Serenity, Insight and Investing

I've been reading Bhikku Bodhi's "In the Buddha's Words", which is an anthology of discourses from the collection of Buddhist scriptures known as the Pali Canon. The message is simple but powerful: "From development of the mind arise happiness, freedom, and peace." He goes on, "Development of the mind... means the development of serenity (samatha) and insight (vipassana). Both serenity and insight are considered necessary to achieve true development. "The cultivation of serenity requires skill in steadying, composing, unifying, and concentrating the mind. The cultivation of insight requires skill in observing, investigating, and discerning conditioned phenomena...While meditators may [approach the two aspects] differently, eventually they must all strike a healthy balance between serenity and insight."

While these precepts form the foundation of one of the world's major philosophical traditions, one does not need to be a Buddhist to see their broad applicability. Stoic philosophy conveys similar ideas. Closer to the current day, Jonathan Haidt's "The Happiness Hypothesis" presents another metaphor, that of the elephant and the rider. The mind is divided between conscious/reasoned processes and automatic/implicit processes. These two parts are like a rider atop an elephant. The rider's inability to control the elephant explains many puzzles about our mental lives. Haidt posits that learning how to train the elephant is key to self-improvement.

Unsurprisingly, I think these ideas provide a useful philosophical basis for the tiny sliver of life that is investing. I've written before about Robert Hagstrom's view of investing as the last liberal art. Investors need a grasp of (in order of least controversial to most controversial) finance, microeconomics, macroeconomics, psychology, history and sociology. All these contribute to insight, i.e. seeing the financial markets as they really are, and being humble enough to create a risk management framework that deals with the uncertainty inherent in investing. Developing insight is certainly more than just being knowledgeable, particularly in this era of Information. It's about trying to develop wisdom. To quote T.S. Eliot, "Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?" It's easy to mistake information for knowledge, and knowledge for wisdom. 

That said, even wisdom seems to only be part of the equation. One can be a brilliant analyst but lack the equanimity and humility required to translate good ideas into successful investments.Serenity allows the investor to actually implement an investment, and to maintain an even keel whether things are going particularly well or particularly badly. Anyone observing financial markets comes to realize that they just another medium conveying the vicissitudes of human life. Fear and greed are rightly identified as two emotions that drive much of how we act in financial markets. But market participants experience other emotions too: for example, they experience anger, disgust and shame when taking losses, trust and pride when things appear to be going well, and confusion when market action goes against expectations. The skilled investor therefore needs to be master of his own emotions. Despite his homespun image, Warren Buffett too merges investing acumen with a steely constitution, and the combination has led to his stellar record. Stan Druckenmiller is more of a trader than a value-oriented investor, but my former boss Scott Bessent, in "Inside the House of Money", describes Druckenmiller's toolkit as such: "Stan may be the greatest moneymaking machine in history. He has Jim Rogers' analytical ability, George Soros's trading ability, and the stomach of a riverboat gambler when it comes to placing bets." 

The emotional component to investing is well-recognized these days, with books like Kahneman's "Thinking Fast and Slow" popularizing behavioural economics. Kahneman uses the terms System 1 and System 2 to represent fast, unconscious thoughts and slow, effortful thoughts respectively - analogous to Haidt's elephant and rider respectively. But despite Kahneman's literary success, my guess is that investors still pay far less attention to this side of investing than they should. While there are numerous mainstream avenues to develop the analytical tools of investing (again, just one part of insight, in my analogy), such as going to business school or getting the CFA qualification, these tools are not worth very much without a sound emotional grounding. In fact, they can even be harmful, creating the illusion of certainty where none exists. 

Sadly, there aren't schools devoted to helping investors gain the type of serenity they need. Most investors (retail and professional) succumb to those old enemies, fear and greed, far too often, leading to sub-optimal investment performance. Perhaps we all need to take a step back to learn from Druckenmiller and Buffett - and maybe even the Buddha.

Are You A Value Investor, Or Just A Cheapskate?

