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certain negative character: the attempt is made to free oneself from the existing model only to realize this model has been replaced by a broader but still limited set of possibilities which in turn need to be over come and so on in an iterative process.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.
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.
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.
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.
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.
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.
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.
In 2018 I refined my reading habits in a manner that drastically improved my overall experience. I sought out more books with big ideas that had stood the test of time, and started more systematically filtering and skimming newer non fiction. I also started reading more fiction.
I read the Financial Times and the Economist regularly, monitor key topics on Google News, and regularly peruse reliable curators on blogs and Twitter for news and essays. I ignore most “breaking news” that isn’t immediately relevant to me, and instead look for carefully researched work. Some of this is necessary because I need to stay up on what is happening with capital markets and technology. News is often bullshit, but its entertaining, and I often get useful ideas piecing together trends.
For actual books though publication date isn’t quite as important. I generally choose non-fiction books three ways: (1) Focused on a particular topic (2) timeless deep reading (3) timely speed reading.
When I’m interested in a topic, I’ll skim whatever book I can find about it, and sometimes find a few valuable ideas. This applies not just to business, but life in general. In the past year this has included topics as wide as gilded age businesses, securities law, uranium mining, and child psychology. I like to see not just what the “accepted wisdom” is, why and how it came to be widely accepted, and if it is likely to be correct. Reality is rarely black and white.
Timeless deep reading
When I hear smart people talking about books that are a few years old, I listen closely. Often the most valuable books are those that have stood the test of time. Core concepts stay relevant, even if the technological specifics change. Information Rules by Hal Varian and and Technological Revolutions and Financial Capital by Carlota Perez are prime examples of this category that have become important influences on my thinking. Similarly, historical biographies are almost always relevant decades after publication.
Timely speed reading
Many newer non-fiction books, have a couple key ideas that make them worth reading. Yet sometimes authors stretch a great potential blog post into a long fluffy book. Sometimes I can get the key point from listening to podcast interviews with the author.
If I listen to an interview, and it seems like there is more depth than can be captured in an interview, I’ll consider getting the book.Often I’ll first see if I can get an audio book version from the library via Libby. Then I’ll download the key ideas(at 2x speed) into my head while working out or walking to work. If I listen to the audio book, and I find myself needing to pause and take notes, or wanting to capture quotes, then I’ll look at getting a kindle or dead tree version of the actual book.
I’ll skim through books that present well known ideas in unique ways, but reserve my deep focused reading for life changing insights. Of course sometimes being presented with a familiar idea will have more salience based on new experiences or just my subjective perception. So this isn’t an objective filter, even though I sometimes try to make it so.
There are of course exceptions to this filtering heuristic. There are a few familiar authors whose books I’ll buy right when they come out. I keep a lot of random books all around the house, so sometimes I’ll just pick one up and read it. And often serendipity leads me to find good books randomly on Twitter, in the library, or a bookstore.
Reading is definitely my thing, too, and I think you have to read not just business stuff but also history, novels, and even some poetry.: Investing is about glimpsing, however dimly, the ebb and flow of human events. It’s very much about breasting the tides of emotion, too, which is where the novels and poetry come in.
Barton Biggs, Hedgehogging
I went through a phase as a non-fiction snob. Who has time to read fiction, I thought? I have since done an almost complete 180 on this thinking. Fiction is more challenging to read and is generally better written than non-fiction. My day job involves reading a lot of dense regulatory and legal filings. There is usually an obvious structure to any given piece. But the broader meta game is piecing together disparate parts into a coherent narrative.
Fiction challenges the reader more because one has to spend more time thinking about what is important, understanding character development, and anticipating a story as it develops. Plus after a day of reading dense legalese and staring at screens, sometimes I want to engage my mind in a new way.
