A Great Way To Lose Money
Moneyball is a fortnightly newsletter from Koble exploring the limitations of human decision-making and their implications for startup investing.
We’ve spent two years developing our groundbreaking algorithms, which discover early-stage startups that outperform the market and predict their probability of being successful.
🧠 Mental Model #11 – Groupthink – A Great Way To Lose Money
📖 Investor reading – The tech slump is encouraging venture capital to rediscover old ways – Founders Fund slashes size of its flagship VC fund – Sceptical investors worry whether advances in AI will make money
💬 Some tweets – Modern venture capital summarized – Yesterday and today – Bad lessons for the past 10 years
A Great Way To Lose Money
Investment partnerships are fertile ground for Groupthink.
Groupthink (not to be confused with other dystopian portmanteaus) describes “a deterioration of mental efficiency, reality testing, and moral judgment that results from in-group pressures.”
It results when group members seek to minimise conflict and reach a consensus decision without critical evaluation of alternative ideas and viewpoints.
And it’s rife in Venture Capital.
Irving Janis, a research psychologist from Yale University, remains the authority on Groupthink (he coined the term in a sly nod to Orwell’s Doublethink). In his 1982 book “Groupthink”, he frames various fiascos from history as collective decisions made by small bodies of government officials who constituted cohesive groups.
Pearl Harbor, the escalation of the Vietnam War, the Bay of Pigs invasion, the invasion of North Korea and the Watergate cover-up… all products of the same flawed mental model, which Janus described as exhibiting:
High group cohesiveness
Lack of impartial leadership
Lack of norms requiring methodological procedures
Homogeneity of members’ social background and ideology
Which is where Venture Capital comes in. Because, let’s face it, the standard venture partnership ticks all of these boxes.
Funds tend to select staff and investments that remind them of themselves. And it leads to suboptimal outcomes.
In a paper entitled “The Cost of Friendship”, Harvard researchers show that the more affinity there is between two VCs who co-invest in a new company, the lower the likelihood of the company succeeding.
In other words, the tendency to co-invest with others whose ethnic and educational backgrounds are similar to our own is bad for business.
Implications for investors
Understanding the dynamics and dangers of groupthink drives better decision-making.
Whether a group is involved in invading a country, covering up a political scandal, or investing in a startup, there is always risk to be managed. And as Barton Biggs points out, “Groupthink = Groupstink”.
Howard Marks has written convincingly about the dangers of investment committees:
“Committees rarely take high-risk positions for which the members can be criticised. They rarely embrace idiosyncratic opinions. They rarely capture the most insightful member's uniqueness, as expressed in a lone non-conformist viewpoint. And thus they rarely produce highly superior investment results.”
The most skilled investors understand the limitations of group decision-making (and its distant and poorly understood cousin, Collective Intelligence). Instead, they insist on highly concentrated decision-making processes. Legendary investor Peter Lynch sums it up when he says:
“If no great book or symphony was ever written by committee, no great portfolio has ever been selected by one, either.”
There is no silver bullet for slaying the Groupthink beast. To counter this effect, awareness is everything (and hard to achieve).
Technology, data, and a healthy dose of intellectual humility help us to become more aware of our limitations as human investors – less blind to the dangers of Groupthink.
Work with Koble
At Koble, we’ve spent two years developing our groundbreaking algorithms, which discover early-stage startups that outperform the market and predict their probability of being successful.
We’re working with forward-thinking angels, VCs, family offices, and hedge funds to re-engineer startup investing with AI. If that resonates, get in touch.
💰 The tech slump is encouraging venture capital to rediscover old ways – The industry that is emerging from the tech slump and into an era of dearer money looks different from the one that went into it
📉 Founders Fund slashes size of its flagship VC fund – Fund VIII was raised just prior to the tech market correction, which could persist for years. If deal volume and prices decrease, then so should VC fund size.
🤖 Sceptical investors worry whether advances in AI will make money – VCs are caught between excitement over AI and a broader tech downturn that has led to falling investment in start-ups over the past year.
“In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule.”
― Friedrich Nietzsche
Regards from your [individualistic] startup investing AI,
Koble is re-engineering startup investing with AI, applying quantitative strategies that have disrupted public markets to early-stage startup investing.