Decision Making: Rationality vs. Intuition

During their recent episode, Taylor, Carlisle, and Alex Morris discussed Decision Making: Rationality vs. Intuition. Here’s an excerpt from the episode:

Jake: Yes. Let’s feast on veggies. So, as you guys probably know by now, I’m endlessly obsessed with decision making science and today we’re going to dive into this fascinating master’s thesis of this guy, Nicolai Tangen, where he asks in his master’s thesis do good fund managers rely on intuitive decision making? And Alex, please will chime in on this on intuitions that you’ve noticed from going through all of the Berkshire stuff. But first, a little bit about Tangen. He’s not just a regular hedge fund manager. He’s actually now, the CEO of the Norges Bank Investment Management Company, which oversees Norway’s $1.7 trillion sovereign wealth fund. That’s a bit of money. It’s the largest in the world. And put that in perspective, they own about 1.4% of every publicly traded company on the planet. So, no sweat there.

Before this, he founded and ran a hedge fund called AKO Capital. And his background is actually quite eclectic. He trained interrogation with the Norwegian Intelligence Service and then was educated at Wharton. Holds a master’s degree in art history and social psychology from LSE. Actually, a real renaissance man. And now he’s got this podcast too that you can check out that’s pretty good. He’s got a lot of big names on there because he’s a big name.

But back to this master’s thesis, he dives into this kind of classic fund management dilemma that everyone faces like should decisions makers prioritize one rational data driven analysis, hard numbers, spreadsheets, or two, intuitive decision making, which is also called in the research natural decision making, NDM, you’ll see that a lot, which are gut feelings, subconscious pattern recognition and matching split-second insights like aha moments.

Well, to explore this tangent, interviewed 25 different fund managers responsible for billions of AUM each. They weren’t disclosed who they were, but he travels in pretty rarefied air, so I imagine they were pretty good. And his punchline of this research was that it’s not an either or, it’s actually both. And the best fundamentals rely on this hyper rationality and intuition. And of course, he explains that intuition isn’t this mystical thing. It’s a skill that’s honed through experience. And if you’ve lived through multiple cycles and you’ve been analyzing markets forever and the scars can create this mental database that can help you spot patterns even when you might not be able to articulate why. And it’s kind of this muscle memory that you build up but it’s a big but is that the intuition isn’t flawless, and of course Kahneman and Tversky showed us that biases sneak into everything and distort our judgment. But skilled managers actually know this and they actively work to counteract their own biases.

So, one of the most compelling arguments in Tangent’s thesis is that rationality and intuition aren’t opposites, they’re actually complementary. He calls it the art of balancing. And so, the key takeaways from his thesis were, intuition is essential, especially in uncertain situations where data alone falls short. And maybe this has to do with these big capex things, potentially. I mean, what’s the base rates on those things? It’s kind of hard to tell. Experience matters. Years of exposure in markets can sharpen that intuition, but you have to stay balanced. Being aware of your biases is critical. And then maintaining context. The ideal balance kind of depends on the individual and the situation.

And here’s kind of the little funny part that’s a kicker in here that he talks about, is that intuition is often a privilege of the experience. So senior managers, these PMs, they trust their own guts, but they don’t extend that luxury to their junior analysts at all. And it’s very much kind of an intuition for me, not for the dynamic. And to wrap this up in funded management, intuition might be a bit like a fine wine. It gets better with age. But if you’re a junior analyst, your gut is more of like a boxed wine situation and you should probably keep it corked. So, there’s Nicolai Tangent’s master’s thesis from a few years back.

Tobias: How are they measuring intuition?

Jake: There’s nothing in his thesis that has any real numbers to it. He just conducted these 25 interviews and asked managers how they did it, how they think about it, how do they structure their own approach to making decisions? And it wasn’t, there was no real measurement to the whole thing.

Tobias: Like a Phil Tetlock survey interview question, follow up 10 years later, see how it all worked out.

Jake: Well, I mean, that would be– Ideally, that’s what you would be doing was, would be recording these intuitions and feelings and then closing the feedback loop on them on the appropriate timeline, which often can be years to reveal itself. I mean, who knows when these capex decisions today we’ll actually be able to pull out the scorecard and say, “Oh, that was a good one, or that one was dumb, or oh, duh, obviously were all trying to stand on our tippy toes to see the parade better.”

So, as you guys know investing is a very wicked learning environment, meaning that feedback loops are often ambiguous, noisy, intermittent. So, what do you need to do there? Like, you probably really need to be pretty systematic about writing things down and keeping track of it and then following up and doing the work to try to close those feedback loops and figure out when you can and can’t trust your intuition.

Tobias: You have a little Journalytic sign hanging over your shoulder back there.

Jake: It is kind of the whole reason that I made the thing.

Alex: Yeah. It reminds me of one thing Warren’s talked about over time. I can’t remember where it was. I think it was at one of the meetings, but he talked about the idea of going back and reading Coca Cola and reports from whatever, 50 years ago, or in the case of IBM, just saying on CNBC that he decided to buy the stock after having read the annual report for 50 years and having minimal or no activity in the stock over that entire period and he bought it after reading the annual report one Saturday morning and something struck him differently than it kind of had previously.

In the Coke example, I think he explicitly said, “If you’re going to talk about owning something for a long time or potentially owning for something for a long time, it’s useful to know what it’s like to have been to have owned it for a long time.” So, I think there’s a lot to be said for that, it developing over time. And as someone who has been in the junior analyst role of that example earlier, some of my opinions were like that boxed wine, so I could appreciate it from that perspective as well.

Jake: I like when Munger brings up– He calls it “The oddball pastimes of Warren Buffett.” Like, these are the silver trade that Warren put on. They’re these like little kind of oddball things that Warren does and Charlie even points out, like, imagine—He’s like, this is how weird your management is here at Berkshire. This guy’s been sitting watching the silver market for 30 years. Never done anything but recognized this supply, demand, imbalance and then did something like, this is a not duck is basically what he’s saying. Those ones are always funny to me.

Alex: Yeah, they are. I mean, even in that discussion, it’s funny. I think he says something along the lines of, “Warren likes to go do these things. And it’s basically, from my perspective, it’s basically a waste of time.”

Tobias: It’s better than being in the buffer.

Alex: Yes, exactly. That’s fair.

Tobias: Keeps him out of bottles, I think, is what he says.

Jake: Yeah. Hilarious.

Alex: Yeah. Yeah. It’s just funny to think this slightly different. And it gets back to what I was saying before on something like PetroChina, where I think Charlie’s scope of what he was interested in and I always wonder how much of this is– What’s the cause effect between someone who runs concentrated or has that type of, is it an output of that or is it basically an input that then feeds back the other way through? It’s interesting to think about what part of it all is a choice that we make at some point as investors versus something that we kind of optimize for lack of a better term.

Jake: I mean, Charlie did some of that himself as well. He had a story he would read. I think it was maybe Barons for like 50 years. Never done anything with one of the picks and then found some little company that was in there and bought it and I don’t know, whatever 10x this money or something. That would probably fall under the oddball pastimes of Charlie, right?

Alex: Yeah, definitely.

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