Feb 19, 2024 · 54m · capital-allocators
Michael Mauboussin - Pattern Recognition and Public Markets (EP.370)
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Michael Mauboussin joins Ted Seides to examine the cognitive limitations of pattern recognition in investing, alongside structural shifts in public markets including power-law wealth creation, intangible capital, and drawdown resilience.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 23.2% of the talking time here. How this is scored →
Ted as informed peer 5.5 Guest teaching 5.6 Guest disagreement 0.3 Ted pushing back 1.1
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 20:26 Pushing back on practitioners' overuse of pattern recognition
Mauboussin gently challenges the common money manager trope that pattern recognition is the sole key to successful investing, noting that people frequently rely on faulty causal narratives.
Hardest push from Ted ▶ 36:21 Ted challenging the multi-decade wealth creation premiseTed presses on the practical application of Bessembinder's data by asking how the dynamics shift when truncating the timeline from a century to standard three-to-five-year horizons.
Biggest teaching moment ▶ 31:40 Bessembinder's stark wealth destruction statisticsMauboussin educates listeners on the surprising empirical reality that nearly sixty percent of all public stocks fail to beat Treasury bills and destroy trillions in aggregate wealth.
Ted holds their own ▶ 36:21 Ted highlights percentage returns versus dollar wealthTed demonstrates sharp allocation acumen by reminding the guest that money managers operate on percentage returns rather than aggregate dollar wealth creation across generations.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Episode Overview and NetSuite Promotion | 5 | 6 | 1 | 2 | Ted opens with an intro and ad read, then initiates an inquiry into pattern recognition by asking how to distinguish true expertise from mere experience in complex adaptive systems. Mauboussin provides a structured tutorial differentiating stable linear domains like chess from complex systems like financial markets. | |
| Applying Decision Aids to Microeconomic Analysis | 6 | 5 | 0 | 1 | Ted probes whether microeconomic corporate analysis is less reflexive and more amenable to pattern recognition than macroeconomic forecasting. Mauboussin affirms Ted's intuition and outlines how corporate base rates and quantitative decision aids can assist fundamental investors. | |
| Base Rates and Skill Evaluation in Manager Selection | 6 | 4 | 0 | 1 | Ted asks how decision aids and pattern recognition map onto manager selection. Mauboussin defers to Ted's domain expertise on allocators while explaining the importance of separating persistent causal skill signals from luck. | |
| Cognitive Biases and the Domain Applicability Continuum | 5 | 5 | 1 | 1 | Ted inquires about common misuses of pattern recognition and how practitioners can calibrate their intuition. Mauboussin describes cognitive biases and outlines his framework of a domain applicability continuum. | |
| Sports Analytics Parallels and Behavioral Acquiescing | 6 | 6 | 1 | 1 | Ted draws a parallel to Michael Lewis's Moneyball to ask why professionals persist in gut storytelling despite data. Mauboussin introduces the psychological concept of acquiescing and details a study on NFL fourth-down analytics. | |
| Public Market Return Profiles and the Listing Gap | 5 | 6 | 0 | 1 | Ted pivots the conversation to the structural evolution of public markets. Mauboussin outlines historical equity risk premia shifts and details the academic literature behind the listing gap and micro-cap delistings. | |
| Sponsor: Ridgeline Investment Management Platform | 5 | 7 | 0 | 1 | Following a sponsor read, Ted asks how private equity has influenced public market contraction and return generation. Mauboussin shares Hendrik Bessembinder's findings showing that only two percent of public companies account for nearly all net wealth creation. | |
| Portfolio Construction Strategies for Skewed Return Distributions | 7 | 5 | 0 | 2 | Ted astutely notes that Bessembinder's wealth creation data spans multi-decade horizons and asks how the dynamic alters over shorter horizons. Mauboussin enthusiastically agrees, breaking down the difference between percentage returns and cumulative dollar wealth creation. | |
| Intangible Capital and High Return Persistence | 5 | 6 | 0 | 1 | Ted asks about identifying persistent long-term compounders. Mauboussin explains how intangible capital, proprietary software, and scale benefits allow top-tier technology firms to sustain unprecedented returns on invested capital. | |
| Private Market Macro Shifts and Exit Bottlenecks | 5 | 6 | 0 | 1 | Ted asks for an assessment of private markets. Mauboussin explains why allocators moved into private markets to meet liabilities and analyzes current exit bottlenecks caused by the frozen IPO window and antitrust hurdles. | |
| Drawdown Resilience in Long-Term Compounders | 5 | 6 | 0 | 0 | Ted asks what is required to hold compounders long term and what new research Mauboussin is undertaking. Mauboussin highlights the necessity of enduring 75-85% drawdowns and outlines his ongoing studies on increasing returns and corporate hurdle rates. |
Statements from this episode (28)
Mauboussin: Genuine Expertise Requires a Predictive Model, Not Just Experience
“I guess the way you could say it is all experts have experience, but not all experienced people are experts. And so what Northcraft says is an expert is someone who has a predictive model that works.”
