Teach A Math Idea To Internalize It

My 8-year-old Zak is going to be taking the OLSAT soon. It’s a 64-question test that looks an awful lot like an IQ test. The test (or one of its brethren like the CoGat) is administered to all 3rd graders in CA. If you score in the top 2 or 3% you can be eligible for your local ‘gifted and talented’ program. 20% of the questions are considered “very challenging” and that’s where the separation on the high end happens.

I gave Zak a practice test just to familiarize him with it. He’s never taken a test with a time limit before and never filled out Scantron bubbles. Do not underestimate how confusing those sheets are to kids. It took a while for him to register how it worked because he only saw choices A,B,C,D for each of the 64 questions.

Daddy, the answer to question 1 is ‘cat’ not A,B,C, or D

I know, Zak, it’s just that…you know what bud, how about just circle the right answer on the question for now.

Hopefully, some practice breaks the seal so he isn’t scared when he sits for his first test ever. I think a small amount of prep is helpful even though I get the sense that caring about tests is not in style around here. Call me old-fashioned. I’m not bringing out a whip, but having the option to go to the program seems worth putting in a token effort if you think your kid has a shot.

Anyway, he took one test. Poking around a bit, I think his raw score would land him in the 90th percentile. Not good enough but it was his first shot and if he doesn’t improve much, that’s also totally fine too. Plenty of people are content just flipping burgers (I’m kidding, calm down. Also, get your own kid to stuff your insecurities into). One thing did stand out. He got all the math questions (about 1/3 of the test) correct.

Hmm.

It made me think of how I was a decent math student growing up.

I'm Something of a Scientist Myself | Know Your Meme

Not good enough to compete with peers who did math team in HS, but enough to get through Calc BC. Regretfully, I never took another math class after that. I optimized my college courses for A’s not learning. Short-sighted.

I really felt the pain of that decision when I got hired to trade options and was surrounded by a cohort in which 50% of the trainees had an 800 math SAT. (There were 3 people in our office of about 60 that had an SAT verbal > math. I was one of them.) That inferiority exists even to this day. Until Google Translate can decode academic papers, those things are for lining birdcages.

However…

Every now and then, I’ll come across a math topic that seems useful for making estimates about practical things, so I’ll learn it.

And then I’m reminded I have no math gifts because that learning process is uphill in molasses. When I was young I did lots of practice problems (how else are you supposed to become a doctor and please mom) which got me proficient. Today, it’s a similar process. I just power through it.

But there is a difference in how I power through it.

Instead of practice problems, I watch YouTube until I can write the ELI5 version for others. Everyone has heard that if you want to test your knowledge, teach it to others. In that case, it’s a win-win. We all learn.

So that’s what I did this week. I wrote an ELI5 version of a concept called Jensen’s Inequality.

  • Jensen’s Inequality As An Intuition Tool (10 min read)

    You will learn:

    • Why I found Jensen’s Inequality interesting
    • The conditions and statement of the inequality
    • An example that affects us all
    • Spotting Jensen’s in the wild

    If you struggle to understand it after reading it tell me. I am challenging myself to see if I can relay not just the concept but the significance of it with minimal effort on behalf of the reader. If I can get to the point where I’m “putting in the effort so you don’t have to” then I’ll feel like I’m being useful here.

    If you think you got it, test yourself the way I did. Construct an example. (That’s what I did with the “traffic on the way to Sizzler” example.)

  • If you grok Jensen’s Inequality and want to relate it to portfolio construction Corey is your guy. Before I learned of this concept his tweets would have made no sense to me, but now I at least kinda get it.

Moontower #120

My 8-year-old Zak is going to be taking the OLSAT soon. It’s a 64-question test that looks an awful lot like an IQ test. The test (or one of its brethren like the CoGat) is administered to all 3rd graders in CA. If you score in the top 2 or 3% you can be eligible for your local ‘gifted and talented’ program. 20% of the questions are considered “very challenging” and that’s where the separation on the high end happens.

I gave Zak a practice test just to familiarize him with it. He’s never taken a test with a time limit before and never filled out Scantron bubbles. Do not underestimate how confusing those sheets are to kids. It took a while for him to register how it worked because he only saw choices A,B,C,D for each of the 64 questions.

Daddy, the answer to question 1 is ‘cat’ not A,B,C, or D

I know, Zak, it’s just that…you know what bud, how about just circle the right answer on the question for now.

Hopefully, some practice breaks the seal so he isn’t scared when he sits for his first test ever. I think a small amount of prep is helpful even though I get the sense that caring about tests is not in style around here. Call me old-fashioned. I’m not bringing out a whip, but having the option to go to the program seems worth putting in a token effort if you think your kid has a shot.

Anyway, he took one test. Poking around a bit, I think his raw score would land him in the 90th percentile. Not good enough but it was his first shot and if he doesn’t improve much, that’s also totally fine too. Plenty of people are content just flipping burgers (I’m kidding, calm down. Also, get your own kid to stuff your insecurities into). One thing did stand out. He got all the math questions (about 1/3 of the test) correct.

Hmm.

It made me think of how I was a decent math student growing up.

I'm Something of a Scientist Myself | Know Your Meme

Not good enough to compete with peers who did math team in HS, but enough to get through Calc BC. Regretfully, I never took another math class after that. I optimized my college courses for A’s not learning. Short-sighted.

I really felt the pain of that decision when I got hired to trade options and was surrounded by a cohort in which 50% of the trainees had an 800 math SAT. (There were 3 people in our office of about 60 that had an SAT verbal > math. I was one of them.) That inferiority exists even to this day. Until Google Translate can decode academic papers, those things are for lining birdcages.

However…

Every now and then, I’ll come across a math topic that seems useful for making estimates about practical things, so I’ll learn it.

And then I’m reminded I have no math gifts because that learning process is uphill in molasses. When I was young I did lots of practice problems (how else are you supposed to become a doctor and please mom) which got me proficient. Today, it’s a similar process. I just power through it.

But there is a difference in how I power through it.

Instead of practice problems, I watch YouTube until I can write the ELI5 version for others. Everyone has heard that if you want to test your knowledge, teach it to others. In that case, it’s a win-win. We all learn.

So that’s what I did this week. I wrote an ELI5 version of a concept called Jensen’s Inequality.

  • Jensen’s Inequality As An Intuition Tool (10 min read)

    You will learn:

    • Why I found Jensen’s Inequality interesting
    • The conditions and statement of the inequality
    • An example that affects us all
    • Spotting Jensen’s in the wild

    If you struggle to understand it after reading it tell me. I am challenging myself to see if I can relay not just the concept but the significance of it with minimal effort on behalf of the reader. If I can get to the point where I’m “putting in the effort so you don’t have to” then I’ll feel like I’m being useful here.

    If you think you got it, test yourself the way I did. Construct an example. (That’s what I did with the “traffic on the way to Sizzler” example.)

  • If you grok Jensen’s Inequality and want to relate it to portfolio construction Corey is your guy. Before I learned of this concept his tweets would have made no sense to me, but now I at least kinda get it.

