2014 destroyed the railway line at Dawlish and cut off 800,000 homes from power
On the face of it, there’s not a lot to link the management of an investment portfolio with preventing the River Test from bursting its banks or averting the collapse of a key bridge in Sierra Leone. Well that’s what I thought as I sat down to listen to former British Army engineer Nick Francis speaking at our in-house TED Talks event this week. I was wrong.
Francis’s talk was about how to respond effectively to a crisis – clearly a useful skill when you are tasked with building emergency Ebola treatment centres in Africa and the only bridge over a 250-metre wide river is about to crash into the water below. What struck me, however, was how relevant his four-point crisis plan is to managing money.
Faced with a crisis, the first thing Francis does is to consider how his biases might be getting in the way of good decision making.
The nature of market crises, just like floods and epidemics, is that when they strike we are least likely to be calm and rational
When it came to the Hampshire floods two years ago, his mental baggage included the uncharitable thought that keeping Range Rovers dry in the Home Counties was not a high priority. He had just returned from dealing with road-side bombs in Afghanistan.
Having recognised and dismissed these internal mental distractions, step number two in his crisis plan is an objective assessment of the situation at hand.
Back in Sierra Leone, this meant looking at the damage caused by a bulldozer driving into the bridge and working out that collapse really was imminent. In part that was an engineering calculation, in part an intuitive recognition of the speed with which his colleagues were moving off the bridge whenever a heavy truck approached.
Next up is a decision about how best to respond to the situation. Back in the Hampshire flood plain, this involved deciding that the key to preventing the inundation of the town of Romsey was supporting a bank on a stream running into the main river, and doing it quickly. The clock was ticking.
2014’s winter storms
The final stage for Francis is coming up with a solution and implementing it. On the bridge in Sierra Leone the challenge was less the design of the replacement strut, or sourcing the contractor to build it, than persuading the highways agency to approve and pay for it. On the River Test, it was all about learning from the failure of the first solution and quickly coming up with a better plan.
So how might this four-part plan help an investor? Clearly, portfolio management is rarely a life and death situation but at moments of crisis and extreme volatility, the same systematic approach is precisely what distinguishes the successful investor from the rabbit in the headlights. The nature of market crises, just like floods and epidemics, is that when they strike we are least likely to be calm and rational.
Understanding mental biases is an essential attribute of good investing. The human brain is very good at shutting out anything which contradicts our belief system and latching onto that which supports our view of the world. This bias is hugely limiting when it comes to investing in a fast-changing world.
The understandable but constraining belief that Brexit would cause significant short-term damage to the British economy fuelled the market’s initial reaction to the Leave vote in June and most likely prevented many investors from participating in the subsequent rally as it became clear that the impact may well turn out to be a slow-burning affair.
A crisis is when we are least likely to display calm and rational behaviour
Looking ahead to November, an emotionally biased response to what looks like an increasingly plausible Trump victory in the US election could prevent the effective implementation of stage two – assessing the situation. As I discussed last week, there are pros and cons to both possible outcomes, in terms of sentiment and economic impact. These need to be assessed dispassionately.
Deciding how to react to an unfolding market crisis is also a key determinant of success or failure in investment. I touched on this last year when I reviewed The Art of Execution, an excellent guide to how to respond to a plunging share price.
Its author, Lee Freeman-Shor, proposed two valid responses: Assassination (killing the investment dead) and Hunting (buying more of your collapsing stock). Most of us do neither of these. We are neither Assassins nor Hunters but Rabbits, frozen by indecision.
If Francis were a rabbit, many more people would have died in the Ebola epidemic and Romsey would have become very wet.
Like most analogies this one is helpful but incomplete. It misses a key distinction between being a Royal Engineer or an active share trader or long-term investor.
Sometimes doing nothing really is the right solution in investment, just as long as it follows an understanding of our mental biases, a calm assessment of the situation and a rational decision about the best way to react to it.
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