Good poker skills certainly seem to help if you’re a hedge fund manager. A new study, Hedge Fund Hold’em, has found hedge fund managers who do well in poker tournaments enjoy significantly better fund returns. “This effect is stronger for tournaments with more entrants, larger buy-ins, larger cash prizes and for managers who win multiple tournaments,” the study notes, “suggesting poker skills are correlated with fund management skills.” Is it possible the hedge fund managers in the sample are simply big gamblers who got lucky, or that they were rewarded for taking extra risk? No – managers who played poker “are not more risk-seeking than their non-player counterparts”. Quite simply, the results show “skilled poker players are, on average, better fund managers”.
This isn’t news to the hedge fund community. Billionaire hedge fund manager Steve Cohen, the study notes, has attributed poker as “the biggest determinant in [his] learning to take risks.” High-profile hedge fund manager David Einhorn, famous for having bet against Lehman Brothers more than a year before the bank collapsed in 2008, finished third in one of the biggest poker games of all time in 2012. Options trading giant Susquehanna International Group, founded by six poker enthusiasts in 1987, gives new recruits copies of poker manuals and ensures they undergo rigorous training at poker tables. Vanessa Selbst, a former poker pro who last year joined the largest hedge fund in the world, Bridgewater Associates, said her new job “feels a lot like poker – a bunch of nerdy kids collaborating to try to beat our opponents at a game”.
The study quotes game theorist and philosophy professor Kevin Zollman, who describes poker as “the best off-time activity to improve investing skills”. Why? “Investing has a lot of the same features as poker,” says Zollman. Both are games of “incomplete information”; like investing and unlike the game of chess, which is determined solely by skill, there is randomness in poker.
That’s echoed by former world poker champion Annie Duke. “You could teach someone the rules of poker in five minutes, put them at a table with a world champion player, deal a hand (or several), and the novice could beat the champion,” Duke writes in her book Thinking in Bets. Most things in life – including investing – are like poker, not chess. It is a “game of incomplete information”, of “decision-making under conditions of uncertainty”; important information “remains hidden” and there is “an element of luck in any outcome”. Luck can allow a hopeless poker player to go on a winning streak, just as a clueless investor can make a bundle by getting lucky on a speculative stock.
Duke’s emphasis on the part played by luck is shared by money manager and behavioural finance expert Michael Mauboussin. He points out that while it’s hard to beat the market, it’s also difficult to construct a portfolio that will do a lot worse than benchmark indices. The fact that it’s so hard to lose on purpose indicates investing is “pretty far over to the luck side of the continuum”, says Mauboussin.
You don’t need to be a risk-taking gambler to be interested in poker, says Duke, who argues everyone should view decisions as bets. “Job and relocation decisions are bets,” she says. “Sales negotiations and contracts are bets. Buying a house is a bet. Ordering the chicken instead of the steak is a bet. Everything is a bet.”
While some bets are implicit rather than explicit, investments are “clearly bets”, she says. “Deciding not to invest or not to sell a stock, likewise, is a bet. These are the same decisions I make during a hand of poker: fold, check, call, bet or raise.”
Duke’s message is that to make good bets, you have to think probabilistically and avoid what is known in poker as “resulting” – the tendency to believe that results indicate the quality of a decision. She gives the example of the 2014 Super Bowl, where there were only 26 seconds left in the game when Seattle Seahawks quarterback Russell Wilson was instructed to pass the ball. The pass was intercepted and the Seahawks lost “because of the worst call in Super Bowl history”, as one headline writer put it the next day. In fact, opting to pass was a perfectly reasonable decision; Duke notes only about 2 per cent of passes are typically intercepted in that situation.
Resulting, or outcome bias as it is known in behavioural finance circles, is an extremely common mistake. In her consultations with executives, Duke often asks them to give a brief description of their best and worst decisions of the previous year. “I have yet to come across someone who doesn’t identify their best and worst results rather than their best and worst decisions,” she says.
Like poker players, investors should learn to embrace uncertainty and think in terms of probabilities (a point also stressed by noted predictions expert Prof Philip Tetlock in his book Superforecasters). Similarly, instead of asking, “Are you sure?”, Duke suggests asking: “How sure are you?” The former is a yes-or-no question that demands unreasonable certainty, Duke tweeted earlier this year; the latter “allows for shades of grey” and says “uncertainty is okay”. That’s good advice, says Ritholtz Wealth Management strategist Ben Carlson. “Many investors would like to hear advice that is unreasonably certain,” says Carlson. “It provides a level of comfort, even if it’s a false sense of comfort.”
Another way of diminishing our instinctive overconfidence, says Duke, is to ask a simple question: “Wanna bet?” Doing so helps you recognise there is always a degree of uncertainty and that nothing is black and white – a “pretty good philosophy for living”, she says, not just for investing.
Investors should also be wary of what poker players call “going on tilt”, says Duke. After a run of bad luck, players can get frustrated and play over-aggressively in order to try and make up their losses. Again, the parallels with investing, where it’s all too easy to make bad bets in a misguided attempt to claw back earlier losses, are obvious.
Invest with poker players?
Instead of learning poker skills, couldn’t investors simply invest in funds headed by skilled poker players? Alas, no – the aforementioned study found such hedge funds underperform following big poker wins. The connection between poker skill and investing skill is well known, so money tends to flood into such funds following high-profile tournament wins. Size hurts investment performance; as Warren Buffett often points out, it’s a lot easier to be nimble and to make big bucks if you’re managing millions rather than billions. Thus, it’s too late to buy into a fund after a big poker victory.
“Put another way,” the study concludes, “investors in hedge funds do not know when to hold’em.”