On the other hand, it is important to differentiate between swings within a
cycle and structural changes. As we pointed out in a
previous Fund Library article, it is clear that the fundamental nature of capitalism and the drivers of
successful business models are rapidly changing. It that context, perhaps
it is different this time. For some historical context, consider
when humanity moved from the agricultural era into the industrial era.
Born in England in 1766, Robert Malthus was one of the world’s first
prominent economists. His life coincided with the beginning of the
industrial revolution, but his world view was firmly shaped by the very
harsh realities in agrarian society across many millennia. The central
theme of Malthus’ work was that population growth would always overwhelm
food supply growth, which would create perpetual states of hunger, disease
and conflict. Malthusians raised the alarm and were sure a catastrophe was
inevitable as global population began to soar during the dawning of the
industrial era. If nothing had changed, the Malthusians would have been
right. Or at least, population growth would have been generally restricted
by available resources. But things did change.
The industrial age changed the fabric of society and coincided with new
farming techniques and improved livestock breeding, which lead to amplified
food production. Later, mechanization created incredible food abundance
which enabled the global population to grow rapidly unlike any other time
in history. The Malthusians were wrong, because “that time it actually was different,” The old methods that worked so well in the past
were no longer useful. The big fortunes of the industrial era were built by
the Carnegies, Rockefellers, and Fords of the world, not by the large U.S.
agricultural land owners who had relied largely on slave labour during the
Another shift underway
Once again, another huge structural shift is underway. The world is moving
from the analog industrial era to the digital-driven world of the
information age. Like the transition of the industrial revolution, this new
world is harder to comprehend, and requires new ways of thinking.
Human nature has evolved over time to successfully navigate the world based
on what is easy to understand. This is the world where, for example, the
average person is five to six feet tall, with the tallest about 8 feet and
the shortest about tow feet. There are no exceptions to this distribution. In contrast, in the
intangible digital-driven world, the tallest man could be 10,000 feet tall
one day and the shortest might be negative 1,000 feet. This world is hard
to conceptualize because it doesn’t make much sense in the world we live
in. It is hard to overcome hardwiring that’s been optimized over thousands
of years of human evolution. (For related reading, see Nassim Taleb’s
concepts of “Mediocristan & Extremistan” in his classic book,
The Black Swan.)
Yet, we must adapt to this new world. The reality is that extreme outcomes
are far more common in the intangible digital-driven world than in the
tangible world. The rapid rise and domination of companies like Google and
Facebook, driven by the winner-takes-all (or most) competitive dynamics of
the digital world, are unprecedented. This is largely due to the feedback
loop of the network effect, or the positive effect that an additional user
of a product or service has on the value of that product or service to
Due to the network effect, the larger the winners of many of these
intangible businesses become, the faster they can grow (that is, until they
hit critical mass…nothing grows forever!). This dynamic is in sharp
contrast to the industrial era, where growth rates generally slowed as businesses became larger, and it took much longer to
reach critical mass, often measured in multi-decade timeframes. Rapid
growth is far more feasible among large digital businesses than in older
industrial industries because they are capital-light and not constrained by
time-consuming needs like building factories or distribution centers and
maintaining inventories that drive growth for these firms.
On the other hand, there is plenty of evidence that even the big winners,
backed by powerful network effects, can still be fragile if they fail to
reach true critical mass. Consider that in June 2006, social networking
pioneer MySpace surpassed Google as the most visited website in the U.S. By
January 2018, MySpace was ranked 4,153 by total web traffic, and 1,657 in
If social networking were an Olympic sport, Facebook would have taken the
Gold medal whereas MySpace, winner of the Silver medal in social
networking, might as well have been in last place. Quite often, the
runners-up are practically irrelevant in the digital world, whereas the
second- or third-largest and even smaller businesses are still competitive
in the industrial era. Winners tend to be singular leaders in their
respective categories, so “paying up” for the leader makes sense in a world
where there is only one real winner.
Similar to the Malthusians of the past, most people today have a hard time
absorbing new mental models that are separate from those needed to thrive
for most of human history. Not surprisingly then, investors tend to have a
very difficult time conceptualizing exponential growth and are caught off
guard when the world works differently than their pre-existing linear view.
In his thought-provoking book Principles, famed investor Ray
Dalio explained: “Our biggest barriers to [being radically open minded] are
the ego barrier and the blind spot barrier. Our ego barrier is our innate
desire to be capable and having others recognize us as such. The blind spot
barrier is the result of our seeing things through our own subjective lens;
both barriers can prevent us from seeing how things really are. The most
important antidote for them is radical open-mindedness…it is the ability to
effectively explore different points of view and different possibilities
without letting your ego or your blind spots get in the way.”
To grow as investors, then, we need to be our own greatest critic and have
the intellectual honesty to kill some of our best-loved ideas.
Indices, lagging indicators, and seeing the world as it is.
Felix Narhi, CFA, is Chief Investment Officer and Portfolio Manager at PenderFund Capital Management.
He works alongside David Barr, Pender’s President, in setting the
direction of Pender’s overall investment strategy. This article first
appeared in the
blog. Used with permission.
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