[The Weekend Bulletin] #171: Everything Must Be Paid For Twice, Upside Capture or Downside Protection, 10% or 10x,...

... Simple Questions and Big Innovations, 15 Lessons and Frameworks from 15 Years, Reading Filter, Lessons from an Investor's Biggest Mistake, and more.

A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.

Investing Wisdom

• This case study of an investing mistake provides some interesting insights. First, it shows why investing is simple, but not easy. Second, it shows how mistakes are unavoidable in this game. Third, it provides some lessons in how the cost of failure can be managed through position sizing. Lastly, it demonstrates how sometimes long term investors overstay a position in the hope of things eventually working out (the current price reflects the problem, but under-appreciates the business). I am reminded of a quote by Fancois Rochon here:

  "Our bias toward buying and holding has at times made us too quick to rationalize a problem that hits one of our companies as temporary and “already priced into the stock.” If the problem turns out to be more long-term and fundamental, it’s likely not fully discounted into the current price at all. We’ve been blind at times to fundamental changes in a company’s business because we think the quick 25-30% drop in the share price makes the stock too cheap to sell."

• An investor looks back at 15 years of investing to draw some lessons and frameworks in this article. Some highlighted snippets below:

  "It is easy, in a backtest, to look at the multi-year drawdown of a low-Sharpe strategy and say, “I could live through that.” When it’s a multi-decade simulation, a few years looks like a small blip – just a statistical eventuality on the path. You live that multi-year drawdown in just a few seconds in your head as your eye wanders the equity curve from the bottom left to the upper right. In the real world, however, a multi-year drawdown feels like a multi-decade drawdown"

  "Ultimately, I developed my view that diversification was three dimensional: what, how, and when.

  What is the traditional diversification almost everyone is certainly familiar with. This is the diversification across securities or assets. It’s the what you’re invested in.

  How is the process by which investment decisions are made. This includes diversification across different investment styles – such as value versus momentum – but also within a style. For example, how are we measuring value? Or what trend model and speed are we using?

  When is the rebalance schedule."

  "A corollary to this point is what I call the frustrating law of active management. The basic idea is that if an investment idea is perceived both to have alpha and to be “easy”, investors will allocate to it and erode the associated premium. That’s just basic market efficiency.

  So how can a strategy be “hard”? Well, a manager might have a substantial informational or analytical edge. Or a manager might have a structural moat, accessing trades others do not have the opportunity to pursue.

  But for most major low-frequency edges, “hard” is going to be behavioral. The strategy has to be hard enough to hold on to that it does not get arbitraged away.

  Which means that for any disciplined investment approach to outperform over the long run, it must experience periods of underperformance in the short run.

  But we can also invert the statement and say that for any disciplined investment approach to underperform over the long run, it must experience periods of outperformance in the short run.

  For active managers, the frustration is not only does their investment approach have to under-perform from time-to-time, but bad strategies will have to out-perform."

• In his latest memo to investors, Howard Marks ruminates on a very important questions - should we focus on maximising the upside, or minimising the downside. He discusses the trade-offs in each case, and concludes that while you have to choose one over the other, neither of them singularly solves the problem. Like most things, the answer depends on the person asking the question, and, the truth lies somewhere in between.

  https://www.oaktreecapital.com/insights/memo/fewer-losers-or-more-winners

• Thanks to the internet, there is so much information that we are bombarded with all the time. Such an overflow of information requires us to have a good filtering system. As we discussed in #165, 'Choosing what to pay attention to is hard, but the best strategy is the idea of a wide funnel and tight filter.' One such filtering system is discussed in this short note. Although it pertains to financial news, its application can be broadened with a few minor tweaks.

Mental Models & Behavioral Biases

• We've usually read about the benefits of small incremental changes - the power of compounding small benefits over long periods of time. While that has its own benefits, there are times when you need to think radically different, rather than in increments, as per this article. Using examples of corporate success and failures, the author argues that companies should think about 10x improvements rather than marginal 10% improvements.

• On similar lines as the above article, this one looks at some simple questions that have led to path-breaking innovations in the past. Of course what looks like simple questions with the benefit of hindsight are not all that simple in reality. However, the lesson here, like in the earlier article, is to often pause and think outside the box. The key question is how would this look if done differently?

Personal Development

• This article claims that we pay twice for all our possessions. While the first price is the monetary value that we pay, that is less important than the second price that we pay. However, since the first price is easily quantified, we pay more attention to it, while ignoring the value of the second price that we pay. The authors explains the problem and provides a simple solution to overcome the problem.