Money Angle

My buddy Jake sent me this post:

Active vs. Passive Investing and the “Suckers at the Poker Table” Fallacy.

It’s an 8-minute read worthy of your time because it demonstrates several useful realities about markets.

  • Reconciling a paradox: The idea that smart active managers can profit from the distortion of passive flows but if everyone is passive then there are no longer active suckers to exploit.

    The author does a neat demonstration decomposing market returns into money-weighted returns (active) and dollar-cost-averaging (passive) to disentangle beta from alpha.

  • Markets are not a zero-sum game, even if the battle for “alpha” is.

    The size of the profits pie is not fixed…The “suckers at the poker table” paradigm goes astray because there isn’t some exogenous fixed size of the investment pie investors are fighting over. The returns are endogenous: They are in part determined by how smart the investors are, how well the capital in the economy is allocated, and by everything else that impacts economic and market outcomes.

    …Smart money going into appropriately priced investment opportunities grows the whole pie. Dumb money going to bad businesses shrinks the pie. Once it’s not a strictly zero-sum game, you don’t need “suckers at the poker table” to outperform.

  • The demonstration shows how there is no such thing as truly passive. And if I may add, that means benchmarking your investing, which is constrained by your personal asset/liability picture (ie sometimes you get a bonus or extra cash to add to the market and sometimes you need to pull money out to send a kid to college) to some index is not a great comparison.

    If you’re planning to invest for an objective other than buying and holding forever, you have to make decisions about when and how much to invest and when and how much to withdraw. On a sufficiently long timeline, the probability of being a completely passive investor goes to zero.

    Eventually, you have to make an active investment decision, and at that point, the shrewd investors are lying in wait. Everyone eventually has to pay Charon to cross the river Styx.

In addition to these points, there’s a brief aside about the Grossman-Stiglitz Paradox which is a rabbit hole of its own. I’d buy stock in that paradox as something you will continue to hear more about.

Finally, while the author finds the zero-sumness of poker to be a poor analogy for investing, he links to a post about how poker has useful lessons for risk management called Getting Schooled In Risk (12 min read).

From My Actual Life

I got married 12 years ago on October 2nd. The wedding was in Cabo which means everyone sweat right through their clothes. The pictures of the reception look like the finish line of a marathon.

When I was at my mom’s house this summer, I found a treat in the magazine stand. It was the personalized US Weekly Yinh made for the guests. I’m unapologetically biased, but this is the greatest document ever made.

Jensen’s Inequality As An Intuition Tool

I came across a tool from mathematics called Jensen’s Inequality. I’m going to explain the rule, provide intuitive examples, then end by pointing you to real-world applications.

A warning to math whizzes — I don’t have formal math training so this post is divorced from pedagogical context. Yes, there will be numerical examples. But the real goal is for readers to recognize when the domain they are reasoning about is subject to the surprising predictions of Jensen’s Inequality. For most of us, the value of this tool is how it nudges our intuition to better predictions, not in the direct application of a formula.

Here’s where we’re going:

  1. Why I found Jensen’s Inequality interesting
  2. The conditions and statement of the inequality
  3. An example that affects us all
  4. Spotting Jensen’s in the wild

Why I Found Jensen’s Inequality Interesting

Blindness To Exponents

Exponential phenomena confuse our brains. It has become tiresome to point out that we do not have natural intuition for growth and decay rates. Even finance folk who are apt to appreciate the idea of compounding  seem to not recognize it when the investing skin is pulled off it.

Covid is a timely example. A virus’ R0 (“R naught”) indicates how transmissable it is. Remember “Covid is the flu”. Say the flu has an R0 of 2. So for each person that contracts the flu, they infect 2 more people. Now let’s suppose Covid has an R0 of 3. Here’s how the 2 viruses would spread 1.

R0 is a more complicated function than I’m stylizing here (it should be obvious that behavior, like masks, change it. And if a virus was super effective at replicating itself, well it would find new hosts harder to come by). My point is that even smart people will not hear the “This Is Not A Linear Phenomena” song unless their station is tuned to it. The failure to recognize non-linear domains is serious, because it leads to wildy wrong predictions. And life is prediction. We implicitly predict that the sun will rise tomorrow.

Jensen’s Inequality guides our predictions by forcing us to deliberately consider how the average input maps to the average output. When the function that maps the input to the output is non-linear, Jensen’s Inequality tells us in which direction our predictions will be biased. Stated another way: Jensen’s Inequality informs us when an average occurance is a poor predictor of the average result.

Before we get to any equations, let’s predict the outcome of a simple game.

Dice Payoff

Imagine a game, you stake $1, then roll 2 dice. Whatever the roll returns times your stake amount is how much money you make. That’s the payoff function.

So if you roll a five you receive $5.

Question 1: On average, how much do you expect to get paid?

This is a straightforward expected value problem. You get paid the weighted average of all the outcomes or on average $7.

The average value that you roll will correspond to the average value of the payoff function. If that sounds obvious, that’s the point. So far, so good.

Question 2: If you staked $100, what would you predict the average payoff from playing the game?

A quick way to estimate that would be to ask yourself, “what do we expect to roll on average?” then multiply that by the staked amount. In this case, we roll a 7 on average, and since the staked amount is $100 then on average when we play this game we expect to be paid out $700.

That prediction is correct. We can brute force the expected value of the payoffs.

At this point, things are feeling pretty obvious and redundant, but let me remind you what we did to just answer Question 2. We used a shortcut. We took the expected value of the roll, which was an input, to estimate the expected value of the payoff function or the output. The shortcut worked because the payoff function was linear. We are just scaling the expected input by the staked amount since the function is simply (dice roll x staked amount). This kind of payoff function exists all around us. When you buy a stock, your p/l function is just change in stock price x share quantity. The “staked amount” in our example performs the same scaling role as share quantity.

You can feel the twist coming.

Question 3: Same game but we change the payoff function to (staked amount) x (dice roll)2. What’s the average payoff?

First, what does our shortcut predict? Let’s say we bet $1 again. Since the average value we roll is a 7, then we expect the average payoff to be $72 x $1. So we expect the average payoff of this game to be $49.

As you may have guessed from the unsubtle narrative arc, $49 is the wrong answer. Our shortcut doesn’t work. Brute force method:

It turns out the expected value or average result from the squared game is $54.83, a higher value than what we would predict if we took the average value of the input and simply applied the squared function to it.

It’s intuitive to take the average value of an input, apply a function to it and call that the “expected value of the function”. It turns out that if the function we run the input through is exponential, our estimate will be wrong. So in service of becoming better at making estimates on the fly, we should get better at thinking about what kind of function we are running an input through and if our prediction is likely to be biased higher or lower than the actual expected value of the payoff function.

With that long intro we can now turn to Jensen’s Inequality and its practical applications.

A Look At Jensen’s Inequality

I’ll start with stating the inequality the way I learned it2:

E[f(x)] ≥ f(E[x])

…if f(x) is convex

Let’s try saying this in words several ways, assuming f(x) is convex (a term I will address in a bit):

  • The expected value of a function is greater than or equal to the function applied to the expected value of the input.

