Noise - Chapter 3
Nature Of Noise: Chronic Noise
Briefly: Chronic Noise
Chronic Noise. Chronic noise is an ongoing, low-level disturbance that distracts and interferes with your ability to function at an optimal level. All fund managers everywhere are exposed to chronic noise.
Neurobiology. The neurobiological effect of chronic noise is that it gives rise to prolonged exposure to stress hormones like cortisol, which undermines physical resilience and can trigger predispositions to serious illnesses.
Psychology. The psychological effect of chronic noise is that it erodes the cognitive resources required for effortful and deliberate thinking, and increases the likelihood of errors of judgement.
Chronic noise is a set of ongoing, low-level distractions and interferences that detracts from your ability to function at an optimal level. In contrast, acute noise is something that interferes briefly and intensely with your ability to function. All fund managers everywhere are exposed to chronic noise.
One of the more insidious characteristics of chronic noise is that, for the most part, it doesn’t seem to be a problem. By definition anything that is chronic is experienced on an ongoing basis and, precisely because of this, it will feel normal after a while. But just because it feels normal, it doesn’t mean that it’s not a problem.
The effect of chronic noise accumulates over time and it leads to a slow and inevitable deterioration in your ability to leverage your professional relationships and your ability to generate alpha, until eventually there can be a systemic cascade which leaves you barely able to function at all. Despite this, chronic noise is poorly managed across the fund management industry, perhaps because it is not recognised as being a problem, or because it is not considered to be manageable. Unfortunately it is a problem, but fortunately it is manageable.
Like acute noise, chronic noise can arise in either of the domains that you inhabit as a professional fund manager, the market domain or the people domain.
Market-Related Noise
Price action is a source of market-related noise that can be acute or it can be chronic. Whereas acute noise arises from extreme price action, chronic noise arises from unexceptional price action.
Unexceptional moves in the prices of securities are a problem in two related ways. The first is that your screen-watching of this price action diverts your attention away from potentially alpha-generative work. The second is that higher frequency of observation gives rise to an experience of higher volatility, which can lead to overtrading. These apparently benign price moves have a malevolent side: they will leach away the alpha that is available to you, with serious long-term consequences for your investment track record.
People-Related Noise
Your associates can be a source of noise. These are the people, both internal and external to your firm, who you rely upon for support. Associates can include people in your firm in areas such as Business Development or IT, as well as people outside the firm, such as the prime broker for your hedge fund or the firm’s PR outfit.
There is a long line of associates who need access to you. If you freely grant each person the time that they want, all of your time will quickly evaporate and with it your ability to function properly. These subtractions from your store of scarce resources are the effects of chronic noise.
The perspectives of the related fields of neurobiology and psychology can again, as in the previous chapter, provide insight into the manner in which chronic noise erodes your capacity to function at an optimal level as a fund manager.
Neurobiological Perspective
When you are faced with a challenge or disturbance, even if it is not particularly severe or acute, your body readies itself to deal with the challenge by releasing hormones like cortisol into the bloodstream. Once the resulting physical tension has been discharged through action, your hormonal balance can return to normal.
In the case of chronic noise, there is usually no natural and satisfactory release of physical tension, and so over time each small dose of cortisol accumulates in the bloodstream. There is overwhelming medical evidence that indicates that prolonged exposure to cortisol leads to dysregulation of various physical systems, which can culminate in a host of serious illnesses.
When you are exposed to elevated levels of cortisol for even a relatively short length of time you will begin to experience growing fatigue and increasing anxiety. If this is left unmanaged it can lead to insomnia and a compromised immune system, and can trigger a predisposition to heart disease, diabetes and depression.
All those minor-seeming irritations and distractions that you encounter on a daily basis, if not constructively dealt with, can shorten your biological life or at least make it pretty miserable. A single shot of cortisol can save your life, but an accumulation of many small doses of that same hormone can eventually kill you.
