Listen to the deep-dive discussion – The Physics of Zero Cost Growth (41:48 min)

 

“The most powerful force in the universe is compound interest.” — Attributed to Einstein

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The Question Nobody Asks

Every investor asks the same question: what should I buy?

Few ask the better question: why does it compound?

The difference matters. The first question produces a list of tickers. The second produces understanding. And understanding is the only thing that prevents you from selling at the worst possible moment — which, statistically, is what most investors do.

In a previous post, we examined Chris Hohn’s portfolio and observed something striking: his capital migrates in one direction — from physical monopolies toward information tollbooths, from businesses where growth costs billions to businesses where growth costs nothing. We called this the gradient. But we never explained why the gradient exists.

This post answers the why. And the answer is not financial. It is physical.

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A Brief Vocabulary

For readers arriving here first: in The Infinite Investor, we decompose every business into two forces. A is the revenue generated by existing operations — the moat, the recurring cash flow, the engine that runs today. B is the incremental capital required to generate the next unit of revenue — the factory, the R&D, the fleet expansion.

When B is zero — when growth costs nothing — the business compounds freely. Every incremental dollar of revenue falls directly into free cash flow. No new factory, no new fleet, no new patent. We call this condition a Free B, and we call a business that has a Free B while riding a growing wave of demand a Freesurfer.

Visa is the archetype. Global electronic payment volume grows 8–10% annually. Visa’s revenue grows 8–10% annually. Additional capital required to capture that growth: zero. The same network. More volume. More revenue. Automatically.

The thesis of this post is that the word automatically is doing more work than it appears. What makes a Freesurfer extraordinary is not a brilliant CEO, not a clever strategy, not a well-timed acquisition. It is that the compounding is governed by forces that resemble natural laws — forces that are structural, directional, and largely irreversible. To understand why, we need to borrow from physics, chemistry, and information theory.

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I. The Gradient

In physics, a gradient is a directional force. Heat flows from hot to cold. Water flows from high to low. Pressure equalizes from dense to sparse. These flows are not decisions. No one instructs the heat to move. The Second Law of Thermodynamics guarantees it.

Capital has its own gradient. It flows from high-cost B to zero-cost B. From businesses that must spend to grow, toward businesses that grow for free. From atom to bit. From heavy to weightless.

This is not a metaphor. It is an observable, measurable phenomenon.

Chris Hohn’s portfolio demonstrates it empirically. Over three consecutive quarters in 2025, Hohn sold Canadian Pacific Kansas City (physical rails, heavy capex) and bought more Visa, Moody’s, and S&P Global (information tollbooths, zero capex). He was not making a tactical trade. He was following the gradient — moving capital from high-B to zero-B, exactly as heat moves from hot to cold.

Buffett did the same thing over a longer arc. His career migrated from textile mills (Berkshire’s original business — atoms, heavy B) to insurance float (financial instrument — lighter B) to Apple (technology platform — lighter still) to the implicit endorsement of Visa and Moody’s through his portfolio and his public statements. The trajectory is identical. The gradient is the same.

Why does the gradient exist? Because zero-B businesses compound faster, compound more safely, and compound with less human intervention than high-B businesses. Each of these advantages is rooted in a different natural law.

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II. The Irreversibility — Why the Wave Cannot Reverse

The Second Law of Thermodynamics states that entropy — disorder — always increases in a closed system. A broken egg does not reassemble. A dissolved sugar cube does not reconstitute. Time flows in one direction, and so does entropy.

The secular trends that drive Freesurfers have the same property. They are thermodynamically irreversible — not in the strict physics sense, but in the structural sense that reversal would require more energy than the system can provide.

Consider the digitalization of payments — Visa’s wave. Eighty-five percent of global transactions are still conducted in cash. Every year, a fraction migrates to digital. This migration is driven by governments (who want traceability and tax compliance), by banks (who want transaction fees), by merchants (who want speed), and by consumers (who want convenience). Four independent actors, each with their own incentives, all pushing in the same direction.

For this wave to reverse, all four actors would need to simultaneously prefer returning to cash. Governments would need to prefer opacity. Banks would need to prefer losing fee revenue. Merchants would need to prefer slower settlement. Consumers would need to prefer carrying paper. The probability of simultaneous reversal is effectively zero — for the same reason that entropy does not spontaneously decrease. The system has moved to a lower-energy state, and there is no force pushing it back.

The same irreversibility applies to the growth of global capital markets (S&P Global and Moody’s wave) and to the shift from active to passive investing (MSCI’s wave). Global debt issuance grows because credit-based economies structurally require it. Passive investing grows because the academic evidence, the fee compression, and the regulatory environment all push in one direction. These are not trends. They are entropies.

