The Garrulous Jay – Logic Versus Magic

In his excellent book Alchemy the columnist and erstwhile advertising executive, Rory Sutherland, draws a distinction between ‘logic’ and ‘magic’. He argues that too many Board Rooms are driven by a focus on the former rather than the latter.

At the start of the book he cites the example of the soft drink, Red Bull, pointing out that no highly-paid team of marketing experts or management consultants would have created the infamous drink that “gives you wings”.

That a beverage that draws a violently negative reaction from many on first taste, the colour of cloudy wee, packaged in small cans and sold at a premium could end up being one of Coke’s biggest rivals would have seemed inconceivable based on “logic” alone.

But Sutherland’s point is we humans do not act solely on logic… Until, that is, we pass through the revolving doors into the companies where we work, and the banks where analysts pore over their spreadsheets trying to find hidden value in those businesses.

Logic, Sutherland argues, is the safe bet: the way to avoid being fired… Like “buying IBM” used to be according to the old adage.

He goes on to suggest that long-term business success is based as much on ‘magic’ as it is logic. In other words, one needs to recognise the psychological as well as the logical drivers of people’s purchasing propensities.

“All very well,” I hear you say, “but this clearly doesn’t apply to the world of investing and portfolio management does it?”

The answer is both ‘yes’ and ‘no’.

On the one hand, I fear most investment managers and equity analysts fall into the trap of being driven by logic, P&L progression, balance sheet resilience and peer group comparisons. They are bound by numbers and incrementalism.

To be fair, it’s incredibly hard to value a future market disrupter, because they start by being both rare and small in size. Even so, in my experience of working in the City branding, marketing, advertising, innovation and new product development were viewed as more of a cost centre than a profit centre.

That’s a good way to miss some of the Big Opportunities.

On the other hand, and perhaps perversely, investors do sometimes seek magic as well as logic when deciding to back a fund or fund manager with their money.

One investment company exemplifies this better than any other. It flies in the face of conventional wisdom on diversification, making concentrated bets on a few companies and sectors. What’s more this company is run by one 92 year-old man who has been at the helm of the fund since its inception.

As at 30th June Berkshire Hathaway had 46% of its listed portfolio in Apple, and a further 15.6% in Bank of America and American Express (source: company 13F return). It also holds $147.4 billion in cash… Yes, you read that right.

To be clear, I have no view on whether or not Berkshire Hathaway is a good or bad investment. But I do know that those that buy the fund base their decision on a belief in magic as well as logic.