In our last survey, we found that 41% of our readers’ main portfolio strategy is buying and holding individual stocks. The most common suggestion when asked how we can improve Market Sentiment was to introduce a section where you can get exposure to new companies and industries.
To do this, we are interviewing some of the top hedge fund & mutual fund managers to dive deep into their highest conviction ideas. These investors have already spent weeks and months building conviction in their idea before investing.
With that, we are interviewing Jacob Rowe this week, founder of Rogue Funds, a small hedge fund based out of North Carolina focusing on value-oriented and special situation stocks.
Quick Facts
Fund manager: Jacob Rowe
Fund: Rogue Funds
Established: Q2 2023
AUM: ~$2 million
Unaudited returns (net of fees since inception): +57% (S&P 500: +38%)
Company in focus: ASP Isotopes (NASDAQ: )
Sure thing. I started investing when I was 14 after reading 'You Can Be a Stock Market Genius' by Joel Greenblatt – that's what kicked everything off for me. Like many investors, I tried my hand at swing trading early on, but that didn't work out so well.
After graduating with a mechanical engineering degree and working in aerospace for a bit, I started building a track record portfolio in 2022. Things went well, and by May 2023, I was ready to launch the fund. While I was supposed to start with five investors, I ended up launching with just one who put in $100,000. From there, we've grown to manage a bit over $2 million today.
By focusing on distressed opportunities and spinoffs, we aim to identify companies that are undergoing significant changes and offer the potential for high returns. Our approach is characterized by a concentrated portfolio of high-conviction investments, backed by rigorous research and analysis.
We take a value-oriented approach, seeking to purchase assets at a price lower than their intrinsic value, and holding on to them until their value has been realized. Since our inception last year, the fund has returned 57.4% compared to the 38% return of the S&P 500.
I’ve always wanted to run a hedge fund. I think the fee base for performance is a lot friendlier, whereas most ETFs are just an allocation game. You just try to get a large allocation subset. With ETFs, you also have to deal with redemptions — I've never had a redemption – all my investors have stuck with me. I’m going on a year and a half now and I’ve had exactly one investor that said in a few years they might need a redemption.
Also, by running a hedge fund, I can have a personal relationship with my investors that I can’t have with ETF holders. This helps when I am making a new investment and makes it easier to convey all the risks associated with that investment.
My research process starts with several screeners, including low price-to-sales ratios and a modified version of the magic formula. Being a smaller fund gives me more flexibility, which allows me to be highly selective. I'm not looking for modest returns like one or two-baggers over five years – I'm searching for potential 20x returns.
I review thousands of companies, and over time, I've developed the ability to quickly eliminate opportunities that don’t meet my strict criteria. This efficiency comes from evaluating companies based on their valuations, growth prospects, and other key metrics that align with my investment goals.
Our highest conviction position is ASP Isotopes , a nuclear enrichment company that I believe is significantly undervalued even after its recent price appreciation. The company operates in a critical space where Russia has historically dominated the market since the '90s when they flooded it with enriched materials from decommissioned nuclear weapons. With Russia now facing U.S. sanctions, there’s a major supply gap emerging.
Congratulations on making that call. I saw you were one of the first to analyze the company in September, and it’s now up 278% in 2 months! Can you explain what the company does in simple terms? Is it still a good opportunity?
Let me break down what they do in simple terms. Take carbon for example – every carbon atom has 6 protons, but it can have different numbers of neutrons. Carbon-12 has 6 neutrons, Carbon-13 has 7, and Carbon-14 has 8. These different versions are called isotopes, and adding those extra neutrons changes the physical properties of the atom.
To see how valuable this process is, a kilo of Carbon-12 (Charcoal) only costs $1. But a kilo of Carbon-14 costs $24 million!
The challenge is that useful isotopes are incredibly rare in nature - sometimes only one in a trillion molecules. ASP Isotopes’ job is to increase the concentration of these valuable isotopes. They do this using two technologies: one that's like a super-fast centrifuge, and another that uses lasers to identify and extract specific isotopes.
Deep Dive into ASPI Technology — Corporate Overview Deck
As for the valuation, even at the current market cap of $500 million, I think we’re still in the early innings. Their biggest competitor, Centrus, won’t be producing HALEU (High-Assay Low-Enriched Uranium – The fuel used in new nuclear reactors) until 2032, and they need billions in capital expenditure. ASP only needs $100 million per plant and could be up and running by 2027. This gives them a potential five-year monopoly in a rapidly growing market.
The recent 200% jump was primarily driven by two events:
Proving their laser enrichment technology works (which was a huge technical risk that's now behind us) — Source
Securing a contract with Terra Power — Source
These developments significantly de-risked the company, but I believe the market still hasn’t fully appreciated how important eliminating the technology risk was. With revenue expected to start flowing in Q4, a potential HALEU license coming soon, and their capital-efficient approach, I think they could reach a billion-dollar valuation much sooner than most expect.
What's your hypothesis on valuing the company given that it’s pre-revenue with a $500M market cap?
At the end of the day, valuation is an estimate of future cash flows. I mean, that's what it is. Anyone who says they can put a solid number on a pre-revenue company is a liar – just outright. Unless there are already contracts in place, which doesn't always mean anything either, you should always play it safe on your valuation until that revenue starts coming in and you can actually see it.
That said, what makes ASP unique is the multiple paths to significant revenue. Once they start uranium enrichment, they could go from zero to $300 million in revenue almost overnight. Paul (the CEO) expects 70% gross margins across the board, which makes sense given what we see from other enrichers and the fact that they're the only ones who can do a lot of these isotopes right now.
Their capital efficiency is also a huge advantage – they need $100 million per plant versus billions for competitors. And much of this capex isn't even coming from them – Terra Power is paying for their HALEU facility, which significantly reduces the risk.
You also have to consider the macro backdrop where Russia's been basically monopolizing enrichment since the '90s. Now with sanctions, Western companies are scrambling for alternative suppliers. ASPI is positioned to be one of the few viable options, especially in the HALEU space where they could have a five-year head start on competition.
The recent technology validation and Terra Power contract weren't just good news – they fundamentally de-risked the business. I think the market hasn’t fully processed how significant these developments are.
The company seems to be spreading itself too thinly across various industries by trying to get into nuclear energy, medical applications, AI Silicon chips, etc.
The CEO diluted once again after repeatedly stating that they were done with dilution and would raise future funding via debt.
There was a short report by J Capital in Feb ’24
What do you make of this?
]]>This week’s guest is Brad Freeman. Brad writes Stock Market Nerd, a free newsletter focused on company deep dives, earnings coverage, and general stock market developments.
You can follow his thoughts or connect with him on Twitter.
Thanks for having me! I’m a 26-year-old who has just always had a fascination with studying different businesses. I graduated from Michigan in 2019 and got my Masters in Finance degree there last year. I worked at a small registered investment advisory firm (called Diversified Portfolios in Metro Detroit) for a while, before falling in love with turning my company research and analysis into writing. To my surprise, there was a ton of interest on Twitter and what started as having fun chatting through things with a few folks really exploded into something I’m surprised by and grateful for. I briefly wrote for Motley Fool but was determined to go out on my own to gain full control over content creation.
Since beginning to publicly track my performance in July 2022, I am up 17.11%. This is well in excess of the S&P 500’s returns over the same time frame but lags the Nasdaq by a small, shrinking margin as I’m less exposed to mega-cap tech than that benchmark is.
100% of my funds are available for single-stock investments. 5% is in cash with the other 95% in holdings. This is a byproduct of being 26, having no children, and enjoying disposable income. I’d expect my allocation to shift partially towards indexes over time as responsibilities grow and I age.
It goes back to that fascination with businesses. I love studying businesses and some are more interesting to learn and master than others. That’s what drew me to writing about Shopify as there’s so much going on under the hood of the company. What’s labeled as a web builder is so, so much more. This is generally how I pick companies to dive into. They’re usually holdings or companies I’m interested in holding at some point and that I’m excited to read about. When you’re digging through all available filings and document archives, it’s important to pick a firm you’re excited about so you can stay motivated. Fortunately, I find a wide range of sectors interesting.
My dad got me passionate about stock picking from a very young age. He taught me to read financial statements before I knew how to drive a car. I focus on disruption and innovation in the broadest sense. Within that, healthcare, advertising, FinTech, security, and the app economy are key themes in my portfolio. My largest 5 holdings are Meta, Duolingo, SoFi, Progyny, and Lululemon.
There’s no one size fits all. There will be bright people everywhere telling you how successful they’ve been within their own niche. What works for them is likely not what works for us. It’s important not to copy, but instead to explore and hone in on what works best for you. Structuring an approach that lets me sleep well at night while participating in the secular growth trends in our world is vital to me and guides my processes. “Responsible pursuit of disruptive growth” is a decent label.
My research process involves reading recent annual and quarterly filings, earnings/investor day/conference transcripts. I consume all relevant public info available. It’s important, however, to also glean insight and data from sources besides a firm’s leadership team. These teams are inherently motivated to paint a rosy picture, and vetting that view with vendors like Gartner, SensorTower, etc. can really help to be confident that the picture is actually rosy.
Red flags:
Excess management turnover.
Accounting blunders and shady off-balance-sheet items.
Excess financial leverage.
Shrinking margins over a long period of time.
Plummeting growth (gradual slowing is inevitable).
Egregious dilution and executive compensation practices.
My best investment to date has been investing in the CrowdStrike IPO a few years ago. A decision I regret is investing in the cannabis space before regulation becomes more clear. I assumed politicians were more rational and predictable than they turned out to be and my equity has been obliterated as a result. Luckily it is a tiny piece, but still, a lesson learned. Investment cases shouldn’t need a piece of legislation to pass to work. Aside from that, trusting management teams a bit more than I should have is something I’ve had to learn to avoid. I trusted some leaders pounding their chests on “macro immunity” throughout 2021 while their models were intimately tied to those macro cycles. They were wrong. I was wrong to believe them and should have trusted my background, experience, and education more than I did.
This week’s guest is Gautam Baid, Founder and Managing Partner at Stellar Wealth Partners and the author of The Joys of Compounding. Gautam is an avid reader with interests in a variety of fields.
You can follow his thoughts or connect with him on Twitter.
I am the youngest of four siblings in my family and my parents, my two elder sisters, and my elder brother reside in Kolkata, India. Prior to my relocation to the US in 2015, I served for seven years at the Mumbai, London, and Hong Kong offices of Citigroup and Deutsche Bank as Senior Analyst in their healthcare investment banking teams.
As is typically the starting story of many investors, I got lured into the stock market out of greed during the final euphoric phases of a bull market. In this case, it was the 2003-2007 one in India. I invested in Reliance Power Sector Mutual Fund in late 2007 and Ispat Steel in January 2008 as both were in “hot sectors” of the times and both had recently appreciated “sharply in a very short span of time” when I had first noticed them.
So, I just engaged in the blind extrapolation of their recent price trends without paying any attention to their valuations. Recency and vividness biases are very powerful but highly costly behavioral mistakes. Both investments crashed 70%-80% within 12-18 months of my purchase. I had successfully gained admission into the stock markets by paying my tuition fees.
Despite this bad initial experience, my curiosity and interest in the stock markets always remained very high throughout the years of my investment banking career. We have just this one life to live our dreams and I did not want to waste any further time doing something that I was not passionate about.
I was so keen for a career shift that I relocated to the US (one of my relatives who is an American citizen sponsored my green card) without any job in hand! I thought I would land a job in my desired profile within a short time since I was a CFA Charter holder and this particular degree is generally considered highly valued in the investment management industry.
Alas, life is not a bed of roses for those trying to carve their own destiny. I got rejected in my first three stock market job interviews, but I did not give up. I was adamant that I am not going to go back to my previous field of work where the presence of perverse incentives constantly led to incentive-caused bias and conflicts of interest and did not suit my personal nature, so I kept declining all investment banking job interviews calls that came my way (even though they would have had very high dollar salaries).
At the same time, I ran out of whatever little money I had brought with me from India and to take care of my living expenses in the US, I did not want to sell even a single share from my portfolio of Indian stocks as I did not want to interrupt the process of compounding. So, I took up a minimum wage job as a front desk clerk at a hotel in San Francisco where I used to work during the “graveyard shift” (for the uninitiated, this is the shift that runs from 11 pm at night to 7 am in the morning).
Even though it was a big struggle for me physically, emotionally, culturally, and intellectually, today, in hindsight, I highly value those days of my life because, for the first time since the beginning of my professional career, I got some free time for myself to read and learn. This was the phase during which my learning curve really took off from a tiny base.
Little did I realize at the time that I was laying down the strong building blocks for compounding in my life. The pace of work from late night to early morning at the hotel was pretty slow and I made full use of the free time to read every single article published on blogs like Safal Niveshak, Fundoo Professor, JanavWordpress, Base Hit Investing, and Microcap Club among others. The passionate pursuit of lifelong learning had begun.
All of us who discover our calling in life get to do so through a defining moment, event, or experience. Let me share mine with you.
During a stormy night in San Francisco in mid-2016, I was at home (I used to rent and live in a single room as a paying guest. I was trying to save every single dime that I could during this phase) reading the 2012 edition of Tap Dancing to Work, a compilation of articles on Warren Buffett published by Fortune between 1966 and 2012. Immediately after finishing the book, I came to know that there was a more recent 2013 edition of it which contained one additional chapter.
I did not want to spend money on buying the newer version of the book, so I went to the local bus stand, got badly drenched (even while using an umbrella) while waiting for over an hour in the midst of the storm, and traveled all the way to a distant Barnes and Noble bookstore to read the final chapter of the book inside the store and save a few dollars (I had a monthly bus pass at the time, so the bus ride did not cost me anything).
That night I realized that I had finally discovered my calling in life. It is difficult to express in words the sheer intensity of the emotions, thrill, joy, and excitement that I experienced. I could not sleep that entire night. Only the fortunate few who discover their true passion in life will be able to relate to what I am trying to convey.
Luck, chance, serendipity, and randomness have always played a big role in various aspects of my life to date. One fine night in November 2016 while working at the hotel, I randomly clicked on the “quick-apply” button on a LinkedIn job application during my routine online job search.
I unexpectedly received an interview call for the job and that too for a senior role in an investment firm even though I had zero formal work experience in the stock market! And this was the phase in my life during which I was about to experience the power of compounding knowledge in action.
All those hundreds of hours I had spent during the previous year at the hotel reading the blog articles had built a strong intellectual foundation for me in investing (this is what I was lacking during my first three stock market job interviews in the US) and I excelled in all the three rounds of my job interview (body language derives from self-confidence and self-confidence, in turn, derives from knowledge).
I was offered the role of Portfolio Manager of Global Equity Strategy and it was a dream come true for me. During my stint of 4.5 years at Summit Global Investments when I was tracking global markets, India clearly stood out to me with regards to the many high-growth investment opportunities in its stock market. In July 2021, I left my job to set up my India Fund in the US – Stellar Wealth Partners India Fund – to bring the India opportunity to investors in the US. The Fund went live in October 2022. Earlier this year, I also launched Stellar Wealth PMS for NRIs and Indian citizens. Both the India Fund and the PMS are modeled after the Buffett Partnership fee structure and invest in listed equities in India with a long-term, fundamental, and value-oriented approach.
My personal investment philosophy has evolved over the years with time and experience in the markets. Initially, it was restricted only to secular growth stocks at reasonable to slightly expensive valuations.
But now, it covers multiple areas of the investment universe like spinoffs, merger arbitrage, cyclicals, deep value, and management change special situations. In a nutshell, I now invest wherever I find “mispricing” of value and a highly favorable risk-return trade-off.
Another key area of my evolution as an investor has been in the understanding of human nature and the significant role of incentives in governing individual behavior. Always think about the possible incentives involved in any situation before making your final decision.
Between low-quality businesses at a cheap valuation and high-quality businesses at a fair valuation, my preference is always for the latter since I can have meaningful allocations of my portfolio in them with peace of mind and higher stress-adjusted returns. High-quality businesses typically demonstrate sustainable competitive advantages, known in investing parlance as “moats”.
Strong brands with “share of mind” which confer pricing power, network effects, high switching costs, a collection of patents (as opposed to relying on only one or two), favorable access to a strategic raw material resource or proprietary technology, and government regulation which prevents easy entry – these can confer a strong competitive advantage which in turn enables excess returns on invested capital over the cost of capital for long periods of time (also known as the Competitive Advantage Period/CAP).
Growing firms with high Return on Invested Capital (ROIC), opportunities for reinvestment at those high ROICs, and longer CAPs are more valuable in terms of net present value.
One of the most highly underappreciated sources of sustainable and difficult-to-replicate competitive advantage is “culture”, best epitomized by companies like Berkshire Hathaway, Amazon, Costco, Piramal Enterprises, and HDFC Bank, to name a few.
