Saturday, November 8, 2014

Kill your investing gurus: Charlie Munger

In Kill your investing gurus, I offered a skeptical opinion of Warren Buffett and his public persona. That post's comments became a discussion of his business partner, Charles Munger, which is appropriate because much of the criticism I directed at Buffett can also be directed at his partner.

I've never taken Munger or his persona seriously, for several reasons:

1. His ideas, while generally correct, aren't novel or profound. Most of his "worldly wisdom" is just common sense. I think people give Munger's ideas more credit than they deserve because of the halo effect: he's a billionaire, and he's associated with an even richer billionaire, so people assume his ideas must be important.

2. I disagree with his philosophy of investing and some of his advice on how to invest successfully. There's a lot of room for debate about the nature of investing, so I won't claim that he's wrong and I'm right, but this post will offer a few counterpoints to his ideas.

3. I find him arrogant, although I'm sure many people will find this article arrogant too. De gustibus.


Munger's ideas

Kill your investing gurus claimed that "many investment gurus are famous less for their ideas than for their personalities. They are famous for being themselves." I wrote that about Buffett, but it's even more true of Munger: he expresses his opinions much more bluntly than almost anyone else, and that appeals to a lot of people.

But when Munger's ideas are separated from his earthy manner and considered on their own merits, they become much less impressive. They're really just rehashes of other people's ideas or rehashes of common sense.

For example, Munger has argued that:

• We're creatures of habit, so having good habits is a prerequisite of success.
• Being articulate and persuasive isn't the same thing as being right.
• Envy and the desire for revenge can lead to irrational decisions with poor outcomes.
• Drugs are bad.

These things are all true, and understanding them could benefit a novice investor or someone who lacks common sense, but they're obvious to experienced investors. The obvious doesn't become profound just because a billionaire says it.

Munger's most famous idea is probably his "latticework of mental models." Poor Charlie's Almanack, which is a collection of his speeches and quotes, describes it as follows:

[Munger] calls the tools he uses [to evaluate investments] 'Multiple Mental Models.' They borrow from and neatly stitch together the analytical tools, methods, and formulas from such traditional disciplines as history, psychology, physiology, mathematics, engineering, biology, physics, chemistry, statistics, economics, and so on...

When properly collected and organized, his Multiple Mental Models (about one hundred in number, he estimates) provide a context or 'latticework' that leads to remarkable insights as to the purpose and nature of life.

The thing is, this is nothing new. "Mental models" are merely ideas or rules of thumb. The necessity of placing them in a "latticework" isn't new either: everyone knows that discretion is important in applying ideas. The power of compound interest and the law of large numbers could both be considered mental models, but they're obviously relevant to different situations.

Like Nicholas Nassim Taleb, Munger coins new terms for old ideas and claims them as original insights. Apart from his mental models, there's his "elementary world wisdom," which is really just common sense, his "availability-misweighing tendency," formerly known as the streetlight effect, and his "liking/loving tendency" formerly known as the halo effect. These ideas were fine in their original forms and didn't need him to re-brand them.


Reading widely is overrated...

The excerpt from Poor Charlie's Almanack about Munger's mental models makes it clear that he thinks that reading widely is important. Elsewhere, Almanack states that:

[Munger's] encyclopedic knowledge allows him to cite references from classical orators to eighteenth- and nineteenth-century European literati to pop culture icons of the moment. Where else would you find Demosthenes and Cicero juxtaposed against Johnny Carson or today's investment managers set against Nietzsche, Galileo, and a "one-legged man in an ass-kicking contest"?

I agree that knowledge is valuable: psychology plays a prominent role in financial markets, and human psychology changes very slowly if it changes it all, so reading about the financial markets of the past can help one understand the present. But reading widely is less important than being able to determine what information is meaningful and what isn't. Professional investors are constantly inundated with ideas and data, and most of those data are irrelevant, misleading, or trivial.

