On diversity

I’ve got this friend and neighbor who I hike walk with after we drop the kids off at school sometimes. It’s like 90 minutes of dorm-room musings befitting of the Moontower scene. Those conversations have influenced a few of these weekly letters.

This recent one was no different. It got me thinking about diversity.

See, this friend has an early-stage startup in the education space. The internal research at his company parses diversity across many dimensions. You are familiar with the capital “D” types of diversity — race, religion, gender, age, sexual orientation, socioeconomic, etc.

Interestingly, he expressed concern that his team might not be diverse enough. Not in a visible way. The team runs the gamut of the capital “D” diversity categories. But he was interested in cognitive diversity. He was concerned that an intellectual echo chamber of fancy-college liberals could lead to blind spots in their collective decision-making.

Now I don’t have much team-building experience. So I flexed some knowledge I recently read. (This is why people read right? To at least have a tennis racket when they find themselves on the court of conversational Wimbledon.) And now you too shall witness the fact that I read a book. Confer prestige heavily and without reservation, my esteemed landsmen.

Nah, really I actually read a book and it said some cool stuff. I’ll get to that in a sec. First, I want to re-surface some points professor Mauboussin made about cognitive diversity. He described it as the training, experience, and personality that make an individual unique.

He writes:

I think one can make the case very seriously and quite rigorously that social category diversity contributes to cognitive diversity, but it is cognitive diversity that we’re after.

He describes a less-talked-about form of diversity as well.

“Values diversity”. You might think about it as a sense of purpose, and on that, you actually want to be low. We want a common mission, even if we are of very different backgrounds, we’re pulling in the same direction.

In other words, my friend’s instincts about diversity are correct. Visible diversity is an imperfect proxy for intellectual diversity.

Back to the book I was reading — Superforecasting by Phil Tetlock and Dan Gardner. The book’s main thesis, which falls out of the lessons from the Good Judgement Project, is that it’s possible to become a well-calibrated forecaster in complex (but not all complex) domains. How good can you become? The best are able to consistently beat prediction markets, something even demonstrably above-average forecasters struggle to do.

This is rightly provocative because markets are effective truth-finding mechanisms. They are an ancient way of coordinating human behavior (democracy is another example of a human-coordination machine…for a contrast between markets and democracy see Dinosaur Markets).

If you read this letter regularly you know I have a lot of respect for the efficiency of markets. It’s not a strong-form academic belief. It’s more of an informal razor: “my null hypothesis is there’s no easy money and the burden of proof is on investors who think otherwise”. The academic compromise is markets are “efficiently inefficient”, reflecting the idea that there’s a cost associated with finding inefficiencies so some amount of inefficiency always exists to justify the hurdle of hunting for it.

To appreciate why markets, under certain conditions, triangulate on the truth, I paraphrase Tetlock’s explanation of how the “wisdom of crowds” works:

Bits of useful and useless information are distributed throughout a crowd. The useful information all points to a reasonably accurate consensus while the useless information sometimes overshoots and sometime undershoots but critically…cancels out.

The Role Of Diversity In Truth-Finding

The “under certain conditions” is an important asterisk. The expression “wisdom of crowds” is actually a modern idea that plays off the “madness of crowds”, a term coined nearly 200 years ago by journalist Charles Mackay. For the crowd to generate wisdom, it needs diversity. In other words, the errors in judgment need to be uncorrelated to cancel out.

In Tetlock’s studies, they tested the forecasting abilities of individuals. They were rigorous in their experimental design. They were curious how teams of forecasters would perform against individuals. They further experimented with the composition of those teams.

The eye-opening results underscore the importance of diverse thinking:

  • Teams are more effective
    • The results were clear-cut each year. Teams of ordinary forecasters beat the wisdom of the crowd by about 10%. Prediction markets beat ordinary teams by about 20%. And superteams beat prediction markets by 15% to 30%.
    • “Emergence”: teams are more than the sum of their parts. This cuts both ways…even actively open-minded individuals could surrender to “groupthink”
  • “Diversity trumps ability”
    • This provocative claim highlights how the aggregation of different perspectives can improve judgment. The key to diversity was, unsurprisingly, cognitive diversity.
      • The revealing result: When they constructed the superteams they optimized for ability and those teams happened to be highly diverse because the superforecasters themselves were highly diverse. They did not optimize for diversity first, but it turned out the most diverse teams were the most effective.
  • The asymmetry of the extremizing algorithm
    • The “extremizing algorithm” is a technique where you boost a 70% prediction closer to the extreme, perhaps bumping it to 85%. It’s a technique that is employed when the forecasters have diverse perspectives because it leads to better-calibrated forecasts.

      You do the opposite (push the forecast probability closer to 50%) to combat “groupthink” if the team is comprised of people who think the same or possess similar knowledge. (The use of the extremizing algo allowed teams of regular forecasters to actually perform better than some superteams!).

      My own observation: this is the same logic by which correlated observations “shrink” the sample size, an idea familiar to data analysts.

Example Of Cognitive Diversity

My friend with the start-up gets it. He is concerned that the visible diversity on his team might be a poor proxy for what he really wants — cognitive diversity. If you are an oil company you need geologists, finance people, managers, political connections, real estate expertise. This is a clear example of needing to pull together many object-level competencies.

But cognitive diversity is not just “what do they think about”, but “how do they think”. For an example of what I call meta-cognitive diversity, Tetlock uses the “hedgehog” vs “fox” duality. As a pre-defense of Tetlock, he warns about overstating this dichotomy. (He exemplifies non-binary thinking throughout the book, doing an honest and eloquent job of pointing out tensions and caveats, not unlike the superforecasters themselves).

I’ll take a stab at describing hedgehogs and foxes:

  • Hedgehogs

    Hedgehogs are specialists. The 10,000 hours crowd. The natural endpoint for the logic of economic comparative advantage or simply the rightful throne of the devoted craftsman. The “specialization is for insects” objection is too reductive. We are better off when Eddie Van Halen wants nothing else than to just be Eddie Van Halen.

    But there are trade-offs. Hedgehogs often filter observations through the lens of their expertise. (My online friends have a good-natured running joke that I see everything as an option — classic “when all you have is a hammer, everything is a nail” thinking). But a camera lens’ usefulness depends on the context. Sometimes that fisheye or telephoto lens is exactly the wrong tool for the job.

    This is inconvenient for the status-aware hedgehog whose incentive to remain consequential leads to motivated reasoning and self-delusion. Academic researchers who become famous for writing about an idea that catches fire have a lot to protect. They become fast friends with Mssr. Confirmation Bias and Madame Overconfidence, the very enemies they used to fight when they were building their reputations of good work. It’s like America fighting against the same Afghans they armed as rebels in the 80s. As DiCaprio’s character in Up In The Air would attest, the warm embrace of fame beats the cold loneliness of cultural anonymity.

  • Foxes

    Foxes are generalists. Businesspeople, investors, politicians, administrators. It’s an imperfect description of course but you know the type. The disadvantages of being an “inch deep and a mile wide” are established. That person is never going to design a bridge or coach a professional sports team. Some are self-aware enough to recognize when they “know enough to be dangerous”. Many are not. Their advantage, however, is their mercenary relationships with lenses. The ego cost of finding the most useful lens is much lower, making foxes at least psychologically fit for reasoning across domains.

Remaining careful not to play into false binaries, the hedghog/fox continuum reminds me of the importance of shifting between diffuse and focused thinking modes. Diffuse thinking (see More Shower Thoughts Please) provides both inspiration and the ability “see over the neighbor’s fence” while focused thinking enables us to synthesize those scattered insights into a useful output. Most of my posts start either in the shower or when I’m taking a walk. (I strongly recommend this old New Yorker piece Why Walking Helps Us Think). “How we think” is a dimension of diversity.

The Complicated Discourse Around Diversity Is Inevitable

When I described the thrust of this piece to my wife, Yinh, she yawned. “So you’re writing a post saying ‘diversity is good’? Who is this news to?”

I immediately got nervous that I was belaboring an obvious point. I asked her why she thought it was so obvious and she started citing studies and initiatives that could easily have 10x’d the length of this post.

Now I can take feedback, but I’m not above quibbling en route to my final destination. So let me get this straight. You read a bunch of stuff arguing that diversity is good, now it’s obvious to you and presumably everyone else who reads, so I shouldn’t spend any time making arguments that diversity is good. I mean, this post is to a Moontower reader as that other research was to you. Next time just put my head in the washing machine woman.

But she still has a point. Diversity, in its many forms, is widely celebrated. In-breeding is taboo. I was just watching the National Parks series on Netflix with the kids and learned that rainforests, the most biologically diverse ecology on land, are the origin of more than 25% of modern medicines. So why do I feel the need to cheerlead an “obvious” point?

The short answer is I don’t think the case is closed on the merit of diversity. I know it’s exhausting to hear me say this, but it depends on contexts. For example, whenever America’s dysfunction is compared to a homogeneous European country, I scratch my head. If we are tribal in nature, our default wiring might simply make governing a melting pot inherently more difficult. I think diversity makes us stronger overall, but some measures of local harmony should expect to suffer. I’m even open to the possibility that tolerance runs counter to our natural instincts. (It just makes a normative approach to overriding our base impulses require extra care. Law-making is always a tug-of-war between collective values and the animals within us.) In other words, I can appreciate how diversity can be a headwind.

But there’s more.

Even if we wave a wand and agree that diversity is an unalloyed good, there remains the harder question. At what cost? The lightning rod version of this question is you have a white student and black student who look the same in all other ways and you need to choose one (the premise is unrealistic, but this is the collapsed version of how these questions get passed around the media and people extrapolate entire political identities on how they’d answer such a fake question). If everything else is the same and there is a non-zero probability that social diversity leads to cognitive diversity, then the optimal (although not necessarily morally fair which is a different criteria battleground) decision gate would say select the black kid (assuming the majority of the student body were white).

Still, even if we agreed on that, a harder question remains. What if the black kid had a slightly worse score on a standardized test? From a strictly efficient-utilitarian point of view (again, moral consideration aside), then we are faced with trade-off on a diversity-competence frontier. In a purely academic sense, I was likely an inferior hire at SIG, but perhaps something about how I thought or acted might have made my “diversity” or “complementariness” worth more than just hiring yet another 1600 Math SAT kid from MIT (or they just exhausted the supply of those, I’m not trying to flatter myself here). The point is that the merit of diversity is fairly intuitive, but doesn’t lend itself to legible number-crunching in the way test scores do.

Pricing “diversity” could very well be a fool’s errand. But I have one final bit of intuition to sprinkle on the problem. In There’s Gold In Them Thar Tails: Part 2I rehash how nature uses diversity as fuel for evolution.

  1. Diversity is an essential input to progress. Nature’s underlying algorithm of evolution penalizes in-breeding.
  2. In addition to a loss of diversity, signals decay as you get closer to the extremes. This is known as tail divergence. The signal can even flip (ie Berkson’s Paradox).
  3. The point where the signal noise overwhelms the variance in the candidates is an efficient cutoff. Beyond that threshold, selectors should think more creatively than “just raise the bar”.

At some point, incremental diversity is worth more than incremental “signal”. Evolution acts like a basket of options (I really am a hedgehog). It sees a mutation. If it’s useless, discard. If it’s adaptive, exercise it and let it multiply through the population out-competing those without the adaptation. When discernment becomes random, select for diversity. The downside is limited, the upside is massive learning.

Wrapping Up

Diversity is valuable. The word is highly politicized today. There are many arguments, with varying degrees of merit, harping on diversity in the name of fairness. Those are debates that need to be had. But this is not that debate. This has been an argument that diversity is important as a matter of efficiency and flourishing. Perhaps the argument isn’t needed, but I suspect that many reactionary arguments against the equity angles of diversity may dilute the value of diversity as a general concept.

We have seen diverse dimensions all around us: social, cognitive, and values themselves. It’s worth unloading the hangups artificially narrowing the meaning of a beautiful word — “diverse”.

Moontower #162

The paradox is that you write to become more fully yourself, but then you find it hard to live with the self you’ve become. I do what I can to remain a possibility instead of a reality. Thus the flow. And, next week, the effort to erase this too.

-Freddie deBoer on why he feels the need to write frequently. I don’t think you need to be a writer to appreciate that feeling.


Friends,

I’ve got this friend and neighbor who I hike walk with after we drop the kids off at school sometimes. It’s like 90 minutes of dorm-room musings befitting of the Moontower scene. Those conversations have influenced a few of these weekly letters.

This recent one was no different. It got me thinking about diversity.

See, this friend has an early-stage startup in the education space. The internal research at his company parses diversity across many dimensions. You are familiar with the capital “D” types of diversity — race, religion, gender, age, sexual orientation, socioeconomic, etc.

Interestingly, he expressed concern that his team might not be diverse enough. Not in a visible way. The team runs the gamut of the capital “D” diversity categories. But he was interested in cognitive diversity. He was concerned that an intellectual echo chamber of fancy-college liberals could lead to blind spots in their collective decision-making.

Now I don’t have much team-building experience. So I flexed some knowledge I recently read. (This is why people read right? To at least have a tennis racket when they find themselves on the court of conversational Wimbledon.) And now you too shall witness the fact that I read a book. Confer prestige heavily and without reservation, my esteemed landsmen.

Nah, really I actually read a book and it said some cool stuff. I’ll get to that in a sec. First, I want to re-surface some points professor Mauboussin made about cognitive diversity. He described it as the training, experience, and personality that make an individual unique.

He writes:

I think one can make the case very seriously and quite rigorously that social category diversity contributes to cognitive diversity, but it is cognitive diversity that we’re after.

He describes a less-talked-about form of diversity as well.

“Values diversity”. You might think about it as a sense of purpose, and on that, you actually want to be low. We want a common mission, even if we are of very different backgrounds, we’re pulling in the same direction.

In other words, my friend’s instincts about diversity are correct. Visible diversity is an imperfect proxy for intellectual diversity.

Back to the book I was reading — Superforecasting by Phil Tetlock and Dan Gardner. The book’s main thesis, which falls out of the lessons from the Good Judgement Project, is that it’s possible to become a well-calibrated forecaster in complex (but not all complex) domains. How good can you become? The best are able to consistently beat prediction markets, something even demonstrably above-average forecasters struggle to do.

This is rightly provocative because markets are effective truth-finding mechanisms. They are an ancient way of coordinating human behavior (democracy is another example of a human-coordination machine…for a contrast between markets and democracy see Dinosaur Markets).

