Monday, December 21, 2015

Books I Enjoyed In 2015

The end of the year is rapidly approaching, and it looks unlikely I'm going to add to this list in the next few days. I modified this list somewhat from last year's in that I decided to include titles that I wasn't reading for the first time. I define "2015 Favourites" as books I can see myself re-reading, while "Honourable Mention" names are things I enjoyed but am unlikely to tackle again. Happy reading, and a very happy end to 2015 to one and all!

2015 Favourites

The Incredible Shrinking Alpha (Swedroe & Berkin): A quick and readable survey of the challenges facing active asset management. Anyone engaged in active management simply must grapple with these issues, as a matter of intellectual and professional honesty as well as to consider the business challenge posed by passive management strategies (be they indexers or rules-based quantitative strategies). Swedroe is a good follow on Twitter too.

The Greatest Trade Ever (Zuckerman): I have a longer post on this one, but it's just a terrific read to understand John Paulson's stupendous success in profiting from the housing debacle of 2007-2009. As I say in the other post, it's hard to write a page-turner about credit derivatives, but Zuckerman does an amazing job.

Efficiently Inefficient (Pedersen): This is a clear and entertaining read on hedge fund strategies. It features interviews with some of the leading lights in the hedge fund world, though I must confess I was a little disappointed with some of the interviews. The main material is excellent, though.

Becoming Human (Vanier): I first heard of Jean Vanier through an "On Being" interview. A philosopher and Catholic social innovator, he started the L'Arche movement for people with intellectual disabilities. His simplicity and compassion were deeply moving.

The Dhandho Investor (Pabrai): I have long heard of Pabrai's book, and finally got round to it this year. I wish I'd read it earlier. It's funny and readable, but a deeply wise book on value investing. His mantra of "Heads I win, tails I don't lose much!" is as good an explanation of how to think about achieving asymmetry in investing as you'll hear anywhere.

The Art of Charlie Chan Hock Chye (Liew): In a year when my beloved Singapore celebrated her 50th anniversary as an independent nation, this sharp graphic novel traces the country's history in parallel with a fictional graphic artist.

The Looming Tower (Wright): Everyone wanted to talk about ISIS this year, but I was a few steps behind. I bought this thinking it was an account of the 9/11 attacks, but it was much, much more. A wonderfully crisp read on the rise of modern Islamic fundamentalism and al-Qaeda.

The Outsiders (Thorndike): An excellent book on how contrarian CEOs created shareholder value, recommended by no less a luminary than Warren Buffett. It's a shame that most CEOs (and boards) think "capital allocation" = doing share buybacks when their stock is at record highs, rather than when it's the most accretive to shareholders.

Buddhism Without Beliefs (Batchelor): Batchelor is one of the giants of secular Buddhism, the movement that distills the wisdom of Buddhist thought while shedding traditional Buddhist ritual and beliefs on cosmology and reincarnation. In this volume, he makes a strong case for understanding the historical and social context in which Buddhism developed. As good as I remembered the second time round.

A Guide to the Good Life (Irvine): This is a wonderful introduction to Stoic philosophy, updating an obscure and misunderstood set of beliefs for modern times. The parallels between Stoicism and Buddhism are interesting, and goes to show you can find wisdom in disparate places if you look hard enough.

Superforecasting (Tetlock): Quite simply a must-read on decision-making and prediction. I think this is one I will read and refer to many, many more times.

The Alliance/ The Start-up of You (Hoffman/Casnocha): I enjoyed these two books by the LinkedIn founders. At times they seem a little too much like ads for LinkedIn, but I think there's a lot of wisdom in here about how to think about careers and organizations in the modern world.

The Essays of Warren Buffett: Buffett is so well-covered that it was hard to imagine that there would be much original in this collection, but I still found it useful and insightful. I did a longer post on the key messages.

Honourable Mention

Exorbitant Privilege (Eichengreen): It's really hard to write a book on the international monetary system for popular consumption. I think Eichengreen does a pretty good job here, although some may prefer a deeper look at specific events (e.g. Ahamed's Lords of Finance and Connolly's Rotten Heart of Europe). Reading it in 2015, it's funny how the book was written at a period of extreme concern about the dollar - something which seems to have vanished from the mainstream. But who knows what people will say in 5-10 years?

Poor Economics (Duflo & Banerjee): I've been hearing about Duflo & Banerjee's work for years, and enjoyed their take on the global fight against poverty. So much of what we think we know about poverty, and the poor, seems to be wrong, but it's gratifying to see people tackling the field in novel ways.

The Hard Thing About Hard Things: Entrepeneur and venture capitalist Ben Horowitz writes about his experiences in the business world. There are some great anecdotes and lessons here. Definitely one for those interested in start-up world.

Leaving Alexandria (Holloway): I've had this on my reading list for ages. In 2003 or so, I discovered a book called "Godless Morality", and was stunned to discover the author was the Bishop of Edinburgh. Since then I have been an avid consumer of Holloway's talks. This autobiography details his eventual departure from the church. While my thinking on religion is more in line with Holloway than Vanier, I preferred the simplicity of the latter's prose. Still, there was much to appreciate here.

The Novice (Schettini): Continuing the theme of those who had given up the robes, Schettini recounts his life as a Buddhist monk. Like Holloway's book, there was much to enjoy, even if the prose wasn't always quite to my taste. The epilogue was my favorite part of this, with Schettini describing the changes in his life after giving up the robes. A shame it's a relatively small part of the book, but it would be impossible to really understand without hearing first about his prior journey.

Benjamin Graham and the Power of Growth Stocks (Martin): This is an unusual take on Ben Graham as a growth investor. Martin argues that the 1962 edition of Security Analysis reveals Graham's shift in investment philosophy.

Damn Right! (Lowe): I hadn't read this since 2006, but decided to pick it up again as I re-explored the value investing classics. I found I enjoyed it less than I remembered. It's possible that Munger has become such a popular subject in the past 9 years that this edition no longer seems quite as original. Still, always worth a read for Buffett/Munger fans. And for those relatively new to the world of investments, it's a wonderful reminder that Munger didn't meet (and go into business with) Buffett till he was 36 years old, which seems positively ancient in the modern age of 30 year-old hedge fund wunderkinds.

The Education of a Value Investor (Spier): Part autobiography, part investment guidebook, part discourse on the good life. Spier's honesty was refreshing. This led me to Pabrai's book. The friendship between the two investors inspired a longer post as well.

