Superforecasting Part II: Portrait of a modal superforecaster

In Part I of this two-part series, we covered a framework for improving one’s forecasting skills that started with asking good questions, quantifying one’s forecasts, and keeping score of the outcomes. Part II will conclude with a portrait of the modal superforecaster. In his book “Superforecasting: The Art & Science of Prediction”, Tetlock identifies a range of attributes shared by the superforecasters that he followed, and these are discussed below as they relate to investing. The good news is that none of these attributes are innate nor governed by high intelligence, and all of them can be developed and improved through effective practice.

Philosophic outlook

  • Cautious – nothing is certain, especially when it comes to investing. The human mind prefers order and coherency over uncertainty, and intuitively jumps to conclusions that coherently close the cause-effect loop rather than conclusions based on a deliberate consideration of the evidence. Therefore, it pays for investors to replace the desire for certainty with degrees of doubt, which aligns with the idea that hypotheses can never be proven, only rejected or modified.
  • Humble – by thinking in degrees of doubt and acknowledging the profound complexity of reality, investors assume a state of intellectual humility that helps mitigate the influence of overconfidence on decision making.
  • Non-deterministic – investors must be comfortable thinking probabilistically; that is, thinking about outcomes on a probability scale rather than as point estimates with strong (or perfect) correlation. Probabilistic thinking is fundamental to the understanding of risk, which Professor Elroy Dimson eloquently defined as “more things can happen than will happen”, and just because one thing happened doesn’t mean a range of other things couldn’t have happened. Deterministic thinking leads investors to give too much weight to past events, for example “B followed A last time, so B will happen given A occurred again”.

Abilities and thinking styles

  • Actively open-minded – investors who are actively open-minded seek views that are different to their own and consider them carefully. Open-mindedness is critical because an investment thesis is a hypothesis to be tested and disproved, and that can only be achieved by actively considering evidence that is contrary to the foundation of the thesis (otherwise confirmation bias has taken place).
  • Intelligent and knowledgeable – superforecasters are intellectually curious, enjoy puzzles and mental challenges.
  • Reflective – superforecasters are introspective and self-critical. This translates into investing in two ways: i) successful investors spend time thinking about and constantly try to improve their investment process; and ii) they conduct post mortems on unsuccessful investments to maximize the learnings from the experience and minimize the risk of repeating controllable mistakes.
  • Numerate – investors need to be comfortable with numbers, although this does not mean using fancy quantitative models and adding layers of complexity for its own sake.

Methods of forecasting

  • Pragmatic, not dogmatic – investors need to be pragmatic about their forecasts and their hypotheses, and not be wedded to any particular idea or preconception. To quote John Maynard Keynes, “When the facts change, I change my mind. What do you do, sir?” Venture capitalist Marc Andreessen described contrarian value investing as “strong opinions, loosely held.”
  • Analytical – superforecasters and successful investors alike are good at repressing what psychologist Daniel Kahneman calls System 1, and harnessing System 2 when it comes to decision making. System 1 is automatic thinking, which draws fast conclusions using intuition or emotion, often acts unconsciously with little attention, and is prone to biases and systematic errors. System 2 is a slow, thoughtful and deliberate mode of thinking that can be mentally draining, but is required for logical reasoning and analysis.
  • Dragonfly-eyed – a dragonfly’s eyes each contain 30,000 lenses arranged in a hemisphere, which gives the dragonfly almost perfect 360degree vision and allows it to catch tiny insects in mid-flight. Successful investors replicate this by seeking out diverse views and perspectives from a wide variety of sources to synthesize into their own view. This aggregation of different points of view may not come naturally, particularly if they are contrary to our own beliefs, but is important because it allows the investor to leverage the knowledge and experience of others to offset any internal shortfalls or biases, and form a more holistic view of reality.
  • Probabilistic – consistent with a non-deterministic outlook, successful investors think and forecast probabilistically (using many grades of maybe) and are thoughtful updaters for new information. While Tetlock’s superforecasters tended not to apply Bayes’ Theorem mathematically, they were nonetheless adept at following a Bayesian process to update their forecasts for new evidence.
  • Good intuitive psychologists – by being aware of cognitive and emotional biases and errors, investors are better equipped to avoid them.

Work ethic

  • A growth mindset – this comes from Professor Carol Dweck’s research on mindsets. People with a fixed mindset believe that ability is innate and therefore can’t be developed. People with a growth mindset believe that ability can be developed and improved over time. By having a growth mindset, investors are motivated to always seek ways to improve their forecasting and investing skills.
  • Grit – finally, following from a growth mindset is grit, or the ability to persevere in the face of failure or other obstacles. For the contrarian investor, grit is important to maintaining one’s conviction when investing against the current.

While the above may seem like a daunting checklist, not all the attributes are equally important. Tetlock identifies the strongest predictor of forecasting skill as “perpetual beta” (perpetually under development), or in the context of investing, the degree to which one is committed to updating one’s hypotheses and investment process.

DH5_2155Daniel Wu is a Research Analyst with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.

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Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.