Competitive Moats in an Information World

Investors today are surrounded by businesses whose competitive advantage purports to be data, or its derivative, network effects. But what is data and what is software? Is data the new oil? Is it something else entirely? If competitive advantages derive from possession and acquisition of data, then what prevents a competitor from simply copying the data? Isn’t data today both abundant and frictionless? Could competitive advantage arise from AI / ML algorithms, when they are largely unpatentable? If our world is comprised of data, then where do profit opportunities come from and where might they emerge?

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The Commoditization of Information

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I work in the investment business and I’ve come to realize that many investment strategies seem to be really information problems in disguise. This essay discusses why the speed of information might be a root-cause of declining investment alpha, and what it might portend more broadly for certain business models and their future profitability.

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The Abstracted World

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If The Investing Meta-Game discussed the competitive interactions between investors in stock markets and an underlying business reality, this essay is about a more fundamental change, the large potential shifts in industry profit pools driven by changes in the technology of distribution.

It seems two worlds exist today: the “physical” world we know and the “abstract” world of the internet, software, and information. This transformation of tangible assets of distribution into digital assets of abstraction is driving the commodification of formerly profitable activities in the value chain towards new areas of emerging opportunity. In an earlier essay I used the concept of emerging scarcity as a leading indicator of where profit pools might move next.

If investment strategies reflect assumptions about the incremental sources of business profitability, then the interaction of technology on competitive dynamics might explain some conundrums of the current investment landscape.

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The Investing Meta-Game

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This essay explores, through the metaphor of the water we swim in, why changes in the market environment are changing the investment strategies that may work going forward.

There are five important takeaways:

  • All investors are engaged in a common myth – or narrative;

  • Most investors describe the “quality” of their investment process, but this is only one part of what generates alpha; it is investment process relative to your competition which matters more;

  • A strategy’s ability to generate alpha (or excess return) depends on the eco-system in which it operates. And investment alpha can only be generated relative to another dominant strategy;

  • All investment strategies, even value investing, are information front-running. Widely available information reduces these opportunities;

  • Idiosyncratic risk is likely the last preserve of human investment managers.

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The Investment Paradox of Software

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The period 2014 to the present has been one of soul-searching for value investors as many formerly successful fund managers retire following stagnant performance. Commenters increasingly describe a market rally that is remarkably narrow in breadth led by FANG (Facebook, Amazon, Netflix, and Google) and other software-driven technology stocks which trade at valuations which appear unhinged from traditional cash-flow based valuation metrics. There are several possible explanations for value investors' under-performance: more competitive markets, diminished information asymmetries, a venture capital bubble, or changes in business models, especially in terms of technology and intangible assets. Yet, there is also some historical evidence that our current tech-dominated market indexes may simply reflect the out-sized importance of software in emerging business models

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