of knowledge - statestreet.com...the purpose of this paper is to demonstrate a number of situations...

Center for Applied Research

TheFOLKLORE

of KNOWLEDGEA Day in the Life of an

Investment Professional

2 STATE STREET CENTER FOR APPLIED RESEARCH | FOLKLORE OF KNOWLEDGE

About the Center for Applied Research

The Center for Applied Research (CAR), an independent think tank, conducts research to provide strategic insights into issues shaping the future of the investment management industry.

CAR comprises a global team of researchers and selects its research topics based on input from investment management industry professionals. The studies include primary research — driven by face-to-face interviews and surveys — and secondary research, covering the Americas, Europe, Middle East, Africa and the Asia-Pacific region.

Areas of focus include:

• Investor behavioral shifts

• Country-level analysis of investable assets

• Asset allocation patterns

• Implications of regulatory changes

• Fee versus alpha evaluation

CAR presents at conferences and provides executive briefings for clients and their boards of directors as a value-add service.

If you would like more information about the Center for Applied Research or our studies, you can contact the authors or send an email to [email protected].

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If we want to become great decision makers and achieve long-term success, we have to understand the human decision-making process and the factors affecting it. Many of us think that we’re fully aware of how we select data, form assumptions, develop beliefs and act. But, without exaggerating, it’s probably fair to say that most of us aren’t as aware as we think we are. However, in the spirit of Socrates, we’d like to emphasize that 1.) humans can know themselves, 2.) humans can change themselves (we can use our reason to change our beliefs) and 3.) humans can consciously create new habits of thinking, feeling and acting.1

The purpose of this paper is to demonstrate a number of situations in which our emotions and cognitions can lead us to suboptimal decision-making in relation to our long-term goals, and to give some techniques for cognitively rewiring unproductive behaviors. If we can learn to master these situations, we’ll most certainly improve our decision-making quality.

In this paper, we’ll follow two hypothetical professional investors, Anna and John, during a working day. During this particular day, we’ll observe a number of challenges that these two investors are faced with. Moreover, we’ll have access to a toolbox, including tactics that can help solve the challenges presented.

We’ll take a look at challenges related to the decision-making process, the way we understand the market, how we communicate with stakeholders, how we work as teams and how leaders of the investment management industry act. Lastly, we’ll explore what it means to learn and how to develop a learning culture that can help us address the challenges and move toward a more constructive and successful future.

Throughout the paper we’ll ask the following pressing questions:

How can we learn from (and deal with) the divided self?

How can we effectively climb the Ladder of Inference?

How can we make better-informed decisions?

How can we become better communicators?

How do we interact more effectively in meetings?

How do we improve leadership?

How can we learn?

Executive Summary

Contents4 EXECUTIVE SUMMARY

6 BACKGROUND

7 A DAY IN THE LIFE OF AN INVESTMENT PROFESSIONAL

7 8 A.M., THE SELF

8 10 A.M., THE DECISION

10 NOON, THE MARKET AND THE STORY

Storytelling in a Complex Decision-Making Environment ........................................... 10

Storytelling and Self -Image ........................................................................................ 11

Storytelling and Feelings .............................................................................................. 11

12 1 P.M., THE STAKEHOLDERS

An Enquiry Situation ..................................................................................................... 13

14 3 P.M., THE TEAM

17 5 P.M., THE BOSS

18 6 P.M., LEARNING HOW TO LEARN

Toolboxes8 HOW CAN WE LEARN FROM (AND DEAL WITH) THE DIVIDED SELF?

10 HOW CAN WE EFFECTIVELY CLIMB THE LADDER OF INFERENCE?

12 HOW CAN WE MAKE BETTER-INFORMED DECISIONS?

14 HOW CAN WE BECOME BETTER COMMUNICATORS?

16 HOW DO WE INTERACT MORE EFFECTIVELY IN MEETINGS?

18 HOW DO WE IMPROVE LEADERSHIP?

19 HOW CAN WE LEARN?

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Background

We often think of ourselves as rational creatures who base conclusions on real facts. We think we’re fully aware of our assumptions and beliefs, and that we take actions that are aligned with our underlying values. However, that picture of the world often differs starkly from reality. Both cognitive structures and emotions (innate and learned) will unconsciously affect our thoughts, words, actions and habits. In our previous paper “The Folklore of Finance,” we introduced the concept of Folklore as traditions and customs that have slowly calcified into investment wisdom. Among the folklores we identified in that paper, the Folklore of Knowledge represents the unconscious thoughts and beliefs that affect our everyday investment behavior.2 It involves that which investment professionals don’t know, but think they do. The Folklore of Knowledge affects all of us — including investment professionals who work within asset manager organizations, asset owner organizations and intermediaries — to a much larger degree than we can ever imagine.

