Book Review: The Nature of Value
The Nature of Value: How to Invest in the Adaptive Economy. 2014. Nick Gogerty.
In The Nature of Value: How to Invest in the Adaptive Economy, Nick Gogerty, the founder of a value research and portfolio allocation consultancy firm, uses evolution as a framework for understanding growth. He explores the concept of value by examining the parallels between economic and ecological systems. Gogerty describes economies as nonlinear, complex, adaptive systems that can be compared with evolving biological ecosystems. He incorporates concepts from several disparate disciplines — including anthropology, ecology, psychology, math, physics, biology, and sociology — to examine how evolutionary processes can help investors manage risk and improve their capital allocation decisions. The book moves successfully between theory and practice in improving the reader’s understanding of both.
Gogerty uses the term allocator in preference to investor throughout the book, despite using the terms capital allocation and investing interchangeably. The distinction he makes is that typical investors are price focused whereas allocators direct resources to the most effective value-creating projects in pursuit of higher expected returns. Despite the well-known notion that price does not necessarily equate to value, investors tend to forget this important point. Many asset-pricing models based on the efficient market hypothesis erroneously use historical prices as inputs and proxy risk with standard deviation. In contrast, Gogerty states that risk is the probability of permanently losing the capacity to receive future economic value.
Gogerty references evolutionary concepts contained in Richard Dawkins’s 1976 book The Selfish Gene (Oxford University Press) to describe the role of evolution in the economy. Dawkins, an evolutionary biologist and ethologist, characterizes genes as selfish, with the sole objective of replicating. Attributing language to the selfish gene helps explain the flow and amplification of successful genetic information throughout the ecological network. Applying the selfish gene metaphor to economics means replacing “life” with “value” and replacing the biological unit of information, the gene, with its economic equivalent, the informational unit of innovation, or “ino.” Gogerty regards inos as the fundamental building blocks of the adaptive economy. Inos are expressed as capabilities, giving organizations the potential to deliver value if they are properly nurtured.
Companies create value by exhibiting several competitive advantages. Ten categories of unique business competitive capabilities are cited, including the business model, brand, channel, service, enabling process, and product performance. Gogerty argues that the more unique competitive capabilities a firm’s goods and services offer, the longer it is likely to dominate the competition. He uses a biological metaphor: “It is one thing to be the fastest frog in the pond. It is another to be the fastest, healthiest, best-looking, strongest, most fertile, and most metabolically efficient frog in the pond.” Ideally, a firm should exhibit advantages in as many of the 10 innovation capabilities as possible.
Gogerty also draws on Red Queen: Sex and the Evolution of Human Nature (1993, Harper Perennial), in which author Matt Ridley explores the evolutionary psychology of sexual selection. Ridley argues that few, if any, aspects of human nature can be understood separately from sex because human nature is a product of evolution and evolution is driven specifically by sexual replication. Another concept Gogerty discusses is clusters, which are competitive spaces in which firms compete for scarce resources of customer value flow. Gogerty describes four broad types of clusters, including the Red Queen cluster. The Red Queen metaphor, which has been useful in biology, states that “for an evolutionary system, continuing development is needed just in order to maintain its fitness relative to the systems it is co-evolving with.” Co-evolutionary adaptation can be seen as an arms race between prey and predator capabilities or between a species and its symbiotic niche. The Red Queen process is expensive for shareholders. The capital required to fuel the endless need for innovation repeatedly destroys return on capital margins. Instead of exiting the race, most firms simply fight harder, often spending their capital on such items as branding, distribution, and marketing.
Finally, Gogerty analyzes the nature of various kinds of economies. He divides them into those that are investable and those that are noninvestable.
In summary, The Nature of Value is a lucid and thought-provoking book that incorporates concepts from evolution and ecology to help allocators improve their allocation decisions. Gogerty presents the economy as an evolutionary system on the premise that an understanding of how evolution works in the biological realm provides insight into this process. The Nature of Value will help all investors attain a more robust understanding of the dynamics that create and sustain value.
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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.
