Skills that set you apart as an investor

Some time ago, I wrote about grit as a vital characteristic for investors. That triggered a couple of email exchanges with younger readers who are at an earlier stage of their career as financial analysts or money managers.

In general, the discussions revolved around the skills a successful analyst and investor should have. And while a passion for markets and grit are one key trait, I think there are a few that are more fundamental.

First, there are cognitive skills, i.e. the ability to think analytically and logically. Investing is a numbers game and requires analysts to make sense of the mountain of data that is available on every level, whether we are talking about the economy and markets as a whole or individual stocks and bonds. Without good cognitive skills, an analyst doesn’t have the foundation to become successful, in my view. A study by David Gill and Victoria Prowse examined the skills and traits of people during their childhood and how they influence success in different classes in school, the type of jobs they end up in and how successful they were in terms of income.

It won’t surprise you that children with high intelligence and strong cognitive skills were more likely to excel in maths, science, and English classes in school and less likely to excel in arts, sports, and practical classes like shop class (yes, those clichés are true, at least statistically).

And this training in maths and science compounds the strong cognitive skills and leads these people to choose jobs that fit their talents. As young adults, people with strong cognitive skills are more likely to end up in managerial and technical jobs and professions like medicine, teaching, engineering, finance, and law. The result is that these people also have higher lifetime earnings since managerial and technical jobs as well as the professions tend to pay better.

So, without good analytical and cognitive skills you are not going to get anywhere as an investor. But most people who work in finance as analysts or money managers are smart and skilled. So what sets the good investors apart from the average?

In my view, it is two traits.

People who are focusing on individual stocks and bonds tend to do better when they are diligent. Working your way through a financial statement with all its footnotes and being able to ask probing questions to management in earnings calls is not easy. And the more diligent analysts are, the more likely it is they will find the flaw in the story management is trying to tell. Let’s face it, no CEO is ever going to tell investors that she thinks the company is going to be in trouble or not doing well. The job of investors and analysts is to see if there knight in shiny armour really is as shiny as he appears to be.

In the most extreme cases, being diligent in your analysis and able to think critically and challenge management can uncover frauds. Think of the Enron case twenty years ago. Most analysts were hoodwinked by the management into thinking the company was doing great. Yet, a few analysts questioned the accounting practices of the firm and the use of SPV. This probing led some analysts to conclude that Enron was a fraud. These are the analysts that I want to talk to about companies because they are the ones that add value and will help you perform better. The rest of the pack that just bought into the hype you can safely ignore. They won’t make you money as an investor.

And then you have the generalists and strategists that don’t dive deep into the financial statements of companies. For this group of investors, I think diligence is less important and less of a differentiator. You can literally outsource that trait to research analysts who cover individual stocks.

But these generalist fund managers, strategist and, asset allocators need another trait. This trait makes all the difference between being average and being above average: creativity. And I am not talking about creativity in the sense of painting or being a member of an amateur acting troupe. Those are fun hobbies, but when I talk about creativity here, I mean the ability to look at data and markets in a different way than other people. Being able to put the individual pieces of information together to form novel insights.

In particular, I mean being able to deal with uncertainty and a lot of noise and navigate this noisy, uncertain environment with the required flexibility and conviction. Howard Marks put it best when he said: “You can’t do the same things as others do and expect to outperform.” But unfortunately, too many analysts, strategists and fund managers essentially do the same as others do. The amount of true creativity in the investment world is very low, in my experience. Most people are just tinkering with existing approaches to investing, adding a few additional parameters here and there but that is not the creativity that gets you additional performance. Performance is created by doing things truly differently and differentiated. What does that mean in practice? It can take on so many different forms that it is impossible to say and I won’t tell you how I try to do it because that would take my edge away. So, you’ll just have to become a client of my company and read my notes and book some meetings with me (if you haven’t already).

But going back to the study by Gill and Prowse mentioned above, they showed that being more creative has distinct advantages in life. Creative people are more likely to end up in management and technical positions. The effect is about a fifth as strong as the effect of cognitive skills, but it is a compound effect. Cognitive skills give you the foundation and creativity is the little extra that sets you apart.