Karma

Here is the attention game in a nutshell:

Identify the zeitgeist around certain issues. Preferably related to sex, money and power.
Choose a side (there are always sides to choose).
Identify your side’s talking points and the opposition’s talking points.
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.

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.

Games

Concentration gets you rich. Diversification keeps you rich.

For most of us who are not career money managers (or skilled DIYers who might as well be), we are looking for a balance of these two concepts in our portfolios.

There is an ascetic strain of financial advice that abhors any kind of concentrated risk-taking. The world is a random and frightening place. It is difficult to distinguish skill from luck. Concentrated risk-taking is just gambling. Your returns will probably end up looking like the broad market averages over long periods of time, and you run the risk of significantly underperforming those averages. Why bother?

On the other hand, many people have earned vast fortunes through concentrated risk-taking. I don’t imagine they lose much sleep over whether their returns came from luck or skill. Likewise, most of us who spend time editorializing on portfolio construction have obtained our megaphones through some kind of concentrated equity or quasi-equity exposure. We either explicitly own a concentrated equity position in an advisory or asset management business, or have implicitly built a concentrated quasi-equity position in some kind of personal brand.

One of my first posts was about regret minimization as the organizing principle for financial decisions. Regret functions vary. Personal attitudes toward “get rich” versus “stay rich” portfolio construction necessarily vary as well. Overall, I suspect regret functions are relatively normally distributed. There is a thin left tail of extremely fearful investors who abhor the idea of any kind of loss. There is a thin right tail of extremely aggressive investors who cannot stand the idea of forgoing gains. The rest of us fall in the body of the distribution. We don’t want to risk gambling our wealth away, but we’d like to own a few lottery tickets on the side.

I like to think about investing as a series of nested games. The ascetics are right to point out the difficulty many of us face distinguishing between positive expected value and negative expected value games. A positive expected value game that pretty much everyone can play with minimal effort is to shovel money into a diversified portfolio at regular intervals. This strategy has its failure modes (positive expected value =/= guaranteed return), but I believe this is “good enough” for most people who want to spend their time and energy on other pursuits.

Beyond that, the most straightforward +EV game to learn is probably “value investing” and its innumerable variations. In Fancy Terms, this is a short convexity strategy based on mean reversion (a.k.a dip buying). The basic strategy is simplicity itself. Find an asset you believe has suffered a temporary price dislocation for whatever reason, and buy it conditional on some expected return hurdle. You can make a lot of money doing this, though you have to be mindful of additional failure modes compared to the diversified strategy. Chief among these is the “value trap”: the asset that is not merely “cheap” but “cheap for a reason” and does not mean revert. Archetypical, vanilla value investing deliberately disregards market feedback. Smart value strategies develop guardrails to help mitigate this failure mode.

B-b-buh Buffett… some might respond.

LOL. Buffett changes his mind all the time.

There is a subtle difference between what I describe as value investing above and what I would describe as growth investing. My definition of growth investing is different from the widely used style-based concept, which is just the mean-reverting value investing strategy applied to higher growth, more optically expensive stocks. My definition of a growth strategy is a strategy that is long convexity, with a return profile that looks like a call option. The archetypical example is venture capital, though I would also include other long duration, “permanent capital” types of equity strategies under this umbrella.

We could get into games like trend/momentum and some of the more esoteric stuff that goes on in options land. But this post is already running long and, more importantly, I may want to grift off this taxonomy some day. What I am hinting at is a more systematic way of thinking about whether/how to go about concentrated risk-taking.

What is the game I’m playing? (the real game, not the cartoon version people talk about on the internet)

Why is this is a positive expected value game?

Do I have the time and resources to learn this game and play it well?

Who are the donkeys in this game? (remember, when you are learning, you are one of the donkeys)

Do the skills and mindset needed to play this game well match my own skills and temperament? If not, can I develop the necessary skills and mindset? Am I willing to put in the work?

(with some slight modifications you can easily extend this to “real world” risk-taking such as entrepreneurship)

If your reaction to this is “no” or “this is stupid LOL I just want to gamble on stonks” then I would suggest smaller position sizing in your games of choice. Or, consider delegating some of the day-to-day game-playing to a professional who specializes in that type of game.

There is a whole elegant investment manager selection and evaluation framework to be built out here. But in deference to future grifting, I’m not going to get into that here.

Religion

In a prior post I wrote that money is like religion for a lot of people.

