How Bacterial Mutation Informs Investment Strategy

During their recent episode, Taylor, Carlisle, and Phil Pearlman discussed How Bacterial Mutation Informs Investment Strategy. Here’s an excerpt from the episode:

Tobias: It’s coming up to the top of the hour, which means that it’s JT’s vegetables. Mark it down, folks. Phil, there are people who tune in this show only for the veggies. So, there you go. Top of the hour.

Jake: Well, I don’t know if Phil might not approve of vegetables [crosstalk] if he’s nearly carnivore.

Phil: No, no, no, I love vegetables. [Jake laughs] I’m not a total carnivore, man. I eat salads all the time. Tonight, I’ll have an Israeli salad with chicken. Fiber’s great. Recent findings that fiber lowers the risk of cancer. Go ahead. Sorry.

Jake: Yeah, no worries. So, I think I try to always match up a little bit of the guest and what we’re talking about for the veggies. And so, this is in the world of– we’re going to be talking about bacteria. Bacteria are some of the most adaptable organisms on earth surviving billions of years, and really by doing one thing exceptionally well, which is mutating. I think anything that’s lasted billions of years is worth studying. There’s just some proof in the pudding.

So, mutation is a bacterium’s way of adapting to change. Whether it’s a new environment, a hostile immune system that they’re part of, or a sudden flood of antibiotics, they have to be ready to really mutate. But not all bacteria mutate at the same rate. So, some are like speed demons and they’re rapidly changing to keep up with their environment. Others are much slower and they’re making small adjustments.

The reason for these differences are fascinating. So, for instance, the bacteria which causes tuberculosis has a very slow mutation rate. Why? It tends to live in relatively stable environments. They’ve evolved a very robust DNA repair mechanisms to avoid subjecting themselves to errors in the DNA replication process.

There’s another example of a slow mutating bacterium that’s– I won’t try to pronounce it. It’s hard. It’s in the marine, in the ocean. It’s distinguished by its small genome and a low rate of mutation in comparison to most bacteria. So, it’s really this effective DNA repair that lets them do slow– prevent excessive mutation. So, they basically have a strategy of like, fix it really well rather than reshuffle the cards and see what might become a better fit. So, two different strategies that you see mother nature testing out.

Now, on the other hand, bacteria that are facing a high stress environment, they tend to mutate much faster, because their survival depends on it. There’s another interesting observation that might be relevant to a future analogy that we might make. Even within the same bacteria, not all parts of the DNA mutate equally. There are some regions that are hotbeds of change, and then there’s others that remain steadfast and stable and they resist mutation.

So, all right, what analogies from billions of years of successful survival can we torture out of this? In volatile, fast changing market environments, you might want to be more open to– open your investment process to more change and flexibility. If the pace of the change in the world is really increasing, maybe all of us stodgy “principled investors.” Well, like maybe we’re in for a wake-up call, I don’t know.

So, maybe if you’re a VC or someone who’s focused on really early business, early in their life cycle, where you might expect more change if you’re on that bleeding edge, maybe you need to have a more adaptable investment process. It’s always easy to make fun of VC community for bouncing around to whatever seems like it’s hot. There’s SaaS to crypto to AI, whatever the next thing is, but maybe that’s actually an evolutionarily sound strategy. I don’t know, I think we maybe should be more curious and less judgmental about that.

And then, just like I said that there are those certain regions of DNA that are resistant to change and there are other parts where that should– Those are the parts that should remain stable. There’s probably also parts of your investment process that should remain stable. Maybe wouldn’t be subject to whatever’s happening in the market. So, call these your core principles. As Thomas Jefferson may or may not have said, “In matters of principle, stand like a rock. In matters of style, swim with the current,” just like a bacterium. Okay. He didn’t say that last part. [Tobias laughs] I just added that.

So, I think it’s interesting you might want to spend some time thinking about your own investment process and your environment and how much change would actually be appropriate. Like, what would be the optimal amount of change that you might look for? And maybe here’s some simple rules of thumb that might help. Look at your environment and the pace of change. If it’s stable, maybe focus on refining what works. If it’s unpredictable, maybe you need to experiment more. Protect your slow, mutating core, these are your timeless principles, the anchors that ground your decision making no matter what.

I think it’s an under discussed topic in finance generally. But how can you embrace the right amount of change at the right time? Too little, and you’re stuck in the past too much, and you risk following fashion and just bouncing around, which we know probably doesn’t work most of the time.

So, I’m just curious for both of you, over time I know that Toby, especially yours, you’ve made some tweaks and changes. I know that there’s a lot of firm principles as well. But have you thought about like, why to change one part versus another depending upon environment or what’s being selected for?

Tobias: Yeah, it’s hard. There are plenty of business biographies of investors who in the mid-1990s they saw the market getting extremely expensive for the first time, got into cash. There’s really been no opportunity since then that would have matched that same valuation as in– If they were looking at, say Shiller PE or something like that.

Jake: Yeah, definitely would have led you astray.

Tobias: You never– [crosstalk] Yeah. So, you need to be more flexible in that. But equally, as we all know, if you’re always using whatever strategy or style is working right now, then you’re going to trail, because it’s just the nature of it, the law of ever-changing cycle says that the thing that hasn’t been working is going to start looking a little bit better. And the thing that’s been working really well gets a little bit crowded and starts working less well. So, that’s the tension. You have to be surviving without trailing too much. I don’t know if there’s any good solution to it, but Phil’s been around longer than I’d have. What do you think, Phil?

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