Michael Mauboussin on Relative Skill

A few years ago Michael Mauboussin published a paper on what makes for successful investing.

Success in investing has two aspects. The first is skill, which requires you to be technically proficient. Technical skills include the ability to find mispriced securities (based on capabilities in modeling, financial statement analysis, competitive strategy analysis, and valuation all while sidestepping behavioral biases) and a good framework for portfolio construction. The second aspect is the game in which you choose to compete. Some games are highly competitive and others are not. You want to find games where your skill is greater than that of the other players. Your absolute skill is not what matters; it’s your relative skill.

Alpha and the Paradox of Skill: Results Reflect Your Skill and the Game You Are Playing, Credit Suisse

Before you invest, know what game you are playing.

In cases where two or more players have the same level of skill—whether that skill is high or low doesn’t matter—the skills of the players offset one another and luck becomes the primary determinant of the outcome. “Players” can be athletes, investors, or business executives. In many competitive realms, including investing, the skills of the participants have improved on an absolute basis but have shrunk on a relative basis. Today’s investor has vastly more resources and training than his or her predecessor from years past. The problem is that investors, broadly speaking, have gotten much better which means that the difference between the skill of the best and the average participant isn’t as great as it used to be.

Look for the game where the other players are not as skilled.

David Swensen, the chief investment officer of Yale University’s endowment, uses the dispersion of active managers as a proxy for market efficiency. He discusses the dispersion of returns—which he measures as the difference between the returns for first and third quartile funds—in various asset classes, suggesting that he seeks to invest in active managers only where dispersions are high. “You want to spend your time and energy pursuing the most inefficiently priced asset classes,” he told the students during a lecture, “because there’s an enormous reward for identifying the top quartile venture capitalist and almost no reward for being the top quartile of the high-quality bond universe.”

By the way, Michael Mauboussin appeared twice on Capital Allocators.

Episode 36: Michael Mauboussin – Active Challenges, Rational Decisions and Team Dynamics

Episode 99: Michael Mauboussin – Who’s on the Other Side

Photo by Chris Liverani on Unsplash

Post by Marcelino Pantoja


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