Financial Selection and Investor Herding: Lessons from Evolutionary Biology

Biologists have long debated the mysterious role of mate selection in evolution. Investors can learn much from their findings. Mate selection, after all, is the competitive process by which scarce reproductive resources are allocated.[1] And what is financial selection, or investing, if not the competitive process by which scarce productive resources are allocated? Thus, mate selection and financial selection are similar evolutionary processes.[2]

But first, what is financial selection? We define it as “any capital allocation decision.”[3] Capital allocators (i.e., investors) are thus the agents of financial selection. They are the filter through which capital passes, and their preferences dictate who gets capital and who doesn’t. Accordingly, seekers of capital adapt to their preferences. The more widespread a preference among investors, the more capital its satisfaction will unlock and the more influential the preference will be.

This evolutionary process of adaptation is financial selection. It does not shape our commercial world alone, however. It operates alongside consumer selection. Consumers select products with superior value propositions. A product must have differentiating traits, or “premes,” to be superior. Firms that produce such a product tend to be more profitable, grow faster, and survive longer. They are fit, and their differentiated products are copied by less-fit competitors.

Consumer selection shapes the investor preferences behind financial selection much like natural selection shapes the mating preferences behind mate selection. Mating preferences at odds with natural selection, for example, produce unfit offspring unable to survive. Likewise, investor preferences at odds with consumer selection finance unfit firms producing inferior products.

Thus, “as [mate] selection is to natural selection,” I concluded elsewhere, “financial selection is a byproduct of, and an aid to, consumer selection.” It is, in other words, “nested within consumer selection.” But is this always true? Perhaps not. As we will see, biologists are unsure whether mate selection is always nested, and under certain conditions it may only be quasi-nested. If the same is true of financial selection, the implications are material.

Nested or Not? When Selection Favors Fashion over Fitness

The evolutionary role of mate selection is an old mystery. Evolutionary biologist Charles Darwin thought mate selection is not necessarily subservient to or contained within, that ruthless economizer he called natural selection.[4] It can become unnested and produce harmful traits with negative survival value.

Alfred Wallace, Darwin’s contemporary, disagreed. He thought mate selection must be subservient to natural selection since mating preferences are themselves subject to natural selection.[5]

The peacock’s elaborate train is a classic case that divided the two camps. Such an elaborate train must make the peacock more obvious to predators and therefore must harm its survival, said Darwin. Wallace disagreed. He said it must somehow signal survival fitness.[6]

Wallace’s view has since been vindicated in part. Peafowl, as the species is known, suffer from parasitism, but immune resistance is hard for females, or peahens, to observe.[7] Peahens can, however, observe an elaborate train, and only those males, or peacocks, with strong immune resistance can bear the cost of such an ornament.[8]

In this way, the peacock’s train is an honest signal of survival fitness, but its size and vibrance seems like overkill to many. Why, then, has natural selection allowed mate selection to favor such an extreme ornament?

British mathematician, statistician, biologist, and geneticist Ronald Fisher provided an explanation – the “sexy son hypothesis.”[9] Once a preference for elaborate trains is dominant among peahens, the choosy sex, every female must select males with elaborate trains to have sexy sons.[10] Mom’s genes won’t pass to later generations if her sons survive but don’t seduce.[11]

The mating preferences of peahens therefore have a powerful herding tendency thanks to the “sexy son” effect. This sparked an evolutionary arms race among males, or peacocks, whose trains became ever more elaborate in their effort to seduce.[12] The peacock’s train evolved towards a costly extreme, however, as the “sexy son” effect swamped the honest signal effect.[13]

At this point, “[the] sexy son effect will continue even if the peacock’s ornaments themselves are giving no reliable information about the quality of the male in other respects. Once [a] female preference is established, the females are slaves to fashion. They dare not choose differently lest they have unsexy sons.”[14]

In fact, John Maynard Keynes foreshadowed this idea when he observed, 

“[P]rofessional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view.”[19] (emphasis added)

We now have a quasi-nested explanation for the peacock’s train. Natural selection allows this mating preference to persist so long as the trait’s positive reproductive value outweighs its negative survival value.[15] It is, however, a suboptimal outcome. The species’ mating market is stuck in an evolutionary disequilibrium.[16] It is a market failure, so to speak, where “[a] mating preference has driven the entire species down a hazardous evolutionary path.”[17]

Weighing vs. Voting: Why Investor Preferences Can Distort Value

If mate selection is not always subservient to, or “nested” within, natural selection, then surely the same is true of financial selection. It may only be “quasi-nested” within consumer selection under certain conditions. And why not? If “reproduction of the sexiest [can] trump survival of the fittest,” as Matt Ridley says, then promotion of the popular can trump survival of the economical.[18] Thus, financial selection may cause firms to evolve objectively harmful traits with negative value. 