The way we think, talk and behave is affected both by biology and the environment in which we grow up. The way our cognitive and emotional processes are interrelated and affected by the external environment is so complex that we’re only able to grasp bits and pieces of the puzzle. What’s become evident over the years is that we’re much more affected by unconscious cognitive and emotional processes than we think. One way to picture this is to think of “reason” as a rider on the back

of an elephant, where the elephant represents unconscious cognitions, habits and emotions. The rider can pull the reins one way or the other, but can only direct things when the elephant does not have a desire of its own. When the elephant really wants to do something, the rider doesn’t stand a chance.3

As human beings, our emotions are the lighthouses that guide our entire decision-making process: We like things that induce a positive feeling, and we stay away from things that are punitive, or induce a negative feeling.4 In other words, an emotion is a complex multicomponent episode that creates a readiness to act.5 The emotion begins with a cognitive appraisal (an assessment of the meaning of the current circumstance). The component that we first recognize is the feeling. Feelings then spark thoughts and action tendencies (fight or flight). Feelings also give rise to a physiological reaction (our palms may sweat or our pulse increase). Our emotions exist to tell us when something is important enough to pay attention to. They can give us great strength in terms of motivation and guide us to make decisions in line with our underlying values. However, emotions can also lead us toward decisions that are in opposition to our long-term values and goals. To deal with emotions that negatively affect our decision-making, we need to learn about them (emotional and behavioral literacy), accept them (rise above our egos) and, with the help of different techniques, try to diminish the damaging impact they can have on our daily decision-making.

The purpose of this paper is to demonstrate a number of situations in which our emotions and cognitions can lead us toward suboptimal decision-making in relation to our long-term goals and to give some techniques for cognitively rewiring unproductive behaviors. This list of situations is by no means exhaustive. It sheds light on a number of situations, particularly relevant to investment


unconscious

cognitions

reason

professionals working within asset management and asset owner organizations, in which the Folklore of Knowledge can deceive us when trying to achieve our long-term goals.

A Day in the Life of an Investment Professional

This paper charts the course of a working day in the life of two hypothetical investors. Anna is a portfolio manager at an asset management organization, while John is head of external managers at a pension fund, and one of Anna’s clients. Anna and John have both worked in the investment industry for a long period of time and are experienced investors. Throughout their careers, they’ve dealt with all sorts of market developments and regard themselves as skilled investors with great analytical capabilities. They’ve always seen themselves as integrated individuals (mind and body operating as one unit) who make investment decisions based on objective data. But they never really question these basic ideas and assumptions. If they were to turn their perspective inward, they might be surprised. That’s because the likelihood that they are, in fact, fully integrated people, acting on some sort of objectively truthful information, is very small. There’s a much higher probability that they’re divided within, acting on stimuli not even closely related to what happens in markets.

8 a.m., The Self

When Anna and John walk to their respective workplaces every morning, they see themselves as “fully integrated” people whose minds are entirely focused on the tasks ahead of them. But the truth is, both of them are more like a committee whose members have been thrown together to do a job (and unfortunately often find themselves working at cross purposes).6 This isn’t something they would ever reflect on — but maybe they should …

To be truly successful investors, we have to remember to take a look at what type of creatures we are. Our emotions are ubiquitous, even though we constantly make a cost-benefit analysis of the risks, the expected value as well as the short- and long-term rewards of our actions.7 We’re neither the fully rational fantasy of economic theory, nor the emotional “slave” pictured by Freud. We’re stuck somewhere in between.

If Anna and John were to take a more inward-looking perspective, they might have an “aha moment” when they first realize that there’s a disconnect between what they think they do and what they actually do — even though this sort of knowledge goes back to ancient times. Plato writes about his theory of the tripartite soul, consisting of reason, spirit and appetite.8 Sigmund Freud looks at the human as a bundle of drives that pulls us in different directions.9 And Kahneman talks about the human mind being divided into two different systems.10 As humans, we have to live with a constant internal conflict between mind vs. body, left brain vs. right brain, new brain vs. old brain and controlled actions vs. automatic actions.11 Humans are governed not only by reason, but also by habits and automatic responses partly regulated by the automatic nervous system.

The neuroscientist Antonio Damasio made a number of important discoveries regarding the connection between our reason and emotions. He researched individuals with a particular type of brain damage that had impaired their ability to feel secondary emotions (i.e., learned emotions — emotions that rely on memory as well as reflexes). It turned out that these people were incapable of effective decision-making. What Damasio found is that effective decision-making is strongly linked to the ability to feel emotions.12 But the decision-making process can also be impaired by emotions. For example, we often prefer short-term instant gratification, even when it hinders

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longer-term successful outcomes. We want to learn and develop, but at the same time, we dislike not knowing and discovering our weaknesses. We know we’ll live a fuller life if we listen more to what others are saying — but we just cannot stop talking about ourselves and formulating answers even before we’ve heard the full story. We know we ought to accept who we are and use that as a starting point when planning for how to evolve, both personally and professionally, but we end up spending most of our time protecting the image of the person we would like to be. If we want to improve our decision-making process, we first have to acknowledge these inner conflicts, start to understand them, and finally learn from them.