To illustrate the critical importance of culture just consider this: From 1957 to 1969, Warren Buffett did not mention the word “culture” even once in his annual letters. Since 1970, he has mentioned the word more than thirty times.
Some of my favorite books on competitive advantage are The Little Book That Builds Wealth by Pat Dorsey, Understanding Michael Porter by Joan Magretta, and Different by Youngme Moon. For learning about how to evaluate the culture of an organization, I recommend reading A Bank for the Buck: The Story of HDFC Bank by Tamal Bandopadhaya, both the editions of Intelligent Fanatics by Sean Iddings and Ian Cassell, and Investing Between the Lines by L.J. Rittenhouse.
The answer lies in your question itself. It is “time in the market” and not timing the market that drives wealth creation. If I had gotten scared and exited the market during the periodic phases in 2013, 2015, 2016, and 2020 when my portfolio value fell 30%-35% (with many individual stocks down 40%-50%), then I would have completely missed out on the big bull market years of 2014, 2017, and 2020 which helped me achieve financial independence early in life. The words of Peter Lynch on this subject are noteworthy:
“Whatever methods you use to pick stocks, your success will depend on your ability to ignore the worries of the world long enough to allow your stocks to succeed. No matter how intelligent you are, it isn’t the head but the stomach that will determine your fate.”
This week’s guest is Matthew Tuttle, CEO & CIO at Tuttle Capital Management. Matthew has been managing money since the mid-80s and now oversees 8 different ETFs with $350M+ in AUM. Tuttle is famous for going against trends and was successful with his anti-ARK ETF returning 100% in just 5 months. He is hoping to replicate these results with the recent launch of the Inverse Cramer ETF.
You can follow his thoughts or connect with him on Twitter.
I've been managing my own money since the mid-80s. I started on Wall Street in 1991 and worked for a bunch of different brokerage firms, insurance companies, and in 2003, ended up forming my own wealth management firm.
In 2012, other wealth managers started asking us if we could manage money for them and we formed a money management firm. Finally, in 2015 we started launching ETFs and have been doing that pretty much ever since. Right now we manage about $350 million in eight ETFs and got a bunch of other things we're planning on launching over the next couple of months.
One of the things we do is to help other people who have great ideas launch ETFs. There are 5 that we are helping out on and in 4 of them, I am the sub-advisor.
We're always looking to partner with other investment managers who have interesting ideas. So we have always got a bunch of that stuff on the drawing board.
I've been trading since the mid-80s and I spend a lot of time trading my own account. I have got probably 10% of my portfolio on SJIM, which is our inverse Jim Cramer ETF, and the rest of the portfolio I actively trade.
Right now, I am sitting on a lot of cash and some small positions. What I've been doing lately is buying gold miners, shorting REITs, and shorting regional banks. We launched SARK, which is the inverse Cathy Wood (ARK), which we're not involved with anymore, but I actively trade in and out of that.
Overall, I would say that I have around 10-20% of my portfolio in our ETFs, and the rest I actively trade.
It very much depends on the environment — I'm more comfortable as a short-term investor. But you know, if we get a period where the markets are ramping up, I just buy stuff and sit on it.
Right now I am a short-term investor. I prefer counter-trend types of methodologies of buying weakness and selling strength. But again, if we get into a trending market, I will go back to being a trend follower. It just really depends on what's going on in the marketplace.
Yes. It's all individual positions. I just sold all my gold miners recently because I didn't think that they should be going up that much. The only thing I had is I've got a bunch of puts on some regional banks and some REITs. I am long few companies. Overall, I've got about 12 positions right now.
The strategy has obviously changed a lot over time. When I started out in the 80s, companies were getting taken over. Then the strategy was pretty simple — You hear a rumor, and you know, you buy it, and then you wake up the next morning and find out it’s being taken over and it’s up 40%.
One of the best learning experiences I had was when that changed in the 90s. I was still trying to do what worked in the 80s and ended up losing a lot of money. My biggest loss was in 1991, when I was still trying to buy things on takeover, speculation, and the whole takeover boom was over. I then realized, alright, I gotta get smarter about what I'm doing. And from there, it's just been a constant and continual learning process.
A quick note from MS — We first did the interview on April 12th and Matthew mentioned that he was still skeptical of regional banks and was short Metropolitan Bank ($MCB). As of today, the stock was down 20%! We reconnected with Matthew and here are his current positions.
I am still short a couple of regional banks, but I think the easy money is now over and you have to be very cautious on these trades.
]]>Welcome to investor interview #7. I’m putting together this series to bring you diverse experiences and perspectives from other investors.
This week’s guest is James Bulltard. James has vast experience building tools to study options trades and selling puts using the strategies he develops. He writes “The Running of the Bulltards” on Substack where he shares his insights and data. You can follow his thoughts here and connect with him on Twitter as well.
We got to ask him about:
His journey in the options trading world and performance
How he shares his insights and picks
Why options flow is important, even for fundamental/long-term investors
How he allocates his portfolio
Why he disagrees that price action is based on fundamentals
Also, for premium subscribers:
What are James’ favorite ideas and themes on the radar right now?
What can fundamental investors learn from technical analysis?
What does his research process look like?
What red flags does he look for in a company?
Subscribe here for full access to all paid posts and investor interviews:
I worked as a trader at a vol firm in Chicago right out of school, and spent years working in various roles in New York and Miami afterward. Afterward, I ended up managing a family office for a previous client of a firm I worked for. I did that up until my retirement in 2022 to spend more time at home with the birth of our second kid.
I wrote that thread you are referencing in March after 9 months of publishing all my work on my substack. When you post things online, it’s hard for people to believe you until you show them. That thread has all 9 months of my postings where I outperformed the S&P by 90% in a fairly horrible market. For me, it all began in June 2022, when I saw one of the oddest options trades I’ve ever seen be placed. I began writing on Substack that day because I couldn’t rant on Twitter with character limits and it just took off when Sierra Wireless was acquired a couple of weeks later. That trade I noted was the first in a series of giving people insights into the real inner workings of the market. My Substack has turned into one of the fastest growing ones on their platform: my objective is to take the millions of options placed daily, sort them into a curated list of the most unusual ones every day, and input them into my database to model trends in the hopes of finding a direction to trade.
I do not make “picks” but I do post my open book every day on my Substack just in an effort to be open and transparent about what I’m doing for those who care, but the reality is that most are on my Substack for a cheap way to obtain institutional data. Retail investors typically aren’t going to pay $2,000/mo for a Bloomberg Terminal to have access to a platform where you can gather data. I took a problem I saw in that all the existing platforms that offer options data offer too much and most of it is not important. I try to cut out the noise and share the best data for a low fee. For me, I do this work anyways for my own daily homework to see what tomorrow’s game plan is. I’m just publishing it now for others who want the same data for their own discovery process.
They’re giving a live look at huge bets institutions place. I know long-term investors like looking at 13fs to see who is doing what, but that is backward-looking data. By the time investors see it, the funds have already made a fortune – but the options market is live. I’ve called out so many moves in advance whether it be Pinterest before the massive Elliott Management stake was disclosed or even that recent 30% move in Alibaba. The option flows show what the big funds are doing and when you see one ticker attacked over and over, you can tell something is brewing, the what isn’t my concern.
Having my custom database allows me to share with readers every day not only a list of the day odd action, but also share trends over multiple timeframes ie weeks, months,etc. Something like this is simply just taking all the unusual trades I input into my database to give me a bull/bear score which is just a net of all the trades. This gives me an idea of pockets of emerging strength which allows me as a trader to attack areas of strength as they are gaining steam. What you can see below is a screenshot I took of the trends I am seeing over the past month (the timeframe is on the left). You can see the total amount of unusual action I’ve noted and the net of them. I don’t know anyone who uses anything like this – it is all my own modeling after years of working with this data and wanting something customized for my own needs:
As you can see above something like SLV has been trending hard for the past month, and if you look Silver has had quite a run, I can then search my database ticker by ticker to see all the trades that my parameters caught and for SLV this is what it shows. This allows me to see pockets of demand for the equity from institutions, and it helps guide me in my decision-making in terms of what levels I want to sell puts at.
When I retired, obviously protecting my assets was the number one objective. I am younger so I have a long time to go. Obviously, I could go back to work whenever, but that isn’t the goal – so the first thing I did was to invest the bulk of my capital into some NNN properties. I wanted a really hands-free experience, I know lots of investors prefer single-family or multifamily, but NNN offers lower returns in return for longer-term corporate-backed leases and a mostly hands-off experience. I would say probably 60% of my portfolio is commercial real estate. I would say another 30% is in various equities and private investments, I do not own any passive funds, and lastly, 10% or so is in my trading book that I focus on every day.
I got into investing at maybe 14 years old. I had an older cousin who was my big brother so to speak, he was a stockbroker back in those days and he would always work with me when he was in town visiting. He helped me buy my first stocks. He helped me learn a lot about the market. I was always fascinated with his nice cars and as a little boy who loved cars, I wanted to do whatever it took to get something like that so I listened intently to everything he would teach me.
What’s my investment strategy? If I had to explain it, I would say it is basically taking all the available data known to investors using options flow, along with technical analysis to model direction, and then selling puts into strength in an effort to generate income. That sounds like a lot but I sell puts because I always want to enter equities lower. Why would you pay full price ever for a stock? Even Warren Buffett sells puts to enter trades. The way I model data is simply an effort to find equities that institutions are buying and then selling puts lower, to try and ride the wave so to speak.
As for the second part, there are many comparables in the trading world that blow away Warren Buffett, I wouldn’t call it the “day trading world”. Look at guys like Jim Simons, Ken Griffin, Steven Cohen, and many more. Their returns are amazing but Buffett has definitely done it for longer so he is more prominent. But there are plenty more active managers who have significantly higher returns, though not everyone has access to capital like Warren Buffett.
What drives a stock price is the amount of buying going on, that’s it. Look at something like NVDA – fundamentally it doesn’t make sense and a lot of short sellers have learned a hard lesson this year trying to use fundamentals to justify their trade. Stocks don’t have to make sense short term, if they did, we would have an efficient market, but we don’t. We have a market driven by trends in the short term. If the fundamentals of the company you’re looking at are as good as you think they are, these funds and their armies of number crunchers will have established a position long before retail at home is all I’m saying. In the end, these funds and their positioning are what drive markets and my objective is trying to align my positioning with them.
As a trader, that isn’t something I think about. Trends are constantly changing and new sectors of strength are always emerging. There is always a bull market somewhere and my focus is on finding and utilizing all the data that is out there. In terms of my long-term investments and the themes I’m interested in…
]]>This week’s guest is Marco Pabst, Group Chief Investment Officer at Arbion. Marco has more than 30 years of experience in investing and his team currently manages several billion dollars across equities, fixed income, hedge funds, and private investments. You can follow his thoughts or connect with him on Twitter or Linkedin.
I started as an equity research analyst on the sell-side, working for a large German private bank covering small and midcaps, and then focused on European software companies, working for UBS in the late 1990s. After the dot-com bubble, I moved to the “buy-side” and joined a multi-family office in London in 2004.
We subsequently grew this business to just under $5bn and then sold it to Swiss private bank UBP - Union Bancaire Privee - in 2018. UBP currently manages around CHF 140bn ($156bn) globally for wealthy clients.
However, over time I felt that our clients preferred working under a multi-family office setup and, therefore, I left the bank last year, having been their CIO in London and Chairman of the global equity committee of the bank.
At Arbion with a team of 30, we manage several billion dollars across equities, fixed income, hedge funds, and private investments for around 200 families worldwide. On the liquid side, our core business is discretionary multi-asset portfolios but we also run tailored fixed-income and equity allocations for clients. In terms of structures, we typically run managed accounts but we also have a range of funds.
As I run or oversee most of Arbion’s strategies, logically all my liquid funds are in investments that we also own for clients. If I identify what I believe could be an interesting idea for clients, why would I not also invest my own money into it? So, yes, all my skin is in the game.
As a student, I started trading stocks and warrants of Japanese companies at the tail end of the Japanese equity bubble in the early 1990s as they tended to be mispriced, trading in Europe versus their home market. I then focused on European deep-value names before moving into what we call growth stocks today. Alongside that, in macro terms, I was in the market during the 1994 bond crash, LTCM, the Russian, the Asian crisis, and everything that followed.
So whilst my primary interest is in equities and credit, I also spend a fair amount of time looking at the bigger picture. This blend of macro and micro is what I find the most interesting, where everything comes together, not always but most of the time. As most people just focus on one particular area, they often ignore signals from others. Ignorance is every investor’s worst enemy.
Leaving the macro part aside, and whilst I don’t mind the occasional trade, I would consider myself a medium to long-term investor. If I can find the right business to invest in, ideally I would like to own it for as long as possible.
There are many things that I have learned over time, and almost all of them are associated with mistakes I made. This led to an investment process that has elements of risk management at every single step even if it is not explicitly called risk management.
As a result of this negative selection process, there are many areas and strategies that I don’t spend much time on anymore, as the odds of success in them, at least from my perspective, are stacked against me.
I tend to ignore most things that are exotic, illiquid, looking too cheap, or overly complex. Similarly, I would not spend much time on industries that are highly commoditized, very complex to evaluate, extremely capital-intensive, have no particular edge, or have not shown any attractive sector economics historically. Typically, this includes mining, airlines, football clubs, biotech, most oil companies, banks, and some others.
This has narrowed my focus towards companies with defendable strong business models, that are not too cyclical, generate high returns on capital, are run by strong and incentivized management, and are not overly leveraged. Therefore, stable non-cyclical compounders are the ideal bedrock for a great long-term portfolio. Whatever the macro worry might be, the best names also tend to bounce back the fastest.
This led to another important learning which is that time in the market is much more important than trying to time the market, which is what many people appear to be attempting primarily. However, I would be lying if I said we don’t also look at timing aspects. There are pros and cons to it but I admit, that less is more sometimes.
I strongly believe that there is no growth without value and no value without growth. When I look at many companies today, including large tech businesses, I would find it hard to categorize them - hence I tend to skip this whole debate.
I believe most people who own stocks today are not very familiar with them. I am convinced that the average investor spends more time choosing a $3,000 TV set than a $50,000 stock investment. Hence, I am convinced that someone who reads the company presentation from the investor relations section is already ahead of 75% of his co-investors in that company. Annual and quarterly reports contain a lot of interesting details that help build a good mental picture of the business in question and this accumulated knowledge then leads to a much steadier hand, holding this investment hopefully for the long term. From that base of knowledge, it is then easy to expand into the broader sector and other competitors. As a result, the time I spend reading it is increasing every month.
The size and scope of our investment universe have not massively changed over the years. There are just not that many good companies out there that are worth considering for investment. Hence, the process is more gradual now as we keep processing new information to inform an existing view.
The fundamental selection process is fairly straightforward and not too unique: we look for not-too-cyclical businesses with high and sustainable returns on investment and a strong position in their core markets. In addition, management and balance sheet quality are also important. I am not a fan of too much leverage, i.e. anything higher than 3x EBITDA typically. So far so good.
What I then like to do is to look at the whole capital structure and see if there is any other interesting angle. For instance, in some cases, I start investing via selling out-of-the-money put options because implied volatility was temporarily very high for the stock for some reason. In several cases, this is how an investment started – with a short put that typically yielded more than 20-25% annualized.
Sometimes, we also approach an investment from the bond side only. Spreads could be attractive for some reason or occasionally we also find the odd busted convertible that pays an interesting yield and has the call option upside. As always, there are many ways to skin a cat.
Looking at the whole capital structure is obviously generally quite informative as it reveals what other markets are thinking about a company. Very often, one can find cases where the stock price is under pressure but credit is trading fine – a clear divergence. Conversely, a weak picture on the credit side but unfazed equity would be a major red flag in my books.
Aggressive accounting or accounting changes in that direction are also always a precursor for exiting a position. Frequent management changes are another.
On the other hand, insider purchases are certainly a positive as are conservative accounting methods and incentivized management. A strong R&D profile in businesses where this is important, strong cash conversion, and sector leadership are also key elements we are looking at.
Once we have identified our target investments, I like adding a somewhat contrarian angle to it and maybe this is where an element of market timing is entering the equation too. I like entering such positions when they are somewhat out of favor (after a profit warning or another otherwise short-term issue). Equally, I am rather a seller when something is in unusually high demand. This general approach is not limited to stocks.
A good example was Brexit Day – the day after the 23rd June 2016 Brexit referendum. The result of the vote was unexpected and domestic equities crashed alongside the currency. We were heavy buyers of these names on that day and the day after when many of them lost 30% and more during the panic selling. Buying when others were indiscriminately selling for little fundamental reason turned out to be an exceptionally profitable opportunity for us.
Two other more recent examples maybe to highlight this approach outside direct equities: In the third quarter of 2019, equity markets were riding high whilst the yield curve was inverting, signaling some potential trouble ahead. Because of the bullish equity environment, implied volatility was low, so I hedged the majority of our equity holdings at little running cost. The insurance premium simply was so low that it almost didn’t matter, creating a very asymmetric potential return outcome. Then, as the COVID pandemic broke out, we were almost fully hedged and performance benefitted accordingly.