Monday, November 2, 2015

Pattern-Seeking, Story-Telling Animals

One of my favourite quotes about macroeconomics comes from Ed Leamer, who wrote, "We are pattern-seeking story-telling animals." The brilliance of this quote (which he originally heard from a radio commentator) is that it applies to many other aspects of human thought, such as physical and social science, as well as religion. I've been thinking this week about the ways in which we seek patterns and tell stories, both in trying to understand past events and trying to predict future ones. The original impetus was a captivating talk by Bruce Riedel on JFK and the Sino-Indian crisis of 1962. One of the most remarkable things about this crisis is how many unanswered questions remain, despite it involving some of the world's largest and most scrutinized countries, and the passage of more than 50 years. Many questions will never be answered. These are the hypothetical "what if?" questions that are amusing fodder for speculation but will never be answered definitively.

I was reminded of a wonderful passage from Ed Catmull's "Creativity, Inc." (a book I wrote more about last year). Catmull writes:

"In thinking about...the limits of our perception, a familiar, oft-repeated phrase kept popping into my head: "Hindsight is 20-20." When we hear it, we normally just nod in agreement - yes, of course - accepting that we can look back on what happened, see it with total clarity, learn from it and draw the right conclusions.

The problem is, the phrase is dead wrong. Hindsight is not 20-20. Not even close. Our view of the past, in fact, is hardly clearer than our view of the future. While we know more about a past event than a future one, our understanding of the factors that shaped it is severely limited. Not only that, because we think we see what happened clearly - hindsight being 20-20 and all - we often aren't open to knowing more. "We should be careful to get out of an experience only the wisdom that is in it - and stop there," as Mark Twain once said, "lest we be like the cat that sits down on a hot stove-lid. She will never sit down on a hot stove-lid again - and that is well; but also she will never sit down on a cold one anymore." The cat's hindsight, in other words, distorts her view. The past should be our teacher, not our master."

The Catmull quote identifies 2 distinct issues related to hindsight:

1) Looking back and thinking something was obvious, when it wasn't
2) Looking back and drawing the wrong lesson, i.e. that the future will resemble the past.

It's easy to look back at a 10-year chart of the S&P and think to oneself how easy it should have been to have picked the bottom on Mar 6 2009. Indeed, I have lauded the courage of investors who were steadfastly buying cheap securities in the face of financial panic. But only some of these people are worthy of praise. I think of these as mainly being (a) those who made well-reasoned estimates of valuation, (b) those who understood the likely mechanisms of QE and Fed policy, and (c) those who, for other, thoughtful reasons decided that the odds of investing were in their favour. The common thread is that these groups relied on facts as the inputs to weigh the odds of investing. This is intelligent speculation rather than hopeful gambling.

The fact of the matter is that it was far from clear that the economic and financial panic were over. Most investors faced genuine uncertainty as to the efficacy of Federal Reserve policies, and the implications for financial assets. One of many communication problems we have in finance is the double meaning of the word "cheap". Some mean it to mean "low-priced". Many mean it to denote "lower than fair value". I prefer the latter definition, and by that definition, assets are cheapest not when their prices are the lowest, but when their prices deviate most significantly from an informed view of their true value. Apart from the groups listed above, there are others who may have bought in the depths of 2009, but were merely lucky (or perhaps foolhardy). For some, the lesson was to buy the dip, and in particular the most leveraged, economically sensitive assets. I hardly recommend that lesson. For others, hindsight has taken the form of stricter drawdown control measures, and a heightened jumpiness when faced with any market turbulence. These nervous investors seem sure to forego the benefits of long-term compounding as they sell winners prematurely.

It seems to be that the follies of hindsight and extrapolation are closely related. John Templeton reportedly said that the four most dangerous words in investing are "This time it's different." This is usually taken to mean that only the foolish ignore the fact that asset prices are cyclical, and mean-reverting. To me, this is second-order thinking and assumes the deluded investor has enough knowledge of history to believe that this time will be different. I actually think most people respond in a far simpler fashion. The more dangerous words for them are "this will go on". Most people are probably not as greedy as we may them out to be after the bust. Rather, they make the perfectly understandable error that the future will look similar to the recent past. Nominal GDP will grow at rates similar to the past. Interest rates will look similar to the past. Corporate profits and economic moats will look like they did in the past. Markets will look like they did in the past (up, down or flat depending what they looked like most recently). Megan McArdle had it spot on when she wrote: "Bubbles are not fundamentally about evil people doing evil things. They are not even about stupid people doing stupid things. No, the problem with bubbles is worse: It's quite ordinary people, doing stupid things that a trick of the light has made appear very smart."

I don't have any bold prescriptions for these problems. Acting in an unknown and unknowable environment is the central problem of investing. I defer here to the thinking of Richard Zeckhauser, who says some very interesting things in "Investing in the Unknown and Unknowable" (some of which the most conservative value investors will disagree with). Nassim Taleb is clearly another deep thinker on these issues. My modest additions include the recommendation to document our beliefs in real time, and judge ourselves honestly on how events match up to our predictions. Another of my favourite quotes is physicist Richard Feynman:"The first principle is that you must not fool yourself - and you are the easiest person to fool." It's also an argument for focusing on process, rather than individual outcomes. But again, caution is warranted: the process should be well thought through, and not merely "Sell when the market is down X%" (the investor's version of "Don't sit on stove-lids"). This focus on process makes us simultaneously harsher on ourselves, when we've been lucky rather than good, and more forgiving, when we made the best possible (but ultimately wrong) decision with the information available. If we can avoid getting knocked out of the game on any one bet, a robust process should deliver returns over time.

But don't take it from me. I'm just another pattern-seeking, story-telling animal.

Monday, October 19, 2015

The Third Emotion of Investing

It's often said that financial markets are driven by two competing emotions, greed and fear. Skilled investors attempt to control these emotions, and to capitalize on the failure of other investors in that regard. Warren Buffett has repeatedly said that while he focuses on fundamental value, his behaviour is dictated by a simple dictum: "Be fearful when others are greedy, and be greedy when others are fearful."

There's a third emotion that requires constant management: boredom. 

It's exciting when assets go up or down by a lot. Generally, they don't. It's boring to watch things that don't do much in a hurry. And it's boring to wait for the market to validate your assessment of fundamental value. 

It's boring to sift through financial statements or filings and then discover a company is fairly valued. It's boring to wait for a better opportunity to purchase an asset. It's boring to own a company that has excellent prospects but that no-one has ever heard of (or is likely to ever hear of). It's boring to remain invested in a company that is quietly compounding its value (and whose business you understand well), when new opportunities appear more alluring. It's boring to invest the same way you always have, when the world around is full of "sophisticated" investors raising a lot of money for complex strategies. 

Sitting through long periods of boredom is a prerequisite for the fundamental investor. Dealing with this boredom is every bit as important as avoiding being swept away when valuations are high, or being decisive when it seems like businesses, economies or financial markets will never improve. 

Pascal said, "All men's miseries derive from not being able to sit in a quiet room alone." I doubt he had investment portfolios in mind, but subduing the third emotion of investing goes a long way to preventing misery of the financial variety.

