Michael Mauboussin – Active Challenges, Rational Decisions & Team Dynamics

“When you are thinking about any kind of forecast, it is incredibly important to understand and acknowledge the reference class from which this problem comes, and to weight your own views with the evidence you have from the reference class. An analyst suggested Amazon would grow revenues 15 percent a year through 2025. The outside view, the base rate, looked at every company with initial revenues of $100 billion or more since 1950.”— Michael Mauboussin

Strategy & Decision Making · Psychology & Behavior · Economics & Markets

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Weight inside view with reference class

“Burke and Green recommended a different way of evaluating managers. They said the way to think about it is gross return of the manager, pre-fee, risk-adjusted, minus their benchmark, times assets under management. How much value can that manager extract from the market in dollars? Peter Lynch in his first five years running Magellan had amazing alpha but was running a puny amount of money. His monthly gross profit was $770,000.”— Michael Mauboussin

Business & Entrepreneurship · Economics & Markets · Strategy & Decision Making

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Dollar alpha better metric than percentage

“Stephen Jay Gould argued that Ted Williams hitting .400 in 1941 was exactly a four standard deviation event. By 2016, a four standard deviation event would get you to about .380. The difference between the very best and the average has decreased because the standard deviation has gone down over time. There is more uniform excellence.”— Michael Mauboussin

Economics & Markets · Psychology & Behavior · Strategy & Decision Making

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Skill improves uniformly, making luck more important

“When both luck and skill contribute to outcomes, as skill gets better, luck becomes more important. Absolute skill has never been better in investing. If I gave you all the technology at your fingertips today and put you back in the 1960s or 1970s, you would crush the competition. But relative skill, the difference between the very best participant and the average participant, has been going down. The variance has been shrinking.”— Michael Mauboussin

Strategy & Decision Making · Economics & Markets

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Better absolute skill narrows relative skill

“Brian Arthur at Stanford did work on increasing returns. We are taught in microeconomics that returns, marginal returns, tend to migrate towards the cost of capital. High return on capital businesses attract competition, which drives returns down. Brian identified situations called increasing returns where there was no regression toward the mean. There was actually a repulsion from the mean. Winners were winning. Losers were losing. He identified qualities and features like network effects.”— Michael Mauboussin

Economics & Markets · Strategy & Decision Making

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Some systems repel from mean, not regress

“John Geanakoplos at Yale wrote papers on the leverage cycle. His very provocative point is that it is not about interest rates. It is about margin requirements. It is about the ability to borrow. We tend to think that if we lower interest rates the world is going to be better, and we raise interest rates going to be tight. He is saying that is not really the key thing. It is the collateral.”— Michael Mauboussin

Economics & Markets · Strategy & Decision Making

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Margin requirements matter more than rates

“While we talk a lot about diversity, which is almost always social category diversity (race, gender, age, ethnicity), the real key is cognitive diversity. People with different experiences, backgrounds, training, and personalities that can surface different points of view. That is really the key to good quality decision making. A typical investment committee says we are going to have the credit guy, the private equity gal, and so forth.”— Michael Mauboussin

Leadership & Management · Strategy & Decision Making · Psychology & Behavior

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Cognitive diversity beats social diversity

“There is an element of career risk. Bill Belichick goes for it on 4th down and it does not work out. People give him the benefit of the doubt. But if you are a coach with a .500 team, it may be the correct decision but you lose that game. People do not think about the quality of your decision-making process; they think about the outcome. These guys might be saying, if I punt it, we may lose the game, but no one is going to say Ted punted, that was bad.”— Michael Mauboussin

Psychology & Behavior · Strategy & Decision Making · Leadership & Management

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Reputation preserves mediocre decisions

“Once you start thinking about markets as complex, adaptive systems, I do not think you can ever think about them in any other way. Markets as complex, adaptive systems both explains why markets tend to be efficient (wisdom of crowds) but also explains why markets episodically go haywire, which they clearly do. The fact that you and I are suboptimal does not necessarily translate into a market setting because our errors may cancel out. You are overconfident and buy. I am overconfident and sell.”— Michael Mauboussin

Economics & Markets · Biology, Ecology & Systems · Psychology & Behavior

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Markets are complex adaptive systems

“Keith Stanovich made an important distinction between IQ, which measures some very real helpful things, and what he calls RQ, rationality quotient, which is the ability to make good decisions. About a year ago he published The Rationality Quotient with colleagues, laying out for the first time an assessment of rational thinking. Find people with weird backgrounds but assess them on their ability to think rationally. That combination might be the sweet spot for success.”— Michael Mauboussin

