A Different Kind of Death Spiral: ETFS, Mutual Funds and Systemic Risk

The rapid growth of ETFs is one of the most significant changes to financial markets in the last decade. Total ETF AUM grew from $0.5 trillion in 2008 to over $3 trillion by the end of 2017. More remarkably, AUM of ETFs invested in illiquid sectors such as global bank loan , emerging market bonds, and global high yield bonds increased 14 fold from $10 billion 2007 to $140 billion at the end of 2017. Prior to the last financial crisis, ETFs were a relatively small niche, but these past few years it seems like every asset manager has launched an ETF. Most investors have a large portion of their retirement assets in ETFs, and many investors exclusively invest in ETFs.

This is a major systemic change from what was in place prior to the last financial crisis. Since markets go through cycles its worth asking: how will the ETF ecosystem hold up next time there is market turmoil?

ETFs have overall been a massive benefit to investors because they lowered costs. Yet as more and investors put more and more money into ETFs, there are growing signs of distortions. Some investors have pointed out how ETFs are creating bizarre valuations that are unlikely to be sustainable. Additionally, there are growing signs that the ETF structure is far more fragile than most market participants realize. These aren’t just doom and gloom conspiracies from Zero Hedge. Organizations such as the IMF, DTCC, G20 Financial Stability Board, and the Congressional Research Service have all pointed out possible risks from the unintended consequences of ETF growth.

How the ETF ecosystem works

The structure and mechanics of ETFs are unique and different from mutual funds.  Unlike mutual funds, ETFs generally don’t have to meet redemptions in cash.  The key difference is the role of Authorized Participants (APs), and the arbitrage mechanism.  The Congressional Research Service provides a handy diagram explaining the structure (Most fund sponsors have similar diagrams in their whitepapers)  :

ETF Liquidity Leveraged Loan ETFs

From the same CRS paper:

In a typical ETF creation process, the ETF sponsor would first publish a list of securities in an ETF share basket. The APs have the option to assemble and deliver the securities basket to the ETF sponsor. Once the sponsor receives the basket of securities, it would deliver new ETF shares to the AP. The AP could then sell the ETF shares on a stock exchange to all investors. The redemption process is in reverse, with the APs transferring ETF shares to sponsors and receiving securities.

ETF shares are created and redeemed by authorized participants in the primary market. The fund sponsors do not sell their ETF shares directly to investors; instead, they issue the shares to APs in large blocks called “creation units” that usually consist of 50,000 or more shares. The APs’ creation and redemption process often involves the purchase of the created units “in-kind” rather than in cash. This means that the shares are exchanged for a basket of securities instead of cash settlements.
The supply of ETF shares is flexible, meaning that the shares can be created or redeemed to offset changes in demand; however, only authorized participants can create or redeem ETF shares from the sponsors. A large ETF may have dozens of APs, whereas smaller ETFs could use fewer of them.

The “arbitrage mechanism” is a key feature of the ETF ecoystem. The market incentivizes APs to correct supply demand imbalances for ETFs because they can always exchange underlying shares for the securities in the portfolio and vice versa. So theoretically ETFs should not end up with discounts or premiums to NAVs like closed end funds.

Additionally, since the ETF Sponsor can redeem in kind, rather than in cash, they don’t need to sell underlying securities to meet redemption requests, like with mutual funds. Additionally, unlike with mutual funds, you get some intraday price transparency. Sometimes media commentary on “illiquid assets in liquid wrappers” mixes these up, but the nuance is important to how the respective ecosystems will react to market turmoil.

The arbitrage mechanism is a huge benefit for ETFs, and it works pretty well for deep liquid markets, like large cap stocks. Yet with less liquid assets such as leveraged loans or high yield bonds, there is reason to worry. ETFs haven’t really solved the liquidity mismatch problem. Closely related, any understanding of market history leads us to conclude that APs are unlikely to function in a falling market.

Liquidity mismatch in ETFs

Theoretically if there is a flood of selling at ETF level, APs can buy from portfolio managers, then exchange for underlying securities. However what happens if there is no bid/ask for some or all of the underlying securities?

There are several large ETFs that consist of leveraged loans and high yield bonds. A retail investor can have instant liquidity in the ETF market, and theoretically if there is an imbalance in the secondary market APs will step in and exchange ETF shares for the underlying bonds and loans. Yet these underlying assets can go days without actually trading(they are “trade by appointment”) . ETFs may be a small percentage of all outstanding bonds/loans, yet there is very little turnover of these assets, and often its difficult to get pricing. Its not clear how the market would respond if there was a macro event that caused loan prices to gap down, and investors to seek redemptions from ETFs en masse. Prior to the last financial crisis, few ETFs held high yield bonds, and no ETFs held leveraged loans.

According to the DTCC:

Some analysts assert that ETFs have become so large in certain markets that the underlying securities may no longer be sufficiently liquid to facilitate ETF creation/redemption activity during periods of stress and could result in price dislocations.

From Duke Law’s FinReg Blog:

Consider a crisis scenario where selling pressure causes underlying assets (like fixed income securities) to become illiquid and rapidly lose value prompting ETF holders to quickly sell their shares. Here market makers and APs would likely widen their bid-ask spreads to “compensate for market volatility and pricing errors.” Increased fund redemptions in the primary market could also detrimentally change the composition of the underlying portfolio basket causing APs – who no longer want to redeem ETF shares and receive, in-kind, the plummeting and illiquid securities – to withdraw from the market altogether.

Also notable, post financial crisis regulatory changes caused bond dealers to hold less inventory. This can mean less liquidity in a crisis, as this recent academic paper notes:

When an extreme crisis hits, historically, OTC market liquidity disappears. That is, no one is available to take the other side of the trade. There are simply no bids, no offers, and no trading activity in OTC markets. The recent reduction in dealer inventories means that markets will be even more volatile in the next crisis.

This is unlikely to be a problem for deep liquid markets such as large cap stocks. So any problem with popular stock index funds is likely to be resolve itself quickly But it could take a long time to unwind problems in leveraged loan and high yield bond ETFs.

Won’t the APs fix this?

