Elite athletes sometimes say about the times when they delivered peak performances that they were in the zone. The athletes say of these experiences that their goals were completely clear and their concentration was total; that they were in control without trying to be; and that they felt an effortless merging of action and awareness. The psychologist Mihaly Csikszentmihalyi has written extensively about the experience, and he says that for this state of flow to come about the contents of consciousness need to be well ordered.

This experience of being in the zone or in a state of flow is not the sole preserve of the elite athlete; it happens in all walks of life, including the investment industry. You may have had this experience yourself as a fund manager, perhaps a period when everything was perfectly clear; when you were totally in sync with the market; and when it seemed impossible to make a bad call. When that happens it’s almost a religious experience, where you feel as if you have been personally anointed by the market gods.

My view is that the reason that this highly desirable state of flow is all too fleeting and all too infrequent, and for some people unattainable, is that we are all subjected to a barrage of disturbances, interferences and disruptions that cause the contents of consciousness to become disordered. In a word, we are all subjected to noise. Noise is a term that is commonly used in the investment industry to refer to a mild irritant, something inconsequential that is best ignored. That’s nowhere near a complete or accurate description.

Noise is the anti-flow. Noise sows disorder in the contents of your consciousness. Noise undermines the quality of your investment decisions and the quality of your professional relationships. Noise destroys.

The nature of noise becomes clearer if you think of noise as a phenomenon that can be categorised into pairs of types.

The first pair of types  differ in this way:

  • Acute. Acute noise is experienced as a sudden, intense shock.
  • Chronic. Chronic noise is experienced as an ongoing, low-level disturbance.

To use an ecological analogy where noise is equated to an environmental pollutant, an example of acute noise is a major spill from an oil tanker into the ocean, whereas an example of chronic noise is the accumulation of carbon emissions in the atmosphere. Both of these pollutants threaten an ecosystem with disintegration and collapse, but they do so in different ways on different timescales.

A second pair of types is:

  • Manifest. Manifest noise is readily perceivable; it’s quite obvious.
  • Latent. Latent noise is self-obscuring; it’s largely imperceptible.

This distinction is made clearer when we consider your investment performance. If you were to have a terrible month, say -10%, or twice as bad as your peer group, that performance print would be an obvious (and acute) source of disturbance. That’s manifest noise; it’s noisy and, man, don’t you know it. This noise would dent your confidence, which would affect future investment decisions.

If, on the other hand, you were to have outperformed your peers for the past year, this situation would not seem obviously noisy. That’s because it’s latent noise; noise that has not yet manifested itself. Your outperformance would have the effect of subtly inflating your sense of confidence, perhaps out of proportion to your actual level of skill, which would also affect future investment decisions, usually not in a favourable way. Overconfidence is a cognitive bias that will eventually bite you in the rear.

So, noise is a problem. But it’s also an opportunity.

Your job as an active fund manager is to take advantage of informational and behavioural asymmetries. Without pricing inefficiencies, there would be no prospect of you capturing alpha. These asymmetries exist because of noise; without the problem of noise, everything would be priced efficiently. But noise also makes it very difficult to take advantage of the inefficiencies. This seems to trap you in a dispiriting circularity.

Fortunately, there is a third pair of types of noise that points the way out.

  • Generalised. Generalised noise is experienced by all people.
  • Localised. Localised noise is experienced by you.

Noise is a problem when you experience it, when it’s localised, because it undermines your capacity to function at an optimal level. But everyone, every fund manager everywhere, is subjected to noise to some degree; therefore it’s a generalised phenomenon.

When you deal with noise better than your competitors you have an advantage. The better you deal with noise, the less prone you are to the cognitive biases that undermine your investment performance, and the less susceptible you are to the non-constructive behaviours that undermine your professional relationships. When localised noise is lower than generalised noise, you have an edge. This edge enables you to take advantage of others’ noise-induced errors of judgement in the markets, and it enables you to constructively shape outcomes in human relationships.

Dealing with noise is a relative game; you don’t have to be 100% noise-free yourself in order for noise to represent an opportunity, you just have to experience relatively lower noise levels than your competitors. To transform noise from a problem into an opportunity, you have to deal with noise; and to do that, you need to understand noise.

Paradoxically, noise is an opportunity because it’s a problem. And while noise is a problem for everyone, it is an opportunity for the few who are willing and able to engage with the issue.

  • How does noise subtract from your capacity to function as an investment professional?
  • What makes it that way? What’s your contribution to the situation?
  • What, if anything, will you do differently?