Luck

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.

Ideas

Let me tell you about an extremely stupid thing I used to do with money.

There was a time, not so long ago, when I couldn’t bear to put money in an idea I didn’t come up with myself. This was dumb. I compounded the dumb with a preference for esoteric, off-the-run stuff with a lot of hair on it. gReEdY wHeN oThErS aRe FeArFuL. nO eDgE iN aNyThInG wElL-cOvErEd. Something like that.

In retrospect this was pure ego. Unearned arrogance.

The small self-directed investor has two key advantages:

Key Advantage Number 1: She has no capacity constraints (there is little slippage when she trades).

Key Advantage Number 2: She does not have career risk to manage.

The small investor is ideally suited to parasitism. The concept of parasitism has a negative connotation. Parasites are pretty gross. (Botflies. Yuck) For Americans like me, parasitism is the antithesis of the whole rugged individualist mythos that is deeply ingrained in our culture. Parasitism is icky.

But for the small investor, parasitism is beautiful.

As a small investor, you can buy almost anything. And you can do it without having to write 75-page diligence memos or pitching positions to investment committees. You are not under pressure to justify a management fee. You are not imprisoned in a small cell in the equity style box. You don’t have to fire yourself for style drift. This is beautiful. It is an enormous advantage.

All you have to do is look for money the big players are leaving lying around.

Then pick it up.

(it’s not that easy, of course, but that’s what it feels like when it’s clicking)

Actually doing this can feel incredibly stupid. Things that can make you a bunch of money are often incredibly stupid. From intellectual point of view, dip-buying large cap equities is super lame. There isn’t going to be a Michael Lewis book about a bunch of pikers dip-buying Facebook to scalp a quick 50% return.

Ignore this feeling of stupidity. The only lame ideas are the ones that lose money!

People expend a lot of time and energy editorializing about how there is no edge in picking large cap stocks. There was a time when I did the same. Now I see it differently. Now, I think an issue is that a lot of strategies are not designed to take advantage of the best opportunities in large cap stocks. Perhaps some of the more interesting opportunities in large caps come from thinking more like a trader than an investor? This is just one silly example.

Muni closed-end funds offer these kinds of opportunities every couple years. The market gets scared. Liquidity dries up. Discounts to NAV blow out. There’s money lying around all over the place, and all you have to do is pick it up. (assuming you’ve got liquidity, of course)

This isn’t to argue that simple ideas are always best, or that complex ideas are never good. This is an argument for maintaining an open mind, and an argument against allowing ego to filter ideas.

Be open to a good idea whenever it may find you! There are no point adjustments for originality or degree of difficulty. It took me too long to realize that and accept it.

Fear

Nothing wrecks portfolios quite like fear.

The fear-based failure mode we know best is the whipsaw. An investor suffers a drawdown. He liquidates his portfolio when the pain and frustration become too much. He just can’t take it anymore. Then the market rallies. Our investor becomes paralyzed by indecision. He is afraid the rally will unwind. So he sits in cash. Maybe for months. Maybe for years. Finally, after a period of stability, he gets invested again. Just in time to eat another drawdown. This is a Behavioral Investing 101 case study. It’s a failure mode strategic asset allocations are intended to mitigate.

Other fear-based failure modes are more subtle.

One I frequently see among professionals is the fear-based tactical trade. At any given point in time, financial product marketers and the financial media are usually pushing at least one major fear-based tactical trade. Right now it’s all about inflation. Fear-based tactical trades are the pro and pro-am version of the archetypical whipsaw. These are highly discretionary trades. They’re usually based on some high attention macro narrative.

Macro narratives lend these trades credibility, and perhaps more importantly, Very Serious optics. But make no mistake. Fundamentally, these are emotional, fear-based trades. They just come with more sophisticated-sounding rationales (and sophisticated-looking charts).

So, it’s not that portfolios shouldn’t be positioned to withstand inflationary regime changes.

It’s that if you’ve never spent any time developing a process for handling macroeconomic regime changes, you’re sure as hell not going to develop one reading “timely,” thinly-disguised sales pieces about such-and-such assets as inflation hedges.

At my day job, I often get emails about whether it is time to add TIPS to portfolios, or gold miners, or crypto. My response is almost always some variation on the following:

What are you trying to achieve here?

What role does this asset play in the context of the overall asset allocation?

What process will you use to size and adjust the sizing of this position over time?

Most importantly, how will you know if you’re wrong?