Its important to emphasize that the APs have no fiduciary duty to provide liquidity. The AP will have an agreement with the fund sponsor, but the fund sponsor does not compensate the AP directly. APs can profit by acting as dealers in the secondary market, or clearing brokers, thus collecting payment for processing and creation/redemption of ETF shares from a wide variety of market participants. APs can stop providing liquidity anytime they want. In the event of a crisis it may be prudent to do so. From Duke Law:

As such, a reliance on discretionary liquidity, in the context of a crisis is inherently “fragile” since dealers and market makers will stop providing it once they start incurring losses, or their balance sheets are negatively impacted from other exposures and they can no longer bear the additional risk from providing the liquidity support

In 2013 some ETFs traded at a steep discount when Citigroup hit its internal risk limits.   That was in the middle of a great bull market.  What will happen if there is a serious macro problem? As a historical precedent, during the financial crisis the auction rate security market collapsed when discretionary liquidity providers exited due to turmoil.

A different kind of death spiral

There are risks for both ETFs and Mutual Funds that hold illiquid assets. However the  reasons are different, and the nuances of a blow up will be different. 

A mutual fund can get exemptive relief from the SEC to suspend cash redemptions in extreme circumstances. Mutual fund investors, who thought they had a daily liquidity vehicle, are left holding an illiquid asset. This happened to the Third Avenue Focused Credit fund a couple years back. This caused a short lived mini-panic in the high yield debt market. When the fund suspended cash redemptions, they paid redemptions in shares of a liquidating trust. An outside party offered to buy the shares at a 61% discount to the NAV, which had already declined sharply.

In the case of an ETF it’s a bit more complicated.  The death spiral could simply take the form of a self reinforcing feedback loop.   Retail investors would be able to exit, albeit at a steep discount.  APs would sell underlying securities that they can sell, causing prices to plummet, causing further retail panic.   Some assets are more illiquid than others, and once once the dust settles, the ETF will be left holding the most illiquid and opaque assets.  

During the past few years we’ve seen a few tremors. There was the short incident in 2013 mentioned above. In May 2010 and August 2015 there were large one day price swings in more liquid parts of the ETF market probably caused by algorithms. In February 2018 there was the great VIX blowup/ “volmageddon”. The VIX example was a bit different because it involved very unique derivatives, but I think the bigger more interesting problems could be in the credit space.    In 2018Q4 there was some volatility in the credit space, and MSCI noted ETFs appeared to have a mild impact on bid/ask spreads. Yet by historical standards what happened in 2018Q4 was very minor.

These examples all occurred during a long bull market. What will happen in the next 2008 type scenario? I Still need to look more into how they might actually unwind.

So what can an investor do?

Most ETFs(and mutual funds) will probably be fine. During a crisis there might be temporary NAV discounts even for large cap index funds and lots of panic selling all around. Mutual fund investors will redeem at the worst possible time, and funds will sell shares into a falling market to meet these requests. Headlines will be full of doom and gloom. The prudent thing for most investors will be to ignore it all. Continue dollar cost averaging across the decades to retirement and beyond.

Nonetheless, investors holding some of the more esoteric, illiquid ETFs and mutual funds could be in for an unpleasant surprise and possible permanent capital impairment. Even though these potentially problematic funds are a small portion of the overall market, there is likely to be systemic contagion, as the IMF noted.

I’ve purchased some cheap puts on more fragile ETFs(mainly high yield bond and leveraged loan) although the lack of an imminent catalyst means that the position size needs to be small. I’ll be looking more closely at the way these different types of structures are unwound, since there are likely to be some major time sensitive opportunities next time it occurs.

Other possible case studies of the unwinding of illiquid assets in liquid wrappers:

  • UK open end commercial property funds during Brexit vote
  • Auction rate securities during financial crisis
  • Interval Funds during the financial crisis.
  • Other mutual fund redemption suspensions and ETF tremors?

See also:

Is Credit Really the Smart Money?

Some Recent Deep Reads- May 2019

Investing/Business

The Ruthless, Secretive and Sometimes Seedy World of Hedge Fund Private Investigations Highly entertaining expose.

Listening to Barakett talk about some of his wildest cases gives some idea of how easy it is for people to fall through the cracks during cursory due diligence. For example, on its website, DDC says it once found that “the president of a large U.S. asset manager was arrested twice for major art theft” but was never charged due to the expiration of the statute of limitations.


The art theft case was a “thing of beauty,” Barakett recalls. The manager, who still runs $2 billion, was even discovered to have one of the stolen paintings in his office when a police investigator went to interview him regarding the second theft. (The man was in college at the time of the thefts, which were from the university.) DDC’s client, a family office considering making a big investment, “could not believe what we were telling them,” Barakett says. It decided to walk away.


Another case involved a Bear Stearns executive whose murder conviction had previously gone undetected because, Barakett suspects, a casual background check either did not look at records in every state he had lived in or checked the wrong name or date of birth. “Our client [an asset manager who was considering hiring the man for an IR position] could not believe it, and we showed him the proof,” he recalls.

Vanguard Patented a Way to Avoid Taxes on Mutual Funds Interesting implications for tax policy, fund structuring and intellectual property strategy.

Vanguard has discussed licensing its hybrid ETF-mutual fund design to other firms, but no deal has come to fruition, according to people with knowledge of the talks. Those that have expressed interest included both index followers and active stock-pickers. United Services Automobile Association licensed the patent but never used it, and Van Eck Associates Corp. once sought regulatory approval for a similar design. Spokesmen for USAA and Van Eck declined to comment


Biglari Holdings is the Fyre Festival of Capitalism Hilarious because I’m not a shareholder in this company.

Many managements probably revile their shareholders, but most of them do not publicly delight in doing so. Sardar Biglari and Phil Cooley, Chairman and Vice Chairman of Biglari Holdings, seem to delight in the annoyance of its shareholders. At one point laughing at them for being upset that the share price went down 58% last year and then subsequently watching the board increase Sardar’s compensation package. It is not my best-self that enjoyed this spectacle, it was more like the part of me that likes watching dragons fight dragons on Game of Thrones that was riveted by Sardar Biglari and Phil Cooley or the part of me that once saw two clowns get into a fist fight at a kid’s party in St. Petersburg and rather enjoyed it.

Buspirone Shortage in Healthcaristan SSR Close look at weird incentives and unintended consequences of regulation in the generic drugs market.

You get more of what you subsidize and less of what you tax. Unfortunately, the FDA is inadvertently taxing companies for being in the generic drug business. And it’s taxing them more if they’re not a monopolist with economies of scale. That means we get fewer companies in the generics industry, and more monopolists.


