Investing Content / Podcasts
Special-sits, endurance, market structures, letting winners run etc
I took break from work & laptop & anything remotely “work type” this week, instead hiking the Mediterranean islands of Malta, Gozo and Comino. Having said that, I caught up on a lot of my reading and listening backlog. From the podcast episodes I heard during the past few days, some stood out as interesting content. Here is a quick round up, with my thoughts.
(pre-script: If you promise to read through the serious stuff, I promise to share more pics that will brighten your day, at the end of this post. No cheating..)
On market structures being “broken”
Here is the context behind the “fundamentally broken” thesis from David Einhorn1, while in conversation with Barry Ritholz:
There’s, there’s value is just not a consideration for most investment money that’s out there. There’s all the machine money and algorithmic money, which is, which doesn’t have an opinion about value. It has an opinion about price. Like what is the price going to be in 15 minutes? And I wanna be ahead of that or zero day options. What is the price of the s and p or whatever stock you’re doing for today, what’s it going to be in the next half hour, two hours, three hours? Those are opinions about price. Those are not opinions about value. Passive investors have no opinion about value. They’re gonna assume everybody else’s done the work, right? Right. And then you have all of what’s left of active management and so much of it, the value industry has gotten completely annihilated. So if you have a situation where money is moved from, from, from active to passive, when that happens, the value managers get redeemed, the value stocks go down more, it causes more redemptions of the value managers, it caused those stocks to go down more.
In essence what Einhorn is saying is that when value doesn’t return results, their funds are redeemed, causing even more selling pressure on their value funds, which in turn depresses other value fund managers’ results causing their funds to be redeemed. Vicious cycle.
Passive investors, or Index holders, or ETF holders, enjoy the exactly opposite phenomenon. Virtuous Cycle.
Obviously, the world isn’t black and white and it is not that value stocks are not held in indices and the “growth” stocks are not sold by investors. It is also the fact that there are ETFs for almost everything, including specific sectors and leveraged and inverse ETFs. So, in theory, investors can use ETFs in a myriad different ways to express opinions.
In reality however, vast majority of the ETFs are long-only ETFs and the biggest ones just about hold S&P 500 & NASDAQ-100. So vast amounts of money is just about holding 500-600 US stocks while everything else is being ignored and that’s a problem.
Add to this the fact that value often correlates very highly with small companies. Not 100%, but very highly, meaning you are more likely to identify a value company at 100M market cap than at $1Tn. If all of the big money however is just hugging the index, and index is concentrated about the big, trillion dollar (and some 100 billion dollar) companies, then who do you think you can flip your value investments to in the future?
And if you can’t, why would you bother buying them in the first place? What the value companies have started doing is to repurchase their own stock, and that might be a way to get paid, but it a lot of slow burn, while fund managers holding these stocks have to vie with other fund managers that are climbing stratospherically. If you are an individual investor with conviction, perhaps you can buy and hold the smaller, value stuff, but don’t expect the market to rerate any time soon. Fund managers have to do so at the cost of career risk, and that’s not going to lead to optimal decision making.
The way Einhorn describes it is interesting. Listening to the full episode might be worth your time.
On Special Situations
Andrew Walker, of Yet Another Value Blog, speaks to Bill Brewster on his public stance on the Spirit-JetBlue merger and his commentary on that not going through. The name “Special Situations” is given to a whole gamut of such trade scenarios -
merger / split / spinoff / privatisation arbitrage
bankruptcies
dual listing arbitrage / relisting arbitrage
etc etc
I dabbled a lot in this category between 2020 and 2022. I made money, which I would even label as “good money”. Not generational wealth, but the kind of money that I would be very happy if I could continue to sustain as the return on capital are outstanding.
However, Special Sits, have a problem. Most special sits tend to be high upside, high downside. Obviously, you use your information to make that biased in your favour and you try and play the trade as asymmetrically as possible, it still continues to be high upside, high downside.
The problem I had then was dealing with sequencing risk. Given that there is no permanent investment in this world and are constantly getting in and out, you are dependent on getting a mix of wins and losses at a rate at which your capital keeps growing. If you have a string of losses, it is tough to fathom the strength to keep allocating capital, even though the expected return, in statistical terms, might be the same whether the wins come first or the losses come first.
Hence I moved on to more Coffee Can style investing. But I still dabble in these once in a while, most recently in derivatives on Chinese Stocks (1, 2), but the capital at risk is a *lot* lower than before. And I sleep well at night.
(nb: In this episode, Andrew talks of Calumet, a MLP in the US with some interesting upside, but bad tax consequences for overseas investors. I dabbled in that too for a while before unwinding it when the tax treatment changed. Do your own due diligence, specially on the tax bits, #DYODD!)
On Endurance
In the veggies section of this episode, Jake Taylor talks about two skiers:
One with 20% win and 10% accident rate vs
Another with 15% win and 1% accident rate
Which one would you take?
That depends on whether you are picking a skier for a single race or a championship. For a single race, the former is optimal, for the championship, the latter.
Investing is also like this. Endurance of stocks is under-appreciated. If we stick to the analogy, and consider “win” is year-by-year return (or quarter-by-quarter, or even day-by-day if that’s what floats your boat) and “accident rate” is the probability of permanent loss of capital (or a marked decline in stock price), then your stock selection will wildly differ on whether you are investing for a single quarter (or week or day), or a few decades. Think about that. And listen to this episode too..
On Letting Winners Run
Andrew Walker, who featured in the second audio as a guest, is this time the host on his own podcast, where Alex Morris and Andrew discuss our favourite topic - Coffee Can Investing. I couldn’t have found a more topical share for this blog even if I tried.
Essentially Alex wrote this post on how Coffee Can style investing can work wonders:
and Andrew and Alex spent quality time when it may not work. Some interesting thoughts:
Coffee Can Investing works a lot better when you have a steady source of income (from your regular job or other investments, like a business) that allows to keep buying fresh positions. This allows you to rebalance, which you won’t have the option to do under normal CCP style investing. I think this is a very valid point.
Selection/Survivor Bias: Most of the Coffee Can investment literature is based on successful outcomes for those who succeeded with this approach. What if your stock selection was soo poor that there were no winners? Or the investor continues to be obsessed with Chinese securities (1, 2) when it has truly become “uninvestable”, like yours truly? Again valid point.
What happens if one of your positions become 50% of your portfolio because it grew so much? What if it becomes 90%? or 99%? If you are going to lose sleep over what might happen to your portfolio because of what might happen on one stock, then perhaps something should be done about it? Again valid point.
Some valid points to ponder about Coffee Can investing.
I will leave you with these to ponder for the time being. As always, happy investing!
Pics
As promised at the beginning of the post, here are some pics from my hikes this week:
Credit: Official Transcript