If you read this letter regularly you know I have a lot of respect for the efficiency of markets. It’s not a strong-form academic belief. It’s more of an informal razor: “my null hypothesis is there’s no easy money and the burden of proof is on investors who think otherwise”. The academic compromise is markets are “efficiently inefficient”, reflecting the idea that there’s a cost associated with finding inefficiencies so some amount of inefficiency always exists to justify the hurdle of hunting for it.

To appreciate why markets, under certain conditions, triangulate on the truth, I paraphrase Tetlock’s explanation of how the “wisdom of crowds” works:

Bits of useful and useless information are distributed throughout a crowd. The useful information all points to a reasonably accurate consensus while the useless information sometimes overshoots and sometime undershoots but critically…cancels out.

The Role Of Diversity In Truth-Finding

The “under certain conditions” is an important asterisk. The expression “wisdom of crowds” is actually a modern idea that plays off the “madness of crowds”, a term coined nearly 200 years ago by journalist Charles Mackay. For the crowd to generate wisdom, it needs diversity. In other words, the errors in judgment need to be uncorrelated to cancel out.

In Tetlock’s studies, they tested the forecasting abilities of individuals. They were rigorous in their experimental design. They were curious how teams of forecasters would perform against individuals. They further experimented with the composition of those teams.

The eye-opening results underscore the importance of diverse thinking:

  • Teams are more effective
    • The results were clear-cut each year. Teams of ordinary forecasters beat the wisdom of the crowd by about 10%. Prediction markets beat ordinary teams by about 20%. And superteams beat prediction markets by 15% to 30%.
    • “Emergence”: teams are more than the sum of their parts. This cuts both ways…even actively open-minded individuals could surrender to “groupthink”
  • “Diversity trumps ability”
    • This provocative claim highlights how the aggregation of different perspectives can improve judgment. The key to diversity was, unsurprisingly, cognitive diversity.
      • The revealing result: When they constructed the superteams they optimized for ability and those teams happened to be highly diverse because the superforecasters themselves were highly diverse. They did not optimize for diversity first, but it turned out the most diverse teams were the most effective.
  • The asymmetry of the extremizing algorithm
    • The “extremizing algorithm” is a technique where you boost a 70% prediction closer to the extreme, perhaps bumping it to 85%. It’s a technique that is employed when the forecasters have diverse perspectives because it leads to better-calibrated forecasts.

      You do the opposite (push the forecast probability closer to 50%) to combat “groupthink” if the team is comprised of people who think the same or possess similar knowledge. (The use of the extremizing algo allowed teams of regular forecasters to actually perform better than some superteams!).

      My own observation: this is the same logic by which correlated observations “shrink” the sample size, an idea familiar to data analysts.

Example Of Cognitive Diversity

My friend with the start-up gets it. He is concerned that the visible diversity on his team might be a poor proxy for what he really wants — cognitive diversity. If you are an oil company you need geologists, finance people, managers, political connections, real estate expertise. This is a clear example of needing to pull together many object-level competencies.

But cognitive diversity is not just “what do they think about”, but “how do they think”. For an example of what I call meta-cognitive diversity, Tetlock uses the “hedgehog” vs “fox” duality. As a pre-defense of Tetlock, he warns about overstating this dichotomy. (He exemplifies non-binary thinking throughout the book, doing an honest and eloquent job of pointing out tensions and caveats, not unlike the superforecasters themselves).

I’ll take a stab at describing hedgehogs and foxes:

  • Hedgehogs

    Hedgehogs are specialists. The 10,000 hours crowd. The natural endpoint for the logic of economic comparative advantage or simply the rightful throne of the devoted craftsman. The “specialization is for insects” objection is too reductive. We are better off when Eddie Van Halen wants nothing else than to just be Eddie Van Halen.

    But there are trade-offs. Hedgehogs often filter observations through the lens of their expertise. (My online friends have a good-natured running joke that I see everything as an option — classic “when all you have is a hammer, everything is a nail” thinking). But a camera lens’ usefulness depends on the context. Sometimes that fisheye or telephoto lens is exactly the wrong tool for the job.

    This is inconvenient for the status-aware hedgehog whose incentive to remain consequential leads to motivated reasoning and self-delusion. Academic researchers who become famous for writing about an idea that catches fire have a lot to protect. They become fast friends with Mssr. Confirmation Bias and Madame Overconfidence, the very enemies they used to fight when they were building their reputations of good work. It’s like America fighting against the same Afghans they armed as rebels in the 80s. As DiCaprio’s character in Up In The Air would attest, the warm embrace of fame beats the cold loneliness of cultural anonymity.

  • Foxes

    Foxes are generalists. Businesspeople, investors, politicians, administrators. It’s an imperfect description of course but you know the type. The disadvantages of being an “inch deep and a mile wide” are established. That person is never going to design a bridge or coach a professional sports team. Some are self-aware enough to recognize when they “know enough to be dangerous”. Many are not. Their advantage, however, is their mercenary relationships with lenses. The ego cost of finding the most useful lens is much lower, making foxes at least psychologically fit for reasoning across domains.

Remaining careful not to play into false binaries, the hedghog/fox continuum reminds me of the importance of shifting between diffuse and focused thinking modes. Diffuse thinking (see More Shower Thoughts Please) provides both inspiration and the ability “see over the neighbor’s fence” while focused thinking enables us to synthesize those scattered insights into a useful output. Most of my posts start either in the shower or when I’m taking a walk. (I strongly recommend this old New Yorker piece Why Walking Helps Us Think). “How we think” is a dimension of diversity.

The Complicated Discourse Around Diversity Is Inevitable

When I described the thrust of this piece to my wife, Yinh, she yawned. “So you’re writing a post saying ‘diversity is good’? Who is this news to?”

I immediately got nervous that I was belaboring an obvious point. I asked her why she thought it was so obvious and she started citing studies and initiatives that could easily have 10x’d the length of this post.

Now I can take feedback, but I’m not above quibbling en route to my final destination. So let me get this straight. You read a bunch of stuff arguing that diversity is good, now it’s obvious to you and presumably everyone else who reads, so I shouldn’t spend any time making arguments that diversity is good. I mean, this post is to a Moontower reader as that other research was to you. Next time just put my head in the washing machine woman.

But she still has a point. Diversity, in its many forms, is widely celebrated. In-breeding is taboo. I was just watching the National Parks series on Netflix with the kids and learned that rainforests, the most biologically diverse ecology on land, are the origin of more than 25% of modern medicines. So why do I feel the need to cheerlead an “obvious” point?

The short answer is I don’t think the case is closed on the merit of diversity. I know it’s exhausting to hear me say this, but it depends on contexts. For example, whenever America’s dysfunction is compared to a homogeneous European country, I scratch my head. If we are tribal in nature, our default wiring might simply make governing a melting pot inherently more difficult. I think diversity makes us stronger overall, but some measures of local harmony should expect to suffer. I’m even open to the possibility that tolerance runs counter to our natural instincts. (It just makes a normative approach to overriding our base impulses require extra care. Law-making is always a tug-of-war between collective values and the animals within us.) In other words, I can appreciate how diversity can be a headwind.

But there’s more.

Even if we wave a wand and agree that diversity is an unalloyed good, there remains the harder question. At what cost? The lightning rod version of this question is you have a white student and black student who look the same in all other ways and you need to choose one (the premise is unrealistic, but this is the collapsed version of how these questions get passed around the media and people extrapolate entire political identities on how they’d answer such a fake question). If everything else is the same and there is a non-zero probability that social diversity leads to cognitive diversity, then the optimal (although not necessarily morally fair which is a different criteria battleground) decision gate would say select the black kid (assuming the majority of the student body were white).

Still, even if we agreed on that, a harder question remains. What if the black kid had a slightly worse score on a standardized test? From a strictly efficient-utilitarian point of view (again, moral consideration aside), then we are faced with trade-off on a diversity-competence frontier. In a purely academic sense, I was likely an inferior hire at SIG, but perhaps something about how I thought or acted might have made my “diversity” or “complementariness” worth more than just hiring yet another 1600 Math SAT kid from MIT (or they just exhausted the supply of those, I’m not trying to flatter myself here). The point is that the merit of diversity is fairly intuitive, but doesn’t lend itself to legible number-crunching in the way test scores do.

Pricing “diversity” could very well be a fool’s errand. But I have one final bit of intuition to sprinkle on the problem. In There’s Gold In Them Thar Tails: Part 2I rehash how nature uses diversity as fuel for evolution.

  1. Diversity is an essential input to progress. Nature’s underlying algorithm of evolution penalizes in-breeding.
  2. In addition to a loss of diversity, signals decay as you get closer to the extremes. This is known as tail divergence. The signal can even flip (ie Berkson’s Paradox).
  3. The point where the signal noise overwhelms the variance in the candidates is an efficient cutoff. Beyond that threshold, selectors should think more creatively than “just raise the bar”.

At some point, incremental diversity is worth more than incremental “signal”. Evolution acts like a basket of options (I really am a hedgehog). It sees a mutation. If it’s useless, discard. If it’s adaptive, exercise it and let it multiply through the population out-competing those without the adaptation. When discernment becomes random, select for diversity. The downside is limited, the upside is massive learning.

Wrapping Up

Diversity is valuable. The word is highly politicized today. There are many arguments, with varying degrees of merit, harping on diversity in the name of fairness. Those are debates that need to be had. But this is not that debate. This has been an argument that diversity is important as a matter of efficiency and flourishing. Perhaps the argument isn’t needed, but I suspect that many reactionary arguments against the equity angles of diversity may dilute the value of diversity as a general concept.

We have seen diverse dimensions all around us: social, cognitive, and values themselves. It’s worth unloading the hangups artificially narrowing the meaning of a beautiful word — “diverse”.


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Money Angle

I’m trying to read books again. I’m like the opposite of a junkie. I start and just give up. I struggle to watch movies for similar reasons. It’s hard for me to sit still and be passively entertained for extended periods of time.

[I recently admit that I haven’t seen Animal House, I saw Trading Places after I had been a trader for a decade, I saw Caddyshack 2 years ago. I’d like to claim ESL but I was born in Brooklyn. Also I’d be doing a disservice to immigrants, many of whom have large movie repertoires because it’s an effective way to learn English. I have no excuse. I could have watched more classic movies instead of fraying the tape of the Dazed And Confused VHS.]

In an era of amazing tv shows, my diet mostly consists of those that come in 30-minute episodes. I’m making my way through all the seasons of Curb Your Enthusiasm again. I’m also watching it backwards. For example, when season 3 ended, I go to Season 2, episode 1. This isn’t the first time I admit to being a serial killer. Pun intended.

Back to books. To get my groove back, I committed to reading 1 chapter a day. It worked. The streak is intact and I got to cross a title off the list that I’ve wanted to read for a long time: Superforecasting — The Art And Science Of Prediction by Phil Tetlock and Dan Gardner.

I really enjoyed this book and would consider it canon for aspiring analysts and traders. You can find my notes below. Here are the high-level takeaways:

  • The world is complex (a butterfly flaps its wings and small change in initial conditions leads to disproportionate outputs). So our ability to forecast is existentially limited.
  • But some people are demonstrably better forecasters and it’s not just luck. They are consistent.
  • Those people are not geniuses. But they have a mix of qualities and procedures that enable them to forecast at a high level.
  • The key to getting better, same as in sports, is useful feedback and iteration. It takes hard work, “deliberate practice” and a commitment to get better.
  • Getting better is necessarily a conscious, painstaking process because our natural biases conspire against our judgment in areas where causality is opaque. Which are most questions of interest.
  • How groups can hinder or improve forecasting. The role of diversity in group decision making.
  • In many contexts, making accurate predictions is actually undesirable. Regrettably, I want to shout Moloch everywhere I look. The expression to look for in the notes: “kto, kogo?” It’s a disheartening idea.
  • The leader’s dilemma: balancing decisiveness in the face of uncertainty and intellectual humility
  • Objections, progress, and goals in the endeavor of forecasting

    Continue to…

    Notes On Superforecasting (Moontower Book Guides)


Last chance to apply to the free StockSlam workshops I’ll be hosting with Tina and Steiner in NYC the first week of October.

Details and application:

Last Call

A year ago, I talked about seeing comedian Sheng Weng at the Punchline in SF:

His powers of observation on the mundane details of daily life are Seinfeldian. His signature tone and voice deliver self-skewers that you can’t help but turn on yourself.

One of our friends said it was the hardest she can remember laughing for so long. Sheng’s a craftsman and the more you listen to him the better it gets.

He’s actually Yinh’s college friend (they bonded over their rhyming one-syllable Asian first/last name combos). This spring we were supposed to go down to LA to see the taping of his Netflix special (Ali Wong produced it) with my friend Khe and his wife. We had to audible at the last second and missed it, but…it’s finally out!

Check out Sweet & Juicy (Netflix)


Speaking of Khe, he has been a most generous sherpa to so many people trying to raise their productivity game. He’s an alien jedi.

Check out his upcoming bootcamp. Oh yea, it’s totally free.

If you are curious at all as to why I’m always touting Khe and his community, do it.

Sign Up For The Free Bootcamp

The $10K Bootcamp is a free 3-day event hosted by Khe Hy from RadReads. During this free event, we’ll teach you how to design a system to achieve your goals (while working waaay less). You’ll learn how to:

  • Stay focused on the most important things in life
  • Think bigger (versus making smaller things better)
  • Stop putting things off until some imaginary future date
  • Invest in improving your mind, career and relationships

Event Details:


From My Actual Life

I saw Nine Inch Nails last Sunday night at the Greek in Berkeley. (Between Leon Bridges last week and the upcoming King Gizzard and The Lizard Wizard show I think I’m asking to be swallowed by the Earth. The Hayward fault runs beneath Cal’s football stadium and the theater. At least I’ll be in my happy place when the worms eat me).

I never owned a NIN album but since I’m alive I know like 6 or 7 songs. Any preoccupation I’ve ever had with Trent Reznor revolved around him renting 10050 Cielo Drive in the Hollywood Hills — the home where the Manson apostles murdered Sharon Tate and her celebrity friends. The recording studio in the house was called “Le Pig”, a reference to a song on the Beatles’ White Album from which Charles Manson inferred a lot of craziness. The killers smeared the word “pig” in blood on the home’s front door. Downward Spiral and Broken were both recorded at Le Pig. The music video for Gave Up features images of the house and studio. (Not to be extra creepy after I already used the word “serial killer” once in this letter, but the house I used to own here in CA looked similar to that infamous abode before we renovated it).

But I must admit. NIN is in the running for best show I’ve ever seen (n of roughly 200). The gulf between the recorded & live experience is indescribable.

The Greek felt like a rave at a temple. In black t-shirts.