So my very tentative guess as to why buspirone is more plagued by shortages than bread or chairs is because number one, the need for FDA approval makes it hard for new companies to enter the buspirone industry, and number two, the FDA’s fee structure favors large-scale monopolies over small-scale competitors.

Why So Many Investors Missed Nike’s Stock Rebound Good case study


Legendary stock-picker Peter Lynch’s maxim to “buy what you know” has long been misconstrued to mean invest in the everyday products you consume. That’s not quite right, as it only reflects part of his investment strategy. The other half is buying what you have a unique insight into that the market has yet to figure out. Knowing what those things are is the hard part.

Artko Capital 2019Q1 Letter Interesting commentary around position sizing.


This is where the “Valeant problem” that is rarely discussed, becomes an issue for us: what to do with a position that rapidly increases in size relative to the rest of the portfolio and where Hahn Capital Management and Sequoia/Value Act approaches to the matter differed. While the latter funds continued to hold, and allowed the single position to become almost a third of their portfolio, Hahn Capital had strict risk controls and processes in places that forced them to sell down the position to at least 4% of the portfolio when it became 6% of the portfolio’s weight. Luckily for Hahn, they exited the position prior to the spectacular blow up while the other aforementioned funds suffered significant double-digit portfolio losses when the truth about Valeant’s practices became public. Of course that is not to take away from the spectacular track records of all of the aforementioned funds, but to point out how different investment strategies (concentrated versus diversified), portfolio manager incentives (Management Fee Only versus Performance Carried Interest), and risk control processes (on single position sizes) can result in very different portfolio returns and risk profiles for different shareholders of the same stock. To put another way, sometimes a sell decision is not one of security analysis but one of portfolio risk management and fund strategies. As a result of this, and other similar experiences throughout our career, we have tried to approach the middle ground of the two styles by having a strong degree of concentration and conviction in our portfolio while still maintaining a robust portfolio risk management process focusing on capital preservation, position size, and its risk-reward ratio relative to the rest of the portfolio.

Additionally, we believe the other lesson to be learned from Valeant was no matter how high of a conviction, knowledge base or confidence you have in a publicly traded company or its management, at the end of the day things can and occasionally do go unpredictably wrong and are out of your control. This is a staple of public equities investing and is a common mistake made by even the most reputable investors: having the illusion of control.


An Ancient Relationship: FinTech and Financial Advice Classic look at an ancient profession. Interesting how the stock ticker seemed to have an impact almost as large as the internet.

How has this profession lasted so long? The industry’s longevity is largely attributable to financial technology (FinTech), which has historically empowered advisers to better serve their clients. Many companies, for example, offer advisers quantitative and accurate measurement of investors’ risk tolerance. Equipped with this technology, advisers have a better sense of how clients will respond to volatility, and can construct portfolios that most accurately reflect a client’s ability to endure market swings.

The ticker technology served as a means for democratizing access to market information. Prior to its invention, only those physically present at the stock exchange – or very close by – were privy to real-time market prices. Everyone else received their data at a substantial lag, often to the point where it was no longer useful. Once the ticker was released, however, cables and telegraphs connected brokers across the country to a network of data constantly flowing from a central source, the New York Stock Exchange. According to Horace Hotchkiss, 23,000 offices paid for ticker services in the United States

In Defense of Complexity Most people are knee jerk advocates of simplicity, but forget what lies beneath.

But simple is impossible without complex. Simple is how you interact with your web browser or an app on your phone. Complex is everything else happening in the background that allows it to function.

There are some valuable and diversifying asset classes that routinely get discarded to the “Too Complex” pile for reasons related to ambiguous classification, unfamiliar tools, novel wrappers and peer/career risk. Which is unfortunate, because I would argue that certain alternative investments are complex in implementation only. Conceptually, they are often quite simple, intuitive, backed by data and grounded in economic theory. The arc of the investable universe is long, and it bends towards democratization and innovation. Not every shiny new toy deserves a spot in your portfolio, but it would be wise to reconsider exactly what constitutes simplicity in investing.

Geopolitics and History

Robert Caro Interview

You read in every textbook that cliché: Power corrupts. In my opinion, I’ve learned that power does not always corrupt. Power can cleanse. When you’re climbing to get power, you have to use whatever methods are necessary, and you have to conceal your aims. Because if people knew your aims, it might make them not want to give you power. Prime example: the southern senators who raised Lyndon Johnson up in the Senate. They did that because he had made them believe that he felt the same way they did about black people and segregation. But then when you get power, you can do what you want. So power reveals. Do I want people to know that? Yes.

….
There’s always something the other guy doesn’t want to tell you, and the longer the conversation goes, the easier it is to figure that out

Peter Frankopan Interview

The one thing we haven’t had mercifully over the last 60 year except for the breakdown of Yugoslavia, and Iraq and so on is a major confrontation between big powers wanting to escalate.

Philosophy/Psychology Etc

On the Collaboration Between psychiatrist Carl Jung, and Physicist Wolfgang Pauli

While there is a long and lamentable history of science — physics in particular — being hijacked for mystical and New Age ideologies, two things make Jung and Pauli’s collaboration notable. First, the analogies between physics and alchemical symbolism were drawn not only by a serious scientist, but by one who would soon receive the Nobel Prize in Physics. Second, the warping of science into pseudoscience and mysticism tends to happen when scientific principles are transposed onto nonscientific domains with a false direct equivalence. Pauli, by contrast, was deliberate in staying at the level of analogy — that is, of conceptual parallels furnishing metaphors for abstract thought that can advance ideas in each of the two disciplines, but with very different concrete application.

What If We Already Know How to Live?

Philosophy is, in part, kept alive by ever-changing sociocultural circumstances that demand new lived responses to its question. But the changes brought by the digital age are of a magnitude beyond the routine vicissitudes of history. The global distribution of knowledge is arming, perhaps overloading us with more information than ever before, and the proliferation of digital interfaces is reprogramming how we experience life itself, our attentive and perceptual faculties.

…What I’m getting at is the possibility that the basic human conundrum is no longer driven by a deficiency in discovery, but in design. That now more than ever, we’re equipped with the information needed to live well, but aren’t integrating that information into our daily routines, our lived realities. There’s a lag between what we’re discovering and how we’re living.

The flood of information made available through the internet filled the discovery container with more than it can hold. We’re spilling things, getting the fabric of human life all wet. These moments of imbalance are when priority shifts from discovery to design. At these points, the work falls upon those positioned between the two containers, using what we’ve discovered to imagine and implement new designs, to convert influxes of knowledge into wisdom that can be embedded into the internal logic of our ecologies, enriching the relational environments from which our sense of being is woven.