Another important allocation decision and similarly contrarian was when I drastically reduced fixed-income holdings in the course of 2021. Yields at the time were still very low but started rising and the risk of increasing inflation and more hawkish central banks was on the horizon. This simply created an environment for investment-grade bonds where there was little upside and a lot of downside. The rest is history. After the bond crash of last year, we have built back a lot of exposure in the space as the risk/reward has completely changed: bonds are now a very viable alternative for investors vis-a-vis equities and they also have a hedging value again - providing protection when risk markets decline.
I believe active management still plays a very important role in asset allocation, i.e. deciding what areas in the market a client should be focusing on and developing appropriate strategies for it. Risk management is also critical in that context, i.e. managing net exposures in equities, managing duration, and credit risk within fixed income as well as currency overlays.
Passive strategies and index funds play an important role in our portfolios, especially in equities, when we are just looking for ways to get liquid exposure to broader sectors or geographies without trying to pick the best companies.
Within fixed income though there is still tremendous value in active strategies and “bond-picking” as indices are almost always tilted to the fundamentally worst, i.e. most-indebted, issuers. Here, one can add substantial value for clients. Also, in contrast to funds/ETFs where one is typically exposed to more or less constant duration, I can easily design fixed maturity portfolios that match a certain event in the future and run down into cash over time.
Fee compression has been an issue across the board, from ETFs to hedge funds with discretionary strategies sitting somewhere in the middle. I believe this trend is unlikely to stop anytime soon although we are approaching some kind of floor, certainly for the more active strategies.
There simply is a certain cost associated with a very tailored strategy that requires constant attention by professionals and this needs to be reflected in a fair price. At current levels, I don’t think that the price is very high. For commoditized strategies which can effectively be run by a machine, costs will continue to be kept under pressure by competition.
More generally speaking, the broader answer is of course, that a larger scale is required. The threshold to operate a financially sustainable business in terms of minimum AUM today is several times higher than what it was 20 years ago.
More thematically, the areas I spend a lot of time on now are:
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Of Dollars and Data is a great example of how you can always go deeper into financial topics with a consistent vision without caving to the pressure of novelty. Nick Maggiulli writes about how even God can’t beat Dollar Cost Averaging, Portfolio allocation, how investors should think about money, what risk isn’t, and his trademark idea to “Just Keep Buying” in great detail and from different angles.
Nick has built a voice with his writing that people trust and look to, not only to understand what is going on in the market but also to think and rethink their own relationship with money. One of the reasons is that his articles are based on solid data and historical research, and he does not make claims that he can’t back up. But the more important aspect is the human connection because of his personal stories that illustrate how his thinking about money has changed with time.
Let’s dive into the interview to unpack his approach toward money. In this issue, we cover:
Why you should optimize your income over investments at the beginning.
Why people try to beat the market with statistically impossible strategies.
When and how to select a financial advisor.
How to filter out noise and fake news related to investing.
Which is more important: Asset allocation or asset selection?
Why maxing out your 401k is over-rated – and what the most under-rated investing advice is.
Let’s get started.
MS: Can you tell me a bit about your personal journey in life and investing? How have your thoughts about money and investing changed over the years?
Growing up, my parents didn’t have much money. Though I never went hungry, I also knew that there was much to go around. As a result of this, my early mindset around money was one of scarcity. Even through college I only ordered off the dollar menu at a fast food restaurant, though I could afford pricier items.
Over time though, this changed. I learned more about personal finance and investing in college and in the years after. As a result, I began to see money as a tool we could use to change our lives. Today I think investing is incredibly important, but its importance becomes more amplified as you have more money (typically later in life). For most people, their career and their income will be the dominant factor in their early financial success, so I try to get people to focus on that more instead of worrying too much about their investments.
MS: Unlike the usual brand of financial content which is very anecdotal, you have a focus on historical analysis and using data to back up your arguments. You have developed your own niche as a result. What motivated you to start writing about investing and how was your approach shaped?
I’ve always had a passion for investing and I also enjoy programming/data science. I saw a potential fit between the two and thought it would be fun to start writing about finance and economics for fun. I eventually found my niche in the investment space and haven’t looked back.
My approach was shaped by questioning a lot of what we hear (which usually isn’t backed by data). So I simply ask: Is that true? Then go about trying to find out. Many times this leads to nowhere, but once in a while I find a surprising conclusion.
(MS: One great example of testing assumptions to find the truth – Should you invest in stocks lump-sum or DCA? What about other assets like Bitcoin? This article covers it all.)
MS: Who are some financial writers who have had an influence on your style?
Early on it was William Bernstein and Jason Zweig, but over the years I’ve become far more influenced by Morgan Housel. Bernstein taught me the importance of analytics and Zweig the importance of human psychology, but Housel taught me the importance of storytelling. As much as analytics matter, we are still humans at the end of the day. And humans are captivated by stories. So if you want your message to spread into the world, you need a good story.
MS: Your book “Just Keep Buying” is a comprehensive take on all aspects of investing – From the basics of investing to retirement and tax planning. There are some consistent themes in both your book and your blog posts.
For example, you are a staunch advocate of investing in low-cost index funds for most individual investors, and you have written multiple articles about why timing the market and picking stocks are statistically impossible strategies. Why do investors still resort to these strategies? Is it greed? Is it a hope that “this time is different?”? Or do they assume that any chance however small is probably reserved for them?
I think the reason most people try to time the market is based on both fear and greed. Selling at the first sign of trouble is fear-based, while “buying the dip” is greed-based. There is no evidence that either strategy works consistently, but they do work at times. I think this distinction is important, because this is why people market time.
If I told you that no one could ever successfully call a top or bottom, I’d be lying. People have done this before and they will do it again. However, I don't think anyone can do this on a consistent basis. That’s where market timers fail. They may be right now, but they will be wrong later.
And in being wrong they could end up missing out on a lot. My favorite example of this was all the people who sold in March 2020 only to see the market hit new all-time highs in less than 6 months. Predicting the future is hard, which is why I don’t try to do it.
MS: I like the book’s emphasis on how fulfillment, not money, should be the thing to optimize for. Why is it so hard to make this switch for people on both ends of the spectrum (net savers and net spenders)? How can they design a place for investing in their life to optimize for fulfillment rather than investment returns?
I think people have to spend a lot of time analyzing their big decisions in life to figure out what is really motivating them. Once you know that, then you can ask yourself whether it makes sense to continue those behaviors.
For example, we always hear the cliche example of the successful person who works so much that they miss their children growing up. It starts with them skipping out on a sports game or a dance recital and never stops after that. My question is: why is that person working so much? The obvious answer is money, but given how successful they are, money probably isn’t the actual reason, it’s something else.
I think by digging deep inside yourself, you can go through the same exercise. Ask yourself why you do the things you do. Why do you work in the job you work? Why this field? Why did you choose this life partner? Etc. The goal is to know yourself and then solve life from there. That’s how you maximize fulfillment.
(MS: Check out Nick’s piece on Why you shouldn’t optimize your life.)
MS: The book provides many rules of thumb and heuristics that can be used right away, like the 2x rule. One trick I found very useful was how restricting choices artificially can actually result in more peace of mind:
“Holding US stocks for three decades is much harder emotionally than paying off a mortgage. When you have a home, you don’t get the price quoted to you daily, and you probably won’t ever see its value cut in half.”
– Nick Maggiulli
Environment design is seldom discussed when it comes to investing. How can investors design their environment to reduce stress in investing?
The best environmental design I know of is partial ignorance—don’t care too much. For example, though I write about money all the time, I rarely think about it in my personal life. I understand that this is a privileged thing to say, but I’m not even a millionaire. I’m just someone who is trying to enjoy life and helping people with their money along the way.
MS: Your first article was about how hedge funds get rich where you discussed the role of fees, and how funds seldom beat the market. In such a world, what is the role of investment advisors and money managers? What should investors look for?
When it comes to hiring a wealth manager, you should focus on their approach to financial planning, how they make you feel, and their competence. These are all things that the wealth manager has full control of and things that you can easily analyze. No one can control what the market does, so find someone that adds value beyond the portfolio.
(MS: Read more at “When should you hire a financial advisor?”)
MS: Is asset allocation more important than asset selection? Why?
David Swensen, the late famed investment manager, once said that your portfolio returns come down to three things: asset allocation, market timing, and security selection. And, after reviewing the data, asset allocation represents about 90% of the variability in returns.
So, to answer your question, asset allocation is far more important than asset selection for the vast majority of people. Deciding what risk assets to own and in what proportions will have a bigger impact on your portfolio than just about anything else. Of course, this isn’t an easy task, which is why I tell people to focus on broad diversification no matter what they do.
MS: What are your thoughts on a barbell approach to investing?
I see why people like this approach, but I don’t favor it for behavioral reasons. The barbell approach has you holding lots of low-risk assets (i.e. cash) and lots of high-risk assets (i.e. crypto, single stocks, etc.) at the same time. Unfortunately, I think this approach leads to a higher probability of bad investor behavior when times get tough. I think 2022 is a great example of this where many high-risk assets are down 50% or more, while the overall market is only down 20%.
It’s not that the barbell approach couldn’t work, but I think many people would have a hard time sticking to it over long periods of time. Their higher chance of bailing when times get tough makes it a harder strategy to follow than my “Just Keep Buying” indexing approach.
MS: You have written about the existential risk in stock picking – That you can never know for sure whether you have mastered the skill or whether luck worked in your favor. Why is that important? Someone who thinks they can follow in the footsteps of their investing heroes (like Buffett or Lynch or (gulp) Sam Bankman-Fried) might think that they need to get it right only once. Is that a reasonable way to think about risk?
You don’t need to be right only once to be a great stock picker. You need to be right 6 out 10 times and you have to do that consistently over many decades to be the next Buffett, Lynch, etc.
But do you really need that level of returns to be financially successful? I don’t think so. Most people need far less to live an amazing life. Unless you are trying to be remembered as the next Buffett, there’s no point in trying to be like him (or anyone else).
Once again I would analyze the motivations behind why you want to be a stock picker and determine whether those motivations make sense.
MS: How do you think financial media and the abundance of investing resources have affected investor psychology? You have written about how anecdotal stories are sensationalized to grab eyeballs – Can you suggest a simple framework for investors to filter through the noise and assess the validity of financial news and stories in social media?
Ask yourself: is this going to matter 20 years from now? If the answer is no, then maybe you shouldn’t be paying attention to it. This is why I almost never follow macro and don’t think most people should either. It’s mostly wasted time and energy.
MS: The market has always been influenced by perception, but it looks like the last 2-3 years were dominated by perception-based assets. You have written several articles about crypto, the memestock phenomena, etc. as they were happening. Why are narrative-driven assets so hot all of a sudden, and will they become a mainstay?
There are basically two ways in which assets increase in value: fundamentals (increased earnings, value, etc.) and flows (people are bidding them up). You can make money following flows, but it is a difficult game to play especially over long periods of time.
It’s difficult to say which assets will become mainstays based on flows because preferences change over time. What’s hot now may fall out of favor and vice versa. It’s kind of like fashion or music popularity, it varies based on lots of things.
This is why I recommend investing most of your portfolio in income-producing assets. These assets should follow fundamentals in the long run so you can worry less about flows.
MS: A couple of questions from a devil’s advocate POV. Aren’t equities perception-based assets themselves?
Once a stock is out in the market, what tethers it to a company’s performance? Is it just the regulatory framework and institutional infrastructure?
Does that mean regulation can make crypto mainstream like equities?
Well, technically, every asset is based on what other people are willing to pay for it. So while this can vary from fundamentals (i.e earnings and earnings growth) in the short run, it should converge in the long run.
Regulation might make crypto more mainstream, but there will also need to be other use cases for it other than speculation.
MS: A lot of the debate around crypto has been the idea behind the asset. But are exchanges and the infrastructure the bottleneck that nobody is thinking about?
FTX and several other exchanges were not crypto themselves, they were the gateway to access the crypto world, and that was the weak link. When we do a historical analysis of equity markets, are we over-rating the robustness of the equity market infrastructure? They are only a few hundred years old after all.
Equity infrastructure had at least a few hundred years to evolve, which is a feature, not a bug. Crypto tried to go mainstream in 10 years without any such process and we are seeing the results of that today.
I find it ironic that the group of people who support a system based on not trusting others ended up putting so much trust into so few individuals. I never hold my crypto on an exchange and you shouldn’t either.
MS: Your article on viaticals blew my mind – arbitraging death to make money is the most metal idea in finance I’ve come across. Are there any other such wild strategies that people don’t know about?
There definitely are but access tends to be limited (based on bankroll). I also wouldn’t recommend any of these approaches for most retail investors as they may require more expertise. This could include things like litigation finance (financing lawsuits) and royalty investing.
MS: Your articles on your personal experiences and how they influenced your thinking about money and life are some of my favorites - For example, Regrets, It’s never too late to change, and Losing more than a bet.
Personal experience has a huge impact on how people think about money. Sometimes it can have the opposite effect, where people generalize unique cases they know about (like a successful entrepreneur or a lottery winner, without taking survivorship bias into account) and apply it to themselves. What’s a healthy way to incorporate personal experiences into the way you think about money and life, by placing them in the appropriate context?
Great question. I think the best way to incorporate personal experience without getting biased is to also consider what the data shows. I don’t think data is a silver bullet, but if your experience doesn’t fit the typical outcome then you might want to adjust your beliefs accordingly. Of course, there will always be exceptions to this, so use your judgment accordingly.
(MS: Check out Nick’s article on Why Personal Finance has become a bit too personal)
MS: Apart from backing your articles with historical data, you also open-source your analysis programs written in R and share the links. If someone wants to adopt a data-driven approach to testing their own ideas and assumptions as an individual investor, where can people start? Do you have any suggestions about the road to becoming a data-driven investor?
I think everyone should start where they are comfortable and work from there. If that means Excel, that’s fine. I suggest learning how to do financial math (I.e. How to move money through time, How to calculate drawdowns, etc.). There’s lots of value in understanding the basics very well because you can always fall back on them.
MS: What is one idea you discovered in the last few years that blew your mind and changed the way you think about something?
The book Die with Zero. Many of us are over-saving and we probably don’t realize it. Better to spend more of your money while you can then die the richest person in the graveyard. It completely changed how I viewed spending money and I would recommend it to anyone.
MS: What is the most over-rated idea in investing?
For those in the U.S., it’s maxing out their 401(k). Think there is far more to life than saving money in retirement and think the tax benefits aren’t as large as many believe. Of course I support saving for retirement, but I think there are probably too many people maxing that don’t need to be. (MS: Check out Nick’s article on Why you shouldn’t max out your 401k for a detailed explanation)
MS: What is the most underrated idea in investing?
Return on hassle. The basic idea is that higher returns aren’t always better if you have to spend more time/energy to get them. For example, there are a lot of real estate investors who have “passive” income that isn’t quite so passive. Dollars and cents matter, but HOW you earn those dollars and cents matter too.
MS: Is there a book, podcast, a blog, or anything else - that you would like to leave as a recommendation to readers?
Check out Money With Katie and Jack Raines. My two favorite relatively newer bloggers in the finance world.
MS: Do you have any idea or suggestion that our readers can take away to become more well-informed investors, or even make investing a little more enjoyable and stress-free?
I’d assume most of the people reading this are doing relatively well financially. Therefore, I think their problem won’t be growing their wealth over time, but how to spend their wealth to live a fulfilling life. This isn’t as easy as it sounds. You have to work at it actively.
So I’d recommend spending time on that. Be purposeful. Figure out what you really want. Life becomes much easier after that. Thank you for reading.
Thank you so much for reading and being a continued supporter of Market Sentiment! If you enjoyed this piece, please hit the like button and tell a friend about us. You can even forward this paywalled content to a few friends for free :)
But first head over to Of Dollars and Data to read more of Nick’s writing, and check out his book “Just Keep Buying” on Amazon. It’s a great book to think about investing holistically, whether you are a beginner or a seasoned investor.
Were there any topics you wanted to know more about? Whom do you want me to interview next? Let me know in the comments!
Disclaimer: I am not a financial advisor. Please do your own research before investing.
All views are Nick Maggiulli’s alone and do not reflect the opinions of Ritholtz Wealth Management LLC and its affiliates.
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Before we jump in, I want to inform you that we are starting a custom portfolio review service. If you have been a long-time reader of Market Sentiment, you know how much importance we give to data analysis and backtesting. We have built an extensive set of tools over the past year to analyze and backtest various strategies.
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Last week, we went through ’s (AKA Moontower Meta) journey from options trading to investing and his excellent set of tools and frameworks which you can start using right away to think probabilistically and make better decisions in investing and life.