Mauboussin: Intuition and Expertise Only Function in Stable, Linear Environments
“One of the ways to think about this, and this actually frames pretty much the whole report as well, is that you're likely to see expertise work or intuition work, candidly, is when you have environments that are relatively stable, where the relationships are l…”
Mauboussin: Simple Algorithms Beat Expert Forecasters in Complex Markets
“And so what we know, and this has been extraordinarily well documented by folks like Phil Tetlock, psychologist, University of Pennsylvania, and others is that in quotation marks, expert forecasts, they tend not to be very good at it. In fact, typically simple…”
Mauboussin: Pattern recognition works better on micro than macro levels
“So I do think it's going to be more effective on the micro level than it's going to be on the macro level, because it's just a much simpler problem to try to parse.”
Mauboussin: Fundamental investors underutilize available decision aids
“Many fundamental investors don't really use those decision aids, or they don't use them as much as they possibly could, and so that's a fascinating area for us to explore, which is, are there decision aids at our fingertips that we're not accessing as fundamen…”
Mauboussin: Fundamental investors lack structured, quantitative position sizing
“I think most fundamental investors have some sense of why their position sizes are what they are, but in a sense, they're not quantitative or they're not completely structured.”
Mauboussin: Investors Selectively Remember Successful Pattern Recognition and Forget Failures
“We remember when pattern recognition led us to a good outcome, even if it was luck, and we forget about when it led to a bad outcome, even if it was bad skill. That's the other thing is we're very selective as to when we remember when it works and when we reme…”
Mauboussin: People Overapply Personal Experiences and Ignore Broad Base Rates
“The key thing to underscore in all this is that we all have our little mental databases. We've all had experiences. We've all had wins and losses. We value those, right? They're important to us. And so we tend to think that they're going to apply more than the…”
Mauboussin: US expected real equity returns reached mid-6% in January 2024
“January first, 20, 24, expected equity returns are eight and a half percent nominal. You take out the inflation expectations. Your real equity returns are from the mid sixes, low to mid sixes. Not great, not compelling, but a heck of a lot better than Real thr…”
Mauboussin: US public companies declined from 7,300 in 1996 to 4,200
“In 1996, we reached the apex, which is a little over 7300 companies. Today, we don't have the 20, 23 numbers yet, but it's gonna be around 4200. So we're not only way lower than the peak, we're lower than we were in the 19 seventies.”
Mauboussin: US IPOs averaged 280 annually before 2001 vs 120 since
“The main way companies get added are initial public offerings, and what we've seen is IPOs from 76 to 2000 averaged about 280 per year. They're a couple years way above that, and since 2001, they're about a 120. And by the way, the last couple years, Have been…”
Mauboussin: Private equity buyouts represent 20% of public company delistings
“Since in the last 10 or 15 years, buyouts have been about 20% of delisting of public companies.”
