“The scarcest resource for successful investors is not money but attention: how to manage the trade-off between time and rationality to best effect. There is not time in life to find out everything about every potential investment. Investment skill consists not in knowing everything, but in judicious neglect: making wise choices about what to overlook.”
…that’s the first paragraph of the first profile in Free Capital. There is nothing casual about this placement: I think allocation of attention is the most fundamental choice an investor has to make. Some relevant dimensions of attention as follows.
SOME DIMENSIONS OF ATTENTION
Acute observation versus judicious neglect In speaking of judicious neglect, the above extract really gives only half of the recipe. You also need acute observation. The critical inputs to an investment decision are often relatively obscure to an unskilled observer: something in the notes to the accounts, the background of the CEO, recent stakebuilding by an activist, etc. Investment skill consists of being able to spot these critical points, and neglect much else: a mix of acute observation and judicious neglect. Pay sufficient attention (due diligence). But not too much, because that would waste attention which could better used elsewhere (undue diligence).
Depth versus breadth Is it better to look very closely at just a few possible investments, or more briefly at a larger number? My preference is generally the latter. This doesn’t mean researching all possible London-listed investments: at any time only a minority with some combination of good financial metrics or other idiosyncratic attractions are worth investigating at all. When you do focus in on a particular company, ir’s usually more useful to look for more sources of information (another form of breadth), rather than doing more detailed calculations. If you need a calculator, it’s too close.
Local versus global The phrase “London-listed investments” above highlights another dimension for attention. I generally stick to UK-listed companies, which gives the huge advantage of familiarity: I know the parameters of accounting and corporate governance and market dealing. But I often wonder if I would do better by scouring the world continuously for the cheapest markets – Bolivia one year, Botswana the next, Bangladesh the next, etc. (All these countries appear to have stock exchanges. I know nothing about any of them.)
Defence versus offence This is similar to the depth versus breadth trade-off, but worth highlighting separately. Defensive attention means keeping up with news about what you already own. Offensive attention means searching for new ideas. As the number of investments you hold grows, defensive attention cand easily swell to occupy most of your time. It takes conscious effort to allocate sufficient time to looking for new ideas.
Focus versus serendipity Focus is a self-directed and structured agenda: monitoring news on what you already own, daily checking of new market lows, quantitative screens for new ideas, daily or weekly reading of particular sources, etc. Serendipity is pursuing an idea suggested by a friend, or an article on another investor’s holdings, or an RNS headline which catches my eye. I think focus produces better choices most of the time. But the very best investments are necessarily found through serendipity, because the idiosyncratic features which made them great investments don’t shown up on any quantitative screens.
First order versus second order thinking Spend a small but non-negligible fraction of your time thinking about how to think: how to allocate attention (eg writing this blog post!), how to make decisions, how to embrace truths which I dislike, and so on. Almost every chapter in Free Capital says something about the investor’s record-keeping and filing methods – not because they spontaneously talked about this, but because it was of keen interest to me. (My real interest was how they think, but direct enquiry along those lines invited abstract or flippant responses; asking about filing systems kept the discussion concrete and serious.)
BETTER ALLOCATION OF ATTENTION
How can you improve your allocation of attention? The first step is simply to be consciously aware that attention is your scarcest resource, and that it’s worth thinking about trade-offs such as those above. Some further suggestions are as follows.
Develop domain expertise How do you know which elements of a scenario require acute observation, and which can be judiciously neglected? I think this ability – “good judgment” – flows mainly from domain expertise.
For example, I said above that notes to the accounts are often important. This doesn’t mean plod through (or even skim) all the notes. I skim only the following points (parenthesis gives where they’re usually found):
– the totals in the remuneration report (usually separate from the notes, in a dedicated section before the income statement and balance sheet);
– then turn to related parties (towards the end);
– then pensions, if there’s a defined benefit scheme (3/4 way through);
– then contingent liabilities (towards the end)
– and then anything particularly suggested by the company’s line of business or its financial situation. For example if the company has significant debt I would be very interested in the debt notes – anything on the interest margin, maturity and covenants.
Different investors operate in different observational domains. Some (like me) pay attention to the notes to the accounts; others pay attention to what management says in person; others pay attention to price charts. The important thing is to notice something which is relevant, and preferably not noticed by most investors.
Seek what is not offered This heuristic is independent of domain knowledge. It helps to have a predilection to notice what is not said (the dog which does not bark), to seek opinions which are not publicised; and to seek disconfirming evidence. Things which nobody is discussing often have great value in investment. Companies with no analyst coverage, or little coverage relative to their size, are often good investments.
Control your own time Investment is an unusually open-ended activity. There is almost nothing you have to do, and no limits on what you could do; this open-endedness is what makes allocation of attention so important. It helps to keep control of your own time, and to be self-conscious about how you allocate it.
I prefer not to have a schedule of meetings, or even blocks of time allocated to particular tasks. I just work on whatever seems highest priority at every moment, balancing the trade-off between urgency and importance many times every day. By not allocating time in advance, I’m relatively free to switch attention, say to a share I was recently buying where the price falls (so I might want to buy more)
Focus on what is knowable Before pursuing a particular line of enquiry, ask yourself whether it is likely to lead to reliable and actionable conclusions. Generally I find that it is not a good use of scarce attention to think about macroeconomics, because such thinking seldom leads to conclusions which are reliable and actionable. Analysis of big banks, insurers and other financially complex businesses falls into the same “unknowable” category, so I generally ignore them.