The Most Underrated Finance YouTube Channel

I feel lucky that Jason Buck reached out to sponsor the letter because I love what he’s doing (Yinh and I were early investors in their latest fund). In addition to managing a fund, Jason is co-host of what I think is the most underrated show on investing YouTube, Pirates of Finance.

In season 3, Jason and Corey Hoffstein changed the format so that there is zero preparation. The conversation is totally off the cuff. And it totally slaps.

It is free, buried booty that our theoretical economist says can’t exist because of efficient markets. But it exists. I’ll prove it by digging up 3 themes from their amazing recent episode Decision-Making Under Uncertainty and mix them with my own thoughts. We’re blending Moontower and Pirate rum up in here today.

Why ETFs Might Be Unsuitable For Some Strategies

ETFs are liquid structures designed to faithfully track NAVs (“net asset values”) because the arbitrage mechanism is outsourced by the issuer to an Authorized Participant. These AP’s are a subset of the market-making community.

The Pirates wonder:

Is the ETF structure, whose allure is transparency, the correct home for opaque, illiquid, or bi-lateral (ie there’s credit risk in the basket) instruments such as inflation swaps? What about semi-liquid holdings like corporate bonds or even TIPs?

The answer to such questions partially rests on the liquidity of the underlying holdings. Consider a question they allude to but I’ll make explicit:

If you hold long option or long convex positions via ETFs (or for that matter directly) will you be able to monetize them when they pay off?

This is a real and highly underrated concern. Bid/ask spreads are positively correlated with volatility. So how useful is it if the paper profit on a convex position can’t be crystallized because the bid-ask is wider than the parted Red Sea?

Suppose you buy a way OTM put option for $1. It explodes to $20 but the bid-ask is now $16-$24. Sure, you can sell it for a 16x return, but when that option was originally valued for $1, the pricing incorporated the idea that in some rare states of the world the option is worth $20. If you can never realize that $20, then you entered into a pretty negative expected value situation when you paid $1 for it in the first place.

Trading is hard enough, you can’t afford to not maximize small edges. In a separate interview Corey talks to option trader Darrin Johnson.

I paraphrase Darrin:

When you sell tails, you need to capture the entire premium. The hit ratio of selling tails is high but when you lose you lose many multiples of the premium. If you fail to collect the full premium, it will not make up for the losing trades. The difficulty of selling tails is even trickier yet.

Darrin explains how betting against longshots leaves you uncertain if you have an edge in the first place. In my words: good luck differentiating between a 50-1 shot vs a 100-1 shot. That’s the difference of 1 probability point but it’s massive in payoff space. [I discuss that idea further in Tails Explained.]

When volatility increases, transaction costs go up for everyone. Since market-makers are part of “everyone” then the cost of their own hedging (ie replication) goes up as well, so they charge wider-bid ask spreads to keep them whole. MMs represent the marginal supply of liquidity so can they pass the transaction costs of their own “COGs” to those demanding liquidity. We know the house wins both ways, but the house edge itself is correlated to what markets are doing. If the house’s margins above their “COGs” expand in times of stress, you need to haircut the expected risk mitigation from defensive positions. That cost will show up when you try to roll or monetize.

There are cases where that bookie’s vig will not be too punitive even in a volatile market. For example, if the option you buy is now so far ITM that it no longer has meaningful extrinsic value, then you can simply trade the underlying to monetize (although re-hedging will put you face-to-face with the market-makers again).

This brings us to the next theme.

Destination vs Path

If you have a view about the expected return of an asset in 5 years should you care about the path? Depends who you ask. Anyone marked-to-market (HFs, market-makers, futures traders) will say yes especially if they are managing money for others. PE, RE, and bond investors are more likely to say no. The Pirates have a nuanced discussion about whether it’s even possible to manage to path versus manage to terminal value.

I’m biased by my path-or-die experience in trading. Mark-to-market is the goddess of tomorrow, you can’t afford to piss her off.

Here are a collection of arguments that I offer her as tribute.

  1. Bond investors who ignore path are fooling themselves.In Why Volatility Still Matters To Buy-And-Hold Investors, I summarize one of Cliff Asness’ pet peeves:

    You may hear some people say they want to buy an individual bond rather than a bond fund. They worry that bond fund prices move around and have no real expiration, so when interest rates rise your losses are somehow more real. But if you buy a bond and hold it to maturity you can put your head in the sand, and never lose.


    This is nonsense.


    You have lost in a real sense since the money you are being returned is worth less in a world in which rates have risen to compensate for inflation. The bond fund is effectively taking your loss today rather than later. If you sell your bond for a loss, you can reinvest at a higher yield going forward. That’s a similar experience to just being in the bond fund. Holding to maturity does not mean you have less risk. It’s an illusion. A real vs nominal illusion.

  2. Using stale marks to “smooth volatility”Having a preference for private assets that are less volatile simply because their marks are stale is like not getting bloodwork because you don’t want to find out your cholesterol and blood sugar are too high.

    The slow-to-mark investments are still volatile. The fundamentals of the private business are correlated with the public market volatility.

    Even if you don’t believe your investment should be marked down, then you should be sad you can’t redeem your private investment at par to rebalance into public stocks after the market drops 20%. Giving up liquidity without a premium because it will behaviorally “save you from yourself” sure feels like you sold the option to rebalance at zero.

    I walk through that argument in How Much Extra Return Should You Demand For Illiquidity? (7 min read)

  3. Market prices are clever. They can balance the wagers of path vs terminal value investors simultaneously!In What The Widowmaker Can Teach Us About Trade Prospecting And Fool’s GoldI show how the calendar spread options are priced so that the path of the gas price is highly respected, even if there’s strong consensus about the terminal value of the spread (ie the March-April futures spread which is a pure bet on in winter gas being in short supply).

    The OTM calls are jacked, because if we see H gas trade $10, the straddle will go nuclear.

    Why? Because it has to balance 2 opposing forces.

    1. It’s not clear how high the price can go in a true squeeze or shortage
    2. The MOST likely scenario is the price collapses back to $3 or $4.


    Try to think of a strategy to trade that. Good luck.

    Let me repeat how gnarly this is: The price has an unbounded upside, but it will most likely end up in the $3-$4 range. The vertical spreads all point right back to that price range.

    The market places very little probability density at high prices but this is very jarring to people who see the jacked call premiums.

    That’s not an opportunity. It’s a sucker bet.

    Another common example:

    In options land, many investors like to buy 1×2 ratio spreads because the payoffs look amazing for low-probability events. For example, if a stock is $100 and you can buy the $115 call and sell 2 of the $120 calls for zero premium, you think to yourself:

    a) “If the stock does nothing or goes down I break even”
    b) “If the stock goes to $120, I make $5” (or $1 if the stock goes to $116)

    c) “I don’t start losing money until the stock goes over $125. That’s 25% away! This is risk-free return”

    Nah dog. That’s first-time-at-the-rodeo thinking.

    The reason the 1×2 is so cheap is the call skew on the $120 strike is pumped up because someone has been buying them like crazy. That’s where the bodies are hidden. The question you need to ask yourself is “conditional on the stock going to $120 did it get there fast and sloppy, or slow and grindy.” If it goes there in a fast way, the market-maker community will be short beaucoup gamma and be scrambling to buy the $120 calls back. You sold some teenies and went to Santorini and are now getting a margin call on the beach because the 120s you’re short are blowing the f out.

    The path-aware trader is plotting how to be long the scenario where your vacation abruptly ends.

  4. If path is so important, how can you manage to it?a) Avoid excessive leverage

    b) Pre-determine when you will cut losses (beware this can be a big topic with lots of room for disaster)

    c) If you insist on betting on terminal value, do it in fixed premium ways where your max loss is bounded. Now you don’t have to worry about mark-to-market risk.

    In There’s Gold In Them Thar Tails: Part 2I cover the topic of path, how to exploit investors’ lack of appreciation for it, and how Jon Corzine became a symbol for path-blindness.

“Long-Short Portfolios All The Way Down”

You’ve heard the expression, “turtles all the way down”.

Corey says “Long/short portfolios all the way down”.

This is an acknowledgment that every trade you make is relative to something else. If you buy a stock denominated in dollars, you are betting that the stock will outperform dollars. It’s a powerful idea. If you want to short XOM but can’t get a borrow, you can buy all the components of XLE except XOM while shorting XLE. Voila, you are now short XOM.

The pirates offer more great examples:

1. Rebalancing

You start with a 60/40 portfolio and stocks go up so the new portfolio is 65/35. You can think of a regular rebalance to get you back to 60/40.

Or you can re-frame the accounting to an algebraic equivalent:

You own a 65/35 portfolio + a long 5% bonds/short 5% stock overlay

It seems like semantics, but just as different words can refer to very similar things, there remains meaning behind the distinctions. And the subtlety here is useful because it forces you to look at the accounting of subsets of a larger position. Corey argues that this lets you think about how things are contributing to your portfolio at any given time or even over time

Bingo.

This lens is the gateway to better p/l attribution. In the 65/35 example, the intuition is fairly basic. Rebalancing trades profit when the market mean reverts and lose money if the market trends. Gamma-scalping works the same way. It’s just rebalancing for option traders. If you trend, your “daytrading p/l” will be negative if it is dominated by gamma scalps and you’ll regret going into work that day (because you will presumably have been hedging your growing delta, for example, you sold the VWAP but the market closed on its daily high.)

I agree with Corey. Seeing the world as long/short portfolios focuses you on the relative nature of every decision! Every time you are long X, you are short [not X]. If you buy a house and it goes up in value along with every other house in your state, when you sell it, did you really make money if the neighboring cost for shelter has appreciated all around you. Start seeing your decisions as long/short portfolios and it has a funny way of focusing you on what you’re specifically rooting for.

2. Corey poses another thought exercise:

Which do you think has a higher tracking error to a passive 60/40?

a) Replacing the passive equity with small-cap value exposure

b) Layering 60% exposure to the SG CTA Index on top

I promise the discussion thread will make you smarter.

I’ll sprinkle in a related idea that comes from options land.

It’s natural for vol traders, especially dispersion traders, to think about positions as a series of long/short portfolios. That’s because all dispersion is “dirty” dispersion. [If you need a refresher see Dispersion Trading For The Uninitiated].

If you sold SPX index vol and only bought vol on value names, your net position is:

  • short growth volatility
  • long value volatility (you are net long, because if you tried to balance your gross index and single name greeks, you’d necessarily have to overweight the value names. This is extra true if you theta-weight the spread since the value names are lower volatility than the growth names.)

If you had this position on before Softbank started buying the hell out of tech calls in the summer of 2020, you got rocked.

But if you put that same position on right before the Covid vaccine was announced, you killed it as value names surged while growth names barely moved relative to their vols.

Index traders are keenly aware of these “synthetic risks” because at some point you’ve been unknowingly exposed to a risk factor that took a bite out of your p/l. That prompts you to slice and dice your risk to further your understanding of positions. Risk management evolves one bruise at a time. The inevitable body shots and jabs hurt, but also teach. You just have to get your overall controls robust enough to survive the haymaker.

[Speaking of teach…did you know that if a stock is halted, you can compute what price the market is implying it will open at? Just compute the price the SPX cash index would need to be at for the futures to be priced fairly to back out the halted stock’s implied price.]

Corey is spot on. It’s long/short portfolios all the way down. This is native vision for derivatives traders.

In closing, know that I’m not just shouting my friends when I say to watch Pirates. That’s seeing causality backwards. Jason is sponsoring Moontower and I met these guys in the first place because I was attracted to how they think (well that’s half of it…there are plenty of brilliant people out there I have zero interest in hanging out with. These are friends that got through the important funnels after I noticed they were smart.) I always learn when I listen to these guys. They’re entertaining and always have good stories.

Actually, you know what? F those guys. Hoggin all the cool in the room.

On Sponsorship

Last week, I shared the Engine Model. It was a blueprint for designing an integrated life. I paused my regular workflow to write that post for myself as my trip transitions from a three-lane expressway of exploration to a local 2-lane highway. I like doing meta-writeups like that for the same reason I like reading others’ frameworks…it’s a form of “trail magic”.

Via thetrek:

The term “trail magic” was coined by long-distance hikers to describe an unexpected occurrence that lifts a hiker’s spirits and inspires awe or gratitude. “Trail magic” may be as simple as being offered a candy bar by a passing hiker or spotting an elusive species of wildlife.

For those on a similar journey, or see a similar juncture in their future, I hope the post can at least provoke if not be practical. One area I wish it was more practical, was on monetization. That’s a tough topic, so let me back up.

Reputation is the longest-duration asset you have. [The great grift of 2021 will forever be trapped in the amber of my mind as the moment a bunch of business-famous influencers decided the bid to sell their reputations was juicy enough to finally smack. It was a calculated bet on the shortness of your memory.] If you are not a sociopath, your ethical boundaries extend beyond the borders drawn by law. But the law alone seems to fence some people in just barely. Oh my god, fan me now. Watching literal lawmakers insider trade is an act of contortion so lithe it allows them to limbo even under that low bar.

[Collecting myself.]

Where was I? Oh yes, being an f’n normal human. So in that post I didn’t wade into specific monetization models because I don’t know much about them.

Instead, I address them in principle:

Once you begin thinking of your work as an engine, as self-integration, and not a single bilateral transaction with one employer (or overlord if you are especially cranky about your choices) you have replaced an existential problem, namely the rejection of over-compartmentalization, with a technical problem. The technical problem is “how do I sustain such a life?”

This is new to me and I’m learning on the fly so I’m not the best guide here. But I can offer my philosophical perspective, knowing that it will likely evolve with experience. I still think it’s important to lay out principles as a tether to your values as you head out into the unknown. 

  1. Extract less value than you createThis is obvious. Strip-mining is not a renewable strategy. I’d rather underpromise and overdeliver. This isn’t altruism, it’s good business. If you leave the high-pressure race, you have chosen to focus on the long-term. The advantage is you can use a different playbook that relies more on compounding which pays off with time, instead of quick, but hard-to-repeat scores.

    From Working For Free:

    In business, I always enjoy the Costco example. Charlie Munger has written:

    “When other companies find ways to save money, they turn it into profit. [Costco] passes it on to customers. It’s almost a religious duty. [They] sacrifice short-term profits for long-term success”.

    It’s not as hokey as it sounds. Think of it this way. They are hiding profits in the customer’s own pockets. They will be return customers. That profit is hidden from competitors’ wandering eyes and the IRS. The strategy commits Costco to keeping the customers happy because the profit is realized over the long-term. It’s simple but requires rare discipline.

    The profit that “sits in your client’s pockets” has a bookkeeping entry called “trust”. The fact that it doesn’t capitalize as an asset on your personal balance sheet is a shortcoming of accounting. You can’t let it fool you from the reality that you have stored your future income with your clients and in their word of mouth.

