One of the best investing books I’ve ever read is “More than You Know” by Michael Mauboussin. The great thing about Mauboussin is his focus on what he calls Consilient Investing. He takes the best concepts from varying fields and applies them to investing, like what baseball managers can teach investors about improving our odds of winning or how biological patterns can teach us about expectations of human nature. The concept of Consilience is how I came up with the idea for Alpha Theory after reading a book on Poker Theory. Many times the best way to improve your own process is not to take the best practices of those in your field but to learn the best practices of all fields and see if they can spark an idea that makes you rethink the dogma that can ossify even the smartest industries.
Alpha Theory embodies many of the facets of “More than You Know” including a foundation based on expected return, constructing a portfolio based on idea quality, risk management that is not based on volatility, and an understanding that controlling emotions is critical to success.
Here is the opening of Chapter 1 of “More than You Know.”
Paul DePodesta, a former baseball executive and one of the protagonists in Michael Lewis’s Moneyball, tells about playing blackjack in Las Vegas when a guy to his right, sitting on a seventeen, asks for a hit. Everyone at the table stops, and even the dealer asks if he is sure. The player nods yes, and the dealer, of course, produces a four. What did the dealer say? “Nice hit.” Yeah, great hit. That’s just the way you want people to bet — if you work for a casino.
This anecdote draws attention to one of the most fundamental concepts in investing: process versus outcome. In too many cases, investors dwell solely on outcomes without appropriate consideration of process. The focus on results is to some degree understandable. Results — the bottom line — are what ultimately matter. And results are typically easier to assess and more objective than evaluating processes.
But investors often make the critical mistake of assuming that good outcomes are the result of a good process and that bad outcomes imply a bad process. In contrast, the best long-term performers in any probabilistic field — such as investing, sports-team management, and pari-mutuel betting — all emphasize process over outcome.