Would you consider $300,000 a fair price for a book?
Q3 hedge fund letters, conference, scoops etc
Charlie Munger did, and he even considered it ‘light’ payment, considering the billions he made from the learnings he took from within. That’s how powerful Robert Cialdini’s book, Influence, is. If you’ve got one of the greatest investors of all time happy to spend that much money on his insights, we all should be reading it. And no doubt you’ll be happy to know we don’t have to spend anywhere near that, though, to obtain our own copy.
You may recall that I have already posted on this subject before. And if you noticed that, you’d be right. You may even ask why I waited so long to post this final part. And here’s the answer – we just had the ten year anniversary of Bernie Madoff’s fund’s collapse, and if there was ever a scenario that displayed most if not all of the Influence factors that are explained in Cialdini’s book, I don’t know what it is.
Upon that recent anniversary, I found myself engrossed in the SEC report into the greatest ponzi scheme of all time. It’s an incredible story of regulatory incompetence, and that’s incompetence on a level you’d be hard-pressed to beat. As I progressed through the report, I found a smorgasbord of ‘Influencing and Persuasion’ techniques that form the basis of Cialdini’s work, which were apparent as the ponzi scheme developed. The techniques conspired to trip up investors and regulators; Social proof, Scarcity, Authority and Consistency Bias were there in black and white. Had the regulators and investors been mindful of the psychological tripwires, those investors may have been spared capital losses and the fraud would have been detected years, maybe even decades, before.
Once you’ve read Robert Cialdini’s book ‘Influence’ you’ll start to notice the six powerful psychological techniques he unveils in the book everywhere. They each provide a useful principle, like a mental model, that can help explain an individual’s behaviour.
In the previous two posts, we covered off on four of the powerful influences including Consistency and Commitment, Reciprocation, Social Proof and Authority. In this post, we’ll cover off on Liking and Scarcity, two persuasion techniques you’ll see regularly in investment markets.
Scarcity
Let’s start with Scarcity. It should come as no surprise that people want more of those things they can have less of. Humans are challenged emotionally when freedoms are threatened. Retailers use this technique to great effect. Studies show that when supermarkets place limits on the number of items allowed to be purchased on sale, an increasing number of people buy the maximum number allowed. When Adidas releases it’s latest range of shoes, it elevates sales by collaborating with popular designers [social proof] and releasing limited numbers.
“You do much better in this world if you’re selling something, to say “only one to a customer,” and “you have to get in early,” or “you have to know somebody in order to get shares.” And many new issues are sold that way, and it’s very effective. I mean, you know, it’s like those old stories in Russia where there’d be lines, and people would get in them without knowing what they were going to buy when they got to the front of the line. And that’s a very effective selling tool. And it’s one that Wall Street is not unfamiliar with.” Warren Buffett
This tactic is often adopted by promoters in the financial markets. At the 1996 Berkshire meeting, Buffett expanded on the use of the scarcity principle in financial markets.
“Most new offerings are done in a manner where the idea is to have far more demand than supply, and therefore cause people to, maybe, order stock they didn’t even want, and just on the idea that this restricted supply will cause a big jump the first day, whether, you know — you’ve seen Yahoo or a number of other offerings.” Warren Buffett
Bernie Madoff leveraged the power of ‘Scarcity’ by harnessing it’s ‘exclusivity’ and ‘privileged access’ when marketing to potential investors. In the SEC report I mentioned above, the investigation noted one of the Madoff feeder funds, Avellino & Bienes, was not available to everyone… “this was a ‘special’ and exclusive club, with some special investors getting higher returns than others.”
Scarcity is one reason auction prices can sometimes reach unwarranted levels. I’m sure you’ve heard of the winner’s curse, when the auction buyer overpays in the heat of the moment. It’s one of the reasons Berkshire doesn’t participate in auctions of businesses. They like to deal on an exclusive basis. As all businesses are unique, a scarcity element is present. Munger calls this trait the ‘super-deprival-reaction syndrome’ and he’s recognised open-outcry auctions combine some of the worst psychological pitfalls.