Psychological Perspective
Our cognitive processes emerge from a biological substratum; what goes on in the mind is inextricably linked to what goes on in the body. As chronic noise erodes physical resilience there is a parallel deterioration in the ability to think well, and with every error of judgment there is a correspondent shortening of your professional life.
Sleep disturbance is one of the seemingly less malign symptoms of chronic noise, a physical experience that has a clear psychological correlate. Some of the most effective psychological tortures involve sleep deprivation, the experience of which quite quickly leaves the victim mentally disoriented and undefended. If the torture is prolonged, sleep deprivation can cause a collapse in the victim’s existing psychological structures and can lead to full-blown psychosis.
But well before reaching the stage of having a psychotic episode, even mild sleep deprivation causes impaired cognitive functioning by creating deficits in attention and working memory. You simply can’t think well if you haven’t had proper sleep. When you operate the heavy machinery of investment management while under the influence of sleep deprivation, you put your clients’ financial health and your own career at risk.
Many fund managers are familiar with the effects of sleep deprivation and some attempt to deal with this by self-medicating. Sometimes this approach has short-term benefits but often the longer term result is an amplification of the initial problem, so that a relatively minor initial disturbance can become a major wobble.
Engaging with complex problems like stock selection and portfolio construction is a difficult job that places heavy demands on your cognitive resources; it is a job that requires effortful and intentional thinking. At the best of times, which might be defined as those times when noise is well managed, human beings are cognitive misers; you try to conserve your limited cognitive resources by making the least possible effort, without even necessarily being aware of the fact. And when there is an increase in task complexity, you increase the rate at which you try to conserve mental energy by defaulting to less effortful modes of thinking. When your cognitive capacity is impaired by symptoms of chronic noise, such as fatigue and anxiety, you become even more prone than usual to attempting to conserve cognitive resources by abandoning intentional thinking in favour of impulsive thinking. When your cognitive capacity does not meet or exceed the complexity of the problem at hand, you will place greater reliance on simplifying heuristics and consequently you will make more errors of judgment.
You want to put yourself in a position where you have the capacity to engage in the effortful and deliberate thinking that is required to outsmart a lot of smart people in the markets. As we have discussed, chronic noise erodes this capacity and makes you more prone to impulsive thinking and decision error. However, the very act of engaging in effortful and deliberate thinking itself leads to cognitive depletion and therefore an increased reliance on unconscious cognitive processes. A bitter little irony is that the seeds of impulsive thinking are unwittingly sowed by the act of intentional thinking. That is why, even if you’re pretty good at managing chronic noise, you still need to invest in your own physical, emotional and cognitive renewal. Your ability to stay in the game depends on it.
Burnout Profile
Chronic noise causes wear and tear on the mind and body, the symptoms of which include: physical exhaustion; a loss of motivation or enthusiasm; and a deterioration in cognitive performance. This is a list of the classic symptoms of burnout, where mental and physical deterioration reinforce one another in an ever-accelerating downward spiral.
Fund managers who experience severe burnout tend to exit the industry, not always voluntarily. Burnout is a syndrome that is treated by many in the investment industry, especially those who wear their stress as a badge of honour, as something that befalls lesser human beings, the 90-pound weaklings who don’t deserve to be in the game anyway. But is it only the constitutionally frail who are at risk?
People who are most likely to suffer burnout have the following characteristics:
They work very hard.
They are highly competitive.
They have a perfectionist streak.
Their jobs carry a high level of responsibility.
They have low levels of control over the ultimate outcomes of their decisions.
Their identity is closely linked to their performance.
Sound like anyone you know? The combination of the personality profile of the typical fund manager and the noisy environment in which the fund manager operates makes for a particularly toxic brew. Burnout is a real and present danger. While some fund managers acknowledge that this might be true of others, very few believe that it is true of themselves.
References
Williams, J.M. (ed.) (2006) Applied sport psychology: personal growth to peak performance. New York, New York: McGraw-Hill.