There's a big difference between being a value investor and merely being a cheapskate. The dictum goes, "Price is what you pay; value's what you get." To the skilled investor, value reflects the exploitable wedge between price and value. It's a relative concept, rather than an absolute level. This is often hard to remember because we use the same words - "cheap" and "expensive" - to describe two concepts. Something can be cheap relative to its inherent qualities, or cheap in an absolute sense, which is to say selling at a low dollar price. It's often helpful to clarify which people mean.

The father of value investing, Ben Graham, was occasionally unclear on this point. His most famous disciple, Warren Buffett, notably adapted his investing style to incorporate quality as a component of value (influenced by Charlie Munger). In fact, Graham almost made a gigantic error by being a cheapskate rather than a value investor. Buffett recounts, "I offered to go to work at Graham-Newman for nothing after I took Ben Graham's class but he turned me down as overvalued. He took this value stuff very seriously!" Buffett might just be being kind here - if I recall correctly, I've read elsewhere that Graham turned Buffett down because young Jewish men were being barred from so many places on Wall Street that he felt inclined to save spots for them to work at Graham-Newman. But at any rate, the thought of Graham turning away the bright young Buffett seems like an act of folly. 

The distinction between value investing and being a cheapskate applies to regular life too. I posted about a month ago about this paper by Bronnenberg, Dube, Gentzkow and Shapiro that found that informed consumers of headache remedies (such as pharmacists) were less likely to pay extra for national brands, preferring store brands and generics. BDGS suggest therefore that "misinformation explains a sizeable share of the brand premium for health products." In other words, those who are better informed can see past marketing and therefore opt for a lower priced product with the same efficacy.

About a week after writing that post, I found myself choosing between a brand name health product costing $90 and a generic brand at $60. "Screw you, brand name," I proudly thought. "I've read my BDGS." Big mistake. Three weeks later, I discovered the product wasn't working, and was forced to cough up for the more expensive alternative.  

Really, I made two mistakes. First, I incorrectly extrapolated the BDGS finding from the relatively narrow world of headache remedies to a completely separate product. Second, the BDGS finding referred to informed consumers. Alas, that's not me. I'm just a guy who heard a podcast and read a paper. I believed I'd found an exploitable wedge between price and value - and I was wrong.

Thankfully the mistake was minor, and reversible (well, I hope so!). Investing forces us to be both arrogant and humble at the same time, believing that the multitude of investors we call the market is wrong, but being conscious that we might be wrong. The world is full of value traps - investments that look "cheap" but are not. Equally, there are opportunities that appear expensive, when in fact the odds of success and future cash flows are sufficiently favourable as so offset a purportedly high price. I credit Charlie Munger and certainly Phil Fisher for clarifying my thinking on this point. Similarly, value investors sometimes take pride in being thrifty or being out-and-out cheapskates in their daily lives. That, I believe, is a big mistake. Knowing the difference between price and value is a crucial component of value investing - and indeed life. 

It's Not Time To Worry Yet; They Won't Do It Again

In Nov 2002, Ben Bernanke, then a member of the Fed Board of Governors, gave a speech to honour Milton Friedman's 90th birthday. In the speech, Bernanke summarized the findings of Friedman and Schwartz's work on the Great Depression, concluding that "Monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman's words, "a stable monetary background" - for example as reflected in low and stable inflation." He famously ended, "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

Less than 2 weeks later, Bernanke gave another important speech at the National Economists Club, entitled "Deflation: Making Sure "It" Doesn't Happen Here". While the first speech covered historical episodes of monetary-induced volatility, the second focused on future policy prescriptions to combat deflation, countering in particular the notion that monetary policy was impotent at the zero lower bound (ZLB).

(Aside no.1: It's interesting that these two speeches, arguably the best-known of Bernanke's speeches, were given within 2 weeks of each other. As a Fed Governor, Bernanke was in the sweet spot of being able to be relatively candid while having access to the highest corridors of power. Most of his later speeches are necessarily more cautious, and are understandably less objective since they, to some extent, have to defend decisions that he and his colleagues took.)

(Aside no. 2: Wikipedia tells me that Bernanke is married to Anna Friedmann, confirmed by the NYT. I guess Friedman & Schwartz's work had an even bigger impact on Bernanke than he knows. Milton Schwartz was his next option.)

