In this article, lets focus on identifying opportunities to stay ahead of the markets and the public ‘herd’ by looking for unpopular sectors. And in particular, identifying the art of getting accustomed to the emotional discomforts of running an investment position temporarily unpopular to the mainstream. In essence, it is about overcoming conventional biases and also managing your own unique personal biases to improve rational objectivity.
In today’s fast moving electronic global markets, information, opportunities and capital are deployed faster than ever. And not just in the financial markets, but we have certainly witnessed it during the collapse and faster than expected recovery of the American real estate market. In order to find profits worth chasing one must increasingly look outside the box, and to do so, investors need to be able to minimize and manage their human biases. Thinking on a global level is practically mandatory in order to locate rewarding opportunities, and there is no excuse not to do so while the RMB remains strong.
Every investor’s framework needs to have a solid way to “Discover” good ideas. At Oasis Partners, we use the term “Opportunity Spotting”, and we have evolving routines to scan and filter out situations in the global markets that we find of interest. After “Discovery”, comes evaluation and deeper, in-the-field research. And it is during these two early parts of our investment process that we don’t want to let human biases interrupt what could be a truly attractive opportunity.
Identification and Awareness of fear, uncertainty due to bias.
Our egos are pulled between greed and fear, and at Oasis, we prefer to operate closer to the fear side rather than the exuberient greed side
The first step to combating our human bias is to be aware of it. To be totally conscious of what it feels like, if you get lazy about this, it will be too easy to stay comfortable in one’s own narrow zone of reality. If I told you that tomorrow, you should invest one year’s worth of your income into Lithium (what your cellphone batteries are made of) would it feel odd? How about investing in construction companies in Nigeria, Africa? Would you be worried about putting your money into Russian stocks right now? Is there an uncomfortable cringe in your face yet? If that doesn’t do it then to really pound home my message, how about we invest in Greek junk bonds together? Or development of real estate in Xinjiang? I specifically chose these ideas because there are powerful negative news headlines about these areas.
The point here is to evoke an uncomfortable emotion as I ask you to consider to put your hard won playing chips on the table. Depending on your personality, you may feel the ideas above are crazy, stupid, a waste of time, weird, maybe worth looking into, maybe even twisted fun. The point is we are all human creatures, following our instincts and emotions. Now how about if I told you Tesla Automotaive just figured out how to build a car battery that can last for 1000km and can be recharged in less than 10 minutes? Does that sound attractive? Whether you think so or not, that’s your greed combined with positive biases about clean, hi-tech, transportation.
Our egos are pulled between greed and fear, and at Oasis, we prefer to operate closer to the fear side rather than the exuberient greed side because we can make more money with less risk. Before we can turn an uncertain and unpopular idea into a plan for profit is to work on our biases because they seriously affect our performance.
- ANCHORING BIAS
- RECENCY BIAS
- CONFIRMATION BIAS
- POST-PURCHASE RATIONALISATION
- BANDWAGON EFFECT
- ATTRIBUTION BIAS
- ILLUSION OF CONTROL
- HINDSIGHT BIAS
- BIAS BLIND SPOT
- HOME STATE BIAS
- NEGATIVITY BIAS
In this article, will focus on these four Recency Bias, Negativity Bias, Loss Aversion Bias and Home State because these are the most common biases faced by investors and traders when entering trends early. In each of these four biases, two real life examples we at Oasis have come across in recent years will be used to illustrate how to manage bias.
Our brains simply put more weight on recent experience and information observed. It is the tendency to think that trends and patterns we observe in the recent past will continue in the future.
In the financial markets we can rewind to the beginning of 2014 when the RMB was at its strongest level ever against the US Dollar. Around China, many people were believing that the RMB would rise a further 10 percent, to 5.5 per dollar. The RMB was marching higher on every piece of news, and market speculators and exporting companies were all conditioned for continuing gains. Two years prior in 2012, we put the RMB-USD pair on watch for a possible trend change based on slowing manufacturing production and shrinking export profit margins. By 2013 we started to question the conventional wisdom that the RMB could not fall or that the government had the ability to defend the level, both of which were not popular positions at the time. At present, in light of the allowed devaluations, it is still unpopular to point out that even $3 tillion USD in foreign reserves is not sufficient to defend exchange rates, but merely smooth out market forces.
We faced strong recency bias in the real estate markets when we started researching and investing in the U.S. real estate market in 2010. As we looked for answers, asking questions to many local people in various fields, it was clear practically everyone was expecting property rises to fall further. You can’t blame them, they watched as houses priced at $350,000 dropped to $200,000, then to $170,000. Young bank tellers that could afford to buy homes did not want to. Investors outside of the United States didn’t want to touch the market that was stained by Lehman brothers. In our own checks of the market, the deeper we dug, the more we managed to unearth cheaper prices that it caused us to hesitate on our entry point. We saw houses we liked for $90,000 in Phoenix, and a month later, we could find an identical property for $80,000. We adapted to the chaotic market by treating it like a stockmarket, data mining the thousands of properties being pushed onto the market each week, carefully monitoring the speed of the foreclosures, gathering as much data possible to objectively see the market for what it was. We followed the data, resisting emotion, resisting fear and uncertainty and bought the first two units that later turned into many many more.
Scientists theorize that we perceive negative news to be more important than positive news. Negativity bias causes investors to put too much focus on the bad and being blind to a change in market trends. Some might call this risk management, but it is not necessarily objective or rational at all.
