The Wisdom Wall

“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.”

“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 returns on capital that have really not been driven down in a…”

“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 six or eight or 10, it doesn't make any difference. They're…”

“And the paradox of skills when both luck and skill are contributing to outcomes, which, which is most things, right? There are some things that are mostly skill like running races, but, but most things in life have at least a dollop of luck. It can be the case that a skill gets better. Luck becomes more important,…”

“The fact that you and I are suboptimal and it's easy for us to show that we're suboptimal as individuals that doesn't necessarily translate into a market setting, right? Because our errors may cancel out. You're overconfident. You buy, I'm overconfident. I sell. It's a wash, right? Basically.”

“If you're an entrepreneur and you actually know the base rates of failures for entrepreneurs, you might never try in the first place, right? So there's this really interesting tension, I think, between we want that optimism at the global level. We want people to try out stuff at the global level, but if you're making…”

“in some ways, I think that one of the advantages of private equity for, I will speak specifically to buyouts, Is that investors can't pull their money out of these things. And as a consequence, they don't see the volatility. They have no chance to transact at what would be deleterious prices relative to what they…”

“what we have shown is that it's very clear that the standard deviation of alpha is Is greatest following periods of high dispersion. So that's saying that high dispersion allows, the tide goes out, you know, who's wearing a swimsuit. High dispersion, that allows us to figure out who's skillful and who's not skillful.…”

“So saying this slightly differently, you might have two companies They're both losing money, but one where the economics are fantastic, and you want them to lose money because they're engaging in NPV positive investments. Another company losing money that's actually bad, right, because they're engaging in negative NPV.…”

“The point I try to stress is that it's not clear to me that those little things actually manifest in markets, right? Because They can cancel out, essentially. So the market is really, you're not competing. It's not me, Michael versus Ted. It's really Ted versus the market, and that's a different dynamic. So you're…”

“So the wisdom of crowds exists when you have Heterogeneous agents. Good aggregation mechanisms. So in other words, the information is being brought together and you have good incentives. And by the way, that should be your default assumption is that markets are pretty smart and probably smarter than you are. But we…”

“the biggest mistake in the investment business is a failure to distinguish between between fundamentals and expectations, which is to say, when fundamentals are good, we all want to buy. Welcome to the human race, right? And when fundamentals are bad, you want to sell. And really, the mindset you should have is that of…”

“Well, what would the world look like, and what are the primary, secondary, and tertiary effects of that happening? There is no program that can help you, computer that help you do that, because this is not in the data, right?”

“It's almost always the case when individuals get excited and start directly investing that the story doesn't end happily for them.”

“I've always thought that in the world of investing, it's just really rare to have an honest consensus. You know, most good investment ideas are controversial. It's very rare that everyone says this is obviously brilliant or obviously right.”

“the small variance and performance of active managers, part of that's also a function of the volatility being low. And we can demonstrate that. So, you know, it's very difficult to distinguish yourself either favorably or unfavorably when the volatility of the markets are very low.”

“Bill Belichick goes four and a fourth down, and it doesn't work out. People give them the benefit of the doubt, but if you're a coach who's got a 500 team, it may be the correct decision, but you lose that game. People don't think about the quality of your decision making process. They do think about the outcome and…”

“some of the academic work and some of the simulation work suggests that the time horizon is a little bit longer than it is practically. But the flip side is if I'm an allocator and I have someone who's underperforming, I don't really don't know if it's just a good process. That's, you know, having a tough spell or…”

“John's, I think, very provocative point is that it's not about interest rates. It's about margin requirements. It's about the ability to borrow. And we tend to think that if we lower interest rates, the world is going to be better and we raise interest rates is going to be, you know, loose tight. He's saying that…”

“at Lake Mason Capital Management, we, you know, the, the AUM got to, I think, 65 or seventy billion dollars. It's a lot harder to run seventy billion dollars than it is to run seven billion dollars than it is to run seven hundred million dollars, and that's something you always have to take into consideration.”

“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.”

“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 linear, so cause and effect are quite clear.”

“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.”

“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 fundamental investors? I think the answer to that is yeah.”

“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.”

“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 diversification rules.”

“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.”

“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.”

“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, for instance, without really understanding what it implies…”

“you know there's skill in the activity if you can lose on purpose.”

“a lot of what led to great investors versus good investors had nothing to do with actually those technical skills. Those were requisites to get into the game prerequisites for the game, but, but not the keys. It was really how they made decisions and especially the decisions under, under, uh, stress.”

“If I had to put this under one big banner, the big banner I would probably select is they fail to consider alternatives.”

“what I think Kahneman and many other psychologists have demonstrated beyond the shadow of a doubt is the combination of this inside and outside view is the best way to think about things.”

“So some Base rate distributions are fairly well behaved, you know, things like sales growth rates for companies, obviously things like, you know, a lot of things that are normally distributed in life, like the heights of people and so forth. And then there is another part where it's vastly more complicated. Where you…”

“When you're young, you know, exploration is much more interesting than exploitation, right? So you want to try out the new restaurant, meet new people and so on and so forth. And as you get older, right? Well, your payoffs are much more finite, right? And there were some days I feel that very much. Then you say, well,…”

“just asking people to assign a probability, just that app, as you point out, compelled sort of a much more thoughtful process, which then led to a much more, you know, much richer discussion around the issues. So you're right. Probably the calibration is sort of level two. Well, level one is sort of just getting…”

“Somewhere between it can be 10 to 20%, but that's sort of the high end.”

