Creativity in Investment Process

A recent article in the CFA Institute’s enterprising Investor explores the role of creativity in investing, highlighting legendary investor Peter Lynch’s comment to “invest in what you know,” but also pointing out that Lynch believed “it was also necessary to support [creative] insights with traditional, in-depth research.” Freelance author Ed McCarthy asks: “Where do creative investment ideas originate? Are investment managers at the mercy of serendipitous, eureka-like moments and automated screens, or can creativity be learned and inculcated in a firm’s investment process?”

Jason Voss of the CFA Institute recently published a book seeking to guide investors in developing processes that improve idea generation. He explains that psychological and neuroscience research over the last 15 years has shown that “creativity is a natural function of the mind and there are things you can do to cultivate it.”

Voss discusses two ways of enhancing creativity in investing: “taking stock of mental models” and “scenario planning.” The former involves, in McCarthy’s words, “tak[ing] a proper mental inventory of our primary and secondary skills” to “illuminate the interconnections between things [one] already knows and move [the person] into new areas.” It leads to identifying one’s blind spots. Voss said: In taking that mental inventory . . . and making a mental map of what you know, what you don’t know oftentimes becomes very obvious, and it has a ready-made solution – get more information.”

Scenario planning is a process of “considering predetermined events” and “add[ing] uncertain events . . . which can result in different outcomes and form the basis for senarios.” This qualitative process (which Voss describes as “almost the opposite approach to forecasting”) does not generate probabilities. Instead, it creates “stories” that may prepare investors to “recognize certain parts of the scenario occurring” and “have a sense of each event’s direction” to be able to “respond before others recognize the trend,” potentially “creat[ing] an opportunity to capture alpha no one else recognizes.”

The article highlights LVW Advisors, where co-CIOs Lori Van Dusen and Joseph Zappia have built creativity-enhancing processes into the firm’s culture and operations. Van Dusen, who has a background in music, describes creativity as putting disparate pieces together “so that you really get something that sounds great, is orchestrated well, isn’t diluted, isn’t too noisy – that’s the creative process.” It is “pattern recognition, and putting a lot of different pieces together,” she said, continuing: “That’s how I think the better research people and investment people think. It’s not about just filling buckets and following what everybody else is doing.”