Mauboussin: Top 2% of public companies generated 90% of US wealth creation
“What's remarkable is if you distill that even one step further, the top two percent of that 28,000 created 50 trillion dollars. Of the 55 trillion in total. So just two percent of all these companies are essentially 90% of the total wealth creation.”
Mauboussin: Public equity returns exhibit the same power law as venture capital
“We associate power laws with venture, but if you let it play out in public markets, it's also the exact same power law. It's a power of compounding is the key insight.”
Mauboussin: Finding superstar compounders creates difficult portfolio diversification challenges
“The one thing I'll point out though, I guess to state the obvious, is if you do find one or two or three of these superstar companies, They appreciate a lot, and they get really big in your portfolio, and so you get in these interesting challenges with diversi…”
Mauboussin: GM and GE remain top 20 lifetime wealth creators
“For example, you think about the leaderboard, the top 20 greatest wealth creators of all times, and it would include some suspects you would guess, which would be Apple and Microsoft and Amazon and Alphabet and so forth, but it also includes things you might n…”
Mauboussin: Mega-Cap Economics Have Defied Classical Theory Since 2000
“Since 2000, roughly speaking, it feels like the economics of the biggest companies have been almost economic law defying by that. I mean, two things. One is they've grown faster than what we would expect big companies to do. And they've sustained very high ret…”
Mauboussin: Top Quintile Public Company ROICs Have Widened Lead
“The ROICs for the top quintile of public companies has distanced itself from the next quintile and sustained at a very high level”
Mauboussin: Magnificent Seven Economic Profit Exceeds Market Cap Share
“When you take a look at the economic profit, so return on capital, less cost capital spread times invested capital, the economic profit Of the Magnificent Seven, it's actually larger than their market cap representation.”
Mauboussin: DOJ and FTC antitrust focus chills strategic M&A exits
“We've seen a really substantial uptick in antitrust focus. Whether or not the Justice Department or FTC wins these cases, it creates friction and makes managers and executives, it creates uncertainty as to whether they want to do these things.”
Mauboussin: Sponsor-to-sponsor sales became the primary buyout exit mechanism
“Obviously the number one technique for buyouts to exit was selling to other buyout firms.”
Mauboussin: Mandatory long lockups in VC and PE benefit investors
“And because venture and buyouts have essentially longer time horizons, whether people like it or not, they have to sit in their seats for a while. And that's actually, I think probably been to their benefit versus to their detriment.”
Mauboussin: Tech companies are not overrepresented among top compounders
“The other thing he pointed out technology companies, they're not overrepresented actually.”
Mauboussin: Almost all top compounder stocks suffer 75%+ drawdowns
“He documented that almost every one of these great compounders had massive drawdowns at some point. And it was common to have drawdowns of 75% or more, but some were 80, 85% drawdowns.”
Mauboussin: Non-Financial Companies Built Cash Rather than Investing During Easy-Money Era
“What did companies actually do? None of that stuff. They actually didn't invest more. And so what capital structures got more conservative cash balances. Built up on balance sheets is excluding financial services companies.”
Mauboussin: Companies Ignore Cost of Capital and Rely on a 15% Hurdle Rate
“So it turns out it's really interesting that companies, they calculate their cost of capital. They know it, but they don't use it. For almost everything they do, they use a hurdle rate, and that hurdle rate's roughly 15%. So whether the cost of capital goes to…”
Mauboussin: Top investment managers excel at curiosity and epistemic rationality
“The thing that almost always strikes me about the best managers that I know is I guess two aspects of it. One is they're always curious about the world and want to learn about the world. And so anytime you find someone in investing who's not curious, you shoul…”
Mauboussin: Investors must understand underlying economics before using valuation multiples
“I always tell my students, you have to earn the right to use a multiple. In other words, you can demonstrate that you understand what the economic implications are. That always bothers me that people are very comfortable throwing around heuristics or multiples…”