I'm skeptical that reading about "history, psychology, physiology, mathematics, engineering, biology, physics, chemistry, statistics, economics" makes people better investors. Apart from the psychological aspect of finance, I think that Wall Street is a discrete system with relatively few parallels to other fields. For example, famous economists are notoriously bad at making financial predictions even though economics is related to finance. By contrast, many of the most talented investors seem to be idiot savants: e.g. George Soros is a brilliant trader with an intutive understanding of the market, but no one takes his philosophy seriously.

Reading about biology or engineering might be useful in helping investors understand how systems withstand stress and exogenous shocks, but that's just one limited benefit. Reading extensively about art history or the human body or whatever won't make one a better stockpicker.


...so is acting rationally

Munger has talked and written a lot about the importance of acting rationally. I think this is just self-aggrandizement. When people give exhortations to act rationally, it's usually a way for them to say, "I am a superior thinker."

The Wall Street Journal has a Munger quote that demonstrates the absurdity of the "act rationally" rhetoric:

I don’t have the slightest interest in gold. I like understanding what works and what doesn’t in human systems. To me that’s not optional; that’s a moral obligation. If you’re capable of understanding the world, you have a moral obligation to become rational. And I don’t see how you become rational hoarding gold. Even if it works, you’re a jerk.

First, when one has to react to other people's irrationality, the rational response isn't always obvious. Panics, financial crises, and hyperinflations all involve people doing things that are beneficial individually but worsen the overall problem. When other people's irrational panic can damage you financially, it often makes sense to panic first, even if doing so isn't strictly rational. If Munger were really interested in understanding what works and what doesn't in human systems, he would respect this dynamic.

Second, I think it's important to separate morality from investing as much as possible. I don't mean that people should invest in companies that violate their ethical principles, but they should avoid seeing moral issues where they don't exist. Imagine a farsighted investor in Germany after World War One: he sees that crushing reparations payments will lead to hyperinflation, so he invests in gold. That lets him preserve his family's wealth while countless other people lose their life savings, but according to Munger he's a jerk who shirked his moral duty.


Munger's arrogance

Apart from philosophical disagreements, I find Munger's arrogance offputting. That doesn't automatically invalidate his ideas, but it takes a lot of chutzpah to claim, as Munger did, that "Ben Graham had a lot to learn as an investor."

Munger criticized Graham for practicing a very limited strategy of buying only net-nets, but that's a oversimplification of Graham's ideas. As Oddball stocks recently wrote, "Sprinkled throughout Security Analysis are recommendations that investors look for higher quality companies over lower quality companies.  At one point [Graham] even recommended that investors simply buy the best company in each industry when the entire industry hit its low point in the business cycle."

Munger also says that the Great Depression stunted Graham as an investor by making him overly conservative. He implies that Munger-Buffett strategy of buying quality GARP stocks is superior to Graham's strategy of buying cheaper, but lower-quality, companies with a margin of safety.

I think the issue is less clear-cut and that which kind of investment performs better is largely a function of the economic environment. Buying quality businesses with long-term growth prospects has been a phenomenal strategy for Munger and Buffett, but their careers have coincided with the longest bull market in history. Graham's approach may offer fewer rewards in an extended bull market, but it's arguably more robust during bear markets and periods of stagnation. It's a solid all-weather strategy.

Regardless of which is better, it's crazy to say that Graham "had a lot to learn." I've read several books by or about Graham, and the salient feature of his writing is the breadth of knowledge it displays. He wrote thoughtfully on numerous topics: valuation, financial history, competitive advantage, agent-principal conflicts, and many more. To Munger's credit, he acknowledges that Graham was "one of the only intellectuals — probably the only intellectual — in the investing business at the time."

The book I quoted from earlier, Poor Charlie's Almanack, is another example of Munger's hubris. It's primarily a compilation of his quotes and speeches, but it also includes a biography hagiography of Munger along with numerous blurbs from his friends testifying to his brilliance. Essentially it's a vanity project that Munger, to give a false appearance of modesty, couldn't compile himself.

