On the morning of 15 October 1962, President JF Kennedy and his team were advised a United States U2 spy plane, on a routine reconnaissance flight over Cuba, had photographed the Soviets assembling nuclear-armed missiles. These missiles were capable of killing millions of Americans, on their home soil. The world was teetering on the brink of Armageddon. The youthful President and his team of closest advisors were about to undertake a series of decisions, knowing the consequences of each would impact the whole world.
Many of you will be aware the decision making routines President Kennedy employed, during what became known as the Cuban Missile Crisis, are the subject of numerous articles and text books. Every year, hundreds of MBA students around the world are taught to recognise the dangers of ‘groupthink’ and learn about the approach Kennedy introduced to avert them; creating a decision-making architecture that provided him the best opportunity to get things right. In the September 2013 VFTD (click here), we addressed the prevailing turbulence in financial markets – known as the “Taper Tantrum” - triggered by the then Fed Chair, Ben Bernanke, announcing the end of Quantitative Easing. We compared the challenges to those faced by mountaineers, stating Climbing Everest is risky, as is managing investment portfolios, although thankfully, it does not involve life or death decision making – it just feels that way sometimes!
Returning to the crisis engulfing The President, there is no doubt he was facing life or death decisions. In developing his approach, Kennedy had purposely sought to learn from his past and often very public mistakes. His blueprint for better team decision-making was based around four principles;
- Each participant should function as a “skeptical generalist,” focusing on the problem as a whole, rather than approaching it from his or her ‘specialist’ standpoint.
- To stimulate freewheeling discussions, the group should use informal settings, with no formal agenda and protocol, so as to avoid status-laden meetings in the White House.
- The team should be broken into sub-groups that work on alternatives and then reconvene. They then swap papers, dissecting and criticising one another. In this way, the groups are able to probe decisions and surface pros and cons.
- The team should sometimes meet without Kennedy present, so as to avoid people simply following his views.
That morning in 1962, Kennedy’s top military Chiefs of Staff insisted on an immediate and massive military strike, to take out the missiles. Instead of debating only the one plan, the broader team followed the new approach and explored options. An alternative was suggested – a naval blockade to force the Soviets to remove the missiles. Kennedy split his team into sub-groups; one developed a position paper arguing for the military strike, the other for the blockade. Two days later, the group presented the fully developed alternatives to the President, who chose to pursue the blockade. Thankfully, we all know this proved successful and a nuclear confrontation with the Soviet Union was averted.
The 4 principles identified by Kennedy and the framework they created no doubt contributed to the successful outcome for humankind, during those dark days in 1962. Principles is the title of the book we and the wider investment team at Affinity have read over the summer. Regular readers will be aware we have a ‘reading week’ every six months selecting books which we believe will help us review, develop, or even redefine how we manage money for our clients. This book – which we highly recommend – is authored by Ray Dalio, the founder of the investment company Bridgewater Associates which, according to Fortune magazine, is the fifth most important private company in the US. Dalio has been described as one of the 100 most influential (Time) and 100 wealthiest (Forbes) people in the world. He attributes his success to a set of principles he has learned, largely by making mistakes, from which he believes most people can benefit.
One such principle, double-do rather than double-check, resonates with Kennedy’s approach where he divided his team into sub-groups to work on alternative solutions and reconvene. Dalio firmly believes this approach ensures better answers, but warns a double-check can only be done by someone capable of double-doing.
Implications for portfolios
The finance world is built on double checking – 4 eyes audit routines run through almost every check-list employed by banks, accountancy firms, insurance companies and money managers. They play an essential role in protecting client assets, but we question how many firms routinely employ double-doing? Learning from mistakes and adapting processes and routines is paramount in the evolution of a successful business, particularly one like ours which involves lots of pressured decision making around how and when to deploy capital for our clients. As we have stated before, the very best asset managers in the world – Bridgewater Associates included – get, on average, only 6 out of every 10 investment decisions right. Being wrong, at least 40% of the time, can take the wind out of anyone’s sails and building the culture to learn from mistakes is the hallmark of a good investment business.
Bringing this to a close, earlier in this piece we made reference to the Taper Tantrum. This proved a very volatile period for asset prices, particularly those based in emerging markets. We wrote about this in September 2013, and here we are in September 2018 with markets experiencing a similar period of volatility and emerging market equities, bonds and FX once again facing the brunt of investor negative sentiment. Indeed, we recently spoke to a manager responsible for an Asia ex-Japan equity fund, who commented he had not seen share prices so disconnected to underlying fundamentals since the Tantrum. Growing uncertainties around trade have been the catalyst for this, with investors having to decide;
- whether Trump’s policies are simply a calculated escalation of measures against China;
- whether the direction of travel is towards a bilateral trade war between the two nations;
- or, worse still, whether we are heading to a full blown trade war where a series of retaliatory sanctions and tariffs drag Japan and the EU into the conflict and global growth is significantly impaired.
All cards are currently on the table and the unpredictability of Trump adds a further dimension to the complexities faced. In this instance, the double-checking has involved one-on-one dialogues with every single one of our EM managers – debt and equity – to understand their current views and positioning. This proved insightful and caused us to pause and reflect. First level thinking naturally leads to a risk reduction bias in such circumstances. However, double-doing ensures we re-test our assumptions and explore several options. Medium-term, even if this evolves into a fully-fledged trade war, it doesn’t necessarily spell doom for EM or even China. China is still an important consumer market for many US firms; as such, some of these firms may be forced to relocate their operations to China, or elsewhere, as a consequence of tariffs.
Additionally, Asia is steadily moving towards a monetary zone that is centered on China. As Asian currencies stabilise against each other (see chart above), then it becomes more feasible for regional trade to be conducted using local currencies, therefore bypassing the US dollar. In other words, despite the near-term pressures – the long-term fundamentals largely remain intact.
So it is worth remembering, like Kennedy, the first option may not be the right one – double-do rather than double-check.
Julia Warrander and Russell Waite
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