In fact, money IS religion for a lot of people.

We’re all familiar with the concept of conspicuous consumption: consumption as social status marker. We don’t talk as much about conspicuous asceticism: extreme frugality as gateway to financial nirvana. There’s a kind of yin and yang thing happening here. The internet is full of arguments about whether it’s better to increase income or cut spending. These arguments will rage forever, for the same reasons we will always have religious wars. (aside: most modern religious wars have secular optics)

Here is my favorite zen story dealing with personal finance:

A man visited a local monk and said, “my wife is so stingy, she’s making life miserable. Please help.”
The monk visited the wife. First, he held out a closed fist. “What would you say if my hand were always like this?” he asked.
“Your hand is deformed,” the wife replied.
The monk opened his hand so his fingers were outstretched. “And what if my hand were always like this?”
“Deformed,” the wife replied.
“If you understand this then you are a good wife,” he said, and left.
From then on the woman helped her husband spend as well as save.

At its core, this stuff is pretty simple. However, the business of religion and the business of personal finance are a lot like the business of golf instruction. They tend to deliberately overcomplicate things. People want Answers. The more confused people are about what they’re trying to accomplish, and how they might accomplish it, the more money there is to be made selling Answers. Maybe that’s a gap wedge with a diamond dusted face. Maybe it’s healing crystals. Maybe it’s rental real estate.

Don’t get me wrong. I, too, am selling something. I just happen to be selling process.

Ask yourself: am I living the life I want to live right now?

If the answer is Yes, then STOP. You are done! Keep doing what you are doing. Enjoy the journey.

If the answer is No, then ask: what can I do right now to move myself in the direction of the life I want to live?

People will claim they can’t answer these questions. I call bullshit. You’ve thought long and hard about this. We all have. If you think you can’t answer, I’d suggest you just don’t like the answers. Probably because the answers imply you need to endure some material hardship, or confront some deep-seated fear, or acknowledge some personal weakness that threatens your ego.

You can sit on your ass and shell out subscription fees to some grifter and wait for Answers to fall from the sky, or you can get off your ass and do something about it.

Religion can offer real value. But you’re not going to realize that value obsessing over esoteric doctrinal issues.

The value is in the praxis.

Values

I have a little mantra I like to repeat sometimes. It is a riff on the famous quote from Fight Club.

The things you own, end up owning you.
The thoughts you think, end up thinking you.
The masks you wear, end up wearing you.
Me (with apologies to Chuck Palahniuk)

If you’re reading this, you probably think of yourself as having values.

But where do they come from?

Are they your values, or are they merely values that have been transmitted to you via prestigious institutions and mass media?

It is worth meditating on this. Values are not an unalloyed good. Values often function as obedience collars and/or prison walls.

Investors and investment organizations anchor on an identity and its associated values just like everyone else. A lot of this boils down to whether you are a mean reversion person or a trend person psychologically, and where you happen to land in terms of formative market experiences. People internalize this stuff and construct mental and emotional scaffolding around it. If they are successful, their sales and marketing strategies will invariably build on that scaffolding. The scaffolding is used to lay down masonry. Maybe this is the foundation for an exceptional investment career. Maybe it is the foundation for a psychological prison. Maybe it is both.

The thoughts you think, end up thinking you.

Market regimes apply selection pressures. What tends to happen is the poster children for a given regime get killed during regime changes. They are overfit for a particular environment. They cannot escape the psychological prisons they have built for themselves, and/or their investors have become their jailors. Woe unto she who offends the style drift police! (on Twitter, @ebitdaddy90, once commented that we should all strive to be beautiful cockroaches that are maddeningly difficult to kill)

A wise man once said: dinosaurs had their shot, and nature selected them for extinction.

Now do systematic value investors.

(I know value guy. I can see the steam coming out of your ears. That was just some good-natured ribbing. You’re getting your rotation year-to-date in 2021, and this is a big tent. I can’t resist poking the bear a bit is all)

Suppose we want to bust out of our psychological prison. How would we do it?

I would suggest a bit of LARPing. For those who are not huge nerds, LARPing stands for “live action roleplaying” a.k.a playing adult make-believe. As a creative-adjacent, woo-adjacent professional, one of the dumb assumptions I am guilt of making is that everyone plays a lot of adult make-believe in their heads.

