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"Nobody knows anything"

It’s not just music bosses who have sometimes erred horribly. Publishers rejected C.S Lewis, Agatha Christie, Dr Seuss and J.K. Rowling many times before they went on to sell millions of books. And the producers of countless blockbuster films - including Star Wars and Raiders of the Lost Ark - have tales of how the Hollywood studios rejected their ideas.

This inability extends way beyond the entertainment business. The telephone “is inherently of no value to us” wrote Western Union bosses in 1876. “The wireless music box has no imaginable commercial value” said some bosses at RCA. “There is no reason anyone would want a computer in their home” said Ken Olson of DEC in 1977. TV’s Dragons’ Den is following this pattern; the dragons have turned down several successful ideas.

All of this supports the observation of Sussex University’s Alex Coad, that success is pretty much impossible to predict. Venture capitalists know this: they expect many of their investments to fail, and hope that one or two great successes will offset the many failures. For this reason, the performance of VCTs is hugely variable: in the last five years the best has almost trebled your money whilst the worst has lost almost three-quarters of it.

Screenwriter William Goldman’s famous saying, “nobody knows anything” is, therefore, a good investment principle. Upside tail risk - the small chance of a massive payoff - is unpredictable. Sadly, though, investors often pay too much for this chance. Aim shares and newly-floated companies have, in aggregate, under-performed the main market for years perhaps because investors are overconfident about their ability to predict the unpredictable.

This, though, raises a question. I claim elsewhere that aggregate equity returns are partly predictable. So, how can it be that we can have some knowledge of the future in some places but not others?

The answer’s simple. Knowledge requires learning and learning requires a stable environment; if “O” sometimes meant “Z”, “S” or “E” we would find it very hard to learn to read. (This is one reason why knowledge might advance faster in the natural sciences than in the social ones: there is more stability across time and place in in nature than in societies and economies). And there is – to a degree – some stability in the aggregate market, in the sense that it’s plausible that the things that influenced it in the past, such as investors’ attitudes to risk, will influence it in future. But there’s less stability at the micro level. A new investment project, new film or new product has no antecedents; that’s what the word “new” means. The knowledge we’ve acquired in the past is, therefore, little help to us in assessing its chances of success – except to the extent that the new project might have some features in common with past ones.

My point here is a simple one, but is often forgotten. Investing is a philosophical activity, in the sense that it rests upon epistemology: what is it possible to know? A big reason why I favour tracker funds is that I believe the answer is: “very little”. The successful investor must distinguish between degrees of probability; some views are well-founded; some are reasonable probabilities; and others are wild punts.