Besides, sometimes you have to refresh your mind and soul by consuming some crafted, eloquent writing.When I get home at the end of a business day, after being absorbed in investment babble and dull, plodding writing, replete with trite phrases such as make no mistake, which is my pet peeve, I am stuffed with babble. My gorge rises at the thought of more business carbohydrates. So I sit down with a nice big glass of wine and immerse myself in something I want to read. I always have at least one book going, and my taste is eclectic, but the sine qua non is that it has to be well written
Barton Biggs, Hedgehogging
I have been reading 3-5 non fiction books for every fiction book I finish, but to start reading fiction again was a major change in this past year. I still don’t have a good heuristic for filtering fiction. I mostly rely on recommendations from smart and interesting people. So send me your recommendations!
Cleaning more book notes out of my Google Drive files…
Hour Between Dog and Wolf is a useful complement to Misbehaving and Thinking Fast and Slow. The author started out as a derivatives trader, then changed their career to neuroscience bringing unique personal perspective to the well worn path of studying how humans can act irrationality in financial markets and life.
Thinking Fast and Slow is a somewhat pendantic and rambling summary of groundbreaking research. Misbehaving is a humorous summary of the development of behavioral economics. Hour Between Dog and Wolf is a more personal story, with emphasis on dealing with risk and stress. All three are worth reading.
Written on the temple of Delphi was the maxim “know thyself” and today that increasingly knowing your biochemistry.
Probably the most valuable part of the book is a discussion of mind-body connection in the context of dealing with risk.
Category divide between body and mind, runs deep in western philosophy. This idea:
originated with Pythagoras, who needed the idea of immortal soul for his doctrine of reincarnation, but the idea of a mind-body split awas cast in its most durable form by Plato, who claimed that within our decaying flesh there flickers a spark of divinity, being an eternal and rational soul. The idea was subsequently taken up by St. Paul and enthroned as Christian dogma. It was a very edict also enthroned as a philosophical conundrum later known as the mind-body problem; and physicists such as Rene Descartes, a devout Catholic and committed scientist, wrestled with the problem of how this disembodied mind could interact with the physical body, eventually coming up with the memorable image of a ghost in a machine, watching and giving orders.
Today Platonic dualism as the doctrine is called is widely disputed within philosophy and mostly ignored in neuroscience, but there is one unlikely place where a vision of the rational mind and pure as anything contemplated by Plato or Descartes still lingers- and that is in economics.
Author argues that this platonic dualism has impaired ability to understand financial markets. Need to study how people react to volatile markets. For too long people have ignored brain body feedback.
Book goes on to discuss crazy behavior of traders, bankers, and the idiotic decision they made. Not original, but well worth reading, and the author puts a unique spin on it.
A couple other related ideas:
- Neocortex gave us reading, writing philosophy. Making tools throwing spears etc.
- Another brain region outgrew neocortex- cerebellum like a separate brain acting as operating system for rest of brain.
We may be gifted with considerable rational powers, but to solve a problem with them we must first be able to narrow down the potentially limitless amount of information, options and consequences. We face a tricky problem of limiting our search and to solve it we rely on emotions and gut feelings.
See also- Cialdini’s Law of Data Smog.
“Somatic Market Hypothesis”
Each event we store in memory comes bookmarked with the bodily sensations…. Called somatic markets we felt at time of living through it at our first time, and these help us decide what to do when we find ourselves in similar situations. These bookmarkers basically help us sort through options. Somatic markers help rational brain function.
Moving towards stress adaptation
Some scientists study stress and response too it. Chronic stress leads to illness, learned helplessness. Short lived bursts of stress, in contrast, cause people to emerge hardier. Can be verified with lab rats. Well known for anyone building muscle mass or aerobic capacity.
Humans are built to move, so we should. The more research emerges on physical exercise, the more we find that its benefits extend far beyond our muscles and cardiovascular systems. Exercise expands the productive capacity of our amine-producing cells, helping to inoculate us against anxiety, stress, depression and learned helplessness.It also floods our brains with what are called growth factors, and these keep existing neurons young and new neurons growing – some scientists call these growth factor brain fertilizer- so our brains are strengthened against stress and aging. A well -designed regime of physical exercise can be a boot camp for the brain.
