Thursday, December 31, 2020

Being Relieved and Reassured When I am Wrong

Considering the realm of points of view where thoughtful minds can disagree, we simply cannot have very much confidence that all of our views are correct and justifiable. In fact unfortunately it is likely that we are right only half of the time, an epistemic coin flip. Therefore, it should be reassuring when we discover areas within this realm where we are incorrect because then we can have more confidence in our other points of view being true. 

Similarly I take comfort when I find error or at least disagreement with the intellectuals I follow and admire. This lets me know I am thinking critically, which holds even if they are right and I am wrong. 

To make sure I am not just stubborn and cherry-picking my points of agreement, I always seek to change my mind (2020 edition coming soon). And by the same token, we must be careful not to use this as a cognitive bias giving confirmation and validation to views we should now doubt. 

If there are correlations and other entanglements between points of view, doubt cast upon one of these casts doubt upon all of them. Being wrong about one part of a system probably means one must be less confident in one's views about the other parts of the same system and perhaps wrong about the system itself. The Bayesian updating is a sticky wicket. 

P.S. One recent example for me was listening to an episode of The Libertarian Angle podcast.  The host Jacob Hornberger is someone for who I very much align in my view of the world. He ran in 2020 to be the Libertarian Party's presidential candidate. If he would have won, I would have gladly voted for him. In fact I would have ideologically preferred him as the actual candidate over Jo Jorgensen (Jorgensen was probably the better candidate for general electoral appeal). Yet he has strong beliefs with high confidence that the JFK assassination was a regime change conspiracy done through the CIA and the rest of the national security state. The case he makes causes me to adjust my views slightly but only slightly. I can believe there was unacted-upon desire to thwart Kennedy's foreign policy changes (Kennedy was making concrete movement away from war and hostility). I just don't believe this materially came together in a conspiracy of action. 

Listening to Hornberger gave me a bit of a challenge to my priors about the Kennedy assassination as he is very much more informed about it than am I. At the same time I didn't change my mind and adopt his view. If we do finally someday get a release of the classified records from the assassination (Trump surprisingly agreed to extend the classified status in 2018 until 2021), I might discover I was completely wrong. Either way I'm relieved and reassured because it shows I am not simply outsourcing all of my views to my intellectual heros, and if I am wrong about this, I can have more confidence in the areas where Hornberger and I are in agreement. 

Saturday, December 26, 2020

Three Characters From Bewitched Have Taken Over America

I know this is a hopelessly-dated allusion, but it is important that we remember the great works of fiction and see how they are commentary on real life. 

Although Bewitched first aired a bit before my time, it was in afternoon reruns when I was in my formative grade school years. In addition to the pure entertainment value of this sitcom, it was good for a young kid to learn from some of the characters in this show. Notably, the caricatures of the Larry Tate, Gladys Kravitz, and Endora.

For those who don't know exactly what I'm talking about, let me explain. 

Larry Tate is the boss of the show's main male character, Darrin Stephens. Larry is a rudderless client yes-man obviously willing to do anything and everything a client asks no matter the cost. He will turn on a dime to agree with a client even if it awkwardly and obviously makes him contradicts himself. It is not that the customer is always right. It is that he doesn't really care about the customer's needs. He only wants the customer's business. This means he would gladly let a client make a mistake as long as it meant Larry gets the business. 

Larry Tate is seen today in all those who so willingly and easily succumb to the demands and desires of those in power and authority. Read this how you like, but I see it in those who would wear a mask in the shower if Dr. Fauci so commanded along with those who would believe aliens (space or illegals) voted repeatedly, fraudulently for Joe Biden. 

Gladys Kravitz is the nosey neighbor who thinks everyone else's business is her business. She freaks out about other people and the goings on around her on a regular basis. 

Mrs. Kravitz is seen today in every so-called Karen and other busybody who so much wants to patrol, police, and protect other people's lives. Less someone point out the gaslighting that poor Kravitz endured, I will admit that She Was Right! in her observations at least. But she was not right to be minding other people's concerns. Adults should be allowed to make their own mistakes, and we should defer to others with respect to their own choices. We likely do not know best for other people. Whether she is on the local zoning board or guiding health policy (be it for cocaine and vaccines or for social distancing and ruling business essentialness), Gladys Kravitz doesn't see it this way. 