  • The average value of a function is greater than or equal to the function applied to the average input.

  • Returning to dice…the [weighted] average of all the squares is greater than the square of the average roll.

In practice this means, you cannot estimate the average value of the function based on the average value of the input IF the function is exponential.

Convex

Let’s address the term “convex”. You know what it is visually.

Mathematically, a convex function:

  • has a first derivative that is greater than 0, meaning that the function has a positive slope everywhere.
  • has a second derivate that is also greater than 0, meaning as X increases the slope itself increases. The steepness of the chart is increasing.

If we go back to the dice example and consider the convex payoff function, we can see the average value of the payoff function of $54.76 is greater than the payoff ($49) at the average roll. In other words, the convex function ensured that:

average value of all payoffs > the payoff of the average roll

Concave

For concave functions, like y = sqrt(x), we have a positive slope, but the slope is decreasing as x increases. The second derivative is negative. Let’s look at a concave case for the dice game by making the payoff function = sqrt(roll).

Notice that the average value of the payoff, if you stake $1, is $2.60. But if you tried to predict the expected payoff by using the shortcut of taking the square root of the average roll you’d predict $2.65 which is the sqrt(7).

Wait a minute. The prediction this time overshot the true expected value of the function?!

That’s correct. If you multiply one side of an inequality by -1 you flip the sign…a convex function can be flipped to concave by flipping the sign as well. So a concave function flips the sign of Jensen’s Inequality, making the overshoot the expected result.

Visualizing the concave payoff:

Let’s practice with a highly stylized example I made up, but relates to something we all intuitively feel.

An Intuitive Example That Affects Us All: Traffic!

We are celebrating a big W, so it’s time to take the kids to Sizzler. We’re going to drive. Sizzler is 10 minutes away + some extra time depending on how many cars are on the road. Let’s keep things very simple and assume the number of cars that can be on the road is 10, 20, 30, 40, or 50 and with equal probability. None of these quantities is enough to slow the flow of traffic to a halt, but the impact of the extra cars is not linear.

We’ll create a function called “time to destination” denominated in seconds and make it a function of “cars on the road”:

f(cars on the road) = x2 + 600 

Let’s play “How long will it take to get to Sizzler?”

Before you discovered this post, you likely would have said 25 minutes. Why? Since we can have 10, 20, 30, 40, or 50 cars all with equal probability, then on average we expect to see 30 cars on the road.

302 + 600 = 1500 seconds or 25 minutes.

But because we know about Jensens’s Inequality we:

  1. recognize the traffic output function is convex
  2. realize that the expected value of the traffic function will be greater than sticking the average number of cars in the road into the traffic function

Enlightened, we instead estimate that on average it will take longer than 25 minutes to pounce on that glorious salad bar with the popcorn shrimp.

How much longer? Brute force tells us 28.3 minutes!

Spotting Jensen’s Inequality In The Wild

Here’s a few common applications that abide Jensen’s Inequality

  • Geometric mean ≤ arithmetic mean

    I’ll need to point you to an actual math person. See his beautiful derivation on YouTube. It’s easy to follow along and quite clever. The key to this inequality is recognizing that the geometric mean, which takes the nth root, is concave just like the sqrt(x) function.

    It’s worth noting that the LN(x) function is also concave so when you are in price space we know that the LN(average price) > the average of the LN(prices). Same idea as the geometric means, concavity flips the sign of Jensens.

  • Call options

    Here’s a generic chart3.

A call option is convex payoff function with respect to the stock price. Its first derivative with respect to the price of a stock is delta which is always positive. In other words, as the stock price goes up, all else equal, the call option always goes up (the slope or delta of a way OTM option is 0 so it’s possible for the call to not change in value, but that’s the lower bound). The second derivative with respect to stock price is gamma and it also is always at least worth 0. That means that as a stock price increases the delta or slope itself increases (or hits the zero lower bound). 

In options land, stock prices are assumed to be lognormally distributed. This is a reasonable distribution since a stock is bounded by zero and stretches to infinity. The expected value of a stock is the current stock price (in a no arbitrage framework)4.

Now let’s go back to Jensen’s Inequality:

E[f(x)] ≥ f(E[x])

…if f(x) is convex

Substituting words:

The expected or average value of a call for all possible prices of the stock (of course weighted by their probabilities) will be greater than the value of the call based on the stock being at it’s expected price (which is just the current price in Black Scholes).

In other words, the average value of a call will be higher than the value of a call in the average scenario.

It is easier to see with a binary stock (as opposed to a lognormally distributed stock). Suppose a binary stock is $10. That’s its expected value. Suppose now that the expected value is driven by the fact that it’s 90% to be worth 0 and 10% to be worth $100. The 50 strike call is worthless in the average scenario (since $10 is the weighted avg of the scenarios…again that’s what a stock price is by definition).

 But the weighted average of its value over both scenarios is $5 (90% x 0 + 10% x (100-50))

Again, the average value of a call will be higher than the value of a call in the average scenario.

So next time somebody uses the logic that they don’t buy options because most options expire worthless you can remind them that the typical outcome is not what drives the value of options. Instead, you should care about the average value of the option over all scenarios.

By the way, nothing I said here is revelatory. It’s not like any serious person thinks OTM options are worthless in the first place and just prices options based on the stock’s expected value. 

  • Technology

    Here’s a qualitative one. Suppose teacher skill follows a bell curve. Skill is the independent variable. Our X. Our payoff function is going to be how many people the teacher can effectively educate. A great teacher will impact a higher percentage of the students they actually come into contact with because they are more effective. If we had to predict the payoff, we might be tempted to apply a function to the average teacher. This would be like taking the 7 we rolled and running it through some payoff function.

    But if we consider the average value of the teacher payoff function for all level of teachers we will find that prior estimate to be wildy too low. Sal Khan comes to mind. He literally broke the function despite being just a good or even great teacher but very much on the bell curve. 

    The point is that technology leads to a huge range of possible payoff functions semingly extending to billions. Estimates of output based on the average input will fail to appreciate the convexity of some of the payoff functions in a hyper-connected world network. 

    This might not map perfectly to Jensen’s Inequality but it was a thought I had as I turned these concepts over in my mind.

Takeways

Be careful when trying to make estimates of how a function or process will payoff based upon the average input. If the function has exponential dynamics, Jensen’s Inequality tells us that the weighted average value of the function will not coincide with average input you feed it.

If the function is convex, the average input will underestimate the average output. If the function is concave, it will overestimate the average output.


A Reader Explains The Psychological Grind Of Trading

This is an email I received from a long-time friend and successful founder of an options trading business (he is bankrolled by a prop shop). He’s chopped a lot of wood, so I changed some details to keep insiders from figuring out who he is. He was very forthcoming and approved this of course.

My understanding is that loss aversion is the idea/phenomenon of different reactions to “losing” versus “winning” despite the same (or even a worse) net actual outcome.  I believe there are several studies of this in a controlled/lab setting, but I didn’t go back to review, as I just needed to get this sent!

The loss aversion reference from our call, referred to annual p/l, as I recall. Below, are a few examples (with more or less real world inputs from my past few years).  