The Year the Singularity Was Cancelled

In other words, the singularity got cancelled because we no longer have a surefire way to convert money into researchers. The old way was more money = more food = more population = more researchers. The new way is just more money = send more people to college, and screw all that.

But AI potentially offers a way to convert money into researchers. Money = build more AIs = more research.

If this were true, then once AI comes around – even if it isn’t much smarter than humans – then as long as the computational power you can invest into researching a given field increases with the amount of money you have, hyperbolic growth is back on. Faster growth rates means more money means more AIs researching new technology means even faster growth rates, and so on to infinity.

Presumably you would eventually hit some other bottleneck, but things could get very strange before that happens



Why all great investors are intellectual cross dressers

A recurring motif in Capital Returns: Investing Through the Capital Cycle, by Edward Chancellor is that growth vs. value is a false dichotomy:

Our belief is that stocks should be viewed not as “growth” or “value” opportunities, but rather from the perspective of whether the market is efficiently valuing their future earning prospects.

Marathon’s approach is to look for investment opportunities among both value and growth stocks, as conventionally defined. They come about because the market frequently mistakes the pace at which profitability reverts to the mean. For a “value” stock, the bet is that profits will rebound more quickly than is expected and for a “growth stock,” that profits will remain elevated for longer than market expectations.

Marathon looks to invest in two phases of an industry’s capital cycle. From what is misleadingly labelled the “growth” universe, we search for businesses whose high returns are believed to be more sustainable than most investors expect. Here, the good company manages to resist becoming a mediocre one.From the low return, or “value” universe, our aim is to find companies whose improvement potential is generally underestimated. In both cases, the rate at which a company reverts to mediocrity (or “fade rate”) is often miscalculated by stock market participants. Marathon’s own experience suggests that the resultant mispricing is often systematic for behavioural reasons.

Labelling fund managers as “value” or “growth investors risks distorting the investment process

Warren Buffett discussed a similar idea in Berkshire Hathaway’s 1997 Shareholder letter:

…most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross- dressing.


We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.
In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).

Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase.

Similarly, business growth, per se, tells us little about value. It’s true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain….

…Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.


Berkshire Hathaway’s 1997 Shareholder letter

False dichotomy, but useful heuristic

Growth vs. value is a false dichotomy, but it might be a useful heuristic for organizing a portfolio. With a “value” investment, you are buying assets, and betting on a reversion to the mean. Generally this means other people are overestimating the bleakness of the future. With a “growth” investment you are buying the future business, betting on change. Generally this means other people are underestimating the brightness of the future.

The key is having an intellectually honest variant view.

Venture capital and value investing

In a similar vein, its easy to see how venture capital and value investing are actually quite similar. Both are mispriced bets on the probability of change.

Tren Griffin wrote about this:

Venture capital and value investing share many different elements but each system is based on a different mispricing. This is a critically important point for an investor to understand. If an asset is not mispriced, market outperformance is not mathematically possible. It is also important to understand that investments can be mispriced for different reasons.


In venture capital the mispricing occurs because very few investors or asset owners understand optionality. This allows a VC to buy what are essentially long-dated, deeply-out-of-the-money call options from companies at prices which are a bargain.

In value investing the mispricing occurs because the market is bipolar (i.e., neither always rational nor always efficient). This allows an investor to sometimes buy assets at a price which reflects a discount to intrinsic value (i.e., a bargain) and to wait for a good result rather than trying to “time” the market.

The fundamental difference between venture capital and value investing

Marc Andreessen, in an interview with Tim Ferriss, expressed a similar idea, noting how much he studies and admires Warren Buffett:


… every time I hear a story like See’s Candies, I want to go find the new scientific superfood candy company that’s going to blow them right out of the water. We’re wired completely opposite in that sense. Basically, he’s betting against change. We’re betting for change. When he makes a mistake, it’s because something changes that he didn’t expect. When we make a mistake, it’s because something doesn’t change that we thought would. We could not be more different in that way. But what both schools have in common is an orientation toward, I would say, original thinking in really being able to view things as they are as opposed to what everybody says about them, or the way they’re believed to be.”

Business Lessons From Marc Andreeseen

A decent portfolio has a combination of mean reversion bets, and underpriced deep out of the money options. It pays to be an intellectual cross dresser

Aggregators by any other name

In the past I have been a knee jerk advocate of disintermediation. However upon closer examination I realized that the reality of middlemen is far more nuanced. Many people believe that modern technology is eliminating middleman, yet in fact their role is changing shape, not disappearing. In the Middleman Economy , Marina Krakovsky examines this aspect of the modern economy. The Private Investment Brief has also produced valuable analyses of middleman business models. Additionally, Michael Munger’s paper puts this all into a historical context with emphasis on the importance of reduced transaction costs.


Conventional wisdom says that middleman take a cut of every deal, so they raise buyer costs and reduce seller profits. In reality by facilitating transactions that would otherwise not happen at all, good middlemen enlarge the size of the pie, making all parties better off. Many people assume that middlemen’s work is easy because they don’t actually create anything. But to create value… good middlemen must cultivate distinct skills and practices, which they deploy in work that until now has been largely hidden from public view…

“Instead of the of the demise of the middlemen, we are seeing the rise of the middleman. In fact , ours is more than ever a middleman economy.”


Marina Krakovsky, Middleman Economy

There seems to be a gap between public perception and market reality. Therein lies the opportunity:

And yet—thousands of years after it first occurred to someone to ask “why don’t they just cut out the middleman?”—middlemen continue to exist and even thrive. Therein lies the opportunity, for if we can learn to appreciate what others dismiss or misunderstand, we might then have an investing green field all to ourselves


-Mystery of the Middleman

Indeed, Michael Munger takes it even further and argues that we are experiencing a profound historical shift that will alter capital allocation incentives across the economy:

The Neolithic revolution made it possible for humans to enter complex relations of more or less voluntary dependence, and to share economies of organization and information. The Industrial revolution created an astonishing burst of productivity, which made ownership of
a bewildering variety of commodities and tools possible for all but the poorest of people, where just 50 years before such items would have denied all but wealthiest. The Middleman revolution, the third revolution whose leading edges we are now crossing, will transform owning
into sharing. The Middleman revolution will make it possible, for the first time, for entrepreneurs to create value almost exclusively by reducing the transactions costs of sharing existing commodities, or by sharing commodities or services made expressly to be shared by the new platforms and new market processes.