Endora is the mother of the main character, Samantha Stephens. Endora believes herself to be quite superior to mortals. She would be quite happy to control and command all of her daughter's life as well as any others who got in her way. She wasn't always harsh about it instead using charm and seduction more often than brute force.

Endora is seen today as always in government at so many levels. She will steamroll over the lives and desires of Samantha and Darrin (people everywhere) if it serves her. She seduces the Larry Tates of the world and uses the Gladys Kravitzes of the world preying upon their respective weaknesses. The effect of government is Endora, but the composition of government is individuals. Those individuals are not fully Endora by themselves, but when good intentions are combined with poor incentives and weak principles, the outcome is Endora.

Partial List of Current Practices Future Humans Will Detest as Immoral and Indefensible

I've speculated on this before, as have others. As we sit anxiously awaiting a new year so as to put the current one behind us, this thinking is on my mind. None of these are specific to this year, but I could write and probably will write soon on my hope that many things about this year will someday (hopefully soon but unfortunately not soon enough) be thought of as abhorrent or at least a very, very poor use of cost/benefit analysis.

Here is the short but important list:
  • Abortion
  • Immigration restrictions (especially for those seeking to escape poverty or tyranny)
  • Trade restrictions (to a lesser degree)
  • Tolerance for people living (anywhere) involuntarily in a condition of (meaning without a reasonable ability to escape) extreme poverty (coupled with no acceptance for ignorance as to the solution for extreme poverty--we know how to fix this--free markets and free minds)
  • Living conditions of the institutionalized elderly
  • The death penalty
Short note on abortion (perhaps the most controversial item on the list): Nearly all of the arguments in favor of abortion today sound to me very similar to those arguments made contemporarily to and in apologetic memory of slavery.

Friday, December 18, 2020

Does Active Investing Work in Theory?

We know active investing almost always doesn't work in practiceThe vast majority of professional money managers underperform their respective index over meaningful periods of time. Let that sink in. Compared to what we could easily do on our own through indexing, most of the people we pay very large sums to invest our money give us back less after they do their job and take their fee. For those few that do, we say they earn alpha--return in excess of the market for the same level of risk taken. 

As a side note realize something. Your Uncle Fred with all the great stock picks or your friend who just quit his job to start day trading and who has actually has been making money trading stocks, bonds, options, or whatever HAS NOT been taking the same level of risk as any index. Those two happen to be winners in a likely random pool of many people taking on tremendously more risk than they realize. If 10,000 people all flip coins ten times in a row, some of them almost certainly will get ten heads in a row (singularly by itself a 1 in 1,024 chance). 

However, I am focused on professionals here. Guys and gals who dress sharp, use all the right jargon, are actually highly intelligent and reasonable, and who most of the time lose money for their clients. Perhaps their clients are buying something else than returns [paging Robin Hanson--investing professionally isn't about making money]. Highly likely in many cases. It feels good to deal with these pros. Plus they can in fact help investors stay disciplined--better to make 5% versus the benchmark's 6% over 10 years than to bail out when the market declines and earn only 1% over that same 10 years. Fortunately for EMH and unfortunately for this theory, this affect has been shrinking to recently be nearly nothing.

So, while active management doesn't work in practice, does it work in theory? Start with the assumption of a manager that can consistently and reliably earn 1% alpha. When her benchmark is up 6%, she is up 7% on average. Why does she need your money? 

I can think of two likely reasons:
  1. She could want to use it to reduce her own risk. 
  2. She could have more opportunity than she can herself realize.
Notice that these are not altruistic motivations. The first is fairly unfavorable for the client--you are giving her money not for your benefit but for hers. She uses the additional funds to smooth out the volatility in her own income. When you pay a management fee to her, you are directly subsidizing her income. And just the use of the funds themselves is an indirect subsidy allowing her to invest more broadly. All of this might be justified if the second reason holds.

