A number of our Portfolio Minutes have focused on different types of fallacies or common errors people tend to make, and how best to avoid them when investing. In this Portfolio Minute, we will be taking a look at what is often referred to as “faulty premises”, or “arguing from the conclusion”.
What is a Faulty Premise?
This logical fallacy can take several forms. The first is known as “begging the question.” In this instance, the argument will typically be self-referential and therefore does not address the question at hand. For example, if I say that a hero is someone that is being heroic I haven’t really made my point. We need to consider the actual characteristics of what a heroic person is doing or has done.
The second variant of this type of fallacy is “circular reasoning.” If a product claims that it is “ethically created” because it was made by “good people,” the claim begins and ends with the same conclusion. We still need to understand what it means to be ethical or good since the words effectively mean the same thing.
The third common example of a faulty premise is “the fallacy of many questions” also known as a loaded question. Here the person will presuppose what is being debated rather than showing how the argument proves the result. This fallacy is often used rhetorically so that the question limits responses to something that serves the questioner’s agenda. For example, the statement that one should not walk in the woods because pixies are likely to charm you presupposes that pixes exist–a doubtful proposition. Because it is presupposed by the questioner, and if it has not been agreed upon prior, the question is improper, and the fallacy of many questions has happened.
How does this happen with investing?
Many companies and investment ideas are pitched using these types of arguments. For example, someone might say that we need to invest in a specific industry because it represents “the wave of the future.” But this merely begs the question: What is a “wave of the future” and how do we make it tangible? A better reason might be to show how a company will change the way consumers buy a specific product and deliver it to them at a lower cost.
Another investment pitch might say that a company is a good investment because it has “good governance”. But this too merely begs the question- what do they mean by good governance? How is it better than what is practiced by its competitors? Do the managers have a track record of running their companies more ethically than normal? What specific measurable examples can they offer of them actually walking the walk, and not just talking the talk?
Alternatively, a company may use a circular argument, saying that its products are organic because they are “all-natural.” But the words organic and “all-natural” mean the same thing. We need to dig deeper (no pun intended) to find out what their growing processes are, and how they are different from industry standards that may or may not be less organic/natural.
Finally, we might be told not to buy a specific stock because it is too risky. But until we know the type and level of risk, the methods being used to mitigate against that risk, and the prospects for success we do not know if the company is worth buying or not. By definition, every investment idea contains risks. We want to know what the company is doing to make it a risk worth taking.
How do we at CH avoid this fallacy?
When we evaluate investment teams we want to look past sweeping characterizations and find out the specifics of how the managers actually implement their claims. This helps us to avoid “trendy” ideas promoted with buzzwords and broad generalizations. We ask them to show us specific examples of where they uncovered a best-in-class company to buy, and what sorts of tests they applied to see if those companies were more ethical, or would disrupt their competitors, or have a very good chance of succeeding in a risky venture. If a claim cannot be measured then its value is, at best, hard to quantify. This makes it difficult to know if we can invest in it profitably.
Similarly, we want to know if a manager refuses to invest in specific market sectors for non-financial reasons. And again, what sorts of measurements do they use to make this determination. No less importantly, if they are buying a company they would not normally invest in then we want to know why. Recently, for example, one of our growth managers told us they had bought an insurance company. Traditionally insurance is not viewed as a growth industry since most developed markets have a large number of competitors in the field, and pricing power is very limited. But this insurance company is operating in Asia where insurance is still a relatively new industry, making the opportunities for growth much higher than normal. In their minds, this is not just a “wave of the future” type of company. It is an established industry breaking into a previously untapped marketplace. This is the kind of growth story that we find compelling.
Our goal in this Portfolio Minute was to highlight yet another fallacy trap, and how we at CH work to avoid it. We want to see our managers recognizing and measuring risks accurately and incorporating the kinds of tools needed to avoid investment mistakes that could harm our clients’ portfolios. Understanding the tools that they use to avoid faulty premises helps us to do that.
All the best,
Brian Trafford, Chief Investment Officer
& Your CH Financial Team