If you've never read the speeches, or if it's been awhile since you last read them, I encourage you to spend 30 minutes (I'm a slow reader) and marvel at their lucidity and prescience. Reading them isn't merely an academic exercise. For investors, the first would have warned you of the potential impacts of the ill-fated decisions in 2008 to focus on inflation. The second laid out the Bernanke playbook, and could have helped you understand the possible rebound in economic performance and asset prices. It's easy to say that in retrospect, of course. But I find it interesting to go back to these speeches as we wrestle with another question: Will we see another 2008?

The answer to this question depends a great deal on one's reading of the causes of the 2007-2009 conflagration, and deciding if similar conditions are in place. You don't have to look far to find those worrying about the fragility of the financial markets. Noted bear John Hussman wrote recently, "I view the stock market as likely to lose more than half of its value from its recent highs to its ultimate low in this market cycle." A host of savvy investors, most pertinently Seth Klarman, have expressed their concerns about market valuations and sentiment. There are also those like the excellent SoberLook.com who look at this chart of investor sentiment (from Yardeni Research) and conclude that there isn't enough bearishness in the market: 

And of course, the Fed has voiced its concerns about valuations in tech stocks and the leveraged loan market recently.

I haven't exactly been a bundle of optimism this year, worrying that the Fed is extremely unlikely to allow (or generate) a boom that would make up for some of the lost growth of the past 7 years. And I agree there are many reasons to be bearish - the Fed concluding its asset purchase programme, the seemingly intractable problems in the Eurozone, slow relative growth in the Chinese economy, and a plethora of geopolitical conflicts.

But still, I have to say, I just don't think conditions are the same for another meltdown. My quick summary of 2007-2009 is as follows: a serious financial crisis occurred due to lax credit conditions, poorly understood financial instruments, and inaccurate beliefs about risk. This interacted in powerful and catastrophic ways with serious monetary policy errors to produce an economic and financial spiral.Specifically, there was an inappropriate focus on inflation at the expense of growth, compounded by paralysis when confronted with the ZLB.

The situation today seems a little different:

(1) Sentiment does not seem as optimistic. There may be fewer bears, but there are fewer bulls as well. I don't think it's realistic to say that we've gone back to the go-go days of the Dotcom bubble or 2007. Investor psychology was profoundly altered by the experience of the dark days of 2008 in particular. Yes, 7 years later, the memories have faded a bit, but I simply don't buy the argument that investors are ready to throw caution to the wind. Are there sectors that are overvalued? Almost certainly. But that's how markets work. 

(2) The policy landscape is completely different. The psychological barrier of breaking $100 oil has long been shattered, reducing the risk of inflation-phobia. Far more importantly, the playbook of tools for easing at the ZLB has been firmly established. In his speech on deflation, Bernanke pointed out that "an essential element [of taming the inflation dragon] was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability."A similar story applies to easing at the ZLB. There was a story in the news today about the Bank of Israel (which has been extremely innovative in the past few years) being willing to consider unconventional tools should rate cuts fail to achieve the inflation target. Stories like this no longer even make us bat an eyelid. Yes, the ECB is struggling to implement QE, but that's for political reasons. I accept, and worry, that there are short-term risks that the Fed would be relatively slow to reverse its tightening course even if serious global shocks occurred. But another 2008 simply doesn't seem to be in the offing.

One of my favourite quotes (from one of my favourite books) is Atticus Finch's refrain "It's not time to worry yet" in "To Kill A Mockingbird". I suppose that Finch-ism captures how I feel about the state of the equity markets in particular. Successful long-term investing requires discipline - discipline to ride out periods of volatility, and discipline to take advantage of ebbs and flows in investor psychology. That's the best way I know to harvest risk premia over the long run.Of course there are times to worry, particularly when no-one else seems to be doing so. But for the time being, I'm taking the Fed at its word that, thanks to Milton and Anna, they won't do "it" again.