But trading and investing are just one aspect of Kris’s writing - He is also passionate about learning and has created many excellent resources to help investors better their game. Whether you’re a beginner looking to get a solid footing or trying to broaden your horizon after years of investing, his resource lists are invaluable!
In part 2, we cover the challenges in educating yourself as an investor, the most common mistakes and no-brainers, and how to tailor your approach to investing. If you’re strapped for time, here are the
The quality of your information sources will determine the quality of your returns. Invest time into looking for credible sources.
Wasted attention is expensive. Guard it ruthlessly.
To guard your attention and improve results, match your dashboards to your objective and game. Your goals should inform your strategy.
Too much information is actually counterproductive. Identify the highest signal factors and reject the rest.
It’s easier to spot another person’s mistake than your own - So forming a community of trusted people will accelerate everyone’s improvement.
Stock picking is over-rated. Focus on portfolio construction instead.
Investing is about covering your bases rather than looking for brilliant decisions.
There is no risk premium without risk. Think of it as fees vs fines.
Human capital is the most important form of capital. Focus on growing it.
But I highly recommend you read the whole thing! It’s packed with useful information which will change the way you approach systematic learning.
MS: Another area you’re passionate about is learning - I want to pick your brain on that. Some people jump into investing without studying it much, burn their fingers, and turn away. There are others who read the theory for years together and don’t even get started. What’s the right balance?
Kris: Start with a model portfolio suitable to your goals and risk tolerance. 60/40 isn’t necessarily horrible, but it’s not that hard to just go with a permanent portfolio. Use its performance to explore topics related to portfolio construction. Your asset allocation is the foundation of performance because inter-asset performance spreads are wider and less correlated than intra-asset.
But if you want to be a hands-on learner (or satisfy a gambling itch) have a laboratory for more speculative ideas, carve a well-defined percent of your portfolio for that and use those experiments to learn about interesting things (BTC, SPACs, closed-end funds, individual stocks etc).
MS: How can you learn about investing effectively and also validate it by putting it into practice?
Kris: a) Learn by reading and talking to good sources. How do you identify credible sources? That’s already a hard meta-problem. Charlatans are masters of blending in with well-meaning people and the intersection of well-meaning and competent is itself smaller than anyone wants to admit.
My friend Khe had me talk to a group of people that were aspiring personal investors. The feedback was that it was very helpful so maybe start there to see what credibility (I hope) looks like. It includes a reading list → Investing Q&A.
b) On validation: It’s a hard problem because the Signal-to-Noise Ratio is low. If the signal to noise were strong the strategy's capacity would quickly get filled or you are underwriting a risk that doesn't show up often. Validation is never fully possible in the same way that scientific inquiry never proves anything… It can be used to reject a hypothesis but not prove the success of any one theory. (This is really just a restatement of the black swan problem. No matter how many white swans you see, you can never rule out the possibility of a black one.)
MS: Another problem with investing is the deluge of information out there. How do you personally filter out the noise and design a feed that fits your investing approach the best? Do you have any advice for readers?
Kris: Match your dashboards to your objective and your game. You don't look at fundamentals when evaluating a daytrade anymore than Warren Buffet looks at a chart when he considers buying a business. When I traded equities I barely knew what some of the companies even did. Trading is about playing the player, not the cards.1 If you find yourself citing fundamentals, you have lost the script. Appreciating this would have saved the people who said Gamestop is overpriced a lot of money. So don’t drift into another style when your dashboards are designed to understand your own approach.
Wasted attention is insidiously expensive. Guard it ruthlessly. Ask yourself, “Am I equipped to know how this piece of info can even inform a decision?”2 The Paul Slovic horse handicapper study showed how excess information raised bettors’ confidence but not their accuracy. A dangerous combo.
Horse handicappers are experts who game betting by studying the various factors that winning and losing horses have. A study of horse handicappers found that the accuracy of their predictions improved for every new variable they considered, up to 5 variables.
But beyond that, the accuracy of their predictions did not improve from the original 5 variables they selected from a large menu of data. As they were given more variables their confidence went up (confirmation bias effect) although their accuracy did not!
In addition, the handicappers with only 5 variables were well-calibrated. They were close to 2x better than chance at predicting the winner - 20% vs 10% - and they estimated their confidence as such. When they were given more variables their accuracy remained 20% but confidence grew to 30%!
So it’s better to assess the few pieces of information that really help and calibrate your confidence accordingly.
MS: True. The most important thing is to not fool yourself. As you mention in one of your pieces, it’s better to have an IQ of 130 and think it’s 120 rather than have an IQ of 150 and think it’s 160. Could knowing their limitations help individuals set different goals, and what would that look like?
Kris: Understand that in investing, the ratio of return-to-effort is low for most ranges of effort. To make a high signal difference in your portfolio, investing would need to be a full-time job.
Although a little knowledge can go a long way by sparing you big mistakes. (Understand diversification, understand explicit vs implicit costs, avoid being adversely selected, understand what fees are reasonable and for what purpose, understand risk as the possibility of failing to match your liabilities and has nothing to do with your performance relative to peers).
The best use of your time is to learn the basics and implement them in a disciplined way, then get on with making money with your human capital.
MS: How can you assess your own investing knowledge to avoid delusion and figure out what to improve?
Kris: Talk to trusted others!! The importance of a team is hard to overstate in trading and the lessons can be ported to life:
In this summary of SIG’s Todd Simkin’s chat with the Knowledge Project, I wrote:
“There’s a paradox in cognitive science. Knowing our biases doesn’t seem to help us overcome them. This is a topic the brilliant Ced Chin has studied in depth. Ced told me that the literature suggests the only way cognitive bias inoculation works is via group reinforcement. I told him that was exactly the cultural DNA when I was at SIG which makes me believe there is a lot of value in being aware of bias. Anytime you replayed your decision process, it was a cultural norm to point out where in the process you were prone to bias.
Todd Simkin addresses why this works:
It is definitely true that it is sort of descriptive of the past. A lot of these heuristics and biases are things that we can see after we’ve already identified that a mistake has been made. And we say, Okay, well, why was the mistake made? Say, oh, because I was anchored, or because of the way the question was framed, or whatever it might be, we have a really hard time seeing it in ourselves.
But here’s the key: We have a really easy time seeing when someone else is making that type of stupid mistake. A big part of our approach to education is to teach people to talk through their decisions, and to talk about why they’re doing what they’re doing with their peers, the other people on their team. If we can do that real-time, that’s great. Often in trading, you don’t have that opportunity, because things are just too immediate. But certainly, every time things have changed. If you’re doing things differently, it’s a really good time to turn to the traders around you. And the quantitative researchers around you and the assistant traders and your team and say, Hmm, it looks like all the sudden Gamestop is a whole lot more volatile than it was a week ago. Here’s how I’m positioning for this trading. What do you guys think? And have someone say, oh, it seems like you’re really anchored to last week’s volatility. If things have changed that much, you need to move much more quickly than you’re moving right now.
So you don’t realize that you’re anchored - that’s the whole nature of being anchored, is that you don’t recognize the outsized importance that the anchor has on your decision, but somebody else who’s a little bit more distant from it can. So if we’re good at encouraging communication, then we’re going to be really good at getting other people to help improve your decision process.
So cultivating a community where you can spot each other’s mistakes and errors faster is an accelerated way of overcoming your biases.
MS: What investing advice is over-rated according to you?
Kris: Two things.
A) Stock picking. Focus on portfolio construction instead. So much brain and compute power is thrown at picking stocks that beating the spread consistently is nearly impossible. Charley Ellis really brings this to life in Notes from Capital Allocators: Charley Ellis when he describes the evolution of the investing business.
B) Concerns about de-worsification. How concentrated you are is downstream of your goals – get rich vs stay rich. If you are trying to get rich relatively quickly you need to take lots of risk, and that means concentration - either in your investments or ideally in your own career/business. Once you are in stay-rich mode, then deworsification isn’t really a thing and if it were it’s not especially expensive unless you confuse fake diversification for real diversification (ie both value and growth are long risk).
MS: What investing advice is under-rated?
Kris: A) Appreciating that markets are biology not physics, so history is actually a poor guide. Markets are “complex” in the chaos theory interpretation of the world. They’re so-called “wicked” learning environments where causation is opaque. This means the future is more random than you think. Another framing is what Nick Magguilli calls the “privilege of knowledge”. Index investing has been a great strategy but it’s only been a recently available technology (1 generation). Now that everyone knows it works means it should be more crowded going forward. That’s exactly what we see with the rise of “passive indexing”. Knowing that indexing was a great strategy would have been hard to see 30 or 40 years ago and even if you knew it it would still be costly to implement. The corollary to this is what I call the “no easy trades principle”.
B) Investing is a “loser’s game”. An excerpt from Investing Is A Loser’s Game:
Tennis author Simon Ramo described professional tennis as a "winner's game" — the superior skills of the top players drive the score. This is deeply contrasted with amateur tennis where winning is determined by the player who makes less mistakes. This should seem intuitive to any weekend warrior. If you play tennis with your spouse the winner will be the player with less unforced errors. In other words, it's a "loser's game".
In the 1975 paper, Loser's Game, published in the Financial Analysts Journal, investor Charley Ellis described investing as a "loser's game". In a winner's game, you need to perform spectacularly. You need to be elite. This is not the case for investing where survival is at least half the battle. You are not trying to win. You are trying to not lose.
MS: How do you handle risk?
Kris: Here’s how:
Way in first place: Hard rules – never risk what you need for what you want no matter how attractive the proposition is.
Diversify not concentrate. (I’m trying to maintain wealth and have it keep pace with liabilities. I don’t even call it investing. It’s more like “savings plus”. To get rich, focus on building or using your human capital where the signal has a chance of swamping the noise.)
Understand how your portfolio can zig or zag together.
Minimize drawdowns – you care about geometric returns because the math of investing is a serially compounding process. You do this by not concentrating (and being wary of false diversification – unlike many foreign indices the SPX is mercifully well-diversified across style and geographical source of revenue. But it's still levered to earnings and therefore economic growth risk premia.. so diversification means not just equities)
MS: What advice do you have for retail investors related to risk, managing volatility, or anything that they may be missing out on which could make a big difference to the psychological aspect of investing?
Kris: A few pieces of advice:
Don’t compare yourself to others. Your goal isn’t to beat some abstractly constructed basket of 500 stocks, rebalanced annually and chosen by a committee. For most people, the goal is to keep pace with their liabilities so they can enjoy their life. If your goals differ, fine, just be explicit because the goal will inform the strategy.
If you don’t want to deal with it, hire help.
Satisfice, don’t optimize. Try to reach good-enough and do it robustly, not perfect. Robustness > perfection
Sizing is more important than entry so stop trying to time markets. There are 100 chumps for every hero you see.
MS: What is one idea you discovered in the last few years that blew your mind and changed the way you think about something?
Kris: People care more about protecting their ego than accuracy. We want to feel safe and we can think we are right cheaply, so that’s basically why confirmation bias is the mother of biases. Actually being right is expensive (ie it’s hard) and it does matter since we need bridges to stand up. But everything that matters philosophically has been unanswered since the Greeks. There’s a temptation to either be nihilistic (pure relativism, nothing matters) or a temptation to subscribe to a coherent and therefore perfectly prescriptive worldview (like fundamentalist religion) that alleviates the burden of thought and the inevitable paradoxes that torment people who need closure. See: How The Need For Coherence Drives Us Mad
If I had to make a speculative link to this idea to investing – it can explain why people do stupid investments – they’d rather be “right” than make money so they invest according to what they’d like to be true instead of what is true. Maybe “fighting the Fed” fits this. I don’t know. Just waxing poetic here.
MS: Which article of yours is the most popular, or most talked about? Does it surprise you?
Kris: It’s this one: Why Investing Feels Like Astrology. It surprises me just a little bit. I know when I write a technical article that it will be well-received because if you break down something complex, you do people a favor. But with an editorialized article like this one, it’s hard to predict if it will “land”. So if the popularity was an example of upside variance it’s not really that surprising because I just expect a lot of variance in those types of posts in the first place.
MS: Which article or idea of yours is your personal favorite?
Kris: Sacrifice To The Delta Gods is my favorite.
MS: You have an entire library of investing resources for readers. But is there a personal favorite or something that you are consuming now - a book, podcast, blog, or anything else - that you would like to leave as a recommendation here?
The best book on the topic of “trading as life lessons” is Agustin Lebron’s Laws Of Trading. You should read it but my notes are here as a refresher when you’re finished.
MS: Finally, do you have any idea or suggestion that our readers can take away to become more well-informed investors, or even make investing a little more enjoyable and stress-free
Kris: I have a work-in-progress for some evergreen ideas for appreciating the nature of investing. I will point to 2 important points that I think are counterintuitively liberating:
1. The fact that markets are relatively efficient should actually calm you. You are benefitting from the wisdom of crowds by passively participating in a risk premia that you can’t control anyway. You just attenuate your exposure to it.
I call this The Gift Of Market Efficiency and the point is to not waste time on things you can’t control, cannot get useful feedback from, or are random and focus on your human capital. It’s the most important input into your capital allocation especially when you are young. And it doesn’t show up in a spreadsheet. And closing the loop on acceleration curves, if you focus on what you like and are good at, you will get better faster…your human capital will compound faster. See:
The Gift of Market Efficiency
Time and Human Capital
2. Understand that without losses there can be no gains. There are no risk premia without risk. If X was a sure thing, it would earn the risk-free rate. (Be careful of the converse, just because something is risky doesn't mean it will earn a return).
Morgan Housel has a good framing:
The way that I’ve phrased it in the book was “understanding the difference between a fee and a fine,” which seems like they’re really similar but there’s a very important difference which is, a fine means you did something wrong like, “Shame on you, here’s your speeding ticket. Don’t do it ever again, you’re in trouble.” And a fee is just a price of admission that you paid to get something better on the other side. Like you go to Disneyland, you pay the fee, and then you get to enjoy the theme park. You didn’t do anything wrong, it’s just that’s the fee.
I think if you could situate your life to where you view a lot of the ups and downs, not all of it, but a lot of the volatility in investing, a lot of the volatility in your career, as a fee instead of a fine, then it just becomes a little bit more palatable. And when the market falls 30 percent, it’s not that you enjoy it, you don’t think it’s fun, but you’re like, “Okay, I understand this is the fee that I have to be willing to pay in order to do well over a long period of time.” Most investors don’t do that. When their portfolio falls 30 percent, they say, “I fucked up. I did something wrong. I clearly made a mistake. And how can I make sure this never happens again?” And that’s the wrong way to think about it. And I think if you view it as a fee instead of a fine, it’s just much more enjoyable. It’s much more realistic to deal with.
Now, I said earlier that there are some areas in life where it’s like that. If you’re talking about a death in the family, a divorce, there’s things that’s like, “No, that’s not — that’s just a straight negative.” Like no silver lining to some of these things in life so I want to be careful at parsing that. But particularly investing, the huge majority of the pain that people go through and put themselves through is just the fee for earning superior returns over time. And if you’re not willing to pay that, then you’re probably not going to get the reward on the other side. And that’s why you can see so many people who at the first experience with being uncomfortable in investing with a loss, they view it as they screwed up and then they want out. They want to move on to something else.
And of course, they’re not going to get the rewards over time. Nothing in life is going to give you those rewards for free. There’s a cost to everything. And just identifying what the cost is then realizing that the cost is not on a price tag, you’re going to pay for it with stress and anxiety, and dopamine, and cortisol, like that’s how you pay for these things, I think that’s the only way to deal with those big ups and downs.
See:
Risk Is Unavoidable Let’s Get To The Good News
MS: That’s it for this week’s interview folks. Let me know which idea you found most interesting and would like to know more about. If you have suggestions for future guests, do let me know in the comments.
If you enjoyed this piece, please do me the huge favor of simply liking and sharing it with one other person who you think would enjoy this article! Thank you.
But first, check out Moontower Meta and subscribe to (it’s free!) for Kris’s posts on volatility, risk, investing, and learning.
If you missed the link at the beginning, do take a moment to let me know what you felt about the interview.
Disclaimer: I am not a financial advisor. Please do your own research before investing.
Note from MS: Warren Buffett doesn’t just have an in and out pile, he also has a “too-hard” pile of businesses - Companies that might be good whose business model he doesn’t understand, but doesn’t want to waste his attention on. A good framework!
Kris Abdelmessih from the Moontower Meta blog was a delightful find for me last year. I stumbled upon “Why Investing feels like astrology” and went on a binge-reading spree through his articles. For those unfamiliar with his work, Kris spent 20+ years trading options, starting out at Susquehanna (SIG). He writes about options, volatility, investing, learning, and more.
The beauty of his blog is that there is something for everyone regardless of their background. His wikis and reading lists are fantastic resources for beginners who want to educate themselves. This interview with Kris is split into two parts:
Lessons from options trading that can be applied to investing and life
How individual investors can educate themselves to be among the best
This is Part 1. Part 2 goes out next week - so stay tuned. If you’re strapped for time, here are the top actionable insights you can take away from this interview -
Your investing goals and direction should shape your strategies. Don’t be a day trader using fundamental analysis tools or vice-versa.
