As the world of investing has become more quantitative, with alpha, beta and various “factor exposures” being sliced and diced and repackaged in various ways, it is easy to lose track of the fact that businesses are just collections of people working together as a tribe.
These tribes are formed in pursuit of some mission that revolves around creating value for customers, who themselves are just collections of people. And while the company tribe seeks to create value for various customer tribes, they are operating within an ecosystem of cooperating and competing tribes with the actions of every tribe within the ecosystem interacting with each other.
(Source: Harvard Business Review)
When you recognize that investing in stocks is about financing various parts of a living ecosystem, it becomes obvious that many of the mental models that investors should draw on to inform their decision making come from fields such as sociology, evolutionary biology, anthropology, and social psychology. Yet somehow, the investment field in recent decades seems to have drawn more from models found in the hard sciences. As if there was some sort of underlying “laws of investing” – a “magic formula” – that explains the ways that stock prices move as if they were physical objects subject to the sort of immutable laws that govern chemistry, math, and physics.
While written nearly 20 years ago, one of the best investment books to draw lessons from the so called “soft sciences” is Investing: The Last Liberal Art, by Robert Hagstrom. Hagstrom is a professional investor who has written many books about the investment strategies of Warren Buffett, but in The Last Liberal Art, he explores what Buffett’s investment partner Charlie Munger has called a “latticework of mental models” drawn from a range of disparate fields including biology, psychology, philosophy, literature, sociology and more to inform the investment process.
More recently, Katherine Collins, a professional investor and a board member of the Santa Fe Institute, a world leader in multidisciplinary research on complex adaptive systems, published The Nature of Investing: Resilient Investment Strategies Through Biomimicry. In her book, Collins argues for an approach to investing based on the lessons of the biological world that “values resiliency over rigidity and elegant simplicity over synthetic complexity.”
Ecology is the branch of biology that deals with the relations of organisms to one another and their surroundings. What is equity investing other than the study of collective organisms (humans’ superpower is our ability to assemble individuals into a collective group that acts as a single super organism) and how they relate to other organisms (other companies and customer sets) and their surroundings (the economic, social, political, and cultural systems in which business is conducted)?
It was with these sorts of mental models on my mind that I recently listened to Michael Mauboussin give an interview with the Alliance for Decision Education, a nonprofit group focused on helping students learn to be better decision makers in service of living better lives and building a better society. For those of us who have spent a lot of time in the field of decision research, the formal and advisory board of the Alliance is a remarkable who’s who in the field including Michael Mauboussin, Daniel Kahneman, Garry Kasparov, Barbara Tversky, Paul Slovic, Barbara Mellers, Phil Tetlock, and Annie Duke. If you don’t know those names, just take it from me that this is like the Mount Rushmore of decision-making researchers. We referenced the work of several of them in our series about position sizing.
Michael Mauboussin is not only a leading expert in the field of decision making and the chair of the board of the Santa Fe Institute (see Katherine Collins bio above) but is first and foremost one of the most influential voices in the practice of equity investing. Our team has read most everything he has written publicly while in his roles at Legg Mason, Credit Suisse, BlueMountain Capital, and currently as the Head of Consilient Research at Counterpoint Global, a division of Morgan Stanley. The title of “Head of Consilient Research” is an uncommon one, but since consilience is “the linking together of principles from different disciplines” you can see how relevant Mauboussin’s background is to this topic.
In his interview, Mauboussin discussed the ways in which ants forage for food and in doing so clarified for us an important element of how we think about evaluating corporate management teams.
“So now I’m going to talk about social insects. This is about ant foraging. We’ll use ants as an example. You have a nest of ants and there’s a food source. Exploitation would be when the ants go out, find the food source, and then they just focus their attention on getting as much of that food into the nest as possible. The way the ants do this is they go out randomly. But they’re laying pheromone trails as their means of communication.
Once an ant finds the food, they come back. That trail gets a little stronger. The ant comes out, senses that and so that reinforces it. As they travel the same path that becomes a very strong pheromone trail, and that’s how they figure out how to do that.
If you actually watch ants in your backyard in the summertime, they’re kind of doing crazy stuff all the time. The scientists were studying them, and they would find out that some ants would just peel off of the pheromone trails that lead to the food source. Then they got much more scientific about studying that rate of peeling off and it turns out there’s a mathematical probability.
Here’s the thing that’s absolutely beautiful. This is the thing that’s so cool. It turns out that the probability of peeling off the path is in fact[…]