See Ya Later, Allocator

A recent episode of Freakonomics discussed a paper by Bronnenberg, Dube, Gentzkow and Shapiro that showed that informed consumers of headache remedies (such as pharmacists) were less likely to pay extra for national brands, preferring store brands and generics. BDGS suggest therefore that "misinformation explains a sizeable share of the brand premium for health products." In other words, those who are better informed can see past the veneer of marketing, and more accurately assess the quality of a product. Towards the end of the show, host Stephen Dubner asked the researchers (just G&S) if they thought similar results would hold true for other products - for example, if they thought that a university professor would use her educational expertise to send her child to a fairly priced second-tier university instead of an overpriced Ivy League school. G&S responded that they suspected that it would be quite the opposite - the university professor would be even more keen on sending her daughter to a top-rated university, regardless of price.

There's no doubt that we can learn a lot from how people act, rather than what they recommend. Gerd Gigerenzer says in "Risk Savvy" that one should never ask a doctor what he would recommend. Instead, one should ask the doctor, "What would you do for your mother?" Because I'm so very predictable, you might already have sniffed out where I'm heading with this. Naturally, I was listening to the podcast and wondering if the same result held true for investment professionals. I was intrigued by the analogy Dubner brought up at the end. Thinking about it a little more closely, I see a slight difference in the scenarios. Pharmacists are informed consumers and distributors, yet are not themselves producers of the remedies, and can therefore speak objectively. University professors and (some) investment professionals are more like producers. They are therefore either believers in the product they dispense, or have a cynical incentive to defend their product (reminiscent perhaps of Upton Sinclair's comment that it is difficult to get a man to understand something when his salary depends on his not understanding it).

Still, the question should be asked: are those involved in the active management of investments more or less likely to themselves invest in active strategies? I don't have the data, and a quick Internet search didn't turn up anything fruitful. You often hear hedge fund managers, for example, boast of "eating their own cooking", i.e. investing in their own funds, so I assume that this is common practice for many. But you hear some disquieting things as well. Blackstone's President Tony James recently commented on the hedge fund industry at an event, saying "A lot of people think about hedge funds as a way to get higher returns. Hedge funds are a way to play the stock market with somewhat lower volatility and somewhat lower returns. You don't expect hedge funds to get shoot-the-lights out returns. You save that for private equity and real estate." I found those to be extremely damning remarks from someone whose firm runs Blackstone Alternative Asset Management, which claims to be "the world's largest discretionary allocator to hedge funds, with $61 billion in assets under management." If I were paying a 10-20% performance fee, I would certainly be demanding something more than "somewhat lower volatility and somewhat lower returns" than the stock market. This would be doubly true if I were paying a second layer of fees to an allocator. To most of these intermediaries, I have no more to say than "See ya later, allocator."

The question of hedge fund returns is particular interesting right now. The debate over their value is reaching a crescendo with the news that California's pension fund, CalPERS, is exiting its hedge fund investments due to insufficient returns (post-expenses) and excessive complexity. Responses range from "If CalPERS thinks hedge funds are too complex, then who should invest in them?" to those saying "CalPERS simply didn't do a good enough job in its hedge fund portfolio."

Despite engaging in active asset allocation and security selection, I must confess my low regard for most active management. There are some truly spectacular investors out there who combine keen analysis with strong risk management and a contrarian bent. These people are few and far between, and chances are that if you've heard of them, it's too late. The average investor, I'm sorry to say, is best served by focusing on passive funds. Very often, active strategies are more headache than they're worth - so perhaps headache remedies and investment funds are not so different after all.

What Kind Of Dollar Do They Want?

Benjamin Cole ends his most recent blog post saying "To get to higher interest rates and inflation, we may have to endure years and years of prosperity. And even that may not work. I think we should try anyway." This is a terrific bit of writing, and will inflame those whom he calls the "righty-tighties".

I did, however, take slight issue with his first two comments, namely (a) that tight money is sacred to the right, and (b) that the right always finds monetary policy too loose. That is (deliberately, I'm sure) exaggerated, and thus unfair to the right. The likes of David Beckworth and Ramesh Ponnuru have published numerous times in the National Review in favour of easier monetary policy, as has Jim Pethokoukis at the AEI. Still, Benjamin's jibe raises a valid question: What kind of dollar does that faction of the right want?