  2. Price your attention carefullyWhen you consider a project, you must decide how much to charge. If the project requires diesel fuel and you are a sports car, it might not run or it might be inefficient. This feels like a one-off transaction. You should probably quote a “go-away” price. At some price, you’ll suck it up. But this should be rare.

    You want projects that have recyclable exhaust. If you suspect the exhaust is especially powerful, maybe you charge less. The point is to price your time or effort holistically. What is the first and second-order cost/benefit of taking on a particular project?

    An example of holistic thinking: I don’t paywall my letter because the loss of subs would cut off a valuable inbound fuel source. The cash would not be worth it. Instead, I reframe the forgone income as “marketing cap-ex”.

I don’t know much about monetizing an integrated body of work. I’m not especially commercial-minded. But I have friends that are further ahead on this path that I can lean on. In thinking about creating your engine, realize you are not alone.

Identify your own principles. It’s a way to stay “green” as you experiment with sustainable business models that empower you to stay on the path.

Sponsorship

In the past year, I’ve been approached by companies that want to sponsor this letter. Extra cash would make it easier to justify doing stuff like hiring a designer. I have some fairly irreverent ideas for Moontower swag that would be decidedly, umm, [lowers voice] befitting of the namesake?

So I was open to the idea. Especially since I will never paywall this letter. The only issue was most of the potential sponsors didn’t get me too excited. And the higher their bid, the less exciting they are. Go bumhunt somewhere else.

When I write to “find the others” I mean it. You make this effort worth it for me. You see, if I had to pick a single external metric to grade the body of work I’ve been calling Moontower, it would be the quality of its subs. By quality, I mean thoughtful people who care about getting better as co-passengers on this ferris wheel.

Out of respect to both you and me, I’ve been guarded about who I’d let get mindshare here. While I haven’t done a formal survey (I’m working on one though), I can tell this readership is smart and has many ultra-successful people within it. Almost all of you want to invest better and live better. You’re a pretty dream demographic to marketers. Fortunately, instead of me wrestling with which sponsors to match with, the answer landed in my lap.

My friends Jason Buck and Taylor Pearson asked me to sponsor the letter. They manage a fund of funds that comes from the “all-weather” style of investing. Many of you are familiar with that term because of Ray Dalio, but Bridgewater is to Kleenex as all-weather is to “permanent portfolios”. I have been invested in Jason and Taylor’s fund for nearly a year and I’m doing my own research now on how to be more hands-on transitioning my own portfolio to be more “permanent” 1.  The exhaust of this research will be making its way into these letters so we can learn together.

In addition to the sponsorship and in keeping with my desire to keep this totally inclusive to everyone I have added the ability to be a patron of Moontower.

If you hit this button you will see the choices.

If you pay you don’t get any special posts, but if there were interest amongst patrons for higher levels of 2-way interaction I’d be happy to explore that.

There’s no pressure. It’s not like tipping in U.S. restaurants where it’s expected because servers don’t make a serious wage. I pay for about 20% of the publications I sub to. And it’s never about “is it worth it?” for me. It’s just, “do I want to support this?” I turned the feature on this week and there is seriously zero pressure. I already get a lot from your attention.

[For the more accounting curious…since I’m not a W2 employee and I incur expenses to run these sites and have a home office, any income I receive up until my costs are recouped is like an untaxed dollar. We aren’t talking real money, but eventually, I expect to have built a biz where I re-purpose a portfolio of solutions to my own problems so that it solves other people’s problems too. So these moves can be seen as practice with live rounds.]

By the way, a quick shout-out to my first paying sub, Max S., who signed up shortly after I turned that feature on. As soon as I get some swag made, I’ll be asking for your address man!

Moontower #161

I learned a new term.

“To Go On Account”

A pleasant term used by pirates to describe the act of turning pirate. The basic idea was that a pirate was more “free lance” and thus was, more or less, going into business for himself. — The Pirate Glossary

It applies to several parts of today’s letter. Oh and don’t miss the special announcement at the end.


Friends,

Last week, I shared the Engine Model. It was a blueprint for designing an integrated life. I paused my regular workflow to write that post for myself as my trip transitions from a three-lane expressway of exploration to a local 2-lane highway. I like doing meta-writeups like that for the same reason I like reading others’ frameworks…it’s a form of “trail magic”.

Via thetrek:

The term “trail magic” was coined by long-distance hikers to describe an unexpected occurrence that lifts a hiker’s spirits and inspires awe or gratitude. “Trail magic” may be as simple as being offered a candy bar by a passing hiker or spotting an elusive species of wildlife.

For those on a similar journey, or see a similar juncture in their future, I hope the post can at least provoke if not be practical. One area I wish it was more practical, was on monetization. That’s a tough topic, so let me back up.

Reputation is the longest-duration asset you have. [The great grift of 2021 will forever be trapped in the amber of my mind as the moment a bunch of business-famous influencers decided the bid to sell their reputations was juicy enough to finally smack. It was a calculated bet on the shortness of your memory.] If you are not a sociopath, your ethical boundaries extend beyond the borders drawn by law. But the law alone seems to fence some people in just barely. Oh my god, fan me now. Watching literal lawmakers insider trade is an act of contortion so lithe it allows them to limbo even under that low bar.

[Collecting myself.]

Where was I? Oh yes, being an f’n normal human. So in that post I didn’t wade into specific monetization models because I don’t know much about them.

Instead, I address them in principle:

Once you begin thinking of your work as an engine, as self-integration, and not a single bilateral transaction with one employer (or overlord if you are especially cranky about your choices) you have replaced an existential problem, namely the rejection of over-compartmentalization, with a technical problem. The technical problem is “how do I sustain such a life?”

This is new to me and I’m learning on the fly so I’m not the best guide here. But I can offer my philosophical perspective, knowing that it will likely evolve with experience. I still think it’s important to lay out principles as a tether to your values as you head out into the unknown. 

  1. Extract less value than you create

    This is obvious. Strip-mining is not a renewable strategy. I’d rather underpromise and overdeliver. This isn’t altruism, it’s good business. If you leave the high-pressure race, you have chosen to focus on the long-term. The advantage is you can use a different playbook that relies more on compounding which pays off with time, instead of quick, but hard-to-repeat scores.

    From Working For Free:

    In business, I always enjoy the Costco example. Charlie Munger has written:

    “When other companies find ways to save money, they turn it into profit. [Costco] passes it on to customers. It’s almost a religious duty. [They] sacrifice short-term profits for long-term success”.

    It’s not as hokey as it sounds. Think of it this way. They are hiding profits in the customer’s own pockets. They will be return customers. That profit is hidden from competitors’ wandering eyes and the IRS. The strategy commits Costco to keeping the customers happy because the profit is realized over the long-term. It’s simple but requires rare discipline.

    The profit that “sits in your client’s pockets” has a bookkeeping entry called “trust”. The fact that it doesn’t capitalize as an asset on your personal balance sheet is a shortcoming of accounting. You can’t let it fool you from the reality that you have stored your future income with your clients and in their word of mouth.

  2. Price your attention carefully

    When you consider a project, you must decide how much to charge. If the project requires diesel fuel and you are a sports car, it might not run or it might be inefficient. This feels like a one-off transaction. You should probably quote a “go-away” price. At some price, you’ll suck it up. But this should be rare.

    You want projects that have recyclable exhaust. If you suspect the exhaust is especially powerful, maybe you charge less. The point is to price your time or effort holistically. What is the first and second-order cost/benefit of taking on a particular project?

    An example of holistic thinking: I don’t paywall my letter because the loss of subs would cut off a valuable inbound fuel source. The cash would not be worth it. Instead, I reframe the forgone income as “marketing cap-ex”.

I don’t know much about monetizing an integrated body of work. I’m not especially commercial-minded. But I have friends that are further ahead on this path that I can lean on. In thinking about creating your engine, realize you are not alone.

Identify your own principles. It’s a way to stay “green” as you experiment with sustainable business models that empower you to stay on the path.

Sponsorship

In the past year, I’ve been approached by companies that want to sponsor this letter. Extra cash would make it easier to justify doing stuff like hiring a designer. I have some fairly irreverent ideas for Moontower swag that would be decidedly, umm, [lowers voice] befitting of the namesake?

So I was open to the idea. Especially since I will never paywall this letter. The only issue was most of the potential sponsors didn’t get me too excited. And the higher their bid, the less exciting they are. Go bumhunt somewhere else.

When I write to “find the others” I mean it. You make this effort worth it for me. You see, if I had to pick a single external metric to grade the body of work I’ve been calling Moontower, it would be the quality of its subs. By quality, I mean thoughtful people who care about getting better as co-passengers on this ferris wheel.

Out of respect to both you and me, I’ve been guarded about who I’d let get mindshare here. While I haven’t done a formal survey (I’m working on one though), I can tell this readership is smart and has many ultra-successful people within it. Almost all of you want to invest better and live better. You’re a pretty dream demographic to marketers. Fortunately, instead of me wrestling with which sponsors to match with, the answer landed in my lap.

My friends Jason Buck and Taylor Pearson asked me to sponsor the letter. They manage a fund of funds that comes from the “all-weather” style of investing. Many of you are familiar with that term because of Ray Dalio, but Bridgewater is to Kleenex as all-weather is to “permanent portfolios”. I have been invested in Jason and Taylor’s fund for nearly a year and I’m doing my own research now on how to be more hands-on transitioning my own portfolio to be more “permanent” 1.  The exhaust of this research will be making its way into these letters so we can learn together.

In addition to the sponsorship and in keeping with my desire to keep this totally inclusive to everyone I have added the ability to be a patron of Moontower.

If you hit this button you will see the choices.

If you pay you don’t get any special posts, but if there were interest amongst patrons for higher levels of 2-way interaction I’d be happy to explore that.

There’s no pressure. It’s not like tipping in U.S. restaurants where it’s expected because servers don’t make a serious wage. I pay for about 20% of the publications I sub to. And it’s never about “is it worth it?” for me. It’s just, “do I want to support this?” I turned the feature on this week and there is seriously zero pressure. I already get a lot from your attention.

[For the more accounting curious…since I’m not a W2 employee and I incur expenses to run these sites and have a home office, any income I receive up until my costs are recouped is like an untaxed dollar. We aren’t talking real money, but eventually, I expect to have built a biz where I re-purpose a portfolio of solutions to my own problems so that it solves other people’s problems too. So these moves can be seen as practice with live rounds.]

By the way, a quick shout-out to my first paying sub, Max S., who signed up shortly after I turned that feature on. As soon as I get some swag made, I’ll be asking for your address man!


Today’s letter is brought to you by the team at Mutiny Fund:

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Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended. 


Money Angle

I feel lucky that Jason Buck reached out to sponsor the letter because I love what he’s doing (Yinh and I were early investors in their latest fund). In addition to managing a fund, Jason is co-host of what I think is the most underrated show on investing YouTube, Pirates of Finance.

In season 3, Jason and Corey Hoffstein changed the format so that there is zero preparation. The conversation is totally off the cuff. And it totally slaps.

It is free, buried booty that our theoretical economist says can’t exist because of efficient markets. But it exists. I’ll prove it by digging up 3 themes from their amazing recent episode Decision-Making Under Uncertainty and mix them with my own thoughts. We’re blending Moontower and Pirate rum up in here today.

Why ETFs Might Be Unsuitable For Some Strategies

ETFs are liquid structures designed to faithfully track NAVs (“net asset values”) because the arbitrage mechanism is outsourced by the issuer to an Authorized Participant. These AP’s are a subset of the market-making community.

The Pirates wonder:

Is the ETF structure, whose allure is transparency, the correct home for opaque, illiquid, or bi-lateral (ie there’s credit risk in the basket) instruments such as inflation swaps? What about semi-liquid holdings like corporate bonds or even TIPs?

The answer to such questions partially rests on the liquidity of the underlying holdings. Consider a question they allude to but I’ll make explicit:

If you hold long option or long convex positions via ETFs (or for that matter directly) will you be able to monetize them when they pay off?

This is a real and highly underrated concern. Bid/ask spreads are positively correlated with volatility. So how useful is it if the paper profit on a convex position can’t be crystallized because the bid-ask is wider than the parted Red Sea?

Suppose you buy a way OTM put option for $1. It explodes to $20 but the bid-ask is now $16-$24. Sure, you can sell it for a 16x return, but when that option was originally valued for $1, the pricing incorporated the idea that in some rare states of the world the option is worth $20. If you can never realize that $20, then you entered into a pretty negative expected value situation when you paid $1 for it in the first place.

Trading is hard enough, you can’t afford to not maximize small edges. In a separate interview Corey talks to option trader Darrin Johnson.

I paraphrase Darrin:

When you sell tails, you need to capture the entire premium. The hit ratio of selling tails is high but when you lose you lose many multiples of the premium. If you fail to collect the full premium, it will not make up for the losing trades. The difficulty of selling tails is even trickier yet.

Darrin explains how betting against longshots leaves you uncertain if you have an edge in the first place. In my words: good luck differentiating between a 50-1 shot vs a 100-1 shot. That’s the difference of 1 probability point but it’s massive in payoff space. [I discuss that idea further in Tails Explained.]

When volatility increases, transaction costs go up for everyone. Since market-makers are part of “everyone” then the cost of their own hedging (ie replication) goes up as well, so they charge wider-bid ask spreads to keep them whole. MMs represent the marginal supply of liquidity so can they pass the transaction costs of their own “COGs” to those demanding liquidity. We know the house wins both ways, but the house edge itself is correlated to what markets are doing. If the house’s margins above their “COGs” expand in times of stress, you need to haircut the expected risk mitigation from defensive positions. That cost will show up when you try to roll or monetize.

There are cases where that bookie’s vig will not be too punitive even in a volatile market. For example, if the option you buy is now so far ITM that it no longer has meaningful extrinsic value, then you can simply trade the underlying to monetize (although re-hedging will put you face-to-face with the market-makers again).

This brings us to the next theme.

Destination vs Path

If you have a view about the expected return of an asset in 5 years should you care about the path? Depends who you ask. Anyone marked-to-market (HFs, market-makers, futures traders) will say yes especially if they are managing money for others. PE, RE, and bond investors are more likely to say no. The Pirates have a nuanced discussion about whether it’s even possible to manage to path versus manage to terminal value.

I’m biased by my path-or-die experience in trading. Mark-to-market is the goddess of tomorrow, you can’t afford to piss her off.

Here are a collection of arguments that I offer her as tribute.

