Category: Books

Is it really necessary to have a meeting?

A lot of time and money is wasted on unnecessary corporate meetings. Since the early days of Amazon , Jeff Bezos has taken a unique approach to meetings.


At a management offsite in the late 1990s, a team of well-intentioned junior executives stood up before top brass and gave a presentation on a problem indigenous to all large organizations: the difficulty of coordinating far-flung divisions. The junior executives recommended a variety of different techniques to foster cross group dialogue and afterward seemed proud of their own ingenuity. Then Jeff Bezos, his face red, and the blood vessel in his forehead pulsating, spoke up.

“I understand what you are saying, but you are completely wrong,” he said.

“Communication is a sign of dysfunction. It means people aren’t working together in a close, organic way. We should be trying to figure out a way for teams to communicate less with each other, not more.”

…At that meeting and in public speeches afterward, vowed to run Amazon with an emphasis on decentralization and independent decision-making. “A hierarchy isn’t responsive enough to change,” he said. “I’m still trying to get people to do occasionally what I ask. And if I was successful, maybe we wouldn’t have the right kind of company.

Bezos’s counter intuitive point was that coordination among employees wasted time, and that the people closest to problems were usually in the best position to solve them. That would come to represent something akin to the conventional wisdom in the high-tech industry over the next decade. The companies that embraced this philosophy, like Google, Amazon, and, later, Facebook, were in part drawing lessons from theories about lean and agile software development. In the seminal high-tech book The Mythical Man-Month, IBM veteran and computer science professor Frederick Brooks argued that adding manpower to complex software projects actually delayed progress. One reason was that the time and money spent on communication increased in proportion to the number of people on a project.

When you do have a meeting, make it useful

Of course, some meetings are necessary. There is value to cross-pollination of thoughts among intelligent people. Some processes do require explicit coordination and discussion. However, in practice, many hours are wasted on routine updates, grandstanding, and “thinking out loud”. To ensure meetings were productive Bezos required the person who leads a meeting to write detailed prose explaining their thoughts. The first half hour or so of every meeting would be silent reading time. This ensured everyone thought deeply and expressed complete thoughts cogently.

Meetings no longer started with someone standing up and commanding the floor as they had previously at Amazon and everywhere else throughout the corporate land. Instead, the narratives were passed out and everyone sat quietly reading the document for fifteen minutes—or longer. At the beginning, there was no page limit, an omission that Diego Piacentini recalled as “painful” and that led to several weeks of employees churning out papers as long as sixty pages. Quickly there was a supplemental decree: a six-page limit on narratives, with additional room for footnotes.

History Repeats: The Serpent on the Rock

“History Repeats.  The first time as a tragedy, the second time as a farce.”

– Karl Marx(1)

There are amusing parallels between the rise and fall of the real estate private partnership market in the 1980s, the pre financial crisis tenant in common(TIC) syndication market, and  the post financial crisis non-traded REIT market driven by Nick Schorsch and his AR Global empire.

Each episode involved high fee investment products designed to fulfill investor desires for yield, tax efficiency and perceived stability, while creating disproportionate benefits for intermediaries.  Each episode ended badly.  And the cycle repeats, again and again.

First of all, the charts tell parallel stories:

Real Estate Limited Partnerships 1970-1991

Real Estate Limited Partnerships

Source: Obstacles and opportunities in the establishment of a secondary market for real estate limited partnerships  

 

TIC Equity raised 2001-2012:

Tenant In Common Equity

Source: Securities Litigation and Consulting Group

Non-traded REIT Equity Raise 2000-2016:

Source: Stanger Report, author’s calculations based on SEC filings.

Note that the 2015-2016 dropoff would be much sharper if you excluded Blackstone’s REIT, which entered the wirehouse channel in late 2016, and accounted for 50% of total annual NT REIT sales within a few months.  Sales to the independent broker dealer(IBD) channel, which Blackstone largely bypasses, were completely decimated, and the dropoff has accelerated in 2017. (2)

May Day

High fee products are sold, not bought. The commissions on illiquid real estate products have always been higher than other investments available to retail investors.

In Serpent on the Rock Eichenwald traces the original real estate partnership craze back to the May 1, 1975 abandonment of fixed commissions on sale of stocks and bonds. Yes it is viciously ironic that commissions were fixed before 1975. The financial services industry was apparently afraid of capitalist competition and all the wonderful creative destruction it brings. Once they lost large commissions on simple security trades, they went looking through more complex higher fee product.

After May Day:

No longer could brokerage firms subsidize their bloated through fat commissions on securities trades. Firms unable to adjust collapsed by the dozens. The industry had to either dramatically cut back expenses or find new products with higher commissions that could be pumped through the sales force. Suddenly tax shelters, which sold for higher commissions than stocks and bonds didn’t look so unappealing.