And if it does turn out you’re wrong, what are you going to do about it?

Making highly discretionary trades with a finger in the air based on salesy whitepapers and/or financial doom porn is not a process.

Fear is natural. Occasional bouts of fear are inherent in risk-taking. As long as fear is not persistent, or debilitating for decision-making and daily living, it is a healthy emotion. In a financial context, fear is a signal to revisit strategy and process. Consider fear in the context of the game(s) you’re playing. Much of the time, you’ll conclude that it’s just part of the game. Occasionally, however, careful consideration may trigger an adjustment.

Risk tolerance is not easy to measure. Nor is it static. There is a dynamic element to it. Sometimes fear signals you are taking too much risk relative to emotional or even financial tolerance.

Fear may also point you to vulnerabilities in a strategy you may not have considered previously. This is an opportunity! The inflation example is instructive here. In my experience, “mainstream” portfolios tend not to be well-balanced to highly inflationary regimes (particularly stagflationary regimes). In this case, fear may lead to some introspection that results in a more robust overall strategy.

Tempo

A wise man once said: there are decades where nothing happens and weeks where decades happen.

This is true in all areas of financial life. There are long periods of relative inactivity. Automated savings programs do their thing in the background. Everything hums along. Then there is a major life change requiring critical decisions be made in a short span of time. You sell a business. You inherit a large lump sum. Someone gets sick. You lose a job. Suddenly a whole bunch of decisions need to be made all at once. When it rains, it pours.

This is particularly true of investing. Investments have their own peculiar tempos. Much of this is a function of investment strategy. Volatility trading is high tempo. “Permanent equity”-style fundamental discretionary investing is low tempo.

You can think of tempo in terms of the velocity of critical decision-making a strategy requires.

Volatility trading requires lots of critical decisions at frequent intervals.

Fundamental discretionary equity investing requires fewer critical decisions at less frequent intervals.

Tempo varies further at the level of individual line items. If you are buying a Class 1 railroad because of the industry structure and potential for excess returns on capital over decades, you are looking at a classical low tempo investment. The cadence of decision-making and information processing should match a multi-decade investment thesis. For investments like this, you might make one or two decisions per year (usually whether to average down or not). You might read an annual report and a couple quarterly earnings reports in detail. You’re going to spend a lot of time thinking about capital allocation. You’re going to spend hardly any time thinking about quarterly earnings beats or misses.

Dumpster diving is a higher tempo activity. If you are buying a deeply cyclical stock early in a recovery with an eye toward a quick double or triple, you will have more decisions to make on shorter time horizons. Here the quarterly beats and misses will matter more. You may need to watch daily newsflow and price action. You should probably trade the position actively.

A pet theory of mine is that high tempo investments and strategies offer the potential for returns less correlated with broader market averages. In theory, these are wonderful return streams. However, they are higher cost in terms of time, energy, resources and degree of difficulty. It’s a higher brain damage approach.

The ultimate low tempo investment strategy is diversification within a strategic asset allocation. Here you rarely need to make any decisions at all, beyond a rebalancing discipline. You’re just harvesting broad market risk premia. The advantage to this approach is that it can be done cheaply and easily. The downside is you’re hostage to broad market risk premia. Broad market risk premia are neither guaranteed nor static.

There is no “right” tempo to maintain in a portfolio. What matters is awareness. Being in sync with the natural tempo of each investment. Don’t fight this! Fighting it is a good way to make yourself crazy. It will also destroy your returns.

In my experience, the more common failure mode is going too fast, and trying to pull large returns forward. There is a human itch for portfolio activity. Sometimes we simply get bored. For professionals, there are business pressures agitating for activity. Investors in funds want to know you’re “doing something” with that management fee. Unfortunately, there isn’t a 1:1 correspondence between “stuff done” and “returns generated.”

Another pet theory of mine is that the best money managers know this, and much of what they sell to investors and consultants under the guise of “process” is just elaborate theatre. Look at all this “stuff” we’re doing with that management fee! Obviously we’re taking all this Very Seriously. Would you like to talk top positions now?

The best way to develop an intuitive understanding of tempo is to spend some time meditating. You don’t have to get all woo-woo about it like me. Any old secular mindfulness routine will do. The important thing here is the experience of observing the activity in your mind from a distance. If you meditate with some regularity, you’ll begin recognizing different states of mind.

