A recurring motif in Capital Returns: Investing Through the Capital Cycle, by Edward Chancellor is that growth vs. value is a false dichotomy:
Our belief is that stocks should be viewed not as “growth” or “value” opportunities, but rather from the perspective of whether the market is efficiently valuing their future earning prospects.
Marathon’s approach is to look for investment opportunities among both value and growth stocks, as conventionally defined. They come about because the market frequently mistakes the pace at which profitability reverts to the mean. For a “value” stock, the bet is that profits will rebound more quickly than is expected and for a “growth stock,” that profits will remain elevated for longer than market expectations.
Marathon looks to invest in two phases of an industry’s capital cycle. From what is misleadingly labelled the “growth” universe, we search for businesses whose high returns are believed to be more sustainable than most investors expect. Here, the good company manages to resist becoming a mediocre one.From the low return, or “value” universe, our aim is to find companies whose improvement potential is generally underestimated. In both cases, the rate at which a company reverts to mediocrity (or “fade rate”) is often miscalculated by stock market participants. Marathon’s own experience suggests that the resultant mispricing is often systematic for behavioural reasons.
Labelling fund managers as “value” or “growth investors risks distorting the investment process
Warren Buffett discussed a similar idea in Berkshire Hathaway’s 1997 Shareholder letter:
…most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross- dressing.
We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).
Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase.
Similarly, business growth, per se, tells us little about value. It’s true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain….
…Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.
Berkshire Hathaway’s 1997 Shareholder letter
False dichotomy, but useful heuristic
Growth vs. value is a false dichotomy, but it might be a useful heuristic for organizing a portfolio. With a “value” investment, you are buying assets, and betting on a reversion to the mean. Generally this means other people are overestimating the bleakness of the future. With a “growth” investment you are buying the future business, betting on change. Generally this means other people are underestimating the brightness of the future.
The key is having an intellectually honest variant view.
Venture capital and value investing
In a similar vein, its easy to see how venture capital and value investing are actually quite similar. Both are mispriced bets on the probability of change.
Tren Griffin wrote about this:
Venture capital and value investing share many different elements but each system is based on a different mispricing. This is a critically important point for an investor to understand. If an asset is not mispriced, market outperformance is not mathematically possible. It is also important to understand that investments can be mispriced for different reasons.
In venture capital the mispricing occurs because very few investors or asset owners understand optionality. This allows a VC to buy what are essentially long-dated, deeply-out-of-the-money call options from companies at prices which are a bargain.
In value investing the mispricing occurs because the market is bipolar (i.e., neither always rational nor always efficient). This allows an investor to sometimes buy assets at a price which reflects a discount to intrinsic value (i.e., a bargain) and to wait for a good result rather than trying to “time” the market.The fundamental difference between venture capital and value investing
Marc Andreessen, in an interview with Tim Ferriss, expressed a similar idea, noting how much he studies and admires Warren Buffett:
Business Lessons From Marc Andreeseen
… every time I hear a story like See’s Candies, I want to go find the new scientific superfood candy company that’s going to blow them right out of the water. We’re wired completely opposite in that sense. Basically, he’s betting against change. We’re betting for change. When he makes a mistake, it’s because something changes that he didn’t expect. When we make a mistake, it’s because something doesn’t change that we thought would. We could not be more different in that way. But what both schools have in common is an orientation toward, I would say, original thinking in really being able to view things as they are as opposed to what everybody says about them, or the way they’re believed to be.”
A decent portfolio has a combination of mean reversion bets, and underpriced deep out of the money options. It pays to be an intellectual cross dresser
In the past I have been a knee jerk advocate of disintermediation. However upon closer examination I realized that the reality of middlemen is far more nuanced. Many people believe that modern technology is eliminating middleman, yet in fact their role is changing shape, not disappearing. In the Middleman Economy , Marina Krakovsky examines this aspect of the modern economy. The Private Investment Brief has also produced valuable analyses of middleman business models. Additionally, Michael Munger’s paper puts this all into a historical context with emphasis on the importance of reduced transaction costs.
Conventional wisdom says that middleman take a cut of every deal, so they raise buyer costs and reduce seller profits. In reality by facilitating transactions that would otherwise not happen at all, good middlemen enlarge the size of the pie, making all parties better off. Many people assume that middlemen’s work is easy because they don’t actually create anything. But to create value… good middlemen must cultivate distinct skills and practices, which they deploy in work that until now has been largely hidden from public view…
“Instead of the of the demise of the middlemen, we are seeing the rise of the middleman. In fact , ours is more than ever a middleman economy.”
Marina Krakovsky, Middleman Economy
There seems to be a gap between public perception and market reality. Therein lies the opportunity:
And yet—thousands of years after it first occurred to someone to ask “why don’t they just cut out the middleman?”—middlemen continue to exist and even thrive. Therein lies the opportunity, for if we can learn to appreciate what others dismiss or misunderstand, we might then have an investing green field all to ourselves
-Mystery of the Middleman
Indeed, Michael Munger takes it even further and argues that we are experiencing a profound historical shift that will alter capital allocation incentives across the economy:
The Neolithic revolution made it possible for humans to enter complex relations of more or less voluntary dependence, and to share economies of organization and information. The Industrial revolution created an astonishing burst of productivity, which made ownership ofMichael Munger: The Third Entrepreneurial Revolution: A Middleman Economy
a bewildering variety of commodities and tools possible for all but the poorest of people, where just 50 years before such items would have denied all but wealthiest. The Middleman revolution, the third revolution whose leading edges we are now crossing, will transform owning
into sharing. The Middleman revolution will make it possible, for the first time, for entrepreneurs to create value almost exclusively by reducing the transactions costs of sharing existing commodities, or by sharing commodities or services made expressly to be shared by the new platforms and new market processes.
Aggregators by any other name
In a world where buyers and sellers can just find each other online quickly and easily, middleman must be obsolete, right?
Wait a minute…
Often when people talk about cutting out the middleman, they are actually just replacing it with a new middleman. All the aggregator platforms are in fact distinct breeds of middlemen whose businesses are made possible by the internet. Examples include: Airbnb, Lyft and Uber, Taskrabbit, Grubhub, ZocDoc, etc. Instead of a person, buyers and sellers deal with software on a website that is developed and managed by people. As Krakovsky points out:
In many ways, the internet is a middleman’s ally. Thanks to the internet, middlemen who used to do business in person — a position that limited their geographic reach can a attract customers from all over and can share information with them more quickly and easier than ever…
These days, two sided markets (sometimes called two-sided networks or two sided platforms ) are everywhere because many of today’s internet startups are middlemen business of exactly this type
Understanding middleman requires multidisciplinary thinking. There isn’t really one accepted definition, and there are many different angles from which to analyze how this social and economic phenomenon works:
Economic theory has much to say about transaction-cost economics, two sided markets, and intermediaries ability to reduce information asymmetries between buyers and sellers. In particular, game theory informs our understanding of repeated interactions, reputation, shirking and cheating, and third party enforcement. Social psychology and experimental economics show how acting on behalf of others affect people’s behavior and impressions. And sociology offers insights into the way acting on behalf of others affects people’s behavior and impressions. And sociology offers insights into the ways the structures of social networks create opportunities for middlemen
Six kinds of Middlemen
Krakovsky identifies five different roles that middleman can play. These roles define what middleman’s trading partners expect, so its critical for a middleman to know what role they play, and do play it well. They often overlap, so a successful business may fill of these roles at different times in the same supply chain.
A bridge promotes trade by reducing distance(either physical, social or temporal). RA Radford’s study on the development of a market in a WWII POW camp is a stark example. An itinerant priest was willing to connect disparate groups who did not interact, facilitating trade along the way.
Another example featured in the New York Times and highlighted by Private Investment Brief involves an Afghanistan based used clothing wholesaler who makes an annual trip to Pakistan to buy bulk clothing. He is able to succeed for many reason, one of which is the fact that he reduces the fixed costs of dealing with travel, customs, logistics, etc.
