In a rising market, the investors taking the most risk generate the highest returns, making them appear brilliant. However, this same aggression ensures they will be hurt the most when the market turns. This dynamic creates a powerful incentive to increase risk-taking, often just before a downturn.

During due diligence, it's crucial to look beyond returns. Top allocators analyze a manager's decision-making process, not just the outcome. They penalize managers who were “right for the wrong reasons” (luck) and give credit to those who were “wrong for the right reasons” (good process, bad luck).

Underperforming VC firms persist because the 7-10+ year feedback loop for returns allows them to raise multiple funds before performance is clear. Additionally, most LPs struggle to distinguish between a manager's true investment skill and market-driven luck.

This anecdote illustrates the peak irrationality of the dot-com bubble. A tech hedge fund manager, despite being up 135% year-to-date, found he was the worst performer at a dinner with peers. Recognizing this as a sign of a top, he went 100% cash and was the sole survivor among them.

History shows that markets can remain irrational longer than investors can remain solvent. For instance, the Nasdaq was 40% higher at its post-crash low in 2002 than when media first called the dot-com market "nutty" in 1995. Selling too early, even with sound analysis, often means missing substantial gains.

Many LPs focus solely on backing the 'best people.' However, a manager's chosen strategy and market (the 'neighborhood') is a more critical determinant of success. A brilliant manager playing a difficult game may underperform a good manager in a structurally advantaged area.

Being fundamentally correct in the long run ("money good") is irrelevant if you cannot survive short-term market volatility and pressure. Successful investing requires managing career risk, liquidity, and timing, not just being right about an asset's ultimate value.

AQR's Cliff Asnes highlights that a prolonged period of underperformance is psychologically and professionally more damaging than a sharper, shorter drop. Enduring a multi-year drawdown erodes client confidence and forces painful business decisions, even if the manager's conviction in their strategy remains high.

Marks emphasizes that he correctly identified the dot-com and subprime mortgage bubbles without being an expert in the underlying assets. His value came from observing the "folly" in investor behavior and the erosion of risk aversion, suggesting market psychology is more critical than domain knowledge for spotting bubbles.