocks you're currently holding that are five months old. And they have it now built into their reports as well. And then it asks them some questions. It says, would you be a buyer of this stock today? How much more alpha do you think is in this? For over what time frame? How confident are you in that? These are questions that they said they wanted to ask themselves when they were next in that situation. But it's like you're serving yourself up some extra process at a point. You know, in the Daniel Kahneman parlance, it's about like moving from system one brain to system two brain and making a deliberate decision. Otherwise, you would have just made a passive decision to do nothing, probably.
Jamie: [35:50] I mean, I remember it so clearly, you're walking in and looking at your portfolio and you had to ask yourself if your sheet was blank today, is this what you would have on the sheet? And I just wonder because as you say, you get that sort of passive fatigue of just leaving it as it is. Do you ever recommend that to people? I mean, if there are people listening and obviously presuming your stocks or your securities are liquid enough is to sometimes just go to zero, you know? Sometimes you just take everything off. And then at that point you have no emotional bias towards anything because you start telling yourself a story after a while. But it's not until it's completely off the sheet that you can be a little more objective.
Clare: [36:32] Yeah, if you can do that because the way you run money allows that. It can be so liberating.
Jamie: [36:40] Oh, yeah, I remember it.
Richard: [36:43] Yeah. And it's so challenging. I mean, with the sunk cost bias, right? We all get attached to the positions we have, even if we don't know it.
Clare: [36:50] And you don’t want to look dumb. There's just something about, like. Oh, God. But what if it turns out I'm wrong, and then I'm going to look stupid that, you know, what if I never buy it back? You can buy it back. You know, people just assume that once they're out, they're never going to buy it back. Well, that shouldn't be the case. You shouldn't be saying that even though it's true, particularly if you lost money, you're probably never going to touch it again. You got to train yourself not to be so subjective about that. It's not about you. It's either a good opportunity at any given time or it's not.
Richard: [37:24] There's a relatively new bias, at least, eight years ago or so called the repurchase effect, where after you sell something, if it drops and you buy it back, it tends to underperform, I think 5% annually, positions that you sold and then bought back after they had risen. So, most people have this tendency after you sell it, you think, oh, it dropped in price, I'm getting a better deal. I should buy this back. But actually, you'll lose 5% annually versus if it went up in price, that's actually a signal that the market likes it. Things are going in your direction and then you buy it back. So, a lot of people, they're embarrassed, or it hurts their pride to chase something higher that they sold. So, the danger with selling everything is if it ticks up and then just keeps ticking up, you're likely to stay out of it, but that's bad too. So, it's almost counterintuitive. The repurchase effect. And it was Carey Frydman at USC who has a great paper about it.
Clare: [38:24] Yeah. I could totally see how that would be the case. And yet, it takes some fortitude to exit a stock and then buy it back 5% higher. I mean, it's not impossible. It's doable. And yet people will just sort of assume. No, I can't do that. It makes no sense, really.
Richard: [38:45] Yeah. I had seen Claire in your research. It was something like 80% annual underperformance based on sell timing. So, you guys found if you sold at five months, for example, versus waiting longer, it was something like 80% average annual outperformance for the managers who sold on time versus otherwise. Is that about right?
Clare: [39:05] Yeh, it has a huge impact. The selling decision is definitely the part that humans struggle with more than the buying decision, right? Probably all of us can relate to that.
Richard: [39:15] 80 basis points I think is what I read. Annualised.
Clare: [39:19] I mean it'll be between that and like 150 basis points in general will be the difference between somebody making good decisions in that situation. So, following what we do is we send them this nudge. It says here are all the ones that are five months old. Time to ask yourself these questions. And then you do what you're going to do. You know, it's not a rule that's saying you must sell everything at this point. Historically, it would have made you money if you had done that. But the history isn't necessarily the same as the future, so let's just use it as a point to ask some extra process questions. And the bet is that you'll make a slightly better decision slightly more often because you're doing that extra process. And then we track. All right. So now let's look at all the trades you did on the back of this nudge and compare those with the trades you did not on the back of the nudge at the same time. And you find people's stats are better because it's a point where historically it would have made a difference to make a deliberate decision. And now you're making a deliberate decision. And sometimes you're right and sometimes you're wrong, but you are right more often. And when you are right, you're more right. But it is you that's doing it. The computer and the nudge and all that stuff is really just about serving you up the question to be asking at the moment that matters.