A certifier gives reassurance about underlying quality. This is important anywhere there is need for a trusted third party. Essentially, they help fix information asymmetry in a market. That same clothing wholesaler who facilitated trade between Pakistan and Afghanistan was also known as a trusted counter party to disparate group of buyers and sellers.
Trust is an elusive and intangible quality, so those of us in the more contemplative, analytical corners of the business world tend to underestimate how important it is to people transacting day to day
Mystery of Middlemen
An enforcer makes buyers and sellers cooperate and stay honest. Like certifiers, they are important in situations where there is need for a trusted third party. My favorite example of an enforcer is the role of a pimp at a truck stop in Uganda.
A risk bearer reduces fluctuations. Micro VCs play this role, especially now that technology has drastically reduced the cost of starting businesses. “Uber for this or that” business models are an example of a risk bearer business model. Additionally in the Japanese fish markets, risk bearing middleman ensure smooth functioning of trade in a highly perishable commodity.
A concierge reduces hassles and helps clients deal with information overload. For example, travel agents, in spite of widespread predictions of their demise, play a critical role in high end business travel as concierge middlemen.
An insulator helps clients get what they want without being though of as too greedy, self promotional, or confrontational. Sports agents help defuse tensions between players and teams. Additionally, sometimes an investor will use a broker to build up a position without signalling the market. This may be essential in distressed and illiquid securities, or disputed situations.
Munger looks at markets in the broad sweep of history. The role of technology, he argues, is in creating a new “entrepreneurial revolution” that makes middleman more important in an an economy based on sharing, not owning.
The third entrepreneurial revolution will be based on innovations that reduce transactions costs, not the costs of the products themselves. An unimaginable number and variety of transactions will be made possible by software platforms that make renting from a middleman, rather than renting from one’s self, cheaper.
A former student of Douglass North, Munger emphasizes the transaction cost angle throughout:
To succeed, a middleman has to reduce three key transactions costs:
• Provide information about options and prices in a way that is searchable, sortable, and immediate
• Outsource trust to assure safety and quality in a way that requires no investigation or
effort by the users
• Consummate the transaction in a way that is reliable, immediate, and does not require negotiation or enforcement on the part of the users
Investing goes through fads. Investing strategies and fund structures(1) go in and out of style. Nowadays long/short hedge funds are out and infrastructure funds are in. Within the public equity markets, value is out, growth/momentum is in. Each time this happens, people forget how the cycle repeats.
In fact, one CIO contended that if he brought a hedge fund that paid him to invest to his board, the board would dismiss it without consideration — simply because it’s called a hedge fund, and hedge funds are bad.Institutional Investor
Hedge funds may have to do a name change if they want to raise capital.
Remember last time?
And yet people forget:
Allocators woke up craving the next rising hedge fund star and couldn’t invest enough at high and increasing management fees after the widespread success of long-short funds in the weak equity markets of 2000-2002. Board rooms back then castigated CIOs for not having long-short equity hedge funds in their portfolios.
This isn’t the first time:
People forget that 40 years ago, officials such as Paul Volcker of the Federal reserve wanted an active hedge fund industry to absorb the risk that was not well managed by state-insured banks.Financial Times
Each investment strategy picks up a certain type of risk(and potentially earns a profit in doing so)- if a strategy disappears that particular risk can become a systemic issue. Fortunately, around this time it also becomes more lucrative to bear the risk others are unwilling to bear. Eventually the risk reward tradeoff starts to make sense again.
Different, different, yet same
In the 1960’s Warren Buffett put up ridiculous returns, and Alfred Winslow Jones proteges profitably exploited anomalies in markets. By the mid 1970’s of there were many articles about hedge funds shutting down though. Industry AUM declined ~70% peak to trough. Nifty fifty boom and bust followed by the long nasty bear market. But as the institutional architecture of international trade and currency shifted we entered glory years of global macro/commodities traders. Then the 80’s were great for Graham deep value and Icahn style activist investing after the 70’s bear market left a huge portion of the market selling below liquidation value.
Likewise late 90’s again saw the death of hedge funds as day traders in pajamas earned easy returns from the latest dot-com- until the crash. Yet out of the rubble of the tech bubble rose a new generation of great hedge fund managers. There was rich pickings for surviving value hunters- and those with the guts and skills to execute became household names a few years later. Many value managers that nearly went out of business during the tech bubble put up ridiculous numbers 2000-2002 and through the next financial crisis. (See: The arb remains the same)
The greatly exaggerated death of a style gives rise to an environment where there is a plethora of opportunities for something similar to that style to work. Each time the narrative in the greater investment community favors some type of uniform strategy, and LPs give less capital to other strategies- causing them to nearly die off. But then the lack of people pursuing the out of fashion strategy makes its return potential more lucrative. Eventually someone finds a new method to pick up those dollar bills on the ground that shouldn’t exist.
Economics emphasizes rational actors and equilibrium. Yet the messy reality is far more complicated. Ecology is a far more useful mental model.
A giant self over-correcting ecosystem
There is in ecological function to speculative capital and over time there should be some excess returns to those willing to take mark-to-market lossesFinancial Times
Like biological species, financial strategies can have competitive, symbiotic, or predator-prey relationships. The tendency of a market to become more efficient can be understood in terms of an evolutionary progression toward a richer and more complex set of financial strategies.Market force, ecology and evolution
Ecology emphasizes interrrelationships between different individuals and groups within a changing environment, and indentifies second order impacts.
Thinking like a biologist
One can develop a useful framework by replacing species with strategy, population with capital, etc
Flows and valuation interact, self correct, and overshoot.
….capital varies as profits are reinvested, strategies change in popularity,and new strategies are discovered. Adjustments in capital alter the financial ecology and change its dynamics, causing the market to evolve. At any point in time there is a finite set of strategies that have positive capital; innovation occurs when new strategies acquire positive capital and enter this set. Market evolution is driven by capital allocation.
Market evolution occurs on a longer timescale than day-to-day price changes. There is feedback between the two timescales: The day-to-day dynamics determine profits, which affect capital allocations, which in turn alter the day-to-day dynamics. As the market evolves under static conditions it becomes more efficient. Strategies exploit profit-making opportunities and accumulate capital, which increases market impact and diminishes returns. The market learns to be more efficient.
When an ecoystem is overpopulated with a certain species, it eventually overshoots and results in mass starvation. Populations fluctuate wildly across decades, and sometimes species go extinct or evolve into something that seems new.
New conditions give rise to new dominant species.
(1) Although I am frequently pedantic about the differences between structure, strategy, and sector, many in the media seem to use these interchangeably when discussing reversion to mean situations. Fortunately they all exhibit the same boom/bust phenomenon, so I am using them interchangeably here.
- Technological Revolutions and Financial Capital
- Capital Returns
- Modern Monopolies
- How the Music Got Free
- Laws of Human Nature
- Debt’s Dominion: A History of Bankruptcy Law in America
- Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts
- The Coffee Trader
- Three Body Trilogy :
- Pattern Recognition
Technological Revolutions and Financial Capital did more to advance my understanding of the modern economy than any other book I read in 2018. Traditional economics treats sudden changes of technology as a separate exogenous factor. This mode of thinking is pretty much useless for anyone forced to allocate capital under uncertain conditions. In reality there is strong empirical evidence that financial markets and technology interact in repeated cycles . Carlota Perez shows the pattern in these cycles by breaking them down into Installation and Deployment Phases. She identifies four main parts of each technological cycle: Irruption, Frenzy, Synergy and Maturity. The book illustrates these patterns in the most important disruptions in economic history, including: the industrial revolution , steam engines/railways, steel/electricity/heavy engineering, automobiles/mass production, and information/telecom. Marc Andreesen hailed Technological Revolutions and Financial Capital as the single best book for understanding the software industry. Since software is eating the world, its probably also the best book for understanding any industry.
Capital Returns is about how competitive advantages change over time, and how changes in capital availability can alter industry dynamics. It covers a fund manager’s thoughts and activities from 2002- 2015, including periods of disruption and volatility in a variety of industries. Ultimately the book is about how mean reversion occurs and and impacts investors.