Think about the market as a casino and yourself as a player - The house wins... most of the time. If you think you have an edge, be really skeptical. Why isn’t anyone else spotting it? Avoiding a bad choice is as simple as asking – why am I getting a look at this?
Savings and investments are for maintaining wealth you’ve earned, but human capital is how you get rich or earn.
When it comes to investing and trading, there are two levels of probabilities to consider: You have to play the cards, and you have to play the opponents.
Event probability doesn’t exist in isolation - A low probability trade executed enough times can lose you a lot of money. Learn to think about probability on a per-trial basis to see how it will really affect you.
Passive investing doesn’t come without risk - Passive investors are paid a risk premium for the flow they provide to the market.
Options are a good tool to teach investors to think in specific terms - to be rigorous about bet expressions and the basis risk between the idea coming true and actually making money.
Don’t play with money you can’t afford to lose.
There is no magic formula. The majority of the work is mundane but rewarding.
I highly encourage you to read the whole piece. It’s one of the most thoughtful, detailed interviews I’ve done so far! There are four sections in this part:
An options trader’s investing journey
How to make better decisions in investing and life: A crash course
Options trading: An inside look
Starting from scratch with options
Let’s jump right in.
MS: From being an active options trader to now: Can you tell me a bit about how your mindset towards money and investing changed? Can you think of any milestones in your journey?
Kris: I think my answer is going to be more interesting (you might even think I’m a moron…and you wouldn’t be wrong) than useful but here it goes.
The entire concept of investing was fairly foreign to me. My parents never really had enough savings to invest. I knew I wanted to make a lot of money, but I never thought about what I would do if I had it. You know, other than spending it. I actually never really cared about luxury items, I just wanted to not have to work. I wanted money because that meant leisure.
So when I got into the world of trading my goal was to just make so much money that I didn’t have to think about money. I’d rather not spend my time thinking about money and that’s pretty true today as well. And even when I started making money, I always had a good excuse to not think about investing. For example, I wanted to buy a house as the conventional script says that’s what’s next. While saving for a downpayment you don’t consider risking those funds in the market, which of course is a good lesson right there. Even when you get to investing, a healthy goal is liability matching. You want to save for your kid’s college or a downpayment or retirement. The timeline of each of these dictates a different risk tolerance. If I need ransom money by Friday it’s risky to NOT go bet everything on black in Las Vegas.
When I got into trading it was as a market-maker. So I was the house. The bookie. Being on that side of the business, taking the other side of people’s hunches and opinions actually makes you think that investing is a mug’s game (at least if you were a hedgehog like me, who failed to see the broader picture). Eventually, as I matured, two things happened:
I had investable assets even after owning a home (actually after upgrading a few homes). So I started to feel that cash is not a good way to store value. Then I was like, oh, that’s why people invest. Some people actually have extra money. I know it sounds stupid, but I was really not someone interested in investing. I liked the game of trading and the business of making money by playing what felt like a game. But investing felt like something I had no expertise in so in that world I’m a tourist. I would need to start learning about investing.
When I went from being a Market Maker to becoming a Portfolio Manager at a volatility hedge fund that had clients I started to understand the world more realistically. When you are a market maker, you are putting up 100% returns on small capital. At a hedge fund, you slide down the alpha/capacity continuum. Then I realized that trading is a business and not an investing strategy, instead of thinking they were the same and that I was just on the smart side of investing. Now I realized that trading’s outsized return was compensation for doing a bunch of difficult things just as a restaurant needs to bring together many activities (procurement, hiring, cooking, serving, billing, etc) to make money. So if you are going to invest in secondary markets of course the returns would be lower. You weren’t running a business, you were just harvesting risk premiums that were set by an auction. That auction is the collective forecast of many smart investors minus a risk premium. And that’s ok. The flipside is you weren’t doing the work of a trading firm or restaurant to access it.
I went to the internet around 2016 to learn about investing AFTER having been a trader for 16 years.
Sitting here now, my core belief is that money is just a means to an end and not an end in itself. I don’t care if I beat markets as long as I can accomplish my goals. Savings and investments are for maintaining wealth you’ve earned, but human capital is how you get rich or earn. And compounding is a critical lesson to learn when you are young. Not understanding investing while sitting on savings was a costly mistake. (Although dwelling on that is silly…if I lived in Japan not investing would have been wise but the point is that you should learn about investing to understand the larger issue that wealth stored in cash decays so you need a plan for having your savings match your future expenses).
I discuss these topics further in:
My Investing Shame Is Your Gain
How I Misapplied My Trader Mindset To Investing
MS: One thing that Naval said stuck with me: The most profound philosophers are the ones who have dedicated enough time to a craft or skill that they are able to view life through that lens. Buffett and Munger give a lot of investing metaphors that are equally applicable to life. Martial artists talk about life in fighting jargon. I’ve noticed that even when you write about non-financial topics, like designing your life or finding meaning, you use options jargon like Calls and Puts and Deltas and it totally makes sense.
How has trading options shaped your perspective on life? Has it given you an extra set of tools to think about life/investing/decision-making in a different way?
Kris: The answer to this is a resounding yes. Now the founder of SIG, Jeff Yass, has a very strong form expression of this when he says you can’t understand decision-making without understanding options. I think if you view this narrowly where “options” = financial options it’s a stretch. But Jeff and interestingly both Buffett and Munger admit to having thought deeply about options as early teens.
I don’t advocate for everyone to rush out and learn about calls and puts as a means to learn about decision-making but I do believe that thinking about risk and second-order effects is critical to making good choices. So to that end, I suspect the tip of the spear in understanding decision-making is likely proprietary trading firms who have massive sample sizes and feedback to learn from, and the military. (I’d like to throw doctors in this mix but my 10,000 ft view is that doctors are probably undertrained in this regard).
Circling back to what we can extract, I think of 2 categories: Object level or mechanical inputs into decision-making and meta-level. In a poker analogy these would map to:
1. Playing your cards
2. Playing your opponents
This is understanding probability and the concept of edge. What are my odds of winning this hand with KK suited in a heads-up (ie 1 on 1) hand vs a multi-way pot (say 5 players)?
Extrapolating to decision-making in life, you need to consider what the distribution of a decision looks like: is it a normal curve or is it highly skewed? For example, if you are deciding what time to leave the house to make an appointment, the expected value might be 15 minutes, but there’s a lot of skew. A traffic jam could make it 30 minutes but there’s no way it will ever be 0 minutes. The same applies to investing sometimes.
An example that is highly direct to understanding options is being able to evaluate them in real life. For example, I wrote a post about car leases to help people appreciate the lease vs buy decision. This is a more straightforward calculation than understanding, say, the option of renting a home vs buying which has a harder-to-handicap variable.
Another example is what I call repeated game thinking which comes directly from the idea of edge and expected value. If I have a ⅔ chance of winning a bet but I have to lay 4-1 odds on any one trial, I’m likely to win. But in the long run, this is a losing game. So you want to convert the edge into a per-trial expectancy. In life, this is the same as good habits. Eating a donut once is fine, but as a habit, you are asking for health problems.
Understanding edge helps you think long-term. When I buy a lotto ticket, it doesn't cost me $2. It costs me $2 x the number of times I will do this because I’ve given myself permission to think of this as a one-off decision even though it’s not. Wearing a seatbelt, buying vitamins or interventions when you can’t tell if they actually do anything, the list goes on.
Betting is incremental information. And bets themselves say something truthful or deceptive. Narrowing the opponent’s hand based on their betting history and current pattern requires a mix of memory, a tree of deduction, and an understanding of their psychology which may take in external factors such as how tired they are, how much bankroll they have left, etc.
Extrapolating to real life, there are so many market concepts that summarize the behavior of groups that are viscerally felt in trading and can be safely extended to the wild. These include:
Market efficiency: If a market is widely accessible, transparent, and made up of a diverse group of actors then the consensus price it generates will be “fair” in that it incorporates all relevant information including information you don’t directly possess. For example, if you browse Zillow and see a house that looks like a great bargain, your instinct should be – something is wrong with that house (foundation, freeway noise, etc. Something you can’t see in the listing) not that you are the only person seeing a deal on something that is publicly visible on a Multiple Listing Service.
Avoiding adverse selection is as simple as asking – why am I getting a look at this? Have smart people had a chance to see this before me and passed? Trading hones this adversarial instinct.
Continuing with market efficiency is the appreciation for “wisdom of the crowds”. If a CEO says she’s stepping down I don’t assume this is bad for the stock. I just go look at the price and that tells me what the market thinks. Maybe it’s good news and the stock has been weighed down by this CEO. If an NFL player gets hurt mid-week I don’t need to wonder how bad this is for the team – I just look at how the line moved. It’s a good habit to outsource a lot of judgments to the wisdom of crowds or the “outside” view so you can focus on decisions where your judgment has more bearing.
MS: But surely the wisdom of crowds can go wrong, can’t it? How do you identify this?
Kris: Two interesting ways the wisdom of crowds turns into the madness of crowds are bubbles and perverse incentives. Both work by homogenizing the crowd (the wisdom of crowds depends on diverse actors who all bring a bit of useful information to the mosaic). The reason for the homogenization of a crowd is a big topic (Minsky is a great reference for this) and perverse incentives come from overly narrow values or poorly constructed rules. Goodhart’s law of when the measure becomes a target is embodied by the “cobra” parable. A govt in India offered a bounty on cobras to prevent overpopulation. The result: people started breeding cobras to kill them. If you think abstractly, this is not unlike a bubble – the output gets recycled as an input leading to a reinforcing loop.
MS: Do option “Greeks” have anything to teach the average person as well?
Kris: Of course. Consider option “greeks” like delta and vega. These are simply ratios or sensitivities which tell us how much an option’s price will change based on variables. Delta tells us how much an option price changes with respect to the stock price. It depends on the “moneyness” or how far the stock is from the strike price. This concept maps to real life as well. What’s the delta of a company’s value with respect to its costs? Think of an oil company, when oil is trading at a lower price than its cost to drill. That company’s value is pure extrinsic value. It’s an out-of-the-money call option. Think of the idea of Greeks in tech. SaaS companies have low marginal costs for serving their next customer so their unit economics or margins are amazing. Think of how its Greeks look compared to a service business where the economies of scale are not as attractive.
There are second-order greeks as well. Gamma is the change in delta vs the change in the stock price. This maps to acceleration and velocity in physics. You can’t estimate the final destination of a car in 1 hour if you just took a snapshot of velocity 30 seconds into the journey…you need to know what the acceleration curve looks like. And curve is the key word because acceleration is non-linear and leads to convexity.
MS: What is convexity? Why is it important?
Kris: In simple words, convexity is when values at the extremes, with low probability of happening, cannot be predicted from the average trend. Convexity wreaks havoc on estimates that linearly interpolate. That’s exactly why compounding is so unintuitive - you don’t see results for years on end, but once the returns start accumulating, the growth is exponential!
An investing example could be: Thinking that a stock is cheap because it appears to have a large runway (the cashburn measured in months or years). But what is the change in the cash burn if the economy gets weaker? If revenues fall, the net cashburn accelerates and the runway shrinks faster than what the snapshot predicted. Chain reactions are not captured in linear estimates.
For more on curves, see:
Where Does convexity Come From?
Greeks Are Everywhere
Moontower on Gamma
MS: What do most people miss about options trading when looking at it from the outside? What is the real difference between investing and trading?
Kris: Finally, options trading is a business, not quite an investment strategy. You invest IN businesses. The distinction is subtle but important. Trading is shorter-term in nature – the feedback loops are tighter, and there are endpoints in the form of catalysts and expirations, where convergence between price and reality occurs. You win a tournament, you take the profits off the table. You hunt for a new bet. In fact, that's why I like futures and options...they expire - which is a pre-determined catalyst for convergence.
Stocks are perpetual, and investing is really about re-investing. That’s how you compound. (In fact, Another way to think of a cheap stock: the market thinks the company will have a low return on invested capital?...the market discounts windfalls that won’t recur, and in its own language actually thinks about return per trial!)
I marry the two concepts by remembering that trading is a service to provide liquidity. There’s a mismatch in risk tolerance and horizon between buyers and sellers. Traders basically broker that. You can think of investing similarly if you think of your role as supplying liquidity to an unbalanced market preference and earning a risk premia for that job.2
MS: Continuing with that question, I want to examine how interest in derivatives has exploded in the last few years - Gamestop, AMC, Wallstreetbets, Crypto derivatives, etc. come to mind. Some of that might have even given options a bad name (?). Should everyone learn a little about options and how they work even if they never intend to use them?
Kris: Depends on the context. With options, you can speculate or hedge. When you use options, you are highly levered to specific outcomes (i.e how much will X move in some specified time frame). The bad news is you can be generally right but specifically wrong. For example, buying an OTM call, watching the stock increase but fall short of the exact strike you picked. That’s brutal.
The good news is you can use options to quarantine your risk, and only for a specific outcome. Just as term-life is cheaper than whole life. I generally recommend term-life because it solves a specific risk (“supporting my family until my kids are out of college in case something happens to me in the next 20 years”). So you can fine-tune or target your hedge and not pay for scenarios you aren’t worried about.
Because of this, using options as trade expressions forces you to tighten your thinking around the timing and potential return distributions of your thesis. So overall, I think learning options forces you to think better. The flip side is you become a degenerate gambler in a casino with an expensive vig3.
You should be meta about why you want to learn options in the first place so you don’t accidentally drift into degeneracy.4
Understanding put-call parity would help you understand that selling covered calls is equivalent to a short put and in general, show you that options are about volatility regardless of whether you use calls or puts. See:
What Part Of Selling Calls Is “Income”?
Selling Calls: It Might Be Passive, But It Ain’t Income
MS: What can index investors or value investors learn from the world of options to augment their own money management?
Kris: The specificity of options requires users to be rigorous about their bet expressions and the basis risk between the idea coming true and actually making money.
For index investors, they can be aware of the proposition they are signing up for. In today’s world, the implied earnings risk premium in the SPX is about 4% (Aswath Damodaran updates this quarterly at least). So a passive equity investor is signing up for a proposition that offers 4% over the Risk-Free Rate with about 20% volatility and fat tails (meaning large drawdowns occur more often than a normal distribution would suggest. In fact, we can look at an option surface for the outside view of how likely say a 25% selloff is in one year).
Overall, it’s not a very attractive proposition compared to history but everything is relative to the opportunities that currently exist. You can use the risk/reward of the proposition to modulate your sizing (one could argue that this is timing) but I’m answering this question for value investors who presumably start with valuation (as opposed to say a momentum investor).
MS: If Wallstreetbets has given a very sleazy shade to the world of options, what’s a healthier, more disciplined way of approaching options?
Kris: Understand your goal first. Is it to hedge, speculate on specific outcomes, or vol trade?
For speculating, read the below first. One of the key takeaways is: for directional trading, 90% of the work happens upstream from the options i.e fundamental analysis, etc. It’s the fundamental work of handicapping the distribution. If you can do that, then comparing the option prices to your own assessment is a reasonably mechanical exercise - hence why it’s a small percent of the meaningful work. See: Structuring Directional Option Trades and How Options Confuse Directional Traders
For hedging, again there’s work upstream. Are you sure that hedging is the answer instead of just shrinking your trade size or diversifying more broadly? If you want to be rigorous about this question this post will give you the mental framework: If You Make Money Every Day You’re Not Maximizing
For vol trading: Don’t bother. It’s low margin, requires institutional cost structure and infrastructure, and detailed diversification. Hedging a market neutral book needs economies of scale. An analogy would be – AMZN wouldn’t have developed AWS if it didn’t need to be its first client.
Appreciate explicit vs implicit cost.
“Explicit cost of trading options is the transaction fees. RobinHood makes them zero to trick you. The implicit costs are what should concern you. Optically it looks cheap to trade options but you will chop yourself to pieces without clear objectives and plans. It’s tempting to sling them.
A 1% edge in a stock or ETF is enormous. Imagine buying a stock that was trading “fair” for $50 for $49.50. This is an order of magnitude more edge than HFTs earn. Hold my beer now as we do options. If the fair price for a call or put is $.50 and the bid/ask is $.49-.$51, you are giving up 2% edge every time you hit or lift. Before fees!
Option prices themselves are more volatile than the underlying stock so from the market-maker’s perspective the Sharpe of the trade might be pretty small (getting 2% edge on a security that might have a 100% vol for example). But think of the second-order effect…the optical tightness of the market and high volatility of option prices means it can take many trades before the option tourist realizes just how much the deck is stacked against them.
For independent market-makers, like I was 10 years ago, the tight markets made our business worse because our risk and capital limits did not allow us to keep pace with the volume scaling required to make up for the smaller edge per trade. But the large market-makers welcomed the increased transparency and liquidity because they could leverage their infrastructure effectively.