Sunday, October 11, 2015

Sometimes An Investor Wears A Mask So Long...

The debate over "nature vs. nurture" pervades biological science and the social sciences. Unsurprisingly, the debate even wends its way into the world of investing. Are great investors born, or can they be moulded? In a previous post, I took issue with Warren Buffett's search for "someone genetically programmed to recognize and avoid serious risks" (emphasis mine). But Buffett himself has always been a proponent of how investors - and people, more generally - can change themselves through the force of habit. In a speech to business school students, he said "You can't change the way you were wired much, but you can change a lot of what you do with that wiring. It's the habits you generate that matter." I watched that speech on YouTube maybe seven years ago, and was deeply struck by this multi-billionaire preaching the virtue of habits and character, rather than cutthroat competition or iridescent intellect, as the way to success.

I consider myself pretty firmly in the habit-forming camp. Many of you have probably seen hackneyed secret agent/undercover cop movies, and heard some version of the cliche "Sometimes a person wears a mask so long, he doesn't know which one is his real face." That's usually meant to convey the costs of duplicity, but the flipside of that seems true to me as well: act in the appropriate way (despite your instincts to do otherwise), and eventually that will become second nature. Easier said than done, perhaps, but it still seems true. As with investing and corporate strategy, a long horizon helps. For example, business strategy researcher Robert M. Grant recommends taking an inventory of a firm's resources and capabilities as a start to formulating corporate strategy. Then, he suggests (a) exploiting key strengths, (b) managing key weaknesses, and (c) capitalizing on "superfluous strengths" (more on this below). He notes, "Converting weakness into strength is likely to be a long-term task for most companies. In the short to medium term, a company is likely to be stuck with the resources and capabilities that it inherits from the previous period." The same is true for individuals.

That said, I don't think that it's a simple matter of identifying one's bad habits, targeting good habits, and then replacing the bad with the good. Rather, it is a constant and dynamic process of change and growth. My thinking on this has been influenced by a variety of sources:

- Neuroplasticity, i.e. the notion that the brain is constantly changing and rewiring itself
- Growth mindset, i.e. Carol Dweck's work on how attitude shapes success.
- Non-self (or anatta), i.e. a tenet of Buddhist thought, which, in the words of Stephen Batchelor, focuses on "an authentic vision of the changing, contingent, and creative character of ourselves and the world"

Given these prior beliefs, I see these precepts in action everywhere. Over the past 2 weeks alone, I came across examples which supported my notion (possibly confirmation bias, I'll admit!):
- Kaizen, i.e. the Japanese philosophy of continuous improvement
- Life as improvisational art, in the words of writer Mary Catherine Bateson
- "Superforecasters" - as written about by Philip Tetlock and Dan Gardner, and summarized by Michael Maubossin - who see themselves as being in perpetual beta mode, constantly updating their knowledge and revising their beliefs. (Side note: If I were ever to get a tattoo, a pretty strong contender would have to be, "Beliefs are hypotheses to be tested, not treasures to be protected.")
- Sufi poet Rumi: "Yesterday I was clever, so I wanted to change the world. Today I am wise, so I am changing myself."

I don't want to give the impression that I discount "nature" completely. In a prior post, I referred to investor Guy Spier. Spier has gone so far as to place a bronze bust of Charlier Munger in his office, while simultaneously acknowledging that he will never be Munger or Buffett, and can only be the best version of himself. I, similarly, have spent a great deal of time thinking about how best to achieve high risk-adjusted returns in a manner that is both in line with my personal temperament and actually fun.

And yet even these inherent characteristics can be harnessed creatively. Again, there are parallels with corporate strategy. As mentioned earlier, Grant suggests (a) exploiting key strengths, (b) managing key weaknesses, and (c) capitalizing on "superfluous strengths". As an example of (b), he cites Harley-Davidson, who is unable to compete with Honda and Yamaha on technology, and has instead chosen to make a virtue out of its outmoded technology and traditional designs as a key part of the Harley-Davidson experience. Item (c) refers to developing innovative strategies that turn apparently inconsequential strengths into key strategy differentiators. As an example of this, he cites the brokerage firm Edward Jones, whose network of brick-and-mortar offices appeared outdated in the Internet era. However, "by emphasizing personal service, trustworthiness, and its traditional, conservative investment virtues, Edward Jones has built a successful contrarian strategy based on its network of local offices."

So if I had to summarize this rambling collection of thoughts, it would be as follows: We have some inherent endowment of qualities, but we can use them creatively, and can in fact change those qualities far beyond what we thought was possible over a long enough period of time, given sufficient determination. Or perhaps more succinctly, sometimes an investor wears a mask so long, he doesn't know which one is his real face. And that can be a good thing.

Friday, September 25, 2015

Empathy and Investment Management

A curious thing happened to me this morning. As I was walking through the hallway of my apartment building, I noticed that the door to a neighbour's apartment was open. I glanced into the apartment as I passed, and was struck by how different the apartment looked to mine. Despite having similar layouts, the two apartments were (unsurprisingly) furnished and arranged differently. None of this should have come as a surprise to me, but it was still jarring to see an apartment different from the model I had created in my head.

Later on, I was browsing the news and chanced upon a story about the pessimism shrouding Brazil's financial markets. Lamenting the state of Brazil's economy and equity markets, analyst Vitor Suzaki was quoted as saying, "We just can't imagine what kind of news would bring confidence back."

What do these two incidents have in common? In both instances, the people involved appeared to suffer from a distinct lack of imagination, or perhaps an overly narrow perspective. For investors, this flaw can be harmful. Renowned macro trader Bruce Kovner said, "I have the ability to imagine configurations of the world different from today and really believe it can happen." He believed this was an important element of his success.

Sanjay Bakshi refers to a similar concept, which he calls empathy. In a talk entitled "The Prejudices of Mr. Market", he touts empathy as a way for investors to better understand the customers, competitors and executives of businesses they own, as well as other financial market participants. 

This comes as a time when empathy, in its more traditional sense, is making a resurgence as a valued skill. Summarizing his new book, "Humans Are Underrated", Geoff Colvin writes, "The evidence is clear that the most effective groups are those whose members most strongly possess the most essentially, deeply human abilities - empathy above all, social sensitivity, storytelling, collaborating, solving problems together, building relationships."

Many fund managers deliberately avoid excessive contact with their underlying investors. There's no doubt that it can be detrimental to a manager's sang-froid (and a drain on scarce time) to be constantly reacting to investors' concerns about volatility in financial markets. Yet at the same time, it's worth remembering that fund managers serve not only to invest wisely, but to shepherd their investors through turbulent times. This involves understanding investors' concerns while effectively communicating a long-term strategy. It seems clear that investment managers who can harness technology - or "race with machines", to quote Brynjolfsson and McAfee, will outperform those who try in vain to race against machines. But the human element of investment management - empathy, communication and leadership - will remain every bit as important. Fund managers will do well to nurture these skills to become better analysts as well as more valuable guides on the treacherous path that is investing.

