Every so often people start talking about investing superpowers. If you could have one investing superpower what would it be?
The power to regularly source and legally trade on material non-public information would be my number one pick. But that’s kind of against the spirit of the game.
So my backup pick is “infinite and overwhelming luck in the markets.” I’d rather be lucky than good. Always. Not trying to get onto any World’s Greatest Investor Lists here. I’ll take my winnings any way I can get them and leave it to you all to fight over multifactor return decompositions of my performance.
If you are a regular reader you will recall that my favorite portfolio shape is “core and explore.” There are different permutations of this, but the basic intuition is a diversified core designed to harvest broad market risk premia alongside a speculative sleeve of public and private investments. In the speculative sleeve, much of what I am trying to accomplish is “putting myself in a position to get lucky.”
What does luck look like?
Luck is when something goes from reasonably valued to wildly overvalued.
Luck is when you own something that turns into a meme stonk.
Luck is when the market bails you out of a position when you’re wrong.
I realize this is fairly trite. Of course it is good to get lucky. Money is money. There is a larger point here though and that is to embrace the role of randomness in investment outcomes. Flow with it. Don’t fight it.
Spending a bit of time gambling can teach you a lot about how you respond to risk. Casino games are dumb in the sense that for the most part they are negative expectation games. One (very) small thing you have going for you, if you don’t play regularly, is the short-term variance of outcomes. The casino’s edge manifests itself over many repetitions, across many players. This goes for advantage players, too. A card counter doesn’t win every night. And in the markets, there is a reason “true” quant portfolios have the shape they do.
Anyway, if you spend some time gambling it will not take you too long to experience streaks. Runs of extraordinarily good luck. Runs of extraordinarily bad luck. Of course, mathematically this is just noise bouncing around a (negative) mean. You’re just riding the output of a random number generator.
But that’s not how it feels. For us human beings, random outcomes don’t feel random. One of the hills we die on here on this site is that working within our evolved biological and physiological constraints will lead to better outcomes than fighting them.
A wise man said of investing:
Life goes in streaks and like a hitter in baseball, sometimes a money manager is seeing the ball and sometimes they’re not. If you’re managing money you must know whether you’re cold or hot, and in my opinion when you’re cold you should be trying for bunts. You shouldn’t be swinging for the fences. You got to get back in a rhythm […] If I was down I had not earned the right to play big and the little bets you’re talking about were simply on to tell me had I re-established a rhythm and was I starting to make hits again.
Another theme of mine is that in investing and trading, different failure modes are common to different “levels” of play. Absolute beginners typically suffer from indiscipline. They have no real strategy or epistemology of markets. They risk shotgunning capital all over the place without rhyme or reason, often at the urging of some online grifter.
More advanced players can develop the opposite impulse: holding too rigidly to a strategy, or epistemology of markets, or specific idea. Trying to “force” returns. A hedgie fund on a cold streak should not be taking her gross exposure up, swinging aggressively. She should be working toward re-establishing equilibrium.
The impulse to double down on losing bets is a strong one. Professionals are hardly immune. What’s more, our susceptibility to this impulse is not constant. It changes with time and circumstance. There can be significant personal and business pressure to double down in the investment game. People fetishize conviction. It’s an anchor point in a frightening, dynamic and random world. There is a fine line between courageously pulling the trigger and recklessly doubling down. Walking this line is part of the game.