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Faking It?

The statue shown is of a Greek kouros, which was purchased by the J. Paul Getty Museum, Los Angeles, in 1985 for nine million dollars. A kouros is the modern term given to free-standing ancient sculptures that first appeared in the Archaic period (800-479 BC) in Greece. The word ‘kouros’ means youth, or boy, especially of noble rank. This piece was viewed as a magnificently preserved work, close to seven feet tall and highly sought after. The Getty undertook the standard background checks, to establish its provenance. A geologist determined the marble came from the ancient Cape Vathy quarry on the island of Thasos. It was also covered in a thin layer of calcite, a substance that accumulates on statues over hundreds, or even thousands, of years. In total, the Getty went through 14 months of investigations before the staff concluded the sculpture was genuine and went ahead with the purchase.

Not long afterwards, an art historian named Federico Zeri was taken to see the statue and immediately decided it was a fake. Another art historian took a glimpse and sensed that ‘while it had the form of a proper classical statue, it somehow lacked the spirit’. A third, felt a wave of ‘intuitive repulsion’ when he first laid eyes on it.

Further inquiries were made and doubts soon began to build as to the authenticity of the kouros, with an argument presented that the statue had been sculptured by Roman forgers, in the early 1980s. To this day, neither art historians nor scientists have been able to settle the argument. If genuine, it is one of only twelve complete kouroi in the world and extremely valuable. If fake, it exhibits a high degree of technical and artistic sophistication by an, as yet, unidentified forger. In recognition of this ambiguity, the statue is labelled in the Getty museum as ‘Greek, about 530 BC, or a modern forgery’.

This story of the Getty Kouros struck a chord, as we see a very similar parallel with the ‘art versus science’ analysis made by the museum and the ‘art versus science’ associated with our own decision making. All too often, we undertake days, or weeks, of analysis and research into the rights and wrongs of an investment, when we could simply go with our gut. The application of ‘quants’ to underpin decisions is core to the investment management industry; so why – from time-to-time – do we feel able to go with our hunches?

In our January edition of VFTD, we discussed the importance of recognising and managing brain fatigue. Before the onset of this condition, all of us have in our brains a truly mighty backstage process, which works its will subconsciously. Through this process we have the capacity to sift huge amounts of information, blend data, isolate telling details and come to astonishingly rapid conclusions, even in the first two seconds of seeing something. This gut feeling, instinct or intuition refers to those snap decisions we often cannot explain; those moments when we know something is right, but we don’t know why.

The psychologist, Gerd Gigerenzer, Director at the Max Planck Institute for Human Development in Berlin, has long argued gut feelings can often be relied upon and – in many cases – lead to better decisions, than those that involved complex calculations and analysis. He believes that if you want to explain the past, this can be done through the use of very intricate rules; however, if you want to predict the future, this is not always the case. In these circumstances, less is more and we can use our instinct or innate ‘rules of thumb’, which enable us to focus on the most important information and ignore the rest.

Reading Gigerenzer’s theory is quite chastening when we reflect on how much of the investment management process relies on backward looking data. It is dominated by charts and numbers, which record what happened in the past and can naturally lead the decision maker(s) to extrapolate this into what will happen in the future. Over the years, however, our industry has developed some ‘rules of thumb’ that are used to guide decisions when we are immersed in the fog of data and charts. For example, the yield on the 10 year US Treasury Bond should be more or less the same as US GDP growth; “sell in May and go away” (in recognition of the seasonality effect on asset prices observed over the summer months); and “the trend is your friend” relating to the predictable ‘next move’ in prices based on the recent momentum in the price of an asset or currency, in either direction.

The latter rule of thumb is the fundamental principle of one type of hedge fund approach known as CTAs or, perhaps more appropriately, trend-following strategies. Through the analysis of changes in price of, sometimes, hundreds of traded assets over tens of years, trend-following programs use computer models to assess the relative strength of these price moves and invest either long, or short, to make money from what is predicted to be the next move in price. Without doubt, this is on the ‘science’ end of our ‘art versus science’ debate, referred to earlier. However, we recently met with a US-based trend-following manager, which has developed its strategy to be more responsive and empathetic to the moods of the market. In other words, the very ‘human’ aspect of investing which, at the margin, drives asset prices - the ‘art’ side of our debate. We were intrigued to learn their approach applies what they term ‘common-sense’ factors to help explain observed price changes and uses this data to predict the next change in price and position their portfolio accordingly. How do they do this? Through the application of computer-based statistical learning, a sub-set under the umbrella of what many of us will know as Artificial Intelligence.

We appreciate we are have travelled from science to art and back to science again, but we think the combination of both is very relevant when investing. Moreover, a solution that applies these principles in a systematic way – removing the natural biases of humans – is potentially hugely valuable in what we think could become a very emotionally-driven period for global financial markets. Think Trump, Brexit, European politics, Putin and China … it’s enough to cause “intuitive repulsion”.

Julia Warrander and Russell Waite

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