Modern Monopolies deserves most of the hype that it has received. Many business decision makers were schooled in “linear” business models, but the most valuable and disruptive businesses are platforms, business model that facilitate the exchange of value between two or more user groups, a consumer and a producer. This book covers how technology has enabled more platform business models, and what the implications are for investors and entrepreneurs.
How the Music Got Free tells the story of how streaming music and piracy upended the music industry. It also covers the story of how the MP3 format struggled to gain acceptance for many years before becoming ubiquitous. The contrasting attitudes and actions of the winners and losers in the story are an entertaining juxtaposition , and a useful case study. As a teenager I had been one of the early pirates, but was less aware of what was going on inside the old line music companies, and had not zoomed out to consider the broader industry implications.
Laws of Human Nature is an essential guide for understanding how people act and how society functions. It teases out key lessons from psychology along with successes and failures throughout history. Reading one Robert Greene book provides a reader with the benefits of reading dozens of business biographies and history books. It provides ideas for avoiding certain problematic tendencies in oneself and exploiting traits in others. Laws of Human Nature looks at the dark reality of patterns in thought and behavior that don’t conform to an idealistic rational expectation:
As long as there are humans, the irrational will find its voices and means of spreading. Rationality is something to be acquired by individuals, not by mass movements or technological progress. Feeling superior and beyond it is a sure sign that the irrational is at work.
Debt’s Dominion: A History of Bankruptcy Law in America, is a bit wonkish, but well worth the slog for the insight into the American bankruptcy system. Its easier to understand the subtle nuances of the bankruptcy process and navigate opportunities in the distressed debt market when I think about how the system evolved. Indirectly the book is also about the slow process of institutional change.
Thinking in Bets is basically a long essay on behavioral economics, with one valuable message. Under a plethora of entertaining anecdotes about professional poker it provides an immediately applicable framework for functionning in an uncertain world. Basically its a slightly less nerdy and less nuanced companion to Fortune’s Formula. It also fits in well with some of the more important behavioral finance books, such as…. Misbehaving, and Hour Between Dog and Wolf, Kluge, etc. (more notes here)
The Coffee Trader is historical fiction taking place in 17th century Amsterdam, when coffee was first brought to Europe and the modern concept of stock and derivative markets were just beginning to form. It tells the story from the vantage point of Miguel Lienzo, a small time speculator who must navigate complex social structures, and deal with shady counter parties and aggressive creditors and competitors while trying to get rich in a nascent market. He is also a Jewish refugee who fled the Portuguese inquisition but then struggles with overly conservative Jewish leaders in Amsterdam, who constantly threaten to shun him. Complicating matters further, he has a conflict with his brother, who is at the beginning a far more successful and respected member of the community.
The first person narration includes gems like this one:
There was no shortage of my kind in Amsterdam. We were as specialized as taverns, each of us serving one particular group or another: this lender serves artisans; that one, merchants; yet another, shopkeepers. I resolved never to lend to fellow Jews, for I did not want to travel down that path. I would not want to have to enforce my will on my countrymen and then have them speak of me as one who had turned against them. Instead, I lent to Dutchmen, and not just any Dutchmen. I found myself again and again lending to Dutchmen of the most unsavory variety: thieves and bandits, outlaws and renegades. I would not have chosen so vile a bunch, but a man has to earn his bread, and I had been thrust into this situation against my will.
Three Body Trilogy is a deep character study of humanity itself in the form of an epic science fiction story spanning multiple centuries. It ultimately focuses on the way people act in situations of duress and conflict, both within and between different countries and groups. The Three Body Problem starts slowly, opening during the Chinese Cultural revolution, and tells of the initial contact with alien civilizations. The Dark Forest explores the paradoxical alignment of incentives in high stakes inter galactic diplomacy. The ultimate conclusion for the future of civilization in Death’s End is pessimistic, but getting there is thrilling.
Pattern Recognition is a thriller set in the early 2000s that feels like a science fiction take on modern media. The protagonist is a branding consultant/corporate spook who gets sent on a mission to uncover the anonymous creator behind a series of video clips that have spawned an obsessive subculture of fans. She tracks people and clues down in London, Tokyo and Moscow meeting many bizarre and unseemly characters along the way.
As with all Gibson novels, the dialogue and descriptions are fantastic.
“Of course,” he says, “we have no idea, now, of who or what the inhabitants of our future might be. In that sense, we have no future. Not in the sense that our grandparents had a future, or thought they did. Fully imagined cultural futures were the luxury of another day, one in which ‘now’ was of some greater duration. For us, of course, things can change so abruptly, so violently, so profoundly, that futures like our grandparents’ have insufficient ‘now’ to stand on. We have no future because our present is too volatile.” He smiles, a version of Tom Cruise with too many teeth, and longer, but still very white. “We have only risk management. The spinning of the given moment’s scenarios. Pattern recognition.
Around 200 BC Chinese strategist Zhuge Liang first used a sales trick still re purposed by consultants and lawyers today.
Zhuge Liang was an amateur meteorologist, and he used this fact to convince people that he could control the weather. His knowledge of meteorology was very basic, something any farmer who paid attention would have known. Nonetheless his enemies didn’t have this knowledge. So it was easy to bamboozle them.
During one battle , he realized that the wind was likely to switch direction in a manner that was highly favorable for his army.
He made sure the enemy saw him do an elaborate ceremony that looked like black magic. He kept at it until the wind changed direction. As a result his reputation as a fearsome indispensable strategist grew massively.
This was featured in the historical fiction Romance of the Three Kingdoms . The phrase “Borrow the East Wind (借东风) refers to this story. Its sometimes used to described taking advantage of a situation.
A bit of dancing, drumming and smoke. Zhuge Liang took basic observation skills and sold them as black magic.
Modern knowledge work
I think of this anytime I see a knowledge worker selling their work makes it look more complex than it really is.
Jargon, chartporn and powerpoint replaces dancing drumming and smoke. Or alternatively with legal and compliance work, fear of regulatory risk leads to a company paying high fees to avoid problems. Even if all that is needed is filing a simple form at the right time.
There is a risk of a similar phenomenon in any business where there is a huge knowledge gap between seller and customer. Will the seller take advantage of that gap in a way that harms the buyer?
It may seem like there is one fundamental problem with this comparison: Zhuge Liang was a diplomat/military strategist. A sales call isn’t a war. Its not supposed to be adversarial!
That might actually be the problem. An honest sales process is about helping the client see the value. The battle is against any misperception not against the client. A dishonest sales process is about taking as much from the client as possible.
Zhuge Liang’s life was on the line. And warfare (against sentient opponents) is all about deception. Deceiving competitors is justifiable. But deceiving customers is not. Some businesses may feel their life is on the line, but I bet they could make a good living by reducing complexity rather than playing it up. I know I’m willing to pay up for reduced complexity!
Dealing with this issue has proved to be a major challenge in dealing with lawyers, compliance consultants and technology contractors. I’ll ask around and get quoted absurdly large price ranges for the same set of work.
I’m getting better at asking the right questions in order to see what services are really worth.
I place great value on lawyers, consultants and developers who can cut through the bullshit.
“Fuck a wind tunnel. The biggest wind tunnel in the world is up there. Its called reality.”
John Boyd’s OODA loop is in my opinion one of the most valuable mental models to apply in basically all aspects of life, especially where there is high stakes competition. Boyd’s life makes for an entertaining bio, and Boyd: The Fighter Pilot Who Changed The Art Of War is one of the first completely detailed versions to cover his development as a person, and strategist.. The book develops his character through a series of political battles and personal trauma”. He had an intense belief in empirically testing everything, and he was willing to struggle in the wilderness for decades until he got everything right. His bio tracks how his thinking evolved over time, culminating in several important aeronautical engineering theories, along with the OODA loop.
“Do not write it as a formula. Write it as a way to teach officers to think, to think in new ways about war. War is ever changing and men are ever fallible. Rigid rules simply won’t work. Teach men to think.”