If you make a 50/50 bet with a bookie but need to pay them 105 to 100 you are giving up 2.5% per bet (imagine you win one and lose one…you are down 5% after 2 bets). Now think of a vertical spread or risk reversal in the options market. Pay up a nickel on a $2 spread? Might as well have a bookie on speed dial.”
Kris: For options, the Moontower Option’s Wiki is a one-stop-shop. Totally free resource:
The Options Starter Pack
For mindset: be realistic about your goals. Your goals inform the strategy. Are you trying to grow savings to match liabilities, get rich or something in the middle?
If you just want to tinker, don’t play with money you can’t lose. Journal about what you do – create speedbumps for yourself. It’s very convenient to trade options, which masks the danger of what you are doing.
Seek help from others who aren’t invested in you churning
Now if you want to be an active trader and have it be worth your time you will need to bring a lunch pail and a professional mindset. I discourage this generally but if you are determined these are the best interviews I’ve seen on the topic:
How To Turn Pro As A Trader
Specifically, go to 1:15:30 and listen for 2.5 minutes. This episode is the best dose of reality/debunking. It's simultaneously encouraging and discouraging. If you read between the lines it's saying there are lots of ways to make money. Some are being AMZN and some are possible as a small player.
The formula is you have to work very hard either to figure things out or to get into a firm that can teach you. And you have to be smart. The competitive nature of this business comes through strongly. You will also need people skills so in that sense it's like any business. And there's definitely no magic formula.
Finally, remember that the mark of a professional is self-evaluation and measurement. If athletes didn’t watch film, they wouldn’t learn. It’s hard work to go back and dissect what you did wrong. We all just want to go forward. If a runner never timed (ie measured) themselves and experimented methodically with training, they’d never get better. Being an active or professional investor is no different. See: Being a Pro And Permission To Be Serious
MS: Is there any insight that you gained by being in the thick of the options trading market, witnessing thousands of transactions over the years, seeing how institutions operate, that individual investors have no idea about?
Kris: There is no magic formula. It’s not some hidden bit of IP that makes firms profitable. It’s the ability to be a chef, combine ingredients, and execute. The most important things for survival are mundane. This means the mundane is the priority – catching trading errors, communicating effectively, monitoring risk.
In the next part, Kris dives deeper into how long-term investors can educate themselves, his insights from the legendary trader training program at Susquehanna, and much more! Stay tuned for next week’s issue.
Part 2 is out! You can read it here.
Kris’s blog Moontower Meta is named after the moontower from Dazed and Confused - The same movie in which Matthew McConnaughey debuted with his signature catchphrase.
I liken the investor to the casino or the “house” here (at a different layer of abstraction – the execution level – the intermediaries are the casino but I digress). See: On Having An Edge
vig is short for vigorish, or the cut you have to pay to the casino (or the market makers in this case) from your winnings.
Apologies to anyone from r/wallstreetbets reading this.
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Some businesses are a bet that the future would look the same as the present,
while some are a bet on a different future altogether.
Both are different sorts of call options on the future.
One’s a boring one though, and therefore also gets short shrift.
Rohit Krishnan writes Strange Loop Canon - one of my favorite finds of 2021. Rohit’s bio is equally fascinating. “I'm an engineer and an economist, ran a hedge fund, worked in 4 continents, and currently am a venture capitalist.” (Sounds a bit like Iron Man) I’m a fan of his thematic articles on:
What it takes to build a great company or organization
How to identify and nurture genius
Lessons from history for investors
In this interview, I picked Rohit’s brain about how Venture Capital works, how to identify great companies to invest in, and protecting against risks in perception-based and innovation investing. He drops a lot of actionable insights along the way, so read the whole thing - But if you’re short on time, here are some key takeaways:
VC is the attempt to build a portfolio to solve two equations: Getting 3-5x MOIC (Multiple on Invested Capital) in a decade or less with early-stage companies and reducing your failure rate.
Metrics help in tracking performance. But the real learning is in comparing what you think is important vs what turns out to be actually important.
You maximize the chances of finding great companies if you pick a lane and stick to it. While you build a narrative to say yes to the company, also check financial health to ensure that there aren’t reasons to say no to it.
Dividend investing is completely undervalued - It aligns the incentives of the business and the investor, but growth investing has better PR these days.
In any model of the future, identify the moving parts to project bull and bear cases, and understand how things can turn out. This is especially useful when it comes to perception-based assets like crypto.
A small group of people can have an outsized impact on the world. Most people will respond if you reach out!
Let’s dive right in…
Since life experience is probably the investor’s best resource, can you tell me one thing you took away from
Engineering
Economics
Running a hedge fund
That improved your investing framework?
Ha, this is a perfect example of an irreducible problem, since I don’t know any easy way to disentangle what I learned from each space. But taking a wild stab I’d say that
Engineering was great because it taught me that while I love systematization and science, I’m not temperamentally suited to bug fixing or soldering.
Economics was great because it taught me the power of toy models, fantastic for investing (and dangerous).
Running a hedge fund taught me that while playing a video game for a living is great fun in the short run, it can get boring.
Though I do look back and wonder about the road not taken. But that said one thing I do take very seriously is systematizing my thinking on even private investments and trying to keep a log across metrics, so I know if I'm an idiot or more likely how exactly I'm an idiot.
Which space are you interested in as a VC?
I look primarily at enterprise software companies, which end up being B2B SaaS quite often, Fintech that’s more on the infrastructure side, open source, database companies etc.
Morgan Housel said VC is like indexing but with compressed timelines - with higher risk-reward as well. How would you describe what you try to do in VC?
Well, I have a general thesis that VC is interesting in finance because of two things:
It’s primary capital deployment, pushing capital into the company to help it grow.
It’s looking to get 3-5x MOIC in a decade or less.
Everything else is a solution for this equation. You need to create a portfolio because the survival rate for young companies is not that high. And you need young risky companies that are growing fast because that’s the only way to get these MOIC numbers.
So yes, it’s kind of like indexing, in that you have a bunch of bets with the distribution of outcomes being a steeper power law in VC, and with a higher degree of death rates in VC. But the fact that it’s primary capital makes this a different bet - Also frankly a more fun bet because it's actually something being built partially because of you!
What core metrics do you track? How have you systematized this?
I use a number of metrics to evaluate companies, which you can access in this Google Sheet (I have anonymized the names of the companies, but my process can be seen there - Check the metrics tab). The true impact was on what I thought was important vs what turned out to be actually important.
(Note from MS: Getting an inside look at how a VC investor picks their companies is a rare opportunity - If you’re interested in identifying great companies and are working on your process, I highly encourage you to take a look at the sheet!)
What makes for a great company? How do you go deeper into studying companies? What should you look for?
Now, what’s a great company? Well, it’s an easy question because the answer is nobody knows. Literally nobody. High-risk high-reward is a true idiom except it looks the same as high risk, no reward. The only ways I know how to distinguish are to play in my lane (look at companies in spaces I have some clue about). This is very similar to reading, in that I use my curiosity as a guide, and this is why it helps to look at spaces that you personally find interesting.
And also it’s important to do the smell test to make sure that something is working in the business (sales, unit economics, marketing efficiency, etc). A lot of this is using the data to make sure you don’t need to say no while looking for reasons to say yes - which is to figure out a narrative where you can figure out if it’ll be a huge company one way.
There seems to be an unsaid understanding that a “rockstar” or prominent leader is a good thing for a company - Steve Jobs, Zuckerberg, Elon Musk, etc. But is that true?
I’m not very sure about this. You do see a lot of prominent leaders, and sometimes they’re exceptionally good and often bad, and many times just middling. Steve Jobs, it’s worth remembering, got kicked out of his company! The danger for investors is that wilful rockstars are less receptive to feedback often, are headstrong, and can often lead the company off a cliff. But the pro here is that occasionally this is the exact cluster of characteristics that leads one to create extraordinary value!
So to me, this is a portfolio construction question. Rockstars are great if you have market tailwinds and strong execution, which makes them particularly attractive for ventures. It's worth noting Apple’s meteoric rise was under Tim Cook, for whom charisma is kryptonite.
It seems like cutting-edge developments these days are happening mainly in interdisciplinary areas. But how do we tell apart the generalists who have something from the over-simplistic generalists who lack know-how (every wannabe Elon Musk/Steve Jobs)?
I do feel that we should absolutely be focusing way more on creating better interdisciplinary collaborations. It’s a core belief of mine that this is core to progress! Santa Fe Institute here is one of my favorites, but my friend Sam Arbesman has an ongoing list I believe, and is a big proponent of this idea too.
The difficulty is in identifying generalists who are just playing the Glass Bead Game for their edification and status, vs those who are actually interested in trying and creating something new. I’m actually not very sure anymore that we can even tell them apart to be honest. The question I’ve turned to is less can we tell them apart, but rather - how can we risk-manage our way through the ones that aren’t all that good?
It’s like with trading, it's not about whether all trades are profitable, it’s how well you cut the losses for those which aren’t! Or, to use another analogy, it’s like venture capital, it’s not about whether all your bets are profitable, it’s about ensuring that the few exceptional ones make up for all the rest.
What mental models can protect investors from tail risks when investing in rockstars?
I’m relatively unsure mental models can protect from tail risks, to be honest. Thinking of your portfolio as a portfolio is a great start, rather than a collection of companies. Also, it’s a good idea to do due diligence on whether the company you’re investing in is a fraud…
Beyond that, it's worth asking what the rockstar is bringing to the table. If it’s general swagger like Neumann, then probably not as worth it. If it’s actual competence like Musk, more so. If it’s taste like Jobs, worth it again. We come back to whether there's a narrative about a future you can believe here, that stands separate from the rockstar.
What tools and resources does each level of investor (VC, institutional, employee, outsider) have for assessing company management, and what’s a good process?
One thing I’ve noticed is that private market investing just lets you see so much more information about the management than anything public. Generally speaking, this holds true, so the question is to make sure this doesn’t hurt you much in your investing style.
For instance, in retail markets, it’s better to look at external factors regarding management. For example, sure, Frank Slootman of Snowflake has a track record, but also the actual performance factors of the company have to stand in for any management specialties. It’s worth noting even as a VC: Though you have a lot of interaction with management, it’s not a given that this helps you suss them out or has a direct impact on better decision-making!
“The price of following your passion and charging ahead in a given direction, that prize is the Elvis Presley of prizes - to live fast, die young, and leave a good-looking corpse.”
Your piece on what makes companies long-lived and immortal touched on a great idea: Looking at Company Lifetime Value as a metric of the longevity and long-term value of a company.
Has IPO or acquisition culture driven entrepreneurs into an “exit-model” mindset rather than building empires that last forever?
I have this deep fascination with the idea that we’re living in an era that completely undervalues dividend investing. I’d love to own a business that throws off dividends or profit shares to its owners. To me, this is the tried and tested model of a business that is incentivized to help grow sustainably in the long term and provide ongoing returns.
Now, when you’re investing in the markets you’re a participant in it regardless of if you want to be or not. And it’s definitely the case that companies definitely have an exit mentality as an option. But to a large extent, this shows up in a rather loose way of organizing and running the companies - if you’re penalized for profitability why would you ever develop those muscles after all?! If you've been looking at Tech in the last decade this surely stands out!
If dividend investing and profitability are the tried and tested methods, why has there been such a rapid switch in mindset away from them? Is it just plain “greed”, or is it something else?
I think they fall along a continuum. I mean, is Google growth or value? Or Apple? The difference is that some businesses are a bet that the future would look the same as the present, while some are a bet on a different future altogether. Both are different sorts of call options on the future. One’s a boring one though, and therefore also gets short shrift. That said I've come around to the POV that the best investment is one that gives you enough cash outflow to live comfortably, and everything else is then alpha hunting.
On a different note, how do you align long-term incentives with short-term incentives? Your VC firm Unbound’s vision is to back “100-year companies.” How do you demonstrate long-term vision when there are short-term fluctuations?1 Why is longevity investing even good if lifespans are short?
Investing for fees as funds get large is a genuine problem. It's partially ameliorated today by hiring smart people and promising them eventual riches, but there's definitely an aristocracy that gets built up. Part of the interest in longer-term investing is twofold -
The best companies e.g the tech giants are products of like decades of steady growth. In banking, insurance, energy, materials, utilities, healthcare, and so on. Compounding is magical.
It feels like one of the few areas which are anti “the growth now and forever” ethos. Whether it'll work tomorrow I don't know, but whether it'll work eventually seems an easier question.
Sam Bankman-Fried created some commotion when he compared tokenomics with VC: “This is how VCs work as well - They listen to their friends talking about the coolest projects in town and when their investors ask them about it, they say, we’re working on getting into that space.”
Do you think that’s as bad or ridiculous a model as it sounds like? How do you filter out the signal from the noise and how do you do an independent assessment? Or should you just leave perception-based investments alone?
I think it's ironically actually a rather great model. If you trust that there exist pockets of capability where there are networks of people who are innovating in a space, then the best way to bet on that ecosystem is to find a way to hack into that network. Which would, from the outside, look like listening to who’s talking about the coolest project and get into it once they hear a few people refer to the same things. The bad way to do it is to listen to any random Joe, the good way is to listen to someone who’s credibly in or adjacent to the relevant network. That’s the art.
I'd also say the most interesting parts of tokenomics I've seen are to use it to provide utility or to bootstrap a network. But they're both fragile for different reasons. First, because the utility is always hard (it's a seed stage company) and second, because the incentive structure of people in the network becomes muddied once there's trading involved.
Also all investment kind of relies on perception somewhere. Crypto is at one end because it's younger and crazier, but your equity investments also get on the hype Keynesian beauty contest pretty often. Yes, one has an underlying business, but a priori I'm not sure a basket of outcomes like f(0, 100) is less compelling than f(30, 70).
Interesting. I’ve often thought about this: how the stock of a company many times is just stock backed by a story. Why do they have greater legitimacy than crypto? Is this sort of decoupling a good thing, a bad thing, or just inevitable?
Legitimacy is a function of both utility and legibility. If something is highly usable but completely illegible it gets tough to value. As does something completely legible and easy to value.2 A story stock still is higher on present-day utility which gives credence to lower risk, also because the general vetting of companies to go public is high enough. Crypto is less legible and has no institutional grade assessment mechanisms so it's a lot more caveat emptor.
Any “independent assessment” here - in stocks, crypto, anything - has to create a few credible models of what the future looks like (bear case, base case, bull case) for a particular investment you're considering, look at the bet size (how much you're putting in), and the portfolio (total number, size and distribution of bets).
So if you're putting 2% into a crazy boom or bust bet but the rest is sensibly invested, have fun. Barbell strategies rock, as I've written before, in life and finance. Rule #1 is simple in investing, don't be stupid. Come to think of it, also in life!
What counts as an “independent assessment”? News, DCF valuation, looking through financial statements… You must have personally started somewhere, how has this evolved with time?
I started with macroeconomics, which I loved and still do. I made a brief foray into technical analysis that ended disastrously because I didn't understand it, respect it, or believe in it. I then moved to fundamental analysis, basically buying for the future in companies where I could credibly create a longer-term narrative, and this I still do. It fits me.
Regarding DCF etc, any equation where the variables are highly uncertain is pretty pointless in my opinion. Those who do it well, like Damodaran and Michael Mauboussin, use it this way: To identify the moving parts and create plausible futures, with the prices being the output of those futures even if they themselves don't mean all that much.
One other helpful note here is that if you do cases (bull, bear, etc) and you assign probabilities to those outcomes, you can get better at assessing those such that your Brier score gets better. It's like a portfolio management approach to get better outcomes for the overall ROI. Though it should always be emphasized that even if you get really good at predicting the outcome case, probabilities usually aren't the same across market cycles, meaning there are likely to be plenty of times, usually around market turbulence, when many things go to hell together.
That also makes me prefer Buffett’s rule number one, which is to not lose money!
What are you reading now?
A whole bunch of essays and articles in my pocket list, a few books (Talent by Tyler Cowen, David Graeber’s latest The dawn of everything, What We Owe Our Future, Where Good Ideas Come From, and a reread of the Culture Series).
How do you curate your reading list? And if you fall into rabbit-holes during your research, how do you pull yourself out?
I use the Marie Kondo style asking “does it bring me joy?” Reading is fun, and when it stops being fun, I stop. Information’s everywhere, there’s no reason it has to be a slog!
Fun doesn't mean you have to be a greedy algorithm, maximizing and optimizing at every turn, but that you're using your sense of fun as a guide to read and imbibe something. The trick is not to never fall into rabbit holes, but so you have enough forward momentum that even if you fall you end up coming out of them through sheer momentum. Writing helps here a lot because it's direct tangible output and helps you think, enormously!
Are there any reading/educational suggestions for our readers that will make them better investors? (Books, newsletters, podcasts, courses, etc.)
