The fabric pattern of reality
First Principles Reasoning Series
Fellow Partners,
As discussed in our founding story this partnership began with simple questions:
What is the most effective way to invest money we do not need for years?
Are there better alternatives to the dozens of options I had tried for my family?
Thus, the years-long experiment in assessing the effectiveness of practical wisdom applied to investing was born and culminated in the creation of this partnership.
The fabric pattern of reality
Wisdom is becoming competent with regard to the realities of life.
Gerhard von Rad
Pause for a moment and think about the implications of this definition of wisdom. It is astounding. It implies an order and truth in our reality, and that the ability to comprehend it and act accordingly will result in competence — the sort of competence that will make us better in the roles we fill (investors, parents, children, etc.) Thus, wisdom is understanding our reality and composing ourselves in such a manner as to act effectively within it.
The most impactive learning on the journey leading up to this partnership was the continual realization that there is indeed a fabric pattern to reality, that we can know some of it, and that acting in accordance with it will result in effectiveness.
That is motivating.
Rich or right
The second most impactive learning on this journey has been the continual realization of the many ways humans are constantly hindering their ability to understand reality as it really is and act in accordance with it.
I suspect most people would rather believe they are right (about anything) than submit themselves to truth and wisdom. I hope I am wrong. I fear I am not. Hence this motif in my writing.
Open mindedness / mental flexibility is an underrated trait in our business.
Dennis Hong, ShawSpring Partners
This is true from the opposite angle as well: humility is an enormous asset. There is something innate in humans that deeply desires approval in others — not just to be right, but to be seen as being right. This roadblock to learning continually truncates an enormous amount of humanity’s potential.
Willingness to pursue truth over ego is a competitive advantage in any context in which acting in accordance with truth wins in the long run. Investing is certainly such a pursuit. (Another way to measure this: what is one seeking to compound? If ego is prioritized over wisdom…we know how that usually ends.)
Changes
Believing there is a fabric pattern to reality does not imply that life and investing becomes entirely formulaic.
As discussed in previous essays, we believe businesses and capital markets are best understood as complex adaptive systems. They behave as organisms, with some more predictable traits (e.g., oscillation between greed and fear) and some less predictable traits (e.g., value creation departing from the concept of book value).
We often cannot predict changes within complex adaptive systems, but we can observe their complexity and their adaptation and adjust how we deal with them accordingly.
This drives at the importance of reasoning from first principles. For example, the past couple of months have seen a cacophony of bad headlines under the theme of “record results”, such as a Latin America ETF that is up 100% in the trailing 12 months. What happened? The terrible month of March 2020 was dropped from the data set (by the way, including March 2020 in the data set results in a 37% loss in the trailing 12 months.)
Year to date vs. inception to date
These concepts connect many places — including how we assess performance.
Many fund managers are primarily compensated on their annual performance. The (good) need for accounting and auditing requires running the numbers, assessing performance, and paying fees on a periodic basis.
An unfortunately common externality of this structure is year-to-date thinking — that is, management of the portfolio in such a way as to increase returns or protect gains to maximize the annual paycheck, often at the expense of longer-term performance.
We avoid this by staying closely aligned — in philosophy and capital. 100% of the performance fees I earned in 2020 were invested back in this partnership, and in addition to my role as general partner my family and I are and will remain substantial limited partners — continuing to grow our family’s wealth alongside yours.
This creates a better set of incentives and promotes longer-term thinking. We improve our chances of outperforming by focusing on inception-to-date performance — that is, total growth in our capital since the foundation of the partnership. This calm, patient incentive lets us ignore an enormous amount of noise which we would otherwise pay an emotional and financial toll to manage. It also helps us remain humble as we grow as it reduces temptations to assess or focus on shorter-term outcomes.
Closing thoughts
I recently finished one of Jack Schwager’s collections of interviews with traders. The interviewees had many different styles, and while they collectively focused on much shorter timeframes than this partnership, what they had learned in their careers about truth vs. ego was strikingly common. A few excerpts:
Winning streaks lead to complacency, and complacency leads to sloppy trading…if everything is going great, watch out.
The flexibility to change your opinion is an attribute, not a flaw. The flexibility to change your market view is essential to succeeding as a trader. If you are rigid in your market stance you only need to be wrong once to decimate your account.
When it comes to markets, strong opinions weakly held is a right approach.
Ego, and the need to be right, are detrimental to effective trading. Many traders are more invested in their market theories and prognostications being right than they are in being profitable, which is all that matters…it’s not about being right, it’s about making money.
The knowledge that there is a fabric pattern to reality, the understanding that we can know some of it, the desire to pursue wisdom, and the humility to act in accordance with it are all enormous competitive advantages.
All the best,
John
Founder and Managing Partner