During this day, as we follow Anna and John, we’ll take occasional breaks and examine a learning “toolbox” that might help them deal with the challenges that we’ve learned about.

10 a.m., The Decision

When Anna and John make investment decisions during their day, they generally consider it as a linear process: gathering data, analyzing data and then finally making decisions. But are they right to view decision-making as walking down a line? Aren’t they actually climbing up a ladder …?

Given their roles, the main activity for both Anna and John is to make investment decisions. When making decisions, both cognitive structures and emotions will unconsciously affect their thoughts, words, actions and habits. Even if Anna and John both believe they’re objectively looking at the data at hand and making well-informed decisions —using that objective data as input — the actual decision-making process is usually more complicated. A good illustration of how we incorporate data into our decision-making process is the so-called ladder of inference.13 But before we start climbing the ladder itself we should take a closer look at two concepts that are central to any decision-making process, namely “mental models” and “inference.”

• Before making an investment, make sure you have done an in-depth analysis on two different occasions. This will prevent specific feelings you might have had at any one point in time from dominating the investment decision.

• Accept the full you, both the strengths and the weaknesses. Acknowledging your weak spots is key to making faster progress.

• Always combine advocating your position with encouraging people to question your underlying

assumptions, to make sure that they are brought up to the surface.

• Incentivize people in the organization to ask questions and admit when they don’t know something.

• Work actively to increase behavioral literacy — the understanding of how humans learn and make decisions.

• Identify the biggest hurdles to achieving productive decision-making.

How can we learn from (and deal with) the divided self?

See Toolbox Section /


Mental Models No individual working within an organization can, for example, carry that whole organization in his/her mind. We don’t keep every detail about all the constituents that comprise an organization (relationships, routines, patterns of communication, etc.) in our heads. Human beings can’t hold that amount of information. What we carry in our heads are images, assumptions and stories about the organization.14 These underlying assumptions and stories can be referred to as mental models.

Inference is the production of new mental representation in our mental models based on previously held representations (e.g., the production of new learning based on previous knowledge). Inference does not have to be deliberate or even conscious. It is a part of conceptual thinking, perception and motor control.15

Two people participating in the same situation may well experience it in very different ways. How can this be? Since they have different mental models, they’ll look at details and interpret these details differently. Moreover, a person cannot retain all information in a situation; instead, the mind unconsciously selects observations or bits of information on which to focus. We then make interpretations of what these mean.16

This is a quick and automated process of whichwe most often are completely unaware.

When Anna discusses a new investment case with one of the analysts on her team, she starts at the bottom of the ladder with objective data and then climbs up the ladder as she selects what data to focus on and how to interpret it. Assumptions are where she interprets data to add meaning to the data she has selected. She then climbs up one step and draws conclusions. On the conclusion step, the concept of causality is introduced. This is where Anna tries to connect an effect to a cause (i.e., draw conclusions about the reason for the situation). Beliefs are what she comes to think about the situation, or the person she is talking to, and these beliefs will in turn lead her to act and make decisions in certain ways. The ladder of inference also consists of two loops. One loop goes from beliefs to selected data. Anna’s beliefs lead her to select certain data without questioning those beliefs. The other loop goes from actions to available data. When she has formed beliefs about something, she will act and make decisions in ways that reinforce those beliefs. Hence, the actions she takes put her in situations where her beliefs are confirmed. This is when beliefs become embedded in norms that govern decision-making as well as relationships between people and groups within an organization.17

Everyone who operates within the investment management industry, and who has as a stated goal to develop and learn, must deal with the fact that we risk slipping further away from reality with every step we take on the ladder of inference. The ladder of inference is a cause-and-effect of our cognitions and emotions, and the way we climb it will determine the quality of our future decision-making.

See Toolbox Section / Page 10

The Ladder of Inference

Actions

Beliefs

Conclusions

Assumptions

Selected Data

Available Data

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Noon, The Market and the Story

Anna and John are “storytellers” — even though it’s probably the last word they would use to describe themselves. And they need to recognize both the opportunities and failings of this role.

Now let’s examine some of the challenges that emotional and cognitive processes pose when Anna and her team interact with markets. As previously stated, Anna and her teammates will select bits and pieces of the data provided by the market, interpret that data, draw conclusions and finally make decisions. This process will bring with it all the challenges illustrated by the ladder of inference. These challenges will grow in magnitude when the available data is a result of random outcomes. This leaves us with a bigger risk of having our mental models, cognitions and emotions reflect an inaccurate picture of reality.