Blast From The Past

Revisiting articles from a past issue for the benefits of refreshing memory and spaced repetition, as well as for a fresh perspective. Below are articles from #95:

• Investing is all about the future, and the future is unpredictable. In addition to this the general over-confidence that we have on our own ability as well as our over- optimism/pessimism about the future, makes forecasting future growth an ardent task. While there is no exact science to forecasting, the following five part series lays out a simple frame-work to reduce such forecasting errors:

  • FORECASTING GROWTH PART I: THE SIREN SONG OF GROWTH - we are all forecasters, whether we explicitly forecast or not. We are usually over-optimistic about the future, making forecasting error-prone.

  • FORECASTING GROWTH PART II: USING BASE RATES - the inside view and the outside view in forecasting.

  • FORECASTING GROWTH PART III: PROBLEMS WITH BASE RATES - whats good about base rates is also a problem with them.

  • FORECASTING GROWTH PART IV: BEYOND BASE RATES - marrying the inside view with the outside view.

  • FORECASTING GROWTH PART V: CATEGORY KILLERS & POSITIVE FEEDBACK LOOPS - when to ignore base rates.

• Morgan Housel is a master story-teller, and one of the best financial writers of our time. In his latest, he draws two lessons from nature about cycles and compounding. A very insightful read.

• This short note presents some very interesting data on multi-baggers. It shows that multibaggers are not that rare - about 45% stocks increased their market values by 5x, 30% of those increased their market value by another 5x, 30% of those increased their market value by another 5x, and so on... Does this mean that multi-baggers are easy to find, or that using a momentum strategy, if you buy stocks that have increased their market value by 5x recently, you will end up multiplying your wealth at a similar rate in the future as well? The article will tell you why it isn't so easy.

• More the merrier has been a long held belief of mankind. From hunter-gatherers, we have evolved into consumers and hoarders. This belief also extends to our network of influence. With the proliferation of the internet and the advent of social media, we are constantly increasing the size of our networks. However, if experts are to be believed, when it comes to our networks, the smaller the better. This article explains why.

Readworthy Passage

Let's read together a random, but read-worthy, passage from a randomly picked book.

“Because happiness requires struggle. It grows from problems. Joy doesn’t just sprout out of the ground like daisies and rainbows. Real, serious, lifelong fulfillment and meaning have to be earned through the choosing and managing of our struggles. Whether you suffer from anxiety or loneliness or obsessive-compulsive disorder or a dickhead boss who ruins half of your waking hours every day, the solution lies in the acceptance and active engagement of that negative experience—not the avoidance of it, not the salvation from it.

People want an amazing physique. But you don’t end up with one unless you legitimately appreciate the pain and physical stress that come with living inside a gym for hour upon hour, unless you love calculating and calibrating the food you eat, planning your life out in tiny plate–sized portions.

People want to start their own business. But you don’t end up a successful entrepreneur unless you find a way to appreciate the risk, the uncertainty, the repeated failures, the insane hours devoted to something that may earn absolutely nothing.

“People want a partner, a spouse. But you don’t end up attracting someone amazing without appreciating the emotional turbulence that comes with weathering rejections, building the sexual tension that never gets released, and staring blankly at a phone that never rings. It’s part of the game of love. You can’t win if you don’t play.”

“What determines your success isn’t, “What do you want to enjoy?” The relevant question is, “What pain do you want to sustain?” The path to happiness is a path full of shitheaps and shame.”

- From The Subtle Art of Not Giving a F*ck by Mark Manson

Quotable Quotes

"If a plant only gets sunlight, it’s very harmful. It needs darkness too…In the darkness, it converts oxygen into carbon dioxide. We are like that too. We need periods of doing & periods of non-doing.”

- Robert Pirsig

"The greatest revelation of our generation is the discovery that human beings, by changing the inner attitudes of their minds, can change the outer aspects of their lives."

- Caroline L. Arnold

(Small Move, Big Change)

"One sign you haven’t done enough reading is if you find yourself agreeing with whatever book you read last. At first, it’s easy to be swayed by any reasonable argument. Once you’ve read a lot, you can see that even the best arguments have limitations."

- James Clear

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That's it for this weekend folks.

Have a wonderful week ahead!!

- Tejas Gutka

[Sep 16, 2023]