How Buffett Became a Midwestern Manjusri

February 3, 2018


If you spend any time at all in the world of investing, you very quickly realize how many clever people you're competing against. I recently finished "Frontier Investor" by Marko Dimitrijevic, who ran a successful EM-focused fund for many years. Make no mistake - "Frontier Investor" is a wonderful book, which I reviewed a few weeks ago. But putting its lessons into practice might be challenging for most investors. First, the author's go-anywhere style depends on knowledge on the ground, and often, the ability to speak the local language. Clearly, this requires a large organization, which few investors have. Secondly, his global macro style demands an understanding of numerous asset classes. He describes trades in equities, debt, currencies and derivatives in the book, which makes for fascinating reading, but would spell folly for an inexperienced investor blindly attempting to mimic him (a fact Dimitrijevic clearly recognizes, since the book is full of "don't try this at home" warnings).


Reading this book highlighted a tension I often face as an investor still developing my own style. It can be seductive to want to debate the Federal Reserve's next moves, Chinese capital flows or cryptocurrencies. This temptation is particularly strong when you interact with the clever denizens of the investment industry who seem to know a frightening amount about everything. So for most people, it's a good idea to inoculate yourself against that temptation by internalizing Warren Buffett's idea of a circle of competence. Buffett articulated this view in his 1996 Shareholder Letter:


"What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital." (For more, see Farnam Street's excellent take.)


Another expression of this in popular culture came from Bruce Lee, who said, "I fear not the man who has practiced 10,000 kicks once, but I fear the man who has practiced one kick 10,000 times." When investing, you don't have to be Marko Dimitrijevic. One's circle of competence may very well mean focusing on a specific geography or asset class. Just because you understand the economics of the restaurant industry well doesn't mean you should be investing in restaurant equities in Indonesia, or engaging in complex options trades in the restaurant sector. 


But creating an overly narrow circle of competence has its downsides. If you've only mastered one kick, and your opponent has an effective defense against it, you're toast, even if you're Bruce Lee. Developing expertise in a single industry is valuable, until that sector encounters technological or regulatory disruption and enters terminal decline. Imagine being a coal analyst in the US. Excessive specialization leads to fragility, when we should be seeking robustness.


In addition, "experts" are often guilty of missing the forest for the trees. In a previous post, I explored the success of John Paulson and other "outsiders" in targeting derivatives linked to real estate and financials before the crash. These outsiders brought a new perspective to the real estate boom, which let them cut through the morass of stale knowledge. 


It would be a mistake, though, to think of these outsiders as mere dilettantes. Here's the key point in understanding why the debate between depth and breadth is sometimes a false dichotomy: Paulson and others were outsiders, but they also went very, very deep into the dynamics of the real estate sector and its derivatives. If anything, it was the incumbent investors who had become shallow, relying on lazy truisms rather than research. They thought they had a circle of competence, but failed to heed the essence of Buffett's warning, which is to make sure you know what you think you know. Instead, it was the outsiders who were exemplifying the best of "deep work" and "deliberate practice", to cite two frameworks that are influencing my views on this conflict (I use the present tense because I know I have yet to truly internalize their lessons).


I'll be the first to concede that "deliberate practice" is far from easy in investing. Firstly, it isn't always easy to find a mentor to provide feedback. Second, the nature of financial markets means that (a) there's a lag between what an investor does and the outcome, and (b) luck and circumstance always complicate the direct feedback between one's approach and the outcome. On the plus side, though, deliberate practice encourages pushing the boundaries of practice, which is consistent with exploring new industries or asset classes, while being conscious of one's limitations.      


Developing expertise while eschewing dogma is also hard. This is a struggle for the ages, not just for investors. A common image in Zen meditation centres is Manjusri, wielding a sword in one hand and a sacred text in the other. But Tim Burkett notes, "the text is not present to teach us something new; it's about deconstructing our ideas and concepts... Manjusri represents the beginner's mind because he is always cutting away old ideas, opinions and patterns - down with his sword and away with them, once and for all... he cuts away habituated thoughts before they have a chance to solidify into a pattern."


Warren Buffett became the world's most successful investor because he took Ben Graham's philosophy of investing in cheap securities with a long-term view, and allied it with Munger's notions of quality. By developing expertise, but taking a sword to what he considered unnecessary (mere statistical cheapness), Buffett embodied the best of deliberate practice and a beginner's mind - an unlikely Midwestern Manjusri, if ever there was one. 

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