Nov 4, 2022 · 52m · news
Michael Mauboussin: The Single Biggest Mistake Investors Make In Decision-Making | 20VC #945 · 20VC with Harry Stebbings
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Renowned investor and academic Michael Mauboussin joins Harry Stebbings to discuss the critical balance between luck and skill in investing, how to design robust, bias-resistant decision-making processes, and how to maintain perspective during periods of high market volatility.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Harry holds 18.5% of the talking time here. How this is scored →
Harry as informed peer 4.9 Guest teaching 5.1 Guest disagreement 0.7 Harry pushing back 3.4
speaking balance: gold is Harry, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 3:09 Rejection of popular luck aphorisms
Mauboussin explicitly rejects common sayings like 'luck is where preparation meets opportunity', dismissing them as unappealing under a rigorous definition of luck.
Hardest push from Harry ▶ 23:52 Challenging DCF models for early seed investingHarry directly pushes back against applying DCF models to pre-seed investments like BeReal, arguing that rigid monetization modeling causes investors to miss massive opportunities.
Biggest teaching moment ▶ 26:31 Horse race betting analogy for venture expected valueMauboussin reframes venture capital payoff distributions by comparing them to sophisticated horse race betting on parlays and exactas.
Harry holds his own ▶ 9:30 Harry outlines his media-venture investment committee processHarry demonstrates sharp domain expertise by explaining how his media platform creates deal flow and how he constructs 3-founder investment committees to maximize decision quality.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Harry as informed peer | Guest teaching | Guest disagreement | Harry pushing back | Why |
|---|---|---|---|---|---|---|
| Distinguishing Luck from Randomness | 3 | 5 | 2 | 2 | Harry asks Mauboussin to distinguish luck from randomness. Mauboussin politely rejects popular aphorisms on luck and details his coin flip classroom simulation to separate system-level randomness from individual luck. | |
| Attribution Bias and the Skill-Luck Continuum | 5 | 5 | 1 | 4 | Harry poses a thesis on how misattributing luck to skill can paradoxically benefit venture investors by reducing fear. Mauboussin expands on persistence in VC returns driven by preferential attachment. | |
| Designing a Congruent Investment Process | 7 | 3 | 0 | 3 | Harry presents his own investment process at the intersection of media and VC using 3-founder investment committees. Mauboussin strongly validates the process as congruent with Harry's source of edge. | |
| Pitfalls of a Bad Process: Biases and Overconfidence | 6 | 5 | 1 | 5 | Harry forcefully argues against thesis-driven investing due to confirmation bias risks. Mauboussin agrees and outlines pre-committed signposts and decision buddies to mitigate overconfidence. | |
| Psychological Safety and Deference to the Hippo | 5 | 5 | 0 | 2 | Harry asks how investment firms can foster psychological safety and eliminate fear in ICs. Mauboussin introduces the HiPPO concept and discusses techniques like starting with junior team members. | |
| Collaborative Hygiene: Independent Inputs and Premortems | 6 | 5 | 0 | 3 | Harry shares his tactic of using isolated Word documents prior to IC meetings to preserve uninfluenced thoughts. Mauboussin praises the hygiene and discusses premortems and Bayesian updating. | |
| Why Everything is a DCF (Even in Venture Capital) | 4 | 6 | 2 | 4 | Harry asks about Mauboussin's claim that all investments reduce to DCFs. Mauboussin explains how basic economic units, real options, and ultimate exit cash flows apply to venture capital. | |
| Value of Option Play in Pre-Seed and Seed Investing | 6 | 7 | 3 | 7 | Harry challenges the DCF framework for pre-seed investments like BeReal where monetization is unknown. Mauboussin defends expected value models using horse race betting analogies like exactas and parlays. | |
| Supply of Capital and Venture Return Compression | 7 | 5 | 0 | 5 | Harry warns that surging capital supply in VC threatens to compress venture returns toward private equity levels. Mauboussin validates the concern and cites academic data on public market equivalents. | |
| Exit Strategies and Latching Onto Winners | 6 | 6 | 0 | 4 | Harry references Doug Leone's advice to never sell winners and compares index-style VC to concentrated picking. Mauboussin cites Bessembinder's research on return concentration and capacity constraints. | |
| Advice for Young Investors: Focus on Business Analysis, Not Macro | 4 | 6 | 0 | 2 | Harry asks how young investors should navigate volatile markets. Mauboussin advises focusing on business analysis rather than macro forecasting and shares his memory of the 1987 market crash. | |
| Market Volatility and Volatility Clustering | 5 | 6 | 1 | 5 | Harry presses on whether current macro and geopolitical instability makes this crisis unique. Mauboussin explains volatility clustering and puts current turbulence into historical context. | |
| Valuation Drivers: Real Rates, Duration, and Consumer Surplus | 5 | 7 | 0 | 4 | Harry asks whether software multiple compression reflects a new normal. Mauboussin provides a detailed lesson on real interest rates, equity duration, and pricing power via consumer surplus. | |
| Quick Fire: Consilience and the Genius of Bill Gurley | 3 | 4 | 1 | 1 | In the quick-fire round, Harry asks about Mauboussin's favorite book and Bill Gurley's strengths. Mauboussin highlights EO Wilson's Consilience and Gurley's early grasp of increasing returns. | |
| Quick Fire: Strengths, Weaknesses, and Advice | 4 | 5 | 0 | 3 | Harry asks about personal strengths, weaknesses, and investment mistakes. Mauboussin reflects on his Sears Holdings investment and lessons on challenging businesses versus strong managers. | |
| Quick Fire: Performance Routines: Exercise and Sleep | 3 | 2 | 0 | 1 | Harry asks about daily performance routines. Mauboussin emphasizes the cognitive benefits of eight hours of sleep and daily exercise, concluding with his belief that the best teachers are constant students. |
Statements from this episode (38)
Mauboussin: Luck operates individually while randomness operates at the system level
“I'm going to say luck has three conditions. It happens to an individual organization, so to you or your company or your favorite sports team. Second is it can be good or bad. Don't mean to suggest that it's symmetrical, but there's a positive sign potentially …”
Mauboussin: Strong investment track records often stem purely from systemic randomness
“When you think about investing, there may be a lot of randomness in the system, and some people are going to be in the position to be lucky, and hence, they'll, their track record, for example, may look good as just beneficiaries of a random system.”