In the second she only would invest your money once she has invested all of her own money including all the money she can borrow at less than the total return of the investment, which is the market return plus alpha (6% plus the 1% in this case). Theoretically and in practice she will charge you a small fee to cover transaction cost plus a little profit to her to let you participate in her investing endeavors. Yet as we saw in the first reason she should probably be paying you as you are giving her a benefit of lower risk in the form of a smoother income stream.

Essentially this is an arbitrage which we know is going to have a limited capacity. Even if she is in that elite company of professionals who can outperform the market, her last idea (say the last stock her analysis says to buy) will be her worst idea and only be at best just as good as the market itself. It seems very likely by the time she gets to your money, we are firmly in reason-one (personal risk reduction) territory. 

This is quite damning for professional money management--in theory. What might save it and asset managers like myself who do in fact invest client money with money managers? 

First, we must admit just how challenging it is to find professionals who can outperform the market. Second, we must consider that the first reason above, income-smoothing risk reduction, might actually have a win-win aspect to it. Yes, she does enjoy less risk by using your money, but she doesn't get this for free. In fact she is probably risk averse enough that the second reason doesn't hold firmly.

Rather than fully lever all of her available resources--put her risk at ludicrous speed--she would likely prefer giving you most all of the risk of her performance and collect a steady fee for doing so. She is giving up the potential for return upside so that she has only very little downside risk. This flips the concern from being a pure doesn't-work-in-theory problem to being a pure principal-agent problem. sigh We can't catch a break. Now we have to worry that she isn't incentivized properly to continue to do what we hope she can do--outperform the market at the same level of risk. But at least we partially rescued active management in theory.

As bad as this is (in theory), this is in public market active management. The same forces are at play plaguing private markets like private equity and private debt. At least public markets are not opaque, very hard to benchmark, illiquid, et al.

Sunday, December 13, 2020

I Was Desperate. Honestly Afraid. And Completely Helpless.

At first it was gradual, and then all of a sudden it was acute. I could be blamed for putting myself in such a position--at least it was somewhat my fault. But live long enough and you'll inevitably find yourself at the mercy of those around you, willing and desperate to take their help, and completely without options. 

It was late. Very late. And I was on a rain-drenched highway. Tired. Unable to go farther. And very hungry. 

I hadn't called ahead because I hadn't planned to be there. But there I was on a highway in the middle of nowhere Texas. To say I was between large cities was both true and meaningless. The middle of the Pacific Ocean is between large civilizations. 

I am a strong believer in the power of the consumer--that if you shop around and negotiate, you can drive a great bargain. But I was at the mercy of the supplier--a mere price taker that night. 

A warm meal, a dry bed, a safe place. My needs were a short list. Yet not fulfilling each would be critically bad. Drive on and the risks grew exponentially. Try to negotiate a better deal, and my only options might evaporate before my desperate eyes. 

Any slightly observant person could see my position of weakness. Any slightly opportunistic person could sense my vulnerability. So how bad did it get?

Not too bad at all under the circumstances. The motel owner had stayed up late, as it turns out, just for me on the off chance I would be there in need of his accommodations. His accent made clear he and I were not born and raised in the same place. I was a stranger on his doorstep, but he welcomed me as one would a good, long-time acquaintance. I paid him $159 for a room with a hot shower and comfortable bed I would use for the next 8 hours. After, he (or his staff) would have to clean it up restocking and doing laundry. I would leave without saying goodbye. 

Before that shower, I needed food. Two in the morning is not when many meals are served as evidenced by the many closed restaurants. No one ever starves missing one meal, but it can be quite unpleasant to do so. And good decisions are not made on an empty stomach and a poor night's sleep from the same. The 24-hour restaurant made sure that wasn't my fate. I was their only customer in the 45 minutes I spent. At least three people (couldn't tell if there were more in the back) gave me nourishment and quiet companionship all for the price of $23.