The impact of May Day has continued to drive down commissions decades later. This makes sense. After all, transactional costs should approach zero over the long run, because with computers the marginal cost of doing a trade in all but the most illiquid complex markets is effectively zero. Significant scale and technological investment is necessary to run a brokerage business focused on liquid markets.

Consequently, the current IBD ecosystem is highly dependent on non-traded REITs and other high fee direct private placement programs. This is complicated by the fact that IBDs payout a high proportion of commissions to the financial advisers(like 90% in many cases). Many financial advisers built their business on 1031 exchanges, non-traded REITs or other private placements. TICs typically charged 20-30% commissions. Commissions eat up a large portion of offering proceeds for non-traded REITs.  Additionally, non-traded REIT sponsors pay out a due diligence kickback to broker dealer home offices. Many smaller IBDs depend on these kickbacks for survival.

Of course, the commissions were much more egregious the first time around. Old timers fondly remember 20%+ loads on product. up front sales loads have now declined to high single digits and low double digits. Inland has driven down commissions on 1031 exchange product. Plus state securities regulators put out NASAA guidelines to limit loads on registered products. Nonetheless in an age where interactive Brokers charges $1 per side on a trade regardless of size, and few modern brokerages charge more than $7 per trade, even high single digit sales loads on non-traded retail product are absurd.

In Backstage Wall Street Josh Brown outlines his “Iron law of product compensation”:

The higher the commission or selling concession a broker is paid to sell a product, the worse that product will be for his or her clients.

This was the thread that connects the 1980s private partnership craze, with the pre financial crisis TIC explosion and the post financial crisis non-traded REIT market.

Yield Pig Exploitation and the Illusion of Safety

Just like private partnerships in the 1970s and 1980s, brokers sold TICs and Non-traded REITs to unsophisticated yield hungry retirees as safe, stable investments.
Here is one description of the private partnership market:

Many of the public offerings were promoted as a way for the small investor to participate in real estate, widely believed to be an inflation hedge, offering greater return and moderate risk as compared to stocks. The ability for an individual of modest net worth or income to invest in securitized real estate was viewed as a real benefit of public syndications.
The limited partners were sold their investments on the assumption that real estate was a safe, growing investment. Often these investors were unsophisticated in investment matters, and were more often swayed by aggressive brokerage salesmanship. The importance of liquidity became apparent to the investors only after substantial investment had already occurred. Liquidity was never promised for limited partnership securities and the partnership structure itself was designed to constrain liquidity.

Source: Obstacles and opportunities in the establishment of a secondary market for real estate limited partnerships  

In Serpent on the Rock Eichenwald meticulously tracked the juxtaposition between sales materials promising safety and the ultimate collapse in values.Non-traded REITs and TICs are also sold as safe investments that do not have the volatility of the stock market. Of course the stability is an illusion, and investors are still highly dependent on the real estate performance.

 

Due diligence

Eichenwald describes due diligence at Prudentialduring the peak of the private partnership craze:

The due diligence team was not just overwhelmed from the number new deals they had to approve- they also had to keep tabs on the old deals that had already been sold. Darr had negotiated for Bache to be paid a monitoring fee from some tax shelters it sold in exchange for reviewing their financial performance. Supposedly, this was designed to make sure that the general partners managing the deals did things right and took care of their investors. It was a key selling point for Bache brokers: In sales pitches, they painted a picture of top Bache financiers in green eyeshades peering over the shoulders of the General partners, watching everything that was done, The image of financial professionals crunching numbers late into the night to make sure investors were protected was a persuasive marketing tool.

But asset monitoring paid only a small fraction of the fees that Bache received from selling new deals. So the job of keeping an eye on the performance of old shelters quickly became viewed as simply a headache. It was an obligation that slowed down the whole process of churning out deals., without enough juice from fees to make up for the effort. The monitoring assignment became a hot potato, passed from executive to subordinates, and from then on down the line.

Many similar scenes in the book are shockingly familiar to anyone who has worked in the alternative investments space.

In subsequent years, third party due diligence firms serving broker dealers helped drive improvements in deal quality, but there are still many serious gaps. Since IBDs depend on the revenue from commissions and due diligence kickbacks, they are under pressure to find product to approve. This bias leads to cognitive dissonance. As non fiduciary middlemen, they often sell things that they wouldn’t invest in themselves, especially with a full sales load.

In the wake of the bankruptcy of TIC Sponsor DBSI, and the collapse of several tax driven energy deals, Reuters investigated due diligence in the independent broker dealer space. It highlighted a too cozy relationship between sponsors and third party due diligence firms.

Perhaps of even greater concern is the  disconnect between due diligence process and the needs of end investors.