“The open-outcry auction is just made to turn the brain into mush: you’ve got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away… I mean it just absolutely is designed to manipulate people into idiotic behavior.” Charlie Munger
When demand exceeds supply and everyone is chasing the same investment, it’s more likely investors are overpaying. Howard Marks makes a pertinent observation:
“Watch which asset classes they’re holding conferences for and how many people are attending. Sold-out conferences are a danger sign.” Howard Marks
In addition to people wanting more of what they don’t have, people feel losses more than they feel gains. This is known as ‘loss aversion’ and it’s one reason most investors fail to cut losing trades. It’s also a reason investors can be wrong-footed when faced with portfolio losses.
Like the other ‘Influence’ principles, the mental short-cuts are innate actions; we make them without thinking. Dan Ariely and Daniel Kahneman provide an evolutionary explanation as to why we experience loss aversion:
“If you think about nature, if you get something good (like you get to eat more food and so on) that’s a good thing, but if you do something bad, you can die. So nature has kind of tuned us to look at the negative side because if you get a bit more food, a bit more money or whatever, there’s a positive expected value but it’s limited. Whereas on the negative side, you can lose a lot. So because of that we just attune more to losses.” Dan Ariely
“Loss aversion – When directly compared or weighted against each other, losses look larger than gains. This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history. Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce” Daniel Kahneman
The Investment Masters, are well aware of loss aversion.
“People are really crazy about minor decrements down. Huge insanities can come from just subconsciously over-weighing the importance of what you’re losing or almost getting and not getting.” Charlie Munger
“One of prospect theory’s most important contributions to finance is loss aversion, the idea that for most people, losses loom larger than corresponding gains. The empirical evidence suggests we feel losses about two to two-and-a-half times more than we feel gains. Loss aversion is a clear-cut deviation from expected utility theory.” Michael Mauboussin
“There is the argument that for virtually any investor, the marginal utility of an extra gain is smaller than the marginal utility of an equal percentage loss.” Ed Thorp
One method for not letting loss aversion trip you up is to take a longer term view. Remember the stock you own is a business, and the share price will reflect earnings over the long term. Prices don’t always equate with value, so monitor the business performance and understand the stock price contains less useful information. Given short term stock movements are largely random, checking your portfolio less frequently can also help.
“If I knew how to be up every single day, I would do it because up is better than down. The shorter the time frame on marketable securities, the closer you approach 50/50 as to whether it’s going to be up or down.” David Abrams
“Well-worn studies confirm the financial utility of long-term viewpoints; however, behavioral psychologists augment the case by showing investors dislike losses two to three times more than they like gains. If short-term gains/losses carry 50/50 odds, then the disdain for losses implies that infrequent monitoring and long-term horizons aide both mental health and financial wealth. In short, Winston Churchill’s quip on revenge may aptly apply to myopic investment habits: “Nothing costs more and yields less.” Allan Mecham
“If you don’t check your portfolio every day, you will be spared the angst of watching daily price gyrations; the longer you hold off, the less you will be confronted with volatility and therefore the more attractive your choices seem. Put differently, the two factors that contribute to an investor’s unwillingness to bear the risks of holding stocks are loss aversion and a frequent evaluation period. Using the medical word for short-sightedness, Thaler and Bernartzi coined the term myopic loss aversion to reflect a combination of loss aversion and the frequency with which an investment is measured… In my opinion, the single greatest obstacle that prevents investors from doing well in the stock market is myopic loss aversion.” Robert Hagstrom
Liking
The final technique Cialdini recognised was the human trait of liking. People prefer to say yes to those that they like.
“Everybody likes people who like them.” Charlie Munger
Cialdini notes three important factors when it comes to why people will be inclined to ‘like’ others; we like people who are similar to us, we like people who pay us compliments, and we like people who cooperate with us towards mutual goals.
“One very practical consequence of liking/loving tendency is that it acts as a conditioning device that makes the liker or lover tend (1) to ignore faults of, and comply with wishes of, the object of his affection, (2) to favor people, products and actions merely associated with the object of his affection, and (3) to distort other facts to facilitate love.” Charlie Munger
A classic example in investment markets is an analyst who gets close to the company. Analysts can become less objective and focus only on the positives at the expense of potential negatives. Marathon Asset Management are wary of such analysts:
“There is always a danger that an analyst is ‘captured’ by management. This risk rises for specialist analysts who spend most of their time covering a small handful of companies, whereas a generalist might cover a few hundred. Capture poses the threat that an analyst lands up becoming the mouthpiece of management” Marathon Asset Management
They use the analogy of the ‘Stockholm syndrome’..
