1. Information Overload

    INVESTING IN THE MACHINE AGE

    Iain Campbell, Investment Manager. Third Quarter 2018
  2. All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

  3. We are living in a time of chronic information overload. The growth of the internet, 24-hour television and mobile devices means that we now receive five times more information daily than we did 30 years ago. Each one of us is now bombarded by the equivalent of 174 daily newspapers of information per day. In turn we have increased our own personal data production; each of us produces the equivalent of six newspapers worth of information every day, a 200-fold increase over 30 years.
  4. Hal Varian, the chief economist at Google has quantified this explosion of professionally and personally created data, “Between the dawn of civilization and 2003, we only created five exabytes; now we’re creating that amount every two days. By 2020, that figure is predicted to sit at 53 zettabytes (53 trillion gigabytes) – an increase of 50 times.” 

    The enabler for this is of course technological innovation. The first formal methods for data transmission and storage were the clay tablets of fifth millenia BC Sumer, records which were both time consuming to produce and difficult to store. Modest improvements in manuscript technology (ink and paper replacing sharpened reeds and clay) allowed data recording to accelerate somewhat in the following millennia with printing and the Gutenberg press in 1440 mechanising this and bringing about a step change. However, even this dramatic improvement appears as a small blip on the chart when the clock is rolled forward to the digital age, where rather than being constrained by the speed of the human hand, or the physical constraints of mechanics, data proliferation is limited only by Moore’s Law of exponential growth. 

    Early cuneiform writing tablet recording the allocation of beer in southern Iraq, 3100–3000 BC, British Museum.


    The approaching proliferation of data-harvesting-devices enabled by sensor technology, the internet of things and robo-journalists automatically generating copy for news sites will add further to what has been described as a Cambrian explosion1 of data. 


    The Cambrian Explosion... of Data

    Source: IDC Global DataSphere 2017

    Notes: The Global DataSphere is a measure of how much new data is created and replicated worldwide any given year. Most of the Global DataSphere is transient data – meaning that most of the data is not stored. Much of it is created for the purpose of digital consumption (e.g., streaming a digital movie). For example, IDC calculated the size of the Global DataSphere in 2018 to be 29 zettabytes (ZB). However, IDC estimates that of the 29ZB of data created, less than 2 per cent is actually stored.


    Our job as investors is based on gathering and analysing data to make decisions, so perhaps this situation of limitless data sounds like wonderful news, but the sheer volume of data also makes it intimidating. A related challenge to our role is raised by the ubiquitous availability of information also enabled by technology. Recently a client of ours posed an interesting question. “Isn’t it getting more and more difficult to have an edge as a stock picker”, she asked. “It used to be the case that professional investors had an information edge; it was claimed that 200 years ago Nathan Rothschild was able to know the result of the battle of Waterloo because his agent sent him a message by carrier pigeon. But with the internet all the information you need is at your fingertips, no one has an advantage anymore...”. The investment consultant Charles Ellis has made a similar point: “Forty years ago, getting more or better information – information other investors did not have – was the “secret sauce” of active investing” and  “Today everyone knows everything at the same time."2

    As is often the case with the best questions our clients ask us, I didn’t answer it very well at the time, and the question lingered in my mind for many of the following days. How can we cope with the vast quantities of information thrust at us by robots through near frictionless channels? And now that everybody can access official company information at the same time as us; what hope is there for us to be successful investors with an edge in the machine age?

    This paper is my attempt to answer these questions in a more considered way.

     

    1. This concept of comparing the proliferation of organisms in a non-linear fashion during the Cambrian period 500 million years ago to the proliferation of data, ‘Internet of Things’ devices and robotics today was first developed by Dr Gill Pratt of the US Defense Advanced Research Projects Agency, and now CEO at Toyota Research Institute. More recently Masayoshi Son, CEO of Softbank has used the concept to describe the proliferation of connected devices.

    2. Charles Ellis in Competition Has Made Indexing a Winner’s Game Interview in American Association of Individual Investors, November 2016 and Charles Ellis quoted in A Small College’s Endowment Manager Beat Harvard With Index Funds, Bloomberg May 2018.