  1. Bond investors who ignore path are fooling themselves.

    In Why Volatility Still Matters To Buy-And-Hold Investors, I summarize one of Cliff Asness’ pet peeves:

    You may hear some people say they want to buy an individual bond rather than a bond fund. They worry that bond fund prices move around and have no real expiration, so when interest rates rise your losses are somehow more real. But if you buy a bond and hold it to maturity you can put your head in the sand, and never lose.


    This is nonsense.


    You have lost in a real sense since the money you are being returned is worth less in a world in which rates have risen to compensate for inflation. The bond fund is effectively taking your loss today rather than later. If you sell your bond for a loss, you can reinvest at a higher yield going forward. That’s a similar experience to just being in the bond fund. Holding to maturity does not mean you have less risk. It’s an illusion. A real vs nominal illusion.

  2. Using stale marks to “smooth volatility”

    Having a preference for private assets that are less volatile simply because their marks are stale is like not getting bloodwork because you don’t want to find out your cholesterol and blood sugar are too high.

    The slow-to-mark investments are still volatile. The fundamentals of the private business are correlated with the public market volatility.

    Even if you don’t believe your investment should be marked down, then you should be sad you can’t redeem your private investment at par to rebalance into public stocks after the market drops 20%. Giving up liquidity without a premium because it will behaviorally “save you from yourself” sure feels like you sold the option to rebalance at zero.

    I walk through that argument in How Much Extra Return Should You Demand For Illiquidity? (7 min read)

  3. Market prices are clever. They can balance the wagers of path vs terminal value investors simultaneously!

    In What The Widowmaker Can Teach Us About Trade Prospecting And Fool’s GoldI show how the calendar spread options are priced so that the path of the gas price is highly respected, even if there’s strong consensus about the terminal value of the spread (ie the March-April futures spread which is a pure bet on in winter gas being in short supply).

    The OTM calls are jacked, because if we see H gas trade $10, the straddle will go nuclear.

    Why? Because it has to balance 2 opposing forces.

    1. It’s not clear how high the price can go in a true squeeze or shortage
    2. The MOST likely scenario is the price collapses back to $3 or $4.


    Try to think of a strategy to trade that. Good luck.

    Let me repeat how gnarly this is: The price has an unbounded upside, but it will most likely end up in the $3-$4 range. The vertical spreads all point right back to that price range.

    The market places very little probability density at high prices but this is very jarring to people who see the jacked call premiums.

    That’s not an opportunity. It’s a sucker bet.

    Another common example:

    In options land, many investors like to buy 1×2 ratio spreads because the payoffs look amazing for low-probability events. For example, if a stock is $100 and you can buy the $115 call and sell 2 of the $120 calls for zero premium, you think to yourself:

    a) “If the stock does nothing or goes down I break even”
    b) “If the stock goes to $120, I make $5” (or $1 if the stock goes to $116)

    c) “I don’t start losing money until the stock goes over $125. That’s 25% away! This is risk-free return”

    Nah dog. That’s first-time-at-the-rodeo thinking.

    The reason the 1×2 is so cheap is the call skew on the $120 strike is pumped up because someone has been buying them like crazy. That’s where the bodies are hidden. The question you need to ask yourself is “conditional on the stock going to $120 did it get there fast and sloppy, or slow and grindy.” If it goes there in a fast way, the market-maker community will be short beaucoup gamma and be scrambling to buy the $120 calls back. You sold some teenies and went to Santorini and are now getting a margin call on the beach because the 120s you’re short are blowing the f out.

    The path-aware trader is plotting how to be long the scenario where your vacation abruptly ends.

  4. If path is so important, how can you manage to it?

    a) Avoid excessive leverage

    b) Pre-determine when you will cut losses (beware this can be a big topic with lots of room for disaster)

    c) If you insist on betting on terminal value, do it in fixed premium ways where your max loss is bounded. Now you don’t have to worry about mark-to-market risk.

    In There’s Gold In Them Thar Tails: Part 2I cover the topic of path, how to exploit investors’ lack of appreciation for it, and how Jon Corzine became a symbol for path-blindness.

“Long-Short Portfolios All The Way Down”

You’ve heard the expression, “turtles all the way down”.

Corey says “Long/short portfolios all the way down”.

This is an acknowledgment that every trade you make is relative to something else. If you buy a stock denominated in dollars, you are betting that the stock will outperform dollars. It’s a powerful idea. If you want to short XOM but can’t get a borrow, you can buy all the components of XLE except XOM while shorting XLE. Voila, you are now short XOM.

The pirates offer more great examples:

1. Rebalancing

You start with a 60/40 portfolio and stocks go up so the new portfolio is 65/35. You can think of a regular rebalance to get you back to 60/40.

Or you can re-frame the accounting to an algebraic equivalent:

You own a 65/35 portfolio + a long 5% bonds/short 5% stock overlay

It seems like semantics, but just as different words can refer to very similar things, there remains meaning behind the distinctions. And the subtlety here is useful because it forces you to look at the accounting of subsets of a larger position. Corey argues that this lets you think about how things are contributing to your portfolio at any given time or even over time

Bingo.

This lens is the gateway to better p/l attribution. In the 65/35 example, the intuition is fairly basic. Rebalancing trades profit when the market mean reverts and lose money if the market trends. Gamma-scalping works the same way. It’s just rebalancing for option traders. If you trend, your “daytrading p/l” will be negative if it is dominated by gamma scalps and you’ll regret going into work that day (because you will presumably have been hedging your growing delta, for example, you sold the VWAP but the market closed on its daily high.)

I agree with Corey. Seeing the world as long/short portfolios focuses you on the relative nature of every decision! Every time you are long X, you are short [not X]. If you buy a house and it goes up in value along with every other house in your state, when you sell it, did you really make money if the neighboring cost for shelter has appreciated all around you. Start seeing your decisions as long/short portfolios and it has a funny way of focusing you on what you’re specifically rooting for.

2. Corey poses another thought exercise:

Which do you think has a higher tracking error to a passive 60/40?

a) Replacing the passive equity with small-cap value exposure

b) Layering 60% exposure to the SG CTA Index on top

I promise the discussion thread will make you smarter.

I’ll sprinkle in a related idea that comes from options land.

It’s natural for vol traders, especially dispersion traders, to think about positions as a series of long/short portfolios. That’s because all dispersion is “dirty” dispersion. [If you need a refresher see Dispersion Trading For The Uninitiated].

If you sold SPX index vol and only bought vol on value names, your net position is:

  • short growth volatility
  • long value volatility (you are net long, because if you tried to balance your gross index and single name greeks, you’d necessarily have to overweight the value names. This is extra true if you theta-weight the spread since the value names are lower volatility than the growth names.)

If you had this position on before Softbank started buying the hell out of tech calls in the summer of 2020, you got rocked.

But if you put that same position on right before the Covid vaccine was announced, you killed it as value names surged while growth names barely moved relative to their vols.

Index traders are keenly aware of these “synthetic risks” because at some point you’ve been unknowingly exposed to a risk factor that took a bite out of your p/l. That prompts you to slice and dice your risk to further your understanding of positions. Risk management evolves one bruise at a time. The inevitable body shots and jabs hurt, but also teach. You just have to get your overall controls robust enough to survive the haymaker.

[Speaking of teach…did you know that if a stock is halted, you can compute what price the market is implying it will open at? Just compute the price the SPX cash index would need to be at for the futures to be priced fairly to back out the halted stock’s implied price.]

Corey is spot on. It’s long/short portfolios all the way down. This is native vision for derivatives traders.

In closing, know that I’m not just shouting my friends when I say to watch Pirates. That’s seeing causality backwards. Jason is sponsoring Moontower and I met these guys in the first place because I was attracted to how they think (well that’s half of it…there are plenty of brilliant people out there I have zero interest in hanging out with. These are friends that got through the important funnels after I noticed they were smart.) I always learn when I listen to these guys. They’re entertaining and always have good stories.

Actually, you know what? F those guys. Hoggin all the cool in the room.


Last Call

This was a dense issue. Reading is the worst. I know.

Instead of more links to ignore, I will leave you with an invitation to learn in-person.

Me and 2 old friends who all traded at SIG together are going to host 3 free teaching sessions in NYC the first week of October.

We are ridiculously stoked to meet many of you. That said space is limited so there’s a short application.

You can find the details and application in this thread:

“The Unplugged Controller”

I’m going to stick with a somewhat irreverent tack for Labor Day with this share.

On Meaningless Careers (7 min read)
by Jack Raines

Jack’s Young Money finance blog is consistently fun to read. A few excerpts from this post:

The abstract:

People love work.

The problem isn’t that the youngest generation hates work; the problem is that many of the jobs offered to the youngest generation aren’t work at all. The spreadsheet-heavy, mid-level-manager-dominated, buzzword-filled roles offered to us are jobs, but they are hardly “work.”

For any gamers out there, one of the oldest tricks in the book is giving your younger sibling an unplugged/disconnected controller, so they feel like they are “playing”, while you are in control the whole time.

Many “jobs” today are simply unplugged controllers. The work would get done, whether or not we take part in the process. We are simply moving numbers, smashing buttons, and staying busy, with no regard for actual productivity.

We never stop to ask “is this job necessary?” Because we are paid increasingly higher and higher salaries for our participation in this ever-growing proliferation of pointless jobs.

Sebastian Junger once said, “Humans don’t mind hardship, in fact they thrive on it; what they mind is not feeling necessary. Modern society has perfected the art of making people not feel necessary.”

The concrete:

Football was overbearing, painful, and straight-up frustrating at times, but from day one on the football team, I felt like my contributions mattered.

Contrast that with my experience working in corporate finance.

The people I worked with and worked for in corporate finance were great. My supervisors were certainly nicer than my coaches (which wasn’t a difficult hurdle to surpass, considering some of my football coaches called me things that cannot be repeated over text). And the work wasn’t hard. It was easy, simple. And anything that I didn’t already know how to do could be learned in a few days.

And the best part? I was paid a living wage for my efforts in this corporate finance job. And yet, I hated it. Actually, hate is much too strong of a word.

The opposite of love isn’t hate, it’s indifference. And I was aggressively indifferent to my work.

If pandemic-induced remote work showed me anything, it showed me how little “work” was necessary to do my job. I legitimately “worked” 5-10 hours per week at times, but I was always pretending to “work”, by either moving my mouse to look active or tinkering with files, models, and decks that didn’t really need tinkering to pass the time.

It was pretty obvious that if I didn’t show up for a day, week, or month, the show would go on. I was playing with an unplugged remote.

I was trading my time for a paycheck, with no regard for the actual work being done.

And I wasn’t alone.

The “prestige lie”:

The paradox of modern work is that the most prestigious jobs often involve the least actual work. If you can grind on tedious tasks longer than anyone else, you can get paid a lot of money. You gain material riches at the loss of your individualistic drive.

To quote David Graeber’s Bullshit Jobs:

Shit jobs tend to be blue collar and pay by the hour, whereas bullshit jobs tend to be white collar and salaried. Those who work shit jobs tend to be the object of indignities; they not only work hard but also are held in low esteem for that very reason. But at least they know they’re doing something useful.

Those who work bullshit jobs are often surrounded by honor and prestige; they are respected as professionals, well paid, and treated as high achievers – as the sort of people who can be justly proud of what they do.

Yet secretly they are aware that they have achieved nothing; they feel they have done nothing to earn the consumer toys with which they fill their lives; they feel it’s all based on a lie – as, indeed, it is.

Of course, this whole thing makes sense. Prestige is the lie we tell ourselves to justify our “bullshit jobs.”

We don’t like the work, and in the back of our heads, it feels like we are selling our souls and our time for a paycheck. If we dwelled on that realization too long, we would probably hop off this treadmill entirely. But prestige is that North Star that continues to pull us forward.

The thing about prestige is that it isn’t real. It’s a vanity metric. Don’t believe me? Then why are half of all middle-management jobs now called “vice president?”

Prestige.

Prestige has mollified our collective work restlessness, our existential angst. Prestige keeps those uncomfortable self-realizations imprisoned in the backs of our minds.

Prestige allows the show to go on.

But if you adjust your values, and if prestige loses its luster, the nothingness of these jobs becomes impossible to ignore.

This all ties back cleanly to my post. The prestige “North Star” is one of many compass headings that can leave you with that “pebble in the shoe” feeling.

I’d imagine Labor Day would be an important day for Graeber. A day to celebrate those shit jobs that pay by the hour. They have no prestige but they are honest.

All of this reminds me of this section from 15 Ideas From Morgan Housel’s Interview with Tim Ferriss:

The optimal amount of bullshit

You had Stephen Pressfield on your show, and he was talking about a time when he lived in a mental institution. He was not a patient himself, but he lived there and he starts talking to all these people. And he made this comment that a lot of the common denominators of these people who lived in a mental institution was they were not crazy, they just could not handle or put up with the bullshit of life. They just couldn’t deal with it. And that was kind of why they ended up in the mental institution. And he said all these people were the smartest, most creative people who he had ever met, but they couldn’t put up, they had no tolerance for the bullshit of the real world. And that to me, just brought this idea that there’s actually an optimal amount of bullshit to deal with in life. If your tolerance for bullshit is zero, you’re not going to make it at all in life…

I listened to that [interview] and it was like, “Oh, see, these people could not function in the real world because they had no tolerance for bullshit.” The second step from that is, there is an optimal amount of bullshit to put up within life. And that was where this article, “The Optimal Amount of Hassle,” came from.

And I remembered I was on a flight many years ago and there was this guy in a pinstripe suit who let everyone know that he was a CEO of some company, and the flight was like two hours delayed, and he completely lost his mind. He was dropping F bombs to the gate agents and just completely making an ass of himself because the flight was delayed. And I remember thinking like, “How could you make it this far in life and have no tolerance for petty annoyance, like a delayed flight?”

And I just think like there’s a big skill in life in terms of just being able to deal with some level of bullshit, and a lot of people don’t have that. There’s another great quote that I love from FDR, who of course was paralyzed and in a wheelchair. And he said, “When you’re in a wheelchair and you want milk but they bring you orange juice instead, you learn to say, ‘That’s all right.’ and just drink it.” And I think that just having the ability to put up with that kind of stuff is, I think, really important and often lost in this age where we want perfection. We want everything to be perfect, and it never is.

[Kris comment: I have a good friend who is insanely smart and well-traveled (top 1% in both categories of everyone I know). His brother is not conventionally successful but I was curious what that brother is like. His brother is also very well-traveled in part to choosing a life in the armed forces. But my friend also described his brother as extremely smart. But…incapable of tolerating the b.s. The military life is simple in the ways he prefers. It has always stayed with me, that my friend quite explicitly described his brother as being unwilling to suffer bullshit. I often feel that “getting ahead” in a conventional sense is really just alpining sedimentary layers of compressed bullshit. When I use the word “integrated” metaphysically, a large portion of that is finding your personal sweet spot on the b.s. continuum.]

