Investing: The infinite game
While game theory is indeed the study of games, it involves a broader and perhaps more “boring” definition of what counts as a game. In A Course in Game Theory, Martin J. Osborne and Ariel Rubinstein define a game as “a description of strategic interaction that includes the constraints on the actions that the players can take and the players’ interests but does not specify the actions that the players do take.” Specifically, in this article, the focus is on the distinction between finite and infinite games—a distinction born from James P. Carse’s philosophical dive into game theory.
Simon Sinek does a great job of describing these two categories in his book The Infinite Game. He characterizes finite games as those with defined rules, known players, and finite length, meaning there are ultimately winners and losers. Strategic contests like poker and basketball fit this definition and are what commonly come to mind when we think about games, but a political debate would also fit into this category.
Sinek argues that infinite games are more obscure: the rules are dynamic, there are no winners and losers, and players drop out as their ability or their desire to continue playing deplete.
Importantly, the strategies for approaching each type of game are different. When playing a finite game, victory is your main goal, so it makes sense to base your actions on what maximizes your chances of winning. When playing an infinite game, given that there are no winners or losers, what you’re aiming for is resilience. Therefore, basing your actions on consistent principles is often the best way to protect against poor decision-making.
Investing is a fitting example of an infinite game. Lending capital in exchange for an expected return is a practice that has existed for centuries, be it through debt financing, private equity, or the first public issuance of equity in Amsterdam in 1602. But the landscape of players (investors, in this case) has been changing constantly. Why is it that some players last longer in this game than others?
My story is that issues surface when investors begin to treat their work as a finite game when it is one of the most complex infinite games out there. Too often, when markets are booming and there are too many dollars chasing too few quality assets, investors feel compelled to hunt for returns even if they aren’t being fairly compensated for the risk they’re undertaking, exposing themselves to significant downside risk when the cycle inevitably turns.
Simply put, they’re playing an infinite game with a finite strategy; playing to win, rather than to continue playing. And over the last decade, the winning strategy seems to have been about maximizing risk:
- Eliminating bonds and cash
- Buying aggressive companies with high leverage—those companies that have continued to benefit from lower rates
- Buying quality at any price—not paying attention to valuation
While, as an investor, you may have produced strong nominal returns over the last few years with such a strategy, it was not a good blueprint for success in the context of an infinite game because the world could have played out differently. It is hard to resist the urge to let your portfolio drift in favour of what’s working at a given time, but that’s what it takes to have staying power in the infinite game.
That’s why we steer clear of practices like market timing, choosing instead to focus on what is within our control: performing rigorous research on companies by analyzing financials, evaluating strategies, assessing barriers to entry, interviewing management teams, and modelling valuations. We focus extensively on mitigating risks, because we acknowledge that overconfidence is the easiest way to make poor decisions. This explains why we have thresholds in place for each of our portfolios, such as 6% and 20% maximum portfolio weights per security and per industry, respectively.
This is not to say that we think that performing fundamental security-by-security research is the only way to make money in the infinite game of investing. Rather, we believe that by specializing in a principled and rigorously tested approach, we can provide attractive long-term risk-adjusted returns for our clients by avoiding the errors that come with short-sighted decision-making.
—Ramiz Razzak spent his summer as an equity analyst at Mawer Investment Management Ltd., he is pursuing his Bachelor of Arts in Applied Mathematics and Economics at Harvard University.