  5. …it was claimed that 200 years ago Nathan Rothschild was able to know the result of the battle of Waterloo because his agent sent him a message by carrier pigeon.
  6. 1. More information not always better

    We all know that making predictions about complex systems when faced with incomplete information is difficult and fraught with behavioural pitfalls. A common and understandable response to uncertainty is to collect more and more information, with the belief that this will result in better decisions. However, studies have shown that this is not always the case. In a paper written in 1973, Paul Slovic, a psychology professor at the University of Oregon, tested the assumption that more information leads to better decisions by using the results from horse handicappers. “For horse handicapping is an information game,” he wrote, “much as investment analysis is an information game.” Each handicapper was given a choice of 88 variables and asked to judge race outcomes based on five, then 10 then 20 then 40 variables, selected according to their priorities. The surprising result of this experiment was that the quality of the decisions did not improve with additional information. Predictions made using the five variables were as good as those made using 40 variables. Other studies have shown similar results, with more information leading to higher confidence in the prediction but not a more accurate prediction.

    The result is fascinating in that not only did it reveal that more information did not improve the prediction, but that it resulted in an incorrect change in the decision maker’s perception of the quality of the decision. This tendency to be more confident about being right when we have more information has echoes of the philosopher Abraham Kaplan’s ‘drunkard’s search’, which refers to the old joke of a drunk searching for his keys under a lamp post. A police officer stops and offers to help. They both search for several minutes until the policeman asks if he is sure that he lost them here and the drunk replies, no, and that he lost them in the park. The policeman asks why he is searching here and he replies that this is where the light is… 

    We laugh at this but investors often do exactly the same when they pore over reams of data, not because they have taken a view that the data is the most important, but simply because it is the most available. It is easy to fall into this trap as an investor; it is more satisfying to have a case backed up by a weighty file of ‘data’. The reverence for the excel spreadsheet model (the more detail the better) attended to by the high priests of the industry (the investment bank analyst) is a symptom of this admiration of data and precision. However, such preoccupations run the risk of ignoring what really matters to the investment case. Donald Rumsfeld, the former US Secretary of Defense, described just such a thing when he talked about the “known knowns, known unknowns and unknown unknowns”. Each of these three is important to working out the correct decision, but it is all too convenient to forget about all but the known knowns. 

     

     

    In our work, we frequently experience the desire to go on collecting information, but we understand that we can create a situation of paralysis by analysis. We also recognise the behavioural pitfall of allowing our decisions to be swayed by factors associated with lots of data rather than factors which are most important to the future of a business. One of the reasons we work in small teams is because we find that the collegiate atmosphere of team-based investing creates the challenge and support to avoid getting stuck down rabbit holes collecting more information, and to identify through debate and discussion the critical aspects of the investment case, regardless of where the volume of information is. Working in small teams, as we have always done, is an effective check on such behavioural pitfalls.

     

  7. 2. Separating the signal from the noise

    A second important solution to coping with the torrent of information, is being clear about what to ignore. Most of the data available to us as analysts is not in fact information – it is noise, data which is irrelevant or even counter-productive to an assessment of the long-term prospects of a business. The dirty secret of the investment industry is that such a situation is made many times worse because it is in the investment banking industry’s interest to amplify noise. The investment banking industry makes money from the turnover or ‘churn’ of stocks in institutional portfolios and spends much of its time encouraging this. The obsession with the minutiae of quarterly trading results, tracking changes in analysts’ recommendations and 12-month target price movements is fed by an industry that thrives on noise and does all it can to contract the attention spans of intuitional investment managers and feed them with 100 reasons to change their minds before breakfast. The sophisticated investment banking sell side, with its ranks of highly qualified analysts, sales people and relationship managers is not in fact structured so that its clients make better decisions. It is structured so that its clients make more decisions.

    In addition to this, much of the broadly defined media, seeks to attract eyeballs rather than differentiate the relevant from the irrelevant. The development of robo-journalists working on simple rules to produce (almost entirely) pointless copy to draw eyeballs has compounded the flood of noise in the market.

