You like the idea of proving a strategy is broken rather than it is right.

This was the question Michael Covel asked Ewan Kirk of Cantab Capital during one of his recent trend following mega episodes. The answer was fascinating:

I don’t think I’m the first person to come up with that. Effectively that is the scientific method, and it works pretty well for humans since the Greeks came up with it. Science is about proving things wrong, it is not about proving things right. What you are trying to do is break your strategy. You can never really prove whether a strategy works or doesn’t work. 

Finance is dominated by randomness. Randomness is everything. Because randomness is everything, you need to be uncertain. You need to have a lack of conviction and dogma in certain things. Because you want to be able to prove certain things are wrong. And so when we come up with a new strategy, idea or trading system.  What we are trying to do is – at least when we are simulating it –  finding out what is wrong with it. After literally months of testing, retesting and rethinking (about different environment for example), if it gets through months of that maybe it is going to work in the future. These are all very weak uncertain statements. But to a great extent the philosophy of what we do is around that uncertainty.

Ewan Kirk has certainty about some elements however:

There are certain things we have conviction about: the importance of technology, the importance of risk weighting and coherent portfolio design.

 But no conviction about any particular technique. You just do what you think is best and what you think is persistent. 

He also talks about an intellectually satisfying technique to approach problems:

What we try and do is approach the problem from the perspective: the reason why this happened was chance. Now prove that it wasn’t chance. Very often that is quite hard. 

Even if they have a totally different investment style, I see some great discretionary (fundamental) investors also put this kind of pre-mortems on their checklist. Tren Griffin from 25 IQ highlights the following about Bruce Berkowitz:

The only thing you can spend is cash. We want companies that generate significant cash in most times. That is how we start. We don’t care much about what they make, but we have to understand it. The balance sheet has to be strong; we want to make sure there are no tricks in the accounting. Then we try and kill the company. We think of all the ways the company can die, whether it’s stupid management or over leveraged balance sheets. If we can’t figure out a way to kill the company, and its generating good cash even in difficult times, then you have the beginning of a good investment.

Even organizationally these pre-mortem excercises can be useful.

Interesting creative exercise for your team – ask them how to kill your company; how to put your company OUT of business. Adam Grant (at DLD 17 via Bill Gross).

Maybe it all boils down to the following conclusion from Tom Brakke (research puzzle):

Jones said, “I encourage you to seek humility and curiosity in your physicians.”  Similarly, I encourage you to seek humility and curiosity in your asset managers and investment advisors.  Those qualities are indications that they are ready to learn, not to tell you everything they already think they know.

In the end, the investors mentioned in this article are trying to be humble and uncertain while trying to destroy their own investment thesis. They are curious to find out where they are wrong before they start investing.