Fatigue and focus
I once had a coach who told me “rest is a part of training. ” Similarly, one of the top performing hedge fund managers I know sleeps 9 hours a night, and is obsessed with importance of rest.
A recently developed model in neurosciences provides an alternative explanation of fatigue. According to this model, fatigue should be understood as a signal our body and brain use to inform us that than expected return from our current activity has dropped below its metabolic cost. The brain quietly searches for the optimal allocation of attentional and metabolic resources and fatigue is one way it communicates its results. If we are engaged in some form of search and have not turned up any results, our brain, through the languages o fatigue and distractibility tells us we are wasting our time and encourages us to look elsewhere. The cure for fatigues, according to this account, is not rest, it is a fresh task. Support form this idea comes from data showing that overtime work in itself does not in itself lead to work-related illness such as hypertension and heart disease, these occur mainly if workers have no control over allocation of their attention. Applying such a model could benefit workers and management alike, for more flexibility in choosing what to work on, and when, could reduce worker fatigues, while management might be delighted to find that workers may be just as refreshed by a new assignment as by a vacation. This model of fatigue provides a good example of how understanding a bodily signal can alter the way we deal with it.
Only complaint about Hour Between Dog and Wolf is it probably could have been a long form article- I suspect the book publisher wanted to fill it out. Still worth taking a look though. Hour Between Dog and Wolf provides a useful framework for anyone who has a high stakes job that requires stamina.
Askeladden Capital on Sleep/Rest/Chronotypes Mental Model
The Mezzanine by Nicholas Baker is a stream of consciousness novel that follows the protaganist’s thoughts during lunch-hour activities, including the purchase of new shoelaces. Since the novel is basically just the running dialogue of the a person’s thoughts, it includes deep observations of a lot of everyday items. After reading the novel, I came away appreciating the design of everyday objects much more. The book manages to be simultaneously, deep, absurd, and hilarious.
I originally picked up The Mezzanine, after Matt Levine mentioned it during a Reddit AMA as a literary inspiration for his use of footnotes, supplementing his legal experience. The novel’s protaganist indeed praises the “luxuriant incidentalism of footnotes” in certain classic works. Those that appreciate footnotes:
“…know that the outer surface of truth is not smooth, welling and gathering from paragraph to shapely paragraph, but is encrusted with a rough protective bark of citations, quotation marks, italica, and foreign languages, a whole variorum crust of “ibid’s” and “compare’s” and “see’s” that are the shield for the pure flow of argument as it lives for a moment in on mind.”
Great scholarly works can use footnotes as “reassurances that the pursuit of truth doesn’t have clear outer boundaries: it doesn’t end with the book; restatement and self-disagreement and the enveloping sea of referenced authorities all continue.”
“Footnotes are the finer-suckered surfaces that allow tentacular paragraphs to hold fast to the wider reality of the library.
Additionally, the book indirectly considers a lot of Epistemological questions. The protagonist wonders what influences his thoughts:
“Will the time ever come when I am not so completely dependent on thoughts I first had in childhood to furnish my comparisons and analogies and sense of the parallel rhythms of microhistory? Will I reach a point where there will be a good chance, I mean a more than fifty-fifty chance, that any random idea popping back into the foreground of my consciousness will be an idea that first came to me when I was an adult, rather than one I had repeatedly as a child?”
“Perfect is the enemy of good.”
“Better done than perfect.”
Neither of these quotes apply to surgery, or dismantling bombs. Fortunately, this blog does not involve surgery, or dismantling bombs.
Getting details right is important. In bankruptcy cases, the word “and” can have $450 million consequences. A single misplaced space can derail an entire python script. One must be cautious before putting money and reputation at risk. Nonetheless, that is not an excuse for not taking action, and starting the first draft.
According to Byron Wien: “If you want to be successful and live a long, stimulating life, keep yourself at risk intellectually all the time.” This blog should keep me intellectually at risk.
“We should hunt out the helpful pieces of teaching, and the spirited and noble-minded sayings which are capable of immediate practical application—not far-fetched or archaic expressions or extravagant metaphors and figures of speech—and learn them so well that words become works.”