Potentially alarming findings are often obscured in multiple pages of recondite language, with no definitive conclusions. “They’re these long-winded things that bury things that might be important inside boilerplate disclosures,” said Jennifer Johnson, a professor at Lewis & Clark Law School in Portland, Oregon, who has written extensively about the private-placement business.

Due diligence firms say their reports aren’t designed to be read or understood by investors. Rather, they are meant to help brokers decide whether to recommend private placements to their customers.

Source:Reuters

Same Same, But Different

Although the distorted incentives,exploitation of unsophisticated yield pigs,were almost identical in each of the three historical examples in this post, there are several key differences. Broker dealers primarily sold private partnerships in the 1980s as a way of reducing taxes. An investor can use a TIC structure as part of a 1031 exchange to  delay taxes when selling a property. REITS are a unique IRS creation but the reason for investing in a REIT is mainly income(Excluding situations where someone exchanges via an UPREIT transaction)
The private partnership market collapsed because the tax reform act of 1986 destroyed their entire structure, and basically collapsed the national real estate market. (see: this FDIC report )

The TIC market collapsed when the financial crisis hit the entire real estate market, exposing the problematic underwriting of the TIC Sponsors. However, regulatory issues weren’t the main driver of the collapse. Like the private partnership craze in the 1980s, the modern Non-traded REIT market also collapsed due to regulatory change although the . Finra 15-02, which increased the transparency on client statements, made it harder for advisors to get away with charging the massive sales loads. The fiduciary standard required broker-dealers to act in the best interest of clients, also led many broker-dealers to suspend or slow down the sales of high commission products.

 

The farce of AR Global’s collapse

Although private partnerships and TIC sponsors generally overpaid for properties they purchased, the collapse of their structures happened during a time of across the board real estate declines in the US

In contrast, investors in post financial crisis vintage non-traded REITs have suffered, in spite of a buoyant real estate market.    ARC Hospitality(Now Hospitality Investors Trust) offered shares at $25.00 a share from 2013-2015, and a client statement never would have shown a value below $22.00 until this summer. It  revalued at $13.20.  A PE fund recently offered  $5.53 for the shares.  Likewise ARC Healthcare Trust III sold shares $25.00, and recently marked its value down to $17.64, and is now subject to an affiliated transaction with no liquidity event in site.

Private partnerships and TICs were tragedies, AR Global was a farce.

 

To be continued….


 

(1) This is from The Eighteenth Brumaire of Louis Napolean.
The full translated quote is :Hegel remarks somewhere that all great world-historic facts and personages appear, so to speak, twice. He forgot to add: the first time as tragedy, the second time as farce.

(2) Wirehouses generally did not sell non-traded REITs until Blackstone entered the market in 2016 Anyone who carefully read The Serpent on the Rock will note how incredibly ironic it is that wirehouses have started to sell non-traded real estate securities again.  More on his in a future post.

9 Steps to 10x Thinking

Smartcuts: How Hackers, Innovators, and Icons Accelerate Success is a book about the power of lateral thinking- solving problems through an indirect or creative approach. “Smartcuts” means sustainable success achieved through smart work.  This is different than “shortcuts”, which are rapid, but short term gains. Ultimately the book outlines 9 key ideas, that lead up to the concept of “10x thinking”.

#1 Hacking the Ladder

Find sideways paths, like the warp pipes in Super Mario  that allows someone to beat the game in seconds, not hours.

#2 Train with Masters

Find mentors, and/or study the greats. Shoe designer Dwayne Edwards stole discarded shoes so he could study and draw the designs. This helped him develop the ability to notice tiny design details in shoes.

#3 Rapid Feedback

Rapid feedback accelerates learning. This has been critical to a lot of companies that have a website as their main product. In this book, the example of Upworthy illustrates the point. Turn work into rapid scientific experiments, and depersonalized feedback.

#4 Platforms

Tools and technology that people can buid off of. a platform “amplifies the effort and teaches skills in the process of using it.“ Key example: development of Ruby on Rails as a programming language.

Platforms are how Twitter could build Twitter in mere days while running a separate company. And Platforms are why Finland made all its teachers get a Master’s degrees and its students learn with hands-on tools that made learning better.

See also: Modern Monopolies: What It Takes to Dominate the 21st Century Economy

#5 Catching waves

The world’s best surfers arrive at the beach hours before a competition and stare at the ocean. This is a valuable metaphor for a lot of things in business and life.

“Intuition is the result of nonconscious pattern recognition,” ….. However, research shows, that we can also see patterns just as well by deliberately looking for them. Deliberate pattern spotting can compensate for experience. “but often people don’t even try it”

Budgeted Experimentation helps business avoid being disrupted, by helping them harness waves on which younger competitors might otherwise used to ride past them. Its helped companies like Google, 3M, Flickr, Conde Nast, and NPR remain innovative even as peer companies plateaued. In contrast, companies that are too focused on defending their current business practice and to fearful to experiment often get overtaken.