-In scenario #1, we are having a rough year, losing after-expenses around mid-year. Then, we catch one big winner and a strong q4, including 3mm in the last week of the year during the xmas crash.  We finish the year +4mm net.  Overall, that’s a mediocre year to historical avg.  But, given the alternative– an ugly losing year with no bonus, and possible clawbacks going forward, I’m thrilled to realize 750k or so from that slice of my comp (my specific team performance).  That was basically 2018…

-In scenario #2 we are having a home run year, +20mm in the account in March. Then the Cboe closes for 6 weeks while we have our biggest position in 10 years of XXX trading.  The position bleeds, we have no outs, no volume…  then the XXX makes several gaps from [low number to high number], and right back to [low number], on no liquidity.  We negatively scalp (10mm).  XXX p/l is now gone, and the product is dead, and Cboe remains closed.  Meanwhile, Softbank happens in tech, and we are short a lot of tech vega in YYYY, etc.  We lose another 5mm there.  So we go from +20mm to +2mm in 3 months (expenses never slow down).  We spend the 2nd half of the year grinding back some $$, and finish around +7mm.  I get paid a lot more than in scenario #1, but I have horrible PTSD, I don’t sleep for months, I lament (daily..) what could have been if I had booked a 30mm p/l year, and it’s misery all around.  (My XXX trader even had a nervous breakdown and had to take a leave from work.)  This is obviously 2020.   Despite the much better outcome, it’s a much “worse” year in terms of performance/comp.  but it’s all in my head.  Overall, I was paid more, which in trader land, should always be better.  Right?  Right?!

I think these longer term (annual comp) examples illustrate the concept of loss aversion quite well. But there are of course countless others.  Just Friday, as I typed this, another arose.  We had a winner to the morning news/gap in ZZZZ. Long gamma was good for about +50k.  Market opened, we start trading, stock keeps going.  25%, 30%… almost 50%.  We were hedging deltas, and then sold some gamma that was quickly awful.  We now have an Opening p/l +130k, day p/l (60k.): net +70k. The outcome is better than before, but I’m a hot mess, cursing my decisions and the stock. Better outcome, worse head space.  There are so many examples of loss aversion, many of which I’m sure you have considered during your career.  But annual comp and intraday hedging of a winner are 2… 

I’m not sure if this is at all interesting as a potential future post, but the topic fascinates me. The human brain is just not wired to properly handle these things very well.  Or, at least mine is not.

That story is the embodiment of Lawrence Yeo’s terrific Speculation: A Game You Can’t Win.

I realize the numbers my buddy is throwing around make this sound like a high-class problem. But I’ll point you to a post that will prompt you to think deeper before concluding you can’t learn from it.

  • Are You Playing to Play, or Playing to Win? (26 min read)
    Cedric Chin

    This post is fantastic on its own. You might even realize you’re a…“scrub”. But it’s a giant doorway to self-examination. It makes you wonder if you are playing to win. But, and I think this is actually unintentional, the post shows the major limitation of analogizing games to life. Check my short tweet thread before or after reading the post to see what I mean. The expression “play stupid games, win stupid prizes” comes to mind. Only you can decide what’s stupid. We are seeing this happen in real-time, with people calling this period of massive turnover and quitting the “Great Resignation”. Then again, just as we mix up bull markets with brains, there’s a good chance asset markets have pulled many people closer to “their number” and accelerated the types of questions many would usually wait another decade to wrestle with. [The nihilistic whisper in my ear, is the quickened trajectory accelerates the feeling that as we peel back one delusion we just find another. If the onion of delusions was a grand secret, its nature was typically revealed to the aged under the stacking pressure of successive self-crises. But today, that reality is creeping broadly into younger cohorts who, when they threaten to not play traditional games, seem to be serious.]

Channeling Motivation

We ebb and flow through different productive energies. Sometimes we know exactly what we need to do. So we go into heads-down mode and grind. If this overlaps with the concept of “flow”, even better. It’s a great place to be. Even though the work might frustrating, the focus keeps you from an existential crisis. There’s plenty of time for that after you get the trophy.

Sometimes we find ourselves in a meta-funk. Maybe we are burnt out or have a personal difficulty that derails our routine. If the issue is acute (ie your health or loved one’s health), I hope there is enough merciful slack in the system to help you get back on track. In the case of burn-out, that slack may just take the form of rest, re-focus, or simply some time to wander.

Each of these states requires its own forms of guidance or remedies. But there is another increasingly visible state I’m seeing (perhaps too well if you catch my drift):

Restless and motivated but directionless.

Moontower is not some niche, actionable industry newsletter, so if you are subbing to a weekly “musing” there’s a good chance you have some “wander” energy in you. Perhaps there are too many appealing possibilities but none of them says “drop everything”. Or perhaps you need to see a menu of actions that can provide a first step.

Here’s a couple reads that might help.

  • Paul Millerd’s Reinvent: Action Challenge Examples (slideshow)

    You know my feeling that introspection is overrated. I’m guilty of living in my head too much, so I’m not throwing stones. In fact, that’s why I criticize it. To get unstuck you must act. Action begets information and that’s what you need. Paul put together an awesome deck of challenges and experiments to channel that motivation and help you get the information you need.

  • The Art and Science of Getting to the Very Top of Crowded Creator Markets (Reddit thread)

    There are no shortcuts but the encouraging takeaway is the recipe is simple not easy. That’s a recipe you are familiar with if you have ever done anything satisfying. It’s also a reminder: there’s nobody stopping you but you. It’s one of those hard truths that excuse-makers like to recruit their intellect against. Your time is too short to waste your brain making those excuses because you have enough time to prove the excuses wrong. I know. It’s a paradox. You’ll get over it. Even if it’s only because you must.

Finally, you should check out my buddy Khe’s 10K Summit. You probably see stuff like this all the time and gloss over it but Khe has the superpower of constantly over-delivering. And it shows in the caliber of people who he attracts (James Clear will be speaking for example).

There’s nobody I plug more because everyone who listens to me that they should check him out comes back and gives me rep. So I’m actually doing a judo selfish move.

Here’s the sign-up link -→ $10k Summit on Oct 6th-8th

Oh, yea one more thing. There’s no charge.

Assorted Real Estate Thoughts

An assortment of real estate things

  • An in-the-flesh example of growth vs value in real estate

    While traveling this summer we bought a house. It was a quick (that’s how I spell “impulsive”) decision. We weren’t even shopping for RE but it was one of the rare moments where Yinh and I took a look at something and arrived at the same conclusion telepathically. The home has some interesting optionality to us but the first checkbox was thinking about our downside. So we asked our local friend, who found the listing, to handicap the worst-case rent we could get for it. Feeling satisfied, we shot our shot and lifted the house.

    Turns out we underestimated the rent we could get for it by more than 40%. Within 3 days of listing it, we had 4 offers through our asking price, all guaranteed by an insurance company, a re-locating employer, or an upfront check for the whole lease term. Feeding frenzy.

    Now, the interesting part. The house is half the price of the house we rent in CA and fetches more rent than we pay here!

