What does it take to succeed in business and investing?
Differentiation is among the key ingredients. To be successful in your business, you need to offer a product that differs from the competition in a way that clients recognize as added value.
If you want to beat the market as an investor, the first thing you need to do is something different from all other investors. Or as Howard Marks, CFA, 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 develops a great new product had to have an idea about how to do things better than their competitors had done in the past. And every great investment is the result of either luck or skill — with skill reflecting an ability to assess risks and opportunities differently than other investors.
Unfortunately, most people believe creativity peaks at a young age. The myth of the innovative businessperson is driven by stories about young geniuses who revolutionize their fields. Elon Musk is the youthful entrepreneur who tore up the manual on 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, John C. Bogle launched the first index mutual fund in 1976 and went on to revolutionize how we invest today.
But this image of young, disruptive innovators who reinvent their industries is incomplete. As David W. Galenson observes, the media and creativity research have focused too much on these so-called conceptual innovators. Conceptual innovators tend to be very young and enter an industry and turn it upside down. They are not beholden to convention, to how things have been done in the past, or to how things are supposed to work. And ample research indicates that this kind of creativity does decline with age.
Yet the vast majority of innovations are not made by conceptual innovators but 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 deduce from what a car needs to do to what a specific car — his Tesla — is going to look like and what technology is needed to best achieve these goals.
In contrast, experimental innovators 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.
Charles Darwin is a prominent example of an experimental innovator. He published his theory of evolution at the age of 50 after decades of investigation and research. In general, experimental innovators deliver their best work when they’re older, often when they are well above 50. Why? 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 about 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. You will constantly ask questions about why things are done the way they are. This is why so many passionate investors become better over time. They learn from every failed investment 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 become demotivated by failure or lose interest in their jobs and burn out, the drive to ask questions and innovate dies.
Howard Marks, CFA, is one such experimental innovator in the investment world. While Marks was always a good investor, his Oaktree funds were not magazine cover stories coming right out of the gate. 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 shone on Marks.
Similarly, Clifford Asness founded AQR in the late 1990s based on Eugene Fama and Kenneth French’s research on factor returns. Starting from there, the AQR team gradually improved its investment process as it gained experience and progressed one tiny innovation at a time. And today, AQR is among the largest and and most successful hedge fund firms in the world.
What these stories and the research into experimental innovation tell us is that many businesses fail to tap into a massive source of competitive advantage and differentiation: the firm’s human capital — the experienced and still passionate people who work there. These men and women can help the business innovate and create differentiated new products and services because they know the products and services better than anyone.
And that offers a compelling lesson. Businesses and investors would do well to deprogram themselves from the dominant cult of the conceptual innovator and seek to leverage a crop of experimental innovators too often taken for granted: their more experienced and still passionate employees.
For more from Joachim Klement, CFA, don’t miss Risk Profiling and Tolerance: Insights for the Private Wealth Manager, from the CFA Institute Research Foundation, and sign up for his regular commentary at Klement on Investing.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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