As Ryan Holiday said in The Daily Stoic: “Education- reading and meditation on the wisdom of great minds is not to be done for its own sake. It has a purpose.”
I have over a dozen partially written drafts of posts, which I intend to release over the next couple weeks.
In the The Art of War, Sun Tzu wrote that those who excel in warfare do so because they seek out battles that are easy to win. Similarly, Warren Buffett wrote that he likes to look for one foot hurdles to step over, rather than trying to jump over seven hurdles. Of course actually finding easy battles, and one foot hurdles is itself quite challenging. If it was easy market forces would ensure that it quickly becomes hard. With so much brain and computer power dedicated to financial markets, there are few areas of opportunity left worth exploiting. However, by developing a behavioral and structural edge, one can act on the rare opportunities, and perform better than those that theoretically have an analytical and informational edge.
How can one develop a behavioral edge? Cultivating the right habits in order to be physically and mentally healthy goes a long way. Considering carefully what media to read is important to avoid being overwhelmed by noise. Finding time to think requires excellent resource management. It requires discipline to be willing to work on a name for months, only to pass on it, or to wait for months or even years for the right business to become cheap enough. Some might not enjoy spending hours reading about obscure nanocaps or corporate transactions, while ignoring popular stocks in the news. Some people seem naturally more willing to be contrarian, but I doubt anyone finds it easy all the time, especially during drawdowns. Being fearful when others are greedy, and greedy when others are fearful is harder than it sounds. Checking oneself for cognitive biases before any major financial decision is important. This is not an easy process, since cognitive biases have biological roots. I like to take a “red cell” approach, and try to understand potential short arguments for any stock I own. The connection between action and consequence is usually delayed in markets. It requires a lot of discipline, double checking and introspection to make your way through the vicissitudes of investing.
The cultivation of a structural edge is also nuanced. If you have developed a behavioral edge, then you can probably manage your personal finances in a way that allows your personal accounts to be invested for the long term. This requires maintaining excess liquidity at most times. If you manage money for other people, you have to be really careful who you take on as a client. If a client has a shorter time horizon than you, or are likely to need to pull money suddenly, the impact can be devastating. This is a difficult tradeoff, especially for small funds, since more AUM means more fees right away. With the right clients a capital markets disruption is a major opportunity, with the wrong clients it is a disaster. Whether in a personal account or a fund, simply having a long time horizon and a liquidity cushion can be a major source of long term alpha.
If one chooses to look at what other’s don’t one may actually end up with an analytical and informational edge in areas with less competition. I like to invest in things that are uninvestable for most investors with better resources, whether due to “headline” risk, illiquidity, or other institutional constraints. For example liquidations, delistings, and anything nanocap are fertile grounds for bargains. There are also interesting opportunities in distressed debt, and bankruptcies. I also like to look for situations where statistical services(Bloomberg, YCharts, Yahoo Finance, etc) are likely to have misleading or incomplete data, and companies that don’t fit in a comfortable category. Sometimes consolidated financials can be deceptive because of accounting rules, especially if a company has made acquisitions, holds real estate and/or holds a portfolio of securities. I also always make sure to adjust for material events that occurred after the 10-Q or 10-K date in determining a valuation. Judging by occasional market behavior I don’t think everyone does this. In any case there is always a gap between accounting reality and economic reality. The financial statements are just a starting point.
An ideal long term holding is a business that has a major competitive advantage and can easily earn a high return on capital over the long term, even if management screws up. These businesses are hard to find, and they’re sometimes hidden in a group of weak businesses that screened poorly, or attached to an old business that didn’t work. Thrift conversions are ignored by many, and easy to understand. Although the upside for thrift conversions is rarely large, the risk/reward tradeoff is phenomenal. Key information is often found on the OCC and FDIC websites, rather than in Edgar. Most OTC securities are ignored by sophisticated and large investors(plus the messiness of sorting through hundreds means you aren’t competing as much against computers). Sometimes I can get an informational edge by actually bothering to go to the company’s website and/or buying a token share and calling the company to ask for financials, which one has a legal right to access as a shareholder.