Key example of what to avoid: Kodak

#6 Superconnecting

Key example: Che Guevera taking control of the radio, using it as a way of promoting Castro’s revolution to a much wider audience than otherwise possible.

#7 Momentum

Build up potential energy, and amplify unexpected opportunities.

#8 Simplicity

The key feature of disruptively innovative products is cost savings(either time or money). But the key ingredient behind the scenes of every disruptive product is simplification.

Examples, email, USB Drives, Cars.(Henry Ford kept complexity under the hood).

Key example: Sherlock Holmes. He focused on what he needed to know, knowing how to figure out what he didn’t know, and forgetting about everything else.

#9 10x thinking

This quote from Astro Teller is key:

Its often easier to make something 10 times better than it is to make it 10 percent better…. In order to get really big improvements you usually have to start over in one or more ways. You have to break some of the basic assumptions and, of course, you can’t know ahead of time. Its by definition counter intuitive.

This means getting to first principles. 10x thinking forces you to come up with smartcuts.

10x thinking is probably now essential for survival in the modern economy.

Most innovation inside industries and companies today focuses on making faster horses, not automobiles.

This is why the innovator’s dilemma destroy’s so many companies.  What replaces them is something better.  Creative destruction is a beautiful thing.

Education of a Wandering Man: The Ultimate Autodidact

Louis L’amour was an autodidact’s autodidact. John Wayne called him the most interesting man in the world. L’amour spent the first couple decades of his adulthood wandering across the country, and around the world, doing odd jobs, and obsessively reading whatever he could find. Only much later did he become a famous novelist. Education of a Wandering Man is a quasi-autobiography, in which he describes the trajectory of his life, and the evolution of his thinking in terms of the places he traveled and the books he read.

L’amour spent years as a hobo, hopping trains from town to town, working various jobs. In each town he would visit the local library.

Its important to note, that unlike a bum, a hobo is ready and willing to work.

To properly understand the situation in America before the Depression, one must realize there was great demand for seasonal labor, and much of this was supplied by men called hoboes.
Over the years the terms applied to wanderers have been confused until all meaning has been lost. To begin with, a bum was a local man who did not want to work. A tramp was a wanderer of the same kind, but a hobo was a wandering worker and essential to the nation’s economy.

…Many hoboes would start working the harvest in Texas, and follow the ripening grain north through Oklahoma, Kansas, and Nebraska into the Dakotas. During harvest season ,when the demand for farm labor was great, the freight trains permitted the hoboes to ride, as the railroads were to ship the harvested grain, and it was in their interest to see that labor was provided.”

 

He also worked on merchant ships, and traveled throughout Asia and most of the world. He would find books for free or cheap wherever he went, reading 100+ books per year.  For example:

Byron’s Don Juan I read on an Arab dhow sailing north from Aden up the Red Sea to Port Tewfik on the Suez Canal. Boswell’s The Life of Samuel Johnson (Penguin Classics) I read while broke and on the beach in San Pedro. In Singapore, I came upon a copy of Annals and Antiquities of Rajasthan, Vol. 1 of 3: Or the Central and Western Rajput States of India (Classic Reprint) by James Tod.

Although he didn’t have real formal degrees, L’amour understood the value of books and knowledge:

Books are precious things, but more than that, they are the strong backbone of civilization. They are the thread upon which it all hangs, and they can save us when all else is lost.
…Knowledge is like money: To be of value it must circulate, and in circulating it can increase in quantity and hopefully, in value. “

He wrote 89 novels, and clearly a lot of ideas came from paying close attention when he travelled:

People are forever asking me where I get my ideas, but one has only to listen, to look, and to live with awareness. As I have said in several of my stories, all men look, but so few can see. It is all there, waiting for any passerby.”
… for a writer, everything is grist for the mill, and a writer cannot know too much. Sooner or later everything he does know will find its uses.

As with reading, L’amour never let the challenges of a transient lifestyle interfere with writing:

“I began my writing in ship’s fo’c’sles, bunkhouses, hotel rooms- wherever I could sit down with a pen and something to write on.”

L’amour also spent time boxing in various small towns, and coaching other fighters. I’ve seen reference online to a 51-8 professional record, although I wasn’t able to verify it.

In the later years of his life L’amour spent more time in his personal library. His deep knowledge of the world gave him perspective:

Surely, the citizens and the rulers of Babylon and Rome did not see themselves as a passing phase. Each in its time believed it was the end-all of the world’s progression. I have no such feeling. Each age is a day that is dying, each one a dream that is fading.