Mauboussin: Human minds struggle to judge where activities fall on the luck-skill spectrum
“And most things are at some between those two extremes. And I think our minds are not particularly good at sorting out where that activity is on that luck skill continuum. And as a consequence, it's misattribution basically.”
Mauboussin: Venture capital continues to have high performance persistence
“If you look across asset classes, the asset class that continues to have high persistence is actually venture capital.”
Mauboussin: Venture return dispersion leaves median and bottom firms with dismal results
“What we know is that there's huge dispersion in returns in venture capital. So if you own the top decile or top Quintile type of firms you do spectacularly well over time, but if you own the median firm or a bottom quartile firms, the results are actually quit…”
Mauboussin: Buyout fund performance persistence has melted away over 20 years
“That persistence used to have to happen in buyouts. But that effect is mostly melted away in the last 20 years, and it's very difficult to find persistence in public markets at all.”
Mauboussin: Investment processes must align directly with an investor's edge
“So the key is that there is no one size fits all for process, I think. But rather that you want to make your process congruent with your perceived source of edge.”
Mauboussin: Fund managers must execute their actual process, not aspirational marketing
“Usually when you're marketing your fund or something, there's a little bit of aspirational component to what you say you do, but the key is to be as congruent, to do actually, to cue as closely as possible to that process in order to achieve the results you pu…”
Stebbings forms custom three-founder investment committees for every 20VC deal
“Through the media, I meet the world's most brilliant founders, and with each deal, I create an individual investment committee of three leading founders in that specific space, and I bring their collective minds to make the best decisions together.”
Mauboussin: Three-person committees enable healthy dissent via majority vote
“And the other thing about three is if it comes down to it, you can actually have a two to one, people can vote and it can be two to one and you can proceed without, you know, you can have the dissenting voice be in the room in a way that's not ultimately destr…”
Mauboussin: Overprecision and confirmation bias are the biggest investment decision pitfalls
“Two big sources of bias, I think are one is overconfidence. And when you look at overconfidence, usually the sub-component of oral confidence of the problem is over precision, which is you start to think you know what the world is going to be rather than bette…”
Stebbings: Thesis-driven investing creates confirmation bias and leads to bad decisions
“So this is why I don't like thesis-driven investing, if I'm honest, Michael.”
Mauboussin: Thesis-driven investors must pre-define probabilistic signposts to prevent bad deals
“If you do have a thesis, and by the way, I'm not adverse to that, but if you have a thesis, you should be thinking about so-called signposts, which is to say, if this thesis is correct, here are the things that we should see happen as we travel down this road,…”
Mauboussin: The optimal decision-making team size is three to six people
“Usually smaller is better, right? And that the right number is between three and six, something like that.”
Mauboussin: Team decision failures stem from poor management, not cognitive homogeneity
“Usually there's cognitive diversity in the room. Almost always where the failures occur is in how it's managed.”
Mauboussin: Leaders should solicit team feedback starting with the most junior person
“Thing is if I'm the leader in the organization to go and ask the opinion of the most junior person in the room first, and then go, go up in seniority from there.”