The investor’s insight: when the wave driving a Freesurfer is irreversible, the compounding does not depend on a forecast. It depends on the Second Law. The question is not will digitalization continue? The question is can you construct a plausible scenario in which it reverses? If you cannot, the wave is as close to a physical law as finance permits.

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III. The Autocatalyst — Why the Wave Accelerates

In chemistry, an autocatalytic reaction is one whose product accelerates the reaction itself. The more product is created, the faster the reaction proceeds. It is a positive feedback loop built into the chemistry.

The classic example: a fire. The heat released by combustion raises the temperature of surrounding fuel, which ignites, which releases more heat, which raises the temperature further. The product (heat) catalyzes the reaction (combustion). Once started, the reaction sustains itself without external energy.

Certain Freesurfers exhibit this property. The most striking case is MSCI.

MSCI licenses the indices on which passive investment products are built. The shift from active to passive management — already a powerful secular wave — is now being accelerated by artificial intelligence. AI-powered portfolio construction naturally gravitates toward indexed products because algorithms optimize for systematic, rules-based allocation. More AI means more passive investing. More passive investing means more index licensing revenue for MSCI. More revenue means more data. More data feeds better AI products. The cycle repeats.

This is autocatalysis in finance. The product of the reaction (more passive assets under management) accelerates the reaction (the shift from active to passive). Each turn of the cycle provides the energy for the next turn. No external push is required.

But a critical nuance — one that separates honest analysis from promotion: autocatalytic reactions are not infinite. In chemistry, they follow a characteristic curve called a sigmoid — slow at first (latency phase), then explosive (exponential phase), then flat (plateau), as the substrate is consumed. The substrate for MSCI’s autocatalysis is the stock of actively managed capital. Today, passive represents roughly 50% of U.S. equity fund assets. The remaining 50% is the substrate. When it shrinks to 20%, then 10%, the reaction decelerates. The sigmoid flattens.

The question for the investor is not does the autocatalysis last forever? It does not. The question is where on the sigmoid am I? For passive indexing accelerated by AI, the evidence suggests we are in the early exponential phase — the furthest possible point from the plateau. The runway is long. It is not infinite, but it does not need to be.

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IV. Shannon’s Demon — Why Volatility Itself Becomes Fuel

Claude Shannon — the father of information theory, not a financier — discovered something counterintuitive. Take a volatile asset with an expected return of zero. It goes up, it goes down, it goes nowhere. Now rebalance mechanically between that asset and cash — 50/50, rebalanced periodically. The result: a positive return extracted from nothing.

This is Shannon’s Demon. Like Maxwell’s Demon in thermodynamics, it appears to create energy from nothing. In reality, it exploits the mathematical asymmetry between losses and gains — the same asymmetry that creates the volatility tax. A 50% loss requires a 100% gain to recover. By rebalancing, you systematically sell high and buy low, mechanically, without prediction.

Shannon’s Demon is the mathematical foundation of what we call volatility harvesting in Bucket 4 of the portfolio — the systematic trimming of amplifiers that have surged, recycling paper wealth into real wealth. But it also illuminates something deeper about Freesurfers.

A Freesurfer is Shannon’s Demon inverted. Where Shannon extracts returns from volatility by trading, the Freesurfer extracts returns from structural growth by not trading. The volatility tax — the hidden cost that erodes returns on volatile assets — is minimized because the Freesurfer’s cash flows are stable (the A absorbs shocks) while the structural growth is relentless (the B accelerates recovery). The Freesurfer pays the least volatility tax of any asset class relative to how fast it compounds.

Shannon showed that information theory could extract order from noise. The Freesurfer shows that structural compounding can extract wealth from time — with no human intervention required.

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V. Mandelbrot’s Warning — Why the Terrain Is Hostile

Benoit Mandelbrot — a mathematician, not a financier — discovered that market price movements are fractal. They look the same at every scale: daily, monthly, yearly. Volatility arrives in clusters. Extreme events — the crashes that models say should happen once in ten thousand years — happen every decade.

Orthodox finance assumes returns follow a bell curve. Mandelbrot showed they follow a power law with fat tails. The implications are severe: the market is structurally more dangerous than the standard models predict. The six-sigma event that “should never happen” is built into the geometry of the market itself.

This matters for our framework because it explains why survival precedes compounding. The volatility tax, the non-ergodicity that Ole Peters formalized, the absorbing barrier of ruin — these exist because Mandelbrot was right and the bell curve was wrong. If returns were normally distributed, the volatility tax would be trivial. In a fractal market, it is lethal.