The morning sun brought a new day and a fresh outlook. My car was safely waiting untouched for my departure. I grabbed coffee and a Danish set out for me at the motel before dashing out the door. A quick fill up at a gas station meant I could be on my way not needing to stop for hours. 

I felt slightly uneasy leaving so abruptly that morning. Guilty would be too strong a word, but I was dashing off having taken so much from so many who were so generous to have provided it for so little in return. I can't imagine I'll ever be back on that same highway, and even if I am, it is unlikely I'll ever stop in that little spot again. I hope someone else can do a little more someday to take care of the people who took such good care of me.

P.S. This post's story is truish. It is a amalgamation of true prior experiences in my travels for the purposes of making a point. Life is tough--use markets.

Highly Linkable - the homepage edition

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Friday, December 11, 2020

It Takes a Cynic

I have long been accused of being cynical, and while I will cop to it, I have always maintained that to the degree I am it is a good thing. 

Think of it as the combination of Hanlon’s Razor and Occam’s Razor: the most obvious, self-centered explanation should be considered the most likely until reasonably ruled out. 

This point of view has its dangerous downside. Namely, one can fall into an ugly attitude or a jaded viewpoint that never sees things with an open mind. I strive to avoid this helped a lot by my natural optimism. 

When done appropriately, cynicism has great benefits. Frankly, it cuts through the crap. And it starts one out from a position of epistemic strength as it protects against the fraud of social desirability bias.

In fact I would go so far as to say any analyst worth his salt takes a cynical approach. Let your mind's eye have a cocked eyebrow--it will help keep you from being duped. 

What first got me thinking about this recently was listening to Steve Levitt's story in a recent episode of Freakanomics about advising a firm years ago regarding their advertising budget. The key part was this: 
LEVITT: They said, “Are you crazy?” It was almost if they found out they didn’t work, it was far worse for these people than it was not finding out it didn’t work. Because then they had to explain why for the last 15 years they had been wasting $200 million a year. So, they were happy to just live in a world in which as long as there were ads in every market, every Sunday, life was good.
Or when he says it more plainly in episode 2
LEVITT: If you think about it, no chief marketing officer is ever going to say, “Hey, I don’t know, maybe ads don’t work. Let’s just not do them and see what happens.” So, don’t get me wrong. I’m not implying that advertising doesn’t work. I’m implying that we don’t have a very good idea about how well it works.
Add to that this interesting monologue from Dave Chappelle in which he is arguing, unsuccessfully in my opinion, that we should not watch his former show on any streaming network. The part related to this post is his description of the Three-Card Monty scam and that as a analogy for how the [media] industry works. And also, this point: "Never come between a man and his meal." 

If you want to know what underlying motivation is driving a given set of actions, ask yourself first who is standing to gain (or avoid loss).

My cynical demeanor is probably why The Elephant in The Brain resonates so strongly with me. Seeing that X is not about X is a red-pill superpower. 

It is also why I see recent examples from sports like the gyrations in college football's season cancelled/starting/stopping in 2020 and Duke choosing not to play its remaining non-conference games in 2020-21 basketball season for what they are--selfish ploys by powerful vested interests.

Being cynical has its challenges, but it also has its benefits that are underrated. 

Sunday, December 6, 2020

Walter Williams, R.I.P.


Walter Williams, one of the greatest communicators and expositors of freedom and economics, passed away this week. While I never had the pleasure of being in his classroom, he was quite certainly a teacher to me. My first encounters with his work were reading his articles in The Freeman and his republished op-eds in the Conservative Chronicle as well as attentively listening when he would fill in for Rush Limbaugh. Over time as I became enlightened, with no small part guided by Dr. Williams, it was only his moments filling in for Rush that I would find that show meaningful.

He was a teacher directly to many teachers I have had including ones who entered his classroom avid Marxists and exited passionate free-market capitalists. 

I strongly encourage you to read Don Boudreaux's tribute to him in the WSJ as well as watch the short documentary, Suffer No Fools.

For more tributes, see this list.

May he rest in peace, and may his great work, wonderful spirit, and inspirational message live on.