As plan sponsors and advisors, we make a number of decisions each day. The act of making decisions can be broken down into three components: context, beliefs and analysis.

  • We must consider both the general and unique context.
  • We make judgments about the future by relying on our beliefs.
  • We then consider the possible outcomes of the decision once these beliefs are added to the context (analysis).

In order to improve our decision-making outcomes, we need to enhance our approach to each of these areas. However, the largest competitive advantage comes by improving our approach to beliefs. In a world of imperfect information, there may be some scope for improving the context (better understanding the liabilities, employer covenant and so on), but the scope is limited.

Investment beliefs are views on fundamental issues in institutional investment. These include our attitudes toward such things as asset mix policy, asset classes, rebalancing and active versus passive management. Studies on governance have highlighted beliefs as a core attribute for global best practices in governance. Investment committees with well-developed and well-documented beliefs tend to secure a competitive advantage over other investors.

There are several reasons why it is useful to hold beliefs. In our industry, we are confronted with assuming either a world of “perfect” or complete information or the not unreasonable assumption that the future is “unknowable.” In both cases, beliefs are vital. In the first instance, beliefs are used as shortcuts in decision-making, saving large amounts of time, as the information relevant to investment decisions tends to be substantial. In the second case, with lack of clarity as to how the future will unfold, beliefs are necessary to achieve any sort of quality attempt to add value through a more accurate assessment of the future.

We would suggest that not all beliefs are created equal, as there is a difference between assertion and demonstration. A belief that can be demonstrated to be reasonable or valid is generally superior to a belief that can only be asserted. We say “generally,” as new theories (assertions) can expand upon, and replace, old theories (demonstrations).

There are six key areas in which beliefs are required in institutional fund management. The first two relate to mission, while the next four are high-level investment beliefs regarding strategy.

Mission beliefs

  • the vision and mission of the fund and what resources (governance) are needed to deliver the mission; and
  • optimal time horizon and risk exposure for the fund, given stakeholder requirements.

Strategy beliefs

  • asset class and security pricing, what are “fair” prices, the reasons why mispricing can occur and the degree of this mispricing;
  • the fund’s ability (competitive advantage) to exploit strategy opportunities;
  • how the fund might exploit these beliefs in its strategy; and
  • what these (alpha and beta) strategies can produce in terms of value added and risk, individually and together.

History shows us the following: beliefs are often hard to identify (as they typically parade as certainties), they can be erroneous, and they can be held with varying degrees of conviction.

This final point focuses on the strength of conviction with which a belief is held. There is a significant difference between “inviolable” beliefs—the core elements of our world that we are unwilling to see violated (for example, sentiment plays a very big part in pricing securities)—and “working” beliefs (for example, losses in investments need to be cut quickly).

We would expect inviolable beliefs to be few in number but to be present to some degree in many investment decisions. In contrast, we may hold myriad working beliefs, and these may also be replaced with better beliefs on a frequent basis. The key is in knowing the difference between the inviolable and working beliefs and, in particular, recognizing the beliefs to cling to no matter what evidence there is to the contrary.