“There is also the issue of ‘Stockholm syndrome’.. Research analysts are also vulnerable to this and particularly when they get too close to the companies they follow. If an analyst only covers ten or so companies and works for a big influential house, then it is likely the analyst will have a close relationship with the management of the companies. It is often the case that a friendship and a closeness develops whilst analysts also receive significant hospitality from these companies and as a consequence objectivity may be compromised.” Marathon Asset Management
And investors can get caught too. It’s one reason some investors prefer not to meet management. Instead they prefer to work through old company reports to see if what management said they would do, they did.
“I typically don’t meet management. I don’t talk to management. I was in private equity for 15 years. And generally, if you become a CEO of a company you’re a really good salesman, one way or the other, and you’re gonna probably spin people. I made a couple of big mistakes when I got involved in situations where I liked people too much. And, I generally like people. So, the way to avoid that is put the filter on that rely on reading transcripts, 10ks, 10qs.” Ted Weschler
“Given the availability of so much information on the internet, I’m not so interested in meeting management today. You can get seduced too easily. I’m more interested in finding out how a person has behaved in the past. If I can listen to a few of the CEO’s speeches and read the transcripts or earnings calls, that is more important than talking to him. A smart, dishonest person can fool you, especially when he’s talking about his own business.” Bruce Berkowitz
“The conclusions I’ve come to about managers have really come about the same way you can make yours. I mean they come about by reading reports rather than any intimate personal knowledge or — and knowing them personally at all. So it — you know, read the proxy statements, see what they think of — see how they treat themselves versus how they treat the shareholders, look at what they have accomplished, considering what the hand was that they were dealt when they took over compared to what is going on in the industry.” Warren Buffett
Or it may be that an analyst or expert has had similar views to your own in the past or a track record of success. This can lead one to be less objective and less reliant on the facts than required.
“Avoid the Pied Piper. Just because someone has been right seven times in a row is no guarantee that number eight will work. When he is finally wrong, the size of the herd will be at its maximum – just as it plunges over the cliff and into the sea. As investors walk in lockstep with the guru over the cliff, a new guru who pointed the way correctly (though only a few listened) is thrust to the forefront. When he too falls, investors will again frantically search for a new guru so as to perpetuate the guru loser’s game.” Bennett Goodspeed
When a CEO wants to be liked by the market, their desire, can lead to poor decision making.
“Having a person running a company to please Wall Street can be really problematic.” Jim Chanos
“I admire Amazon founder Jeff Bezos. He has revolutionized the retail industry and has two great qualities: He is patient and persistent, and he doesn’t care to please Wall St.’s quarterly expectations. This last quality is often overlooked but it is seldom found and represents, in my opinion, a true competitive advantage.” Francois Rochon
At times, subordinates can be pressured into making dumb decisions, to keep pleasing the CEO, who themselves want to please Wall Street.
“We have seen really decent people misbehave because they felt that there was a loyalty to their CEO to present certain numbers — to deliver certain numbers — because the CEO went out and made a lot of forecasts about what the company would earn.” Warren Buffett
Corporate Board members are particularly vulnerable to sub-optimal decision making where directors try to be liked. Liking correlates with ongoing director fees.
“I would say that the typical organization is structured so that the CEO’s opinions, biases and previous beliefs are reinforced in every possible way. Staff won’t give you any contrary recommendations – they’ll just come back with whatever the CEO wants. And the Board of Directors won’t act as a check, so the CEO pretty much gets what he wants.” Warren Buffett
“CEO’s get very diluted information. They’re told what people believe they want to hear. We tell them the facts. We call a spade a spade.” Richard Perry
Summary
It doesn’t take a massive leap of the imagination to see how understanding the persuasion techniques that Cialdini uncovered can help you in the markets. When you read the above, could you relate the themes to any personal experiences, or even experiences of those people who are close to you? I certainly could. It’s not hard.
Many people have discovered their uses; you don’t have to travel too far from home before you encounter one or more of the six factors. You can see, also, how the Investment Masters themselves have identified with the traits and taken active steps to avoid getting ensnared within the psychological trip wires. Charlie even paid large for the read, and if that man saw the sense of the ideas, then we all should. And that’s good enough for me.
Further Reading:
Investment Masters Class – ‘Munger Series: Learning from Robert Cialdini’, Part I and Part 2
Bloomberg Masters in Business: ‘Robert Cialdini, author of Influence’, 2018
Article by Investment Masters Class
