“A further related lesson: Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.” -Warren Buffett, 1989 Berkshire Letter to Shareholders
The investing industry is a bit of a head-scratcher: it’s the only industry I can think of where complexity is celebrated (on average). And that is unusual because complexity can lead to poor long-term investment results.
For example – Valeant, SunEdison, Ocwen, non-vanilla banks with complex derivative books, Enron…etc.
With hindsight, it’s clear complexity didn’t work out favorably and really begs the question of whether that complexity was worth the forecasted potential returns. And that question is even more pertinent when taking into consideration that Buffett has performed admirably well with a basket of investments where complexity is anathema.
There are more than a few problems that arise with complexity:
- Investors may be stepping outside of their circle of competence without knowing it
- Complex situations require a lot of work, and after having done all that work, an investor is likely to fall prey to elevated confidence
- Lots of moving parts means lots of things can go wrong (and perhaps lots of things need to go right for the investment to work out)
- Unless an investor is going to take the target private, eventually the investor needs to sell the investment to someone else – who else is going to understand and want to own that complexity?
Of course the reason the industry gravitates towards complexity is because there are too many smart people analyzing investments. And one way to obtain (theoretically) better investment results is to understand progressively complex situations where other smart investors cannot follow. I also believe there is a perverse incentive to seek out complex situations because a successful analysis really massages the ego. After all, the investment industry is really an intelligence / knowledge business…
To close the loop, seems to me the investment industry as a whole has adopted complexity as an investment strategy and business model. This worked when the industry was nascent, but now there are too many smart people all doing the same thing. Complexity as an investment strategy and business model is probably past its prime. How would an investor adapt to this new environment?