Rx – A Dose of Scepticism

With communication tools becoming handier, investors are increasingly confronted with the challenge of navigating through the uncontrolled barrage of information hitting them. A large part of this flow is either not relevant or more dangerously, is misinformation. Being sceptical and questioning is a simple and useful tool, as well as an important first step in sifting through what you read or hear, in order to achieve better investing outcomes.

The global spread of Covid-19 has been accompanied by a steady stream of stories from across the world – of tragedies, of victories and of the heroism of frontline workers. And among these stories there has also been a steady stream (a deluge, actually) of misinformation. From conspiracy theories on the virus’ origin, to home-remedies and exaggerated stories of nature reclaiming itself from humans. The number of different individuals sharing such messages makes you wonder why people do not pause and reflect on the accuracy or question the authenticity of the news before spreading it.

In investing, where information is a key input to any analysis, the risk of being swayed by misinformation, or misjudging the information at hand cannot be understated. Given the information overload that we deal with on a daily basis, there is always a chance of a half-truth or a distortion making its way to our desks or Inbox. Such messages might even come with the caption – HoS, or Heard on Street. It so very often happens that you ‘hear’ of some ‘news’ about a company and are considering how to act on it. Meanwhile, others have ‘heard’ it too and the stock moves up. You react and buy, only to realise what you ‘heard’ was completely wrong. This happened recently when investors wanting to bet on the surge in video-conferencing services took the stock of Zoom Technologies up 80% in two hours of trading. Just that the company running the popular Zoom video call service is called Zoom Video Communications.

While we may not be subject matter experts to check the veracity of a received message, we can at least be sceptics before forwarding it. But why is scepticism so hard to maintain in the face of the relentless stream of bogus stories that come our way?

As the speed and frequency of information flow rises with newer communication tools, it becomes imperative to treat news flow with a degree of scepticism. However, of the many approaches to analysing information that comes your way, scepticism is arguably the most underrated. It is not that investors are not questioning beings in general, but human nature usually comes in the way, in the form of Optimism Bias and Peer Pressure.

Most of us suffer the ‘optimism bias’ and tend to overestimate our likelihood of experiencing good events in our lives and underestimate the likelihood of things going bad. After all, no one buys a stock thinking it will fall in price. Often, the optimism bias tempts you with the opportunity to make a quick buck and prompts you to act on news flow without adequate research and assessment of risk vs reward. The bias manifests in many other investing decisions also, including overpaying for assets or taking on more risk than is warranted or mandated by the portfolio. Not that the optimism bias is all bad – research shows that optimism is linked to better well-being as well as long-term success.

Peer pressure manifests itself in the herd mentality, where it becomes increasingly difficult to bet against the crowd or question the consensus view. It takes rare courage to be seen as an outcast trying to go in a different direction than your friends and colleagues.

In the Indian context, practicing scepticism is particularly hard. A sceptical mindset will yield many ‘short’ ideas, most of which one can’t act on due to the shallow Futures & Options market that we have. There are just 144 stocks listed on the exchanges that can be sold short. Let’s say a certain pharma company’s stock is rallying because, you are told, it has a drug that could be effective in treating Covid-19. You are not sure of this claim, so you spend a week verifying it. If your research proves your doubts and the stock is not among the 144 in the F&O list, you’ve spent a pretty useless week. You did avoid a potential loss by being a sceptic but made no actual profits.

A more general shortcoming of scepticism is that an extreme form leads to paralysis in decision making and you risk end up being just a spectator in the markets rather than an active player. You also need to be careful of not slipping into pessimism. However, a healthy dose of scepticism is, for lack of a better word, healthy. So, what are the ingredients to getting the right dose? Seasoned investors have offered many solutions, of which, here are three easy-to-follow ones.

The first is experience. There is no substitute for the ability to build mental models based on past experiences and mistakes. Say, news ‘sources’ claim the government is planning to bring in major reforms in electricity distribution. An analyst tracking the sector for a couple of years might get excited, thinking a solution to the woes of the sector is on its way and will start identifying potential winners. And an analyst tracking the sector for 15 years and having seen little change after at least three such reform measures in the current century will probably not give it as much priority. An investor who does not have the necessary experience will do well to get counsel from others who do.

The second is to actively seek out opinions that go against your own views. Doing this helps overcome what is known as the Confirmation Bias – the tendency to value information that confirms your beliefs over information that goes against them. Next time you hear something great about a stock you are contemplating buying, talk to someone who has a negative view on the stock. If you are bullish about the government’s economic policies, read material published by people you consider to be anti-establishment economists. Or follow those on Twitter whose opinion you most disagree with. The ability to consider outcomes other than what you desire is a great tool in objectively evaluating and analysing any kind of information that comes your way.

The third is patience. Not reacting to the first piece of information that hits you is an asset, and a highly undervalued one. Mainstream media competition and social media proliferation have made speed of information dissemination a priority over its accuracy. As a result, the first edit of the news ticker might not be an entirely accurate one. A more complete picture, better information and newer perspectives emerge with time and holding one’s horses can end up being very profitable.

At Marcellus, we try and actively practice being sceptical in general, and questioning of received or popular wisdom, in particular. For example, we have raised doubts on the perceived risks of Covid-19 on Indian stocks or the relevance of the P/E ratio in the Indian context.

I am sure all active investors have had to deal with misinformation at some point in time. We would love to hear about your experiences in dealing with it using the right dose of scepticism. We will try and compile a ‘Best Of’ list and write about it in a future blog. Mine was when a friend with many years of professional investing experience suggested buying shares of Chennai Petroleum because Warren Buffett was going to take a stake in the company. It seemed odd that of all investment avenues in the world, Buffett would be interested in a small government-owned oil refinery in India. It turned out he was taking a stake in PetroChina, which, in the investing version of Chinese Whispers got modified to China Petro and then Chennai Petro!

Salil Desai is a Portfolio Counsellor with Marcellus Investment Managers

PS: To see where an extreme form of scepticism takes you, watch this delightful movie, ‘Ankhon Dekhi’ (streaming on Hotstar). After a disturbing incident, the protagonist decides not to believe anything he has himself not seen, heard or experienced.

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Note: the above material is neither investment research, nor investment advice. Marcellus does not seek payment for or business from this email in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services and as an Investment Advisor.