Most investors, in other words, are trying to anticipate their peers’ preferences, not a firm’s value, since preferences dictate money flows and money flows dictate short-run stock prices. And, as we all know, poor short-run performance damns money-raising. Like mating preferences in peahen, investor preferences therefore have a powerful herding tendency. It is risky, after all, to not share rivals’ preferences if the goal is seduction. As the investor Ralph Wanger observed,

“[T]he optimal strategy [for professional investors] is simple: always stay in the center of the herd. As long as he continues to buy the popular stocks, he cannot be faulted. On the other hand, he cannot afford to try for large gains on unfamiliar stocks that would leave him open for criticism if the idea failed.”[20]

This is, in effect, Fisher’s “sexy son hypothesis.” The trade-off between short-run money-raising and long-run value creation is like the peahen’s trade-off between reproductive and survival value, respectively. Money managers earn more if they manage more, after all, and managers of firms earn more if their stock options expire in-the-money. Both seekers of capital may decide seduction offers an easier path to riches than the long, hard, and uncertain path of value creation. Those who seduce may therefore compound (financially and genetically) faster than those who survive.

Such a view does not fit neatly into Neo Darwinian theory; nor does it fit neatly into economic or financial orthodoxy. The “efficient market hypothesis” (or “EMH”) is gospel in academia. It says prices reflect all information about future value.[21] Yet, by definition, prices also reflect investor preferences. It follows, then, that financial selection is always subservient to, or “nested” within, consumer selection if, as we believe, future value is ultimately dictated by consumer selection.

Thus, according to EMH, financial selection cannot cause firms to evolve objectively harmful traits. There would be no financial incentive to do so since Mr. Market immediately recognizes and punishes value destruction. Even Warren Buffett, a staunch critic of EMH, would likely agree if “immediately” were replaced with “eventually.”[22] As his mentor, Benjamin Graham, said, “In the short run, the market is a voting machine but in the long run it is a weighing machine.”[23]

We believe Buffett and Graham’s view explains how financial selection functions, but Keynes’s unorthodox view explains some important exceptions. Financial selection operates at a faster rate than consumer selection. A shift in investor preferences quickly alters prices, and firms quickly adapt to the signal. It takes time, however, for a firm’s response to impact its product’s value proposition. Consumer selection cannot function beforehand.

In the meantime, maladapted investor preferences can spread, and an evolutionary “arms race” can break out thanks to investors’ above-mentioned incentive to focus more on seduction than value creation. This can cause firms to evolve seductive but harmful traits like the peacock’s train. Today’s market structure may be ripe for such an outcome. Consider the following two trends:

Dominance of “Voting Game” Investors | Multi-manager hedge funds pay $100 million or more for star stock pickers that “hold [] positions for just a few weeks or months.”[24] Thanks to the liberal use of leverage, such funds are estimated to own 30% of US stocks, and, given their high turnover, they surely account for a greater share of trading volume.[25] Long-term fundamentalists, however, have seen their influence wane thanks to outflows.[26]

Dominance of Passive Investors | Passive investors own roughly 60% of US stocks if one includes “closet indexers.”[27] These investors blindly buy (sell) stocks that rise (fall). They therefore blindly mimic the “voting game” investors dominating markets. Thus, “voting game” investors are like the dominant peahen that lead mate selection at the “lek” (where males gather to show off to potential mates) while passive investors are like young peahen mimicking their mature rivals’ preferences.[28]

All sorts of seductive ornaments may evolve at firms under these conditions, including elaborate headquarters, quirky CEOs, bitcoin treasury activity, etc. Here, however, let’s focus in on another seductive ornament at firms – costly “Green” initiatives absent State mandates. Today’s technology titans, for instance, prefer “Green” power sources for their energy intensive data centers despite the added cost.[29] All else equal, such initiatives must negatively impact firms’ economic value.

Why, then, do firms adopt them? Recall that, with respect to financial selection, there is a (1) top-down cascade of financial preferences, (2) powerful herding tendency of investor preferences, (3) time-lag between a firm’s adaptation to investor preferences and the manifestation of a negative impact at the firm, and (4) good chance an evolutionary “arms race” breaks out in the interim.

Accordingly, if a preference for “Green” investments spreads among those with capital, they will select as their agents’ investors with “Green” portfolios and fire those without “Green” portfolios. The former gain size and influence while the latter shrink or adapt to this “Green” preference. The evolution of investor preferences shifts money flows. Firms with a “Green trait” see their stock prices inflate, and firms without a “Green trait” see their stock prices deflate.

The dominant “voting game” investors take notice of their peers’ changing preferences. As they, too, buy (sell) firms with (without) a “Green trait,” stock prices adjust even more. Passive investors then blindly follow their lead, which amplifies the price adjustment. In response, firms adapt by adopting a “Green trait” and feverishly signaling to investors to attract capital in pursuit of a higher stock price. Years may pass, however, before consumer selection has any say on the matter.

The commercial equivalent of the peacock’s train may arise in the interim as an evolutionary “arms race” breaks out. As more firms adopt a “Green trait,” the trait must get more extreme to stand out. And as “Green” portfolios become more common among investors, investors’ portfolios must get more “Green” to stand out. It can quickly spiral out of control. Maladapted investor preference can thus drive an entire species of industry down a hazardous evolutionary path.