“If you want to understand something, take it to the extremes or examine its opposites,”
The OODA loop
The quick version:
… to shape the environment, one must manifest four qualities: variety, rapidity, harmony, and initiative.
A commander must have a series of responses that can be applied rapidly; he must harmonize his efforts and never be passive. To understand the briefing, one must keep these four qualities in mind. After marching through commander must operate at a faster OODA Loop than does his opponent.
Boyd said there are two ways to manipulate information gleaned from observation: analysis and synthesis. We can analyze whatever process or event we are observing by breaking it down into individual components and interactions. And from this we can make deductions that lead to understanding. Or we can synthesize by taking various sometimes unrelated components and putting them together to form a new whole.
Key quotes on the OODA loop and related theories:
The purpose of the briefing was not to reveal the “Answer” but to jar listeners out of complacency and into thinking on their own. Boyd abhorred the idea that his briefing might be considered dogma. In fact, he often said listeners should take the briefing out and burn it before they considered it dogma.
Boyd found many such instances in history, and in these victories by numerically inferior forces he found a common thread: none of the victorious commanders threw their forces head-to-head against enemy forces. They usually did not fight what is known as a “war of attrition.” Rather, they used deception, speed, fluidity of action, and strength against weakness. They used tactics that disoriented and confused—tactics that, in Boyd’s words, caused the enemy “to unravel before the fight.”
Becoming oriented to a competitive situation means bringing to bear the cultural traditions, genetic heritage, new information, previous experiences, and analysis / synthesis process of the person doing the orienting—a complex integration that each person does differently. These human differences make the Loop unpredictable. In addition, the orientation phase is a nonlinear feedback system, which, by its very nature, means this is a pathway into the unknown. The unpredictability is crucial to the success of the OODA Loop. Only three arrows are on the main axis, and these are what most see when they look at the Observe > Orient > Decide > Act cycle. But this linear understanding and its common result—an attempt to use the Loop mechanically—is not at all what Boyd had in mind.
Application of OODA Loop:
The ability of an aircraft to perform fast transients does two things, one defensive and one offensive: it can force an attacking aircraft out of a favorable firing position, and it can enable a pursuing pilot to gain a favorable firing position. The advantage gained from the fast transient suggests that to win in battle a pilot needs to operate at a faster tempo than his enemy. It suggests that he must stay one or two steps ahead of his adversary; he must operate inside his adversary’s time scale.
Thinking about operating at a quicker tempo—not just moving faster—than the adversary was a new concept in waging war. Generating a rapidly changing environment—that is, engaging in activity that is so quick it is disorienting and appears uncertain or ambiguous to the enemy—inhibits the adversary’s ability to adapt and causes confusion and disorder that, in turn, causes an adversary to overreact or underreact. Boyd closed the briefing by saying the message is that whoever can handle the quickest rate of change is the one who survives.
The danger—and this is a danger neither seen nor understood by many people who profess a knowledge of Boyd’s work—is that if our mental processes become focused on our internal dogmas and isolated from the unfolding, constantly dynamic outside world, we experience mismatches between our mental images and reality. Then confusion and disorder and uncertainty not only result but continue to increase. Ultimately, as disorder increases, chaos can result. Boyd showed why this is a natural process and why the only alternative is to do a destructive deduction and rebuild one’s mental image to correspond to the new reality. Thomas Kuhn, a philosopher of science, and Joseph Schumpeter, an economist, recognized the destructive side of creativity. But Boyd was unique in his explanation of how the process is grounded in fundamentals discovered by Godel and Heisenberg and by entropy.
What will be the scene at your funeral?
Boyd was both a thinker and a doer, the quintessential man in the arena.
Boyd saw himself as a man of principal fighting superiors to do what was best for his country. He wasn’t one to suffer fools, or careerists, or bureacrats beyond the minimum military courtesy required.He took enormous career risk in order to advance the intellectual caliber of the US air force. He document and codified with mathematics techniques that truly worked in the air. This made the world a safer place.
Over time he built up a team of proteges who admired him intensely.
“Boyd’s Acolytes minimize his faults. They say it is more important that his core beliefs were steel-wrapped and his moral compass was locked on true North, that he never misspent his gifts. His motivation was simple: to get as close as possible to the truth. He would have been the first to admit there is no absolute truth. But he continued chasing something that was always receding from his grasp. And in the pursuit he came far closer to the unattainable than do most men. “
This was the description of the eulogy that one of Boyd’s proteges gave for him:
“Not many people are defined by the courts-martial and investigations they faced,” raucous laughter echoed off the white walls of the chapel. Sprey told how Boyd once snapped the tail off an F-86, spun in an F-100, and how he not only stole more than $1 million worth of computer time from the Air Force to develop a radical new theory but survived every resulting investigation. Chuck Spinney, a boyish Pentagon analyst who was like a son to Boyd, laughed so loud he could be heard all across the chapel. Even those in the congregation who barely knew Boyd took a certain pride in his profanity and coarseness and crude sense of humor. He cared little for his personal appearance and could be demanding, abrasive, and unreasonable. And while in his professional life Boyd accomplished things that can never be duplicated, in his personal life he did things few would want to duplicate.
Boyd’s work habits, were, um, interesting. Here was the perspective of one of his colleagues:
He would look up from his work to see Boyd staring at the wall, oblivious to the world, for maybe fifteen or twenty minutes. Boyd was, as he described it, “having a séance with myself.” Then it was as if a switch had been turned on: suddenly Boyd spun around in his chair and picked up the conversation, waved his arms like a windmill in a hurricane, leaned across his desk.
Boyd went to the library—it was open until 1:00 A.M.—and continued working on equations. He made a list of what had to be done next, which equations had to be written and solved, what theories must be followed up and developed. He filled sheet after sheet of his yellow legal pad. When the library closed he drove up Buford Highway, turned onto McClave Drive, entered his home and continued working. Then he called Spradling( colleague with who he worked). It was about 4:00 A.M. in Atlanta, three hours earlier in Las Vegas.
Boyd, as a senior officer, lived in a trailer. By all accounts he worked eighteen- and twenty-hour days. He bought a reel-to-reel tape deck, and every night as he did paperwork his trailer was filled with the ominous “Ride of the Valkyries” or the majestic “Entry of the Gods into Valhalla.”
His search ranged far afield. From the base library he checked out every available book on philosophy and physics and math and economics and science and Taoism and a half dozen other disciplines. He was all over the map, searching but not quite knowing for what.
It was obvious from Boyd’s phone calls that he was not only spending a disproportionately large amount of his retirement pay on books but was reading them all. Christie’s phone might ring at 2:00 A.M. and when he picked it up Boyd would say, “I had a breakthrough. Listen to this.” And without a pause he would begin reading from Hegel or from an obscure book on cosmology or quantum physics or economics or math or history or social science or education. Christie thought Boyd had taken leave of his senses. Except for the year at NKP, the past nine years of Boyd’s life had been devoted to hosing his superiors. He was a man of action. But when he walked out of the Building, he walked into a world of ideas. There was almost no transition. One day he was on the phone checking on the progress of the F-16 and the next he was calling people at 2:00 A.M. to read German philosophy. And for what? What was this learning theory he kept talking about? He said he had begun work on the thing back at NKP and he still had nothing to show for it. Why didn’t Boyd just retire?
One of John’s favorite stories, one he was to tell all his life, revolved around entering high school on September 2, 1942. He said he took a series of tests, one of which showed he had an IQ of only ninety. When offered the chance to retake the test, he refused. The test gave John what he later said was a great tactical advantage in dealing with bureaucrats—when he told them he had an IQ of only ninety, they always underestimated him.
Of course Boyd did have an advanced degree in aeronautical engineering. So he obviously wasn’t dumb. Apparently he worked harder than anyone at checking every single equation he worked on. Even if he wasn’t the smartest, his intense study over his lifetime allowed him to make all the important contributions that he did.