Stebbings uses isolated Word documents for committee feedback to prevent groupthink
“So the way I do it is I send out actually a Word doc, not a Google doc, because that's obviously collaborative. I sent out a Word doc the night before. So it's all in isolation. No one sees what other people put. And then they have this kind of free space to r…”
Mauboussin: Premortems surface downside risks by forcing independent, forward-looking critique
“And the other one, I mean, the other technique is known as a premortem, which you're probably familiar with, which is we pretend we made the investment. It's now a year from now, or two years from now, and this investment's turned very sour. It's very bad. We'…”
Mauboussin: Empirical data shows odd-numbered investment committees outperform even-numbered ones
“Three is better than two. That's a best practice. And by the way, five is, is not five is better than four. For instance, these odd numbers tend to be good things in terms of, and there's good data. Pardon me. There's good data to back all that up”
Mauboussin: Corporate capital allocation has shifted predominantly to intangible assets
“We've had in the last few decades, a huge rise in intangible investment, right? So companies used to invest in factories and machines and inventory, old fashioned stuff. And the accounting for that was a certain way. Now companies are investing mostly in intan…”
Mauboussin: Four Key Conditions Required for Real Options Valuation to Apply
“Real options tend to be relevant when there's a lot of uncertainty, which is almost always true for young companies. Second, when we have an astute management team that knows how to cultivate and ultimately exercise options appropriately, when there's access t…”
Mauboussin: Investment success depends on win magnitude, not win frequency
“So it's not how often you make money that matters. It's how much money you make when you're right.”
Mauboussin: High seed startup valuations can have positive expected value
“Sometimes it's going to seem insane to pay a lot, thirty million dollars for two people in a garage. When that still may have positive expected value, if that becomes one of the few things that really drive the value.”
Mauboussin: Heavy capital inflows into an asset class inevitably compress returns
“Anytime you see capital flowing into something, you should worry about returns. That's just, that's like a basic rule.”
Mauboussin: Venture capital excess returns are highly episodic and short-lived
“If you look at long-term public market equivalent, so, so this is how academics are measured is public market equivalent for venture capital. It's actually been pretty good over long periods of time, but it's extremely episodic. So almost all the returns are e…”
Mauboussin: Buyout funds consistently beat venture capital on a PME basis
“Buyouts, by the way, have consistently been a little bit better than private equity have been a little bit better than venture. They're much less episodic or dramatic, and they tend to chug along a little bit over one PME.”
Mauboussin: Less than 5% of public companies drive all market value creation
“Work by Hank Bessenbinder demonstrates that in public markets over long periods of time, most companies, public markets earn Returns less than the treasury bill rates. And it's like a handful, less than five percent of companies basically drive all the value f…”
Mauboussin: Scattershot investing strategies will shift primarily to later rounds
“So there's gonna be a bottleneck at, in terms of how many firms can actually do that at a very successful level. And this is sort of Series A really adding value at the Series A level. So I think when, the more the scattershot philosophy can be later rounds pr…”
Mauboussin: Literature proves people are bad at forecasting macro events
“There is a large literature demonstrating that people are not good at forecasting those things.”
Mauboussin: The 1987 Crash Appears Minor on Long-Term Charts
“And then I would encourage you now to look at a long-term stock price chart and go find the crash of 1987 on there and look at it and see like how significant it is. Right. So the, at the time it seemed to be very profound at the time it was earth shattering. …”
Mauboussin: Financial Market Volatility Empirically Clusters in Bunches
“Empirically in finance, we know that's not true. That we know that volatility and shocks tend to come in bunches, right? So, so you get quiet periods interspersed with periods of great volatility, then quiet and volatility and so forth.”
Mauboussin: US stock volatility in 1920s-1930s far exceeded recent financial crisis
“Go back and look at volatility. And, you know, you see that the volatility we've seen in the last 10 or 15 years, even including the financial crisis, really doesn't hold a candle to the volatility we saw in the 19 twenties and thirties in the United States. T…”
Mauboussin: US 10-year real interest rates experienced a 240-basis-point swing
“When the United States, for example, we went from on the tenure negative a hundred basis points, real interest rates, -100 basis points today, about a 140 positive basis points. So it's a 240 basis point swing in real interest rates.”
Mauboussin: Consumer surplus and pricing power shield companies from nominal rate hikes
“You can't dodge the real rate increase, but you can dodge nominal rate increases if your company has pricing power. So this goes back to when we think about technology companies or any kind of company, are they delivering a good or service that creates consume…”
Mauboussin: Solving complex problems requires combining multiple disciplines
“Consilience is the unification of knowledge, and the argument he makes is many of the vexing problems we have in our world will require combining different disciplines together to try to solve them.”
Mauboussin: Bill Gurley pioneered applying return on capital and increasing returns
“I think he's very early on understanding the importance of return on capital investment returns, cash flows, and he applied it right away. Very successfully, by the way, in investments. The second is he was very early on and understanding Brian Arthur's work o…”
Mauboussin: Expected Long-Term Equity Returns Have Increased Significantly in 2022
“When you look at even 20, 22, Expected returns for equities have gone up a lot. I don't know if the markets are going to be good the next month, three months, six months, but I think expected returns look pretty good.”
Mauboussin: Great managers rarely overcome bad business economics
“If a challenging business and brilliant management, it's likely the business's reputation remains intact. I think that was a good example, which is I really liked the CEO, but I the business itself was challenged and the reputation of the business remained int…”