Jobs like trading and finance are especially vulnerable to bullshit because we put abstractions like price discovery, efficiency, and liquidity on pedestals. Rightfully so. In Finance Guilt, I defend these ideals. The progress of civilization does depend on them.
The problem is that whenever something is good it’s easy to rationalize its excesses beyond the point of diminishing returns. It’s hard to know when more isn’t better.

You have heard the lament that too many wicked smaht people go into finance when they should go into science. What about the genius trading quants who literally used to build weapons for Russia? I’ll leave this for the utilitarians to sort out. Meanwhile, someone who just learned to spell libertarian is hyperventilating “the market will decide”. As if the market’s outputs themselves weren’t downstream of rules set by politicians horse-trading in “the room where it happens.”

Byrne Hobart’s quote brings object-level framing to an abstract argument:

The defense of 1031 exchanges is that they encourage growth because they keep people spending money on new property developments instead of cashing out and enjoying their gains. Which embeds two assumptions:

  1. It’s generally better to tax consumption than investment, and
  2. Real estate investment is a particularly worthy kind of investment to avoid taxing.

Assumption #1 sounds true, but is circumstantial. Assumption #2, though, is hard to defend. Real estate speculation does produce jobs, but it also produces macroeconomic volatility and sometimes threatens the financial system. From a macroprudential perspective, where the goal is to reduce the odds of financial crises, it might make more sense to have 1031 exchanges for everything but real estate: sell your company, and you can roll the money into starting a new one; sell a mall or skyscraper, and you get taxed. But it’s always fiendishly hard to predict the long-term incentives created by a change in the tax code. Any tax on realizing gains, for example, is implicitly a subsidy on borrowing against appreciated assets instead of realizing those gains. If that’s true, the net effect of eliminating 1031 exchanges would be that real estate portfolios would turn over less often. If we assume that people vary in their ability to make good real estate investments, this would mean that the best such investors wouldn’t make as many discrete investing decisions, which would make prices a bit less efficient. Which might be a reasonable tradeoff: making real estate investing a less tax-optimal choice could be a fair trade in exchange for making real estate prices less reflective of their value. But it’s still a tradeoff, not a straightforward benefit. Quirks in the tax code become load-bearing over time; even if they didn’t make economic sense when they were made, the structure of the economy only makes sense in light of the tax incentives that economic actors have already responded to. If you assume that people are reasonably good at reacting to incentives—or, more plausibly, that over time the people who are good at doing this end up controlling more assets—then any change in those incentives has complicated and unpredictable results.]

Moontower #160

First, Happy Labor Day!

Sorry about Moontower being a day late. I was traveling much of last week then off-the-grid camping until yesterday. Today’s letter is a follow-up to last week’s Moontower. I wrote last week:

Since leaving my trading career nearly 18 months ago I’ve allowed myself a lot of space to explore. I’ve been wary of narrowing my focus prematurely. However, the last few months have started revealing opportunities that warrant deeper dives. I’ll discuss them when it makes sense to. In the meantime, I felt compelled to write about the meta-framework that has helped me filter opportunities.

I published the post this week.

The post will be especially useful to those who @khemaridh describes as having a “pebble in their shoe”. We are all compartmentalized to some degree. But integration is something that matters more to some than others. The cost/benefit varies by individual. Many are bribed by high salaries to work on things they don’t feel great about (ad tech and some finance stuff come to mind). No judgment from me.

No matter how you start out in your career, it’s inevitable that the cost/benefit changes. You can become more inspired or just get bored. Money may matter less or you find you want more of it.

These changes in attitude coincide with changes in your internal compass. I’m not talking about your morality. I’m talking about the sense of your own potential.

You realize that chasing your own potential naturally integrates you.

If you feel uneasy about how compartmentalized your life feels, I’d bet at least even money that you are not reaching for your own ceiling.

I can anticipate an objection already. Especially on Labor Day. “Bruh, I can’t be chasing my own potential, I gotta knock out this rent.”

You’re 100% right. I’m not suggesting you pull the cord, and chase a fantasy. If in this compartmentalized state (think a starving artist waiting tables or cubicle drone who fancies themselves the next Neal Stephenson), you aren’t taking any part-time steps towards your “passion”, it’s not your passion. It’s just a fantasy. I can tell you from my experience of being a horny 19-year-old once upon a time that there are no prereqs to having a fantasy.

But if you want to make your potential and dreams real you have to take actions. You will need to be intentional. Living deliberately, designing your own omakase life, is hard because society offers many pre-made dishes that satisfy your first need — literal hunger. If anything, menus are convenient.

The problem with menus is their designs are highly suggestive. From ads for Happy Hour to the order of the list, the nudges are everywhere. But no menu ever suggests that you check out the restaurant next door. If you walked into this particular restaurant, the management rightly acts as if this is where you intend to be.

That assumption itself is not as neutral as it appears.

The restaurants you see are the ones that can afford to attract you with shiny logos and prime real estate. Imagine it’s 1994. To go off the beaten path you’d to, what, call your friend on a landline for their epicurean input? I’ll just look for the golden arches thank you very much.

The internet changed all that. From Citysearch (I’m old) to Yelp, we could get fed and happy at the same time. And have a new experience. Choice can be overwhelming or life-affirming. (Your perspective has more to do with the quality of your own taste/filters, but that’s a topic for another day). From remote work to new careers to permissionless access to your own audience, the internet has also changed the menu of work.

Am I being cheeky when I compare what you do with your working life with what you choose to eat? I don’t think by much. Sustenance and delight are not the same. To say someone is surviving versus thriving is a softer way of saying that person is slowly dying. Language is a funny thing that way.

So going back to the objection…”bruh, I gotta knock out this rent”. Yes, you do, but don’t forget that’s just survival. Some people are so trapped that is enough. We grade on curves for good reasons. But for you, a person voluntarily reading this utterly whimsical letter where life and death definitely do not hang in the balance, you cannot make this objection convincingly.

The internet has made ordering off the metaphorical menu easier. Embrace it. You can exchange an existential problem (“what am I doing?”) for a technical problem (“how am I going to sustain what I actually want to do?”). You don’t make that trade because it’s easy.

You do it because it’s worth it.

Anyway, that’s a wordy-enough preamble to the longest post I’ve written. It’s part philosophy, part story, and part reference so feel free to skip around.

Design Your Own Engine (31 min read)

The post is the output of observing myself on a lag.

Practically speaking, I felt the need to write it because as I transition my activities from total free-form to even modest focus, it was useful to think about how to narrow attention and consider at least second-order effects of how you could do that in an integrated (more efficient) way.

I talk about sustainability which is a super-category of monetization. I have little experience there but have some meta-principles and hopefully encouraging and pragmatic thoughts for those who aren’t skilled at being commercial-minded (like myself).

Finally some rah-rah at the end that hopefully manages to not be too cliche. Even if it is, you get to see what cliches seem worth bearing mind from the sea of cliches I could have chosen from.

Random bonuses:

  • You’ll learn the very basics of how a gas-powered engine works. (If this is the extent of your interest then do yourself the biggest favor in the world and check out this benevolence by @BCiechanowski.
  • When you see “:[hypertext]” that’s me experimenting with @ncasenmare new Nutshell technology on my blog.

Money Angle

I’m going to stick with a somewhat irreverent tack for Labor Day with this share.

On Meaningless Careers (7 min read)
by Jack Raines

Jack’s Young Money finance blog is consistently fun to read. A few excerpts from this post:

The abstract:

People love work.

The problem isn’t that the youngest generation hates work; the problem is that many of the jobs offered to the youngest generation aren’t work at all. The spreadsheet-heavy, mid-level-manager-dominated, buzzword-filled roles offered to us are jobs, but they are hardly “work.”

For any gamers out there, one of the oldest tricks in the book is giving your younger sibling an unplugged/disconnected controller, so they feel like they are “playing”, while you are in control the whole time.

Many “jobs” today are simply unplugged controllers. The work would get done, whether or not we take part in the process. We are simply moving numbers, smashing buttons, and staying busy, with no regard for actual productivity.

We never stop to ask “is this job necessary?” Because we are paid increasingly higher and higher salaries for our participation in this ever-growing proliferation of pointless jobs.

Sebastian Junger once said, “Humans don’t mind hardship, in fact they thrive on it; what they mind is not feeling necessary. Modern society has perfected the art of making people not feel necessary.”

The concrete:

Football was overbearing, painful, and straight-up frustrating at times, but from day one on the football team, I felt like my contributions mattered.

Contrast that with my experience working in corporate finance.

The people I worked with and worked for in corporate finance were great. My supervisors were certainly nicer than my coaches (which wasn’t a difficult hurdle to surpass, considering some of my football coaches called me things that cannot be repeated over text). And the work wasn’t hard. It was easy, simple. And anything that I didn’t already know how to do could be learned in a few days.

And the best part? I was paid a living wage for my efforts in this corporate finance job. And yet, I hated it. Actually, hate is much too strong of a word.

The opposite of love isn’t hate, it’s indifference. And I was aggressively indifferent to my work.

If pandemic-induced remote work showed me anything, it showed me how little “work” was necessary to do my job. I legitimately “worked” 5-10 hours per week at times, but I was always pretending to “work”, by either moving my mouse to look active or tinkering with files, models, and decks that didn’t really need tinkering to pass the time.

It was pretty obvious that if I didn’t show up for a day, week, or month, the show would go on. I was playing with an unplugged remote.

I was trading my time for a paycheck, with no regard for the actual work being done.

And I wasn’t alone.

The “prestige lie”:

The paradox of modern work is that the most prestigious jobs often involve the least actual work. If you can grind on tedious tasks longer than anyone else, you can get paid a lot of money. You gain material riches at the loss of your individualistic drive.

To quote David Graeber’s Bullshit Jobs:

Shit jobs tend to be blue collar and pay by the hour, whereas bullshit jobs tend to be white collar and salaried. Those who work shit jobs tend to be the object of indignities; they not only work hard but also are held in low esteem for that very reason. But at least they know they’re doing something useful.

Those who work bullshit jobs are often surrounded by honor and prestige; they are respected as professionals, well paid, and treated as high achievers – as the sort of people who can be justly proud of what they do.

Yet secretly they are aware that they have achieved nothing; they feel they have done nothing to earn the consumer toys with which they fill their lives; they feel it’s all based on a lie – as, indeed, it is.

Of course, this whole thing makes sense. Prestige is the lie we tell ourselves to justify our “bullshit jobs.”

We don’t like the work, and in the back of our heads, it feels like we are selling our souls and our time for a paycheck. If we dwelled on that realization too long, we would probably hop off this treadmill entirely. But prestige is that North Star that continues to pull us forward.

The thing about prestige is that it isn’t real. It’s a vanity metric. Don’t believe me? Then why are half of all middle-management jobs now called “vice president?”

Prestige.

Prestige has mollified our collective work restlessness, our existential angst. Prestige keeps those uncomfortable self-realizations imprisoned in the backs of our minds.

Prestige allows the show to go on.

But if you adjust your values, and if prestige loses its luster, the nothingness of these jobs becomes impossible to ignore.

This all ties back cleanly to my post. The prestige “North Star” is one of many compass headings that can leave you with that “pebble in the shoe” feeling.

I’d imagine Labor Day would be an important day for Graeber. A day to celebrate those shit jobs that pay by the hour. They have no prestige but they are honest.

All of this reminds me of this section from 15 Ideas From Morgan Housel’s Interview with Tim Ferriss:

The optimal amount of bullshit

You had Stephen Pressfield on your show, and he was talking about a time when he lived in a mental institution. He was not a patient himself, but he lived there and he starts talking to all these people. And he made this comment that a lot of the common denominators of these people who lived in a mental institution was they were not crazy, they just could not handle or put up with the bullshit of life. They just couldn’t deal with it. And that was kind of why they ended up in the mental institution. And he said all these people were the smartest, most creative people who he had ever met, but they couldn’t put up, they had no tolerance for the bullshit of the real world. And that to me, just brought this idea that there’s actually an optimal amount of bullshit to deal with in life. If your tolerance for bullshit is zero, you’re not going to make it at all in life…

I listened to that [interview] and it was like, “Oh, see, these people could not function in the real world because they had no tolerance for bullshit.” The second step from that is, there is an optimal amount of bullshit to put up within life. And that was where this article, “The Optimal Amount of Hassle,” came from.

And I remembered I was on a flight many years ago and there was this guy in a pinstripe suit who let everyone know that he was a CEO of some company, and the flight was like two hours delayed, and he completely lost his mind. He was dropping F bombs to the gate agents and just completely making an ass of himself because the flight was delayed. And I remember thinking like, “How could you make it this far in life and have no tolerance for petty annoyance, like a delayed flight?”

And I just think like there’s a big skill in life in terms of just being able to deal with some level of bullshit, and a lot of people don’t have that. There’s another great quote that I love from FDR, who of course was paralyzed and in a wheelchair. And he said, “When you’re in a wheelchair and you want milk but they bring you orange juice instead, you learn to say, ‘That’s all right.’ and just drink it.” And I think that just having the ability to put up with that kind of stuff is, I think, really important and often lost in this age where we want perfection. We want everything to be perfect, and it never is.

[Kris comment: I have a good friend who is insanely smart and well-traveled (top 1% in both categories of everyone I know). His brother is not conventionally successful but I was curious what that brother is like. His brother is also very well-traveled in part to choosing a life in the armed forces. But my friend also described his brother as extremely smart. But…incapable of tolerating the b.s. The military life is simple in the ways he prefers. It has always stayed with me, that my friend quite explicitly described his brother as being unwilling to suffer bullshit. I often feel that “getting ahead” in a conventional sense is really just alpining sedimentary layers of compressed bullshit. When I use the word “integrated” metaphysically, a large portion of that is finding your personal sweet spot on the b.s. continuum.]

Jobs like trading and finance are especially vulnerable to bullshit because we put abstractions like price discovery, efficiency, and liquidity on pedestals. Rightfully so. In Finance Guilt, I defend these ideals. The progress of civilization does depend on them.
The problem is that whenever something is good it’s easy to rationalize its excesses beyond the point of diminishing returns. It’s hard to know when more isn’t better.

You have heard the lament that too many wicked smaht people go into finance when they should go into science. What about the genius trading quants who literally used to build weapons for Russia? I’ll leave this for the utilitarians to sort out. Meanwhile, someone who just learned to spell libertarian is hyperventilating “the market will decide”. As if the market’s outputs themselves weren’t downstream of rules set by politicians horse-trading in “the room where it happens.”