Michael Munger: The Third Entrepreneurial Revolution: A Middleman Economy

Aggregators by any other name

In a world where buyers and sellers can just find each other online quickly and easily, middleman must be obsolete, right?


Wait a minute…

Often when people talk about cutting out the middleman, they are actually just replacing it with a new middleman. All the aggregator platforms are in fact distinct breeds of middlemen whose businesses are made possible by the internet. Examples include: Airbnb, Lyft and Uber, Taskrabbit, Grubhub, ZocDoc, etc. Instead of a person, buyers and sellers deal with software on a website that is developed and managed by people. As Krakovsky points out:

In many ways, the internet is a middleman’s ally. Thanks to the internet, middlemen who used to do business in person — a position that limited their geographic reach can a attract customers from all over and can share information with them more quickly and easier than ever…

These days, two sided markets (sometimes called two-sided networks or two sided platforms ) are everywhere because many of today’s internet startups are middlemen business of exactly this type


See also:

Aggregation Theory Stratechery
Aggregator Economics-Private Investment Brief
Modern Monopolies

Multidisciplinary thinking

Understanding middleman requires multidisciplinary thinking. There isn’t really one accepted definition, and there are many different angles from which to analyze how this social and economic phenomenon works:

Economic theory has much to say about transaction-cost economics, two sided markets, and intermediaries ability to reduce information asymmetries between buyers and sellers. In particular, game theory informs our understanding of repeated interactions, reputation, shirking and cheating, and third party enforcement. Social psychology and experimental economics show how acting on behalf of others affect people’s behavior and impressions. And sociology offers insights into the way acting on behalf of others affects people’s behavior and impressions. And sociology offers insights into the ways the structures of social networks create opportunities for middlemen

Six kinds of Middlemen

Krakovsky identifies five different roles that middleman can play. These roles define what middleman’s trading partners expect, so its critical for a middleman to know what role they play, and do play it well. They often overlap, so a successful business may fill of these roles at different times in the same supply chain.

Bridge

A bridge promotes trade by reducing distance(either physical, social or temporal). RA Radford’s study on the development of a market in a WWII POW camp is a stark example. An itinerant priest was willing to connect disparate groups who did not interact, facilitating trade along the way.

Another example featured in the New York Times and highlighted by Private Investment Brief involves an Afghanistan based used clothing wholesaler who makes an annual trip to Pakistan to buy bulk clothing. He is able to succeed for many reason, one of which is the fact that he reduces the fixed costs of dealing with travel, customs, logistics, etc.

Certifier

A certifier gives reassurance about underlying quality. This is important anywhere there is need for a trusted third party. Essentially, they help fix information asymmetry in a market. That same clothing wholesaler who facilitated trade between Pakistan and Afghanistan was also known as a trusted counter party to disparate group of buyers and sellers.

Trust is an elusive and intangible quality, so those of us in the more contemplative, analytical corners of the business world tend to underestimate how important it is to people transacting day to day


Mystery of Middlemen

Enforcer

An enforcer makes buyers and sellers cooperate and stay honest. Like certifiers, they are important in situations where there is need for a trusted third party. My favorite example of an enforcer is the role of a pimp at a truck stop in Uganda.

Risk Bearer

A risk bearer reduces fluctuations. Micro VCs play this role, especially now that technology has drastically reduced the cost of starting businesses. “Uber for this or that” business models are an example of a risk bearer business model. Additionally in the Japanese fish markets, risk bearing middleman ensure smooth functioning of trade in a highly perishable commodity.

Concierge

A concierge reduces hassles and helps clients deal with information overload. For example, travel agents, in spite of widespread predictions of their demise, play a critical role in high end business travel as concierge middlemen.

Insulator

An insulator helps clients get what they want without being though of as too greedy, self promotional, or confrontational. Sports agents help defuse tensions between players and teams. Additionally, sometimes an investor will use a broker to build up a position without signalling the market. This may be essential in distressed and illiquid securities, or disputed situations.

Transaction costs

Munger looks at markets in the broad sweep of history. The role of technology, he argues, is in creating a new “entrepreneurial revolution” that makes middleman more important in an an economy based on sharing, not owning.


The third entrepreneurial revolution will be based on innovations that reduce transactions costs, not the costs of the products themselves. An unimaginable number and variety of transactions will be made possible by software platforms that make renting from a middleman, rather than renting from one’s self, cheaper.

A former student of Douglass North, Munger emphasizes the transaction cost angle throughout:

To succeed, a middleman has to reduce three key transactions costs:
• Provide information about options and prices in a way that is searchable, sortable, and immediate
• Outsource trust to assure safety and quality in a way that requires no investigation or
effort by the users
• Consummate the transaction in a way that is reliable, immediate, and does not require negotiation or enforcement on the part of the users

Eurasian World Order

The Dawn of Eurasia: On the Trail of the New World Order is a fascinating analysis of the shifting geopolitical landscape. The author, a former Secretary of State for European Affairs for Portugal, mixes a travelogue with discussions of history, literature, and economics. Eurasia is not just a geographical entity, but rather a “descriptive term for a certain way of thinking about a new moment in political history”. It expresses a world order that is the integration of two ideas often seen as contradictory being brought together into a single word.

The rise of the east

Many people wrongly assume that the world will converge on a social organization that is based on western ideals. Instead different societies are adapting and iterating based on their own historical experiences and present circumstances. The dominant cultures of the future may be organized in a very different manner than what we are used to:

On the one hand, it conveys the sense that the European order has come to an end. This moment, so often announced, has been, on the contrary, persistently evaded. When European countries abandoned their imperial dreams, they did so under the illusion that the rest of the world no longer needed guidance because it had voluntarily embraced European rules and ideas. It was an illusion, but an illusion that only now is being revealed as such. On the other hand, this should not be confused with the belief that Europe’s legacy has likewise been abandoned. What we see is that those who are more actively working to replace the old world order with something are just the heirs of the European scientific and revolutionary traditions,. When competing with the European model, they try to present an alternative that is more modern, more rational, better able to lead the transformations of the future. Theirs are new an alternative visions of what a modern society looks like.