Storytelling in a Complex Decision-Making Environment

A feeling of being out of control creates anxiety and makes us feel miserable. In the absence of control and the presence of randomness, Anna and her team start telling stories to have the world make sense to them. To be able to make decisions in a random and chaotic world, stories play a very important role in creating confidence and decisiveness. Stories generate a sense of truth, by tying events together and having them make sense to us. Stories do not have to be accurate; they need only to sound plausible for us to believe in them.20 Both good and bad investment outcomes can serve as the basis for building stories that in the end support our underlying investment beliefs and processes — rather than help us identify the actual underlying causal relationships. After all, people normally tend to look for information that confirms their prior beliefs. They fill out missing pieces of information with stories that fit well with their feelings toward a person or a situation.21 This

How can we effectively climb the ladder of inference?• Before making a financial decision, make sure you

question all input that has not been derived from an in-depth analysis. This might sound obvious, but it’s easy to end up relying on concepts or artifacts (methodologies) without questioning them.18 Do we base our decisions on real facts or on flawed ideas and assumptions?

• Be careful with intuition. Many people say that skillful investing is an art. Implicit in that statement is that good investors have some kind of intuition about what

investments to pick. However, intuition is an extremely conservative process that is based on historical data from previous experience that has formed our mental models and affects the way we draw inference. Intuition can never be creative and can never think new. Intuition can rely only on what has happened in the past.19

• It’s crucial to implement an integrated process in which underlying assumptions and beliefs are systematically questioned and addressed. This process needs to happen within an open and trusting culture that can handle the uncomfortable experience of potentially disproving established beliefs, behaviors and procedures.


tendency undermines skill and the chances of achieving successful outcomes. Only when Anna and her team understand the way in which they construct stories can they turn the storytelling process into a learning process. Without that understanding, storytelling might become oneof the biggest hurdles to success.

When investing, Anna obviously wants the skill component to dominate the investment outcome and reduce the element of randomness. An optimal environment for skill to develop is one that is stable enough to be predictable and, where it is possible, to learn its regularities over time when practicing diligently.22 When these conditions are fulfilled, we’re able to become intuitively skillful. Without these conditions fulfilled, there’s a big risk that we learn the wrong lessons and start making up stories. One of the biggest risks in an irregular environment is that we start to substitute complex questions for easier ones. Instead of trying to estimate whether a share is fairly valued or whether a manager is likely to outperform the market in the future, we focus our energy on judging whether we think the management team/portfolio management team seem professional or not. Studies show that humans are actually worse decision-makers than algorithms in complex decision-making environments. In these situations, we tend to become inconsistent when drawing conclusions and start to rely on heuristics.23

Storytelling and Self-Image

When Anna thinks about what type of investor she would like to be, she pictures a person who knows a lot and is very successful — in other words, a smart person. When she thinks of herself as being smart and at the same time thinks of investing as an activity where outcomes depend on skill, this will implicitly mean that being unsuccessful (underperforming the market) is equal to not being skillful enough. This

inconsistency — Anna’s self-image of being a smart person and the negative investment outcome — creates something called cognitive dissonance. This gives rise to discomfort.24 Most humans strive to reduce this discomfort and regain consistency between cognitions.25 When Anna is figuring out how to regain consistency, she’s not prone to change her self-image (most people aren’t); nor is she, as an active investor, willing to accept that investment outcomes aren’t connected to some sort of skillful behavior. Instead, she’s much more likely to create stories that blame negative outcomes on external circumstances and take credit for positive investment outcomes. These stories can bring back consistency and reduce cognitive dissonance. To attribute success and failure in this way is called the attribution, or self-serving, bias.26 This bias not only helps us feel much better, it also helps us make sense of the world. Unfortunately, the idea of being a smart investor also makes Anna favor answers over questions. She prefers to know, and she dislikes not knowing. This is quite an unproductive way to think about things because the acceptance of not knowing would give Anna the strength to ask questions, and asking questions would give her the gift of learning. Not knowing opens up an opportunity to learn.

Storytelling and Feelings

The idea of being a smart investor brings with it the story of “not letting emotions get in the way of good investment decisions.” But emotions do get in the way of good investment decisions. Feelings will make us value losses differently than gains,27 and they will make us look with different eyes on the stocks and bonds we hold in comparison to the assets we don’t own.28 Feelings might make us overly afraid of things that are potentially very dangerous, but which have a very small probability of actually happening.29 Feelings will affect the way we interact with the market. That’s why we have to

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be mindful of the unconscious processes at play and try to bring them into daylight, evaluate them and possibly try to rewire certain unproductive beliefs and behaviors. We don’t solve the situation by removing our feelings; we learn and evolve when acknowledging them.

1 p.m., The Stakeholders

Their roles require Anna and John to communicate with a variety of different stakeholders. All too often they spend more energy on interpreting the recipient’s reaction than on conveying the message itself. Why is that the case?

