New Paper from Mauboussin: Min(d)ing the Opportunity Excess Returns Require the Chance to Apply Skill

“Much of what we experience in life results from a combination of skill and luck.” —Michael J. Mauboussin, The Success Equation – Untangling Skill and Luck in Business, Sports, and Investing

A new paper is out from Mauboussin and Callahan, both currently at Credit Suisse.

Below, a sneak peak from the introduction:

The point of this report is that all of the skill in the world is for naught if you don’t have attractive opportunities. While the investment industry is focused on ways to ferret out skill, there is less discussion about where and how investors should apply their skill.

There are two basic conditions that present a challenge for skillful investors. The first is where the payoffs are potentially attractive but all of the competitors are very skillful. In this case, the skills of the players are offsetting and luck plays a large role in determining the outcome. For example, a good poker player who wants to make money should seek games with weaker players. Playing in highly competitive events may reveal prowess but is a tough way to make a living.

The second condition is when the payoffs are meager. You can be the most skillful person playing, but there’s not much to play for. Consider the draft in sports, the primary way that professional sports leagues assign amateur players to its teams. In some years the draft is rich with great players. But in other years there is a dearth of talented players. You can have the most skillful scouting and draft strategy around but your skill won’t pay off if the pool of players is poor.

Click image to download PDF. Also, the Mauboussin link post will be updated to include this one to.



New Paper from Mauboussin: Animating Mr. Market, Adopting a Proper Psychological Attitude

“If you want to make money on Wall Street, you must have the proper psychological attitude. You must look at things under the aspect of eternity.” —Ben Graham

A new paper is out from Mauboussin and Callahan, both currently at Credit Suisse, discussing the Mr. Market metaphor, that was once introduced by Benjamin Graham.

The content in this paper is based on a presentation at the Columbia Student Investment Management Association Conference delivered on January 30, 2015.

Click image to download PDF. Also, the Mauboussin link post will be updated to include this one to.



Here’s a summary of this discussion. First, reading chapters 8 and 20 from The Intelligent Investor, as well as chapter 12 from Keynes’s General Theory, can help shape the proper attitude an investor should have toward markets.

The other main points are as follows:

  • To be an active investor, you must believe both Eugene Fama and Robert Shiller are correct, just not at the same time. You need inefficiency to get opportunities and efficiency for those opportunities to turn into returns.
  • Mr. Market remains a very powerful metaphor for thinking about markets. Anthropomorphizing the market makes the story less abstract and more concrete.
  • One way to animate Mr. Market is to understand the market as a complex adaptive system, or to apply the wisdom of crowds. What’s key is that crowds are wise under some conditions and mad when any of those conditions are violated.
  • Diversity breakdowns, which can happen for sociological as well as technical reasons, lead to extremes and hence opportunity.
  • Remember the line from Seth Klarman: You are looking for cases where uniform belief has led to a mispricing of expectations and thus a way to make money. The Triple Crown contenders show this vividly.

Are You Stuck In the Past? Or Is Benjamin Graham Still Relevant in 2015?

Is Benjamin Graham still relevant in 2015? Or is he not? Maybe just to some extent, or is Benjamin Graham more relevant now than he has ever been before?

Maybe these are just another redundant questions, or could they be the most important ones to ask yourself. Asking questions often means trying to find new answers, new answers regarding circumstances not considered earlier, or as a way of questioning your own beliefs and the way you look at things around you.

Why am I asking this question to myself—Is Benjamin Graham still relevant in 2015? Does it really matter? Maybe not everyone. But to all of us trying to improve our value investing skills by following the investment concepts laid out by Benjamin Graham, the question is of utmost relevance I believe. Why? Because if they are not relevant today in 2015, we have to go looking for other sources of knowledges to serve as our main guide out in the investing sphere.

Albert Einstein said:

The important thing is not to stop questioning. Curiosity has its own reason for existing.

John Maynard Keynes said:

When my information changes, I alter my conclusions. What do you do, sir?

Keynes also said:

The difficulty lies not so much in developing new ideas as in escaping from old ones.

From the above quotes, we should keep in mind the importance of “not to stop questioning” from Einstein, and also that we always have to be prepared to “alter [our] conclusions” when “[our] information changes” from Keynes. But, this may be easier said than done, as implied by the last Keynes quote, that the greatest danger when it comes to new ideas, even if our new ideas are hard to come by, might be escaping from the old ones. Why is that?

In his speech—The Psychology of Human Misjudgment—at Harvard Bussiness School in June 1995 Charlie Munger was, among other kinds of biases, talking about the bias from commitment and consistency tendency as (emphasis added) “…a superpower in error-causing psychological tendency: bias from consistency and commitment tendency, including the tendency to avoid or promptly resolve cognitive dissonance. Includes the self-confirmation tendency of all conclusions, particularly expressed conclusions, and with a special persistence for conclusions that are hard-won.”

Charlie also said that (emphasis added) “The human mind is a lot like the human egg, in that the human egg has a shut-off device. One sperm gets in, and it shuts down so that the next one can’t get in. The human mind has a big tendency of the same sort … According to Max Plank, the really innovative and important new physics was never really accepted by the old guard. Instead, a new guard came along that was less brain-blocked by its previous conclusions. And if Max Plank’s crowd had this consistency and commitment tendency that kept their old conclusions intact despite disconfirming evidence, you can imagine what the crowd that you and I are a part of behaves like … What people are shouting out they are pounding in.” 

The most important thing (as Howard Marks would have said) is to:

  1. Never stop asking questions.
  2. Be aware of the consistency and commitment bias and how it affects us.
  3. Be willing to change your mind when the facts change. The “truths” of yesterday may, or will certainly, not be the “truths” of today or the future.

So, is Benjamin Graham relevant? I do think so. Of course not everything he said or put down on paper or in his books is relevant, but the main ideas still seem to serve the ones willing to listen rather good.

For the article that sparkled my mind about the topic of this post, see Net Net Hunter’s article Is Benjamin Graham Still Relevant in 2015?

To read about some of the concepts of Benjamin Graham, see here:

Another great read is What Has Worked in Investing from Tweedy, Browne Company LLC.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Mental Model: Compound interest

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” ― Albert Einstein

“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.” ― Charlie Munger

“We’ve going to compound it at a reasonable rate without taking unreasonable risk or using leverage. If we can’t do this, then that’s just too damn hard.” ― Charlie Munger

Back in 1963 in his letter to partners Warren Buffett wrote about the joys of compounding explaining the difference of compounding depending on the level of growth over different time periods – see image below. Click on image to enlarge.


In the Snowball Warren said Anything times zero is zero.” So, the lesson here is to always remember Warren’s advice Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.”

Mental Model: Anchoring bias

“In many situations, people make estimates by starting from an initial value that is adjusted to yield the final answer. The initial value, or starting point, may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insufficient (Slovic & Lichtenstein, 1971). That is, different starting points yield different estimates, which are biased toward the initial values. We call this phenomenon anchoring.” – Tversky and Kahneman (1974)

Since there is a lot of great articles already written on the subject, I will refer to one of these. For a great summary of the mental model anchoring, head over to the superb blog Farnam Street and the post Mental Model: Anchoring for further reading.

Remember, never look at the stock price before you have done your own analysis and come up with an estimate of a conservative intrinsic value per share.

Go to the page Mental Models for a listing of all mental models.