    What’s going on?

    This is a growth vs value thing. The house we bought is in an area where there are lots of new build permits. Supply is currently constrained because of immediate inflows of residents overwhelming capacity. But this place is nothing like the NIMBY Bay Area where home prices rightly have capital appreciation baked in. Meanwhile, where we bought has cap rates priced for carry.

    In other words, nothing to see here…markets make sense.

  • Why US Housing Prices Aren’t As Crazy As You Think (A Wealth Of Common Sense)

    This brief post by Ben Carlson provides an international perspective. It suggests that the recent surge in real estate prices is hardly a bubble and [gulp] it might even be early innings.

    This may surprise you, but compared with other developed nations, US home prices are merely playing catch-up. This is even more true when we adjust for inflation and disposable income.

    It wasn’t discussed in the post but another point suggesting RE has lagged, is US stocks have massively outperformed international markets since the GFC. This can be reassuring for those of you looking to rebalance out of stock [or crypto] gains into RE.

  • A reminder that RE is a very direct bet on interest rates

    This is from an account I like and follow (as opposed to a ‘hate-follow’) @sidprabhu:

    The median home price in 2007 was ~$250k with 30y mtg at 6.5%. Assume 0 down that’s $1,580/mo. With 30y mtg at 3%, $1,580 gets you a $375k house, which is the current median price. (thread)

    I want to add another insight from @ByrneHobart paywalled letter highlighting the bond-like quality of real estate:

    The higher the price/rent ratio for a home, the higher its duration is as a financial asset, so the rates-sensitivity of big city real estate offsets a lower expected rent.

    The quote refers to the fact that while covid decimated rents in big cities, the home prices fared comparatively well. Because city cap rates are already low they are priced like high P/E growth stocks. They have high duration (ie driven by values much further out in the future) so the immediate earnings (the “rent” in the RE context) have less impact on the price than if they were value stocks which are more sensitive to the cash flow.

  • If RE prices are high but the payment is the same should we care?

    Let’s turn to @sidprabhu again. The emphasis is for the geek readers who thirst option references any way they can get ‘em:

    Some will say what’s the problem? The payment is the same. Who cares what the price is? That ignores the fact that high home prices transfer wealth intergenerationally and can decrease mobility for buyers…

    Mortgages can be prepaid. Savings can be redirected to paying down high mortgage rates early creating a risk fee rate of return. It’s much better to buy a low priced house with a high rate because you can prepay. High prices benefit sellers…Perhaps more importantly, if home prices do go down it effectively traps buyers in their home. If rates go up they lose on their home value but locking in the mark to market gain on their mortgage is very difficult…

    Want to move cities for a better job in a recession? You owe the bank the negative equity or risk damaging your credit by walking away. (thread)

    Sid’s tweets made me reconsider one of my prior takes that I called “Minimum Tick Size Frustration”:

    Real estate prices that are high are mostly annoying because they force you to put a lot of eggs in one basket. This can be true even if the prices are high but cheap (a house on Carbon Beach for $3mm is cheap even if the price is “high”). If you are worth $1.5mm and own a house worth $1mm it’s hard to diversify. Your home is 2/3 of your assets. Many homeowners are even more concentrated than that. The high price might not be a problem from an affordability point of view but it’s a problem from a risk or portfolio point of view. So when you live in a high cost of living area, the minimum acceptable house forces you to concentrate wealth more than you’d like to.

    Here’s another way to look at it. Imagine if the lowest-priced stock in the world was $50,000 a share and there’s no way to buy fractional shares. We don’t need to make a statement about whether the stock is cheap or expensive (that depends on its earnings and how many shares outstanding there are) to be frustrated that the price is high even if it’s not “expensive”. We would just be frustrated that creating a diversified portfolio would be difficult if the minimum purchase prices were so high.

    Sid’s tweets make me change my opinion that high real estate prices are “mostly annoying”. They have much worse multi-order effects, unfortunately.

  • Since the GFC, builders were slow to get their mojo back…see the replies.

Moontower #117

Well hello friends.

It’s been 2 months. Last you heard from me, I was hanging out in the DFW area. We continued on to the Dominican Republic and then NYC/NJ before getting back to the Bay Area for the start of school. Thanks for the patience. We are all awash in “content” so I figure nobody missed me that much especially since I was still tweeting promiscuously.

After 10 weeks on the road, I was craving the warm embrace of a routine. Before I could ease back into a schedule I needed to indulge my organizational OCD otherwise known as “procrastination”. So to transition back into a weekly cadence I’ll briefly talk about this housekeeping before talking about what will change about the Moontower letter and what will stay the same.

Health

I aggressively shed the few extra pounds I put on this summer. Mostly through diet but I got back to lifting 2x/week and walking more (taking kids to and from school by foot helps there). I also got a physical/bloodwork. I was told to lower my blood pressure and blood sugar. Luckily, the Rx for both is the same — treat your body like you only get one. Feed it actual food, move it, and rest it.

Intellectual Inputs

You’d think that I did a lot of reading on my travels. You’d be wrong. I did what I couldn’t the prior summer — I hung out with family, old friends, and new friends I’ve met because electrons are amazing. But I want to get back to reading more. I don’t even mean books necessarily. Articles and blog posts are a step up from where I’ve been. I seriously starved myself of intellectual stimulation this summer. I opened my laptop maybe once a week and mostly used the Notion app on my phone to queue my reading list. I started working through it this week. Here’s a look at my queue system in case you are a serial killer too.

Filing system for reading

For better or worse, filing posts I want to read makes me feel less overwhelmed. Posts that are long or technical require different energy than the “<8 min read” and my Notion dashboard is a useful triage. And it’s fine to discard something you thought you might want to read and later lost the will or need. To get reading times I use the ReadingTime Chrome extension (link).

The “Week of 9/7/2021” is a dropdown where I file the articles I read this week. At the start of the next week, I’ll move that file to the “Weekly Reading Archive”. Sometimes, I’ll read something and want to refer back to it but I didn’t anticipate ever wanting to refer back to it but I might remember roughly when I read it (ie “during Thanksgiving last year”, or “when I was in LA”). This gives me a chance of recovering it even if I can’t remember distinguishing features of the post to feed a search engine.

Other sources of media

I just have a simple list by media type (ie movie, YouTube clip, etc). For audio sources, I use PlayerFM to queue podcasts and Spotify to explore music. My public Spotify lists are indexed for you here.

Courses

Separately, a college bud recently needed to re-arrange an equation for a financial model he was working on. He put it on our group chat that has several electrical engineers and physics folks with advanced degrees. Crickets. I stuck it into an online math solver after taking a crack at it and failing. The solver reminded me that there’s a general formula for a quadratic equation that starts with:

-b ± √ stuff

Oh, the cobwebs. Use it or lose it.

Anyway, that feeling prompted this tweet that led to a treasure trove.

Twitter avatar for @KrisAbdelmessihKris @KrisAbdelmessih

Please reply with your favorite free online algebra, calculus, stats courses please. 🧮

I rummaged through the responses and came up with this shortlist if interested:

And of course, Khan Academy was a frequent recommendation.