Sunday, September 6, 2015

The Three Jewels of Investing?

In order to become a Buddhist, one is encouraged to embrace (and "take refuge in") the "Three Jewels", a set of ideals that anchor the individual. The jewels are (1) the Buddha, (2) the Dharma, and (3) the Sangha. The Buddhist Centre describes the Three Jewels more fully as follows:

(1) "Going for Refuge to the Buddha means seeing him as your ultimate teacher and spiritual example. It also means committing yourself to achieving Buddhahood...which means that you aim to become someone who sees the nature of reality absolutely clearly, just as it is, and lives fully and naturally in accordance with that vision."

(2) "The Dharma primarily means the teachings of the Buddha, or the truth he understood. The word 'Dharma' has many meanings but most importantly it means the unmediated Truth (as experienced by the Enlightened mind)... Regarding the Dharma as a refuge means seeing these teachings as the best guide to reality, and committing yourself to practicing them."

(3) "If we are to practice the Dharma we need the example and teaching of others who have done so before us, especially those who have gained insight into the nature of reality themselves. So the third of the Three Jewels is the Sangha or the spiritual community... We need the guidance of personal teachers who are further along the path than we are, and the support and friendship of other practitioners."

I have recently completed a slew of value investing-oriented books, and have been thinking about whether we can formulate a similar Three Jewels of Investing. You'll note that the title of this post is a question, rather than a statement. It would be immense hubris to pretend that I had uncovered something on the order of importance of the original Three Jewels. Nonetheless, I think it's a useful framework. We should seek to anchor ourselves through Enlightened Investors (Buddha), a valid Investing Philosophy (Dharma), and an Investing Community (Sangha).

Enlightened Investors

Value-oriented investors generally view Benjamin Graham,Warren Buffett and Charlie Munger as the Holy Trinity of sorts of value investing. These three are considered the greats partially because of their status as pioneers and successful exponents, and partially because they have been so generous in sharing their philosophy with others. Luminaries such as T. Rowe Price have left a much smaller footprint on which to base one's learning.

The extent to which this Holy Trinity has influenced investors is easily seen. One of the books I read was Guy Spier's "The Education of a Value Investor". He recounts how he found himself asking "What would Warren Buffett do in my shoes?" The motivational speaker Tony Robbins calls this "modeling" our heroes. While Spier may seem extreme, going so far as to install a bronze bust of Charlier Munger in his office, he remarks how Winston Churchill's office at Chartwell was similarly decorated with reminders of people he admired, such as Napoleon, Admiral Nelson and Jan Smuts. The practice served Spier well in the 2008 financial crisis, as he studied "heroes of mine who had successfully handled adversity, then [imagined] that they were by my side so that I could model their attitudes and behavior." Naturally, we may have to reach into the past to find these true masters. The ever witty Charlie Munger notes that mimicking successful people works equally well "if you go through life making friends with the eminent dead who had the right ideas."

Investing Philosophy

I wrote an initial post about Buffett a few weeks ago outlining his philosophy as seen through the lens of his investor letters. I highly recommend Spier's book for more on his understanding of a value philosophy. Similarly, two of the other books I read, Mohnish Pabrai's "The Dhandho Investor" and Fred Martin's "Benjamin Graham and the Power of Growth Stocks", offer fresh perspectives on the Graham-Buffett-Munger investing style. Reflecting his debt to others, Pabrai says, "I have very few original ideas. Virtually everything has been lifted from somewhere." This is, however, extremely modest of him. While the philosophy may not be new, he comes up with inventive ways to view the challenge of investing, showing that there are different ways to express a broad philosophy. 

Investing Community

Spier is by far the most explicit about the importance of developing an appropriate investing community. He states "we have to be extraordinarily careful to choose the right environment - to work with, and even socialize with, the right people. Ideally, we should stick close to people who are better than us so that we can become more like them." He believes that "creating the right environment or network helps tilt the playing subtly the right direction so that you become far more likely to succeed."

He also goes on to cite several quotes from Buffett emphasizing this principle:

- "The key to life is figuring out who to be the batboy for."
- "Hang out with people better than you, and you cannot help but improve."
- "Nothing, nothing at all, matters as much as bringing the right people into your life. They will teach you everything you need to know."

Finally, Spier is fulsome in his praise of his friend Pabrai, and it is apparent that they have both reaped the benefits of an investing community.

But It's Not All Perfect

While this is a useful framework, I have some reservations. For example, which comes first, the Enlightened Investor or the Investment Philosophy? In other words, do we consider an investor Enlightened because we agree with his philosophy? Or do we start first with the Investor, and then trust in the investing lessons he imparts?  It may be a case of "when the student is ready, the teacher will appear", to quote Spier. But I'm inclined to believe that the philosophy comes first. 

It's also important to note that while we may look to Enlightened Investors as models, our styles will ultimately differ due to our inherent abilities and temperament. Spier recognizes this: "As investors, we all have shortcomings; as I came to see it, the key is to accept who we are, understand our differences and limitations, and figure out ways to work around them." He believes Buffett's "strength comes in part from this rock-solid sense of who he really is and how he wants to live." "Instead of trying to compete with Buffett, I should focus on the real opportunity, which is to become the best version of Guy Spier that I can be." This is something I can empathize with. Early in my career, I was often overwhelmed by the breadth of knowledge my various PMs had. Seeking to mimic them accentuated my natural tendency to be a dilettante ("[fluttering] all ways, and [flying] in none", to quote Philip Wakem in George Eliot's "The Mill On The Floss"). I have had to consciously accept that it is better to develop smaller pockets of knowledge, and to grow the number of these pockets over time.


Finding the jewel of a valid investment philosophy isn't always straightforward. I was struck by how Pabrai's ethos of "Few Bets, Big Bets, Infrequent Bets" differs from much of academic finance, which generally preaches diversification and often seeks to reap small, frequent premia. This is complicated by the fact that there are many variations to a broad philosophy. Pabrai seems willing to bet on much more cyclical and leveraged businesses than most Buffett adherents. Even more unusually, Fred Martin's book positions Graham as a growth investor rather than a traditional value investor, relying on Graham's 1962 edition of Security Analysis, which, for whatever reason, appears to be have fallen out of favour with the value camp.

Deciding on a valid philosophy is a big part of the journey. However, we must be wary of letting a philosophy ossify into dogma. As Spier notes "part of what makes Warren himself so successful is that he's never stopped seeking to improve himself and that he continues to be a learning machine."


