Value Investing Almanack

Wit and Wisdom on Value Investing

Behaviouronomics: Of Parachutes, Road Safety, and the Second Wave

As the second wave of Coronavirus is sweeping across our country, it has left many perplexed. With more than 6.5 crore people vaccinated and the new normal of masks and sanitizers, why does the pandemic seem to be taking a U-turn?

I recently saw a news about a doctor lamenting, “I treated thousands of patients with Covid 19 for the last several months and never caught the infection. But within days of taking the vaccine, I became positive.”

How come? Is vaccine reducing the immunity? That’s absurd.

Well, we have a behavioural bias to explain the phenomenon and it’s called the Peltzman Effect. But before I get into that, here’s an interesting trivia —

Statistics reveal that even though skydiving equipment has made huge leaps forward for improving reliability, the fatality rate has stayed roughly constant when adjusted for the increasing number of participants.

Think about that for a minute and see if you can come up with an explanation.

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📚 On Filters And Rules – Part 3

Prof. Sanjay Bakshi once observed —

People in the investment community are often too judgmental about developments. They forget the Pari-mutuel nature of markets where the behaviour of others changes the odds. They indulge in first level thinking and don’t pause, reflect and ask questions like “and then what?” If the development is unfavourable, the pain avoidance mechanisms in their brains make them run away from a situation which is getting even more attractive because others are running away.

And Then What?

“And then what?” is a very important filter for robust decision making.

Every action has consequences: intended and unintended. No matter how carefully we plan, we can’t anticipate everything. We live in a universe governed by multi-variate cause-effect network. Focusing on one variable can almost always distract you from the unexpected side effects.

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Spotlight: Randomness and Investment Risk

Randomness in itself is not risky when it comes to investing in the stock market. But how you manage that randomness is what matters in the final outcome of your investment process.

Imagine you are offered to play a betting game with a regular dice. The deal is that if your chosen number turns up, you win and get back double the amount you bet. Would you play this game?

Using simple probabilities, we can see that the expected value of this wager is negative. How? The probability of each number on the dice (with six faces) is 1/6. So expected value = 2 x (⅙) – 1 x (⅚) i.e., -(1/2).

If someone agrees to play this game, he’s blindly speculating. Isn’t he? He obviously doesn’t understand probability. The outcome of a dice throw is pretty random and you can’t hope to make money from randomness. But hang on. The game is about to get little more interesting and profitable.

If you’re informed (by reliable sources) that the dice is completely loaded (unfair) and number 6 turns up on every throw, would you bet your money now? Of course. The game is no more random for you. But for a person who doesn’t have this specialized information about dice, the game is still plagued by randomness.

Which means randomness could be subjective. It is not absolute – the same event is more random to one person than to another. Notice that the extent of randomness decreases with the knowledge we obtain (the dice is loaded and favours the number 6). Which simply translates to the idea that the better we understand the business we are exposed to, professionally or through a stock purchase, the less random the environment is to us.

The dice example might look very obvious and uninsightful but if you could draw a parallel in investing, the lesson learnt can turn a losing investment strategy to a winning one. Because there is strong correlation between randomness and risk.
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📚 On Filters And Rules – Part 2

We don’t really bother memorizing the facts and figures with google at fingertips, and we don’t need to. But when our misconceptions about truth are rooted in strong intuitions and the ubiquitous expert opinion, then we expose ourselves to a risk that’s hard to see.

Filters are like a defence mechanism. Defence against so called experts who are increasingly becoming dominant in our world. Anywhere you look, you find some expert dispensing his advice for us novices.

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