Here’s the biggest challenge with investing: the longer that something has worked the more likely it is to stop working. As more and more people embrace a style of investing, the likelihood of outperformance goes away. We see this with investment strategies – Benjamin Graham’s deep value of the 1930’s and the Nifty Fifty of the 1960’s – and with asset classes – venture capital of the 2010’s and, we would suggest, likely to be private equity in the 2020’s.
The mechanism here is simple. Pioneers of a strategy find a new way to make money, early adopters follow them and confirm there is money to be made. Word spreads and more and more people enter the market. Given there is only a finite number of opportunities for any strategy (for example only a certain number of net-net value stocks or a certain number of venture-scale startups), as more and more people enter the market or adopt a strategy they are forced to settle for worse opportunities. At the same time, the strategy has become so popular and early adopters have made so much money that these worse opportunities are justified (often as ‘a new paradigm’ or ‘new normal’ or with those four dangerous words ‘this time is different’). Then, as has happened so often before and will happen again, the world wakes up to the excesses of the strategy and we see a market correction.
This article from Sapient Capital makes the case that the best investors throw out any rules or universal principles when it comes to investing. They argue that reasoning from first principles, so valuable in engineering and scientific fields, is dangerous when it comes to investing because there are no universal, fixed principles. Instead, they argue that markets are complex, adaptive systems driven by human psychology and the best investors should prioritise openness. Openness to new ideas, to new strategies and new information rather than fixating on any permanent principles.
It is an interesting article and one that we probably need some more time to digest. We are used to hearing investment experts discuss universal principles of investing. So our gut reaction was to push back on the ideas in this article. But beyond that initial reaction, we decided to internalise what this article was promoting: openness. Openness to new ideas, even if they challenge our preconceived notions about a topic. That’s what makes us all better learners. And hopefully that is what will make us all better investors.
This is an excerpt from our Thought Starters email. Once a week we send you 5 interesting articles that have caught our attention, to get you thinking. No spam, we guarantee.