Identifying a community of like-minded investors is clearly an important part of the Three Jewels. However, as noted above, the group's philosophy can become rigid. Herding is also a genuine problem. Sometimes the group's beliefs can have little to do with the group's core philosophy (in several earlier posts - here and here - I've puzzled over why value investors routinely seem to be Fed-bashers). Avoiding herding is particularly important in investing. As Pabrai notes, "value investing is fundamentally contrarian in nature", so it would be antithetical to fall in line with groupthink. Referring to his contemporary Walter Schloss, Buffett wryly noted, "I don't seem to have very much influence on Walter. That's one of his strengths: no one has much influence on him."

Another issue is becoming resistant to sources of truth external to our chosen community. Wisdom and knowledge appear in the oddest places, and true learners are open to these opportunities. Investor Sanjay Bakshi recalls how he ignored the investment advice of a high school dropout, but later realized the man was an outstanding investor. In a more humourous riff on this (but no less important to Manchester United fans!), former manager Sir Alex Ferguson recently revealed that he signed club legend Eric Cantona after hearing his players Gary Pallister and Steve Bruce rave about the challenge of facing Cantona. Nothing exceptional about that, you might say - except for the location of the conversation. "I was in the bath with the players, which was highly unusual for me." A generation of Manchester United fans can be grateful for Ferguson's attention to sources of truth, even when in the bath!

The One Perfect Religion

The concerns I've raised apply to any pursuit of truth - investing, politics, or religion. I am reminded of the words of poet Elizabeth Alexander:

We crave radiance in this austere world,
light in the spiritual darkness.
Learning is the one perfect religion,
its path correct, narrow, certain, straight.

The Three Jewels of Investing are a useful starting framework. But no framework is perfect. The only answer is to continue learning (as the greats do), and to surround oneself with people who are intellectually curious and honest. My guess is that this is the key to improved investment results, but more importantly, continued intellectual growth. 

Monday, July 27, 2015

The Wisdom of Warren Buffett

It's been a busy few months, which explains the long blogging hiatus. But in the last 6 weeks, I've been on something of a "value" reading binge, which will hopefully set the stage for a series of posts. The first of these focuses on Lawrence Cunningham's "The Essays of Warren Buffett". I have to admit that I hesitated to write this post. It's Buffett. There's been so much written on the man that it's virtually impossible to say anything original. So set your expectations accordingly, but as with all my posts, recording my thoughts is as much for myself as for a general audience. Another reason to write the post is that, with the general adulation Buffett is afforded by value investors, there is far too much out there that aims to ape Buffett - poorly. Even the ideas of luminaries like Buffett should be subject to scrutiny for their objective truth, and their subjective relevance to the individual investor. 

By the way, these letters are all available for free online, but I was happy to spend a little money and have some of the wisdom distilled for me.

On, then, to the themes:


Cunningham's book starts with the following two quotes:

"The speech I love is a simple, natural speech/ the same on paper as in the mouth/ a speech succulent and sinewy, brief and compressed/ not so much dainty and well-combed as vehement and brusque." - Michel de Montaigne

"The sincerity and marrow of the man reaches to his sentences. I know not anywhere a book that seems less written. Cut these words and they would bleed; they are vascular and alive." - Ralph Waldo Emerson

These may seem like odd choices to begin a book on an investor, but Cunningham knows what he's doing. It's impossible to ignore the clarity of Buffett's writing and thinking (not to mention the considerable wit that shines through). This was reinforced as I was reading Mohnish Pabrai's excellent "Dhandho Investor" (which will be the subject of a later post, when I finally get around to it). Pabrai draws a parallel between Einstein and Buffett (though even Buffett would surely be a bit embarrassed to be compared to Einstein). Pabrai writes, "Einstein noted that the five ascending levels of intellect were, "Smart, Intelligent, Brilliant, Genius, Simple." For Einstein, simplicity was simply the highest level of intellect. Everything about Warren Buffett's investment style is simple. It is the thinkers like Einstein and Buffett, who fixate on simplicity, who triumph."

One example of this simplicity is Buffett's concept of owner earnings, which is basically normalized free cash flow to equity. While I have used a similar concept in my own analyses, I used a much uglier phrase that I masked with an equally ugly acronym (so ugly that I'll spare readers!). The use of the simpler "owner earnings" cuts to the heart of the analysis, and to the heart of the valuation question.

Some make the grave error of confusing the simple with the simplistic. This error runs in both directions. Some are unable to see the beauty and resilience of simple ideas, preferring the complex and fragile. Others may cling to simplistic but sub-optimal ways of thinking. It's a challenge to cull extraneous ideas while retaining the essential.

In addition, Buffett's simple, clear writing suggests a level of comfort with himself. This mirrors his investment style - admittedly shaped over a long, successful career. As I elaborate below, there is a tension between finding one's own style and absorbing the lessons of great professionals.

Organizational Structure

Another focus is on building the right organization. As Buffett writes, "We have carefully designed both the company and our jobs so that we do things we enjoy with people we like." There are two levels to this. The first is relying on top-notch lieutenants at Berkshire. Hathaway. Berkshire is a massive operation, and it again requires a kind of simplicity to have it run effectively. Several quotes illuminate Buffet's thinking on this. 
- "Having first-rate people on the team is more important than designing hierarchies and clarifying who reports to whom about what and at what times." 
- He also quotes David Ogilvy: "If each of us hires people who are smaller than we are, we shall become a company of dwarfs But, if each of us hired people who are bigger than we are, we shall become a company of giants."

Most of us will never run entities on the scale of Berkshire (nor would most of us want to!). But there is another set of stakeholders with whom to build relationships, i.e. underlying investors. Buffett makes abundantly clear the immense amount of thought that has gone into attracting the right investor base at Berkshire. An investor base out of sync with the manager's philosophy is a recipe for disaster and unhappiness.

Suffice to say, the end result for Buffett has been overwhelmingly positive: "To almost a sinful degree, we enjoy our work as managing partners." Furthermore, "we enjoy the process far more than the proceeds - though we have learned to live with those also."

Elements of Buffet's Investing Philosophy

There is a lot of specific detail to be gleaned from the letters, but I'll focus on broader lessons. Perhaps the best expression of Buffett's philosophy is as follows: "In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace." I liked that quote because it encapsulated various sub-themes:

a) Humility - knowing one's limitations

-"Charlie and I decided long ago that in an investment lifetime it's too hard to make hundreds of smart decisions."
- "by confining himself to a relatively few, easy-to-understand cases, a reasonably intelligent, informed and diligent person can judge investment risks with a useful degree of accuracy"
- Buffett quotes Keynes: "As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one's risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. One's knowledge and experience are definitely limited and and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence." Keynes was hardly known for his humility, so these musings are worth taking seriously.
- "What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes."
- "we favor businesses and industries unlikely to experience major change"..."If others claim predictive skill in [fast-changing] industries - and seem to have their claims validate by the behavior of the stock market - we neither envy nor emulate them."