Psychology & Behavior · Leadership & Management

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Rationality quotient over IQ for decisions

“There is an incredible literature demonstrating that people tend to have bad timing. The number one reason you fire a manager is their performance has been poor. The number one reason you hire a manager is performance has been good. Study after study demonstrates that if you bought the funds that were fired and sold the ones that were hired, you actually do much better because of regression toward the mean.”— Michael Mauboussin

Psychology & Behavior · Strategy & Decision Making · Economics & Markets

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Hiring and firing based on performance fails

“Sandy Grossman and Joe Stiglitz in 1980 wrote a paper called On the Impossibility of Informationally Efficient Markets. Their basic argument was markets cannot be perfectly informationally efficient because there is a cost to gather information and reflect it in prices. As fair compensation to assume that cost, there should be a requisite benefit. Lasse Pedersen calls it markets have to be efficiently inefficient.”— Michael Mauboussin

Economics & Markets · Philosophy & Reasoning

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Efficiency requires compensatory inefficiency

“The number one way we use to compare things is by analogy. This is like that. That approach is incredibly effective if you have got the appropriate analogy. But it breaks down pretty quickly in terms of breadth and depth. Breadth: you might have a great memory, but it is probably finite, so you may not remember the appropriate analogy or know of it. Depth: you may pick the wrong things, the wrong features of both the full goal and the analogy to make an appropriate comparison.”— Michael Mauboussin

Psychology & Behavior · Philosophy & Reasoning

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Analogies fail on breadth and depth

“Richard Hackman studied teams across all different disciplines and found the optimal size was four to six. Every person on a committee of seven or more says we would be more effective if we were smaller. Nothing is happening at a board meeting with 25 people. All the work is happening at the committee level, the small groups.”— Michael Mauboussin

Leadership & Management · Operations & Execution

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Optimal team size four to six people

“The standard deviation of excess returns, the standard deviation of alpha, has been getting skinnier over time. The people drawn to this industry are today extremely well educated, very well-trained, with access to incredible information and academic research. The degree of uniformity of excellence is probably higher, making it more difficult to distinguish yourself.”— Michael Mauboussin

Economics & Markets · Strategy & Decision Making

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Better training shrinks alpha distribution

“Kahneman has this line in Thinking Fast and Slow: people who are doing their own work do not feel like they need to understand the reference class. But understanding the reference class almost always makes you a better thinker. We tend to be overconfident. Our ranges of outcomes are too narrow. Confirmation bias: you make a decision, you seek information that confirms your point of view, and you dismiss, disavow, discount information that does not. It is a very natural thing for all of us to do.”— Michael Mauboussin

Psychology & Behavior · Strategy & Decision Making

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Overconfidence and confirmation bias universal

“AlphaGo and AlphaZero are mindboggling. The advancements in how those things became superhuman were expected. But more interestingly, great go players and chess players say these programs are playing moves that were not even in our mental repertoire, and we are learning from them. Some of these moves in retrospect are really beautiful. It is opening up our mental space.”— Michael Mauboussin

Technology & Engineering · Creativity & Innovation · Psychology & Behavior

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AI discovers moves beyond human conception

“In Big Data Baseball, the thing that blew me away was pitch framing. Catchers can position themselves to catch pitches in such a way that the umpire calls it a strike instead of a ball. Some catchers are better at it than others. Simply bringing in a catcher who is really good at pitch framing can lead to a substantial delta in the number of games won over a season. That is a perfect example of analytics and the human dimension.”— Michael Mauboussin

Operations & Execution · Psychology & Behavior

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Invisible skill creates measurable edge

“I am very committed to mental models and thinking about big mental models. I am a huge fan of understanding big ideas from different disciplines, understanding that constant learning will lead you down a number of intellectual cul-de-sacs, but you never know when a framework or model or something will be useful to you. This idea of constant learning. In this industry you cannot live without it. How can Todd Combs and those guys make such big decisions in short periods of time?”— Michael Mauboussin

Philosophy & Reasoning · Strategy & Decision Making

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Mental models enable fast decisions

“Most good investment ideas are controversial. It is very rare that everyone says this is obviously brilliant. I am a big fan of ballot voting systems. Maybe strong majority, but majority ballot voting systems. Let people vote independently.”— Michael Mauboussin

Strategy & Decision Making · Leadership & Management

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Ballot voting prevents groupthink