A Year in Review: Lessons from 2023
“I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.”
—Charlie Munger
1. Want to Predict the Future? Look at the Incentives.
Most would argue that predicting the future is impossible. In the world of investing, we are constantly reminded of this with disclaimers such as, "Past performance is not indicative of future results." This caution is well-founded, as history has shown that even the most successful investors struggle to maintain consistent results over time. However, one could contend that a significant part of an allocator’s or investor’s role—maintaining consistency—does involve a form of future prediction. In the case of an allocator, rather than blindly investing with managers, we dedicate considerable effort to understanding the competitive advantages, people, and culture that define a firm, aiming to maximize the probability of achieving high, risk-adjusted returns.
While I do not believe anyone can truly systematically predict the future, I do believe that studying incentives is one of the closest proxies to doing so. By incentives, I mean the structures and systems that (deliberately and inadvertantly) encourage certain behaviors and actions. To put this into context, let’s consider the philisophical theory of Physchological Egoism:
“Physchological Egoism is long-standing theory in psychology and philosophy that suggests all human actions are motivated by self-interest. According to this view, even seemingly altruistic acts are ultimately done because the person performing the act derives some benefit from it, whether it be a sense of satisfaction, happiness, or avoidance of guilt. In essence, psychological egoism posits that people are inherently driven by their own desires and welfare, making self-interest the underlying force behind all human behavior”.
Without going into the merits and flaws of the Psychological Egoism theory, I believe that most people would agree that humans generally prefer to choose a course of action that maximizes perceived gain and minimizes percieved loss. Of course the percieved “gain” and “loss” is entirely situational and independent from person to person, it could be tangible like monetary or intangible such as socail statues or happiness. However, the bottom line is that systems and structures can directly lend to behaviors and eventual results that are entirely predicatable in retrospect.
In the investing world, such
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The systems and structures put in place will encourage and sicourage benhavior. In most cases,
Incentives, in this case being the systems and structures put in place around
Some examples of the cause and effect of
2. Culture and People Really Matter.
3. Duration and Quality = A Winning Formula for Investing and Business Success.
4. The Value of Discipline and Staying in Your Lane.
5. The Value of Generalists and Specialists.
6. IRR vs. AUM: A Potential Dichotomy?
7. The Commoditization of Investing.