I once had a conversation with an acquaintance about US-China relations. It was not an interesting conversation. To liven it up I said: well, what if we pretend it’s a big board game like Risk and we have to play the Chinese side? What might our strategy look like? The conversation got more interesting after that.

Where I think people get stuck is believing LARPing the Chinese side means you must personally endorse the CCP or Chinese government policy in some way. This is silly. But only to a point. If you LARP long enough and hard enough, you might end up coming around to China’s point of view.

The masks you wear, end up wearing you.

If you are an investor trapped in a psychic prison of your own making, LARP a little. Try looking at the world through a different lens. Let’s say you are a value guy anchored on low multiple stocks cuz cheapness. How would a growth guy evaluate opportunities? How would a growth guy think about risk? All you are doing is learning a new way of playing the game. You aren’t automatically going to turn into a sketchy SPAC promoter or a bellicose Tesla stan. I promise.

You can apply this playful LARPing in any area of your life. I’m not joking when I say you should meditate on it. You might be surprised by some of the prison infrastructure built out inside your head.

A Beggar’s Life

Like it or not, investing is about making calls.

Many of us resist this fundamental truth. And with good reason. We are inundated with financial pornography. With the perfect clarity of hindsight, look how much you would have made if you put $1,000 in this one amazing stock. People love mocking this stuff. Rightfully so. At best it is schlocky infotainment. At worst, it encourages people to be donkeys, and to make stupid, dangerous bets they do not understand.

By contrast, some people think they can put all their money in a total stock market index fund and coast, as if they’re opting out of making decisions. This is still a call. Not necessarily a bad call. But a call nonetheless. Every position we take expresses a view. There is no opting out. This is perhaps the most fundamental truth of trading and investing.

Now, that doesn’t mean we need to express a view on everything under the sun. What matters is we understand the particular game we’re playing, and focus on the things that matter in the context of that game.

If you are investing on the basis of a strategic asset allocation over a 30-year time horizon, it doesn’t matter what the 10-year treasury yield did this week. Hopefully your strategic asset allocation framework is designed to accommodate longer-term, enduring shifts in the economic regime and cross-asset class correlations, should those shifts materialize. (If not, maybe look into that)

If the game you are playing is trading interest rate and inflation expectations with ZROZ… well… in that case short-term changes in the 10-year yield matter. They are, like, the entire point.

If you are contemplating an investment strategy, or a specific investment, a good question to ask up front is, can I reasonably expect to get this right? Answers will necessarily differ across individuals and firms. Knowledge and resources vary significantly across the spectrum of market participants.

For my part, I believe I can reasonably expect to implement a strategic asset allocation. I believe I can reasonably expect to pick stocks such that running a speculative stock sleeve alongside a strategic asset allocation is a +EV proposition (the jury is out on whether I can reasonably expect “outperformance.” Check back in 20 years and we can look at the data together). More recently, I think I can reasonably expect to spot opportunities to make certain, very simple options trades. This options bit is a new game I am learning, where I am currently a donkey.

Donkeys

If you don’t know who the sucker at the poker table is, it’s you.

If you can’t spot the donkey, you are the donkey.

The donkey is the patsy. The easy mark. Us investor types do not like the idea of being the donkey. Partly because being the donkey often means losing money. Also because finance tends to attract intelligent, competitive personalities who do not like losing, period.

But we are all donkeys sometimes.

In my experience, anyone who has any real experience trading or investing, and has been around for any length of time, will readily laugh about all of the ways they’ve managed to lose money. The more beers you get in us, the funnier the stories get (and the dumber the donkey mistakes). Being the donkey is part of the journey. It’s how we learn. One of my first donkey moves was buying a cyclical stock CuZ lOw Pe. ‘Doh! Classic donkey move. Half a cycle later, I had learned an important lesson about low headline multiples on cyclicals. I paid for the lesson. The best lessons don’t come free.

Of course, being the donkey isn’t an unalloyed good. You can easily blow yourself up being the donkey.

It’s not about making sure you’re never the donkey. It’s a matter of realizing whether you *might* be the donkey in a given situation and adjusting your risk accordingly. Where you’ll run into serious trouble is betting like a shark when you are, in fact, a donkey. This seems like a trivial insight. However, in my experience, it can be fiendishly difficult to practice.

The economics of the finance industry incentivize acting smart and looking smart. Act smart and look smart long enough, and I bet you’ll start to believe you’re pretty smart. The masks you wear, end up wearing you. And don’t think I’m writing this from some enlightened state of consciousness. I’m as guilty of this as anyone.