Implications for Investment Practitioners

Investors beware. Voting game investors dominate markets. Accordingly, financial selection is less nested within consumer selection, which has likely allowed maladapted investor preferences to spread. Firms may have evolved harmful ornaments of seduction as a result. Those ornaments may prove too costly to bear, however, when economic reality reasserts itself as it always does.

For investors, the task is to separate genuine economic fitness from false signals designed to seduce capital. That means questioning whether traits are creating long-term value or merely attracting flows. In markets, as in nature, survival favors those who resist fashion and allocate to what endures.

[1] David Shuker and Charlotta Kvarnemo, The Definition of Sexual Selection, Behavioral Ecology (2021), 32(5), pp. 781-794, available at: https://academic.oup.com/beheco/article/32/5/781/6344800 (stating, “Sexual selection is any selection that arises from fitness differences associated with nonrandom success in the competition for access to gametes for fertilization.”).

[2] Drew Estes, Commercial Evolution (June 14, 2024), available at: https://destes.substack.com/p/commercial-evolution.

[3] Id.

[4] Matt Ridley, Birds, Sex & Beauty (New York: HarperCollins, 2025), pp. 44

[5] Id at pp 78

[6] Id. at pp. 82 (quoting Henry Howard’s claim that, “The extremely rigid action of natural selection must render any attempt to select mere ornament utterly nugatory, unless the most ornamented always coincide with the fittest..”).

[7] Id. at pp. 189-192 (citing a 1990 paper by Alan Grafen on the mathematical support for an honest signal theory), pp. 196-197 (citing a 1982 paper by Bill Hamilton and Marlene Zuk showing correlation between colorfulness in bird species and parasite load), and pp. 224 (citing a 2000 paper by Adeline Loyau supporting the honest signal theory regarding parasite resistance in peacocks).

[8] Id.

[9] Id. at pp. 100-103.

[10] Id.

[11] Id.

[12] Id. pp 105-109

[13] Id. at pp. 206 (stating, “Even if females are getting a direct benefit in terms of disease-resistant genes by selecting [males with elaborate trains], they can also be getting an indirect benefit in terms of attractive sons. And the latter will swamp the former.”).

[14] Id. at pp 104

[15] Id. at pp. 104-105 (stating, “So long as the disadvantage is more than counterbalanced by the advantage in sexual selection, Fisher wrote, then further development will proceed. In mathematical terms a Peacock will grow a train that halves its chances of surviving if that tail more than doubles its chances of mating before it dies.”).

[16] Id. at pp. 4 (calling a “lek” a “sex market.”).

[17] Id. at pp. 210

[18] Id. at pp. 105.

[19] John Maynard Keynes, The General Theory of Employment, Interest, and Money (BN Publishing, 2008, originally published 1936), pp. 102.

[20] Ralph Wanger, A Zebra in Lion Country (New York: Simon & Schuster, 1999), pp. 17.

[21] John Cochrane, Eugene F. Fama, Efficient Markets, and the Nobel Prize, Chicago Booth Review (May 2014), available at: https://www.chicagobooth.edu/review/eugene-fama-efficient-markets-and-the-nobel-prize.

[22] Warren Buffett, The Superinvestors of Graham-and-Doddsville (speech, May 1984), available at: https://business.columbia.edu/cgi-finance/chazen-global-insights/superinvestors-graham-and-doddsville.

[23] Warren Buffett, 1987 Letter to Shareholders, Berkshire Hathaway, available at: https://www.berkshirehathaway.com/letters/1987.html (citing Benjamin Graham).

[24] Peter Rudegeair and Gregory Zuckerman, The Frenzied Pursuit of Wall Street’s Low-Profile All-Stars, The Wall Street Journal (June 13, 2025), available at: https://www.wsj.com/finance/investing/the-frenzied-pursuit-of-wall-streets-low-profile-all-stars-ee51b33a?st=VYiFXA&reflink=article_email_share.

[25] Nell Mackenzie and Carolina Mandl, Biggest Hedge Funds Have Doubled Footprint in US Stocks Since 2014, Goldman Sachs Says, Reuters (Sept. 15, 2023), available at: https://www.reuters.com/business/finance/biggest-hedge-funds-have-doubled-footprint-us-stocks-since-2014-goldman-2023-09-15/.

[26] See, e.g., Matt Levine, Nobody Wants Mutual Funds Now, Bloomberg (Oct. 23, 2023), available at: https://www.bloomberg.com/opinion/articles/2023-10-23/nobody-wants-mutual-funds-now.

[27] Felix Moltke and Torsten Slok, Assessing the Impact of Passive Investing over Time: Higher Volatility, Reduced Liquidity, and Increased Concentration, Apollo (Nov. 2024), available at: https://www.apolloacademy.com/wp-content/uploads/2024/11/Passive-Investing-Paper-vF-112224_STAMPED.pdf.

[28] Ridley, Birds, Sex & Beauty, pp. 130.

[29] See, e.g., Spencer Kimball, Microsoft Signs Deal to Invest More Than $10 Billion on Renewable Energy Capacity to Power Data Centers, CNBC (May 1, 2024), available at: https://www.cnbc.com/2024/05/01/microsoft-brookfield-to-develop-more-than-10point5-gigawatts-of-renewable-energy.html.