The west is merely a reference point:

Experimentation is a human but also a scientific ideal. But the faith in an endless power to transform reality can now be found on every corner of the planet. The process has a certain negative character: the attempt is made to free oneself from the existing model only to realize this model has been replaced by a broader but still limited set of possibilities which in turn need to be over come and so on in an iterative process. More importantly, perhaps, each society has its own modernization path. Each society starts from a traditional model and creates new abstractions from that starting point. As the whole world becomes modern, we should expect different or multiple modernities to develop, rather than the cultural programme of modernity as it developed in Europe to become universal,. That programme may enjoy a certain historical precedence, and continue to be a reference point, but it is no more than one path.

Regulatory imperialism

The delineation between “hard power” and “soft power” may not be the most useful for understanding how countries come to dominate. In reality power is more nuanced. If a country has a large market, or other bargaining power, other countries may be forced to make changes to suit them, without a single shot being fired.. This has huge implications considering China’s increasing clout, and America’s disengagement from alliances.

We here a lot about the distinction between hard and soft power, and usually the former is identified with the use of military force; but some forms of power are unilateral even if they have nothing to do with military force. They probably deserve to be part of what one would call hard power because they do not depend on the willingness of the other side to play along. When it comes to the rules being applied in a given jurisdiction, or jurisdictions, it is obviously possible for states to influence what others do through an international agreement where their respective interests are the object of negotiation and bargaining. That is one way. Then we have the way the European Union exercises power, which is completely independent of what the other side wants to do, and more intriguing, equally independent of anything like a European Conscious Plan.

China is now becoming expert at using this type of diplomatic coercion to influence policy in Eurasian countries. Direct and forceful actions risk disrupting and severing economic ties that are critical for china. Economic power is embedded within economy, provides Chinese with ambiguity and deniability. Basically china marshals privates sector for its own goals. Not just its own private sector, but the private sector of One Belt One Road countries, and really all allies. Of course, there is a reason to be skeptical about One Belt One Road:

There can be no land segment of the Belt and Road without Xinjiang , but at the same time it is difficult to see how China will be able to solve the contradiction between the desire to facilitate trade and movement while closing borders and subjecting everyone to permanent surveillance. You inevitably ask yourself whether the Belt and Road initiative might not be a concept far ahead of what social and political reality can deliver. A kind of utopianism, in this sense.

Systems thinking

Interesting quote on how different vantage points can lead to different conclusions. Shifting perspectives is critical:

The whole is only a whole in relation to the parts and the parts are only parts in relation to a whole. When it comes to world politics, this means that what views we have of the whole will always color our understanding of the parts. If your view of the global order is one where Europe is at the center, then the rest of the world will be organized in radiating circles of distance from the centre. Even the traveler will find nothing but distant echoes and pale reflections of the place he started from , and any genuine comprehension of different regions and cultures will be rendered impossible. The goal should not be to look at the whole from the point of view of one part, but to look at each part from the point of view of the whole. We learn this mental habit from the study of atlases and maps, where each point is defined and located by reference to all other points and where we are made to acquire an external, more detached and more objective perspective. At the same time, a map is only complete after we return from the places it depicts and can interpret the full meaning behind every detail and project upon the flat surface the images stored in our memory.

History shows that there is no natural way for the parts of the world system to be organized. Neither has the system any inbuilt propensity to remain static, nor for the parts to settle in a particular pattern. Many times in the past the pendulum of power was exactly balanced between two poles in the system and no inherent historical necessity dictated that one would acquire a hegemonic position.

Rules vs. strategy

Tension between rules based and strategic approach are a key feature of a Eurasian world order. Here is an interesting metaphor discussing this dichotomy:

If we think of the European Union as a computer program, the question arises of how universal that program truly is. Algorithms operate in a controlled environment and perform a set of limited tasks. Inputs coming from the external environment have to be recognized by the program and thus the environment needs to be shaped and organized in order to provide those inputs in the right format. A computer program works by itself, it doesn’t really matter who is using it as opposed to traditional crafts or ever creative endeavor. That is the universal ism of the code, but there is another sense in which it may not be universal at all. Is the system of automated rules able to deal with all the contingent and unpredictable events coming from the outside, from an environment which the code is not prepared and to which it cannot respond? Can it respond to new inputs that are not precisely like those for which it has been designed. And how does the system respond when some of its parts have been destroyed, degraded, or when they are overloaded by a chaotic environment. One could say that even a computer program needs a foreign policy- a key challenge in advanced robotics is to design control algorithms that allow robots to function adaptively in unstructured, dynamic, only partially observable and uncertain environments– but more fundamentally the realization that the world outside Europe works according to different rules reopens the question of history and may force us to abandon the faith in autonomous rules.

… the new dichotomy between systems and environments replicates almost exactly the old one between a supposedly rational and orderly European civilization and the chaos of the Asian steppes.

Chinese acquisitions of German company highlight this. The book quotes a German official:

Think of Eurasia as a field of forces. The question of different political and economic models is one that only power, influence and leverage will be able to decide. It is not enough for the European Union to uphold its rules and way of life. It needs to create a wider environment where they can work effectively.

The 4d chess strategy behind Yang’s circumcision comment

Why does Andrew Yang seem to care so much about circumcision?

One possibility is it is just a weird obsession of his. I’m not a medical doctor but neither is Yang.  I thought circumcision was just a standard medical procedure. WTF is an Intactivist? How will this save us from the robot apocalypse?

Another possibility is the comment was 4d chess jiujitsu, and Yang is seeing several moves ahead in the 2020 meme wars.

It is easy to make fun of him, or criticize him for making an offhand comment about circumcision.  But think of how he can spin it if his opponents fall into this trap. Do they really want to be the one to saying parents shouldn’t have more freedom on this issue?   During the Democratic primaries Yang can bait an opponent into seeming like a power mad uber regulator coming to snip your baby’s genitals.


Yang Circumcision

Only Yang can save us from an army of dick chopping bureaucrats.

And in the general election vs Trump… with those small hands ?   Obviously he just wants to cut everyone else’s junk down to size, or at least that’s what an army of Twitter bots will say.

Think of the memes Yang can use to crush his opponents if they fall into the trap of criticizing his position on circumcision.   Only Yang can protect your Wang.

Is the weird circumcision comment part of a genius master strategy?  Probably not. But you heard it here first.

Links that made me think (March 16, 2019)

Cognitive Enhancers: Mechanisms and Tradeoffs
A classic from the Slate Star Codex archive. As the author notes, the medical component of the article is speculative. However its useful from a mental model perspective. It discusses how people adjust their model of reality, and how “smart drugs” alter this process.