Podcasts, essays, and books, there are others out there (including where you’re reading this), which are excellent. But maybe from the left field let me suggest a few that stayed with me -
The Origin of Wealth by Eric Beinhocker
Glass Bead Game by Herman Hesse
Where’s My Flying Car by J Storrs Hall
The Nature of Technology by Brian Arthur
Do you have any idea or suggestion that our readers can take away to become more well-informed investors, or make investing a little more enjoyable and stress-free?
Know your limitations (Do you love reading 10ks or hate reading economics?)
Figure out your style (macro investing, stock picking, robo-advisor, day-trader) and
Do what you actually find interesting (otherwise you won’t follow through).
And most importantly if you don’t have time or inclination to do it yourself, just make sure you split your play money from your actual long-term investing and put the latter in a market ETF or a lovely robo.
What is one idea you discovered recently that blew your mind or changed the way you think about something?
A creeping realization that small groups of people really can affect or create entire movements that impact the world. The optionality from seemingly pointless activities like writing online is fantastic, and the internet is a brilliant place to make friends.
What this means is that the impetus needed to try something or start something is as simple as not stifling your curiosity about something. Most people will respond if you reach out. Lots of people will engage with your ideas. And with this, it’s crazy in this age of abundance to not start more things!
Which article of yours is the most popular, or most talked about? Does it surprise you?
Probably On Medici and Thiel, and Why do big businesses suck at innovation. They both surprised me, to be honest. Both were very easy to write and snagged an idea that clarified things in the foreground. I think occasionally when you write you stumble onto an idea in the zeitgeist, and that sparks a conversation you weren’t expecting!
Which article or idea of yours is your personal favorite?
Hmm, tough one. I'd probably say Hierarchical Growth Tradeoffs, or A Combinatorial Theory of Progress. First, because it really taught me a lot about the difficulties and benefits of scale, analyzing complexity, and generally systems of all stripes. Plus it has a toy model which was highly satisfying.
The second is because that's probably the article I spent the most time on. It's an idea that I really think is one of the most critical - How innovation actually happens in our society. And it has an extremely gratifying toy model I coded in replit which made me very happy when it worked out.
If you enjoyed this piece, please do me the huge favor of simply liking and sharing it with one other person who you think would enjoy this article! Thank you.
But first, go to Strange Loop Canon and subscribe (it’s free!) for more fascinating posts on innovation, what makes companies great, and thoughts on cutting-edge tech.
If you missed the link at the beginning, do take a moment to let me know what you felt about the interview.
Disclaimer: I am not a financial advisor. Please do your own research before investing.
Some examples of incentives not being aligned: This article by Nick Maggiuli shows that hedge funds maximize fund inflow and fees over long-term returns, tech companies mine attention by polarising over creating value, election races, etc.
Shout-out to Kris Abdelmessih who does an excellent job of explaining this in “Why investing feels like astrology”
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If your financial situation makes it difficult to sleep at night, something is off.
Today’s guest is my friend Jack Raines. Jack writes on his newsletter Young Money about topics ranging from risk-taking and travel, to oil commodities and the dangers of Web3. His writing is sometimes wild but always fun, complete with hand-drawn pictures. His deep-dives and honest sharing of experiences can help you understand your own tolerance and priorities. It’s one of the best reads out there to tune your psychology for investing.
If you’re strapped for time, here are the key takeaways from this interview:
Easy money doesn’t last long. Jack dives into his story of how he lost $150k in a single day trading options, and what he learned from the experience. How did he manage to do this? And is he ok now? You can just read the first question of the interview to find out.
You only have so many opportunities to do so many things and the experiences that you skip out on can’t be “bought back” later.
Knowing your priorities and having a sense of enough are crucial in investing. Money is a way to achieve freedom, stability, or access to opportunities. Once you achieve critical mass, ask yourself if the time and attention you are investing in the chase are worth it, and reprioritize.
The real alpha comes from increasing income rather than optimizing portfolio performance if you don’t have a 7 figure balance.
You know you are taking too much risk when you start rationalizing your decisions to fit what you want to happen rather than what is actually happening.
If the investment thesis can’t be conveyed in a few simple sentences, it’s probably a poor investment idea. Yes, he’s talking about crypto here. Read on to know the six reasons why crypto is not yet a good investment.
Now that you know what’s in store, strap on for a…
One of your wildest articles was “How I lost $150k in a day.” Reading that article, I was curious - How did your life get to that point? Was investing always in the plan? How did you get started?
Great question. That day marked an important turning point in my life. I’ll try to keep this fairly short.
For some context, I finished college in December 2019. I spent the next two months applying to all sorts of finance jobs (typical for a finance major), and my extended free time online led me to Wall Street Bets, the popular Reddit page. Around this time, the stock price of a certain electric vehicle company went ballistic, and some investors (gamblers?) made millions. Naturally, I felt the FOMO.
I started working in corporate finance for UPS in February of 2020, and about a week into my tenure, the Covid crash started. I saw a ton of posts on Reddit claiming that everything was going to 0, so I put all of my money in SPY puts (great risk management, right?)
I turned $10k into $30k in a few days, and I thought I was the next Michael Burry. Then that $30k turned back into $10k (because I shorted the literal bottom), and I realized I was an idiot.
I planned to invest $6,000 in my Roth IRA in index funds, and be responsible.
Until a few weeks later, when my friend texted me about DraftKings going public through a reverse merger with something called a SPAC. I was intrigued, but I had no idea what that meant. However, I tracked the SPAC’s stock price, and I noticed that
it was essentially a risk-free asset near $10 (pre-merger) because of SPACs’ redemption feature, and
when DEAC shares (the SPAC that took DraftKings public) increased by 100% or so premerger, the warrants (which are like 5-year call options with an $11.50 strike price) increased by 700%.
I realized warrants gave you the upside of call options minus the shorter time constraint, and I had to find the next SPAC. So Nikola Motors starts gaining traction. The company seemed ridiculous, but everyone wanted the next Tesla. I bought $6,000 in warrants and make $20k (it would have been like $50k if I had held longer lol). And I kept parlaying warrants in different SPACs until I hit $160k or so. At this point, I started buying SPAC shares, because they provided limited downside (redeemable for $10 cash) while still offering some upside in the bubbly sector.
At my peak, I had turned $6,000 into $400k, more or less.
Over this 10-month period, I joined and grew a community of other SPAC traders who were running similar strategies. Collectively we made several million dollars between 2020 and early 2021.
Unfortunately for me, the SPAC market got saturated (not a huge surprise, easy money never lasts long). I didn’t take any big losses thanks to the floor on SPAC prices, but the easy gains were gone. So I broke my strategy and took bigger risks by trading former SPACs that no longer had downside protection.
I had $300k+ in a buy-now, pay-later company that had gone public through a SPAC because it was undervalued vs its peers, but a poor earnings report last August cost me $157k in about six minutes (thank you, Katapult.)
I don’t know if investing was always the plan, honestly. I just got bored during Covid and found a lucrative strategy.
How has your approach to money changed over time? On the same note, is there one idea that you picked up in the last few years that changed your perspective (on money, life, career, anything)?
When I was wheeling and dealing SPACs, the only thing I could think about was “more”. I was making so much money, my dopamine receptors were off the charts. Imagine being a 23-year-old kid who made $400k from hitting buttons on his phone? Just a ridiculous experience.
However, I was becoming increasingly aware of two things:
the money wasn’t necessarily making me happy. In fact, I was stressed out by my position sizes. But I literally couldn’t stop.
Trading had consumed my life to the point that pretty much all of my conversations and thoughts were on the market.
Losing that money was a crucial wake-up call. I was still up significantly from my initial $6,000, but I was also able to step back and see just how much this had consumed my life. I cashed out, bought index funds, and decided to take a break from the markets for a while and regroup.
Around this time I also became increasingly aware of the tradeoff between money and time. This was probably a byproduct of working remotely from my apartment for 18 months on end, but I felt like I was sleep-walked through the first year and a half of my career. And honestly, it scared the shit out of me. Like, is this what adulthood is? Just doing work you don’t really like, getting paid for said work, trying to ignore the boring reality of my existence on Saturday and Sunday, and repeating it till retirement/death?
The opportunity cost of time became this idea that I couldn’t shake. And from this, I began to realize that as someone in their 20s with a newly found windfall of cash (thank you, SPACs), there were certain experiences that I could pursue now that just wouldn’t work later.
To sum it all up in one sentence: You only have so many opportunities to do so many things, and the experiences that you skip out on in your 20s can’t be “bought back” 30 years later.
So I leaned into these experiences hard. Two weeks after blowing $157k in a day, I quit my job and bought a one-way ticket to Barcelona, with no plans to return.1
What is the biggest mistake that new investors make? What can they learn to save themselves a lot of pain?
Worrying about portfolio alpha with small portfolios. If you don’t have at least 7 figures (and new investors typically don’t), increasing income is far more important than increasing % returns.2
If you have $50k, and you make a 100% return (this isn’t sustainable), you make $50k. How many other ways could you make an additional $50k by increasing your income? And you could simply invest that extra income to make market returns? Active investing is one of the few fields where you could invest 1,000 hours and still lose money.
What’s one investing decision you’re happy about in hindsight? And one investing decision you regret?
I don’t regret any investment decisions as both the gains and losses led to where I am now. The one I’m most happy about is knowing to stop after that $150k loss, because my first impulse was to think about how I could quickly earn it back. That likely would have been a disaster.
Is there any investor or institution whose approach to investing you admire?
For VCs, I think Josh Wolfe and the Lux Capital team are awesome. Josh shares a ton of content online, so I have a good feel for his thought process and how Lux evaluates possible investments.
For individuals, I basically do the same thing as Morgan Housel: buy indexes to maximize likely gains per effort exerted. I think the real alpha is increasing income to make higher net passive returns, vs. spending countless hours pursuing portfolio outperformance.
If risk is good, should investors take on risk in measured doses (like cold exposure therapy?) If so, what’s the best way of experimenting with risk?
Risk is simply risk, how investors handle it is what’s good and bad. The key is knowing what the risk is beforehand, and accepting personal responsibility for the outcomes of your own actions, regardless of the results.
A good way to know if you’re taking too much risk is if you start rationalizing your decisions to fit what you *want to happen* instead of accepting reality for what it is.
Are some kinds of risks just not worth taking? The idea that “higher risk implies higher rewards” seems to be increasingly used to sell Cryptos and NFTs, but it feels like an unfair comparison to other kinds of risk. How can people assess and separate different types of risk?
Being aware of the risk beforehand is the key. I would never recommend “investing” in casino games (aka gambling), but if you are aware of the risk and want to play blackjack, go for it. That applies anywhere.
When you find yourself rationalizing poor decisions through confirmation bias, the risk isn’t worth it. Confirmation bias is rampant where risk is highest, in my experience. Again, risk is simply risk. Investor behavior regarding risk is the factor that matters.
FOMO is probably one of the hardest things to resist. Despite scams, crashes, taxes, lawsuits, fears of bubbles, etc. Crypto still seems to persist. The fear that “we’re NGMI” is probably pushing a lot of people into things that they have no knowledge about. But I wonder where this is heading in terms of the larger trend.
In spite of your predictions in “ When community is shaped like a pyramid”, if Crypto and NFTs persist, what would it mean for investing and the economy in general?
Crypto is the nth version of a greed and fear cycle that has existed as long as mankind. The difference is that the internet has made communication and the spread of information quicker and easier than ever before. Bubbles inflate quicker and more violently than ever before as a result. (I touch on this idea here)
Think about the Tulip Bubble. If you lived in Florence, it may take weeks (if ever at all), for you to hear about this new bubble in Holland. Now? Information is spread instantly, and FOMO permeates as a result. People were launching Queen Elizabeth cryptocurrencies within 30 minutes of her death. The instantaneous spread of information has changed the game.
Could you be wrong? Can you play the Devil’s advocate and think about a world in which Crypto and NFTs have an actual use case?
Sure, crypto “could” eventually give way to a mainstream currency and NFTs could become a widely accepted form of art or be used as tickets/keys for entrance to events and groups (though I have strong doubts), but I have a few thoughts on this:
Use case ≠ good investment. Why would use cases mean that certain assets are worth $X? There is a logic gap here.
We have a trillion-dollar asset class, where startups are raising $100M+, when they are “looking for use cases.” This doesn’t make any sense. The common comparison is “oh but the internet.” Yes, the monetization of the internet in its early days had room to evolve, but the internet’s “use case” was never in question. You could exchange info and communicate with everyone. Compare that to the obscurity of Web3 startups today and they just aren’t in the same ballpark.
Tokenization encourages grifting3 and selling stories over building useful products, because you can cash out immediately if people buy into your story. If you can get paid before actually building anything useful… why would you build anything useful?
Most of the biggest proponents of this space have a vested interest in making other people believe that these projects will take off. If you front-run everyone with a crypto investment and can liquidate immediately, you are, of course, going to promote it heavily.
Seems like a lot of crypto leaders are happy to take US dollars.
The narrative changes every month. Inflation hedge? Not anymore. I have no idea what the main storyline will be by Christmas, but something will catch on.
Crypto has given me a good idea of what *not* to invest in: if the investment thesis can’t be conveyed in a few simple sentences, it’s probably a poor investment idea. The more complex jargon and ambiguous language, the biggest the red flags.
Also, it seems to me that the endgame on crypto is the financialization of everything. Do we really want to turn every interaction into a transaction? No.
Which article of yours is the most popular, or most talked about? Does it surprise you?
Some of my most popular pieces are
Another one that has less to do with money, but also performed well, is “The Case for Traveling More”.
Which article or idea of yours is your personal favorite?
My personal favorite is the “The Case for Traveling More”. I think everyone should get out and see the world more, and it encompasses one of my most strongly-held beliefs: money is best used to buy experiences.
Would you recommend any books or resources that you really love?
A few books:
Greenlights by Matthew McConaughey
Man’s Search for Meaning by Viktor Frankl
Vagabonding by Rolf Potts
The Psychology of Money by Morgan Housel
The War of Art by Stephen Pressfield
Finally, do you have any idea or suggestion that our readers can take away to become more well-informed investors, or even make investing a little more enjoyable and stress-free?
If your financial situation makes it difficult to sleep at night, something is off. Maybe this means your bank account is empty. Maybe you have plenty of money, but you are on call 24/7 with a stressful job. Maybe you have taken on too much risk in your portfolio.
The “can I sleep well” test holds up well.
If you enjoyed this piece, please do me the huge favor of simply liking and sharing it with one other person who you think would enjoy this article! Thank you.
But first, go to Young Money and subscribe (it’s free!). It’s one decision you won’t regret.
Disclaimer: I am not a financial advisor. Please do your own research before investing.
A side note from Jack: I had been accepted to Columbia Business School back in 2019 through a deferred enrollment cohort: basically I would work 2 - 5 years before starting my MBA studies. I knew I was going to Columbia in Fall 2022, so I gave myself 1 year to quite literally have as much reckless fun as possible as a 24-year-old. 1 year later, no regrets.
Note from Market Sentiment: Throwback to my article on getting a good start, which covered this in more detail.
Note from Market Sentiment: The Golden Age of Grift by Jack is one of my all-time favorite articles.
To kick off this series, we have LibertyRPF, a good friend of mine. Liberty writes about investing, technology, art, and anything he’s curious about. He sometimes dissects companies looking at their quarterly numbers. At other times, he curates trends in culture and technology. His interviews with experts are some of the best. That’s one reason I love his newsletter: Great investing ideas can come from anywhere - what matters is whether they work or not.
This issue should take you about 20 minutes to read. I highly recommend reading the whole thing. It’s packed with ideas! But here’s a guide to skip to the sections that most interest you in case you want to revisit them later.
Introduction: Using what you know
Investment as lifestyle design
Assessing funds and understanding crypto
Designing your own information stream
Liberty’s investing process and advice
Enjoy the interview! If you’re new here, you can subscribe by tapping this button for content that will make you a smarter investor:
Hey Liberty,
First off, I want to say that I’m a big fan of the way you approach life and investing - I never know what I’ll find when I open your newsletter, but there’s the possibility of finding some interesting insight or perspective from which to think about things that can change the way I see things. And I love that you don’t restrict yourself to investing - Who knows, maybe the best ideas are cross-disciplinary!
Thank you! I appreciate the kind words, but mostly, I appreciate that you are reading! I know everybody is busy and has countless options of things to spend their time on, so I take it very seriously when someone decides to allocate slices of their life to my stuff.
The thinking behind the newsletter was that I want to always keep it a top priority to have fun doing it, because nothing is forcing me to spend so many hours every week on this project, so if it’s not fun, I’ll just do something else – any other long-term goals for the newsletter won’t be achieved if I don’t stick with it, and I won’t stick with it if it’s not fun…
This constraint has informed all other choices. It’s why I don’t restrict myself to just business & investing. There are so many interesting things out there that don’t fit neatly into that category, and I’d be sad if I felt I couldn’t cover them. I also think that on the other side of the screen – on the reader side – people are multi-faceted, they want a variety of stuff, and what matters most to them is whether it’s good or not, not whether it fits into category XYZ.