"Sound money" is often advocated by Internet Austrians, but is a sufficiently imprecise concept as to be unhelpful. In theory, there should be plenty of middle ground between those who desire "sound money" and flexible inflation targeters. However, some common objections to FIT are (1) the Fed's dual mandate is wrong, and should focus solely on inflation; (2) "sound money" demands no inflation (and hence no loss of purchasing power), not the unforgivable 2% inflation that most central banks target, (3) the Fed uses incorrect (and possibly doctored) inflation statistics to hide its inflationary bias, revealed by ShadowStats and other sources, and (4) the only way to ensure sound money is to rid the world of fiat currency.

While I won't go through the counter-arguments to these (incorrect, in my opinion) points, it's worth noting that this is an age-old debate. This 1896 paper from Fred M. Taylor, for example, evaluates the merits of an "elastic currency" - language that made it into the Federal Reserve Act of 1913 - defined loosely as "a currency the amount of which varies in accord with the needs of industry." While the terminology is archaic, it is the precursor to the Fed's dual mandate. Taylor seems to conflate the concepts of money and credit in the paper, but he properly distinguishes between ordinary and emergency elasticity, writing "By the former, I mean that elasticity which adapts the amount of the currency to the varying needs of trade within the limits of a single ordinary year. By "emergency elasticity", on the other hand, I mean the capacity of the currency to adjust itself to those fluctuations in the need for money which characterize a panic." The concept of "emergency elasticity" is one that "sound money" types seem to ignore. Taylor notes that at the time of writing, victory belonged to "the advocates of a safe rather an an elastic currency." While the supporters of elasticity are mainstream today, "sound money" proponents seem to yearn for a return to "safety". The costs of this safety, however, surely deserve attention.

Equally worth of criticism is the "Strong Dollar" demanded by other righty-tighties. Many "Strong Dollar" types seem to be business people who pride themselves on their practical leanings and material success, and decry the Fed's intervention in the free clearing of a market (unless dollar strength limits their ability to export - there sometimes seem to be fewer true libertarians in business than there are atheists in foxholes!). Alas, these practical types do not seem to realize that they would scoff heartily at fellow producers who decided that their sole goal in business should be a "strong price". Yes, business people seek the strongest price possible, but within the limits of competition. What they truly aim for is the strongest price that customers will bear, and which results in the highest total profit (broadly speaking). To seek a strong price ignoring customers' willingness to pay would be madness. Furthermore, when demand is high for their goods, these producers often increase supply, but criticise the Fed for pursuing a similar course of action (as the Fed should rightly do, when furnishing emergency elasticity, for exampe).

No doubt we'll be hearing more from the righty-tighties as the pressure mounts on the FOMC to raise rates. It's even possible that at some point they'll be right. But the rest of us should remind them they've been consistently wrong for the past 7 years. While "sound money" and "strong dollar" policies sound inoffensive at first blush, the faulty thinking underlying them cannot be allowed to infect central banks, who may face pressure from politicians looking to score points. We've seen how that's played out in Europe, and to allow such thinking to fester anywhere else is an invitation for trouble.

Ebola, and Reflecting On 2007-2008

Twitter's excellent Sober Look pointed me towards the WHO's disconcerting warning that the current Ebola outbreak has been underestimated. The WHO believes that the number of reported cases and deaths is being underestimated, as is the time expected to fully contain the outbreak. This caught my eye because I had earlier insisted on Twitter that news consumers were overplaying the risks of Ebola, while ignoring the potential significance of China's hukou reforms in improving the social and economic lives of millions of people. I don't know if the Ebola outbreak is cause for concern for those outside of West Africa, especially as other commentators like Dan Drezner decry Ebola scaremongering, but I was reminded of another time when I was wrong in assessing the risk of a situation, i.e. evaluating the economy and financial markets in 2007-08.