The Freesurfer is the species best adapted to Mandelbrot’s terrain. Its A provides the piton during the avalanche — stable cash flows that absorb the fat-tail event. Its B ensures the recovery does not depend on human decisions — the structural wave resumes after every storm. In a market that is wilder than it appears, the Freesurfer is the most anti-fragile instrument an investor can own.

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VI. The Reinforcing Loop — Where All the Laws Converge

In systems thinking — the discipline developed by Donella Meadows and Peter Senge — a reinforcing loop is a circular chain of cause and effect where each element amplifies the next. Unlike a single cause-and-effect arrow, a reinforcing loop sustains itself. Each turn of the cycle provides the energy for the next turn.

The Freesurfer is a reinforcing loop made of natural laws:

The wave grows (irreversibility — the Second Law)

→ Revenue grows without capital (Free B)

→ Free cash flow expands

→ Buybacks reduce share count

→ FCF per share accelerates

→ The market re-rates the stock higher

→ More capital flows into indexed products that include the stock

→ The wave grows further (autocatalysis)

→ The cycle restarts on a higher base.

Each node in this loop is governed by a different force. The irreversibility is thermodynamic. The Free B is structural. The buybacks are mechanical. The autocatalysis is chemical. The indexation is Darwinian (the S&P 500 selects winners automatically). No single law explains the Freesurfer. The convergence of laws explains it.

And this convergence is what creates the gradient. Capital flows toward the Freesurfer for the same reason heat flows toward cold — because the system is moving toward its lowest-energy, highest-efficiency state. The Freesurfer is the attractor in the system. Not because someone decided it should be, but because the physics demands it.

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VII. The Implication — What This Means for the Investor

If compounding is governed by laws rather than decisions, then the investor’s role changes fundamentally.

In a traditional portfolio, the investor is the engine. Every return depends on a human decision — what to buy, when to sell, how to allocate, when to rebalance. The portfolio is only as good as its operator.

In a Freesurfer portfolio, the investor is not the engine. The laws are. Thermodynamic irreversibility drives the wave. Autocatalysis accelerates it. The reinforcing loop sustains it. Shannon’s mathematics minimizes the volatility tax. The investor’s only job is to identify the structure — to see the gradient — and then to get out of the way.

This is a disorienting insight. We are trained to believe that investing requires constant vigilance — monitoring earnings, reading reports, adjusting positions. The physics of compounding suggests the opposite. Once the Freesurfer is identified and sized, the optimal action is inaction. The laws do the work. Time is the only remaining variable.

The question the investor must ask, perhaps once a year, is the same question a physicist would ask: are the laws still operating? Is digitalization still advancing? Are capital markets still expanding? Is passive investing still growing? If the answer is yes — and it has been yes for thirty years — then the portfolio requires nothing. Not attention. Not adjustment. Not optimization.

Only time.

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The Foundation

This post has borrowed from physics, chemistry, information theory, and systems thinking. Not to decorate a financial argument with scientific prestige, but because these disciplines describe the actual forces that drive compounding in certain rare businesses.

The hierarchy of borrowed models:

Discipline	Concept	What It Explains
Physics	The Gradient	Direction — why capital flows from high-B to zero-B
Thermodynamics	Irreversibility	Durability — why the wave cannot reverse
Chemistry	Autocatalysis	Acceleration — why the wave speeds up
Information Theory	Shannon’s Demon	Efficiency — why the Freesurfer minimizes the volatility tax
Fractal Geometry	Mandelbrot	Hostility — why survival precedes compounding
Systems Thinking	Reinforcing Loop	Architecture — how the laws converge in a single instrument

Bessembinder showed us that 4% of stocks create all the wealth. Ole Peters showed us that survival is the prerequisite for capturing it. Mandelbrot showed us why the terrain is more hostile than it appears. Shannon showed us how to extract returns from volatility. And the Freesurfer — the business where B is zero, riding an irreversible wave, inside an autocatalytic loop — is the species that obeys all these laws simultaneously.

It is not the highest-returning species. A semiconductor equipment maker like ASML can compound faster when the cycle is favorable. But the Freesurfer’s advantage was never about velocity. It is about certainty. The compounding is governed by physics, not by a CEO’s judgment. And physics does not take a sabbatical.

In the next post, we examine how to measure this certainty — through the lens of duration, and the evolution from mechanical growth (A+B) to physical growth (A×B).

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The Averaging Up Deep Dive on this post is available on Spotify and Apple Podcasts.

Watch the Video

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Related Posts:

What Chris Hohn’s Portfolio Reveals — About the Hierarchy of Tollbooths

The Freesurfer — A New Species of Compounder