What the Himalayas teach us about investing
In June 1924, George Mallory tried to make the first successful ascent of Mount Everest. Sadly, Mallory passed away on the North Face of the mountain, and while he potentially made the summit, no one knows for sure. Famed Everest mountaineer Edmund Hillary later said, “the complete climb of a mountain is reaching the summit and getting safely to the bottom again.” Hillary’s observation provides a tidy analogy for markets. To be successful in investing, like mountaineering, you need to be prepared to tackle the up and down to safely achieve your goal.
Beyond the basic analogy however, there are far more intricate and interesting lessons for investors to draw upon from those who dare to climb extreme heights. Of course, investing from the comfort of indoor offices - or now, home offices - is nothing in comparison to the harsh conditions a mountaineer may face on, say, Seattle’s Mount Rainier. However, when you take out the sheer physical component of climbing a mountain, a mountaineer’s job is, essentially, to maintain composure and make decisions. Those decisions will be potentially flawed, and those flaws could come from bias, poor judgement, or bad information.
A 2015 journal article, “Human Factors in High-altitude Mountaineering” exposes these biases. Below, we take the time to highlight some of these biases’ impact on mountaineering decisions, how those same behavioural judgements could impact investment decisions and what we and you can do to avoid traps.
What you see is not necessarily what you get
One of the first biases discussed by the researchers is cue salience. This is best described as when a climber makes a decision based on seeing clear blue skies to the horizon, missing the information that storm clouds - barely visible - are approaching from behind the mountain.
To overcome this when we invest in markets, we don’t consider the information we can most easily obtain, read and analyse, but actively look for and ask ourselves what we can’t readily find and know. We utilise our team of strategists and researchers from around the world to be on the constant lookout for any warning signs in all markets, and to make sure our process acknowledges an element of uncertainty around the unknown.
The best way forward isn’t always obvious
Stress-induced attentional tunnelling is a bias related to cue salience. Under stress, we tend to focus on what’s directly in front of our vision and what seems most important. A climber on the rockface, with fatigued arms, will focus directly above for a better grip while ignoring potential openings to the side. In markets, we can account for this with a focus on implementation in the investment process.
Say we have a positive outlook on accelerating growth in emerging markets. Rather than just buying the equity index, we use our portfolio analysts and implementation teams to look at how best to gain emerging market exposure. Do various sectors or regions or currencies best reflect the risk-return for our view? Is there a skilful sub-adviser who can find attractive opportunities in a less efficient market? Is there a quick, simple, passive alternative with low liquidity risk?
Don’t ignore the updated information
Anchoring and confirmation biases are well known. Say the morning weather report indicates sunny and clear conditions, but then later on dark clouds appear. A mountaineer needs to react to the new information to survive, rather than look for a patch of sun amid the clouds in order to confirm the optimistic morning report.
To confront these biases when investing, as new information comes in, we constantly update our view on markets and beliefs. We know market irrationality can occur and are well aware of the dangers of getting caught up in short-term fluctuations, but we also know new information is important. Armed with this insight, we continue to look to our framework on valuations and our cyclical outlook, updating both with new information, to ensure we do not remain stagnant and anchored to a particular view.
Zoom out to ensure you have the entire picture
A climber may estimate the probability or frequency that something might occur based purely on their own experience of being on the mountain or a similar situation. While this may be informative, it could be detrimental if the sample size is too small for the climber to know all possible conditions. At Russell Investments, we take a much more holistic approach to our investments. While we undoubtedly learn from our own experiences, importantly, our forward-looking views are informed by as much historical data as we can find - and we supplement that data by lessons we learn from other experiences in our ongoing discussions with best-of-breed investment managers. Lastly, we stress-test our portfolios, simulating scenarios and sensitives with a Monte Carlo approach to ensure we take as much of a complete approach as possible to assess risks.
A path that is stable most of the time doesn’t make it safe
The researchers point out that a mountain slope is stable roughly 95% of the time, so a mountaineer will make it safely across most of the time without encountering an avalanche, even if it is a close-call decision. The key here is the word most and how it incites potential overconfidence in climbers who have not experienced these situations.