Byrne Hobart’s quote brings object-level framing to an abstract argument:

The defense of 1031 exchanges is that they encourage growth because they keep people spending money on new property developments instead of cashing out and enjoying their gains. Which embeds two assumptions:

  1. It’s generally better to tax consumption than investment, and
  2. Real estate investment is a particularly worthy kind of investment to avoid taxing.

Assumption #1 sounds true, but is circumstantial. Assumption #2, though, is hard to defend. Real estate speculation does produce jobs, but it also produces macroeconomic volatility and sometimes threatens the financial system. From a macroprudential perspective, where the goal is to reduce the odds of financial crises, it might make more sense to have 1031 exchanges for everything but real estate: sell your company, and you can roll the money into starting a new one; sell a mall or skyscraper, and you get taxed. But it’s always fiendishly hard to predict the long-term incentives created by a change in the tax code. Any tax on realizing gains, for example, is implicitly a subsidy on borrowing against appreciated assets instead of realizing those gains. If that’s true, the net effect of eliminating 1031 exchanges would be that real estate portfolios would turn over less often. If we assume that people vary in their ability to make good real estate investments, this would mean that the best such investors wouldn’t make as many discrete investing decisions, which would make prices a bit less efficient. Which might be a reasonable tradeoff: making real estate investing a less tax-optimal choice could be a fair trade in exchange for making real estate prices less reflective of their value. But it’s still a tradeoff, not a straightforward benefit. Quirks in the tax code become load-bearing over time; even if they didn’t make economic sense when they were made, the structure of the economy only makes sense in light of the tax incentives that economic actors have already responded to. If you assume that people are reasonably good at reacting to incentives—or, more plausibly, that over time the people who are good at doing this end up controlling more assets—then any change in those incentives has complicated and unpredictable results.]


Last Call

Let’s do follow-up riddles based on last week’s post. You don’t need to read last week to participate. The solutions are at the end of today’s post.

  1. In a follow-up to Another Kind Of Mean:

    You are going on a 2-mile trip. If you drive 30 mph for 1 mile, how fast do you need to drive the second mile to average 60 mph for the entire trip?

  2. A father and son get into a terrible car accident. The father is immediately killed. The boy is taken to the hospital. The surgeon looks at the boy and says “I cannot operate on him. He’s my son”.

    Explain.


From My Actual Life

I went camping for the first time with my family. We’ll do it again.

Solutions to the riddle:

  1. There is no speed you can travel the second mile to average 60 mph for the whole trip. In order to average 60 mph for a 2-mile trip you must travel a mile per minute. So you cannot take more than 2 minutes for a 2-mile trip. If you drive the first mile at 30 mph, you have already driven for 2 minutes.
  2. The surgeon is the boy’s mother. I fell for this riddle when I was in HS. I was reminded of it by a reader in the comments to last week’s post a Sexist Gives A Math Lesson. Here’s the thing…I’ve asked this riddle to many people, male and female. And almost everyone gets it wrong. Their mind goes to harder explanations — it’s a ghost, it’s a stepdad, etc. I’m not kidding, test this out at your barbecues today.

    You know which cohort of people gets it right? Elementary school kids. Even the boys. Do what you want with this.

Moontower #159

Since leaving my trading career nearly 18 months ago I’ve allowed myself a lot of space to explore. I’ve been wary of narrowing my focus prematurely. However, the last few months have started revealing opportunities that warrant deeper dives. I’ll discuss them when it makes sense to. In the meantime, I felt compelled to write about the meta-framework that has helped me filter opportunities.

It’s a long post (it might need to be split into 2 posts for your sake) that is also personal. But I used the personal stuff as a way to move from the concrete to the abstract 1. I saw how to generalize my thinking so you can map it to your own needs. It took a long time for me to see the framework because recent experiences revealed it, instead of me just conjuring it (which I hope means it’s more durable). For those that are in the mental place to receive the post (slight condolences for being in that place — there’s a good chance you’re agitated), I hope it helps.

But, there’s one problem. The dog ate my homework.

The post is only 85% done and still unedited. I’m traveling, then camping most of the next week so inshallah I get it to you by next weekend.

Instead, I give you this.

How The Need For Coherence Drives Us Mad (5 min read)
Moontower

There’s no point in describing this post. Be careful.


Money Angle

Let’s use this section to learn a math concept.

We begin with a question:

You drive to the store and back. The store is 50 miles away. You drive 50 mph to the store and 100 mph coming back. What’s your average speed in MPH for the trip?

[Space to think about the problem]

*

*

*

[If you think the answer is 75 there are 2 problems worth pointing out. One of them is you have the wrong answer.]

*

*

*

[The other is that 75 is the obvious gut response, but since I’m asking this question, you should know that’s not the answer. If it’s not the answer that should clue you in to think harder about the question.]

*

*

*

[You’re trying harder, right?]

*

*

*

[Ok, let’s get on with this]

The answer is 66.67 MPH

If you drive 50 MPH to a store 50 miles away, then it took 60 minutes to go one way.

If you drive 100 MPH on the way back you will return home in half the time or 30 minutes.

You drove 100 miles in 1.5 hours or 66.67 MPH

Congratulations, you are on the way to learning about another type of average or mean.

You likely already know about 2 of the other so-called Pythagorean means.

  • Arithmetic mean

    Simple average. Used when trying to find a measure of central tendency in a set of values that are added together.

  • Geometric mean

    The geometric mean or geometric average is a measure of central tendency for a set of values that are multiplied together. One of the most common examples is compounding. Returns and growth rates are just fractions multiplied together. So if you have 10% growth then 25% growth you compute:

    1 x 1.10 x 1.25 = 1.375

    If you computed the arithmetic mean of the growth rates you’d get 17.5% (the average of 10% and 25%).

    The geometric mean however answers the question “what is the average growth rate I would need to multiply each period by to arrive at the final return of 1.375?”

    In this case, there are 2 periods.

    To solve we do the inverse of the multiplication by taking the root of the number of periods or 1.375^1/2 – 1 = 17.26%

    We can check that 17.26% is in fact the CAGR or compound average growth rate:

    1 x 1.1726 * 1.1726 = 1.375

    Have a cigar.

The question about speed at the beginning of the post actually calls for using a 3rd type of mean:

The harmonic mean

The harmonic mean is computed by taking the average of the reciprocals of the values, then taking the reciprocal of that number to return to the original units.

That’s wordy. Better to demonstrate the 2 steps:

  1. “Take the average of the reciprocals”

    Instead of averaging MPH, let’s average hours per mile then convert back to MPH at the end:

    50 MPH = “it takes 1/50 of an hour to go a mile” = 1/50 HPM
    100 MPH = “it takes 1/100 of an hour to go a mile” = 1/100 HPM

    The average of 1/50 HPM and 1/100 HPM = 1.5/100 HPM

  2. “Take the reciprocal of that number to return to the original units”

    Flip 1.5/100 HPM to 100/1.5 MPH. Voila, 66.67 MPH

Ok, right now you are thinking “Wtf, why is there a mean that deals with reciprocals in the first place?”

If you think about it, all means are computed with numbers that are fractions. You just assume the denominator of the numbers you are averaging is 1. That is fine when each number’s contribution to the final weight is equal, but that’s not the case with an MPH problem. You are spending 2x as much time as the lower speed as the higher speed! This pulls the average speed over the whole trip towards the lower speed. So you get a true average speed of 66.67, not the 75 that your gut gave you.

I want to pause here because you are probably a bit annoyed about this discovery. Don’t be. You have already won half the battle by realizing there is this other type of mean with the weird name “harmonic”.

The other half of the battle is knowing when to apply it. This is trickier. It relies on whether you care about the numerator or denominator of any number. And since every number has a numerator or denominator it feels like you might always want to ask if you should be using the harmonic mean.

I’ll give you a hint that will cover most practical cases. If you are presented with a whole number that is a multiple, but the thing you actually care about is a yield or rate then you should use the harmonic mean. That means you convert to the yield or rate first, find the arithmetic average which is muscle memory for you already, and then convert back to the original units.

Examples:

  • When you compute the average speed for an entire trip you actually want to average hours per mile (a rate) rather than the rate expressed as a multiple (mph) before converting back to mph. Again, this is because your periods of time at each speed are not equal.
  • You can’t average P/E ratios when trying to get the average P/E for an entire portfolio. Why? Because the contribution of high P/E stocks to the average of the entire portfolio P/E is lower than for lower P/E stocks. If you average P/Es, you will systematically overestimate the portfolio’s total P/E! You need to do the math in earnings yield space (ie E/P). @econompic wrote a great post about this and it’s why I went down the harmonic mean rabbit hole in the first place:

    The Case for the Harmonic Mean P/E Calculation (3 min read)

  • Consider this example of when MPG is misleading and you actually want to think of GPM. From Percents Are Tricky:

    Which saves more fuel?

    1. Swapping a 25 mpg car for one that gets 60 mpg
    2. Swapping a 10 mpg car for one that gets 20 mpg


    [Jeopardy music…]


    You know it’s a trap, so the answer must be #2. Here’s why:


    If you travel 1,000 miles:


    1. A 25mpg car uses 40 gallons. The 60 mpg vehicle uses 16.7 gallons.
    2. A 10 mpg car uses 100 gallons. The 20 mpg vehicle uses 50 gallons


    Even though you improved the MPG efficiency of car #1 by more than 100%, we save much more fuel by replacing less efficient cars. Go for the low-hanging fruit. The illusion suggests we should switch ratings from MPG to GPM or to avoid decimals Gallons Per 1,000 Miles.

  • The Tom Brady “deflategate” controversy also created statistical illusions based on what rate they used. You want to spot anomalies by looking at fumbles per play not plays per fumble.

    Why Those Statistics About The Patriots’ Fumbles Are Mostly Junk (14 min read)

The most important takeaway is that whenever you are trying to average a rate, yield, or multiple consider

a) taking the average of the numbers you are presented with

AND

b) doing the same computation with their reciprocals then flipping it back to the original units. That’s all it takes to compute both the arithmetic mean and the harmonic mean.

If you draw the same conclusions about the variable you care about, you’re in the clear.

Just knowing about harmonic means will put you on guard against making poor inferences from data.


For a more comprehensive but still accessible discussion of harmonic means see:

On Average, You’re Using the Wrong Average: Geometric & Harmonic Means in Data Analysis: When the Mean Doesn’t Mean What You Think it Means (20 min read)
by @dnlmc

This post is so good, that I’m not sure if I should have just linked to it and not bothered writing my own. You tell me if I was additive.


Last Call

A few years ago Harvard conducted those “implicit bias” tests and used the results as evidence that even allegedly unbiased people show evidence of unconscious prejudice. I’m not climbing into that cement mixer. But I’ll share 2 quick stories of me catching myself being biased on gender.

  1. Last year, I spoke to a local coding school that said they would hold an in-person class for my son if I could get 5 kids to join the class so it would make sense for them to staff a teacher. I email blasted some parents I knew to ask if their sons would be interested.

    After sending the email, I was kinda shaken that I was looking for “sons”. I told Yinh about it and how bad I felt. In her opinion, I wasn’t biased, she just looked at the list of parents I sent it to and thought it made sense but also since we have 2 boys our parents’ group is skewed (the running joke is if we meet girl parents we really like, it’s like “nice hanging out see you in 18 years”). Yinh didn’t think my actions were evidence of bias but I was suspicious of myself and the verdict is irrelevant. That feeling that I acted in a way that does not accord with my beliefs will help me be better next time. Mistake + growth = all we can ask for.

    Fine.

  2. There’s a project I’m working on in a half-assed way (what else is new?). I was thinking about what it might need if I got more serious. Part of that exercise prompted me to think of who I’d want to be on the board if it became a thing. I wrote a list of names.

    Then I realized it was all men.

    Was this off-the-top-of-my-head list the best list? I opened my CRM.

    [Aside: I keep a database in Notion of everyone I meet, including where they live, what they are working on, what type of help they may need, ie investors or collaborators etc. I recommend doing this. Just makes you a better connector. I have also been keeping a list of every restaurant I have ever to for the past 10 years by location. That way if anyone asks me for a rec, I can look at my phone instead of suddenly going blank. I’m pretty sure I was born to be a librarian or serial killer.]

    When I scanned the CRM, I found multiple women who would hands-down be better choices than the men on the list. Not only that, one of them actually played a part in the brainstorming of the project. WTF Kris.

    I suck. I don’t wanna suck, and I still suck.

    So is implicit bias a thing? It is for me. So I put a checkbox field in my CRM table:

    ”Female?”

    Sounds heavy-handed right? Well, you are free to tell me how I can help myself otherwise, but this is the only way I’ve ever known how to change. Make the thing I want to improve more explicit. What gets measured gets managed.

The subtlety of bias makes it hard to address. What cultural nudges have I silently absorbed that undermine the lessons from the strongest bonds in my direct experience? Consider these following personal facts that have always been top of mind for me :

  • I grew up with a single mother for much of my childhood.
  • I have 1 sibling. A sister who is a brilliant, kind high-achiever.
  • My closest older-than-me relatives are all blood aunts. I have profound respect for their beautiful hearts and can-do-immigrant-tenacity. I have uncles too of course, but only a small percentage of them relative to the women hold my love or respect. (I’m not saying this because I want anyone to generalize about the nature of men vs women, but just to describe how my observations of women have been unusually favorable — on the conscious level).
  • And then I’m married to a woman who inspires me. My wife is an absolute boss but more importantly, has a trail of people who have been touched by her generosity. But she’d never accept recognition for any of it no matter how much they’d want to shout her. However driven she is in professional or measurable ways, her highest priority is her family and friends.

In other words, for the entirety of my existence, I’ve been surrounded by lionesses.

And still, I fail to give women equal consideration without an extra effort. So either the stories we, both men and a special hell-circle of women, tell about why females getting a lesser deal is justified are ego-protecting rationalizations…or I’m alone in being a sexist?

You all have women in your lives that you love. You all have women in your lives you have tremendous respect for or might consider role-models. But that acknowledgment is not a free pass to think you are untouched by bias. Try to catch yourself. Spend some attention on it. And then ask yourself, do you really think unequal outcomes are fully explained by the smart-sounding justifications?

Did fewer girls get interested in coding because I forgot to add them to the carpool? Did the ones who get to hacker camp get discouraged because they were surrounded by farty boys like mine when they arrived? Did the moms not bring their daughters to camp because that idea was less familiar to them since any of the bias that exists today is a fraction of what they faced growing up?