Grinding It Out

In Grinding It Out: The Making of McDonald’s Ray Kroc tells the story of how he built McDonalds into a behemoth. The key themes that run through it are his persistence and obsessive attention to detail. There are also some interesting strategic insights on how he views store operators differently than the typical franchise business, and how he selected real estate locations. If the book is too long, there is also a movie, and a country music song telling the same general story. The book is unique, however, since it provies a direct view into Ray Kroc’s thought process.

On Partnership:

One of the basic decisions I made in this period affected the ehart of my franchise system and how it would develop. That was that the corporation was not going to get involved in being a supplier for its operators. My belef was that I had to help the individual operator succeed in every way I could. His success would insure my success. But I couldn’t do that and, at the same time, treat him a a customer.

There is a basic conflict in trying to treat a man as a partner on the one hand while selling him something at a profit on the other. Once you get into the supply business, you become more concerned about what you are making on sales to your franchisee than with how his sales are doing. The temptation coud become very strong to dilute the quality of what you are selling him in order to increase your profit. This would have a negative effect on your franchiesees business, and ultimately, of course, on yours. Many franchise systems came along after us and tried to be suppliers, and they got into severe business and financial difficulty. Our method enabled us to build a sophisticated system of purchasing that allows the operator to get his suplies at rock-bottom prices. As it turned out, my instinct helped us avoid some antitrust problems some other franchise operators got into.

On selecting locations for new stores:

Back in the days when we first got a company airplane, we used to spot good locations for McDonald’s stores by flying over a community and looking for schools and church steeples. After we got a general picture from the air, we’d follow up wit h a site survery. Now we use a helicopter, and its ideal. Scarceley a month goes by that I don’t get reports from whatever districts happen to be using our five copters on some new locations that we would never have discovered otherwise. We have a computer in Oak Brook tat is designed to make real estate surveys. But those printouts are of no use to me. After we find a promising location, I drive around it in a car, go to the corner saloon and into the neighborhood supermarket. I mingle with the people and observe their comings and goings. That twlls me what I need to know about how a McDonald’s store would do there.

 

Backgammon and Life Philosophy

Backgammon: the cruelest game provides a guide to some key principles of backgammon, and contains analysis of several games between top players. It also gets philosophical about the vicissitudes of randomness that make backgammon so challenging and intriguing:

From the start there is a complicated interplay of possibilities, probabilities, good fortune and bad, which influences every facet of the game. in backgammon, to seek position is to take certain calculated risks, and because all players are ruled by the dictates of the dice- or by chance, which Karl von Clausewitz, the ninetheenth-century military theorist, described as “an agency indifferent to the actor’s preference for the outcomes” – no player is ever in control of his particular destiny. One of the game’s chief tactics, then, is to shield oneself against the dice. The player with the strongest position can withstand the greater number of unfavorable rolls, or “bad luck,” than can the more weakly protected player, who, because he failed to protect himself, is more easily assaulted and overrun.

Nonetheless, no matter how cunningly you play, you are virtually always vulnerable. One unexpected horror roll can undermine the best positions, and derange the most sensible of plans; this is bot hthe charm and the frustration of the game. The best players know they must employ the craftiest of tactics, not because of the dice, but in spite of them. It is the enormously high luck factor in backgammon that causees it to be a game of skill. Without luck or accident, the game would not only be monotonous, but infinitely less skillfull.

In backgammon, to be skillful is to be self protective. At any given point in the ggame, the better players are aware of Murphy’s Law, which states that if anything can go wrong, it will.” Given the whimsical nature of the dice, all players have a chance in the game, but some players have more chances than others, because they have created in environment in which the more propirious is more likely to occur.

In backgammon, an understanding of the correct percentage moves in specific situations qualifies as “inside information” and will enable you to win in the long run. But not every time, alas, and often nt even in what you believe to be crucial games. This condition must be accepted philosophically, of course, and should not deter you from continuing a detailed study of the game.

Quick Thoughts on The Signal and the Noise

Learning to think probabilistically is one of the most critical skills one can master. Nate Silver’s The Signal and the Noise: Why So Many Predictions Fail–but Some Don’t is a valuable book on thinking probabilistically and forecasting in an uncertain environment. It compares and contrasts examples across multiple disciplines, including weather forecasting, seismology, finance, and more.