The right side of history
The 1960s were years of protests and demonstrations on college campuses across America. But not at Georgia Tech. In 1961 the president of Tech called a mandatory all-student meeting and announced that the first black students had been accepted, that all students would welcome them in friendship and cordiality, and any student who behaved otherwise would be dismissed and there would be no appeal. Thus, Tech became the first desegregate peacefully and without being forced to do so by court order. Tech and its students were too serious about academics to become sidetracked by such issues. During the 1960s the most avant-garde activity at Tech was the English professor who sometimes held classes at Harry’s Steak House on Spring Street. This professor’s “liberalism” was the talk of the campus.
Unconventional technique of internal politics and internal diplomacy
If your boss demands loyalty, give him integrity. But if he demands integrity, then give him loyalty.
In his new job, Boyd saw problems that needed immediate attention everywhere he looked. But 7th Air Force sent down paperwork daily that took hours to answer. Boyd thought Air Force bureaucracy was keeping him from the job at hand. His solution was to respond but to add material that caused 7th Air Force more paperwork than 7th Air Force caused him. “Pain goes both ways,” he said. In only a few weeks the time-consuming requests from 7th Air Force shrank to almost nothing.
John Boyd as a diplomatic representative
Then there was the story of the junior officer who was having an affair with a Thai woman. There was nothing unusual about this. Thai women are extraordinarily beautiful and many American officers formed close relationships But this particular officer was married and soon was overcome with guilt. He broke off the relationship. The woman in question was the daughter of an influential village official who felt his family lost face when his daughter was spurned. He was about to charge the young officer with rape. Boyd said he called in the young officer and gave him the big picture of how many base activities depended on the good will of Thai officials. He ordered the young officer, guilty or not, to continue the relationship.
“I’m giving you a direct order to screw her every night until you are transferred out of here,” Boyd said he told the officer. “Sir, I don’t believe that is a lawful order,” the officer said. “Goddammit, I issued it and you better obey it. We’re at war and bigger things are at stake here than your guilt. Your dick can cause you problems but it is not going to cause problems for America. You do as I say or I will make your life a living hell
Hey, sometimes a guy needs to take one for the team.
Boyd also thought the Base Exchange (B-X) at NKP was an unnecessary indulgence. He said a store selling everything from hair dryers to television sets to stereos had no place on a combat base—that such things made Americans “soft.” Persky recalls that once, he and Boyd were talking when Boyd pointed at the B-X and said everything in the store should be loaded aboard C-130s and parachuted into North Vietnam. “Let them get used to the good life and then we can just walk in and take over,” he said. Boyd also dealt with situations
Seems Capitalism did sort of do this in the long run.
In a Blitzkrieg situation, the commander is able to maintain a high operational tempo and rapidly exploit opportunity because he makes sure his subordinates know his intent, his Schwerpunkt. They are not micromanaged, that is, they are not told to seize and hold a certain hill; instead they are given “mission orders.” This means that they understand their commander’s overall intent and they know their job is to do whatever is necessary to fulfill that intent. The subordinate and the commander share a common outlook. They trust each other, and this trust is the glue that holds the apparently formless effort together. Trust emphasizes implicit over explicit communications. Trust is the unifying concept. This gives the subordinate great freedom of action. Trust is an example of a moral force that helps bind groups together in what Boyd called an “organic whole.”
No man need despair of gaining converts to the most extravagant hypothesis who has art enough to represent it in favorable colors.
Sometimes the private equity industry reminds me of travelling charlatans in late Renaissance Europe. I recently reread Robert Greene’s The 48 Laws of Power, and realized that Law 32 “ Play on People’s Fantasies” must be the guide some people use to draft fund pitchbooks.
( I refer to“Private Equity” or “PE” , but the same general logic applies to the entire alternative investments industry. This includes venture capital, some hedge funds, non-traded REITs, etc. )
PE funds have long term lock ups. The lack of mark to market smooths out volatility. It looks nice on a statement to see something holding steady as markets tank. There can be good reasons for long lockups. Many investments genuinely take a long term to workout. Most short term price fluctuation in the public markets is noise that some find hard to ignore. Warren Buffett once remarked that he bought stocks with the idea that public markets could close for a decade, and it wouldn’t bother him. But often unscrupulous fund managers use questionable marketing techniques and exploit the ability to keep money locked up for a long time.
Marco Bragadino, Private Equity Fund Manager
Often allocators or wealthy individuals will seek out private equity and other alternative investments because of frustration with public markets. Maybe the mark to market volatility has been painful. Perhaps the index funds squeezed all the alpha out of the markets. Maybe they feel that better connected people have access to investments. If only they also had access they too could grow their wealth for multiple generations. Plus they might have something to brag about at cocktail parties or in the nursing home.
Similarly, Marco Bragadino, or Il Bragadino was a famous Charlatan who first targeted Venice in the late 1500s, a time that the city was gripped with the feeling that its best days were behind it. The opening of the “New World” transferred power to the Atlantic Side of Europe. Venice struggled to keep up with the Spanish, Portuguese, Dutch, and English. Worse yet, The Turks were making incursions into Venice’s mediterranean possessions.
Now noble families went broke in Venice, and banks began to fold. A kind of gloom and depression settled over the citizens. They had known a glittering past — had either lived through it or heard stories about it from their elders. The closeness of the glory years was humiliating. The Venetians half believed that the goddess Fortune was only playing a joke onthem, and that the old days would soon return. For the time being, though, what could they do?
Many alternative asset managers claim to have proprietary models, and tend to give of an air of exclusivity. Madoff, who managed a fraudulent hedge fund, was an extreme example of this. If only investors have the right “access”, they too can get exposure to that magic investment. This is right out of Il Bragadino’s playbook:
In 1589 rumors began to swirl around Venice of the arrival not far away of a mysterious man called “II Bragadino,” a master of alchemy, a man who had won incredible wealth through his ability, it was said, to multiply gold through the use of a secret substance. The rumor spread quickly because a few years earlier, a Venetian nobleman passing through Poland had heard a learned man prophesy that Venice would recover her past glory and power if she could find a man who understood the alchemic art of manufacturing gold. And so, as word reached Venice of the gold this Bragadino possessed — he clinked gold coins continuously in his hands, and golden objects filled his palace — some began to dream: Through him, their city would prosper again.
Modern asset managers are known for having well scripted due diligence meetings that leave investors with a feeling of awe and urgency. Il Bragadino did this too:
Members of Venice’s most important noble families accordingly went together to Brescia, where Bragadino lived. They toured his palace and watched in awe as he demonstrated his gold-making abilities, taking a pinch of seemingly worthless minerals and transforming it into several ounces of gold dust. The Venetian senate prepared to debate the idea of extending an official invitation to Bragadino to stay in Venice at the city’s expense, when word suddenly reached them that they were competing with the Duke of Mantua for his services. They heard of a magnificent party in Bragadino’ s palace for the duke, featuring garments with golden buttons, gold watches, gold plates, and on and on. Worried they might lose Bragadino to Mantua, the senate voted almost unanimously to invite him to Venice, promising him the mountain of money he would need to continue living in his luxurious style — but only if he came right away.
But look at that Sharpe Ratio!
Some private equity fund managers will claim a superb track record without ever having an exit. Sometimes legacy funds will be valued higher, but fail to provide any cash flow. Sometimes those legacy funds work out, but sometimes are actually complete disasters and the manager is delaying the inevitable reckoning.
Again, this is something they could have learned from Il Bragadino:
Bragadino had only scorn for the doubters, but he responded to them. He had, he said, already deposited in the city’s mint the mysterious substance with which he multiplied gold. He could use this substance up all at once, and produce double the gold, but the more slowly the process took place, the more it would yield. If left alone for seven years, sealed in a cas-
ket, the substance would multiply the gold in the mint thirty times over. Most of the senators agreed to wait to reap the gold mine Bragadino promised. Others, however, were angry: seven more years of this man living royally at the public trough! And many of the common citizens of Venice echoed these sentiments. Finally the alchemist’s enemies demanded he produce a proof of his skills: a substantial amount of gold, and soon.
