What Do Experts Really Know? Embracing the Unknown

“As we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns — the ones we don’t know we don’t know.”  

US Secretary of Defense Donald Rumsfeld during a Pentagon briefing

We assume professional experts know a lot about their areas of knowledge whether in national security, investing, medicine, or other fields. But, as Rumsfeld’s comment highlights, “metaknowledge,” or awareness of the limits of your knowledge, is just as important as knowing what you know.

Do professional experts have an edge over non-experts by having higher levels of metaknowledge? A new study sought to answer that question by conducting research with experts in the fields of climate science, psychological statistics, and investment.

The researchers concluded that experts did tend to have higher metaknowledge than non-experts. For example, they were less overconfident overall but had more conviction in their correct answers than non-experts. However, experts were also more likely to exhibit greater confidence in their wrong answers compared to non-experts.

Previous studies found cognitive biases among finance and medicine experts. For example, economists display overconfidence in their theories, despite a long history of incorrect forecasts. While touting the importance of decision analysis in general, investment professionals often fail to do so in practice. Yet, many maintain strong conviction in their sub-optimal conclusions.

Alas, years of experience does not seem to ameliorate these tendencies. Medical professionals have exhibited similar patterns. In one study, physicians’ confidence in a diagnosis remained at 70%, even when they correctly diagnosed difficult cases only 5.8% of the time. Just as misjudgements can harm a medical patient, sub-optimal decision analysis can harm a client’s investment returns.

Given the durability of certain cognitive biases, how can advisors de-risk decision-making by raising their metaknowledge? One way to do this is by leveraging individual investing talents within a structured team environment. This gives an organizational edge.

Organizational edge is not merely about the sum of individual talents but also how these talents are structured, integrated, and leveraged. A well-designed organization optimizes team dynamics, encourages effective communication, and fosters a culture that supports decision-making aligned with its strategic objectives. Having the right environment and processes in place can amplify individual capabilities which are as essential to success as are market strategies.

Bigger is not always better when it comes to investment teams. Having a large research investment team does not guarantee good decision making or sound judgement. In fact, it can add unnecessary complexity and inefficiencies into the investment process. Flatter organizations tend to do better. This may be due to more simplified structures.

Leveraging the insights of research analysts alongside those of portfolio managers is the mark of skilled leadership and a supportive environment. Teams with diversity in education, experience, skills, and knowledge can add value to an organization through shared goals and open communication.

Studies show that gender-balanced investment teams may have an increased potential to achieve superior risk-adjusted returns. A recent report by the CFA Institute Research and Policy Center offers a framework for improving gender diversity in the investment industry.

Key Takeaway

Confidence is a necessary but insufficient factor in long-term investing success. Raising the metaknowledge quotient of the investment team can help protect against the surprises that lurk in left-tail events and remain unknown, until they’re known.