This book pairs well with Against the Gods, Fortune’s Formula and Superforecasting.   Against the Gods is in my opinion, the most important book on the development of probabilistic thinking. Early civilizations were good with geometry and logic, but helpless with uncertainty. Ironically it was gamblers and heretics who moved mankind forward by  developing the science of  probability, statistics, and ultimately risk management.   Fortune’s Formula shows the connection between information theory, gambling, and correct position sizing for investors. It helps the answer the question: when you have a slight edge, how much should you bet? Nate Silver draws heavily on Superforecasting.  Particularly important is the idea of “foxes and hedgehogs”. Foxes are multidisciplinary, adaptable, self critical , tolerant of complexity, cautious and empirical. In contrast, Hedgehogs are specialized, stalwart, stubborn, order-seeking, confident, and ideological. As you might expect, foxes make far better forecasters than hedgehogs, even though hedgehogs make for better television.

Anyways, here are a few key insights from my notes on The Signal and the Noise

1) Data is useless without context.

There are always patterns to find in data, but its critical to understand the theory behind the system you are studying to avoid being fooled by noise. This is true in forecasting the weather, investing, betting on sports, or any other probabilistic endeavor. The ability to understand context is also a critical advantage humans have over computer programs.

“Statistical inferences are much stronger when backed up by theory or at least some deeper thinking about their root causes. “

The importance of understanding context comes to the forefront when you compare human’s success with weather forecasting, vs relative failure with earthquake forecasting.

“Chaos theory is a demon that can be tamed- weather forecasts did so, at least in part. But weather forecasters have a much better theoretical understanding of th earth’s atmosphere than seismologists do of the earth’s crust. They know more or less, how weather works, right down to the molecular level. Seismologists don’t have that advantage. “

The ability to understand context is what separates success from failure in all pursuits dealing with uncertainty. The profile of professional sports gambler Bob Voulgaris, is highly instructive. Voulgaris focuses on NBA basketball. A key insight is that Voulgaris has powerful tools for analyzing data, and he makes good use of the data, but he also has deep understanding of the qualitative subletities of how NBA basketball works. Obvious statistical patterns are quickly incorporated into betting lines, whether they are signal or noise. Voulgaris looks deeper, and finds places where the line misprices true probabilities.

“Finding patterns is easy in any data rich environment; thats what mediocre gamblers do. The key is in determining whether the patterns represent noise or signal. “

2) Beware of overconfidence

“… the amount of confidence someone expresses in a prediction is not good indication of its  accuracy, to the contrary, these qualities are often inversely correlated. “

3) Think big, and think small. Mix the macro and the micro.

“Good innovators typically think very big, and they think very small. New ideas are sometimes found in the most granular of details where few others bother to look. And they are sometimes found when you are doing your most abstract and philosophical thinking, considering why the world is the way that it is and whether there might be an alternative to the dominant paradigm.”

This is reminiscent of the “global micro” approach used by several manager’s profiled in Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global Markets

4) Recognize the Value of Bayesian Thinking

The work of Thomas Bayes forms the framework underlying how good gamblers think.

Bayes was an English minister who argued in his theological work that admitting our own imperfections is a necessary step on the way to redemption. His most famous work, however, was “An Essay toward Solving a Problem in the Doctrine of Chances,” which was not published until after his death. One interpretation of the essay concerns a person who emerges into the world( ie Adam, or someone from Plato’s cave), and rises to see the sun for the first time:

“At first the does not know whether this is typical of some sort of freak occurrence. However each day that he survives and the sun rises again, his confidence increases that it is a permanent feature of nature. Gradually, through this purely statistical form of inference, the probability that he assigns to his prediction that the sun will rise again tomorrow approaches(although never exactly reaches) 100 percent.”

In essence, beliefs on probability are updated as new information comes in.

Ironically Bayes philosophical work was extended by the mathematician and astronomer Pierre Simon-Laplace, who was likely an atheist. Although Laplace believed in scientific determinism, he was frustrated with the disconnect between (what he believed to be the perfection of nature, and human imperfections in understanding it, in particular with regards to astronomical observations. Consequently, he developed some measuring techniques that relied on probabilistic inferences, rather than exact measurements. “Laplace came to view probability as a waypoint between ignorance and knowledge.” The combined work of Laplace and Bayes led to simple expression that is concerned with conditional probability. In essence Bayesian math can be used to tell us the probability that a theory or hypothesis if some event has happened.

5) The road to wisdom is to be less and less wrong.

forecasting, or at least operating in an uncertain environment, is an iterative process.

Nate Silver titles one of the chapters “Less and Less Wrong, as a homage to the Danish mathematician, scientist, inventor, and poet Piet Hein, author of Grooks:

The road to wisdom? — Well, it’s plain
and simple to express:
Err
and err
and err again
but less
and less
and less.

 

Disrupting Through Good Customer Service

In Zero to One Peter Thiel theorizes that a new innovation must be at least ten times better than the currently existing solution in an important dimension. This is a high bar, but it often achieved by focusing on an ignored or under exploited niche.