This humility is often a hard-won lesson from making errors. But a devotion to learning from one's mistakes is essential: 

- "It's a good idea to review past mistakes before committing new ones". 
- "A prime rule of investing: You don't have to make it back the way that you lost it."

b) Contrarian thinking, i.e. doing things that are unfashionable

On the one hand, it's an expression of humility to avoid popular areas where one has no comparative advantage. On the other hand, it's an act of striking confidence in one's own path to ignore the herd's collective drive.

- "as happens in Wall Street all too often, what the wise do in the beginning, fools do in the end"
- "the less the prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs." 
- "if [investors] insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

One of the most contrarian things in the world of investment management is to do nothing:
- "Inactivity strikes us as intelligent behavior."
- "Lethargy bordering on sloth remains the cornerstone of our investment style." 

Yet this seeming indolence is but preparation for a time of energy and activity: 
- "during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival." 
- Buffett acknowledges that this is easier said than done: "Unlike [baseball player Ted Williams], we can't be called out if we resist three pitches that are barely in the strike zone; nevertheless, just standing there, day after day, with my bat on my shoulder is not my idea of fun."

c) Flexibility

While the power of the value investing framework speaks deeply to me, dogmatic interpretations of Buffett's record always annoy me. It's clear that one can be simplistic, not simple, when trying to characterize his success. Flexibility has been an important quality.
- One example is Buffett's early foray into arbitrage at Rockwood & Co., unlocking the hidden value of inventory (cocoa beans) despite the company's operating losses. As Buffett remarks succinctly, "Sometimes there is more to stock valuation than price-earnings ratios."
-"An investor cannot obtain superior profits from stocks by simply committing to a specific investment category or style. He can earn them only by carefully evaluating facts and continuously exercising discipline."

d) The uses and abuses of quantitative methods

Buffett is terrifically numerate, and from all accounts, an outstanding judge of the risk-reward trade-off. Yet he is selective when using numbers in his investment process:

- "the difficulty of precisely quantifying [the primary factors in investment analysis] does not negate their importance nor is it insuperable."
- "Using precise numbers is, in fact, foolish; working with a range of possibilities is the better approach. Calculations of intrinsic value, though all-important, are necessarily imprecise and often seriously wrong. The more uncertain the future of a business, the more possibility there is that the calculation will be wildly off-base."

e) Temperament

The importance of equanimity in investing is something close to my heart, shown by previous posts. Buffett agrees on its importance as a component of a skilled investment mind:
- "We need someone genetically programmed to recognize and avoid serious risks, including those never before encountered...Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success."

Keep calm, Buffett disciples, but I have to disagree with him here. Perhaps it's unfair to hold him to the turn of phrase, but surely one doesn't need to be "genetically programmed" to follow the investment path he espouses. I recently heard a fascinating 2-part interview with Dr. Ed Taub (see here and here) on Constraint-Induced Movement Therapy (CI Therapy). CI Therapy is a revolutionary approach to physical rehabilitation for stroke and other central nervous system injuries. Based on the principles of brain plasticity, it has several components, of which the most important are (a) repetitive, task-oriented training and (b) the transfer package, i.e. adherence-enhancing behavioural strategies. The parallels with investing are clear. For those lacking Buffett's preternatural "genetic" gifts, hard work and dedication to the investing craft are the next best thing.

With some luck, there will be more posts on Buffett's disciples in the following weeks.

Sunday, April 26, 2015

Is Finance Eating The World?

In 2011, venture capitalist Marc Andreessen wrote a much vaunted essay in the Wall Street Journal entitled "Why Software Is Eating The World". The phrase "XYZ is eating the world" has become standard fare for explaining how some new technology is disrupting old ways, and improving the lives of consumers in the process. Generally, this is seen as a good thing. Sophisticated (i.e. non-Luddite) commentators rightfully fret over the effects of technology on employment and inequality, but it is virtually unheard of for anyone to criticize the improvements offered by advances in technology.

Finance, on the other hand, continues to be reviled as an industry. It's pretty difficult to get the Tea Party and the most left-leaning wing of the Democratic Party in the US to agree on anything, but suspicion of, and antipathy towards, the financial industry seems fairly unanimous. Some of this is self-inflicted, through a never-ending series of scandals and understandable concerns about the power of the finance lobby. But we rarely hear the mainstream media articulate things the industry does well, or even the notion that finance can disrupt staid industries for the better. Take, for example, a steady drumbeat of positive press about the solar industry. My impression is that potential disruption to the archaic utility model is widely considered a good thing, with interlopers like SolarCity generally garnering positive coverage. Rarely covered, though, is that finance (and its red-headed stepchild, securitization) is an intrinsic part of SolarCity's business model. The company itself dutifully discloses in its annual report, "Our future success depends on our ability to raise capital from third-party fund investors to help finance the deployment of our residential and commercial solar energy systems." One might go so far as to argue that SolarCity is in the business of creating safe assets, and solar systems are merely an input in the process. So maybe, then, it's finance that's eating the world.

I can't imagine many people would be comfortable uttering that last sentence. The entry of finance into hitherto pristine fields such as commodities (that's sarcasm) has given rise to an ugly word, "financialization". The debate continues as to whether financialization has contributed to heightend volatility in these markets. To some extent, it seems clear that a common investor base increases the covariance of assets. But financialization may be getting a bad rap when it comes to creating increased volatility. In an excellent article on Keynes's approach to endowment management, Chambers and Dimson highlight his sensitivity to liquidity risk. Ever incisive, Keynes wrote, "Some Bursars will buy without a tremor unquoted and unmarketable investments in real estate which, if they had a selling quotation for immediate cash available at each Audit, would turn their hair grey. The fact that you do not [know] how much its ready money quotation fluctuates does not, as is commonly supposed, make an investment a safe one." Financialization may merely reveal the underlying volatility of asset classes such as real estate and commodities, which is unsurprising given the long known inelasticity of supply and demand. Did a move to spot market pricing create the vicious fluctuations in the iron ore market, as has been argued by some industry executives? I, for one, am skeptical. Furthermore, financial players clearly provide liquidity and produce information for markets. 

Finally, a common criticism is that financial players are merely engaged in rent-seeking, rather than generating genuine social value. A recent article by Harvard economics professor Sendhil Mullainathan captures these concerns, which I share. Mullainathan's balanced treatment does, however, do a nice job of addressing the ambiguity of what constitutes rent-seeking. Thankfully, this doesn't need to be decided in a court of law by a Solomonic judge. The market is a wonderful device for decentralizing this judgment, and it usually works quite well. Broadly speaking, I think we have passed the days when the average person in finance made extraordinary sums disproportionate to his value (and a damned good thing too!). As examples, this has manifested itself in industry job losses and unceasing pressure on fees to investment managers. At a higher level, the combination of government regulation and investor pressure have convinced most large financial firms that simpler, more robust structures are preferable. The market, in other words, has penalized firms for being unwieldy and producing little value in return for increased complexity. 