    It therefore becomes very important for us to differentiate between useful information and noise. In the diagram below I have tried to illustrate this graphically. On the left hand side I have listed the drivers of share price moves (I am being selective here, as we know there are a multitude of factors which could drive share prices). In the time series I show over what time periods these factors move share prices, split roughly between short term, medium term and long term.

    I have then colour coded this: in orange and green are the areas we would categorise as noise or where our potential to make predictions better than the market average is zero. The factors with blue bars are those we consider important. What emerges is that our focus is really quite limited; we are not concerned with change in investment banking analysts’ price targets or whether the quarterly earnings results ‘beat’ or ‘missed’ by a cent or two, or the daily fluctuations in market sentiment. What we care about is the likely long-term growth of company earnings. It is this above all else that drives long-term share price developments and this is the area where we believe our analysis can add value.

  8. What moves share prices?

  9. The second diagram below shows the various factors we analyse in order to assess the likely long-term growth in earnings. As you can see, even when it comes to long-term growth, there are still factors where we cannot hope to add value; luck, which is inherently unpredictable, can have a big impact. However, we can add value when it comes to considering: industry growth and the strength of the competitive advantage, as well as the ability of management and degree to which they are aligned with shareholders. 

    We believe that many market participants are too impatient or short-termist to consider such factors; the impact on the share price of long-term earnings growth can take years to play out. However, it is because such factors tend to be ignored in favour of the daily clamour of the markets, that we believe we are able to have a sustainable edge in our approach to investment.  

     

  10. 3. Useful information can be difficult to gather

    Given the weight of information available to anyone with an internet connection, it seems surprising that we still need to expend effort on the collection of information, but the fact is we do. Financial data, stock exchange filings, market share data, video feeds of management presentations and other sources may all be available at the click of a mouse. However, we still find that there is much to be gained from talking face to face with management, competitors and suppliers, industry experts and academics. The demands of investment banking analysts and disclosure rules mean that company management often spend the bulk of their formal communications with the market on explaining short-term results (something they repeatedly tell us is a source of great frustration). In our discussions we intentionally shift the focus to discussions of long-term strategy and ambitions, and through such information gathering we believe we are able to understand the finer nuances of strategy and the long-dated business opportunities which are not captured in disclosure of quarterly results announcements. 

    In addition to meetings with management and other experts, we also use a network of what we call Inquisitive Researchers. These individuals tend to be trained journalists and we use them on bespoke pieces of information gathering, often when we are seeking to understand the potential development of an industry far into the future. We are also putting growing emphasis on expanding our network of contacts in the world of academia. As growth investors interested in ‘change’, we believe that we can gain great insights from speaking to academics close to the cutting edge of research across various disciplines. 

    The information we gather would be of little use to a short-term trader, but as we try to step back and think about long-term company prospects and broad industry change, we believe that the significant effort it takes to meet over 2,200 companies a year and manage dedicated specialist information gathering networks is invaluable.

  11. 4. Thinking like an owner – the importance of good governance

    Our client’s question, which I referred to earlier, regarding the Rothschild’s Waterloo pigeon post spurred me on to learn more on this area. We believe we can learn a lot from reading about great investors past and present, and in 19th century global finance there was no investor more successful than Nathan Rothschild. 

    On the particular subject of post-Waterloo trading I was surprised to find that the latest research3 finds that the story of the Rothschild’s Waterloo trade was in fact a fiction concocted some time after the event. Given how well-known the story is it was a surprise there was in fact no Rothschild pigeon post in 1815. And, while Nathan Rothschild did hear the result before the official military messenger arrived (weighed down by two captured Napoleonic standards4), Rothschild was not the first in London to hear the news of the victory, and importantly he made very little money trading on it. 