The examples of Uber, and Amazon show how focusing relentlessly on customers can also achieve this goal, especially when incumbents are attached to an old way of doing things that is unpleasant for customers. Good customer service can be extremely disruptive.

When facing regulatory challenges, Uber’s CEO Travis Kalanick went against conventional wisdom of his lobbyists. Rather than seeking to compromise with regulators, he focused on delivering a better product. In The Upstarts the author discusses what is known as “Travis’ law:

“Our product is so superior to the status quo that if we give people the opportunity to see it or try it, in any place in the world where government has to be at least somewhat responsive to the people, they will demand it and defend its right to exist.”

Mobilizing customers is Uber’s  public affairs strategy.

This extreme focus on customers was a key factor in Amazon’s rise as well. Here is Jeff Bezos in the early days of Amazon(quoted from The Everything Store):

“You should wake up worried, terrified every morning.  But don’t be worried about our competitors because they’re never going to send us any money anyway. Lets worried about our customers and stay heads down, focused.”

Bezos reiterated this sentiment in the most recent annual letter:

There are many ways to center a business. You can be competitor focused, you can be product focused, you can be technology focused, you can be business model focused, and there are more. But in my view, obsessive customer focus is by far the most protective of Day 1 vitality.

Why? There are many advantages to a customer-centric approach, but here’s the big one: customers are always beautifully, wonderfully dissatisfied, even when they report being happy and business is great. Even when they don’t yet know it, customers want something better, and your desire to delight customers will drive you to invent on their behalf. No customer ever asked Amazon to create the Prime membership program, but it sure turns out they wanted it, and I could give you many such examples.

I can’t help but wonder if financial services will end up facing a similar level of disruption from Robo Advisers.  Most of the financial services industry is clearly conflicted and not focused  on actually improving client outcomes. That leaves a massive space for new entrants.

Disequilibrium Analysis

George Soros treats developments in financial markets as a historical process. In The Alchemy of Finance, he outlines his theory of reflexivity, discusses historical developments in markets, and describes a real time “experiment” he undertook while running the Quantum fund in the 1980s.

Markets are an ideal laboratory for testing theories: changes are expressed in quantitative terms, and the data are easily accessible.

Three of the key interrelated concepts in his framework, are anti-equilibrium, Imperfect Knowledge, and Reflexivity.

Disequilibrium

In markets, equilibrium is a very rare special case. Further, adjustments rarely lead to new equilibrium. The economy is always in adjustment.

According to George Soros:

If we want to understand the real world we must divert our gaze from a hypothetical final outcome , and concentrate our attention on the process of change that we observe all around us.

In trying to deal with macroeconomic developments, equilibrium analysis is totally inappropriate. Nothing could be further removed from reality than the assumptions that the participants base their decisions on perfect knowledge. People are groping to anticipate the future with the help of whatever guideposts they can establish. The outcome tends to diverge from expectations, leading to constantly changing expectations, and constantly changing outcomes. The process is reflexive.

The stock market, is of course a perfect example:

The concept of an equilibrium seems irrelevant at best and misleading at worst. The evidence shows persistent fluctuations, whatever length of time is chosen as the period of observation. Admittedly, the underlying conditions that are supposed to be reflected in stock prices are also constantly changing, but it is difficult to establish any firm relationship between changes in stock prices and changes in underlying conditions. Whatever relationship can be established has to be imputed rather than observed.

So its better to focus on nature and direction of ongoing adjustments, rather than trying to identify an equilibrium.

Imperfect Knowledge

Perhaps more problematic with an exclusive focus on rarely occurring equilibrium conditions is the assumption of perfect knowledge. Perfect knowledge is impossible. Everything is a provisional hypothesis, subject to improvement. Soros makes the bias of market participants the center part of his analysis.

Reflexivity

In natural sciences, usually the thinking of participants and the events themselves can be separated. However, when people are involved, there is interplay between thoughts and actions. There is a partial link to Heisenberg’s uncertainty principle. The basic deductive nomological approach of science is inadequate. Use of probabilistic generalization, or some other novel scientific method is preferable.

Thinking plays a dual role. On the one hand, participants seek to understand the situation in which they participate; on the other, their understanding serves as the basis of decisions which influence the course of the events. The two roles interfere with each other.

The influence of this idea is inseparable from the theory of imperfect knowledge.

The participants’ perceptions are inherently flawed, and there is a two-way connection between flawed perceptions and the actual course of events, which results in a lack of correspondence between the two.

This two way connection is what Soros called “reflexivity.”

The thinking of participants, exactly because it is not governed by reality, is easily influenced by theories. In the field of natural phenomena, scientific method is effective only then its theories are valid, but in social political , and economic matters, theories can be effective without being valid.