Some days you’ll find your mind engaged in constant, unfocused activity (meditators call this “monkey mind”). At other times you’ll find the mind fogged with sleepiness. On occasion you’ll find your mind in a relaxed, yet oddly focused state of readiness. When I’m “in the zone” in this way, directing attention to particular mental objects and holding it there is trivial. Almost effortless. This is what in-tempo investing feels like to me (in-tempo golf, too).

Mishits

The chief virtue all beautiful investment portfolios share is parsimony. Each line item serves a purpose. Intentionality is evident in the position sizing. There is a clear awareness of risk/reward tradeoffs.

Ugly portfolios are clueless.

Ugly portfolios are tentative.

We’re going to talk about these failure modes today. And because it’s spring, we’re going to do it using golf metaphors.

First, cluelessness. Individuals seeking financial advisors frequently show up with clueless portfolios. People end up with retirement accounts scattered across a bunch of old employers. Maybe some rollover IRAs. They forget about accounts. They make incorrect assumptions about how old accounts are invested. Aggregate the holdings and you find the portfolio is 50% cash. It has been for years. This is not uncommon. The explicit and implicit costs of cluelessness can be immense.

Then there are clueless portfolios that are more or less rudderless. They have no overarching philosophy or strategy. They are invested based on financial news media reports. Financial professionals sometimes display a more sophisticated form of cluelessness, based around an entirely subjective interpretation of macro commentary and sell-side research. There is nothing inherently wrong with discretionary trading and investing. But a discretionary strategy should have some demonstrable efficacy. There should be some underlying rationale for its repeatability.

Cluelessness is a technical failure mode.

In golf terms, you don’t know how to swing. You misjudge distance. You don’t know your game well enough to judge risk/reward across your shot repertoire. Maybe you don’t think about those risk/reward ratios at all. All these issues can be addressed with education, training and equipment.

Tentative portfolios are a different matter. A tentative portfolio is an uncommitted portfolio, which is NOT to be confused with a conservative portfolio. Both conservative and aggressive strategies can result in uncommitted, tentative portfolios.

A tentative portfolio fails the same way as a tentative golf shot. Say you’re playing your second shot on a par five with a creek to carry. You can play a conservative, high percentage shot you’re almost certain will carry the creek and leave you a wedge into the green. Or you could play an aggressive, low percentage shot to go for the green in two. Visions of eagles dance in your head.

A common failure mode is to choose an aggressive shot but not commit to the swing. You’re afraid of mishitting the ball (it’s a low percentage shot after all); the potential for a mishit begins to dominate your thoughts; you take a tentative swing and all but guarantee yourself a poor shot. Perversely, you’re more likely to end up in the creek.

Say you do end up in the creek. Now you’re frustrated. You KNEW you should have hit the more conservative shot but instead you’re lying three next to a goddamn creek that shouldn’t even have been in play. Now you CAN’T play a conservative shot. Now you have to get up and down just to have a shot at par. So you load up for another high risk/high reward, low percentage shot. The cycle repeats.

Tentativeness leads to frustration leads to anger leads to playing on tilt. You will never win anything playing on tilt. Not in golf. Not in the market.

It is not necessarily a mistake to play the aggressive shot. Depending on the round, the juice may be worth the squeeze. The real mistake is choosing a shot you are not committed to executing. And sometimes it is better to play a lofted club to get back on an even keel.

Tentative portfolios take tentative shots. These are equity-centric portfolios with a five percent allocation to VC access vehicles, a five percent allocation to gold, and a three percent allocation to tail risk. These are the portfolios we joke about as contra indicators, that are only invested when it feels good then massively de-risk at the first hint of trouble. They hedge “opportunistically” (read: overpay for downside hedges at the wrong time).

For financial advisors, tentative portfolios often result from principal-agent problems. The client is afraid of hyperinflation, so you add a little gold. The client has FOMO, so you add a bit of VC. The client is a Taleb stan, so you throw in some tail hedging. Taken to extremes, you end up with The World’s Most Expensive Index Fund. A hundred line items and an R^2 of 0.90 to the S&P 500.

A wise man once said of career risk: it is better to fail conventionally than succeed unconventionally.

I would respectfully amend that: it is best to fail conventionally while doing Very Smart Things.

At the principal level, tentative portfolios reflect an unwillingness to accept the risk/reward tradeoff inherent in a strategy. You’re going for the green in two but worried about a potential mishit. So you start doing little things inside the portfolio to make you feel better. Some of them work, some of them don’t. The degenerate form of this is repeatedly whipsawing yourself, in size.

