Category: Uncategorized

Biology and risk taking

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.

Brain-Body Connection

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.

See also:

Askeladden Capital on Sleep/Rest/Chronotypes Mental Model 

Askeladden Capital’s review of Misbehaving

 

Perfectionism Vs. Getting Things Done

“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.

To quote Seneca:

“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.

Annals of Questionable Corporate Governance

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.

Affiliates of BDCA management previously  committed proxy fraud and consequently paid a $3 million fine.

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.

 

The BDC that is also a REIT

BDCS qualify as BDCs under the tax code.  BDCs by tradition also happen to usually be RICs under the tax code.   REITs qualify as REITs under the tax code.  RICs and REITs have  very similar requirements in terms of distributing income, and nearly identical benefits in terms of avoiding corporate level taxation.  However, investment limitations are different.

BDC is an SEC construct. REIT is an IRS construct. These categories are not mutually exclusive.  Mackenzie Realty Capital is a BDC that is also a REIT under the tax code.

From the 10-K:

MacKenzie Realty Capital, Inc. (“MRC,” “we” or “us“) is an externally managed non-diversified company that has elected to be treated as a business development company (“BDC“) under the Investment Company Act of 1940 (the “1940 Act“). Our investment objective is to generate both current income and capital appreciation through investments in real estate companies (as defined below). We are advised by MCM Advisers, LP (“the Adviser” or “MCM Advisers“). MacKenzie Capital Management, LP (“MacKenzie“) provides us with non-investment management services and administrative services necessary for us to operate. MRC was formed with the intention of qualifying to be taxed as a real estate investment trust (“REIT”) as defined under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). We qualified to be taxed as a REIT beginning with the tax year ended December 31, 2014, and made our REIT election in our 2014 tax return.

Anyways, Mackenzie Capital’s group of funds  are fascinating on many levels.  Mackenzie Sponsors/advises non-traded funds that specialize in exploiting inefficiencies in the market for illiquid retail programs.  Basically they buy non-traded retail programs at steep discounts via tender offers and  then either hold them through liquidation, or sell them at a higher price on auction sites.  They will sometimes puts out deep discount tender offers right after a non-traded program suspends its stock repurchase program.  The suspension of the share repurchase program generally indicates either the fund is in trouble, or it is pursuing strategic alternatives.  It doesn’t take long for a literate person to figure out which.    Mackenzie trades with and provides liquidity to uninformed unsophisticated counterparties that have extreme desire for liquidity (in most cases they buy from retail investors who actually bought fully loaded shares during the offering)

Mackenzie’s funds appear to follow the “no bad assets, just bad prices” school of investing.    An illiquid non-traded REIT, BDC or LP that is managed by a parasitic external advisor deserves a NAV discount.  Yet, in most cases they are worth more than zero.     Mackenzie in the illiquid space is sort of like the Bulldog Investors /Special Opportunities Fund is in the traded space, except on steroids without the activism. There are a few other groups that follow a similar strategy, such as CMG Investments, although mainly via personal account or LP structures.

Remember when Third Avenue’s distressed debt fund had a liquidity mismatch problem and had to suspend redemptions? Mackenzie’s funds bid on the shares at a 61% discount to  NAV.  The offer letter reminds me of a vulture eating a vulture .