Whether you’re an asset manager, an asset owner or an intermediary, you don’t exist in isolation, but in a context in which you will interact with your organization’s stakeholders: clients, regulators, employees and owners. As client and provider, John and Anna are interacting and communicating regularly. Humans can communicate in a number of different ways, and we normally do that by thinking that the only component entering into the communicative process is the actual content we’re trying to convey. But we miss something very important when thinking about communication in this kind of one-dimensional way. All communication includes two parts — a content part and a relationship part.34 Normally we’re not consciously aware of the relationship part, but unconsciously, this can become the most important

How can we make better-informed decisions?• When investing in an asset, write down both the pros and

the cons of making the investment. Follow up as closely on the cons as on the pros. If you want to add additional pros and cons to the list, do that in a separate document. Follow up over time to see whether you’re more likely to add pros than cons to the existing holdings.30

• Always ask the question, “Would I be willing to buy this asset today?” (disregarding the fact that you already possess it).

• Consistently try to find arguments against your investment thesis to create as strong a thesis as possible.

• Make sure you have gathered enough observations to support whatever decision rule you will use as the basis for decision-making. Make the number of observations explicit by writing them down.

• Always keep a decision diary.

• The simpler the better. If we try to take into account too many factors when making fundamentally based investment decisions, we’ll likely end up with stories that are far away from reality. Using fewer “decision rules” will help us better question underlying assumptions and test their validity. When dealing with more complex decision rules, one should consider systematizing them in the form of algorithms.

• In the investment industry, it’s particularly important to recognize the weak link between skill and outcome. Recognizing this fact will make us approach the task of investing much more effectively.

• To be contrarian is more difficult than it might seem. You have to listen to your intuition and then do the opposite of what it tells you. It takes courage (and a high pain threshold) to fight an instinct of fear. The prefrontal cortex31 has to be able to dominate the amygdala,32 and for that to happen, you need a well-trained and activated prefrontal cortex. Meditation exercises can help individuals train pain tolerance and become more mindful about their fight or flight behaviors.33



element of the communication. If the relationship part is not well defined (especially if there’s a lack of understanding with regard to the different value sets of the parties communicating), the content part will suffer immensely.35 In other words, if John doesn’t believe that Anna is acting in his best interests, John will resist focusing on the content and will instead concentrate on trying to define the relationship (what does Anna really want from me?), no matter how relevant the topic at hand. If we want to communicate effectively with our stakeholders, we must thoroughly understand both the relationship part and the content part of what we’re communicating. A healthy relationship means that you can communicate at a higher level of abstraction about the actual relationship (What are my values? What do we want out of this conversation? Who decides what?) as a first step, and secondly, move on to concentrate on a constructive dialogue around the topic at hand. Hence, the parties involved in a communicative process must be able to meta-communicate about the communication (communicate about the communication process itself), the relationship and their values in order to focus on solving the existing problem efficiently. If not, the inquiry process might end up being a struggle about winning or losing, or power relationships.36

An Enquiry Situation

Imagine an enquiry situation between Anna and John where they have different ways of interpreting the enquiry situation and the meaning of their interaction. The way they interpret the situation

will affect the way they act toward each other and perceive each other’s actions. These effects, that can be understood using the ladder of inference, complicate the enquirer’s quest for valid information. If John enquires into the actions of Anna, Anna wants to understand the meaning of the question and might answer the question in the light of what she believes John expects from her. Anna may want to give the best possible reason for the action, considering John is her client. If Anna feels threatened in the enquiry situation, she might even withhold information. John’s questions and Anna’s responses, verbal and nonverbal, are intrusions into the interpersonal situation that affect their construction of meanings and their willingness to give valid information. John will ask questions in a different way depending on whether he perceives Anna as ambitious or lazy, honest or dishonest (both verbally and nonverbally). This subtle information might be perceived by Anna and will make her more or less willing to give valid information.37

One common situation in which the relationship part of the dialogue gets in the way of the content part is when asset managers and their clients are discussing expectations. The client has certain expectations about the outcome of a particular strategy offered by the manager. For his or her part, the manager, who desperately wants to work with the client, promises to deliver on those expectations despite the fact that the expectations might be unrealistic. This type of behavior might be profitable in the short term but will

FILTER

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John Anna

most likely be a loser’s game in the long run. Wanting to work with the client and the ability to deliver on the client’s expectations are two very different things and should be kept a part of the dialogue.

3 p.m., The Team

John and Anna spend a lot of time in team meetings. They’re convinced that complex problems are more effectively solved by teams than by one single person. But are they right?