Unlike cluelessness, this is an emotional failure mode.

It’s easy for professional investors to dismiss emotional issues as normie issues. However, all the spectacular blowups I’ve witnessed and studied have had a significant emotional dimension to them. For the professional, getting tilted is more insidious. It’s easy for us to reframe emotionally biased decision-making in optically objective, rationalist terms. Confirmation bias is a hell of a drug.

I’m fond of the golf metaphors because the mental and emotional aspects of golf are quite similar to the mental and emotional dimensions of trading and investing. In both cases, improved performance requires an honest, realistic assessment of your game and a process-oriented mindset. Which is all very zen. If you are a 20 handicap, don’t select shots as if you were a 5 (though it helps to learn to think like one). This is also very zen.

Understand the shots you have at your disposal.

Be intentional about selecting shots to play.

Commit.

Note: I can’t post this note without reference to two of my favorite golf books. Much of this note is based on the material in these books, which is applicable not only to golf and investing, but daily life.

Every Shot Must Have a Purpose by Pia Nilsson, Lynn Marriott and Ron Sirak

Golf is Not a Game of Perfect by Dr. Bob Rotella and Darren Clarke

Karma

Here is the attention game in a nutshell:

  1. Identify the zeitgeist around certain issues. Preferably related to sex, money and power.
  2. Choose a side (there are always sides to choose).
  3. Identify your side’s talking points and the opposition’s talking points.
  4. Hammer them. Relentlessly. Toss digital Molotov cocktails at accounts with large, bellicose followings. For best results, use memes.

On Twitter, the platform I know best, the game is about attracting RTs and quote RTs from large accounts. It doesn’t matter whether they’re positive or negative. If anything, you’re better off attracting hate readers. Hate readers will do wonders for your metrics. Hate readers are highly engaged.

This strategy is powerful in terms of generating attention and reach. It’s a series of what my friends at Epsilon Theory call mirror and rage engagements. Your team stans you because you’re just like them. The other team trolls you because you’re just like the enemy. Clix for days.

A wise man once said: now you’ve got yourself a stew.

A weakness of this strategy is it’s unlikely to surface information. In the formal sense, we can define information as a signal that changes our mind. The attention and reach maximizing strategy is indifferent to the information content of the responses it generates. It’s about generating large volumes of mirror and rage engagements. It’s culture war arms dealing.

Even if there IS information content in some of the engagement this strategy generates, you’re probably going to ignore it. You’re not looking for information. You’re not open to it.

The cost of an open mind is reduced attention and reach. Nuance, circumspection and introspection do not generate intense mirror and rage engagements. They will, however, surface information. And when they do, you’ll be in the right frame of mind to receive it.

We could launch into a whole elaborate discussion of mental complexity with a summary of Kegan’s five stages of mental complexity here.

But let’s just call this karma.

Kill Your Darlings

Once upon a time, I wanted to blog about stocks.

Stock writeups are a literary form unto themselves. A good stock writeup isn’t just about solid analysis. A good writeup keys in on the handful of variables and risks you ought to consider if you own a stock. It’s a useful exercise for crystallizing thinking and creating a record you can review later, for evaluating process improvements.

So why not blog about stocks?

For one, I’m not much of an analyst. I’m drawn more to portfolio construction and management. I’m also a big believer in the Pareto Principle, a.ka. The 80/20 Rule. When it comes to security analysis, I’m impatient. My most successful investments have always been the stupidly obvious ones. Basic pattern matching with some guardrails.

There are times where minute details can make or break an investment. (shoutout to folks who specialize in capital structure arbitrage trades in obscure bank securities) Complex investments requiring lots of analysis are generally not investments I want in my portfolio. I’m not smart enough to carry them off. Even if I were, it’s a lot of brain damage relative to expected returns. So then you end up screwing around with a bunch of leverage to make it worth your while.

I’m not trying to build a world-class hedge fund franchise here. I’m trying to maximize the spread between effort and earnings so I can move onto something useful, like working on my golf game.

This brings me to an interesting failure mode where an investor believes “mainstream” investments are never good enough for her because she she can get an informational edge in esoteric, capacity-constrained situations. Leave dip-buying Facebook for the plebs, she thinks, as if money made from super smart stuff were somehow worth more than the money made from super dumb stuff.

Sometimes the juice is worth the squeeze in the esoteric stuff. Sometimes it’s not. I’m here to tell you parasitism is vastly underrated as an investment strategy.

