The two pathways to creative success in business and investments
This post was originally published on the CFA Institute Enterprising Investor Blog on 4 November 2019. You can find the original post here.
What does it take to be successful in business or as an investor? One of the key ingredients is differentiation. If you want to be successful with your business, you need to offer a product that is different from your competitors in a way that is recognized by clients as added value. If you want to beat the market as an investor, the number one thing you need to do is do something different than all the other investors. Or as Howard Marks put it in “The Most Important Thing”:
“You can’t do the same things others do and expect to outperform.”
But every differentiation is an act of creativity. After all, the business leader who comes up with a great new product had to have an idea how to do things better than his competitors have done in the past. And every great investment is either the result of luck or skill – with skill meaning to be able to assess risks and opportunities differently than other investors.
Unfortunately, most people tend to think that creativity declines with age. The myth of the innovative businessmen is driven by stories about young geniuses who revolutionise their fields. Elon Musk is the young entrepreneur who tore up the book of how to build cars and moved electric vehicles into the mainstream. And now he is about to bring space travel to the masses. And in the investment world one might think of John Bogle who invented the first index mutual fund in 1976 and went on to revolutionize the way we invest today.
But this image of the disruptive innovators who revolutionise their industry at a young age is incomplete. As David Galenson writes in a recent paper, the media and the research into creativity has focused too much on these so-called conceptual innovators. Conceptual innovators tend to be very young, enter an industry and turn it upside down. They are not beholden to the mainstream way of how things are done or how things are supposed to work. And there is plenty of research that indicates that this kind of creativity declines with age.
But the vast majority of innovations are not made by these conceptual innovators. Rather they are made by experimental innovators. These innovators work inductively rather than deductively. A conceptual innovator like Elon Musk may look at an industry as a whole and deduces from what a car needs to do what a specific car (his Tesla cars) are going to look like and what technology is needed to best achieve these overall goals. In contrast, an experimental innovator works inductively. They look at the world around them and learn how things work in practice. Then, based on this experience, they make small adjustments and test them in real life. This methodology means that their innovations become more important and more successful as their experience grows.
A prominent example of such experimental innovators is Charles Darwin. Darwin published his theory of evolution at the age of 50 and it is the product of decades of investigation and research. In general, experimental innovators deliver their best work at an older age, often well above the age of 50 because, as Darwin said:
“I have been speculating last night what makes a man a discoverer of undiscovered things, and a most perplexing problem it is. Many men who are very clever – much cleverer than discoverers – never originate anything. As far as I can conjecture, the art consists in habitually searching for causes or meaning of everything that occurs. This implies sharp observation and requires as much knowledge as possible of the subject investigated.”
Translation: If you are passionate for the subject at hand, then acquiring more experience will make you more and more creative because your passion will drive you to learn more and more about the field and constantly ask questions about why things are done the way they are. This is why so many investors who are passionate about investments become better over time. They learn from every failed investment they make, and then improve their investment process. Step by step, they innovate their way to the top of their field. But passion is key. If people get demotivated by failure or lose interest in their job and burn out, the drive to ask questions and innovate dies.
Howard Marks, in my view, is an example of such an experimental innovator in the investment world. While Marks was always a good investor, his Oaktree funds were originally not the subject of magazine feature stories. Marks wrote his now famous newsletters for years in obscurity. It was only with the long-term success of Oaktree and the consistently high returns provided by the funds that the spotlight was put on Howard Marks.
Similarly, Cliff Asness founded AQR in the late 1990s based on the research of Eugene Fama and Ken French on factor returns. Starting from there, the team at AQR gradually improved their investment process as they gained experience, improving one tiny innovation at a time. Today, AQR is one of the biggest and most successful hedge fund firms in the world.
What we learn from these stories and the research into experimental innovation is that many businesses fail to tap into a massive source of competitive advantage and differentiation: the people who work at the firm and are experienced and still passionate about their work. These are the men and women who can help the business innovate and create differentiated new products and services. Unfortunately, in most businesses the cult of the conceptual innovator has meant that these more experienced, yet still passionate employees have been largely ignored.