Mauboussin: The Two Decision Aids that Fundamental Investors Should Use…But Often Don’t

Michael Mauboussin is the Head of Consilient Research at Counterpoint Global, a $70B asset manager. Michael, for decades, has provided some of the most thought-provoking, well-researched insights on the investment process of fundamental managers. Michael’s book, “More Than You Know” was a major influence for me during the development of Alpha Theory.

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He recently appeared on the February 19^th episode of Capital Allocators with Ted Seides. Michael was discussing the Decision Aids of quant and fundamental investors:

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Ted Seides:
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Pattern recognition, whether it's elements of stock, even in this world, manager selection, it's very qualitative. How do you distinguish between the quantitative and the qualitative?

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Michael Mauboussin:
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It's also a very important question, and one of the things to think about is do you have access to, or do you use so-called decision aids? You use so-called decision aids. Let's take equities, for example. Quantitative investors versus fundamental investors. Well, quantitative investors are using decision aids. So, they're saying here we're going to look at history and we're going to judge why certain stocks did better than what, for example, an asset pricing model would predict that would give us some sort of excess returns. We'd love to have an economic story to explain why that factor did particularly well. That's nice, but those are decision aids. And then once those decision aids have been set, you let the decision models themselves essentially run the portfolio and you're overseeing and doing more research to refine everything. But that's basically it.

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Michael Mauboussin:
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Many fundamental investors don't really use those decision aids, or they don't use them as much as they possibly could. And so that's a fascinating area for us to explore, what are the decision aids at our fingertips that we're not accessing as fundamental investors?

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When asked about the decision aids that Fundamental investors should be using, Michael highlighted creating a position-sizing decision aid as one of the two most important:

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Ted Seides:
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What are some of those decision aids that fundamental investors maybe don't use, but should be readily accessible for them to use?

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Michael Mauboussin:
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One that I think you and I have talked about is the application of base rates. So, thinking about historical performance and the degree to which that can help inform your forecast, they're the devil in the details in terms of what are appropriate reference classes and so on and so forth. But that's, I think, a very rich mine for us to continue to explore. The other one I find fascinating that I don't really understand enough about why it doesn't happen is position sizing. I think most fundamental investors have some sense of why their position sizes are what they are, but in a sense, they're not quantitative or they're not completely structured. So, the question is, might you have a decision aid to say I'm going to lay out in advance here's how I'm going to think about sizing my positions. I'm going to provide the appropriate inputs to allow that to happen. I'm going to consider all the constraints that are relevant and to some degree even let the model generate what I should be doing.

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For fundamental investors, our evidence agrees with Michael. Creating your own position sizing decision aid is one of the best ways to improve returns. You can do it on your own or have a platform such as Alpha Theory lend a hand.  

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