I’ll start this week with an abstract idea I’ve been sitting on in my notes for years. And then I’ll take you through the concrete idea that gave it life (and a reason to publish it).
The Abstraction Sitting In My Notes
Communism doesn’t scale but it can work in small settings where the bonds and norms between people carry more weight.
This shouldn’t be surprising.
If we think of interactions with each other as transactions, money acts like a store of value that is agnostic to how it was generated. It is a commodity but critically it also commoditizes its users. If I sell a guitar on eBay, I default to selling to the highest bidder. But if I was selling it locally I might sell it to the highest bidder, but depending on my preferences, I might also sell it to the next highest bid if having it in that owner’s hands had more meaning for whatever reason. Maybe I’m selling it to a kid who couldn’t afford the higher price but is so bushy-tailed I’d rather hook them up with a deal. (This idea is also why home buyers in competitive markets throw the Hail Mary of writing touching family stories to sellers).
At scale, we use money to “summarize” our values but if we had the time and energy to look closer we could find non-monetary sources of value embedded in transactions. The flexibility in our value rankings is jettisoned in the name of expediency.
Acknowledging this idea explains many behaviors that may seem counterintuitive. The most obvious is what family members will do for each other without any consideration of money. Less straightforward, the sharing economy and open-source come to mind. Some of the explanations become more obvious as status has become more legible and measurable. The existence of “follower farms” indicates exchange rates between status and money. But this compression of value into a single number like followers is similarly lossy as the concept of money itself.
The broader point is we should be open to experimenting with incentive structures, at least on the local scale, to achieve target outcomes more cheaply by addressing a wider range of desires and therefore pressure points. We can allocate more efficiently when we can hack our human instincts.
A Concrete Implementation
Fortune would have it that those thoughts would find a real-life expression.
Friday night served as the grand opening to a local project I’m involved in. It’s been over a year in the making. A group of local friends, about 25 of us, that would have monthly happy hours decided to lease a space to make something of a social club (it’s indeed registered as a 501c7).
The vision for the club is a place to foster community and serendipity. There’s a standing happy hour every Thursday. The first Friday of every month is dinner with partners/spouses. It’s a place to watch big games, have musical jam sessions, host salons and lectures. It’s a studio to video or record podcast interviews. If you meet me for coffee, it’s where I will take you. During the day, it’s a co-working space. With many people working from home, it’s already been used as an on-site for bringing teams together for brainstorming sessions.
It has a co-op ethos, with everyone bringing their own skills (I’m not handy so I did the website), to make it a space owned by all of its members. The members include everyone from teachers and firefighters to tech entrepreneurs and finance folk. A couple of guys built this bar Friday afternoon before the dinner! (it still needs to be finished):
This room is getting a small stage in front where the blue chairs are:
This is the lounge where you walk in:
I’ll talk about this more as this experiment unfolds, but for now, our focus is on finding ways to unlock greater in-person connection in service of both joy and personal growth.
I’ll admit — describing it feels clumsy. It’s not bro-y like Old School, it’s not WeWork, it’s not Rotary or an Elk’s Club — it feels a bit illegible right now. But as it comes into focus we’ll figure out the right language to transmit its essence. To me, it’s about extracting the tangible value that resides in the soft bonds we have with others in high-trust environments for mutual, positive-sum benefit.
That’s a horrible mouthful.
But even with that crypto-ese language, when I tell people about it, it strikes a chord. There’s an appetite for deeper connection as well as the security and increased agency that community brings to our lives Religious, hobby, or work tribes solve for the same thing by coalescing around a common purpose. This is just a different combination of pivot table elements. The common rallying point here is geography + an ineffable quality of, I don’t know, “openness” is the word that comes to mind when I think of this group.
We are documenting all the work required to get us to this point and as it evolves. We are being thoughtful and meta about this entire project, because when it’s done, we want to have the recipe to hand to others who have the same vague sense we did when the idea was born over a year ago — we have a special community of open people and we want to do something I always talk about in this letter — “find the others”.
[There are so many little details from liability to inclusiveness to boundaries to rules to norms to cost-sharing and budgeting that are not straightforward. We will have done something good if we can build a template for others to do this by laying out the details and trade-offs and showing how the experience depends on the design and spirit that you bring to the initiative. Coordination always comes with “tragedy of the commons” risks. We are learning as we go along. We plan to share those lessons to reduce the frictions for others who may want to start something similar in their own communities.]
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Today is a math one.
The power of negative correlations is powerful when you see how rebalancing increases your expected compounded return.
One of my favorite finance educators, @10kdiver, recently wrote an absolute must-read thread on this topic.
You can use the intuition from this exercise to guide your portfolio thinking more broadly. It’s beautifully done.
However, there is a part I struggled with that I want to zoom in on because I’ve never before seen it presented as @10kdiver does it:
He converts probability to an estimate of correlation!