Jamie: [40:46] I feel like this is a sort of idea that we could use outside of the markets just for ourselves to become better decision makers. And like I could divide it up between me and my wife and who gets to pick the next holiday or something? So, we amazingly, we've kind of run out of time, and I always like to finish on something really practical. And Clare, one thing you were just alluding to at the end, which I think is a conclusion we had when Richard and Alden spoke a few weeks ago, was that process really matters, and that discipline is a big part of it. So, I think for anyone listening, I'm sure Clare would agree. It's about having a process in place to try and take a bit of emotion out of it as something you stick to. But Clare and Richard, I want to throw it over to you if you've got any other conclusions before we sort of wrap up.
Clare: [41:32] I mean, I totally agree on process. There's more information, more noise, more everything going on out there than there ever has been. And we're not more scalable than we were as human beings. But we do have the advantage of technology, and technology can help us create and stick to processes. If we do that, if we make sure the process is something that we're likely to stick to. And I think that's where people often fall down, is they read about a process, and they know that intellectually they need to have a process. But when push comes to shove, they're not necessarily sticking to this rigidly. And as a result, it can't do what it was designed to do. So, you have to be prepared to put into place a process that you know you can follow and will follow, and that you're measuring and actually reflecting on to make sure it's working.
Richard: [42:29] Yeah, I would say having a process is a bit like dieting, where If you have a cheat day, it makes it much more easy to follow. So, follow your process. But take vacations a couple times. It has to be adapted your discipline around trading and all your, external framework. It has to be adapted that you can actually follow it. And too many people jump in, they build a process. It's too complicated. So then just start cutting things down to the bare minimum. And if you still can't follow it, just keep cutting. Like just get down to what you can reliably, realistically do. In terms of your research every day. And I've known people who will say, oh, I look at 500 charts every morning before I start trading and okay, that's great, but how long is that sustainable. And why are you looking at 500? Like, which markets are you really focussed on? Where do you actually trade? So, say no to everything that's extraneous and say yes to what you absolutely really need every day. So maybe you really need ten charts, 30 charts, but start cutting back. Minimise your information exposure, minimise everything you do to the bare minimum and then that'll allow you to really flourish in your creativity and your ideas and how you work with that simple framework that you've created. That's my thoughts.
Jamie: [43:42] Look at this, guys. This is first class advice going out to people. I hope they're enjoying it. Before we say goodbye Clare you have a book coming out, Stock Market Maestros, which is a series of interviews with some of the world's most skilled investors. Tell us a little bit about that when it's coming out.
Clare: [44:00] It's coming out early next year, so we've got a little while to wait, but keep an eye out for it if you are interested in hearing straight from the horse's mouths. How it is that these people with these great payoff ratios are actually achieving that. In the end, what matters most is how you behave when you're winning and how you behave when you're losing, and whether you're right about the stock or not, in the end, that's not the key thing that matters. It's that behaviour. And some people have become very excellent at it. So, the book is about what it is that they do differently to the rest of us. And it's nothing. The spoiler alert is it's nothing I can't do if we think about it that way and build that into our process.
Jamie: [44:48] Yeah. Clare. Richard, this has been such fun. I've really enjoyed it. And thank you both for coming on the show. And if people want to get a hold of you, Clare, I know they can get hold of you through your website. Richard, I know through your website or LinkedIn. But I wanted to say thank you to you both. And thanks for another great episode.
Clare: Thank you
Richard: Thanks, Jamie. Great to see you, Clare.
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