Conviction: Arrogance, Indispensable, or Both?
Active investors must regularly walk the line between necessary and destructive arrogance
“That if you have conviction, and I hate that word conviction, because conviction goes with arrogance.” – Professor Aswath Damodaran
“We regard investing as an arrogant act; an investor who buys is effectively saying that he or she knows more than the seller and the same or more than other prospective buyers.” – Seth Klarman
The book Concentrated Investing shares a story of a 1997 breakfast meeting between Glenn Greenberg of Chieftain Capital and Warren Buffett. Greenberg told Buffett about his firm’s big contrarian bet on cable companies, the stocks of which were down on worries about competition from satellite dishes.
Greenberg “was stunned” that Buffett dismissed the idea, saying cable companies didn’t produce enough cash flow. It wasn’t like Buffett didn’t understand the cable business, either. He sat on Washington Post’s board, which owned Cable One.
Despite Buffett’s criticism of the idea, Greenberg held firm and made hefty returns on those investments within a few years.
Could you do it?
When I recently shared this story on Twitter, the replies were wide-ranging. Some suggested that Buffett was right, and Greenberg got lucky. Others - mainly cryptocurrency investors - used it as evidence to not listen to Buffett at all.
I was less interested in who was right or wrong in this situation. Instead, I was mostly impressed with Greenberg’s ability to hold firm after the conversation with Buffett.
If Buffett (or insert another legendary investor) critiqued one of your best ideas, it would be hard not to question or doubt yourself. As social creatures, we seek approval from members of our tribe – and especially from a leader of our tribe.
It’s unnatural to stand athwart the advice or criticism offered by a legend in your field or someone you admire. That requires a quirk. It requires a certain level of conviction, or arrogance if you will.
Two views
The two quotes at the top of this post bracket the spectrum of conviction. Both quotes come from people I have learned much from in the last 20 years. Both viewpoints have merit.
There’s a downside to conviction, which Professor Damodaran aptly identifies. Conviction can lead to destructive arrogance, myopia, and poor decision-making.
On the other hand, the very act of making an investment – which Klarman correctly notes – is arrogant. It presumes other bright and driven investors are mistaken, and you are right.
If you want to avoid the downsides of arrogance altogether, you should broadly diversify, as Damodaran goes onto suggest. It’s a reasonable conclusion to draw.
However, if your goal is to outperform the market over a decade or more, you need to acknowledge that your conviction – or belief – in a limited number of opportunities comes with a required dose of arrogance.
Remember, thou art mortal
There’s a fine line between valuable and destructive arrogance – and valuable and destructive humility. In the book Superforecasters, Philip Tetlock explains:
“The humility required for good judgement is not self-doubt – the sense that you are untalented, unintelligent, or unworthy. It’s intellectual humility…So it’s quite possible to think highly of yourself and be intellectually humble. In fact, this combination can be wonderfully fruitful.” (Tetlock’s emphasis)
Conviction becomes a problem is when self-confidence crosses into intellectual arrogance or intellectual humility leads to self-doubt.
The thin dividing line is your ego. You enter dangerous territory if you let one side (self-esteem) seep into the other (intellectual confidence).
Indeed, in his 1996 shareholder letter Klarman follows the introductory quote with:
“We counter this necessary arrogance (for indeed, a good investor must pull confidently on the trigger) with an offsetting dose of humility, always asking whether we have an apparent advantage over other market participants in any potential investment. If the answer is negative, we do not invest.”
To borrow a phrase from Mad Men, conviction is delicate, but potent. Too much or too little at the wrong times can lead to poor outcomes. Just the right amount at the right time can produce wonderful results.
Here are three questions we can ask ourselves to determine if our conviction in an idea is healthy or unhealthy.
What’s your edge?
Howard Marks has a great follow up question when he hears an investment thesis - “Who doesn’t know that?”
If you can’t answer that question, you probably don’t have an edge or a differentiated thesis worth defending.
Glenn Greenberg and his team thought that more people would want high-speed internet in their homes and that DSL via satellite was an inferior experience relative to broadband offered by cable companies.
Eventually, Greenberg’s team argued, the superior offering would win out.
The beaten up stock prices and negative magazine covers about cable companies at the time suggested that a lot of investors didn’t believe in Greenberg’s thesis. As such, he had both a reason and an opportunity to stand firm.
Is this the real life? Is this just fantasy?
The more time you spend researching a company and building conviction, the more prone you are to overweighting the “inside view.” The stars seem to align, the information you gather only appears to support your thesis, and it becomes more apparent that this time is different.
If a thesis rests on a company generating exceptional sales and profit growth in the coming decade, seek the “outside view” through base rates. How have companies of a similar size and growth profile performed over the subsequent five and ten years?
If the outcome you expect is improbable per the base rates, look for alternative viewpoints and take them seriously.
Are you taking it personally?
After the meeting with Buffett, Greenberg “calmed himself as he came away from the breakfast with the thought, ‘Okay. That’s his view. That’s his view. Our view is that (the cable companies) are very well positioned.’”
He acknowledged that Buffett's concerns about cash flow were reasonable – that cable companies would need to aggressively invest in capex to meet the demand – but believed that the free cash flow would come once those investments were through. The market would then realize the cable companies' value.
If you receive criticism on your idea and feel personally affronted or angry, ask yourself why. Are you defending the thesis or defending your ego?
Based on the story told to the authors, Greenberg calmly defended the thesis and not himself.
Bottom line
The longer I invest, the more I appreciate that so much of successful investing is behavioral. I've made plenty of errors on both sides of the conviction spectrum – not having enough to having too much.
Getting the balance right only seems evident with hindsight. Still, I also believe that only with time and repetitions, can we begin to understand how we respond in different scenarios – but only when we take a sober account of our responses and resolve to do better the next time.
Stay patient, stay focused.
Todd
Sources:
Damodaran on Invest Like the Best
Baupost 1996 Shareholder Letter
At the time of publication, Todd and/or his family did not have an ownership position in the companies mentioned above.
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