This is really cool. Reasons for my post:
- The meta-lesson
This is the easy one:
When I read the post, it was easy to nod along thinking “yep, that makes sense…ok, ok, got it”. Except for that, I don’t “got it”. I couldn’t reconstruct the logic on my own on a blank sheet of paper which means I didn’t learn it. Paradoxically, this demonstrates how good @10diver’s explanation was. Extrapolate this paradox to many things you think you learned by reading and you will have internalized a useful life lesson — get your hands dirty to actually learn.
- Diving into the probability math I struggled with.
An Example Of Using Probability To Build An Intuition For Correlation (6 min read)
More on liquidity
I’ve argued that illiquidity has a cost because you can’t rebalance (or as I painfully learned this year — tax-loss harvest). I describe a conceptual framework for pricing the liquidity “option” from a rebalancing lens in How Much Extra Return Should You Demand For Illiquidity?
This week, GOAT finance writer Matt Levine talked about liquidity. I don’t do this much but this is so good, here’s a full reprint:
One sort of financial innovation is about adding liquidity. There is some class of thing that does not trade very much for some reason, and you find a way to make it trade a lot. Perhaps the thing is very big and not many people can afford to buy it, so you split it into small pieces so people can trade the pieces. This basically describes the stock market: If you like Tesla Inc. as a company, you probably can’t go buy all of it, for a bunch of reasons of which the most important is that it costs $725 billion. But Tesla is split up into billions of shares, and you can go buy a share of Tesla for about $230.
Or perhaps the things are very different and non-fungible, making them hard to trade, so you smush lots of them into a big standardized package that is easier to trade. This is roughly the idea behind mortgage bonds, or bond exchange-traded funds, or we talked the other day about a guy who wants to do it for diamonds. There is no visible trading market price for a 1.53-carat VVS1 diamond, because there aren’t that many diamonds with exactly those characteristics, but if you can build some sort of standardized diamond basket then maybe you can create a market price for that diamond, and thus a market.
Adding liquidity is, conventionally, desirable. It reduces risk: If you can sell a thing easily, that makes it less risky to buy it, so you are more likely to commit capital to the thing. It increases demand: If only a few rich people can buy a thing with great difficulty, it will probably have a lower price than if everyone can buy a share of it easily. It improves transparency and makes prices more efficient. Also, financial innovation tends to be done by banks and other financial intermediaries, and their goal is pretty much to do more intermediation. More liquidity means more trading, which means more profits for banks.
Another, funnier sort of financial innovation is about subtracting liquidity. If you can buy and sell something whenever you want at a clearly observable market price, that is efficient, sure, but it can also be annoying. Consider the following financial product:
- You give me the password to your brokerage account.
- I change it.
- You can’t look at your brokerage account for one year, because you don’t have the password.
- At the end of the year, I give you back your password and you pay me $5.
Is this a good product? For me, sure, I got $5 for like one minute of work. For you, I would argue, it’s also pretty good. For one thing, you avoid the stress of looking at your brokerage account all the time and worrying when it goes down. For another thing, you avoid the popular temptation of bad market timing: You can’t panic and sell stocks after they fall, or get greedy and buy more after they rise, because I have your password…
Cliff Asness, in “ The Illiquidity Discount,” argues that private equity is essentially in the business of selling illiquidity. If you are a big institution and you buy stocks in public companies, the stocks might go down, and you will be sad for various reasons. You might be tempted to sell at the wrong time. You will have to report your results to your stakeholders, and if the stocks went down those results will be bad and you will get yelled at or fired. Whereas if you put your money in a private equity fund, it will buy whole public companies and take them private, and then you won’t know what the stock price is and won’t be able to sell. The private equity fund will send you periodic reports about the values of your investments, but those values won’t necessarily move that much with public-market stock prices: The fund will base its valuations on its estimates of long-term cash flows, and those will not change from day to day. By being illiquid, the private equity fund can look less volatile. Getting similar returns with less volatility is good; getting similar returns and feeling like you have less volatility also might be good. Asness writes:
If people get that PE is truly volatile but you just don’t see it, what’s all the excitement about? Well, big time multi-year illiquidity and its oft-accompanying pricing opacity may actually be a feature not a bug! Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns? “Ignore” in this case equals “stick with through harrowing times when you might sell if you had to face up to the full losses.” What if investors are simply smart enough to know that they can take on a lot more risk (true long-term risk) if it’s simply not shoved in their face every day (or multi-year period!)?
My wife’s birthday was this week. She just wants help raising money for a personal cause:
People think I’m mean.
If you are curious about the outcome.
[The post-script to the outcome was Zak agreed without a fight to share the pain — both will donate 37.5%]
[The post-script to the post-script: one of the best option traders on the planet stuck true to his word and sent Max extra candy in the mail]