As noted earlier, humans never operate in isolation. We’re always part of a social context. Early humans lived in small groups, and the ability of these groups to survive depended on their skill at organizing themselves to meet their basic needs and then reorganizing when the environment changed.39

Through the process of socialization, we internalize the culture of the group to which we belong (society, organization, family, etc.). Through this process, individuals learn how to think and act like other members of their group. In modern society, teams have almost become the basic building block of organizations. Organizational tasks are normally very complicated and require a combination of skills and abilities that no one person would possess alone. One assumption we have regarding teams is that they

How can we become better communicators?• Always couple advocating your position with opening up for

inquiry when communicating with stakeholders.

• Make employees aware of the two parts of the communicative process and consider educating employees in how to communicate effectively. Being able to distinguish between talking to and talking with someone can make all the difference when interacting with stakeholders.38

• Make it a habit to meta-communicate about the communication. Clearly state where you’re coming from, why this dialogue is relevant for both you and the stakeholder, what goals you’re trying to achieve, etc. Be honest! Include both the pros and cons of what you’re conveying. If behaviors are not in line with the message communicated, this will be noticed by the stakeholder and the content part will suffer.

• Don’t underestimate the importance of working actively to incorporate desired values into everyday behavior. Map desired values against behaviors and create a feedback loop that captures behaviors that might undermine desired values. When values and behaviors are aligned across all parts of an organization, they can be clearly communicated to stakeholders and backed up by empirical evidence.

• Include the aspect of emotional quotient (EQ) into the hiring process. People with a high EQ are more able to recognize the relationship part of a communicative process.

• If you believe that creating excellent long-term client relationships is vital for your business, “always acting in the best interests of the client” must be your highest priority. This value should be clearly translated into practical behaviors and linked to incentive structures.



make better decisions than individual team members working alone. Research, however, shows that teams are subject to social processes that undermine the effectiveness of their decision-making.

Since both Anna and John spend a good amount of their days in meetings, they often bump into the challenges that emerge when a group of people interact. But they might not be consciously aware of them. The “hidden profile” phenomenon is one type of team behavior that inhibits efficiency. This is the tendency of group members to focus on information that all team members share and not include information that only one or a few team members know about.40 During Anna’s investment team meetings, positive information about an investment case that all people in the team know about will get more attention than negative information related to the investment case that only a few people are aware of. Even though the team often challenges each other’s investment ideas, they find it much more comfortable to discuss points of agreement than to speak about things where they disagree (pleasant feelings are normally preferred to unpleasant ones). A team meeting will hence often leave team members feeling more confident about their position after the meeting than before, even when they’re wrong.41

Another inefficient behavioral pattern that can emerge in a group setting is conformity. This is when individuals with a divergent view decide to abandon that view and instead conform with the rest of the group.42 Most of us would think that we can withstand social pressure and act in accordance with our own values and beliefs. This is, however, most likely a sign of the fundamental attribution error at work (namely, we tend to overestimate the causal effect of personality traits and underestimate those of situational factors). Psychologist Solomon Ach’s conformity study is a very good example of this.43 When experiencing social pressure, most

of us will tend to agree with the group even when the group very obviously is drawing an incorrect conclusion. John is a member of the investment management committee (IMC) in his organization. Sometimes when he has an opposing view, he keeps it to himself. This often happens when he feels he doesn’t have enough information about a topic or situation (and risks looking stupid if he starts talking) or when the topic is threatening and he knows he would have to break social norms to get his message through. Sometimes he feels as if his probing questions are experienced as directly challenging the group’s competence (and sometimes he simply lacks the courage to do that). We have a very strong social norm about not insulting others, and when we challenge others’ competence, we do in fact insult them. These values and assumptions create a feeling of fear in a situation when our view diverges from the group’s view: “What will they think of me?” “I might look stupid if I say this.” A very important research finding, however, is that conformity will drop significantly if there is just one dissenter in the group. This dissenter will help others with a diverging view to speak up.

Another problem that John has noticed in the IMC meetings is that the CIO and the Head of Equities are very dominant and speak more often and more passionately than others. This leads to their views becoming more prevalent in the group. Moreover, people listen more carefully to them since they have a higher status, leading to the views of the CIO and the Head of Equities having an undue influence over the outcome.44

An additional dangerous behavioral pattern that both Anna and John occasionally experience in team meetings and committees is that of “group polarization.”45 This is the tendency of groups to make more extreme decisions than the average individual participant’s decision. If the team members on an

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individual basis are prone to take risk in a specific case, the outcomes of the group decision will likely be even more risky. By the same token, if the group members individually are very cautious with regard to a particular decision, the group decision will be even more cautious. The more arguments that are raised in support of a position, the more likely it is that the group will move toward that decision. This happens due to informational social influence, when people see others as valid sources of information, and normative social influence, when people want to be liked and accepted by the group.46

Groups can also be victims of “groupthink.” Groupthink happens when individuals suppress their own

disagreement in order to achieve group consensus. Groups that are at risk of suffering from groupthink are teams with a cohesive group of decision-makers, teams that are isolated from outside influence, teams that have no systematic process for taking into account both the pros and cons of a decision, teams that have a strong leader who is clearly in favor of a particular solution and teams that operate under very high stress. These types of teams tend to strive toward consensus and avoid the risk of creating disorder by disclosing views that are in opposition to consensus.47

For Anna and John to effectively navigate through meetings, they need to know about and address all of the above challenges.