Seven years after the onset of the Great Recession, there are many competing theories about what happened to produce such a financial and economic catastrophe. I wrote a post praising Ed Catmull's "Creativity, Inc." last week, and this quote stood out to me, among other gems: "Hindsight is not 20/20. Not even close. Our view of the past, in fact, is hardly clearer than our view of the future. While we know more about a past event than a future one, our understanding of the factors that shaped it is severely limited. Not only that, because we think we what happened clearly  - hindsight being 20/20 and all - we often aren't open to knowing more." I won't even attempt to rehash the arguments, but will merely state my view that financial fragility caused by high leverage, poorly understood products and contagion effects interacted with some pernicious monetary policy decisions to create the crisis. Despite my deep interest in prior financial panics, I believed that the subprime debacle in the US would be contained, leading to a recession but not the mini-Depression that ensued. Suffice to say I was wrong. I had an insufficient appreciation for the hidden leverage throughout the financial system and the potential for contagion. I also failed to foresee that major central banks were allowing monetary conditions to tighten like a vise around their economies. 

I'll let myself off the hook slightly by conceding that it is the very nature of complex adaptive systems that leads to such surprising outcomes. Furthermore, I'm certainly not saying that this Ebola outbreak is the health equivalent of 2007-2008. I'm merely recognizing that there is more to be worried about when contagion is involved. This is in contrast with that other recent favourite of scaremongering journalists, the spate of air crashes worldwide. While I view the air crashes as largely independent and random events, the contagion characteristics of an epidemic offer greater cause for concern.

So what would have been the appropriate response in 2007-2008? This is a more difficult question than it seems. As Kissinger says in his book "On China", "Analysis depends on interpretation; judgments differ as to what constitutes a fact, even more about its significance." An omniscient trading genius would have been heavily short by May 2008, and would have reversed course in Mar 2009. This is highly unrealistic, and much easier said than done, since anyone smart (or nervous) enough to have sold in May 2008 would likely have had an aversion to re-entering the market even when it was cheap (relative to fundamentals) in middle to late 2009. The hardy few will suggest that the best path would have been to do absolutely nothing. After all, if Lehman's bankruptcy had put you in Rip Van Winkle state on 16 Sep 2008, you could have woken up on Apr 23, 2010 to find the S&P 500 unchanged at 1213. Of course, this ignores the opportunity cost of maintaining your holdings - you could have sold on 16 Sep and had the opportunity to buy at lower levels. 

Thankfully we have two tools that can aid us in this difficult task, namely (a) valuation and (b) scenario analysis. Valuation provides an anchor while the investor is buffeted by waves of events and information. Scenario analysis allows us to consider various possibilities and incorporate them into our valuation. Both have to be subject to rigorous scrutiny, because "valuation" can ossify into dogma, ignoring changing facts and the multitude of assumptions under the surface of purported precision. I suspect using these two tools in 2007-2008 would have led an investor to be less long (it takes a different mindset to short successfully), and would have allowed the investor to gradually increase his exposure throughout 2009 (and indeed, through 2013, when I think stocks went from being cheap to being fairly priced). 

These are not easy judgments to make, and this, after all, is why truly talented investors deserve to be compensated accordingly. Combining the relevant financial analysis with a subtle appreciation of the sociology of markets requires an unusual calibre of investor. If you find that person, I suggest you hold on to her - and suggest equally that you prevent her from undertaking any non-essential travel to the affected West African countries until we better understand the extent of this outbreak.

Creativity, Inc., and The Last Liberal Art

I rarely delve into the genre best described as "General Management" since I quickly get annoyed with formulaic nostrums for success and the lionization of specific business leaders, particularly where they appear to have been lucky rather than good. But I'd heard so much positive press about Ed Catmull's "Creativity, Inc." that I decided to dip my toe in just this once. I'm grateful that I did, because Catmull's book is extremely atypical of the genre. Catmull is one of the co-founders of Pixar, and the current President of Pixar, Disney Animation and DisneyToon. He offers a fascinating look at Pixar's history, including its many challenges throughout its history. Steve Jobs fans will find the book worthwhile simply for the anecdotes about him, and an afterword describing his contribution to Pixar. But even more importantly, I think the book has lessons for those outside what we traditionally see as "creative" industries. It won't surprise friends and long-time readers that I think of investing as a creative enterprise to a large degree (note that I said "investing" rather than "finance", since I don't think loan officers, for example, should be too creative in their professional lives - we know how that ends!). That said, I do think that even those who are unambiguously outside the "creative" world (e.g. commercial bankers) can learn a lot about creating strong and flexible organizations from Catmull's deep insights into these issues (as I summarize in the third paragraph).