Sometimes mark to market is indeed mark to fantasy.
Finding new suckers
When an asset manager fails to deliver with one target fundraising channel, they look to others. There is nothing wrong with expanding and diversifying a business. But I get suspicious when a fund manager suddenly shifts their whole targeted capital base. Especially when they shift from institutional to retail. Like certain modern fund managers, Il Bragadino focused on finding new clients when became increasingly suspicious of his unfulfilled promises.
Lofty, apparently devoted to his art, Bragadino responded that Venice, in its impatience, had betrayed him, and would therefore lose his services. He left town, going first to nearby Padua, then, in 1590, to Munich, at the invitation of the Duke of Bavaria, who, like the entire city of Venice, had known great wealth but had fallen into bankruptcy through his own profligacy, and hoped to regain his fortune through the famous alchemist’s services. And so Bragadino resumed the comfortable arrangement he had known in Venice, and the same pattern repeated itself.
Believe in the smart people
Yet fund managers, even bad ones, often get incredibly rich in spite of not adding much value to their investors. Their talent is in exploiting human psychology, not investing. It all links back to their ability to exploit people’s need to believe:
His obvious wealth confirmed his reputation as an alchemist, so that patrons like the Duke of Mantua gave him money, which allowed him to live in wealth, which reinforced his reputation as an alchemist, and so on. Only once this reputation was established, and dukes and senators were fighting over him, did he resort to the trifling necessity of a demonstration. By then, however, people were easy to deceive: They wanted to believe. The Venetian senators who watched him multiply gold wanted to believe so badly that they failed to notice the glass pipe up his sleeve, from which he slipped gold dust into his pinches of minerals. Brilliant and capricious, he was the alchemist of their fantasies — and once he had created an aura like this, no one noticed his simple deceptions.
Psychology of Avoiding Charlatans
There is a paradox here. In most cases, it is better to make investments with the intention of making money over decades, not quarters. Yet that is not a reason to not monitor progress. There are many great alternative asset managers who deliver massive value to their clients over decades. I know from experience that they are usually straight shooters.
Charlatans exploit default tendencies in human psychology. Therefore we must guard against this. Building wealth requires discipline. There is no magic investment that will solve everything. People don’t want to hear that, and the Bragadinos of the world prey on this by giving easy answers. Its critical to get comfortable with being uncomfortable. The market doesn’t owe anyone a good return. We must monitor our own psychology as much as the activity of our fund managers.
Constant vigilance is needed to avoid getting tricked by the Bragadinos of the investment world.
The secret is to make peace with walking around in a world where we recognize that we are not sure and that’s okay. As we learn more about how our brains operate, we recognize that we don’t perceive the world objectively. But our goal should be to try.
Annie duke’s “Thinking in Bets” is basically long essay with an extremely valuable message. Under a plethora of entertaining anecdotes about professional poker it contains a valuable framework for making decisions in this uncertain world. This requires accepting uncertainty, and being intellectually honest. Good decision making habits compound over time
Thinking in Bets is a slightly less nerdy and less nuanced compliment to pair with “Fortune’s Formula”. It also fits in well with some of the more important behavioral finance books, such as…. Misbehaving, and Hour Between wolf and dog, Kluge, etc.
I’ve organized some of my highlights and notes from Thinking in Bets below.
The implications of treating decisions as bets made it possible for me to find learning opportunities in uncertain environments. Treating decisions as bets, I discovered, helped me avoid common decision traps, learn from results in a more rational way, and keep emotions out of the process as much as possible.
Outcome quality vs decision quality
We can get better at separating outcome quality from decision quality, discover the power of saying, “I’m not sure,” learn strategies to map out the future, become less reactive decision-makers, build and sustain pods of fellow truthseekers to improve our decision process, and recruit our past and future selves to make fewer emotional decisions. I didn’t become an always-rational, emotion-free decision-maker from thinking in bets. I still made (and make) plenty of mistakes. Mistakes, emotions, losing—those things are all inevitable because we are human. The approach of thinking in bets moved me toward objectivity, accuracy, and open-mindedness. That movement compounds over time
Thinking in bets starts with recognizing that there are exactly two things that determine how our lives turn out: the quality of our decisions and luck. Learning to recognize the difference between the two is what thinking in bets is all about.
Why are we so bad at separating luck and skill? Why are we so uncomfortable knowing that results can be beyond our control? Why do we create such a strong connection between results and the quality of the decisions preceding them? How
Certainty is an illusion
Trying to force certainty onto an uncertain world is a recipe for poor decision making. To improve decision making, learn to accept uncertainty. You can always revise beliefs.
Seeking certainty helped keep us alive all this time, but it can wreak havoc on our decisions in an uncertain world. When we work backward from results to figure out why those things happened, we are susceptible to a variety of cognitive traps, like assuming causation when there is only a correlation, or cherry-picking data to confirm the narrative we prefer. We will pound a lot of square pegs into round holes to maintain the illusion of a tight relationship between our outcomes and our decisions.
There are many reasons why wrapping our arms around uncertainty and giving it a big hug will help us become better decision-makers. Here are two of them. First, “I’m not sure” is simply a more accurate representation of the world. Second, and related, when we accept that we can’t be sure, we are less likely to fall
Our lives are too short to collect enough data from our own experience to make it easy to dig down into decision quality from the small set of results we experience.
Incorporating uncertainty into the way we think about our beliefs comes with many benefits. By expressing our level of confidence in what we believe, we are shifting our approach to how we view the world. Acknowledging uncertainty is the first step in measuring and narrowing it. Incorporating uncertainty in the way we think about what we believe creates open-mindedness, moving us closer to a more objective stance toward information that disagrees with us. We are less likely to succumb to motivated reasoning since it feels better to make small adjustments in degrees of certainty instead of having to grossly downgrade from “right” to “wrong.” When confronted with new evidence, it is a very different narrative to say, “I was 58% but now I’m 46%.” That doesn’t feel nearly as bad as “I thought I was right but now I’m wrong.” Our narrative of being a knowledgeable, educated, intelligent person who holds quality opinions isn’t compromised when we use new information to calibrate our beliefs, compared with having to make a full-on reversal. This shifts us away from treating information that disagrees with us as a threat, as something we have to defend against, making us better able to truthseek. When we work toward belief calibration, we become less judgmental .
In an uncertain world, the key to improving is to revise, revise, revise.
Not much is ever certain. Samuel Arbesman’s The Half-Life of Facts is a great read about how practically every fact we’ve ever known has been subject to revision or reversal. We are in a perpetual state of learning, and that can make any prior fact obsolete. One of many examples he provides is about the extinction of the coelacanth, a fish from the Late Cretaceous period. A mass-extinction event (such as a large meteor striking the Earth, a series of volcanic eruptions, or a permanent climate shift) ended the Cretaceous period. That was the end of dinosaurs, coelacanths, and a lot of other species. In the late 1930s and independently in the mid-1950s, however, coelacanths were found alive and well. A species becoming “unextinct” is pretty common. Arbesman cites the work of a pair of biologists at the University of Queensland who made a list of all 187 species of mammals declared extinct in the last five hundred years.
Getting comfortable with this realignment, and all the good things that follow, starts with recognizing that you’ve been betting all along.
The danger of being too smart
The popular wisdom is that the smarter you are, the less susceptible you are to fake news or disinformation. After all, smart people are more likely to analyze and effectively evaluate where information is coming from, right? Part of being “smart” is being good at processing information, parsing the quality of an argument and the credibility of the source. So, intuitively, it feels like smart people should have the ability to spot motivated reasoning coming and should have more intellectual resources to fight it. Surprisingly, being smart can actually make bias worse. Let me give you a different intuitive frame: the smarter you are, the better you are at constructing a narrative .
… the more numerate people (whether pro- or anti-gun) made more mistakes interpreting the data on the emotionally charged topic than the less numerate subjects sharing those same beliefs. “This pattern of polarization . . . does not abate among high-Numeracy subjects.