In the predictive coding model, perception (maybe also everything else?) is a balance between top-down processes that determine what you should be expecting to see, and bottom-up processes that determine what you’re actually seeing. This is faster than just determining what you’re actually seeing without reference to top-down processes, because sensation is noisy and if you don’t have some boxes to categorize things in then it takes forever to figure out what’s actually going on. In this model, acetylcholine is a neuromodulator that indicates increased sensory precision – ie a bias towards expecting sensation to be signal rather than noise – ie a bias towards trusting bottom-up evidence rather than top-down expectations.

Learning rate” is a technical term often used in machine learning, and I got a friend who is studying the field to explain it to me (all mistakes here are mine, not hers). Suppose that you have a neural net trying to classify cats vs. dogs. It’s already pretty well-trained, but it still makes some mistakes. Maybe it’s never seen a Chihuahua before and doesn’t know dogs can get that small, so it thinks “cat”. A good neural network will learn from that mistake, but the amount it learns will depend on a parameter called learning rate:

If learning rate is 0, it will learn nothing. The weights won’t change, and the next time it sees a Chihuahua it will make the exact same mistake.

If learning rate is very high, it will overfit. It will change everything to maximize the likelihood of getting that one picture of a Chihuahua right the next time, even if this requires erasing everything it has learned before, or dropping all “common sense” notions of dog and cat. It is now a “that one picture of a Chihuahua vs. everything else” classifier.

If learning rate is a little on the low side, the model will be very slow to learn, though it will eventually converge on a good understanding of its topic.

If learning rate is a little on the high side, the model will learn very quickly, but “jump around” between different understandings heavily weighted toward what best fits the last case it has worked on.

On many problems, it’s a good idea to start with a high learning rate in order to get a basic idea what’s going on first, then gradually lower it so you can make smaller jumps through the area near the right answer without overshooting.

Parallelisms for the future
I’m always fascinated with Chinese Communist Party propaganda:

Parallelism,” or paibi (排比), is a rhetorical method that when used with appropriate measure can strengthen an article, but when used carelessly can have exactly the opposite effect.

What the hell is going on?
A mini book length blog post that explains how the change in media has altered society.

The striking parallels between commerce, education, and politics isn’t a coincidence. In fact, it’s inevitable. In the past decade, the information environment has inverted from information scarcity to information abundance, and the effects are evident in every corner of society….

….
The rise and upcoming fall of commerce and universities frame the context for two big shifts, which account for the weirdness of contemporary society: (1) how information scarcity creates authority, and (2) the transition from one-way communication to two-way communication.

The Unwinding of Globalization: Fallen Angels & Behavioral Alpha
Excellent investment letter focusing on the movement towards regionalism, and the breakdown of historical correlations between asset classes.

Confusion creates anxiety but importantly offers opportunities for those able to control their emotions.

How much due diligence is enough?

“They can’t touch me. I do my homework”
-John Boyd

How much investment due diligence is enough? How much is too much?

The amount of research an investor should do before making an investment depends on three factors: 1) Size of Position 2) Illiquidity of position, and 3) Contrary nature of position.

The Kelly Criterion is a good heuristic, although in real life we never know exact probabilities. Most investments will succeed or fail on one or two factors. The key is to identify those and understand them better then the person selling to us. Anything beyond that is just for fun. Indeed a lot of investors really like to dig. But the 80/20 rule applies. Think jiujitsu not powerlifting.

Position Size


Position sizing is part math and part psychology. The bigger a position, the more a person has to check and double check. This isn’t just a number in a spreadsheet. Conduct a premortem. What is the maximum pain you can take? The only way to survive a large position going against you is to have the confidence in your research.

Its critical not to get causation wrong here. If “concentration” is part of one’s identity as an investor, there is a major risk confirmation bias will takeover and more research will just make them more sure of a false idea. Remember smarter people are actually at greater risk of confirmation bias.

If the facts lineup, it might make sense to “go for the jugular”.

Illiquidity


For most individual investors, illiquidity is a secondary concern. Nonetheless an investor must consider it. An investor can easily sell a widely traded stock or ETF. But for illiquid positions, an investor needs to learn that information ahead of time.

Decisions that are easy to reverse can be made quickly. Decisions that are difficult or impossible to reverse require more analysis up front.

Contrarian nature


Markets are usually right. The more out of consensus a view is, the more data and analysis an investor must have to back it up. “Who is on the other side?” is probably the most important question in investing. I’m only comfortable if I understand the contrary position better than people who hold it.

Active investing requires active thinking.


With investment research an hour of active critical thinking is worth more than a week of passive reading

Techniques of due diligence depend on what’s available, and also on an individual personality. Some people are good at plowing through footnotes or analyzing sentiment data, others are highly skilled at interviewing industry experts. Since computers read 10-Ks the minute they come out, its essential to get creative with due diligence, but this does not mean digging for the sake of digging.

Example:

I was researching, a venture capital focused business development company (BDC) liquidation. Its investments holdings consisted of preferred stock in 11 venture stage companies, with most of the value concentrated in the top five holdings.

Although there was limited publicly available information on the financial condition or valuation of each individual holding, the filings disclosed the aggregate range and average of the metrics and assumptions used by the company in the valuation process to arrive at fair value of Level 3 Assets on the financial statements. My interest was piqued when I noticed that other public BDCs that owned some of the same asset were marking them at much higher prices. Nonetheless, I needed to verify the viability, and growth potential of the main underlying businesses.

I approached this issue from multiple angles:

One of the company’s largest assets was preferred stock in a company that operated a dating site. With permission from my wife, I set up a fake profile to see how the interface of the website and app worked, and to verify that there were indeed a large number real people using it in my area, and a few other cities I checked. This helped me corroborate information from user reviews I had read.

The company owned stock in a highly specialized medical testing startup. I reviewed the background of top employees on LinkedIn, university websites, and various scientific journals. Additionally I discussed the business idea with friends in academia. They verified that the idea had a reasonable chance of working, and would require an advanced degree to replicate.

Accounting rules gave management ample discretion on how to report the holdings on the balance sheet. I carefully reviewed everything they had disclosed about their valuation process, and tracked changes in language between different filings over time.

