Supported by Greenhaven Road Capital, finding value off the beaten path.
In late 2016, Chris Cole joined Patrick O’Shaugnessy to talk about investing. It was not what I expected.
I had Cole’s paper, Volatility and the Allegory of the Prisoner’s Dilemma queued up but couldn’t get through it. After listening to the podcast, the big ideas were loosened and easier to consume. Cole’s paper became simpler. These are my notes.
1/ -1, 0, +1. “(Value investing is) a valid classic strategy, but value investing extracts an equity risk premium. During large-scale declines in markets, value investing is not immune to the crisis that can envelop a market…the irony is that value investing needs these crises because it results in all this behavioral inefficiency that allows for the value risk premium to be extracted.”
A lot of the podcast was about volatility, convexity, and figuring out how to act once you figure out what might happen.
This conversation reminded me of a key that unlocked Taleb for me. When I first tried to read Antifragile I was bogged down. The words were too big. The history too old. The ideas to dense. What freed me was when I realized that Taleb’s triad could be summarized as: -1, 0, +1.
My mistake was in thinking that the opposite of -1 was 0. That’s not it at all. It’s true for Cole’s ideas too:
- Long convexity is antifragile
- Value investing and cash is robust
- Short convexity is fragile
“Cash might protect you,” O’Shaughnessy says, “but you’re not going to earn a big positive by sitting in cash.”
We think a lot about inversion here. Bill Belichick, Mohnish Pabrai, and John Boyd all think forward and backward. They invert.
Sometimes we (mostly me) stop short at the absence, not the opposite. This was my misunderstanding of Taleb. For example, the opposite of spending isn’t saving, it’s earning.
Cole doesn’t want to weather a crisis, he wants to profit from it.
2/ Small Vol. “We have this false stability and underneath that we have this incredible potential for volatility. We see this every time people try to suppress smaller volatility. It’s true with marriage counselors. They say the people most likely to get divorced are the ones that aren’t fighting. The ones that aren’t fighting at all have the most tension because they’ve given up on one another. It happens with avalanche prevention on ski slopes. The forest service will blow up portions of a mountain.
One of my favorite books, though not of 2016, is Deep Survival by Laurence Gonzalez. (Sidenote, did you Gonzalez was Michael Mauboussin‘s editor for The Success Equation?)
The book opens with Gonzalez – of all places – on the deck of an aircraft carrier.
“If you could see adrenaline, then you’d see a great green greasy river of it oozing off the beach at San Diego tonight. You’d see it flowing one hundred miles out toward the stern of the boat – that’s what pilots call it, a boat, despite the fact that it displaces 95,000 tons of water, has a minimum of six thousand people living on board at all times, and is as long as the Empire State Building is tall.”
How’s that for the opening of a book!
Gonzalez is there to find out how pilots don’t die. How do they land an F-18 on the deck of boat. Part of the secret is not repressing ‘small vol’. Briefing officers use “dark, dark humor,” a ritual Gonzalez writes “in which everyone was reminded how to look death in the face and still come up with a wry smile.”
Forests have controlled burns. Snowpacks have controlled avalanches. Marriages have fights. Fighter pilots have humor.
Trouble sparks when flammables accrue.
Cole suggests that current macro mechanizations are borrowing returns from tomorrow for today. Risk from today is being pushed into the future. As snow on a mountainside builds up, it may be a dangerous system.
3/ How much does your insurance cost? “It’s one thing to have convexity but if it’s incredibly costly, then you end up in a hole that you can’t come back out of.”
O’Shaughnessy asks about how someone can be long convexity. Cole explains how to mix value investing so that it pays for the long convexity premiums. It reminded me of a landlord.
Imagine that rather than financial instruments, it’s physical ones. You own an apartment complex and collect rent (Cole’s value strategy). The rent doesn’t make you rich, but it covers your expenses. One of those expenses is a colossal insurance policy. Your hope is that the buildings burn to the ground – while everyone was out, of course – and you collect on insurance.