The Future Of Moontower Weekly Musings

  • You may have noticed Moontower has migrated from Mailchimp to Substack. Mailchimp’s free tier caps at 2k subs and there are now over 2,100 of you. Meanwhile, Substack is always free. And so easy a caveman can do it, lucky for me.
  • I moved the archive (in a painful copy/paste process) to my WordPress site MoontowerMeta.

After >2 years of following a steady format, I’m modifying the letter. How will Moontower be different?

  • It will be much shorter
  • It will be more focused on sharing links I found interesting
  • It will only have 2 sections. The main section is where you will find recommendations and Money Angle is where you will find more finance-focused links.

What will not change?

  • Sunday is the day. Every week.
  • It will remain personal. A lot of reader outreach came from the philosophical and productivity-geared posts. The From My Actual Life section also created an easy relationship with you. So even though the Money Angle drives the subs, this outlet where we try to figure out life together I think becomes the familiar friend. It means a lot to me but removing the weekly prompts reduces the mental overhead of the letter.

This brings me to the reason for modifying the letter — to reduce the hours I spend on it. I want to tackle a list of writing projects and posts that require more effort. I’m just re-allocating time from the letter to the longer posts (which I will of course share in the letter as they get published). When I started Moontower, it was intended to be just links, but your encouragement let me wade into writing. Both the finance and life writing found appreciative audiences once I hit “send” on Sunday. I’m just leaning into that, so 117 letters later, Moontower is coming full circle and going back to mostly links.

Ok, this is already much too long so we will punt on Money Angle this week and just share a few recs/tweets from the past couple of months.

Recs

  • Motivational books…I compiled the results here.

  • Investing in future productivity

    The 8-year-old has been using typingclub.com to speed up. He noticed I peck like a chicken and shamed me into practicing. Jeff introduced me to an even slicker software — keybr.com. Painful but it will be worthwhile. (Yinh, meanwhile, is a ringer and organized a wpm contest at her old firm on her last day and torched everyone. She’s close to 100 wpm. Annualize that.)

  • Fun
    • I saw Ford vs Ferrari for the first time this summer and it immediately became one of my favorite movies. I watched it 4x in a week which reminded me of my early 20s when I first got a DVD player and watched LebowskiZoolanderBoiler Room and Any Given Sunday until I just about wore the discs out.
    • I went to Bottlerock for the first time ever. It was like a food and wine festival with music. It was well-done and comfortable. Nicest port-o-potties I’ve ever seen. And no lines! We went general admission and used car service to go back and forth each of the 3 days (even Best Westerns were about $1500/n for double occupancy). I’d go back to Bottlerock but maybe book accommodations a year in advance.

      Favorite new-to-me discoveries: The Black PumasJoywave, and Cage The Elephant (who are on binge repeat mode in the house now. I made a playlist of the set they played if you wanna partake).

    • I was looking for literal moontowers when I was in Texas this summer so let it be clear that I’m totally biased when I say you need to listen to the audiobook for Greenlights.

    Thanks for reading!

The Most Important Solutions Are Simple Just Not Easy

Here’s an exercise.
Watch this 4 minute vid which shows how people solve their problems AND how corps study you to serve you solutions.  It’s also amusing. The late HBS prof Clayton Christensen reveals some surprising facts about the habits of people who buy McD’s milkshakes.

The Job Of A Milkshake (YouTube)

Then…

This post shows why you don’t need a manufactured solution. You don’t need a “milkshake”.

Decomplication (Link)
Nat Eliason

My takeaways:

We all know the concept of simple but not easy. It’s the truth to everything worth having. Good relationships, good health, good output. You can’t fool yourself and there’s no shortcuts to these things.

It’s easy to forget that because we want to forget that. It’s inconvenient. So we tie ourselves in confusing webs of apps, CBD and expensive mattresses to figure out how to do something babies just do: sleep. And that’s just one example.

We succumb to:

The Law of Artificial Complexity: As the number of people experiencing a problem increases, so will the artificial complexity of the solution.

We need to remember: 

The Law of Decomplication: The more people that are experiencing a problem, the simpler the solution should be.

So strip the problems back down to their essence.

      • Losing weight: People without access to food get very skinny. If I eat less, I will lose weight.
      • Networking: Famous people tend to hang out with other famous people, or people as accomplished in tangential fields. If I want to get to know someone I respect, then I should do something that puts me on a level where I could be friends with them.
      • Productivity: The goal of productivity is to get more done, and the biggest reason you don’t get things done is that you’re doing other things. If I remove the ability to do other things, I’ll do the thing I’m trying to be productive on.
      • Sleep: Removed from modern society, sleep is not a problem. If I can create a sleep environment as if I wasn’t in modernity, I should sleep fine

Bits From DFW

We’ve been up to a lot of fun stuff in Texas. Some of it will make for good discussion when I’m ready but in the meantime, I’ll just mention a few DFW places that we have enjoyed in the past couple of weeks.

  • FC Dallas MLS games

    We went 2x. For less than $40 you get amazing seats. The overall environment is fun and positive. I have never been to an MLS game before and while I know nothing about soccer, I and everyone we went with found the fan experience to be outstanding.
     
  • Burger’s Lake (Fort Worth area)

    We went here 2x as well (the friends we are staying with have been hosting 2 to 4 families from our NYC/CA crews the entire time we’ve been here, so we repeat activities as the revolving door requires). It’s a lake with high diving boards, water slides, a trapeze swing, and attractions catering to younger kids. Bring your own picnic or use the camping grills to make burgers. You will need to sneak booze in. On weekends they check your cooler, but we got away with it during the week. Your welcome for the tip.
     
  • The Stockyards (Fort Worth area)

    Also did this 2x. Step back into the history of cattle-ranching. There’s plenty of activities for kids and rows of old saloons and restaurants for the grown-ups. And if you want something less rustic, the newish Hotel Drover is a great spot to grab a ranch water (I make this drink all the time, but didn’t realize Texans have a name for it). It also looks like a fun spot for a weekend getaway with a nice pool and access to the stockyards. Time your visit to see the daily longhorn cattle drive up the main drag. 
     
  • Deep Ellum (Dallas)

    This is an area of Dallas that reminded me a bit of Wynwood in Miami. Cool restaurants and shops (Jack White’s baseball brand Warstic is headquartered here). Plus lots of locals flexing their muscle cars (my kids are totally obsessed with cars right now especially Challengers with kits such as Demons, Super Bees, and Hellcats. Hellcats come with 2 keys, a black and a red one. The black one is the regular one. The red ones unleash the beastly Hellcat engine. These cars are built for drag racing. If Fast and Furious movies didn’t have cringey sex scenes, I’d take the boys to see F9). If you visit and dig tequila/mezcal you need to go to the Ruins. I tweeted about it. 
     
