Theme and Background
This chapter explores how to make high-quality decisions under extreme uncertainty, with the core distinction lying between "decision quality" and "outcome quality." The author uses a controversial decision in an NCAA basketball game as an entry point to argue that even when the outcome is unfavorable, a decision based on the correct process remains a "good decision." The report extends this logic to the investment field, emphasizing that probabilistic thinking is key to long-term investment success.
Core Insights
- Decision quality depends on process, not outcome: A "good decision" may lead to a bad outcome due to bad luck, but that does not mean the decision itself was wrong. For example, the Tennessee coach in the NCAA game chose to attack early rather than run down the clock. Although the team lost because of an improbable basketball bounce, the decision was correct based on data (which supports shooting early).
- Investment professionals must accept "I am not sure": Overconfidence is a common mistake, especially in the investment industry—even the best practitioners are wrong about 40% of the time. Learning to say "I am not sure" is a prerequisite for successful decision-making.
- Probabilistic thinking prevents blaming bad outcomes on decision errors: Citing Annie Duke's Thinking in Bets, the report emphasizes that when people think in probabilities, they do not dismiss a decision due to a single bad outcome, because luck and incomplete information (sample size of 1) may be at play.
Key Arguments and Data
- Basketball case: In the NCAA second-round game, Tennessee trailed 61-59 with 28 seconds left and possession. The coach chose to attack early, taking a 62-61 lead with 21 seconds remaining. Loyola's final shot bounced off the rim and went in, causing Tennessee to lose. However, the coach's decision was based on data (supporting an early shot), not on running down the clock. The Loyola player himself admitted, "The basketball gods helped."
- Probability analogy: In blackjack, doubling down on 11 against a dealer's 6 gives a 2/3 chance of winning, but there is still a 1/3 chance of losing. One cannot deem the decision wrong because of a single loss.
- Error rate in investing: The report notes that even the best investment professionals often make mistakes, with an error rate of about 40%. Yet these individuals are the most prone to overconfidence.
- Ability to update information: In Texas Hold'em, even the best starting hand, AA, can lose due to subsequent community cards. Skilled players constantly adjust their win probabilities, while amateurs cling to their initial hands. Duke points out that the ability to adjust is unrelated to intelligence, but highly intelligent people are better at using numbers to support their existing beliefs.
Companies/Assets Involved
- Citigroup: Appears as an example of a probabilistic statement. The report notes, "I am not sure whether Citigroup's stock will rise" is a probabilistic statement, not a factual judgment. No explicit bullish or bearish view is expressed.
- Oakmark itself: As a long-term investor, it identifies growth companies and only buys when the stock price is significantly below intrinsic value, patiently waiting for value to return. Internally, a "betting" culture (e.g., one analyst predicts EPS of $5, another responds, "I bet it's below $4.50") promotes probabilistic thinking, with the loser buying lunch.
Investment Implications
- Investors should actively embrace uncertainty: Do not dismiss your investment decisions because of a single bad outcome; instead, focus on whether the decision process was based on data and probabilities.
- Beware of anchoring bias: Investors tend to cling to initial judgments, especially when new information conflicts with existing beliefs. Oakmark reduces this bias by setting process barriers (e.g., forcing analysts to confront contradictory information).
- Establish a "betting" culture: Through internal betting mechanisms (e.g., wagers on EPS forecasts), analysts are compelled to express views in probabilistic rather than deterministic terms, thereby improving decision quality.
- Continuously update beliefs: Like a poker expert, constantly adjust win probabilities based on new information, rather than distorting information to fit existing beliefs. This is key to long-term investment success.
Theme and Background
This section is part of the Oakmark research report, covering compliance disclosures and fund characteristic descriptions. It primarily discloses the portfolio concentration, specific stock weightings, and fund risk characteristics of the Oakmark Fund and Oakmark Select Fund as of March 31, 2018. This content provides investors with the basic legal and risk framework for fund operations.
Core Views
The author (Oakmark) emphasizes two core investment characteristics through compliance disclosures:
1. Highly Concentrated Portfolio Strategy: Both the Oakmark Fund and the Oakmark Select Fund tend to hold a relatively small number of stocks, which increases the impact of individual stocks on the fund's net asset value.
2. Non-Diversification and Volatility: As a non-diversified fund, the Oakmark Select Fund has a greater impact from each holding on total returns, leading to higher return volatility compared to more diversified funds. Additionally, the fund invests in mid-cap companies, whose stocks typically exhibit higher volatility than large-cap companies.
Key Arguments and Data
- Portfolio Concentration Data:
- Citigroup, Inc. accounts for 3.2% of net assets in the Oakmark Fund.
- Citigroup, Inc. accounts for 5.6% of net assets in the Oakmark Select Fund.
- Risk Characteristic Comparison (based on fund strategy):
| Fund |
Portfolio Concentration |
Source of Volatility |
Specific Risk |
| Oakmark Fund |
Relatively small number of stocks |
Fluctuations in individual stocks have a greater impact on net asset value |
Concentrated holdings increase volatility |
| Oakmark Select Fund |
Non-diversified |
Each holding has a greater impact on total returns |
Higher volatility from mid-cap companies; non-diversification amplifies volatility |
Companies/Assets Involved
- Citigroup, Inc.: Used as an example holding, representing 3.2% of the Oakmark Fund and 5.6% of the Oakmark Select Fund. The report does not explicitly express a bullish or bearish view; it merely serves as a compliance disclosure of portfolio data.
Investment Implications
- Specific Guidance for Investors:
- If investing in the Oakmark Fund, investors must accept the high volatility resulting from its concentrated portfolio strategy, though this strategy may generate excess returns through selective stock picking.
- If investing in the Oakmark Select Fund, investors must additionally bear the high volatility of mid-cap stocks and the concentration risk from non-diversification, making it suitable for those with higher risk tolerance and a belief in selective stock picking.
- Investors should monitor changes in fund holdings (without prior notice) and regularly review the latest portfolio lists to assess risk exposure.