It turns out the better you are with numbers, the better you are at spinning those numbers to conform to and support your beliefs. Unfortunately, this is just the way evolution built us. We are wired to protect our beliefs even when our goal is to truthseek. This is one of those instances where being smart and aware of our capacity for irrationality alone doesn’t help us refrain from biased reasoning. As with visual illusions, we can’t make our minds work differently than they do no matter how smart we are. Just as we can’t unsee an illusion, intellect or willpower alone can’t make us resist motivated reasoning.
The Learning Loop
Thinking rationally is a lot about revising, and refuting beliefs(link to reflexivity) By going through a learning loop faster we are able to get an advantage. This is similar to John Boyd’s concept of an OODA loop.
We have the opportunity to learn from the way the future unfolds to improve our beliefs and decisions going forward. The more evidence we get from experience, the less uncertainty we have about our beliefs and choices. Actively using outcomes to examine our beliefs and bets closes the feedback loop, reducing uncertainty. This is the heavy lifting of how we learn.
Chalk up an outcome to skill, and we take credit for the result. Chalk up an outcome to luck, and it wasn’t in our control. For any outcome, we are faced with this initial sorting decision. That decision is a bet on whether the outcome belongs in the “luck” bucket or the “skill” bucket. This is where Nick the Greek went wrong. We can update the learning loop to represent this like so: Think about this like we are an outfielder catching a fly ball with runners on base. Fielders have to make in-the-moment game decisions about where to throw the ball.
Key message: How poker players adjust their play from experience determines how much they succeed. This applies ot any competitive endeavor in an uncertain world.
The best players analyze their performance with extreme intellectual honesty. This means if they win, they may end up being more focused on erros they made, as told in this anecdote:
In 2004, my brother provided televised final-table commentary for a tournament in which Phil Ivey smoked a star-studded final table. After his win, the two of them went to a restaurant for dinner, during which Ivey deconstructed every potential playing error he thought he might have made on the way to victory, asking my brother’s opinion about each strategic decision. A more run-of-the-mill player might have spent the time talking about how great they played, relishing the victory. Not Ivey. For him, the opportunity to learn from his mistakes was much more important than treating that dinner as a self-satisfying celebration. He earned a half-million dollars and won a lengthy poker tournament over world-class competition, but all he wanted to do was discuss with a fellow pro where he might have made better decisions. I heard an identical story secondhand about Ivey at another otherwise celebratory dinner following one of his now ten World Series of Poker victories. Again, from what I understand, he spent the evening discussing in intricate detail with some other pros the points in hands where he could have made better decisions. Phil Ivey, clearly, has different habits than most poker players—and most people in any endeavor—in how he fields his outcomes. Habits operate in a neurological loop consisting of three parts: the cue, the routine, and the reward. A habit could involve eating cookies: the cue might be hunger, the routine going to the pantry and grabbing a cookie, and the reward a sugar high. Or, in poker, the cue might be winning a hand, the routine taking credit for it, the reward a boost to our ego. Charles Duhigg, in The Power of Habit, offers the golden rule of habit change….
Being in an environment where the challenge of a bet is always looming works to reduce motivated reasoning. Such an environment changes the frame through which we view disconfirming information, reinforcing the frame change that our truthseeking group rewards. Evidence that might contradict a belief we hold is no longer viewed through as hurtful a frame. Rather, it is viewed as helpful because it can improve our chances of making a better bet. And winning a bet triggers a reinforcing positive update.
Note: Intellectual Honesty thinking clearly= thinking in bets
Good decisions compound
One useful model is to view everything as one big long poker game. Therefore the result of individual games won’t upset you so much. Furthermore, good decision making habits compound over time. So the key is to always be developing good long term habits, even as you deal with the challenges of a specific game.
The best poker players develop practical ways to incorporate their long-term strategic goals into their in-the-moment decisions. The rest of this chapter is devoted to many of these strategies designed to recruit past- and future-us to help with all the execution decisions we have to make to reach our long-term goals. As with all the strategies in this book, we must recognize that no strategy can turn us into perfectly rational actors. In addition, we can make the best possible decisions and still not get the result we want. Improving decision quality is about increasing our chances of good outcomes, not guaranteeing them. Even when that effort makes a small difference—more rational thinking and fewer emotional decisions, translated into an increased probability of better outcomes—it can have a significant impact on how our lives turn out. Good results compound. Good processes become habits, and make possible future calibration and improvement.
At the very beginning of my poker career, I heard an aphorism from some of the legends of the profession: “It’s all just one long poker game.” That aphorism is a reminder to take the long view, especially when something big happened in the last half hour, or the previous hand—or when we get a flat tire. Once we learn specific ways to recruit past and future versions of us to remind ourselves of this, we can keep the most recent upticks and downticks in their proper perspective. When we take the long view, we’re going to think in a more rational way.
Life, like poker, is one long game, and there are going to be a lot of losses, even after making the best possible bets. We are going to do better, and be happier, if we start by recognizing that we’ll never be sure of the future. That changes our task from trying to be right every time, an impossible job, to navigating our way through the uncertainty by calibrating our beliefs to move toward, little by little, a more accurate and objective representation of the world. With strategic foresight and perspective, that’s manageable work. If we keep learning and calibrating, we might even get good at it.
“Often the biggest changes in history are the achievements of thinly documented, informally organized groups of people. “
The Square and the Tower examines the role informal networks have played throughout history. Its one of the few books I’ve seen that takes a rigorous, empirical and non-sensational look at what secret societies actually did throughout history. More importantly it delineates between societies/institutions that are driven by informal networks, vs those that are driven by formal hierarchies. The world kind of goes back and forth between the two over time. The spread of diseases and ideas follow similar processes and are both are heavily influenced by the role of networks and hierarchies in society. Among its most useful(and amusing) conclusions is that Martin Luther and Donald Trump have something very important in common.
The first ‘networked era’ followed the introduction of the printing press to Europe in the late fifteenth century and lasted until the end of the eighteenth century. The second – our own time – dates from the 1970s, though I argue that the technological revolution we associate with Silicon Valley was more a consequence than a cause of a crisis of hierarchical institutions. The intervening period, from the late 1790s until the late 1960s, saw the opposite trend: hierarchical institutions re-established their control and successfully shut down or co-opted networks. The zenith of hierarchically organized power was in fact the mid-twentieth century – the era of totalitarian regimes and total war.
Martin Luther and Donald Trump
The key insight is that Martin Luther and Donald Trump and their respective suorters both made highly skilld and aggressive use of a new communication medium to spread their message. Luther had ht ebrand new thing called the printing press. Trump had this brand new thing called social media(mainly twitter)
Without Gutenberg, Luther might well have become just another heretic whom the Church burned at the stake, like Jan Hus. His original ninety-five theses, primarily a critique of corrupt practices such as the sale of indulgences, were originally sent as a letter to the Archbishop of Mainz on 31 October 1517. It is not wholly clear if Luther also nailed a copy of them to the door of All Saints’ Church, Wittenberg, but it scarcely matters. That mode of publishing had been superseded. Within months, versions of the original Latin text had been printed in Basel, Leipzig and Nuremberg. By the time Luther was officially condemned as a heretic by the Edict of Worms in 1521, his writings were all over German-speaking Europe. Working with the artist Lucas Cranach and the goldsmith Christian Döring, Luther revolutionized not only Western Christianity but also communication itself. In the sixteenth century German printers produced almost 5,000 editions of Luther’s works, to which can be added a further 3,000 if one includes other projects he was involved with, such as the Luther Bible. Of these 4,790 editions, almost 80 per cent were in German, as opposed to Latin, the international language of the clerical elite.3 Printing was crucial to the Reformation’s success. Cities with at least one printing press in 1500 were significantly more likely to adopt Protestantism than cities without printing, but it was cities with multiple competing
Likewise, Trump was able to get an enormous amount of massive publicity do to his exploitation of social media. It also didn’t hurt that their were highly skilled foreign actors also using social media to spread his influence. Much of this was done in an automated fashion, using bots, etc. Social media allowed this message to spread directly without any filter from media gatekeepers.