  • Bar hopping in Dallas

    Grab a cocktail at the Mitchell, see the decor in the Adolphus Hotel, and end at the Thompson Hotel. There you can see some prettiness and pretty people at Catbird before grabbing dinner at Monarch or sushi at Kessaku. The sushi was outstanding by any coastal city standard but pricey. Sake choices were underwhelming, but the view is a consolation prize. Finally, end the night, at a ridiculously good mezcal bar hidden in a bridal store. In a strip mall. The empanadas and cocktails are lit at this tiny spot started by two bros from Mexico City. It’s called La Viuda Negra. It was better than the movie we saw of the same name last night in IMAX. 

Dan McMurtrie with Howard Lindzon

Link: https://howardlindzon.com/dan-mcmurtrie-founder-of-tyro-partners-llc-joins-me-on-panic-with-friends-to-discuss-information-overload-and-behavioral-investing-ep-151/

About Dan: Dan McMurtrie is a 28-year-old founder, portfolio manager, and Twitter phenom more commonly known to his nearly 60,000 followers as @SuperMugatu. He’s an insanely funny, original and inspiring person who knows a lot about social media, maintaining an audience and the behavioral side of investing. Dan’s New York-based hedge fund, Tyro Partners LLC, focuses on trends and supply chains driving technology, healthcare, industrial, and consumer markets.


An insight common to making money and making people laugh

Something everybody knows it to be true but no one’s speaking up about it being true

On people struggling to make sense of the world

It’s a paradigm shift to a networked world…going from one-to-many media to many-to-many media, and having cycle times for communications go down to sub-second, meaning the number of cycles, the number of communications is going to infinity really fast. That’s leading to all these weird neurological effects because your brain is not used to having hundreds or thousands of opinions scattered at it. Your brain is used to thinking that an opinion from somebody means something, which is super wrong. And so I think this knee-jerk reaction to dismiss things that well-trained investors in the past three years have developed is actually the biggest weakness you can have, because everything now is like this kind of meta game of “it looks absurd but it’s actually not. Actually you shouting that it’s absurd, is what’s going to give it the audience that makes it real!”

The output of our quickly networked world is disrupting seasoned investors’ heuristics

It’s scaring the shit out of people. They’re looking at this and they’ve been around the block a few times, and their experience is betraying them because they’re seeing things that are so behaviourally horrifying to them that they don’t realize that they’re then becoming just instinctive and knee jerk, And they’re not running basic numbers [and asking themselves] “Is this a material amount of money?”.

[consider the lazy argument against Dogecoin that it has unlimited supply]

Is it actually unlimited supply? I’m like, “Yes, but is it unlimited supply forever. No. There’s a more nuanced point  that it’s not unlimited supply at any individual point in time, there’s a rate limiter on time with those points, which is why this pump thing is working. 

An example of how brains get hacked in this networked world, orchestrated by the guy that oversaw such hacking at Facebook

There’s a technique that I think Chamath does that I call “the 90% rule”. What you do is you say something that’s technically accurate, but like maybe 10% off of how a professional would say it, or maybe it’s 10% not correct, but it’s in the spirit of correct. For example, Chamath said something on Twitter — that he was up 120 basis points this year, and the market’s up 30 basis points, so he said he’s outperforming by like 300% or 400% or something. [Everyone jumped on Chamath for this], but do you actually think that Chamath doesn’t understand basic math. Do you think the guy who led monetization of mobile advertising for Facebook doesn’t understand the way things are reported. The guy who’s leading several SPACs, who’s talking to bankers every day, who has a sophisticated family office. You could dislike the guy for a million things, but basic numeracy is not one of them. And yet the knee jerk reaction [by people on Twitter] is that he’s wrong. I think the reality is, and here’s the brutal thing about Twitter, most people on Twitter are strivers. The people that are working really hard, they’re trying to make it, and candidly for most people it’s not working out. Especially the finance guys. The guys who went to finance, they’re not getting the money. It’s not working out. They’ve got the CFA, they’ve got the MBA, they worked at Goldman, they went to Wharton and they’re still not making a fraction what they thought they were. They’re not moving up. It’s not working out because of top-down industry dynamics which you’ve talked about ad nauseum, but that makes them really bitter. They’re really bitter because they feel like they’re getting screwed. And so when they see this guy, who’s making billions of dollars, making a beginner mistake, that would have gotten them fired, the amount of unrighteousness or injustice feels so massive. It overrides all logic and reasoning.

Nobody is immune from the brain-hacking that the networked world is doing, but the first step to understanding it is being aware of it.

My big thesis right now is technology is being used to program people, not the other way around. In the frickin documentary on Netflix [referring to “Social Dilemma”] is half of the stuff and [Chamath] is doing it. It’s crazy how effective this stuff is. A great example of this was when I tweeted a stupid joke that “no one actually knows what’s in chalk, they just teach you to accept the premise when you’re so young, and they just go with it.” And you have people, like real people with PhDs responding like I’m a fucking idiot. Everybody knows what chalk is. Don’t you see this as tweeted from my iPhone?! I tweeted this from a supercomputer in my pocket. Even if I didn’t know what chalk is, I could obviously put faith in it. [This is obvious if you think about this] for more than a split second but you have people who have multiple PhDs from places like MIT, who are completely hacked. Their brains are being hacked. And they look like fools, and they think they think that they’re smart because they’re speaking. Not to validate what they’re saying. They’re speaking to validate themselves, and that’s the weakness that all people have. This is the dark arts that you have to study now.

Change is occurring at an accelerating rate

There’s a concept called the Overton window, which, not to be like a dropper of concepts but Overton Window refers to what like types of political policies are acceptable to talk about in public. [A few years ago universal basic income was considered a quack idea], last year Donald Trump initiates universal basic income. Admittedly because of a virus so I’m not saying it was a wrong move, but you need to understand how insane that shift is society that that went from unthinkable to expecting it, and actually the people almost revolted. I mean I was in Richmond, Virginia when the protests were happening there. We were watching the breakdown of society happened, because there was some uncertainty around it that changed in a year.

You can’t put your head in the sand about the role of social media. The genie is out of the bottle. Dan sees evidence that some managers do not understand that reality.

The thing about Twitter within hedge funds or institutional endowments that nobody really wants to admit is, even if the CIO isn’t on Twitter, (and if he isn’t, it’s only because he’s too old) all of their analysts are! So, like there’s this huge issue right now of mass group gaslighting of mimetics and ideas spreading like viruses and if you’re a CIO right now, you probably don’t actually know what your firm’s sourcing mechanism is (unless you’re pushing all your ideas down). The number of times I meet with the senior guy who runs a fund, and he starts rattling off ideas I’m like “Yo, you know your analysts ripped all of that from Twitter right. And they’re like ‘What are you talking about?’ and I’m like, Look, there are these cliques of people on Twitter, I’m not even I’m not saying they’re bad ideas, but they aren’t original ideas. I’m just telling you. I’m not going to doxx your boy, I’m not going to get anybody in trouble, but I’m just telling you that you don’t know how your own investment process works. You don’t realize you’ve already been fully infiltrated by social media.”

Instead of fighting this new reality, adapt to it.