But I think you’re right that many great ideas are found at the intersection of fields, or by combining things learned here and there. I’ll never beat specialists at their game, so I have to lean into being a generalist and try to leverage the 80/20 rule with as many fields as possible so that my ‘100’ turns into ‘400’, so to speak.
What you are doing is probably every retail investor’s dream - To be able to read and study the topics that you are interested in, while also using that information to get positive returns in the stock market.
I think it’s indeed a lot of people’s ‘dream’ to do something similar, achieve some independence, and have the freedom to work on what they want to work on, but I don’t think that many people actually want it enough to put a plan in place and execute on it. It’s more of a passive dream, in other words. I think most people are more secure following a conventional path when it comes to career and lifestyle. It takes a certain contrarian streak to do things differently from all your peers and family, and because it takes a long time for the plan to bear fruit, you have to be comfortable spending years with everyone doubting you and your decisions.
Once I decided that the thing that made me happiest was control of my time and the freedom to decide how I spent my days (I didn’t pick the name ‘Liberty’ totally at random, after all), it took me 11+ years to get to the point where that was possible.
I never had a particularly high-paying job, but I had a plan and my wife was on board (she’s as frugal as I am, if not more), so we just executed. The math works if you make the trade-offs required, but most people seem to want the results 1) quickly and 2) without downsides, so that’s why it stays mostly a passive dream.
How was the road to the place you are at currently? You started out reading about things that interested you, technology, aerospace, etc. but at what point were you confident enough in your abilities to start investing based on your insights? Was there a defining moment to take the leap?
I’ve always been curious about lots of things. I grew up obsessed with fighter jets, computers, music, video games, movies, etc. There’s never really been a thing that was obvious to me growing up that I should dedicate myself to at the exclusion of all others – in large part because it didn’t feel possible to me, growing up in a relatively modest background where few achieved much, and not speaking English until in my mid-teens – so I kind of always picked paths that left me with options, but if I had to redo things I’d do them differently (we make bad decisions when we’re 16-17…).
Science & Technology always fascinated me because through them you can understand so much of the world, and there are always new things to learn, either by digging deeper into something or by following the new things as they are discovered and built.
But I never wanted to spend my days on just one piece of tech or science. Learning about it is the part that I like, not the day-to-day minutia of execution, spending 6 months on some bit of code that is part of some API, or synthesizing some proteins to see if they react in useful ways or whatever.
It’s only later in life that I discovered that business & investing were also great lenses through which to understand the world. When humans want to do something difficult, they usually have to band together and get equipment and tools and build things, and the best way to do that is to form companies, which are financed by investors, etc.. So by understanding these companies, I could understand more of the world, but it had the added benefit that I could also try to earn a living doing it!
I think that’s why I settled on investing as a full-time gig. So during that decade+ when I had a real job, I learned about investing in parallel, maybe spending 50 hours a week at the real job, and 20 hours on investing. That worked until my wife and I had kids – thankfully around then I had been saving most of my income and investing it for enough years that I could go full-time with the investing.
Does being an individual investor need a minimum corpus to be viable, in your opinion?
I feel like as an investor, you can never know if you’re any good or be sure that you’ll make it, but you can do your best to mitigate risks and to build confidence over time, from experience. So you need a minimum amount of capital to get started, but that number will vary a lot depending on your expenses (which are largely under your control, don’t let anyone tell you differently. It just may mean hard choices and trade-offs), where you live, do you have a partner, etc.
There’s a video by Pete Adenay (aka Mr. Money Mustache) that I often recommend to young people who are kind of thinking about becoming financially independent – not to go on a beach and do nothing, but to have more options and because working is more fun if you don’t need the money:
You’re a huge fan of Richard Feynman (so am I), and have also talked about your fascination with Shannon - Two thinkers who were wildly original, thought from first principles, dabbled in a variety of fields, and also prioritized fulfillment over profit. Has your study of Feynman and Shannon influenced you or given you any principles that you can use to think about stocks?
My first son’s middle name is “Feynman”!
I’m not sure how much of a direct impact Feynman and Shannon have had on my investing, but they have had a big impact on my general decision-making and thinking, and what is investing if not that? So definitely a big indirect impact.
When it comes to physics, you can strip down a problem to the basics and build from there. But when it comes to stocks, it’s not quite clear what the basics are. “Are stocks correlated with their companies? Does value investing work? Does macro matter? Is it all about emotions or price action?” There are so many directions to choose from.
How do you build fundamentals or a framework to think about the market when it’s not clear what the first principles are?
There are so many ways to invest, it feels a bit weird to call all of them by the same name. The analogy I like is this:
Everything at the Olympics is “sports”, but it’s very different to do power-lifting vs sprinting vs decathlon.
So I’m sure some quants have a very physics-like approach to investing, treating stocks and macro as probabilistic clouds of elements with certain properties that can be analyzed and predicted to some extent, trying to make money by identifying inefficiencies and aberrations and overlooked correlations and all that.
That’s not my approach, I’d have no idea how to execute such a strategy.
I’ve long ago accepted that I’ll never be the best investor out there, and that I need to be clear on what my goals are if I don’t want to drift into directions that lead to bad outcomes (either losing money in avoidable ways, or making moneys in ways that make me miserable day-to-day).
I call the concept ‘Investment Style and Stock Selection as Lifestyle Design’ and wrote about it here.
What’s that approach like?
The general idea is that whatever I invest in, I’ll spend my days thinking about (reading about, learning about, discussing with others). So I don’t want it to be things that don’t interest me.
Maybe I could make more money by constantly following the “best forward IRR” around, but if that means being bored or miserable, I’d rather have a lower CAGR and be happier by looking at things that I find inherently interesting, on top of being potentially good investments (there’s still a hurdle that needs to be cleared).
In the same way, maybe I could become a better investor if I cut everything out of my life that isn’t helping me be a better investor. But would that make me happier? I’m making these kinds of trade-offs to achieve satisfactory returns AND do things that I find interesting day-to-day.
Too many people forget to optimize for happiness, they just assume that “more money = more happiness”, but that’s clearly not true, especially above a certain amount that covers life’s basics and a few niceties.
You once mentioned that you started out by studying index funds and then realizing that Berkshire is an index fund of just “good companies.” And then you went on to find others like Fairfax, Leucadia, Constellation, etc.
How do you assess such funds and managers? Because past performance is no guarantee of future performance, but more importantly, if there’s a drop in performance, it could be the fund failing OR it could be the market - How do your emotions play out and how do you handle them?
It’s a good question. I think it comes down to a judgment call every time, but you can build your confidence in companies and management teams over time.
It’s why I tend to hold positions for many years. It takes a long time to get to a point where I’m really comfortable with a company, and so to replace it with something else, the new thing doesn’t just need to have a better return profile, but it needs to be better enough to compensate for the fact that I’ve known this new thing for a lot less time and have a lot less confidence that I’m not misjudging it or that management will really deliver.
For example, I’ve owned Constellation Software for almost a decade. In that time, I’ve seen it all – good times, bad times, short attacks, changes in capital deployment approaches, etc – and all this ‘data’ helps me interpret what happens going forward.
There are other companies that I’ve only been following for, say, 1 year. I really haven’t seen them go through ups and downs, I haven’t seen management under fire in the trenches. I may have read about their history, and that helps, but it somehow is never quite the same as living through it myself.
My approach to assessing companies and stock strategies is usually just to look at the numbers - historical performance, benchmarks, etc. But there’s a risk with that, because there might not be sufficient data to analyze funds or companies that have a very short history, which might go on to do really well! How has your focus on stories helped you identify good opportunities here?
I like NZS Capital’s approach (can’t predict the future, so focus on a barbell of companies with resilience and optionality). I think it’s a probabilistic call, so if a company doesn’t have much of a track record, it’s in a fast-moving industry, it’s growing fast and could become huge, but maybe it could fail to become profitable or a competitor could win the space, etc… I feel like this falls into the optionality bucket, and I would tend to size these positions smaller.
This way, if they don’t work out, not much capital was at risk, and if they do work out, they may turn into big positions organically, and by then they tend to be more predictable and resilient with a more dominant position in their niche, so they deserve the bigger portfolio allocation.
Case in point, this is one of my favorite illustrations of yours: How to think about crypto. Especially because this is such a nascent space and it’s driven so much by stories, finding the good investments is quite difficult. How would you approach the problem of finding a good investment in this space? Making sense of the stories?
With my approach, I do focus a lot on qualitative aspects. Some may call it stories in a pejorative way, but I think that if you’re in a relatively new space, you have to understand products, competitive dynamics, secular trends, management quality, R&D velocity, the stickiness of products, that kind of stuff.
The numbers alone don’t tell you enough to make a bet if things are very new, very fast-changing, or very competitive. Two companies could have the same set of numbers – same gross margin, same growth rate, same EBITDA margin, etc – but one may have a commodity product that is easy to swap for a competitor’s and be selling something that isn’t mission-critical and will be cut at the first sign of economic trouble, while the other may be selling the equivalent of an Oracle database that will still be used by customers in 30 years.
On crypto, I kind of don’t feel it’s a separate thing from the rest of the businesses out there, so the same criteria should apply. Are you solving a real problem for your customers? Are you doing it in the best way? Can someone else replicate what you’re doing easily? Is management high-quality (integrity, intelligence, etc)? Is management aligned with shareholders? Stuff like that.
Too much of the crypto I’ve seen have been ways to speculate on crypto, ways to lever up your crypto speculation, etc. I don’t find speculation inherently interesting, so I tend to stay away from it and wait until I see other kinds of hard problems being solved by projects.
One of the things that you do, apart from creating “serendipity” and introducing people to new things, is that you also curate information for your readers. That’s a great advantage to the people who follow you - They might be specialists, but they get exposure to great ideas from many other fields while focusing on what they are interested in. I want to understand your process a little better:
What does your day look like? How do you identify ideas to explore or things to read?
How do you design a good reading feed?
Thank you. That’s the goal! There’s way too much stuff out there for most people to sift through, and social media isn’t doing a great job of it because it isn’t aligned with giving people what is most interesting, what makes them learn, what makes them think about life differently, etc. It’s optimized for “engagement” and “time on platform” and “ads clicked” and such…
So human curation with a point of view, a personality, not just some bland list of links or machine-learning generated summaries - I think that’s valuable.
“And since it’s curation all the way down, my own day is largely based on how I’ve curated my sources. It’s a mix of who I follow on Twitter (lots of other good curators), my RSS feed, Google Alerts, etc.
One way to think about the importance of curation is that who you decide to follow now largely defines the thoughts that will be in your head later.”
That’s why I don’t understand people who follow 2,000 accounts on Twitter, including lots of noisy ones. Or even just switching from the algorithmic to the chronological helps, because the algo optimizes for engagement, so they’ll show you tweets by popular accounts that get lots of clicks. But some of the best accounts I follow are small accounts that post rarely, but have a very high signal to noise – I don’t want the algo to hide those from me…
You have discussed Personal Knowledge Management tools - what’s your process for integrating all the random bits of information you find in your day so that you actually end up using them? (Because I find that a large portion of my notes remain isolated and unused. Though they sound interesting on their own, they don’t integrate with my main body of thinking)
My personal knowledge management is mostly split between Notion for newsletter stuff, and Obsidian for everything else (which includes all the investing stuff). I have a “working memory” Apple Note file that I keep open on my desktop and phone and I can dump anything quickly there, and then process it later into longer-term storage if necessary.
I did a mini-podcast where I discuss my note-taking a bit:
Are there any reading/educational suggestions for our readers that will make them better investors? (Books, newsletters, podcasts, courses, etc.)
There are lots of them, and that’s kind of what I put in the newsletter.
But here’s one that I’ll recommend: Founders Podcast by David Senra.
He has read hundreds of biographies and memoirs from entrepreneurs, founders, and other interesting people (leaders, scientists, filmmakers, etc). So much to learn from the lives of these people!
How is your process for studying investments different from your general reading?
How do you go deeper into studying companies?
You once mentioned that a company’s ability to iterate fast is a good characteristic. Is there such a set of qualities that you look for in a company that you plan to invest in?
It’s a very organic thing. I look at lots of things, and most just bounce off me fairly quickly. There’s something I don’t like, or something I don’t understand, or I’m just not interested in digging deeper, and so that goes into the “no” pile or the “maybe later, we’ll see” pile.1
But some things just obsess me for a while. I start reading everything I can find, I start talking to people who have been studying it for years or work in the industry, and over weeks and months I build up lots of notes.. It all swirls around in my brain for a while, and at some point I just know that this is something I want to own.
The actual qualities and characteristics to look for and avoid aren’t particularly original, they’re the same as most people are looking for to determine what’s a good business likely to generate good returns for shareholders (mix of business quality and valuation).
For some businesses, you can clearly see what the ROIC and FCF/share trajectory is, for others you have to guess at what a more mature state may be, because they may be in fast-growth, heavy-investment mode. But at the end of the day, it’s about someday getting the most FCF/share that you can for the lowest price that you paid.
I’d like to understand your investing process a little better. This might be the most helpful part for our readers.
Do you agree with Peter Lynch’s “Invest in what you know” philosophy, or are there some caveats that our readers need to keep in mind?
I’m a bit more Phil Fisher than Peter Lynch, but with my approach, it definitely helps to invest in things that I feel like I understand well enough that I won’t be the last to know if things change in the space.
But I also know that it’s entirely possible to invest well without knowing much about the actual business, just generating a large portfolio with tons of positions using quant factors.
It’s more important to know yourself and what works for you than to try to find the optimal investment approach in the abstract, I think.
What is your typical time horizon for investments? Have you experimented with this?
Time horizon tends to be multi-years, ideally decades, but it’s not really up to me. I can’t know in advance which businesses will keep executing and which will stumble, so it’s about watching what you own carefully and keeping a flexible mind to whatever may come (opportunities and problems).
What does your portfolio look like? How do you manage risk and the emotional side of investing?
I try not to give too much details on my portfolio mostly because I want to strike a balance between being able to discuss what I own to get feedback and learn more, but not get so publicly identified with ownership of certain things that it becomes harder to make changes if I need to (Another thing to note is that there are some of my big positions that I don’t talk about because there’s not much to say, and some of my small positions that I write about frequently because they’re more interesting and more is going on with them – people shouldn’t assume that because I talk a lot about something that I own a lot of it, or even own it at all, because there’s a lot that I follow that I don’t own, though maybe I sometimes wish I did…)
Risk management: Ego can lead to mistakes in investing as in the rest of life, so finding the balance that works for you where your ego doesn’t get wrapped up in investments tends to help results over time.
How have the portfolio’s returns been so far? How do you measure its performance?
Everything about how I measure performance is pretty vanilla. I just know what kind of returns I need to achieve my goals, and as long as I’m above that over the long term, everything else is fine. I do benchmark against indices because that’s my alternative if I decided not to invest, and so far I’ve been doing well there, but I try not to see it as a day-to-day, quarter-to-quarter competition.
I know sometimes I’ll be ahead, sometimes I’ll be behind, but there’s no finish line, no prize when I’ve made it (as an investor, you can always lose it all tomorrow, whatever your past track record was). I just want to keep playing the game, that’s my goal.
Which article of yours is the most popular, or most talked about? Does it surprise you?
Probably my first interview with David Kim (aka Scuttleblurb). He’s great in it, so all credit to him:
Which article or idea of yours is your personal favorite?
Hmm, that’s another really good question… I know there’s a bunch of stuff I’ve written about that is really close to my heart and important to me, but like in #1 above, I can’t really put a finger on it…
I do really like the conversation I had with my friend David Senra on a podcast we did here:
Last question: Do you have any idea or suggestion that our readers can take away to become more well-informed investors, or even make investing a little more enjoyable and stress-free?
The answer is of course to become a paid supporter of my newsletter! Haha
I feel like in my early years, I used to read lots of investing and business books. Now I mostly read biographies and history and science/tech stuff. I think it has helped my investing a lot by broadening my knowledge base.
There are real diminishing returns to always reading about the same things, so I would recommend branching out and trying new things. You may not like some of them, but maybe others will become your new favorite things, and who knows when an idea that you’ve learned in some other field will be extremely valuable to you?
Hey reader! This is the first time I’m doing something like this, so I really want to know how you feel about it. Check out this Google Form and let me know.
If you enjoyed it, drop a like and share it with a friend who’ll thank you for it.
But first, go to LibertyRPF and subscribe (it’s free!). It’s one decision you won’t regret.
Note from Market Sentiment: Interestingly, Warren Buffett and Charlie Munger do this too - If there’s something that is not worth the attention trade-off, they push it to a “too hard pile” for later. Filtering out noise quickly is indispensable!