Moreover, it can be dangerous to write publicly about stocks, if it turns into a exercise in feeding your ego.

Say it with me: I don’t care about being right. I care about making money.

Now ideally I want to make money because I’m right. But I make mistakes. I make mistakes all the time. It’s not realistic to expect to avoid mistakes entirely. I’d rather focus on identifying mistakes quickly, and cultivating the mental flexibility to get off those positions quickly. This goes back to the problem of attachment. There’s a lot of talk about conviction in this business. We tend to fetishize the lone contrarian genius. I am susceptible to the lone contrarian genius mythos, personally.

Conviction is not an unalloyed good. Conviction can be a mental prison. Write about an idea publicly and people will come out of the woodwork to tell you all the ways you are wrong. When you put a lot of work into publicizing an idea and then defending it, it’s easy to get attached. Pretty soon you’re more worried about being right than making money. Players of all skill levels make this mistake.

An old piece of writing advice is instructive here: kill your darlings.

Nonetheless, with the right intention and mental discipline, going public with an idea can be a good way to surface risks and facts you may have missed. People will freely investsplain all kinds of helpful things to demonstrate their intelligence and analytical prowess.

If you are a Very Famous Investor, talking your book can move the market in your favor. Or, perhaps more importantly, move the market narrative in your favor. The best activist investors specialize in this kind of thing. A stock’s “brand” has an immense influence on its multiple. This is a different game than the one I’m playing, or even capable of playing, with my own capital. (though it is worth considering how we, as very small, very not-famous investing parasites might ride the coattails of activism for fun and profit)

I have no doubt there are people in this world who can discuss and defend ideas publicly without becoming attached. Good for them. I admire them for it. I don’t particularly care whether you are one of these people, or whether you’re more like me. I care about recognizing the difference.

Meta

Why is there so much woo on this blog?

For starters, it’s the brand. Sometimes I don’t think people take me seriously when I explain this is all laying groundwork for some as-yet-to-be-determined grift. To borrow a koan:

Goso said, “To give an example, it is like a buffalo passing through a window. Its head, horns, and four legs have all passed through. Why is it that its tail cannot?”

Second, I am earnestly into the woo. Sometimes I tweet about the woo. Sometimes I write about it on my other blog. But getting deep into the real woo here would be off-brand. So I won’t.

The Enso brand is about building and maintaining wealth holistically. You can’t do that without addressing issues of values and self. Much of what is written about personal finance and investing is selling particular systems. What I’m trying to sell are techniques and models for navigating those systems. This blog doesn’t read like a system, of course. Thinking about systems is different from thinking within systems, on their own terms.

The very online nerd term for this conceptual layer is “meta.”

A classical text illustrating the meta layer is the 1996 movie Scream. Scream is full of meta takes on the slasher genre. It is explicit in its awareness of genre conventions. The characters know “the rules” of slasher flicks. They talk about them.

Randy: The police are always off track with this shit! If they’d watch Prom Night, they’d save time! There’s a formula to it. A very simple formula!

(yelling in video store)

Randy: EVERYBODY’S A SUSPECT!

Scream (1996)

Since then, meta-horror/comedy has emerged as a genre unto itself. I can’t think of a better example than The Cabin in the Woods. Cabin is meta on almost every level. (example: the special effects and makeup were done by Heather Langenkamp and her company AFX Studio. Langenkamp’s breakout role as an actress was playing Nancy in the Nightmare on Elm Street series)

One way of thinking about various strains of financial advice is as different genres with their own conventions. Enso Finance sits squarely within the Fortune Cookie Advice genre. Fortune Cookie Advice is meditative. It’s about “making people think” (or trying to, anyway). My fortune cookies typically have a meta character, but Fortune Cookie Advice doesn’t have to be meta. The audience for object-level fortune cookies is much larger, anyway.

On the other end of the spectrum sits Fancy Quant Advice. Fancy Quant Advice is about number crunching. Simulations. Backtests. Varying degrees of mathematical formalism. I’ve tried dabbling in this genre a bit, but it just doesn’t come naturally to me. Others do it extremely well. See: Breaking the Market, Philosophical Economics, OSAM, Newfound, Squeezemetrics.

I don’t have much to say about the Investment Tip Newsletter genre. It’s pretty straightforward. Object-level idea generation. Caveat emptor, of course.