Effective here, means having an impact. For example, in a bubble, the cost of capital for some companies drops to be absurdly low, relative to the risk of their respective enterprises. Consequently, some businesses that would have otherwise died, may go on to survive. (Example from two decades after the Alchemy of Finance was written: Peter Thiel mentions when being interviewed in Inside the House of Money, that Paypal did a massive capital raise right a the height of the tech bubble, even though it didn’t need the money at the time) On the flip side, a depression can be self fulfilling, if businesses are unable to refinance.

This seems to be especially true in the credit markets:

Loans are based on the lender’s estimation of the borrowers ability to service his debt. The valuation of the collateral is supposed to be independent of the act of lending; but in actual fact the act of lending can affect the value of the collateral. This is true of the individual case and of the economy as a whole. Credit expansion stimulates the economy and enhances the collateral values; the repayment or contraction of credit has a depressing influence both on the economy and on the valuation of collateral. The connection between credit and economy activity is anything but constant- for instance , credit for building a new factory has quite a different effect from credit for a leveraged buyout. This makes it difficult to quantify the connection between credit and economic activity. Yet it is a mistake to ignore it.

This is reminiscent of Hyman Minsky’s Financial Instability Hypothesis

In terms of the stock market, Soros asserts (1)Markets are always biased in one direction or another. (2) Markets can influence the events that they anticipate.

Lessons From The Landscape of History

In The Landscape of History: How Historians Map the Past, John Gaddis discusses the methods that historians use, comparing them to methods of sciences such as astronomy, paleontology, and geology. The book is a great exploration of different approaches to examining evidence.  Here are a few key lessons.

A library is better than a time machine
Unlike time travelers,  “historians have the capacity for selectivity, simultaneity, and the shifting of scale…”:
Selectivity:  Historians can select from the cacophony of events what they think is important.  They proactively impose significance on events, not the other way around.
Simultaneity they can be in several times and places at once.  By standing apart from events, historians can understand, and compare events. “…understanding implies comparison: to comprehend something is to see it in relation to other entities of the same class…”
Scale.  Historians can zoom in and out between macroscopic and microscopic levels of analysis.  As a result processes are visible to historians even if they weren’t visible to people of the age the historian studies(or a hypothetical time traveler).
Historians integrate induction and deduction
Since we’re historians, not novelists , we’re obliged to tier our narrative as closely as possible to the evidence that has survived: that’s an inductive process.  But we have no way of knowing, until we begin looking for evidence with the purposes of our narrative in mind, how much of its going to be relevant: that’s a deductive calculation. Composing the narrative will then produce places where more research is needed, and we’re back to induction again.  But that new evidence will still have to fit within the modified narrative so we’re back to deduction.  And so on until, as I earlier quoted William H. McNeill, “it feels right, and then I write it up and ship it off to the publisher.”  That’s why the distinction between induction and deduction is largely meaningless for the historian seeking to establish causation.  The verb “to fit” which implies both procedures, is much better.  Its not just tailors who look at what they have to cover, and then what they have with which to cover it, and then back and forth, again and again, until the fit is as good as its going to get.
The combination of induction and deduction is especially important in biography.
Biography, like the larger sphere of history within which it resides is at once a deductive and an inductive exercise.  Patterns of human behavior extending across time and space can alert us to the kinds of questions we should be asking about the particular individual we’re dealing with:  that’s where deduction comes in.
 …
But these patterns alone can’t determine the answers, for it’s all to easy to to find what you’re looking for when you’ve already decided a head of time what it is.  The evidence of particular experience in biography has got to discipline what we know from collective experience: induction is how we do that.
Historians must balance the general against the particular.
Interdependent Variables
Social science is obsessed with separating out independent and dependent variables. Historians along with many scientists working outside of laboratories  view variables as interdependent.  The author calls this an ecological approach, rather than a reductionist approach.
 
Theories like relativity, plate tectonics, and natural selection emphasize relationships among variables, some of them continuous and others contingent.  Regularity and randomness coexist within such theories: they allow for punctuations that upset equilibria such as asteroid impacts, earthquakes, or the outbreak of new and lethal diseases.  Nor do they require singling out certain variables as more important than others.Nor do they require singling out certain variables as more important than others: what would the independent variables be for the Andromeda galaxy or the Norwegian coastline, or the Darwin finch? Reductionism in these realms is only a stepping stone towards synthesis.
Historians,however, reject the doctrine of immaculate causation, which seems to be implied in the idea that one can identify, without reference to all that has preceded it, such a thing as an independent variable.  Causes always have antecedents.  We may rank their relative significance, but we’d think it irresponsible to seek to isolate or “tease out” single causes for complex events.  We see history as proceeding instead from multiple causes and their intersections.  Interconnections matter more to us than does the enshrinement of particular variables.