“High yield typically trades not dissimilarly to equities. It's a little bit more of a senior claim. And so you have sort of something that's not too far off in terms of a comparability and allows you to sort of calibrate.”

“This is also how ideas spread. We talk about this really much in the context of markets. What is an information cascade? It's an idea propagating across a network. Why do we all come to uniform beliefs and markets from time to time? Same basic. It's a mind virus versus a physical virus, but basically it's the same kind…”

“the more frequently you look at the market, the more likely you are to see losses. And so myopic loss aversion says for people who frequently revisit their portfolios, they're more likely to see losses, hence suffer from aversion, and hence increase their equity risk premium with a needed rate of return.”

“Just doing the boring thing never gets you fired, but doing the risky thing that's the right thing exposes you to potential criticism.”

“the more luck there is, essentially, actually, the more patient you have to be to see if a good process is going to reveal a skill over time. So it's sort of this backwards thing, like, you need larger sample sizes when there's more luck.”

“The other thing I'll just say in doing this research, I probably underappreciate it, which is that there's really a market for information. So figuring things out or what you want to do, but there's also a different market, like an asset market for how to implement the ideas. Those are kind of handy to keep as separate…”

“And once again, for example, a simple rule, if you're ever voting on something, it always should be independent ballots. What is not uncommon is for people just to go around the room and say, hey, Ted, what do you think? So, you know, Ted, you're a really important smart guy, and so what you say will deeply influence…”

“Like, you and I can have the exact same 25 stocks, but what we know is how we size our positions will have A huge impact on how our portfolio performs over time.”

“If you have strong strength and low validity, like small sample size, people tend to be overconfident. So you flip that thing 10 times, they go, it's a tails biased coin, right? The opposite side would be like, if you flip the coin 10,000 times and it comes up tails 5100 times, right? So it's 5149. You go, ah, it…”

“for most stocks, there tend to be two or three sort of key issues. You might call them linchpin issues, perhaps, and the ability to find those things and dwell on them as soon as possible tends to be very helpful”

“if you think about a value chain for an industry, so companies and suppliers and so forth, that if one part of the value chain, so for example, if a customer does poorly in an earnings report, for instance, it likely indicates that the supplier is going to do poorly because they're obviously interconnected, and the…”

“It is often the case when some of the arbitrage opportunities are among the most attractive, the arbitrageurs don't show up. And the main reason they don't show up is because they don't have access to capital.”

“And the reason a read, do checklist is really helpful is it takes the emotion out and gives you an action plan. And I think we need something akin to that in the world of investing, which is take the emotion out, have an action plan, and allow people to act on these things. Now, look, maybe someday the world will end,…”

“If there's poor performance, alarm bells come up and down the chain and the committee doesn't say like, Let's do nothing. They always say, like, we should do something, right? So this notion, and by the way, I think it's a Western thing, maybe an American thing, too, like this notion toward action or activity versus…”

“I think when you see episodes of people who are less sophisticated getting involved with reasonable sums of money, that's probably the case where you could get that standard deviation blow back out.”

“find people with sort of weird backgrounds, but essentially test them or assess them on their ability to think rationally. And it could be that combination that might be the sweet spot for, for success.”

“Dealer inventories are way down, and I just don't think we've tested it, because many of the traditional tests of liquidity are things like bid-offer spreads and realized prices, but you can't really test it in non-stressed environments.”

“I think that the market as complex adaptive systems both explains why markets tend to be efficient. This is, you know, the, the wisdom of crowds concepts. But also explains why markets episodically go haywire, which they clearly do.”

“There are people who are for sellers. There are people who are forced buyers and they're doing things that are non-economic or for non-economic reasons. And those can present opportunities for the other side.”

“And I just found as an analyst over the years and a strategist and so forth that analysts, almost every deal, it's like a one-off right there. They're analyzing it without a framework. And if you have a framework for it, it just allows you to put things into context, analyze it quicker, to be more accurate and so…”

“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 remember when it doesn't.”

“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 they do, and we don't open the aperture and think about the…”

“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 should ask the question as to what's going on. And then the…”

“And alternatively, and I guess what you'd want to also do to, to, to, to, to come up with a robust forecast is you might look at the history of all companies of that size and simply ask, what is the distribution of growth rates for companies of that size? And you'll see it's, it's not a perfectly normal distribution,…”

“It turns out that probability of peeling off the path is a function of the rate of change in the environment. So when the environment does not change rapidly, the ants go for mostly exploitation and very little exploration. When the rate of change is rapid, they know that that food source may be exhausted quickly, and…”

“the big punchline is that when we're stressed, these certain conditions for sure contributing to that, we shorten our time horizons. So precisely when we should be casting our eyes out on the horizon, we sort of look down.”

“You think about guys like Warren Buffett, you know, one of the advantages is he's constantly has flowed. He always has money coming in the door and That really helps for you to be able to behave in a way that counters this pro cyclicality.”

“So if you're an equity investor, you should understand what's going on in the credit markets and the options markets and CDS markets. Credit investors should understand equities and so forth, right? So just having other touchstones, I think is incredibly valuable for you to get a full context of what's going on.”

“the short answer is that the number one way we use to compare things is by analogy. This is like that. And that is, that approach is incredibly effective if you've got the appropriate analogy, right? But it breaks down pretty quickly in terms of breadth and depth.”

“And, and the big one is, is that inside outside view, this idea of understanding past performance and how that applies. And, you know, as we go through life, everything feels unique to you. You know, you're moving from, you know, from New York to Boston. It feels like you're the first guy to have done that, but many…”