Why Investors Should Never Let Hedgehogs Manage Their Money

Predicting the future — whether in the realm of financial markets, world events or even sports — is a tough game.

And that’s whether you examine financial statements, interpret stock charts, defer to astrology — or even read animal entrails as the Romans did.

Yet there are some folks who are better forecasters than others.
That is the conclusion of Philip Tetlock’s and Dan Gardner’s book, “Superforecasting: The Art and Science of Prediction.”
Having read his earlier academic work “Expert Political Judgement,” I already was familiar with Tetlock’s ideas and conclusions.

In fact, I previously wrote about Tetlock’s work, in which he compared the forecasting abilities of “hedgehogs” versus “foxes.”

It all comes down to thinking styles.

Hedgehogs Versus Foxes

As the Greek poet Archilochus observed: ”The fox knows many things, but the hedgehog knows one big thing.”

Hedgehogs have one overarching “Big Idea” into which they shoehorn their opinions and worldview. The Big Idea is like a pair of glasses that the hedgehog never takes off. No critical thinking is required. Like a Marxist, a member of ISIS or the head of a cult predicting the end of the world, hedgehogs are ideological. They never change their minds. Even when their predictions are clearly wrong, they tell you, “Just wait.”

Foxes are a very different animal. Foxes are the pragmatic experts who draw on a wide range of analytic tools. They gather as much information as possible from as many sources as possible. They shift mental gears. They talk about probabilities and not certainty. They readily admit when they are wrong and are willing to change their minds.

Thankfully, they are the types of folks who run the space program, the military and occupy the bowels of the top university and government research labs.

Still, hedgehogs have a built-in advantage, which irks Foxes (like yours truly) to no end.

Hedgehogs are more media-friendly, because their simplistic thinking can be reduced to a simple but catchy soundbite. I’ve always envied hedgehogs because they can keep saying the same thing over and over again and still attract the uncritical adulation of their acolytes.

There are two ironies here.

First, Foxes hardly ever make it into the media. They don’t make for “good TV.” Despite his success, George Soros’ laborious speaking style and strong Hungarian accent are a TV producer’s nightmare.

Second, as a rule of thumb, the more confident the forecaster, the more likely it is that she is dead wrong.

Nevertheless, the conclusions of Tetlock’s lifetime of research is clear: In terms of forecasting, Foxes beat Hedgehogs.

And it ain’t even close.

In both accuracy and probability, Foxes have foresight. Hedgehogs don’t.

In fact, Tetlock concludes that Hedgehogs’ insights are statistically worse than random.

Foxes also have certain characteristics that make them better forecasters.

They gather evidence from a variety of sources; they think probabilistically; they work in teams; they keep score; they are willing to admit error and change course. They are open-minded, careful and curious.

And above all, they are self-critical.

This explains the success of speculators like George Soros, who, in my view, has the habit of mind of the ultimate fox:

On the abstract level, I have turned the belief in my own fallibility into the cornerstone of an elaborate philosophy… To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. (T)here is no shame in being wrong, only in failing to correct our mistakes.

–George Soros

Forecasting in Finance

The world of finance and investment is chock full of wrong forecasts.

But get one forecast right, and you can make a career out of it.

Take the case of Texas hedge fund manager Kyle Bass, who earned himself $250 million and a chapter in Michael Lewis’ book, “The Big Short,” for betting on the collapse of mortgages in 2007.

How has Bass done since?

According to the New York Post, which recently obtained a copy of Hayman Capital letters to investors, over the past 91 months, or nearly eight years, Hayman Capital’s main fund returned just 1.56% annually.

That’s slightly better than a Treasury bond ETF. But not much else.

The conclusion is inevitable.

Kyle Bass is not a Fox like George Soros. He is a one hit wonder, a Hedgehog who got lucky in 2007.

My Favorite Hedgehog Forecasts

“The end of the modern Chinese state is near. The People’s Republic has five years, perhaps ten, before it falls.”

–Gordon Chang, author of “The Coming Collapse of China,” 2001

“There’s no chance that the iPhone is going to get any significant market share. No chance.”

–Steve Ballmer, chief executive of Microsoft, April 2007

“No! No! No! Bear Stearns is not in trouble.”

–CNBC pundit Jim Cramer, March 2008, shortly before the bank had to be rescued in a takeover by JP Morgan

“The worst of the crisis in Wall Street is over.”

–Warren Buffett, May 2008

“All who drink of this treatment recover in a short time, except those whom it does not help, who all die.”

–Galen, Roman physician

“The repeated invocation of Ireland as a role model has gotten to be a sick joke.”

–Paul Krugman. New York Times, August 16, 2013 (The Irish economy is now growing at over 6% per year, and debt has fallen from 125% to below 100% of gross domestic product.)

“Now I might have to just say that instead of it going to $5,000, maybe gold is going to $10,000… the relationship between gold and the Dow will be one to one, just like it was in 1980, and just like it was in 1929… I think that those two numbers are going to get very close to one another.”

–Peter Schiff, CNBC, May 12, 2010 (Over five years later, gold is trading below $1,100 and the Dow is trading at over 17,700. Of course, Hedgehogs like Schiff are never wrong. They are just early.)

In case you missed it, I encourage you to read the Global Guru column from last week about whether commodities have reached a bottom in price. I also invite you to comment in the space provided below my commentary.