The title is a takeoff of Benjamin Franklin's Poor Richard's Almanack, and the book frequently compares Munger to Franklin. Among other things, Peter Kaufman, the book's editor, calls Munger "this generation's answer to Ben Franklin" with no trace of irony, and the beginning of chapter two superimposes a picture of Munger on Franklin's engraved portrait.

Despite the constant comparisons, I can't imagine Franklin indulging in this kind of self-aggrandizement. As Peter Lynch astutely wrote, "In my experience the next of something almost never is—on Broadway, the best-seller list, the National Basketball Association, or Wall Street." Or the next Ben Franklin.

6 comments:

  1. Great to see posts discussing stuff that isn't usually discussed in this manner. Not that that in itself is a great thing but when the arguments are sensible it makes it worthwhile.

    I'll admit that I enjoy reading Munger's thoughts and to some extent Buffett, but I don't really think it's a wise idea to go into worshiping, which you can see happening a lot.

    What's your view on Munger's principle of the mental models (or whatever one wants to call them) from the view point of simply studying and understanding different basic things about the world, perhaps using the "Feynman technique" and writing summaries of the principles with your own words, and staying at that? I have no idea whether there has been someone else before Munger who had the idea that there's those 100ish things that you should know well and be able to use in different situations, but I think that's a very useful idea anyway (nor do I really care who's idea it was first, although I agree that taking credit of something that you didn't do or isn't "yours" is not good). I don't think that's necessarily common sense at least. Sure, all the basic principles are old, as I think they even should be, but the idea of taking the most profound ones from different disciplines and really understanding them seems very legitimate to me.

    Would be interesting to hear your thoughts on that! And thanks for all the posts, hoping to read these in the future as well.

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    1. Thank you. I wasn't familiar with the Feynman Technique before you mentioned it, but I assume you mean this? -- http://www.scotthyoung.com/learnonsteroids/grab/TranscriptFeynman.pdf

      My first impression is that it looks very helpful, especially for fields like math or physics (or finance!) where there's a lot of domain-specific ideas and hence a tendency to use jargon. Using Feynman's method to develop and articulate "mental models" about various things is probably a good way to learn. But I'm critical of Munger partly because he tries to tie the mental models together into a theory of everything. He claims they form a cohesive system, and I don't think they do or could, really, given the range of wildly disparate things they're supposed to cover.

      You may be right that his ideas, whatever their provenance, are less obvious than I claimed. There's the old saying that common sense isn't so common.

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  2. the halo effect: he's a billionaire, and he's associated with an even richer billionaire, so people assume his ideas must be important

    Yes! I am reminded of this every time I see Jim Rogers talk on TV, although his worth is only estimated to be $300 million.

    George Soros on Jim Rogers: He Is Not a Great Investor

    Jim Rogers once worked for George Soros.

    There's the association. Once established, it never ends.

    Soros then said that although Rogers is a great analyst, he does not think Rogers has been a great investor. How Soros could actually know such a thing, since Rogers is a private investor and does not have to disclose his positions or profit and loss statement, is unknown.

    I'm guessing, like me, Soros based his opinion on what Rogers has said in public (and that the net worth of Soros is estimated to be 66x the net worth of Rogers). For what it is worth, I don't think the bow-tie worn by Rogers makes him a better investor either. It does seem to get people to notice and talk about him though (as I have just demonstrated ;)).

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    1. Mark,

      Is this a case of great minds thinking alike? I'd planned to write about Rogers in the next "kill your gurus" installment.

      With Buffett and Munger, one can say that the successful showman has eclipsed the successful investor. With Rogers, there's no successful investor for the showman to eclipse.

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  3. Great post. You make good points. It's refreshing to see a courageous common sense thought process in the face of widespread idolization of this man. I displayed skepticism of the brilliant perfect superhuman idol Warren Buffett once and was pilloried for it. Munger is even less relevant. He is the ultimate coat-tail rider.

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