I came across Rory Sutherland’s great work thanks to AbnormalReturns.
I’ve been writing about the need to open up to creativity in quantitative finance in order to improve results and perhaps even to survive as an active investment industry (for example here, here, here, here, here, and here). Rory’s Alchemy book is a treasure chest of ideas that I believe can make quantitative investing and factor investing much more innovative.
From Rory's Alchemy:
The models that dominate all human decision-making today are duly heavy on simplistic logic, and light on magic – a spreadsheet leaves no room for miracles.
Engineering doesn’t allow for magic. Psychology does.
We should never forget that our need for logic and certainty brings costs as well as benefits. The need to appear scientific in our methodology may prevent us from considering other, less logical and more magical solutions, which can be cheap, fast-acting and effective.
The modern world, oversupplied as it is with economists, technocrats, managers, analysts, spreadsheet-tweakers and algorithm designers, is becoming a more and more difficult place to practice magic – or even to experiment with it.
If you want to look like a scientist, it pays to cultivate an air of certainty, but the problem with attachment to certainty is that it causes people completely to misrepresent the nature of the problem being examined, as if it were a simple physics problem rather than a psychological one.
Although humans can learn how to ride bicycles quite easily, physicists still cannot fully understand how bicycles work. Seriously. The bicycle evolved by trial and error more than by intentional design.
If you expose every one of the world’s problems to ostensibly logical solutions, those that can easily be solved by logic will rapidly disappear, and all that will be left are the ones that are logic-proof.
This isn’t the Middle Ages, which had too many alchemists and not enough scientists. Now it’s the other way around
This book is not an attack on the many healthy uses of logic or reason, but it is an attack on a dangerous kind of logical overreach, which demands that every solution should have a convincing rationale before it can even be considered or attempted.
Evolution, too, is a haphazard process that discovers what can survive in a world where some things are predictable but others aren’t. It works because each gene reaps the rewards and costs from its lucky or unlucky mistakes, but it doesn’t care a damn about reasons. It isn’t necessary for anything to make sense: if it works it survives and proliferates; if it doesn’t, it diminishes and dies. It doesn’t need to know why it works – it just needs to work.
Logical ideas often fail because logic demands universally applicable laws but humans, unlike atoms, are not consistent enough in their behavior for such laws to hold very broadly.
Context is Everything
How You Ask the Question Affects the Answer
Never call a behavior irrational until you really know what the person is trying to do.
It’s Better to Be Vaguely Right than Precisely Wrong
But what about snake-oil salesmen,* the fakers, fraudsters and conmen? Alchemy, precisely because it is not an exact science, has always been rife with charlatanry, and we should be on our guard for this. Many of the remedies proposed by people in advertising and design are wrong, and many of the findings of behavioral scientists have already been or will be proved wrong. Some parts of this book are also undoubtedly wrong – I am conscious that I have written this book from an incredibly optimistic perspective, but my argument is not that alchemy is always reliable, ethical or beneficial. Far from it – it is simply that we should not recoil from testing alchemical solutions because they do not fit with our reductionist ideas about how the world works
In physics and engineering, objective models usually make problems easier to solve, while in economics and politics objectivity might make things harder.
Remember that it is easier to get fired for being illogical than for being unimaginative
Beating the market over extended periods of time is much closer to ‘magic’ than ‘logic’.