After 27 years in the asset management industry, Paul Craven packed it all in to start his own consultancy in 2014, focusing on behavioural economics. He spoke to Sebastian Cheek about the impact human biases can have on investment decision making.
Why did you decide to leave a successful career in the City to start doing what you now do?
I’d spent and enjoyed 27 years during which time I worked for three firms that were unbelievably good: Schroders, Pimco and GSAM. I was at Schroders during the equity bull market, including the tech boom. Then, to move to a fixed income house was fascinating at a time when people were thinking about bonds very seriously for the first time; and then to be at GSAM for the last seven years of my career was just amazing. But I got to the age 49 and thought, “I want to do something different; what do I love doing most of all?” Well, I’m really interested in investment, I’m really interested in psychology and I’m a behavioural economics junkie’.
What was the trigger point for the change?
When [Daniel] Kahneman was given the Nobel Prize for Economics in 2002, I actually had a conversation one day with some economists who were a bit annoyed about it, and I asked, “What’s wrong?” They said, “They’ve just given the Nobel Prize for Economics to a bloke called Daniel Kahneman” and I replied, “Well what’s the problem?” and they said, “He’s not an economist – he’s a psychologist”. That just pricked my intellectual curiosity. First of all they’d given the prize to a psychologist and not an economist, and secondly, it challenged traditional economic models.
What was the trigger point for the change? If more people knew about behavioural finance then I think we would cut out the silly errors; that’s the Charles Ellis idea of ‘Winning the Loser’s Game’; if you can focus as much on cutting out the mistakes as much as on picking the winners – avoiding the unforced errors in tennis terms – I think you’re on a much better footing. I wanted to take this message not just to the asset management world but also to the institutional pension fund world; I’d always worked with them as clients so I wanted to be a “Poacher turned Gamekeeper” – and I’ve really enjoyed working on the investment committees of a couple of major pension schemes.
Why have you enjoyed educating people about this?
Because it’s contributing not just to investment thinking, but also to the way that decisions are actually made around the table. It’s one thing to talk about getting decisions right, but what about the process of decision making? I worry I sound a bit evangelical but I really believe in it. It’s about how real people make real decisions in the real world; it’s not something from an academic textbook that gets dusty on the shelves.
If I was a pension fund trustee how could I use behavioural economics to improve my investment performance?
In any group, there’s lots of behavioural ways you can improve your process. Having a devil’s advocate on a committee is a very useful way, actually having someone who’s there to intellectually debate and discuss why something is not a good idea. We must constantly challenge our biases, to test our thinking. “Group-think” is very powerful because that’s the group decision-making equivalent of the herd instinct and it involves conformity; the idea that humans tend to want to agree with each other. That makes sense and yet when it comes to important things like financial decisions, unless we challenge both ourselves and our colleagues, we are definitely making the decision-making process sub-optimal.
Self awareness is also important, so be aware that you as an individual come in to any meeting with preconceived ideas and they might be based on experience or wisdom. There’s nothing wrong in having preconceived ideas as long as you’re prepared to challenge them yourself. Also being aware that within those ideas you may have some biases and use heuristics – in other words, make mental shortcuts. We all go from A to E and we’d like to think we’re going via B, C and D, but sometimes we just jump straight there, which can be quite a dangerous thing unless you can then unpick it and flesh out the reasons why. So, I’m a big believer in taking these decisions apart and saying, “What are the good reasons for doing something? And importantly, what are the reasons why we shouldn’t?”
How many people go to their boss and say, “I’ve got a really good idea, let me tell you why it could be wrong”? It just doesn’t happen, right? But, actually if you could encourage that kind of creative attitude, wouldn’t that be a good thing? Why do all creative companies have a finance department but no financial companies have a creative department? Because I think in our industry we are not necessarily encouraged to be creative. I’m trying to make sure arguments are put forward about how we can be a bit more creative and innovative and I think behavioural science gives us huge clues as to how to do that. Indeed, some of the best investors I ever found did arts degrees.