Resulting

May 7, 2018

Written by Nathan Erickson, CFA®, CAIA, Partner and Chief Investment Officer

 

In Super Bowl Forty-Nine, the New England Patriots defeated the Seattle Seahawks for their fourth Super Bowl title. The game was played here in Phoenix. The Seahawks were down 28-24 with 26 seconds remaining, they had the ball on the Patriots 1-yard line with three potential opportunities to score and Pro Bowl running back Marshawn Lynch in the backfield. They only needed to move the ball one yard to repeat as Super Bowl Champions. What came next is what many consider the worst call by a coach in Super Bowl history.

On second down with one yard to go, Seattle’s coach Pete Carroll called a pass play which was intercepted by New England, virtually ending the game. The entire football world was shocked that Seattle didn’t just hand the ball off to Marshawn Lynch, who led the league in touchdowns, and let him run it in. Carroll, who just one year before was praised for leading the Seahawks to their first ever Super Bowl Championship, was criticized for months by every media outlet and will be forever remembered for that call.

I was reminded of this event from a podcast interview I listened to recently with former World Series of Poker Champion, Annie Duke. She uses this event to describe a habit we as humans have of evaluating the quality of a decision by its results. Poker players call this “resulting”. It occurs frequently when we must make decisions with limited information, which is often the case in poker, football, and investing. Given what information we have we may make the right decision but judge it to be wrong based on an undesired outcome.

As for Pete Carroll, if you asked him in that moment why he would throw a pass play, he might say that with 26 seconds left and only one timeout, throwing a pass on second down gives him more flexibility on third and fourth down than running the ball would. The clock stops on an incomplete pass. However, if Seattle runs the ball on second down and is unsuccessful, they must use their last timeout to stop the clock. In that scenario, they are almost forced to pass on third down if they want to have the opportunity to use fourth down, which New England would anticipate. Without knowing the outcome, a pass play on second down in that scenario makes sense.

In hindsight we can tell you that, on average, teams are 50/50 in calling a run or pass play when they need less than ten yards to score and are trailing by six points or less. Not only does it make sense, but it is quite normal for a team to call a pass play in that situation. Furthermore, interceptions are extremely unlikely for the offensive team at the 1-yard line. This was the first of the year in 109 attempts.

Had the pass been completed, or more likely fallen incomplete, no one would question the decision.  Either Seattle would have scored on a subsequent down or they would not, and credit would go to New England for their great defense. Judging only by the results, however, this is now considered one of the worst coaching decisions in Super Bowl history. Furthermore, it will likely affect not only Pete Carroll, but countless other coaches who find themselves in that same scenario and remember this outcome. They will ignore the data and statistics, and make a decision based on a singular outcome. “Resulting” leads us to decision making that is inconsistent and irrational, where only the outcome matters.

As investors, we get caught in resulting when we ask, “did it work?” Take 2018 for example. If you decided to invest in stocks on January 1st, three weeks later your decision “worked”. The market was up and you made money. However, two weeks after, you had less than when you started and your decision “didn’t work”. We find ourselves both right and wrong for the same decision. When we judge our decisions by their outcomes, we find ourselves in a never-ending cycle of regret and disappointment. After the third week of January you are disappointed you didn’t invest more, and after the second week of February you regret investing at all.

Rather than judging our decisions by their outcomes, we should judge them by our process. At MRA, we often ask ourselves if an investment exhibited the characteristics we thought it would when we first decided to invest. There may be no better example of this than reinsurance. Our decision to start investing in reinsurance in 2012 was based on the fact that it offered a very low correlation to stocks and bonds with an attractive return. The performance of the asset class had nothing to do with stock markets or bond markets, which would result in lower overall risk of a diversified portfolio. In 2012, our investment returned about 10% and everyone was happy. We saw high single digit returns in 2013, 2014, 2015, and 2016, and everyone continued to be happy. However, in 2017, reinsurance lost money.  Inevitably this led to questions about the investment and its utility in the portfolio. These questions never came up from 2012-2016, but only after an unfavorable outcome.

As our clients know, we remain invested in the asset class because we re-evaluated our process. The loss in 2017 had nothing to do with stock or bond markets. Reinsurance investors earn attractive returns for bearing the risk of natural disasters, which from time to time will result in a loss year. This is what we expected from day one. We continue to expect high single digit returns from the asset class as we did in 2012. Therefore, despite 2017, we continue to believe we made the right decision by investing in reinsurance.

At MRA we focus on our process relentlessly. This is why we go through the same asset allocation analysis every year. It is a re-evaluation and reaffirmation of our decision making. We don’t ignore outcomes, but we scrutinize them to see if they are different than what we expected based on our process. Investors will never have enough information to make the perfect decision with the perfect outcome. However, consistency, rationality, and time will all lead to more success than “resulting” ever will.