None of this should be misconstrued as my saying that the industry is omniscient or morally unblemished. It merely means that we should continue to encourage the expansion of finance, even though mistakes will be made. Experimentation is a messy affair, and is particularly challenging in financial markets, which are complex adaptive systems that can be highly unpredictable. But as Mullainathan writes, "I hope [students going into finance] realize that they have the potential to do great good and not simply make money. It may not be how the industry is structured now, but idealism and inventiveness are two of the best traits of youth, and finance especially could use them." I'm reasonably optimistic that creative finance and dynamic technology will continue to disrupt stale models of thinking, benefiting end consumers. After all, if finance is eating the world, perhaps the world is ripe for eating. 

Sunday, April 19, 2015

Doing The Greatest Good (Philanthropy As Investing)

John Arnold isn't a household name, but those involved in the US energy markets will recognize him as an incredibly successful energy fund manager. Arnold cut his teeth as a trader at Enron, and then started Centaurus Advisors, an energy-focused hedge fund in Houston, reportedly building up a net worth of $4b. It thus came as a surprise to many observers when he announced his retirement from Centaurus in 2012 at the age of 38.

In typical Arnold fashion, he appears to be flying under the radar in his second career - though, again, with the occasional big bang. In May 2013, Arnold and his wife were featured in the WSJ for their philanthropy - not simply for writing big checks, mind you, but for taking a keen interest in the efficiency of their contributions, and for being willing to fund projects of uncertain value with potentially large payoffs. As the WSJ reports, "The Arnolds want to see if they can use their money to solve some of the country's biggest problems through data analysis and science, with an unsentimental focus on results and an aversion to feel-good projects - the success of which can't be quantified."

This type of philanthropy isn't new. Bill Gates seems to be the prototype for a guy who's made a lot of money in one field and hurls himself into the weeds of philanthropy. But it does seem to be catching on. No doubt there are various reasons for this, but one can easily point to the increased sophistication of programme evaluation, the larger influence of business and finance types as donors, as well as a general wave of enthusiasm for all things "evidence-based" (evidence-based medicine, evidence-based journalism, evidence-based investing... all good, but what were people doing before?). In their book Poor Economics, Duflo & Banerjee highlight the growing use of randomized controlled trials in development economics. Their line of thinking proposes that "it is possible to make very significant progress against the biggest problem in the world through the accumulation of a set of small steps, each well thought out, carefully tested, and judiciously implemented."

I find this way of thinking very appealing, particularly for its potential to compare the payoffs from competing development or philanthropic strategies. It's no surprise that we often let affinity and empathy obscure our thinking in these issues. By this I mean that we find it easier to contribute to our own communities and countries, even though there are often considerably greater needs once we cast our gaze slightly further afield. Rigorously collecting and evaluating data seems to offer a path to quantify the costs of myopic charitable giving.

As a result, I've been wrestling over the past few months with how to frame philanthropy as a form of investing. The aim should be to maximize the net present value of charitable giving. But there are two weaknesses with this approach. First, this sort of philanthropy is probably much easier for the very rich, who have the means to guide recipients into providing reams of data. My sense is that it is quite hard, as a small donor, to get much insight into the full working of organizations. And, second, the truth is that even if the data were available, I've struggled mightily with how to think about the incremental benefit of donor dollars, and the appropriate discount rate.

In his book The Life You Can Save, Peter Singer makes the point that "there are many organizations doing good work that offer opportunities worth supporting, and not knowing which is the very best shouldn't be an excuse for not giving to any of them." In fact, he goes so far as to argue that "some uncertainty about the impact of aid does not eliminate our obligation to give." 

I disagree with the last assertion. If we have an obligation to give, we have an equal obligation to ensure that we are giving well. Angus Deaton disagrees at an even more fundamental level. In his book The Great Escape, he surprisingly denounces most forms of charitable giving, particularly foreign aid. "What surely ought to happen is what happened in the now-rich world, where countries developed in their own way, in their own time, under their own political and economic structures... We need to let poor people help themselves and get out of the way - or more positively, stop doing things that are obstructing them."

Yet he doesn't think all forms of giving are unhelpful. Deaton goes on to make two distinctive arguments for giving to universities. I've often thought of giving to universities (especially one's own alma mater) as a form of vanity giving, particularly with the thriving endowments many universities have today. But Deaton makes two good counter-arguments:

1)  "As the economist Jagdish Bhagwati has argued, it is hard to think of substantial increases in aid being spent effectively in Africa. But it is not so hard to think of more aid being spent productively elsewhere for Africa." In particular, Deaton suggest funding basic research on health and agriculture.

2) "The effects of migration of poverty reduction dwarf those of free trade... A helpful type of temporary migration is to provide undergraduate and graduate scholarships to the West, especially for Africans. With luck, these students will develop in a way that is independent of aid agencies or of their domestic regimes." (In similar fashion, see Michael Clemens on why migration should be a major part of the UN's Sustainable Development Goals).

More importantly, perhaps, the notion of doing the most good with any specific type of giving is probably unnecessary. One of the basic tenets of investing is diversification. Similarly, it probably makes sense to think of charitable giving as a portfolio, mixing bets of different individual risk, reward, and with little overlap (i.e. low covariance). 

Finally, just as I wouldn't suggest a complete novice spend his time on security analysis or asset allocation, perhaps novice donors don't need to spend copious amounts of time dissecting philanthropic organizations. Intermediaries such as GiveWell have made it easier to learn about NGOs who are doing important work.

These may not seem like the most exciting, or even the most personally satisfying forms of philanthropy. But just as disciplined investing isn't always exciting, I'm starting to believe that philanthropy can quite reasonably be seen as a way to combine a rigorous view of individual organizations with the benefits of diversification to obtain the best long-run outcome with one's giving. 

Sunday, April 5, 2015

Learning From The Greatest Trade Ever

It's slightly surprising that it's taken me this long to get to it, but I finally read Gregory Zuckerman's "The Greatest Trade Ever", which documents John Paulson's multi-billion dollar score in the real estate crisis of 2007-2009. Zuckerman puts Paulson & Co.'s winnings at $15b in 2007 (with astonishing gains of 590% and 350% in its two credit funds), and a further $5b in 2008 and early 2009. I'm actually glad I waited a few years to read this, because it affords some historical perspective on the trade itself and Paulson's results since then.