• To make sure that all information provided during a group meeting (e.g., investment committee) is taken into account, listen carefully to everyone’s contribution and make sure that all information is documented. Pros and cons of investments should be written down, side by side. Pay extra attention to information presented by just one or a few individuals so that this information does not get underrepresented.

• Use a challenge mechanism: Nominate a devil’s advocate, whose role is to challenge broadly accepted opinions.

• Inform the group about the problems of conformity and reward the ones who dare speak a different opinion than the group. Focus on the fact that it is courageous to speak up even when it makes you look stupid (a new norm saying “Looking stupid is good” could be interesting to elaborate on).

• Make sure that everyone in the meeting room gets an opportunity to speak up. The person leading the meeting has to make a conscious effort to become aware of who speaks a lot and who says almost nothing. Help the people who are

silent to speak up, and make sure that people who’d normally dominate a discussion get a more limited space.

• Let junior people speak up first, and let the most senior person wait until the end of the discussion. In this way, you can avoid skewing the opinions of junior people to become more in line with the opinions of those in senior positions.

• Each individual can write down his or her own views on a particular matter before that same matter is discussed in a team context. Each person can then compare his/her view regarding the matter after the meeting has taken place. If the view has changed, one can try to understand the reason for this change. Was the change in view based on new facts, or due to the discussion climate during the meeting?

• The risk of groupthink can be alleviated through well-diversified teams. Diversification can mean diversification of gender, cultural background, social background and, most importantly, diversification of minds.

How do we interact more effectively in meetings?



5 p.m., The Boss

With the end of the day in sight, thoughts turn to leadership. Many leaders in organizations where Anna and John work believe that bonuses and the threat of losing your job are effective tools to motivate employees and foster commitment. Only a minority of leaders know you cannot create motivated employees and that “transactional” leadership will only take you so far.

The leaders of the investment management industry will be the ones who ultimately decide in which direction the industry will develop. There is much about leadership that we don’t consciously grasp, but that unconsciously affects our everyday behavior and decision-making. Leaders must learn to accept and master all of the unconscious processes mentioned in this document if they are to create preconditions for their employees to learn, grow and develop in an optimal way. Leaders who don’t know themselves well will at best have a hard time helping others grow personally. They will struggle giving their employees the chance to be the best they can at work, and will, in the worst cases, create a negative spiral of defensiveness (leading to political behavior, dishonesty, limited information sharing, short-term winning focus and other destructive forces).48

Leadership research has taken different shapes and forms over time. Henri Fayol was one of the first to write about the concept of management more than 100 years ago. He describes management as a set of processes like planning and forecasting, organizing and commanding. In the 1950s, trait theories were developed that described successful leaders as possessing certain native traits. Later on, leadership research switched focus from fixed traits to leadership styles and behaviors, as well as to different types of contingency approaches

(emphasizing the fact that different leadership styles will be effective in different situations). Leadership theories of today have once again switched focus to talk about transactional leadership (giving people rewards for doing what the leader wants) vs. transformational leadership (giving employees a purpose and a vision to aim for). Most importantly, the leadership theories of today have acknowledged the significance of leaders that know and understand themselves well (authentic leadership). The authentic leaders know who they are, and they know how their experiences in life shaped them to become who they are.49 Because these leaders are aware of their weaknesses and mistakes — and are willing to learn from them — they invite people in their organizations to develop themselves as well. When the leaders don’t live the way they learn (hence when stated values are not the same as the values actually deployed), an organization will not be able to develop and learn effectively.50 Unproductive assumptions will put an organization at risk of developing badly functioning behaviors and systems that might not change until a scandal becomes public and no longer can be hidden. Even if employees identify these unproductive behaviors, they’re unable to do anything about them because they are denied. Employees might be punished for talking about them (they create a cognitive dissonance, and the organization will do anything in its power to reduce that dissonance).51 John experiences this problem in his organization. Leaders are telling the employees to give open and honest feedback. But then when someone actually does follow that recommendation, he or she gets punished in subtle ways. And the biggest problem is that this unproductive behavior is denied and can’t be discussed.

It was this type of negative spiral that caused the demise of Arthur Andersen, previously one of the most admired firms in the world, as it became deeply entrenched in the Enron scandal.52 The 2007-

17

2008 financial crisis is also a good example of how faulty, unproductive and unquestioned assumptions can bring a whole industry to its knees. Often the use of unproductive values does not lead to a large scandal but just slowly undermines the organization’s ability to grow and flourish.