Then there’s the Doom Porn genre. This is the reflexive contrarian, “broken clock is right twice a day” stuff where guys have predicted 30 of the last 5 bear markets. Here we’re charting the S&P 500 in Fed balance sheet terms and explaining why everyone’s favorite risk premium harvesting strategy is actually a giant ponzi scheme. Up is down. Black is white.

Of course, we can mash these up, too. Fancy Quant Advice in particular marries well with other genres. Fancy Quant Doom Porn is a potent brew.

This post is primarily a comment on form, not efficacy. Efficacy can vary within each genre. For most genres this is straightforward to grasp. Doom Porn might be the exception. It’s easy to dismiss Doom Porn entirely as an invention of grifters and charlatans. But it can serve a purpose. Per my Attachment Post, Doom Porn can be used as an antidote to complacency. What if the doomers are right? It’s worth considering low probability, high impact scenarios. From a risk management perspective, some of these risks might be worth insuring.

Which brings me back to the woo.

A somewhat woo belief of mine, and a theme of this blog, is that we should not think of systems as more or less “correct” in some idealized form so much as more or less “useful” for particular ends. Systems can be used liked tools on a tool belt.

Don’t reach for a screwdriver if you need a hammer.

Don’t reach for Doom Porn when you’re craving a Fortune Cookie.

Attachment

The last post talked a bit about diversification. We are used to thinking about diversification within a portfolio context, both at the position level and the asset class level.

The diversification math is straightforward conceptually. Ideally, you’d like a bunch of positive expected value bets that are independent and uncorrelated. This is wonderful in theory. It gets tricky in practice. For one thing, correlations tend to go up as you add assets and strategies to a portfolio. For another, cross-asset correlations tend to rise sharply in severe crisis periods, as aggressive selling pressures suck up liquidity.

Sometimes a certain genus of permabear will say something like, “what if the entire financial system collapses? Where will your diversification get you then?”

In one sense, these are silly questions. You can’t address this kind of existential risk through portfolio construction. You can’t even address it with portfolio hedging. If the world ends, good luck collecting on your SPX puts. This is CAPM’s non-diversifiable, systemic risk.

In another sense, these questions aren’t silly at all. I suspect people have come to think of CAPM’s equity risk premium not as compensation for bearing non-diversifiable, systemic risk, but as a free lunch. Something close to a free lunch, anyway. Exhibit good behavior over a long enough time period and these returns will be yours. This interpretation downplays the seriousness of systemic risk. People joke of permabear types that even broken clocks are right twice a day. But catastrophes are catastrophes, regardless of predictability or frequency. This kind of risk is worth taking seriously.

So where does this leave us? We have systemic risk that represents a potential existential threat. This risk is difficult, if not impossible, to hedge in-system. It is meta to the system. It is the risk of the system itself breaking down.

We laugh at people who stockpile guns, medicine and canned goods. But they’re thinking about this the right way. Diversifying against systemic risks requires us to think beyond in-system instruments and methods. This isn’t to argue for stockpiling guns, medicine and canned goods in a bunker (though don’t let me stop you if you are so inclined). For now, it probably suffices to think about ways one can create “value” in the real world, outside the abstracted games of financial markets.

We can think about this in terms of real-world, cash generating assets, like owning and operating a business.

We can think about this in terms of careers and career earnings power.

We can think about this in terms of political participation.

We can think about this in terms of basic skills like cultivating, cooking and building.

What would you do if your portfolio was forced to zero? No more trading. No more investing. This is an extreme scenario to consider, but it’s hardly unprecedented in human history.

In my Values post I quoted the famous line from Fight Club: “the things you own, end up owning you.” I suspect people tend to interpret this line in a narrow, materialist sense. We look down our noses at people spending vast sums on conspicuous consumption. The line is more interesting as a comment on attachment more generally. Attachment to things, sure. But also attachment to particular mythologies, cosmologies, models.

Most things die. All things change.

The ultimate failure mode for diversification is to consider it in too narrow a context, and mistake our attachment to particular mythologies, cosmologies and models for the immutability of those things. There are many triggering ways of illustrating this, but I’ll leave it at this: society can remain communist longer than you can remain alive.

There is a particular zen koan, the buffalo koan, that is relevant here.

Goso said, “To give an example, it is like a buffalo passing through a window. Its head, horns, and four legs have all passed through. Why is it that its tail cannot?”

The Christian version of this talks about being IN the world without being OF the world.

I originally titled this post Diversification. That’s what I intended for it to be about. But I came to like Attachment better. Attachment is a core failure mode that extends into many domains.