A quick review of the book is in order before I launch into some lessons learned. It's a scintillating read, and captures the boom and bust in real estate and associated securities, as well as prior episodes of market mania. It is certainly a difficult task to write a page-turner about credit derivatives, but Zuckerman succeeds admirably. In addition, he seems balanced and even-handed in his treatment of the colourful array of characters, offering wonderful snapshots of the mania that pervaded investment management, and the ensuing collapse.

Now, on to some of the many things I learned from the book:

1) Macro matters. It won't surprise you if you've read other posts of mine, but yes, macro matters. This was essentially a macro bet. Contrary to some views that decried Paulson as a "tourist" from the merger arb space, he had proven to be "gutsier, playing the merger game differently than his peers. He began to short companies set to be acquired when he deduced that their merger agreements might collapse." This penchant for a more creative approach led Paulson to his most famous set of trades. 

Zuckerman lays out the (not always totally correct) macro framework that guided Paulson's thinking:
- In 2004, Paulson became concerned about who would be exposed when the Fed began raising interest rates.
- In early 2005, as Paolo Pellegrini suggested shorting mortgage securitizations, Paulson decided the Fed wouldn't want to lower rates to help borrowers because it might weaken the dollar further and stoke inflation.
- In late 2005, Paulson "trimmed holdings that seemed especially sensitive to the economy and shorted the bonds of others".
- By late 2007, Paulson recognized the impact a real estate and credit collapse would have, shorting shares of banks with significant exposure to the credit card business and those making commercial real estate, construction, and other risky loans. He also shorted Fannie and Freddie on the same premise.

2) Luck matters. There's no doubting the brilliance of the trade, and the nerve that it took to pull it off, but luck played a healthy role too. Paulson was early enough to have time to refine his trade, and late enough not to suffer excessively while the housing market stood firm. It's remarkable that Paulson started from knowing nothing about CDS in Oct 2004, and had time to revise his trade several times. In November 2005, "the Paulson team's original thesis, that a spike in interest rates would cause problems for home owners, seemed dead wrong." Paulson sold his original CDS protection after concluding that it covered mortgages on homes that already had enjoyed so much appreciation that refinancing would be easy. This seemed to happen again in 2006, but they were able to roll protection into the latest vintages. As Zuckerman writes, "Paulson had dodged a bullet." The trade also evolved as the team's views on housing matured. Incredibly, until early 2006, "Paulson's team hadn't put much thought or research into whether housing prices were bound to tumble

But, fortunately for him, he wasn't too early. Zuckerman notes that, "Paulson also had good fortune on his side: By the time he determined that the housing market was in a bubble in the spring of 2006, prices had begun to flatten out, making it the perfect time to bet against the market. Others who had come to a similar determination much earlier were licking their wounds because they had placed wagers against real estate too early and suffered as it climbed further."

Finally, Paulson was lucky to be an outsider. "It was fortuitous that Paulson was a merger pro, and not a veteran of the mortgage, housing, or bond markets. He wasn't deterred by the dismal track record of those who already had bet against housing, and wasn't fully aware that his bearishness wasn't especially unique."

That said, I don't want to overstate this element. It obviously took a tremendous amount of work to get up to speed on an arcane market. Other prominent managers demurred at taking such an outsized bet. "Paul Singer of Elliott Management Corp. and Seth Klarman of Baupost Group bought some CDS insurance contracts on risky mortgages but chose to buy small portions of it and not go overboard." "Buying so much was a reputational risk," Klarman says, "It wasn't a no-brainer." Zuckerman also details how Paulson avoided getting cold feet in 2007 when the trade seemed to have worked partially. Furthermore, he successfully played both sides of the trade, profiting on the long side by 2009. Others, like John Devaney, faced serious losses by re-entering the market too early. All in all, this was the confluence of luck and skill, with Paulson correctly reading macro forces, real estate-specific drivers and investor sentiment.

3) Lucky or not, being an outsider helps sometimes. Zuckerman quotes Bertrand Russell: "The fact that an opinion has been widely held is no evidence whatsoever that it is not utterly absurd; indeed, in view of the silliness of the majority of mankind, a widespread belief is more likely to be foolish than sensible." One stunning example Zuckerman cites is the "discovery" by Deutsche Bank analyst Eugene Xu that "home prices had been key to loan problems for more than a decade, including during the mini-downturn in real estate in the early 1990s." If you're scratching your head that this should be a revelation, Zuckerman goes on to say that "at the time it was quite a radical viewpoint. Most economists and traders figured that a range of factors, including interest rates, economic growth, and employment, determine the level of mortgage defaults." I found it interesting that two outsiders, Paulson and Greg Lippmann, were communicating and helping to reassure one another. Sometimes this is the path to breaking through dogma; sometimes it results in an unhealthy echo chamber. It's hard to know which is which. In a world where things seem to be getting ever more complicated and specialized, we rely on gatekeepers more than ever. Perhaps the skills most needed are common sense and critical thinking.

4) There are ethical grey areas in investing. Zuckerman duly notes the ethical grey area of Paulson working with bankers to create risky investments. But we shouldn't allow hindsight bias to excessively colour our judgement. "In truth, Paulson and Pellegrini still were unsure of their growing trade would ever pan out." Furthermore, Paulson was betting against supposedly sophisticated investors. 

Similarly, Jeff Libert reveals the ethical quagmire he found himself in as he "discovered an odd impulse: He found himself rooting for a rash of home owners to run into problems paying off their mortgages."

5) The emotional strain of a great trade may not be for everyone. Zuckerman vividly describes the strain the trade took on Michael Burry, Jeffrey Greene, Pellegrini and Paulson. Some examples:
- "[Jeff Greene's] very reputation and sense of self-worth seemed tied up with the trade." "If [the trade] doesn't work, I'm cooked", he confided to Jeff Libert.
- Despite a gain of 150% in 2007, Michael Burry was deeply exhausted. "Burry couldn't enjoy his belated success...still weary from the battles with investors and too sensitive to ignore their unhappiness."

Those with lavish lifestyles, such as Pellegrini and Jeff Greene, placed some self-imposed stress on themselves. Perhaps Paulson's earlier decisions to alter his lifestyle provided him with the equanimity to see the trade through.

Most of us will never experience the nerve-wracking strain of a trade like this, and perhaps that's for the best. One of the funniest paragraphs in the book describes Greene meeting his future wife, Mei Sze Chan. Zuckerman writes, "Greene and Chan hit it off. She touched his shoulder. He held her hand. Then they found a quiet spot in the back of the room and began to discuss mortgages.

A few months later they were engaged."

Most of us will have to be content with matrimonial bliss, rather than Paulson's stupendous financial gains. Given the strain he and others underwent in their pursuit of profit, it is a gentle reminder that some of the greatest trades we make happen outside the financial arena.