6 p.m., Learning How to Learn

As they look to the future, both Anna and John are intrigued by the idea of developing their learning capabilities. They would love to be part of an organization that connects their own personal development process with the organizational development process. This would give them a true sense of belonging and an opportunity to grow and be part of something bigger than themselves.

To deal with the above-mentioned challenges, we have to develop our ability to learn. That development process starts with learning how to learn. Learning can take place on several levels. The first level of learning happens on an instrumental level. Something is wrong, and we try to fix the immediate and obvious mistake (error).

The second level of learning takes place when we dig one level deeper and not only address the most obvious mistake, but also inquire into and restructure the values connected to the root of that mistake. Many mistakes happen randomly and have no entrenched roots, but some mistakes keep recurring because they are a manifestation of a much more fundamental problem. The third level of learning occurs when a person or an organization enquires into a situation in such a way that it enhances its capability of learning on both of the above levels. This is, in short, “learning how to learn.”53

In the process of learning how to learn, we need to explore our own and our industry’s underlying assumptions and beliefs. This is, however, easier said than done. To do this we need to live in accordance with productive learning values (valid information, free and informed choice and internal commitment). More than 50 years of research in the area of psychology and learning show that humans have a tendency to resist learning.54 Instead of acting in accordance with learning values, we have a habit of acting defensively in important learning situations in order to protect the image of ourselves and our own self-perception. The use of unproductive values impairs decision-


How do we improve leadership? • Leaders need to be aware of their own defensive reaction

patterns and have a realistic view of their strengths and weaknesses.

• Get the right leaders! Leaders have to deeply understand how to help employees develop both intellectually and emotionally. Hence, hire leaders who know themselves.

• Leaders should set a good example and make sure they have an in-depth understanding of what it means to act in accordance with desired values.


How can we learn?• Work through what productive learning values you would

like your organization to live by and connect these to actual behaviors.

• Implement exercises in everyday working life that can help individuals slowly become used to acting in accordance with the learning values.

• Implement a process for dealing with mistakes, and change the perception of mistakes as something bad that no one else should know about.

• Establish an effective feedback loop. Work on improving feedback skills and self-reflection skills.

• Introduce incentive structures that reward employees for acting in accordance with the desired values.


See Toolbox Section / Page 19

making, creates taboos and blame, and generates discrepancies between what is said in public and what is said in private. It makes problematic norms undiscussable.55 These outcomes leave people within the organization feeling trapped and unable to improve the situation. These processes can, however, be interrupted if the employees can learn to skillfully use learning values and productive reasoning.

Hence, most of us have to leave a system of unproductive learning values and transition into a system of productive learning values. This is a process that involves both personal development and organizational development. In this process, we slowly have to turn our existing view

of the world upside down. Questions should have as high a status as answers. Weaknesses should be accepted, and to admit them is a strength. To care for one another also means challenging one another. Being honest is better than looking good. Mistakes are great learning opportunities.56

Assuming that the success of the investment management industry over the long term is related to its ability to learn and develop, the learning values we internalize will define the quality of that ability. Moreover, a learning culture creates conditions for honesty and commitment — qualities that are highly important when building a responsible and sustainable business.

19

We’d love to be a part of yourjourney. By just applying a few of the

suggested tactics, you can achieve bigand important changes. If you want to know

more, please contact theCenter for Applied Research at

[email protected].

Center for Applied Research,statestreet.com/ideas/applied-research.html

Authors

Mimmi Kheddache Jendeby, Suzanne Duncan

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31 This brain region is involved in planning complex cognitive behavior, personality expression and decision making, and moderating social behavior. Wikipedia.

32 Amygdala is a brain structure that is involved in consolidation of emotional memories. Atkinson & Hilgard’s (2009), Introduction to Psychology (15th Edition), Cengage Learning.

http://www.bokus.com/cgi-bin/product_search.cgi?publisher=Penguin%20Books%20Ltd




https://en.wikipedia.org/wiki/Planning

https://en.wikipedia.org/wiki/Planning

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33 Hölzel, Britta K.; Lazar, Sara W.; Gard, Tim; Schuman-Olivier, Zev; Vago, David R; and Ott, Ulrich (2011), “How Does Mindfulness Meditation Work? Proposing Mechanisms of Action From a Conceptual and Neural Perspective,” Perspectives on Psychological Science, 6(6) 537–559.

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54 Argyris, C.; Senge, Peter; and Schein, Edgar, among others.

55 Argyris, C. (2010) Organiszational Traps, Leadership, Culture, Organizational Design, New York: Oxford University Press Inc.

56 The dark side of storytelling: https://www.ted.com/watch/ted-institute/ted-state-street/suzanne-duncan-the-dark-side-of-storytelling.

https://www.ted.com/watch/ted-institute/ted-state-street/suzanne-duncan-the-dark-side-of-storytelling



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