A wise man once said: never get high on your own supply.

It’s often useful to think of financial markets as a series of nested games. When learning a new game, you are almost certainly the donkey. So, for example, if you are a smart financial advisor or smart high net worth individual who has decided to dabble in private market investing, it would behoove you to proceed under the assumption that you are the donkey. Likewise, whenever you are playing a game with a dynamic ruleset (*ahem* investing), it is possible to become the donkey by refusing to adjust your play style.

A subtle way in which otherwise skilled investors turn themselves into donkeys is through inflexibility. Self-described contrarians–and I promise I say this with love because deep down inside I am one of you–be especially mindful of turning yourselves into donkeys! Our worldview is necessarily dismissive of market feedback. This is both a feature and a bug. Do not be the guy or gal who blows up shorting paradigm shifts.

(It is much easier to be mindful of explicit forms of shorting paradigm shifts than implicit forms of shorting them, btw)

One way of thinking about a “circle of competence” is that you should only do things that fall within the circle. This is dangerous in a dynamic world. Better to think about expanding the boundaries of the circle incrementally, without taking excessive risk.

Take new risks and learn new games.

But play with small dollars until you can spot the donkeys.

Suffering

You might be under the impression that because we are cultivating zen vibes here, it’s all going to be uplifting and inspiring. Wrong. Today’s topic is existential dread.

Bad things happen. They happen all the time. They happen at the level of society; at the level of the the individual; at the level of the portfolio; at the level of the portfolio line item. Much of the time there is no good goddamn reason for it. We are trapped in an asylum on a rock hurtling through space and oh, by the way, the inmates are the ones running the asylum.

Happy Monday all!

When it comes to financial planning and investing, there are certain shibboleths we wield to ward off existential dread. These shibboleths wear the face of empiricism. Chief among them are normative assumptions about life expectancy and capital market returns, spoken in the language of mean reversion.

We are terrible at predicting economic regimes. We are equally terrible at predicting cycles in style premia (growth, value, etc). Yet, for some reason, we are remarkably comfortable accepting normative assumptions about capital market returns over various periods.

“We have to start somewhere.” Yeah, I know. Perfect is the enemy of good enough.

But I prefer to start with suffering. Ask yourself: what is my maximum regret? Interestingly, in my straw polling of acquaintances, no one has ever identified “foregone investment gains” or “failure to maximize expected utility” as max regret. Max regret is untimely death. Max regret is a market crash at the start of retirement. Perhaps foregone gains are the max regret for some readers, though. And that’s okay! This is a big tent. My friends at Epsilon Theory have written extensively about minimizing max regret as an organizing principle not only for investment portfolios and financial plans, but for life. I happen to agree.

The organizing principle for financial matters should be minimizing the max regret scenario.

Max regret is wonderfully flexible in helping clarify your (or someone else’s) thinking about money. For example, there is always colorful public debate over personal spending as a percentage of income. People make passionate arguments on all sides of this. What’s more, there is a lot of money to be made providing capital-A Answers. This topic is like religion for people. For some people it IS religion. This is hardly a coincidence, and I plan to write about it some day. In the meantime, if you’re angsty about how much to spend or save, I’d suggest identifying your max regret.

If your max regret is risk-centric, target higher savings.

If you are hedonistic, spend more and enjoy the now.

Simple, right?

I’m not here to tell you how to live. I suspect most people want a balance of security and hedonism, and where they struggle is prioritizing things. That is precisely where thinking about max regret helps. Prioritize what will minimize your max regret. Relax! There’s no right or wrong here.

But there are tradeoffs. (Cue existential dread again)

We suffer partly because we know, deep down in our bones, our life decisions involve tradeoffs. Life offers its occasional arbitrages. But for the most part, we are making risky trades. You can trade time for money. You can trade money for time. You can pull spending forward or delay gratification. I’m all for delayed gratification. My personal regret function pushes me in that direction. But in defense of hedonism, it’s not as though you earn points for dying with a large pool of assets. If I am fatally injured in a car accident this week, my dying thought isn’t going to be “boy am I glad I maxed my Roth IRA contribution this year.”

Risk cannot be destroyed, the saying goes, only transformed. Yous buys your ticket and yous takes your chances.

Finance is a microcosm of the human condition, and nature is red in tooth and claw.

Author: demonetized