In the Financial markets, we can currently use the Oil market as a good example of negativity bias. There is no shortage of bad news for the Oil sector as OPEC refuses to cut output and as American Oil production now equals Saudi Arabia in capacity. Oil also just traded clearly below the symbolic $40/barrel level at this time of writing and is showing signs of wanting to trade lower. Despite this, an astute oil speculator would be looking for signs of price stabilization amid the all the bad headlines. And if the bad news no longer affects the price…the path of least resistance is probably upwards. We would also like to point out that we are not actively trading oil, but we watch it closely as we trade other commodities and related currencies.
In the Real Estate market, we can re-visit our investments again in the U.S., but this time we will highlight the negative perceptions faced by early investors of which we were a part of. For starters, our first property purchases after the crash was in Phoenix. A city in the middle of the desert not known for producing anything notable. Our next investments were in Las Vegas, which on the surface seemed counter-intuitive. Why invest in a city dominated by gambling and tourism? Aren’t American’s too broke to spend money like this? Who wants to live in a casino town? As it turns out, both Phoenix and Las Vegas were among the five fastest growing cities prior to the crash, with more job and population growth than other cities of comparable size. And yes, while Americans suffered financially from the credit crisis and they did cut back their vacation spending, Las Vegas did not suffer as much as expected because Americans chose to save money by vacationing domestically rather than international trips. And since our team travels the world frequently, we can definitely endorse Las Vegas as a destination with lifestyle options and advantages over the majority of destinations we have seen.
We don’t want to be losers. We would rather win less than to lose. In fact, human beings hate losing so much that there is tremendous asymmetry in emotion. “People hate losing much more than they enjoy winning. How happy are investors when they make 3% on their investments and how miserable are they when they lose 3%?” No one likes to experience loss; as humans, we often find it painful. So painful that the prospect of experiencing the pain of loss can paralyze us from taking another risk, even when it’s potentially small or when the rewards of taking the risk are potentially great. Fear of loss can cause investors to not only miss out on opportunities, but take emotional actions—such as liquidating their assets—that could run counter to their long-term investment goals.
In the Financial markets, inexperienced stock traders may often hurt their profitability even when their position rises. But as the position rises, they also adjust their stop-loss upwards very tightly, and their stops are often triggered prematurely before their stock rises a lot more. But why did they do that? Is it because the price action has a bearish tone? Or is it solely because they do not want to lose?.
The same applies for Real estate markets. In both Canada and China, numerous property owners sold their homes when prices hit records back in 2005. We observed very sophisticated investors with finance backgrounds in Canada figuring the peak had been reached and that home prices were unsustainable. We saw investment bankers moving out of their multi-million dollar homes and renting instead to lock in their profits. The Canadian market took a brief 12 month dip of 10% and then promptly raced higher by another 70% over the following 8 years.
Our recommendation is that investors be patient and continue to strike at opportunities where a slight loss is planned for and tolerated against long term gains that can exceed 50% or higher. Chasing fixed low yield investments is a recipe for severe underperformance over any time frame longer than 5 years. And all of our investment members in Oasis have many business cycles left to live through before true retirement.
HOME STATE BIAS
Most investors are (or at least should be) familiar with the concept of “home country bias” — the natural tendency to be more familiar and comfortable with investments in your home country. Investors everywhere consistently display this trait, which is in direct conflict with the basic principles of international diversification. Nevermind international diversification, even within a country, statistics show that investors over-allocate capital to their own local areas.
Americans investing in the stockmarket have For instance in the United States, if they live on the West Coast, near the technology hubs of Silicon Valley, they are very likely to be overweighted in technology by 9.5 percent or so. Those living in the Northeast (New York), are overexposed to finance by 9 percent. Investors in the industrial Midwest are likely to have 11.8 percent more industrial companies in their portfolio than the rest of the country. The greatest overexposure is in the South (like Texas), where energy holdings are 13.7 percent above the average.
From a real estate dimension, Oasis Partners has been circling the world in search of attractive real estate value. Since 2009, we shifted assets into United States, and now we are preparing add Mexico to the portfolio of assets. We see opportunities in Ireland as a investment proxy for Europe. We understand that real estate investment and the capital chasing it moves much faster than before. Real estate investment in the age of the internet communication is now completely global and minimizing home-state bias is key to capturing the best profits.
Having dived into cognitive biases affecting investment, we should also warn that one should not try to get rid of cognitive biases completely. First, because it is not possible. Second, because it is not necessary. To manage your biases, watch the market, seek less widely available information, expect anything to happen, and don’t form an opinion if possible in the beginning.
In the investment world, PERCEPTION means everything. And anticipating how a story will evolve and capture people’s imagination not just 3 months ahead, but 1 year out, or even 5 years and beyond is similar to a chess strategy. Visualizing how reality and the narrative can change requires creativity that is not too clouded by human bias.
Speaking of evolving realities and visualization, we are also pleased to note that a prominent developer from Shanghai (who we cannot name right now) has been able to look past many common biases by doing solid on-the-ground research to start investing in Las Vegas. When Oasis decided to base itself out of Las Vegas for North American operations, we anticipated that the city would be an increasingly attractive destination for Chinese investment and lifestyle, potentially tripling its community population from 35,000 to 100,000.