How I do research
I am sometimes asked how I come up with the ideas for the research I produce or with investment ideas in general. To be honest, this question always makes me feel uncomfortable, because after two decades of working as an investment strategist and chief investment officer, I still do not know what my process really is. But admittedly, telling people that these ideas “just happen” is not a satisfying answer either.
So, in order to give you an idea of how I do research, let me guide you through the process of writing one of my daily commentaries and then summarise some key steps at the end.
The other day, I was getting off the train back home. I was quite annoyed by the guy walking behind me, talking loudly on his phone. Of course, being annoyed also meant that I started to eavesdrop on his call, and it turned out he must have been a student or academic of some sort because he mentioned how surprised he was to learn that the influence of genes on human traits increases with age. Now this made me perk up, because the natural assumption is that genes would have the strongest influence on a person at the beginning of life and their influence then declines as the person accumulates different experiences and “learns” how to interact in society. Hence, I made a mental note to check that out.
The next day, I looked for academic research on the influence of genes on different traits over the life-span of a person. Thanks to Google Scholar (the most important resource for me together with SSRN), I found an overview paper by Daniel Briley and Elliot Tucker-Drop in the Journal of Personality. In it, the authors show that the genetic influence on cognition (i.e. IQ and intelligence) and personality does indeed vary significantly over time.
As the chart on the bottom right, copied from their paper, shows, the influence of genes on personality traits starts out high, with c. 75% of the variation in the personality of babies explained by genetic factors. As we age, we accumulate more and more experiences which come to dominate our personality. Towards the end of our lives, our experiences explain roughly 60% of the variation in personality between people. This is what one would naively expect to happen, but I make a mental note that this finding relates also to the fact that our experiences influence our investment decisions, as I have described here. It might be an interesting topic for future research to check how personality traits influence investment decisions so that personal experiences are linked not only to personality traits but also via personality traits to investment decisions…
The chart on the bottom left, however, blows my mind. How can it be that genetic traits increase in influence throughout our childhood into early adolescence? This seemingly makes no sense.
In their paper, Briley and Tucker-Drop explain how this could be:
“Early genetically influenced differences between individuals, be they small, may influence the manner in which they move through the environment and thus amplify over time … For example, some individuals may respond differentially to the same educational environment. Teachers may pick up on these individual differences and provide student-specific feedback.”
This quote reminds me of Malcolm Gladwell’s book “Outliers” in which he claims that deliberate practice for 10,000 hours is the foundation of excellence in a specific field. This “10,000 hours”-rule has by now been widely debunked insofar as practice is much less important than previously thought to achieve excellence. But little seems to be known about other factors that create excellence in a field. The study by Briley and Tucker-Drop hints at one possible additional factor: the reinforcement of genetically determined talent by the environment and the honing of this talent through deliberate practice.
So, my conclusion is, to be a good investor one needs to have talent and the right personality to begin with. Investment success takes time, thus a lack of patience is probably detrimental to long-term investment success. It also needs resilience when investments turn out poorly. Both patience and resilience are to some extent pre-determined by our genes. However, in our youth and through adulthood, we learn how to deal with disappointments and failures. Exposing children to difficult challenges and then teaching them how to deal with failure is a vital ingredient to future success.
Obviously, small children with a genetic predisposition to deal better with failure (in behavioural finance parlance: “lower loss-aversion”) will probably be confronted by adults around them or by their own initiative with more and more challenging problems over time. Thus, their resilience in the face of failure gets trained like the muscle of a body-builder in a gym. And because these people are genetically better equipped to deal with failure, they are more likely to train this muscle more often and more vigorously over time, creating a bigger and bigger gap relative to people who are less able to deal with failure.
As the famous marshmallow experiments have shown, a similar process may be at work with patience.
In order to be a good investor or a good research analyst, one thus needs to have the right genetic predisposition. But this is not all. One also needs to create the right circumstances that allow one to practice and hone these skills continuously. Deliberate practice then allows investors and analysts to become better at their job and amplify these small initial differences. Think of the great investors of this world, like Warren Buffet. They typically have started to invest their money very early in life and systematically turned investing not just into a profession, but also into a lifestyle. This means, they constantly try to learn new things about investments, and reflect on past mistakes. The combination of talent with experience and the ability to constantly look beyond the immediate task at hand and broaden the horizons seems to create these exceptional investors and researchers.
And this is what I aspire to in my job as well, though I am obviously not nearly as good an investor as Warren Buffett is. But I blame that on my genes…
To summarise, my idea generation process in research has at least the following elements:
Turn research into a lifestyle and walk through the world with open eyes and ears. You never know where a new idea might hit you and where it may come from.
Once you have an idea to investigate, use data and academic studies to verify or falsify the idea. Stay open-minded and dismiss an idea if the data does not confirm it. Many of my ideas never come to fruition because there is a lack of evidence to support them. Learn to be resilient in dealing with such failures.
Don’t rely on secondary sources like other research analysts or media reports. You would not believe how bad and unreliable research analysts can be. Go back to original sources like peer-reviewed academic studies or use your own models and analysis.
Ask yourself, what the idea means for your job and what conclusions follow from this idea. If possible, test these conclusions with past market data.
Don’t just stick to your narrow area of expertise. Venture into history, psychology, neurosciences and other areas to inform your work. Novel ideas often come from the connection of existing ideas and techniques in different fields rather than genuinely new insights.
Keep some loose ends that you can pick up at a later stage to create a network of interconnected ideas that form your “world view” over time.
Practice, practice, practice.
I feel like there are many more techniques I use in my work, but hopefully, these tips will help answer the original question posed at the top.
Proportion of variation in cognitive ability and personality attributable to different factors
Source: Briley and Tucker-Drop (2017)