Gutenberg’s printing press helped make Lutheranism. Twitter bots helped make Trumpism.
Difficult to suppress
Why was Protestantism so resistant to repression? One answer to that question is that, as they proliferated throughout northern Europe, the Protestant sects developed impressively resilient network structures.
Similarly, traditional political operatives have had difficulty penetrating the social media networks that Trump has so successfully exploited.
Bringing the medium to the masses
Just as the printing press caused a drastic fall in the price of written books, the falling prices of phones and PCs made the internet more widely accessible.
The decline in the price of a PC between 1977 and 2004 followed a very similar trajectory to the decline in the price of a book between the 1490s and the 1630s. Yet the earlier, slower revolution in information technology appears to have had the larger economic impact. The best explanation for this difference is the role of printing in disseminating hitherto unavailable knowledge fundamental to the functioning of a modern economy. The first known printed mathematics text was the Treviso Arithmetic (1478). In 1494, Luca Pacioli’s Summa de arithmetica, geometria, proportioni et proportionalita was published in Venice, extolling the benefits of double-entry book-keeping.
Luther and Trump both spread their message just as new technology was making it much easier for something to go viral. Luther upended the church hierarchy by bringing religious texts and thoughts to the common people. Prior to Luther religious text were almost exclusively in Latin, which the common people could not read or understand. The idea that common people could be allowed to read the bible was considered heretical (see a world lit only by fire). Luther spread his messages into far away villages causing the Catholic church to lose control of its traditional followers. Likewise, Trump upended the political hierarchy by spreading a populist message far and wide, even overtaking previously Democratic strongholds. Many people who felt abandoned by the political process went to his rallies. Washington insiders have been thrown out, an outsiders have taken control. Many readers of this blog may not want to think of Trump in this way, but the analogy is valuable in understanding why Trump has been so successful.
Spread of disease
The speed with which an infectious disease spreads has as much to do with the network structure of the exposed population as with the virulence of the disease itself, as an epidemic amongst teenagers in Rockdale County, Georgia, made clear twenty years ago. The existence of a few highly connected hubs causes the spread of the disease to increase exponentially after an initial phase of slow growth.7 Put differently, if the ‘basic reproduction number’ (how many other people are newly infected by a typical infected individual) is above one, then a disease becomes endemic;
Impact on economics
For economists, too, advances in network science had important implications. Standard economics had imagined more or less undifferentiated markets populated by individual utility-maximizing agents with perfect information. The problem – resolved by the English economist Ronald Coase, who explained the importance of transaction costs* – was to explain why firms existed at all. (We are not all longshoremen, hired and paid by the day like Marlon Brando in On the Waterfront, because employing us regularly within firms can reduce the costs that arise when workers are hired on a daily basis.) But if markets were networks, with most people inhabiting more or less interconnected clusters, the economic world looked very different, not least because information flows were determined by the networks’ structures. Many exchanges are not just one-off transactions in which price is a matter of supply and demand. Credit is a function of trust, which in turn is higher within a cluster of similar people (e.g. an immigrant community). This has implications not only for employment markets, the case studied by Granovetter. Closed networks of sellers can collude against the public and deter innovation. More open networks can promote innovation as new ideas reach the cluster thanks to the strength of weak ties. Such observations prompted the question of
Spread of ideas
The key point, as with disease epidemics, is that network structure can be as important as the idea itself in determining the speed and extent of diffusion. In the process of going viral, a key role is played by nodes that are not merely hubs or brokers but ‘gate-keepers’ – people who decide whether or not to pass information to their part of the network. Their decision will be based partly on how they think that information will reflect back on them. Acceptance of an idea, in turn, can require it to be transmitted by more than one or two sources. A complex cultural contagion, unlike a simple disease epidemic, first needs to attain a critical mass of early adopters with high degree centrality (relatively large numbers of influential friends).In the words of Duncan Watts, the key to assessing the likelihood of a contagion-like cascade is ‘to focus not on the stimulus itself but on the structure of the network the stimulus hits’. This helps explain why, for every idea that goes viral, there are countless others that fizzle out in obscurity because they began with the wrong node, cluster or network.
That is because so many real-world networks follow Pareto-like distributions: that is, they have more nodes with a very large number of edges and more nodes with very few than would be the case in a random network. This is a version of what the sociologist Robert K. Merton called ‘the Matthew effect’, after the Gospel of St Matthew: ‘For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath.’* In science, success breeds success: to him who already has prizes, more prizes shall be given. Something similar can be seen in ‘the economics of superstars’. In the same way, as many large networks
Just like the printing press destroyed the ruling classes monopoly on spirituality, social media has destroyed the “establishment’s” monopoly on political ideology.
Martin Luther and Donald Trump would agree on this
Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed summarizes the key dangers of centrally managed social engineering projects. Its a bit dense, but well worth it. It shows similarities between many seemingly different disasters caused by top-down control and central planning. Case studies include modernist architecture, Soviet collectivization, herding or rural people into villages in Africa,and early errors in scientific agriculture, etc.
Anyone trying to build and manage an organization needs to be aware of the lessons in this book.
One key lesson is that practical knowledge, informal processes, and improvisation in the face of unpredictability are indispensable.
Formal scheme was parasitic on informal processes that alone, it could not create or maintain. The the degree that the formal scheme made no allowance for those processes or actually suppressed them, it failed both its intended beneficiaries and ultimately its designers as well. “
Radically simplified designs for social organization seem to court the same risks of failure courted by radically simplified designs for natural environments.
It makes the case for resilience of both social and natural diversity, and a strong case for limits about what can be known about complex social order. Avoid reductive social science.
Four elements of centrally planned disasters
According to the book, there four elements necessary for a full fledged disaster to be caused by state initiated social engineering.
- Administrative ordering of nature and society
- “High Modernist Ideology” a faith that borrowed the legitimacy of science and technology. Uncritical unskeptical public and therefore unscientific optimism about possibilities for comprehensive planning of human settlement and production. Often with aesthetic terms too.
- Authoritarian state willing to use the full weight of its coercive power for #2
- Prostrate civil society lacking capacity to resist these plans.
“By themselves they are unremarkable tools of modern statecraft; they are as vital to the maintenance of our welfare and freedom as they are to the designs of a would be modern despot. They undergird the concept of citizenship and the provision of social welfare just as they might undergird a policy of rounding up undesirable minorities.”
The discussion of the ecological disasters caused by forestry regulation in 18th and 19th century Germany is instructive:
The metaphorical value of this brief account of scientific production forestry is that it illustrates the dangers of dismembering an exceptionally complex and poorly understood set of relations and processes in order to isolate a single element of instrumental value. The instrument, the knife, that carved out the new, rudimentary forest was the razor sharp interest in the production of a single commodity. Everything that interfered with the efficient production of the key commodity was implacably eliminated. Everything that seemed unrelated to efficient production was ignored. Having come to see the forest as a commodity, scientific forestry set about refashioning it as a commodity machine. Utilitarian simplification in the forest was an effective way of maximizing wood production in the short and intermediate term. Ultimately, however, its emphasis on yield and paper profits, its relatively short time horizon, and , above all, the vast array of consequences it had resoloutley bracketed came back to haunt it.
Department of unintended consequences
I like to joke about wanting to start a department of unintended consequences to oversee economic policy. Often central planners fail because they arrograntly fail to foresee unintended consequences of their policies.
“ the door and window tax established in France under the directory and abolished only in 1917 is a striking case in point. Its originator must have reasoned that the number of windows and doors in a dwelling was proportional to the dwelling a size. Thus a tax assessor need not enter the house or measure it but merely count the doors and windows. As a simple, workable formula, it was a brilliant stroke, but it was not without consequences. Peasant dwellings were subsequently designed or renovated with the formula in mind so as to have as few openings as possible. While the fiscal losses could be recouped by raising the tax per opening, the long-term effects on the health of the rural population lasted for more than a century. “
See also: Goodhart’s Law