    Moreover, looking at his investing life more broadly, what emerges is that very little of the Rothschilds’ success was built on short-term trading based on rapid access to information. Providing merchant banking services for the governments of the day was the Rothschilds’ most profitable activity and this required the infrastructure to place and price bonds and deal in gold bullion. Doing this effectively required a pan-continental network. The ongoing cooperation between the London, Frankfurt and Amsterdam Rothschild offices was vital for this and was only really possible because of the family ties that bound such distant entities. A second important feature was the tendency of the Rothschilds to reinvest in their business. This differed from other prominent banking families of the time such as the Barings, who drew greater income and led a more luxurious lifestyle as a result.

    British banker Nathan Meyer Rothschild.

    © The LIFE Picture Collection/Getty Images


    Thirdly, the Rothschilds understood how important it was to positively influence the institutions that they invested in. In the 19th century, most investment was in government bonds. Recent work5 has revealed that a critical factor to the Rothschilds’ success was their relationships with national rulers of the time and their ability to influence them (to the extent of persuading them against embarking on unaffordable wars). Much as we today attempt to direct management of the companies we invest in towards decisions that are beneficial for long-term shareholder value creation, so the successful investors of the 19th century did the same with their investee institutions. 

    Indeed, while much has changed over the last 200 years, we believe that there are some timeless priorities common to successful investing today and successful investing in the 19th century. A strong emphasis on governance of the investee entities (be they companies or governments) is as important today as it was then. Our meetings with management help us to gather information, but we also believe that by supporting and challenging management in these meetings, we play a positive role in encouraging long-termism in the companies in which we invest. 

    A keen understanding of the benefits of reinvestment and compound growth is also as important today as it was then, and indeed the long-term benefits of compound growth appear to remain unappreciated by a market which is more focused on short-term news flow. And this brings us to the most important factor in investment success, an emphasis on the long term. In their management of risk, investment in a broad network, expansion into New World opportunities and even in the planned marriages of their heirs, the Rothschilds were focused on generational business growth. We place a similar emphasis on the long term and believe that this allows us to ignore noise, to take advantage of investment opportunities that others miss, to take a differentiated view from the market and over long periods of time to deliver outstanding returns to our clients. 


    3. The News from Waterloo: The Race to Tell Britain of Wellington’s Victory, Brian Cathcart, 2015.

    4. Interestingly these were delivered to the Prince Regent as he attended a party in London at an address in St James’s Square, now a few doors along from the Baillie Gifford London office!

    5. The House of Rothschild: Money's Prophets 1798–1848, Niall Ferguson, 1999. This history put more emphasis on the role of financiers in European modern History than previous historians had accounted for.

  12. Conclusion

    In this machine age, where it is so much easier to create and gather information than in the past and where noise has become deafening, we think focusing on the long term and what really matters for the companies we invest in becomes even more important. By working in teams we try to avoid the behavioural pitfalls of investors when faced with large quantities of data. We seek to limit our exposure to noise as much as we can, a strategy that saves a lot of time and allows us to invest in a different way from the bulk of stock market participants. We believe that there are still important pieces of information which are difficult to gather, and we continue to invest heavily, to acquire such information effectively. Finally, while much has changed in our business with the evolution of digital technology, there are certain enduring priorities for investors that have lasted for centuries and we expect to continue to be important for investors in the centuries ahead. These are – a focus on governance and stewardship, the targeting of great franchises that can reinvest and grow and a dedicated commitment to long-termism in investment and in the way we run our own business. Plus ça change, plus c’est la même chose…

          

  13. Important Information and risk factors

    The views expressed in this article are those of Iain Campbell and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions. 

    Potential for Profit and Loss

    All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

    Stock Examples

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  14. Iain Campbell

    Investment Manager

    Iain joined Baillie Gifford in 2004 and is a member of the Japanese Specialist Team. Most of Iain’s investment career has been focused on Emerging and Developed Asian markets. He has responsibility for managing various specialist Developed Asia, including Japan, portfolios and is also a member of the International Focus Portfolio Construction Group. Prior to joining Baillie Gifford, Iain worked for Goldman Sachs as an analyst in the Investment Banking division. He graduated BA in Modern History from the University of Oxford in 2000.