Whatever the investment, I’m only interested in buying if a lot can go wrong before I lose, and just a little going right provides a nice gain. Finding the right security is hard, but it should be easy to win once its in the portfolio. “Sifting through the debris of financial wreckage, out-of-favor securities and asset classes in which there is limited competition”, as Seth Klarman has called it does requires intense discipline and dedication, but provides ample rewards.
The extraordinary delusions and madness of crowds also serves up huge bargains from time to time, but the analysis is much harder. In all transactions, one must ask, why is someone willing to take the other side? I suspect there is more benefit to carefully analyzing my own psychology than to trying to outsmart others. I’d rather buy from a “non-economic” seller, when possible. Funds with industry or market cap mandates sell spinoffs indiscriminately. Funds that manage to an index dump companies kicked out indiscriminately. Delistings and liquidations are also sometimes forbidden by investment mandates regardless of the actual condition of the business or quality of the assets. I like to look at the portfolios of large concentrated funds that are facing massive redemption or shutting down, or from investors otherwise desperate for liquidity(oops did I say that out loud?). Sometimes people sell securities for reasons that make sense from the perspective of their job security, but are actually unrelated to the merits of the security being sold. Of course it takes a lot of searching to find where the right sellers are.
Charlie Munger told Howard Marks: “its not supposed to be easy, anyone who thinks its easy is stupid.” Indeed, finding easy things is hard.
The BDC Activist has some excellent coverage of the in-progress management changes and controversy at Business Development Corporation of America(BDCA), a non-traded BDC managed by affiliates of AR Global. The external manager plans on getting acquired by Benefit Street, pending the vote of shareholders at BDCA. The BDC Activist points out similarities between this situation and recent events at Fifth Street, KCAP, Full Circle, and TICC Capital. The actions of independent directors have a significant impact on shareholder’s returns. Here are a few of the key points:
- Prospect Capital and NexPoint both offered to acquire the manager, and offered BDCA shareholders arguably lower fees and overall better deals, but BDCA turned them down. BDCA was especially virulent in its opposition to Nexpoint
- Nonetheless, the board of BDCA unanimously recommends that investors vote yes on the transaction.
- Board members recently increased their compensation significantly.
- The BDC Activist also points out that independent directors of BDCA have zero ownership of the stock in this $2.5 billion asset company!
It doesn’t appear that the management contract was shopped very well. Is Benefit Street really the best option that’s available？Probably not. There are a lot of asset managers out there with economies of scale that would love to have another $2.5 billion in AUM.
Here is the full piece on BDCA by BDC Activist
Here is the preliminary proxy
AR Global and its affiliates have a reputation aggressive capital raising , but their stewardship of investor assets has been abysmal. They have a history of questionable corporate governance. The “independent” directors often serve on boards of multiple affiliated REITs and/or BDCs, and have been approving of abusive management all along.
As part of an attempted rollup of several non-traded REITS, with the goal of locking in 20 year + management contract, investors were asked to vote on proposals that would have removed investor protections.
The proxy for ARC Hospitality in particular looked like the ballot in a banana republic democracy. Like the others, it asked investors to give up basic rights. But it had a twist. The explanation for proposal 3 contained this:
“If this amendment to the Charter is not approved, the Relief Period under the March Advisory Amendment would be terminated and could cause the Company to be unable to meet its capital requirements, including payments due on our outstanding indebtedness, which could have a material adverse effect on the Company.”
The external advisor, which had previously caused the company to lose deposits on properties due to sloppy planning and management, had temporarily been receiving its fee in shares, since the REIT was so overextended it couldn’t afford to pay in cash. The Proxy stated that if the proposed changes were not approved, it would demand payment in cash, potentially bankrupting the company. They backed down partially on this requirement, but ultimately shareholders ended up approving most of the proposals at ARC Hospitality and the other affiliated REITs. With few exceptions the independent directors at these REITs approved of all of the changes.