Most of the time, historically, equity markets move up. If an investor is overconfident in this statement, they may buy up equities just as the market is reaching a bubble or euphoria. Of course, most of the time, the world is not entering a global pandemic - but as 2020 showed all too well, portfolios need to be able to handle these low-probability events. This might mean an investor has to look silly crossing a perfectly looking slope at a slow rate, or choosing another slope altogether, but such steps, such as holding alternative assets to diversify the portfolio, are necessary to ensure investments can survive and objectives can be met through the investment cycle.
Overconfidence is a particularly hard bias to manage in climbing and investing as inherently both involve taking on risk. Being overcautious or too conservative could mean a climber is too slow in managing daylight hours available to them, likewise an investor under allocated to risk may feel more comfortable in protecting capital but ultimately may fail at reaching the objective. The answer here lies in having a process to ensure adequate risk assessment.
Don’t make decisions based on stories. Have a process.
A climber might be faced with a choice:
- Turn back and have a sure failure to reach the summit; or
- Continue on for a potential summit with x% chance of risk from severe cold
When posed in this way, many might choose to take the risk and go for the summit. However, try framing that choice differently:
- Turn back and have a sure guarantee of safety to try again later
- Continue on for a potential summit and x% probability of risk from severe cold
This time, the choice to return to try another day is more alluring. This sort of framing or story we ask ourselves can be coupled with sunk cost bias. If you failed yesterday to make the summit, the decision to turn back today to safety might be even harder than if it was your first attempt.
These biases are particularly interesting regarding dynamics in today’s markets between a large divergence of growth and value stocks. Growth stocks, up until the fourth quarter of 2020, had been soaring relative to value stocks (a broad rotation in leadership toward value stocks has since taken place). For investors who were somewhat inclined to consider longer term valuation metrics such as price-to-earnings, holding less growth stocks had been very painful.
Investors in this position were faced with a choice to buy up on growth-stock momentum or to stay put. The choice was often influenced by framing. Framed one way, by not buying, the investor was choosing certain near-term failure of not riding a potential significant rise in the market’s largest stocks, whether a bubble or not. Or, framed another way, the investor instead might have been choosing to avoid a potentially serious mishap and protect capital where valuations provide a cushion. Both were different framings of the same potential outcome and risks. If an investor had missed the last great run of growth stocks, the decision probably would have been even harder. What to do?
As professional investors, we are not immune to such framing and stories to influence decisions. To ensure that we do not fall into that trap in the heat of the moment, we have a solid framework and process in place to consider the valuation, cycle and sentiment aspects of the investment opportunity. Regardless of which way we frame a potential choice, or how tempting a choice might be to avoid short-term embarrassment, we stick to a process for the long-term, reassessing elements of the process to improve. If new data becomes available to improve that judgement of the process, great - but if there is no change in the process view, we stick to our views and try not to fall into any behavioural traps. This time-tested process of ours has paid off this year, with value stocks significantly outperforming growth stocks - a rotation in market leadership that we’ve been expecting with the reset of the business cycle.
Focus on true objectives and not the highest mountain
Lastly, and perhaps most importantly for its analogy to investing, is the researchers’ discussion in the aforementioned article about mountaineering goals: “Naturally most people think that the goal of any mountain climb is to reach the top. In fact, most mountaineers are driven by a number of goals that can compete, overlap and vary in priority from trip to trip.”
While obtaining the highest returns possible can be a great outcome for an investor, we at Russell Investments are aware of the risk involved in trying to obtain returns. We are focused instead on helping clients meet their objectives, factoring in the risk of ruin, avoiding the allure of summit-at-all-costs-type thinking and ensuring a successful investing journey.
While investing and mountaineering might seem worlds apart, at the core of it all, there are many similarities humans face when making decisions in difficult environments. At the end of the day, we need to be wary of our biases, create processes to avoid traps and learn from new information to ensure we arrive at our goals safely and in better shape than when we started.
Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.