What Does Sense-making Can Teach Investors?

Sense-making is a qualitative, multi-disciplinary approach to make something sensible, i.e., how we structure the unknown as so to be able to act in it. In other words, it consists in constructing, filtering, framing, creating facticity and rendering the subjective into something more tangible. According to Karl Weick,

sense-making is about plausibility, pragmatism, coherence, reasonableness, creation, invention and instrumentality.

In this synthesis exercise in which accuracy is secondary, I found a couple parallels and antithesis to equity research, investing and managing an asset management firm.

On equity research and investing:

• Sense-making is a synthesis exercise which usually benefits from mental models utilization to simplify complex and open-ended problems – it does not rely on extensive analysis and accuracy as enactment is needed in the learning process. This one is partially correct for investing in my point of view, since extensive analysis is a pre-requisite before synthetizing what the analyst has learned. A complete due diligence is required to mitigate risks, although it will never be complete due to the ever changing landscape and eternal unknown unknowns;
• As I’ve just watched the True Detective TV series, I’ve learned from detectives this time (instead of Munger) that reading and studying different topics from a variety of sources helps us arm our brains with bits & bytes which can be combined later on our professional and personal lives. Although, we need previous knowledge and context to successfully use them “to consolidate bits and pieces into a compact, sensible pattern frequently requires that one look beyond those bits and pieces to understand what they might mean. Often, it is necessary to move outside a system in order to see the patterns within. (…) Of course, there is always more than one metaphor that can capture a situation, which means that any given metaphor is likely to be contested.”
• And when we are unprepared, the man-with-a-hammer syndrome unleashes:  "operators who have specialized expertise do not see the big picture as crises develop and therefore miss key events." We will try to frame the problem within our pre-existing models, unfortunately;
• We are more likely to uncover unanticipated and potentially valuable viewpoints and information armed with open-ended questions. Moreover, in this way we avoid confirmation bias;
• Marcel Proust helped me out in this one: “The real voyage of discovery consists not in seeking new landscapes but in having new eyes.” Again, it's all about having perspective;
• Sense-making benefits from past data (quant, social, etc.) in a given context to extrapolate necessary actions – just like investors learning from post mortem analysis/financial markets history to be better prepared for decision making;
• Consequences are difficult to forecast in advance, though scenario planning could help out with this one;
• Sense-making opposes scenario planning as “explanations that are developed retrospectively to justify committed actions are often stronger than beliefs developed under other, less involving, conditions." This one is screaming for me since I live in Brazil and we are used to see growth embedded in 99% of potential investments here, thus we aren't THAT creative imagining different scenarios. Unfortunately, we usually classify then as improbable as a preconception;
• Learn not only what financial statements represent, but what is behind it: “e very sensitive to operations. Learn from those closest to the front line, to customer, and to new technologies.

On risk:

• “Human errors are fundamentally caused by human variability, which cannon be designed anyway - so our function is to be risk mitigators which must be embedded in the capital allocator job description;
• Compounding mistakes: "Small events are carried forward, cumulate with other events, and over time systematically construct an environment that is a rare combination of unexpected simultaneous failures."
• Constant learning, perspective and team complementarity as a knowledge growth vector and risk mitigator: "Capacity and response repertoire affect crisis perception, because people see those events they feel they have the capacity to do something about. As capacities change, so too do perceptions and actions. This relationship is one of the crucial leverage points to improve crisis management." As investors, we should only act or react when we are prepared and comfortable with what we know and what we don’t know;

On governance:

• “The dark side of commitment is that it produces blind spots" – This one I’ve learned from Malcolm Gladwell article in The New Yorker Magazine: do not engage in negotiation with fanatics, nor trust entrepreneurs living their dreams in listed companies. In other words, do not them live their dreams with your money;
• "Turnover is as much a threat to capacity as is understaffing, but for a different reason. Institutional memory is an important component of crisis management"
• "Perception, however, is never free of preconceptions, and when people perceive without institutional memories, they are likely to be influenced by salient distractions or by experience gained in settings that are irrelevant to present problems."
•  “In a globally competitive environment our reward structures are geared toward rewarding immediate action and hence we may be signaling that sense-making is not a valued activity.”
• “Sense-making is inherently collective; it is not nearly as effective to be the lone leader at the top doing all the sense-making by yourself. It is far better to compare your views with those of others – blending, negotiating, and integrating, until some mutually acceptable version is achieved. Soliciting and valuing divergent views and analytic perspectives, and staying open to a wide variety of inputs, results in a greater ability to create large numbers of possible responses, thus facilitating resilient action." - Sutcliffe & Vogus, 2003

At the end of the day, no single discipline or tenet will solve any problem alone, although sense-making might be useful when analyzing the past performance or story of a company in order to understand how things went out. It is like a mapmaking process. Sensemaking also uses mental models from previous experiences and disciplines. 

I do not agree though that it necessarily is a better exercise than scenario planning because it relies on past facts, as (i) facts are not as clean as they see, afterall someone made the fact up and you don't know in what context and motivation and (ii) in a constant changing landscape it's better to elucubrate about the future and try to foresee through group simulations what scenarios can come up.

References:

Enacted sensemaking in crisis situations - Karl Weick

Sensemaking in organizations - Karl Weick

Sensemaking - MIT by Igor Chalhub