[You’ve been infilitrated by social media] but you actually kind of want that because if you are the only guy who’s not participating in these things [you are missing important context]. For example in January, and the end of December [during the stock squeezes]. I’m not particularly smart, especially relative to other hedge fund guys, but I was seeing where the liquidity was in the market and I was seeing the type of stuff happening on StockTwits and Reddit and all these other places I mean there was just gonna be just some crazy stuff happening. I went to my clients and said “Look, I’m not gonna play this game. I’m gonna take exposure way down. Yes, I believe I should be short half these companies, but I’m short the stock not the company. I’m not messing with this.” I had several people say I lack conviction, long-term investing blah, blah. Then the next three months it was just a hedge fund after hedge fund blow up. This is not going away, it’s not going back because it’s not 2000. This is not instant messaging. Last year was the first year that most waking hours for humans were online, and everybody was on one to five websites. Nobody really understands how significant that is. Everybody’s now networked, all the time 24/7.

The bar for what is considered table stakes is rising. Psychology and the repercussions of being highly networked should receive more of your attention to gain an edge.

People don’t realize how fast these big changes happen and so when I just look at some people who think we’re gonna, we’re gonna be good investors because we do more conservative discounted cash flow analysis than the other guys I’m like, “You’re like a dude with a horse and a saber walking into WWII. You’re about to have a really bad time. Like I can’t even explain to you the ways in which you’re going to get beaten down, and you’re not psychologically prepared to deal with any of this stuff because it’s gonna seem random. It’s just gonna be chaos. There’s gonna be bombs dropping and machine guns and you’re not gonna know what either of those things are. It’s just a really weird time to be an investor and I think you have to move the psychology stuff up in how you’re relating to the world into a really forefront position. Or these systems are just going to eat you.

How Dan’s fund is adapting

We’ve continued to zoom in on this behavioral stuff. Everything else is table stakes. Of course, you need to know how to value something, you need financial analysis, you need to be able to read transcripts, and do value research. But that became commoditized sometime between 1995 and 2010. Look at the number of people who have CFAs or how many people went through banking here or internationally. Companies like thedeal.com. You can go online, hire somebody anywhere in the world in like 10 minutes with a contract and a 1099.

Right now, I think the markets become a pure metagame of the game. Where does it go from there? The thing is humans are still very human, and actually, the rise of passive means the humans are a smaller percentage of the market. When they move at once they have a bigger price impact, because it’s just everybody running out the fire door of a theater. It’s as old as the hills. It’s all the same stuff again but remixed and much faster. It’s still music but it’s going from jazz to dubstep, way more aggressive, way faster, with all these different games being played. So we spent a lot of time trying to understand the fundamentals and what’s going on in these businesses and what’s going on in the supply chain, but also what is the psychological game going on in the market.

You must find a lineup where you’ve got great fundamentals, good business improvement, a really long-term runway, and you have some really distracting psychological thing that’s distorting the price. Or more importantly, maybe in this era, mandate arbitrage. As more and more capital is just driven by somebody’s investment policy statement, or an endowment investment policy statement or the S&P index rebalances. Those legal mandates are really powerful and just getting bigger. So we want to see a clustering of understanding why the opportunity exists. Because of legal mandate, because of agency costs and behavioral things like [where investors] can’t go to LPs and own it because they are going to get upset. If we see that plus it’s a good business [that becomes a potential opportunity].

This bit reminds me of the style of trading I’m more accustomed to where we don’t predict so much as try to “see the present clearly”. I’m more accustomed to measuring what is happening now than predicting tomorrow. (An example from my world would be owning optically expensive volatility because it’s carrying well)

We don’t try to predict. We try to observe. We might have a starter position on but when we see thesis confirmation, we’re going to add. What we do not really like to do, is make a big bet because we think x is going to happen. I don’t think it’s necessary because I don’t think the market adjusts to new information as well.

Dan loves Warren Buffet but scoffs at his cargo-cult imitators

I’m a huge Warren Buffett fanboy. My favorite people in investing are Warren and Charlie and then my least favorite people in investing, generally speaking, are people who tell you that they’re fans of Warren and Berkshire.

A great filter is to ask them “what’s your favorite Berkshire business?” If they say See’s Candy, you know that they know nothing. Nothing about Warren Buffett or Berkshire Hathaway. The reason is Warren Buffett is probably one of the greatest marketers to ever live. He’s built this brand. He’s built this brand that’s hyper-consistent. That allows him to not answer any critical questions, because he doesn’t actually have to defend objectively right or wrong. He just has to defend consistency with his brand.

There are several value investors that really market themselves as like Warren Buffett or Charlie Munger brands. Baby Buffetts. They all have kind of good records of not losing huge amounts of money but none of their records would stand on their own in a vacuum. They live off this same narrative. Recently I’ve had some interesting interactions with a couple these people. You ask them “How do you think about your business?” They’re very candid. “Look, I am looking for somebody, where that’s what they want. They want to feel that they’re investing in a long-term, conservative thing. They’re not going to lose their money. They will compound well and they get to feel like they’re part of the church of Buffett.”

At the end of the day, what are they selling is a psychological safety blanket. They’re not selling an investment product at all…they will only take inbound clients because they don’t want to go out and convert anybody. Look at how these [investors] behave. If you’ve ever studied cults, you see the exact same behavior. I don’t necessarily think it’s malevolent or bad, but I think that in the modern era, with everything that Warren Buffett did now being sped up 100,000 times, and on Twitter everyday with people doing these explainer threads and Substacks. These are all the same psychological manipulation techniques. It doesn’t mean they’re malevolent. If you really understand how Warren built his public persona, why he built it the way he did, and how he changed his business at every scale level of capital [out of necessity] you’d understand that the idea that Warren Buffett The Empire Builder, bears any resemblance to Warren Buffett The Ruler is naivete.

Why 2020 made Dan optimistic

Looking forward, I think the takeaway from last year, has to be a profound optimism for humanity. We just took a global pandemic on the jaw. As pissed off as everybody is we’re calling it the Five Aces Problem. It’s like you being dealt a poker hand with four aces and people are like “It would be good if we had a fifth ace”. There’s no fifth ace in the deck! You can tap something on your phone and have a pizza in 20 minutes! You can have a date in 5 minutes. You can have anything you want delivered to your house within 2 days. Like woe is you that you couldn’t get the specific dumbbells you wanted that week. During quarantine, we were living a better life than people in the 1960s were able to live. People in the 25th income percentile now live better than Rockefeller did. We’re going up a curve that is getting exponential so people are not understanding how insanely awesome the performance last year was of humanity. And sure we have some supply chain chokeholds leftover from last year. Yes, there are obvious knock-on effects. We’ve got some issues around the government explicitly putting all risk onto the dollar and making some big bets on modern monetary policy. Those are generally concerning things, but they are super obvious. I just don’t see how you can’t be optimistic about our ability to solve these problems.

I think one of the things people struggle with, I just wrote about this, is as the world gets better, as you go from being a caveman to being an office worker, your job is moving further and further away from the kind of base Maslow needs. You’re not hunting a saber-toothed tiger, you’re typing in data entry or doing social media posts. That’s why every generation looks at the next generation and thinks they’re soft as hell. You know “they had to walk both ways to school uphill in the snow.”

It always happens like that. That’s what progress is.