This theoretical strategy is insurance fraud, but I think the financial version is what Cole looks for.
What’s key is paying the right price. If you pay too much for fire insurance, you’ll never last long enough to see a fire. If Cole pays too much for options, he’ll never last long enough to see the convexity.
Howard Marks reminds us, “there’s no such thing as a good or bad idea regardless of price.”
4/ Cheerleaders (what to do) and Coaches (how to do it). “I’ve always felt that macro investing is so hard because you need to get two things right; accurately forecast what’s going to happen, but more importantly you need to position your portfolio in a way that will actually benefit if your forecast come true.” – O’Shaughnessy
What to do is easier than how to do it.
5/ Argue well. “I ask myself and my staff that question all the time. ‘What if we’re just wrong?’ This is an existential question if you’re a long volatility manager.”
The best managers of money, sports, and people all try to be proven wrong.
Bill Belichick evaluated assistant coaches based on their pushback and ideas. The Outsiders compared meetings to wrestling matches. Jeff Bezos and Andy Grove argue well with their subordinates. Danny Kahneman had Amos Tversky and Amos Tversky had Danny Kahneman.
No one person knows all. Arguing well, said Wilbur Wright, “rounds the corners.”
6/ Are we all artists? “I hate this idea that people segment left brain right brain. Some of the investors I admire the most are truly creative. Particularly if you look at the global macro space, someone has to envision a reality that is different than the reality we have today and understand how to structure instruments to profit from that potential reality shift and assign probabilities on that. Intellectually I don’t see that as that much different from some highly technical artists.”
We often come back to Howard Marks’ idea that you have to be different and you have to be right. It’s easy to read, but harder to do (see #4 above!). How do you think differently?
Look at the iPhone. Why in the world did Apple make it without a keyboard?
Look at Tesla. Why in the world did Elon Musk start a car company?
Look at Sam Adams. Why in the world did Jim Koch start a beer company?
Maybe the why is in the who.
Maybe they’re artists.
Amanda Palmer makes this case. You’re a performer whether your stage is a BMW dealership, a blog, or Carnegie Hall. You’ve props, an audience, and expectations. You have to show some creativity. What is sales but performance and what is performance but art?
Read this Ben Carlson post about selling and think singing rather than selling. The ideas still stand.
The problem is if you stop at being an artist and fail to roll up your sleeves and make the trains run on time. This is the other brain that everyone talks about. There’s the creative side and the practical side. Jobs, Musk, and Koch would have been footnotes if they didn’t do the work.
Sonal Chokshi had a tweetstorm that helped me think about the balance:
Thanks for reading, I’m @mikedariano on Twitter.
13 thoughts on “Chris Cole”
Cole’s value+bets strategy echoes Soros holding a core portfolio and trading futures/currencies on top of it. Although it’s weird that he’s advertising his thesis, since he’s driving up the cost of the insurance that he has to keep buying.
Why wouldn’t he’d keep his thesis a secret, let the underbrush accumulate, and then make scads of cash when the eventual firestorm hits?
Not sure. I think Cliff Asness revealed his basic thesis to Tyler Cowen. Maybe the idea is that you can know the gist but to actually do it requires a lot more work, knowledge.
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@Patrick this might be the point you’re getting at, but I assume it’s because that strategy is already known for while and it’s late in its lifecycle. At this point, he makes more from popularizing it than exploiting it to the max.
Like coaches having coaching clinics? They teach the fundamentals that everyone already knows but keep their ‘edge’ secret.
@Jason, this idea of lifecycle may be a helpful model. Thanks for suggesting it.
That would imply Cole’s been caught in a pincers of disingenuity, no?
1) late in the cycle means not much left for new partners except the coming negative returns
2) early in the cycle means he’s sure that the investments can scale for his and copycats expected volume.
3) he actually trades a different strategy, and just uses this to advert alpha (similar to Mike’s point).
How the heck does one do #2 when we see saturated trades happen all the time?
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