I also contacted the management of the BDC, and was able to reach the people in charge of the valuation process on the whole portfolio. They helped me understand the facts they were using to justify the valuations supplementing my careful reading of the public disclosure. The conversation verified that the BDC was indeed serious about liquidating its portfolio. Further they candidly reminded me how valuing the portfolio conservatively made the tax consequences of converting to a liquidating trust more favorable for investors(the management group was also a large shareholder).

I did a lot of unconventional work, but didn’t mindlessly dig for more info. It wasn’t a huge position but since its going to be locked up in a non transferable liquidiating trust, and it was an idea most people thought too ugly, a bit of extra work was justified.

The company already paid back most of my initial investment after selling one investment and the portfolio still has a lot of value. The true test will be in the final IRR when its all said and done.

See also: The hard thing about finding easy things

Links that made me think (March 9, 2019)

Will sports betting change how games are played and even watched?

This is an interesting meta view of how betting will change sports.

The games we watch are already enhanced by data collected through technological advances. Announcers tell us how hard baseballs are hit and how far they travel, or how many miles a particularly active soccer player has run. Because such derivatives create new opportunities for betting, we’re sure to see many more of them. (The N.B.A. has been advertising for a gambling data analyst on the employment website Glassdoor.) Hockey hasn’t traditionally generated much in the way of metrics, but in order to learn who is skating the fastest or shooting the hardest, the N.H.L. is preparing to record the movements of every player during every game and even put a chip inside the puck. “Leagues are building a fire hose of data around their product,” says Chris Grove, an analyst who consults for gaming companies and investors. “And the logical recipient of that data is the betting industry.”

….
But gambling’s greatest impact, at least proportionally, could come in the new professional leagues it spawns and the moribund ones it helps to resurrect. The Arena Football League once included 19 teams spread across the continent; last year there were four. Leonsis owns the Washington and Baltimore franchises, which makes him not only the most powerful owner in the league but the only person preventing its demise. He has positioned it as an ideal entertainment vehicle for the next generation. That includes gambling, of course. Arena Football averages a touchdown every six plays, Leonsis notes, as well as 98 points a game. “Lots of data generated,” he says — and a multitude of possible bets.

Personally I would love to see arena football go mainstream.

Death in the time of bitcoin

Purchasing uncertain cryptocurrency claims at a discount is an interesting investment strategy. I know some opportunistic investors were buying Mt. Gox claims , but that situation is arguably less complex than Quadriga.

… this tale of “boy meets girl; boy marries girl; boy stores all client cryptocurrency data on cold wallets with no backup; boy dies; more than 115,000 people get screwed out of their precious crypto” could have a happy ending for a progressive asset allocator.

The cold wallets were subsequently found empty so the search continues I wonder how the hunt for the missing crytpo will be financed?

Theranos: How a broken patent system sustained its decade long deceptionh

I’m not convinced by the assertion that the patent office gives out patents much too easily on a consistent basis. But this article points out that many of Theranos’ patents arguably don’t pass basic tests of patent law.

What does this mean long term now that Theranos has been seized by its lenders?

Accused of having lied to investors and endangered patients, the company leaves us with a parting gift: a portfolio of landmines for any company that actually solves the problems Theranos failed to solve.

So basically the shell of Theranos will become a patent troll? Also, apparently Mark Cuban has endowed a research organization to fight “stupid patents”

When Britain chose Europe

The Brexit debate in a historical context going back to Cobden and the fight against the corn laws. Points out a startling implication of Brexit that the media barely covers:

There is, in fact, simply no way thata hard Brexit, much less a no-deal Brexit, can be accomplished without an intra-national upheaval that will result, sooner or later, in a disunited kingdom”


The fallen superpower: US foreign policy from triumph to hubris

Review of a new book, the Back Channel A Memoir of American Diplomacy and the Case for Its Renewal , written by William Burns, the ultimate foreign policy insider who has served 5 presidents and 10 secretaries of state

…diplomatic profession has lost its near monopoly on presence, access, insight and influence. In the age of WikiLeaks and transnational actors, secrecy is porous, information ubiquitous. Those like Burns who have practised statecraft risk being drowned out. Lost in the Twittersphere are the age-old virtues of diplomacy: the ability to convene, communicate and manoeuvre for future gain, especially through alliances.

The End of Economics?

That economics has since slipped from that pedestal is simply a testament to the fact that the world is messy. The social sciences differ from the hard sciences because “the subjects of our study think,” said Herbert Simon, one of the few scholars who excelled in both. As we try to understand the world of the next three decades, we will desperately need economics but also political science, sociology, psychology, and perhaps even literature and philosophy. Students of each should retain some element of humility. As Immanuel Kant said, “Out of the crooked timber of humanity, no straight thing was ever made.”

Rediscovering literacy

Literacy meant using mastery over language — both form and content — to sustain a relentless and increasingly sophisticated pursuit of greater meaning. It was about an appreciative, rather than instrumental use of language. Language as a means of seeing rather than as a means of doing.

….

Gutenberg certainly created a huge positive change. It made the raw materials of literary culture widely accessible. It did not, however, make the basic skills of literacy, exposition and condensation, more ubiquitous.

Instead, a secondary vocational craft from the world of oral cultures (one among many) was turned into the foundation of all education, both high-culture liberal education and the vocational education that anchors popular culture.

Renaissance Technologies Buying Microcaps

Those of us that invest in microcaps are accustomed to high volatility on low trading volume. Sometimes the company will report major news, and nothing happens to the price until a year later. Other days there are 20% swings when somebody places a 100 share market order.

When there is a surge in volume lasting more than a couple days and a definitive trend in price, it’s not uncommon to see Renaissance Technologies file a 13G, indicating a 5%(or higher) position.

What would such a large systematic trading firm be doing in this part of the market? Aren’t microcaps usually owned by fundamental focused investors? Funny thing is sometimes there is sufficient volume and a definitive trend, causing systematic traders to get interested. The market switches from value dominated to momentum activated, even in microcaps.

This is part of a broader phenomenon explained well in Market force, ecology and evolution:

If a substantial mispricing develops by chance, value investors become active. Their trading shrinks the mispricing, with a corresponding change in price. This causes trend followers to become active; first the short term trend followers enter, and then successively longer term trend followers enter, sustaining the trend and causing the mispricing to cross through zero. This continues until the mispricing becomes large, but with the opposite sign, and the process repeats itself. As a result the oscillations in the mispricing are faster than they would be without the trend followers.

In real life, prices are almost never at their equilibrium.