Investing Billions - E144: How the World’s Top Investors Compound Their Advantages

Episode Date: March 9, 2025

In this special solo episode of How I Invest, I break down one of the most powerful forces in investing: compounding. Over the course of 142 episodes, I’ve discovered that the best investors all leverage compounding—not just in their portfolios but in every aspect of their business. From relationships and reputation to proprietary information and top talent, compounding creates exponential advantages in a hyper-competitive market.

Welcome back. For episode 150, I wanted to do something completely different and record my first solo episode. But just like with my New Year's resolutions, I don't really believe in waiting for an arbitrary date to do something, so alas, I'm releasing this as episode 143. If you enjoy it, please let me know by sharing this episode with a friend, which lets us know that you value the content. Let's dive right in.

Across the first 142 episodes. The one consistent component I found across all top investors is the role of compounding in their business. Today, I'm going to cover how the world's top investors compound their advantages in a hyper competitive capital markets. Lesson number one, when it comes to compounding is that everything compounds when it comes to investing, whether you're investing someone else's money or your own, even areas that appear not to compound.

Most investors assume that going from one investment opportunity to another is a linear exercise, but in reality, it is a compounding exercise. Your reputation compounds, your experience compounds, your ability, diligence compounds, all of these skills compound and stack on top of each other from one deal to the next. That being said, while some things compound exponentially, others only incrementally. What compounds exponentially? Above all else, relationships compound exponentially.

This is both obvious as well as non-obvious reasons. Relationships compound because of course doing the second deal or the third deal with somebody is much easier than the first deal. On the first deal your counterpart needs to diligence both the deal at hand as well as you the individual. When you get to the third deal the diligence at that point is almost entirely based on the deal presented, not on you as a counterparty. The implicit difference here is trust, which is why trust compounds within relationships. When you present a second deal, you're much more trustworthy than when you had presented the very first deal.

By the time you present the third deal, there's almost an automatic trust in the relationship and embedded trust in the diligence process. Of course, capital allocators will rarely admit this and may not even be aware of this, but indeed a bias of trust is present. This trust bias is a heuristic or a mental shortcut that serves to save investors' time. Before you go about criticizing this behavior, keep in mind that when psychologists studied people's behaviors over many decades, there was consistency as it relates to ethics. Just take a moment to think about someone that you've known for 20 years. Have their ethics changed dramatically?

I would venture to guess that although their skills and maybe even their lifestyles has changed dramatically, their ethics have remained consistent throughout the 20 years that you knew them. There's another reason why relationships compound exponentially. And that is because of the familiarity between parties. What does that mean? Once you've done enough deals with a counterparty, you have an implicit understanding of how the other side looks at an opportunity, how it

fits into their overall portfolio and the kind of deal terms they care about. You essentially start with half of the deal cake already baked. The next factor that compounds exponentially is reputation. Reputation compounds when it comes to investing. Teddy Roosevelt once said, reputation is what people say behind your back. Reputation can be a key advantage when it comes to investing. This is the number one reason why Warren Buffett is able to negotiate superior terms on his investments, both because of his reputation as an ethical counterparty and as his reputation as a great investor.

This is so much the case that every deal that he's worked on has been kept extremely confidential, lest it increase the price of the stock before the deal is ever announced. The opposite, of course, is also true. Negative reputations compound exponentially. Institutional investors oftentimes do a minimum of 10 reference checks on a potential manager prior to investing, making it nearly impossible to raise institutional capital if you have a bad reputation in the market.

This is why sadly, many investors will never raise a single dime of institutional capital. The next factor that compounds exponentially is proprietary information. This compounding factor is less obvious versus the other ones. There's a significant compounding effect when it comes to proprietary information. This is because proprietary information leads to higher returns, which leads to improve deal flow and turn leads to additional proprietary information. This is a virtuous cycle. This is why some families

are able to preserve their wealth for many generations, especially in poor countries where information is more concentrated and limited to a small group of powerful individuals. This can even be the case when the next generation is not as hardworking or even as intelligent because proprietary information can beat that much of a competitive advantage. It becomes exponentially easier to make good decisions when you have access to proprietary information.

One does not need to be a genius to buy land in an area where there's a recently discovered oil field that few people know about. The same goes for buying secondary in a private company that you know is doing well. The next factor that compounds exponentially is people. People compound exponentially. Every CEO says, our most important advantage is our people.

But if you don't have policies in place that lead to attracting and retaining the very best people, this statement is simply window dressing. How do you go about attracting and retaining the very best people, the A players? Firstly, A players want the ability to develop skills and develop their own value in the marketplace. This could be a difficult pill to swallow for insecure managers. Insecure manager may think,

what happens if I develop my A player and he or she leaves my organization? The answer is that if you don't develop your A player, they are guaranteed to leave and likely sooner than later as they have many options. To the upside, having a fully developed A player for three years is more valuable than having even an equivalent A minus player for 10 years.

So many ways developing A players is the price for having a great organizations. A players will recruit other A players at your organization. 8 players are the most underrated recruiters on the planet. That is because A players want to work with other A players. Conversely, A players serve as a very effective quality control for the business. A players have zero tolerance for even a single B or C player on their team, as they realize that one bad apple can significantly

hurt the entire team and organization. This is why as investor, even with a small investment team, you could argue that your number one job is to make sure that you attract and retain A players. A players are the ones that will create the organization that leads to sustained elephant performance. The arbitrage when it comes to A players is to pay them 10 to 25% over their market rate.

This is a competitive advantage in both attracting and perhaps most importantly, retaining A players. The reason you can afford to do this is because A players will produce an order of magnitude more in higher quality output than even A minus players leading to overall savings. This arbitrage will only continue to grow as productivity increases with the advent of AI and AI tools.

And that is the lessons I've learned through the podcast and also in my career on what compounds exponentially. Einstein famously said that compounding is the eighth wonder of the world. What do you think? Do you agree? Thanks for listening to my episode on compounding. If you enjoy this episode, please share with a friend. This helps us grow and also provides the best feedback when we review the episode's analytics. Thank you for your support.