Tuesday, December 22, 2015

Philosophy as the Operation System of an Investor's Mind.

One of the better reads I had this holiday season is Mindware : Tools for Smart thinking by Richard Nisbett. This book  shows folks how to think and draws from various academic disciplines like Economics, Psychology, Statistics and Philosophy. It is a powerful toolbox for a problem solver and contains the keys to resolving many practical issues.

The chapter on dialectic reasoning itself should be worth the book's weight in gold.

It summarizes Western Logic into three propositions :

1. Identity : A = A. A is itself and not some other thing.
2. Non-contradiction. A and not A cannot be true at the same time.
3. Excluded middle. A or not-A can be true but not something in-between.

Eastern logic is very different :

1. Principle of Change. Reality is a process of change. What is true will shortly be false.
2. Principle of Contradiction. As change is constant. Contradiction is constant.
3. Principle of Relationships. The whole is more than the sum of the parts.

A successful investor cannot ignore Western or Eastern Logic. Both needs to be installed within the OS of an investor's mind.

An investor with only Western Logic is like a CFA level III candidate who has just invested his first $10,000 into the financial markets. He has the statistical tools to find the stocks which theoretically can result in strong performance but have yet to experience the psychological effect of market cycles. Often these investors would stick to the basic knitting and rely on the older studies of  Fama and French or Modigliani and Miller. The best students would stick to small companies with low P/B value and ignoring the effect of dividends. The strategy works until the investor gets a nasty black swan market event which affects his emotions and breaks his morale.

An investor with Eastern Logic might fare even more badly and not have a central theme or strategy when it comes to investments. Many technical analysis investors rides on the market waves without any understanding of the fundamentals. Theories will be proven false in time so why bother with statistics ? Just rely on reading tea leaves and profound wisdom of the trading mentors that they pay thousands of dollars to. At any point of time, a dotted line on a chart can be a resistance level or a level where a break occurs. Foresight is 10/20, hindsight is 20/20. Just make sure that you only present the answers in hindsight.

The sweet with investments is accepting both Western and Eastern Logic.

Statistics are moderated by R scores and some results are bounded by confidence intervals. But statistics can take an investor only so far. A statistically perfect stock may not have ample liquidity and a good business can be disrupted by a paradigm shift within the industry.

Perhaps this blend of Eastern and Western logic may be useful to assess a counter like Sabana Reits. Statistically it is one of the highest yielding REITs in the industrial REIT space but the yields were not sustainable in light of recent expiration of master leases. As investors start to realise that yields are dropping, they abandoned the counter making the yields irresistible again, but now there is a new development with this counter. Sabana is now showing a willingness to sell off under-performing assets. Played well, this may be a key for investors recoup their investments in the form of yields and returned capital.

Would this strategy work ? I have a small residue position to find out how this plays out.

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