I do believe that over time our awareness of these ideas enlightens us. It just happens over generations. But we shouldn’t take it for granted because it’s not natural to suppress bias. A strained society does not have the energy to suppress bias or prioritize equality. Fear peddlers are opportunists who see people’s pain and sell them scapegoats not solutions. Because solutions to the complexities that weaken a society are hard to see. Our differences are not. They are the first culprits when our insecurities turn to fear.

The word “woke” is stretched to its excess by our mind’s habit of substituting the extremes for the typical. If you label both basic civil rights activism and a fringe effort to have furries considered a protected class as “woke” the word is going to break under tension. So when we push for progress (is that word broken too?), remember there are always people who will pretend there’s none that needs to be made (or that we’ve made so much progress that we need to go backwards).

Maybe I’d listen if they stepped up and told me how bias shows up in their own behavior. If they say it doesn’t, I’ll feel bad for being the only one. But I’ll also know those people aren’t credible.

I get that negative screens work both ways. I’ll let you know how many people unsub. I’ve said my piece. These writers made that easier to do. The cost we incur is still nothing compared to the cost the discouraged bear:

  • The Uphill Battle Women Still Face in High Finance (12 min read)
    by Benn Eifert
  • Markets, discrimination, and “lowering the bar” (12 min read)
    by Dan Luu

    I’ve already wrecked myself today so I’ll comment on this one. Dan uses the term “teenage libertarian”. What a fitting word for the hospital-grade dose of Randian ideology that characterizes so much of Wall Street. I would have described myself as a libertarian at one point but posts like this demonstrate that “market efficiency” is a dangerous expression when used without reference to what conditions must be present for its existence and the degree to which such conditions are unfilled. Libertarianism is as idealized as communism. In their god-given instantiations, both sound beautiful. In reality, one leads to totalitarianism and remains mostly irrelevant as a majority ideal in the US, while the other is insidious because it hasn’t been refuted as the self-serving ideology of those who have been served more than their share (especially if you believe in equality-equity tradeoffs as I do).

    This thread by Benn explains further.

[For the option traders in the room, did anyone else notice the Easter egg in that Dan Luu post? There’s a roll call of thank you’s at the end and one of the people is a Barone-Adesi!]

Stay groovy!

Am I The Only Sexist?

A few years ago Harvard conducted those “implicit bias” tests and used the results to show that even allegedly unbiased people show evidence of unconscious prejudice. I’m not climbing into that cement mixer. But I’ll share 2 quick stories of me catching myself being biased on gender.

  1. Last year, I spoke to a local coding school that said they would hold an in-person class for my son if I could get 5 kids to join the class so it would make sense for them to staff a teacher. I email blasted some parents I knew to ask if their sons would be interested. After sending the email, I was kinda shaken that I was looking for “sons”. I told Yinh about it and how bad I felt. In her opinion, I wasn’t biased, she just looked at the list of parents I sent it to and thought it made sense but also since we have 2 boys our parents’ group is skewed (the running joke is if we meet girl parents we really like, it’s like “nice hanging out see you in 18 years”). Yinh didn’t think my actions were evidence of bias but I was suspicious of myself and the verdict is irrelevant. That feeling that I acted in a way that does not accord with my beliefs will help me be better next time. Mistake + growth = all we can ask for.

    Fine.

  2. There’s a project I’m working on in a half-assed way (what else is new?). I was thinking about what it might need if I got more serious. Part of that exercise prompted me to think of who I’d want to be on the board if it became a thing. I wrote a list of names. Then I realized it was all men.

    Was this off-the-top-of-my-head list the best list? I opened my CRM.

    [Aside: I keep a database in Notion of everyone I meet, including where they live, what they are working on, what type of help they may need, ie investors or collaborators etc. I recommend doing this. Just makes you a better connector. I have also been keeping a list of every restaurant I have ever to for the past 10 years by location. That way if anyone asks me for a rec, I can look at my phone instead of suddenly going blank. I’m pretty sure I was born to be a librarian or serial killer.]

    When I scanned the CRM, I found multiple women who would hands-down be better choices than the men on the list. Not only that, one of them actually played a part in the brainstorming of the project. WTF Kris.

    I suck. I don’t wanna suck, and I still suck.

    So is implicit bias a thing? It is for me. So I put a checkbox field in my CRM table:

    ”Female?”

    Sounds heavy-handed right? Well, you are free to tell me how I can help myself otherwise, but this is the only way I’ve ever known how to change. Make the thing I want to improve more explicit. What gets measured gets managed.

The subtlety of bias makes it hard to address. What cultural nudges have I silently absorbed that undermine the lessons from the strongest bonds in my direct experience? Consider these following personal facts that have always been top of mind for me :

  • I grew up with a single mother for much of my childhood.
  • I have 1 sibling. A sister who is a brilliant, kind high-achiever.
  • My closest older-than-me relatives are all blood aunts. I have profound respect for their beautiful hearts and can-do-immigrant-tenacity. I have uncles too of course, but only a small percentage of them relative to the women hold my love or respect. (I’m not saying this because I want anyone to generalize about the nature of men vs women, but just to describe how my observations of women have been unusually favorable — on the conscious level).
  • And then I’m married to a woman who inspires me. My wife is an absolute boss but more importantly, has a trail of people who have been touched by her generosity. But she’d never accept recognition for any of it no matter how much they’d want to shout her. However driven she is in professional or measurable ways, her highest priority is her family and friends.

In other words, for the entirety of my existence, I’ve been surrounded by lionesses.

And still, I fail to give women equal consideration without an extra effort. So either the stories we, both men and a special hell-circle of women, tell about why females getting a lesser deal is justified are ego-protecting rationalizations…or I’m alone in being a sexist?

You all have women in your lives that you love. You all have women in your lives you have tremendous respect for or might consider role models. But that acknowledgment is not a free pass to think you are untouched by bias. Try to catch yourself. Spend some attention on it. And then ask yourself, do you really think unequal outcomes are fully explained by the smart-sounding justifications?

Did fewer girls get interested in coding because I forgot to add them to the carpool? Did the ones who get to hacker camp get discouraged because they were surrounded by farty boys like mine when they arrived? Did the moms not bring their daughters to camp because that idea was less familiar to them since any of the bias that exists today is a fraction of what they faced growing up?

I do believe that over time our awareness of these ideas enlightens us. It just happens over generations. But we shouldn’t take it for granted because it’s not natural to suppress bias. A strained society does not have the energy to suppress bias or prioritize equality. Fear peddlers are opportunists who see people’s pain and sell them scapegoats, not solutions. Because solutions to the complexities that weaken a society are hard to see. Our differences are not. They are the first culprits when our insecurities turn to fear.

The word “woke” is stretched to its excess by our mind’s habit of substituting the extremes for the typical. If you label both basic civil rights activism and a fringe effort to have furries considered a protected class as “woke”, the word is going to break under tension. So when we push for progress (is that word broken too?), remember there are always people who will pretend there’s none that needs to be made (or that we’ve made so much progress that we need to go backwards).

Maybe I’d listen if they stepped up and told me how bias shows up in their own behavior. If they say it doesn’t, I’ll feel bad for being the only one. But I’ll also know those people aren’t credible.

I get that negative screens work both ways. I’ll let you know how many people unsub. I’ve said my piece. These writers made that easier to do. The cost we incur is still nothing compared to the cost the discouraged bear:

  • The Uphill Battle Women Still Face in High Finance (12 min read)
    by Benn Eifert
  • Markets, discrimination, and “lowering the bar” (12 min read)
    by Dan Luu

    I’ve already wrecked myself today so I’ll comment on this one. Dan uses the term “teenage libertarian”. What a fitting word for the hospital-grade dose of Randian ideology that characterizes so much of Wall Street. I would have described myself as a libertarian at one point but posts like this demonstrate that “market efficiency” is a dangerous expression when used without reference to what conditions must be present for its existence and the degree to which such conditions are unfilled. Libertarianism is as idealized as communism. In their god-given instantiations, both sound beautiful. In reality, one leads to totalitarianism and remains mostly irrelevant as a majority ideal in the US, while the other is insidious because it hasn’t been refuted as the self-serving ideology of those who have been served more than their share (especially if you believe in equality-equity tradeoffs as I do).

    This thread by Benn explains further.

For the option traders in the room, did anyone else notice the Easter egg in that Dan Luu post? There’s a roll call of thank you’s at the end and one of the people is a Barone-Adesi!]

Another Kind Of Mean

Let’s use this section to learn a math concept.

We begin with a question:

You drive to the store and back. The store is 50 miles away. You drive 50 mph to the store and 100 mph coming back. What’s your average speed in MPH for the trip?

[Space to think about the problem]

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[If you think the answer is 75 there are 2 problems worth pointing out. One of them is you have the wrong answer.]

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[The other is that 75 is the obvious gut response, but since I’m asking this question, you should know that’s not the answer. If it’s not the answer that should clue you in to think harder about the question.]

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[You’re trying harder, right?]

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[Ok, let’s get on with this]

The answer is 66.67 MPH

If you drive 50 MPH to a store 50 miles away, then it took 60 minutes to go one way.

If you drive 100 MPH on the way back you will return home in half the time or 30 minutes.

You drove 100 miles in 1.5 hours or 66.67 MPH

Congratulations, you are on the way to learning about another type of average or mean.

You likely already know about 2 of the other so-called Pythagorean means.

  • Arithmetic mean

    Simple average. Used when trying to find a measure of central tendency in a set of values that are added together.

  • Geometric mean

    The geometric mean or geometric average is a measure of central tendency for a set of values that are multiplied together. One of the most common examples is compounding. Returns and growth rates are just fractions multiplied together. So if you have 10% growth then 25% growth you compute:

    1 x 1.10 x 1.25 = 1.375

    If you computed the arithmetic mean of the growth rates you’d get 17.5% (the average of 10% and 25%).

    The geometric mean however answers the question “what is the average growth rate I would need to multiply each period by to arrive at the final return of 1.375?”

    In this case, there are 2 periods.

    To solve we do the inverse of the multiplication by taking the root of the number of periods or 1.375^1/2 – 1 = 17.26%

    We can check that 17.26% is in fact the CAGR or compound average growth rate:

    1 x 1.1726 * 1.1726 = 1.375

    Have a cigar.

The question about speed at the beginning of the post actually calls for using a 3rd type of mean:

The harmonic mean

The harmonic mean is computed by taking the average of the reciprocals of the values, then taking the reciprocal of that number to return to the original units.

That’s wordy. Better to demonstrate the 2 steps:

  1. “Take the average of the reciprocals”

    Instead of averaging MPH, let’s average hours per mile then convert back to MPH at the end:

    50 MPH = “it takes 1/50 of an hour to go a mile” = 1/50 HPM
    100 MPH = “it takes 1/100 of an hour to go a mile” = 1/100 HPM

    The average of 1/50 HPM and 1/100 HPM = 1.5/100 HPM

  2. “Take the reciprocal of that number to return to the original units”

    Flip 1.5/100 HPM to 100/1.5 MPH. Voila, 66.67 MPH

Ok, right now you are thinking “Wtf, why is there a mean that deals with reciprocals in the first place?”

If you think about it, all means are computed with numbers that are fractions. You just assume the denominator of the numbers you are averaging is 1. That is fine when each number’s contribution to the final weight is equal, but that’s not the case with an MPH problem. You are spending 2x as much time as the lower speed as the higher speed! This pulls the average speed over the whole trip towards the lower speed. So you get a true average speed of 66.67, not the 75 that your gut gave you.

I want to pause here because you are probably a bit annoyed about this discovery. Don’t be. You have already won half the battle by realizing there is this other type of mean with the weird name “harmonic”.

The other half of the battle is knowing when to apply it. This is trickier. It relies on whether you care about the numerator or denominator of any number. And since every number has a numerator or denominator it feels like you might always want to ask if you should be using the harmonic mean.

I’ll give you a hint that will cover most practical cases. If you are presented with a whole number that is a multiple, but the thing you actually care about is a yield or rate then you should use the harmonic mean. That means you convert to the yield or rate first, find the arithmetic average which is muscle memory for you already, and then convert back to the original units.

Examples:

  • When you compute the average speed for an entire trip you actually want to average hours per mile (a rate) rather than the rate expressed as a multiple (mph) before converting back to mph. Again, this is because your periods of time at each speed are not equal.
  • You can’t average P/E ratios when trying to get the average P/E for an entire portfolio. Why? Because the contribution of high P/E stocks to the average of the entire portfolio P/E is lower than for lower P/E stocks. If you average P/Es, you will systematically overestimate the portfolio’s total P/E! You need to do the math in earnings yield space (ie E/P). @econompic wrote a great post about this and it’s why I went down the harmonic mean rabbit hole in the first place:

    The Case for the Harmonic Mean P/E Calculation (3 min read)

  • Consider this example of when MPG is misleading and you actually want to think of GPM. From Percents Are Tricky:

    Which saves more fuel?

    1. Swapping a 25 mpg car for one that gets 60 mpg
    2. Swapping a 10 mpg car for one that gets 20 mpg


    [Jeopardy music…]


    You know it’s a trap, so the answer must be #2. Here’s why:


    If you travel 1,000 miles:


    1. A 25mpg car uses 40 gallons. The 60 mpg vehicle uses 16.7 gallons.
    2. A 10 mpg car uses 100 gallons. The 20 mpg vehicle uses 50 gallons


    Even though you improved the MPG efficiency of car #1 by more than 100%, we save much more fuel by replacing less efficient cars. Go for the low-hanging fruit. The illusion suggests we should switch ratings from MPG to GPM or to avoid decimals Gallons Per 1,000 Miles.

  • The Tom Brady “deflategate” controversy also created statistical illusions based on what rate they used. You want to spot anomalies by looking at fumbles per play not plays per fumble.

    Why Those Statistics About The Patriots’ Fumbles Are Mostly Junk (14 min read)

The most important takeaway is that whenever you are trying to average a rate, yield, or multiple consider

a) taking the average of the numbers you are presented with

AND

b) doing the same computation with their reciprocals then flipping it back to the original units. That’s all it takes to compute both the arithmetic mean and the harmonic mean.

If you draw the same conclusions about the variable you care about, you’re in the clear.

Just knowing about harmonic means will put you on guard against making poor inferences from data.


For a more comprehensive but still accessible discussion of harmonic means see:

On Average, You’re Using the Wrong Average: Geometric & Harmonic Means in Data Analysis: When the Mean Doesn’t Mean What You Think it Means (20 min read)
by @dnlmc

This post is so good, that I’m not sure if I should have just linked to it and not bothered writing my own. You tell me if I was additive.