I imagine there are many people who will take issue with my suggestion that investing should be creative. For some, "creative" investing has the whiff of Madoff-style deception, or Victor Niederhoffer-style volatility. For others, investing is best pursued by mechanical rules, either through index funds, dollar-cost averaging or algorithms tied to valuations. It is difficult to refute each of these individually, and I have a fair amount of sympathy for those who eschew active management at all costs. And it seems that active managers have understood their customers well, realizing that career longevity is tied to avoiding underperformance, rather than maximizing long-term performance, as Porter and Trifts have shown. Nonetheless, I maintain that that rare breed of manager - the alpha generator - must be creative in generating ideas, skilled in adapting to the complex currents of economies and markets, and humble in the face of mistakes. Robert Hagstrom was spot-on when he brilliantly described investing as the "last liberal art", and Catmull echoes this in his book when he writes, "Craft is what we are expected to know; art is the unexpected use of our craft."

Catmull's book touches on many themes close to my heart - uncertainty, randomness, and social dynamics, among others. It is difficult to capture his lessons adequately without the resonance of his anecdotes about Pixar. Nevertheless, here are some of the broader lessons that are applicable to creating strong, loosely "creative" organizations:

- Make a policy of hiring people smarter than you are, no matter how threatening it may seem as a manager. An organization that is committed to seniority is doomed to mediocrity.
- "If you give a good idea to a mediocre team, they'll screw it up. If you give a mediocre idea to a brilliant team, they will either fix it or throw it away and come up with something better. Getting the right people and the right chemistry is more important than getting the right idea."
- Create organizations where people are encouraged to - and see it as their duty to - communicate problems and offer solutions. Many problems lie hidden from the view of management. 
- Candid and bracing (but constructive) feedback and the iterative process allows creativity to be channelled into an end product. "You are not your ideas, and if you identify too closely with your ideas, you will take offense when they are challenged."
- "Mistakes aren't a necessary evil. They aren't evil at all. They are an inevitable consequence of doing something new (and, as such, should be seen as valuable; without them we'd have no originality)."
- Leaders should talk about their mistakes to make it safe for others to follow suit. 
- "While we don't want too many failures, we must think of the cost of failure as an investment in the future."
- "The antidote to fear is trust...Trusting others doesn't mean that they won't make mistakes. It means that if they do (or if you do), you trust that they will act to help solve it."
- "Management's job is not to prevent risk but to build the ability to recover."
- "When someone hatches an original idea, it may be ungainly and poorly defined, but it is also the opposite of established and entrenched - and that is precisely what is most exciting about it."
- "In an unhealthy culture, each group believes that if their objectives trump the goals of the other groups, the company will be better off. In a healthy culture, all constituencies recognize the importance of balancing competing desires - they want to be heard, but they don't have to win."
- "Randomness is not just inevitable; it is part of the beauty of life. Acknowledging it and appreciating it helps us respond constructively when we are surprised."
- "Those with superior talent and the ability to marshal the energies of others have learned from experience that there is a sweet spot between the known and the unknown where originality happens; the key is to be able to linger without panicking."
- Hindsight is not 20-20. "While we know more about a past event than a future one, our understanding of the factors that shaped it is severely limited", so we must be cautious about drawing generalized lessons from events.
- Creativity is "unexpected connections between unrelated concepts or ideas", and we need to be in a certain mindset to make those connections. 
- "Our specialized skills and mental models are challenged when we integrate with people who are different."
- "Measure what you can, evaluate what you can measure, and appreciate that you cannot measure the vast majority of what you do."

As I re-read this, I realize there is the danger of this coming across as a bunch of management-speak platitudes, but I urge you again to read the book for yourself and mull over a book that I hope to return to many times in the future.