Dao of Capital - Mark Spitznagel

[60North Investments]

[amazonsearch]Dao of Capital:  Austrian Investing in a Distorted World[/amazonsearch]

 

Just finished reading this book from Mark Spitznagel, founder of hedge fund Universa. I'd be interested in hearing whether fellow board members have read the book or have thoughts on the subject?

 

He is cheering for a roundabout strategy, that sounds very similar to that of Taleb's, where you sacrifice near-term (small) wins to position yourself better to take advantage of future opportunities (and realize the larger wins). Being patient, going where others can't go, finding your own niche, and being in a defensive position in order to take advantage when something happens that sweeps others out. He says that the same principle applies to investing, forests, running businesses etc.

 

The ideas are coming from ancient Chinese (?) philosophies and Austrian school of economics, from people like Mises, Menger and Böhm-Bawerk. He discusses all of these in length, using 8 out of the 10 chapters basically discussing the Austrian School etc.

 

There were some quotes I found worth putting down, among other notes. For example regarding our time preference, "There is merit in stopping to smell the flowers. Our carpe diem attitude, however, should be to seize every day, each individual slice of time, but never at the expense of all the others to come. As Einstein said to a grieving friend to hold past and future moments as equals to present."

 

In the last two chapters he goes on to (shortly) explain his Austrian Investing principles. Basically these were about finding high ROIC companies that are priced cheap (surprise surprise), looking at the overall level of the market (MS Index), considering the amount of distortion introduced by central banks and buying 1-2 month OTM puts with for example 0.5% of your portfolio and rolling these over as they mature.

 

I had some struggles reading the book, especially when almost the whole book talks about stuff that I first found quite hard to associate with investing/business. Also felt a bit disappointed in the end at the depth that the book gave. If you've read the book or have thoughts about the ideas, would be great to hear from you. I haven't done the math even on a theoretical level, but I'd be curious to see if someone has looked at what buying those kind of puts with for example 0.5% of your portfolio could do to your returns in different scenarios?

 

Nov 2014 NYTimes piece on Spitznagel & Universa

[Jurgis]

If you spend 0.5% of your account to buy OTM puts (10% below market let's assume) 1-2 months out, you are going to lose 3% per year in rising markets by definition. That's 0.5% * 6 (12 months / 2 months out) that is total loss. (Yeah, you might be able to roll over, but I am not talking about option-fu trading - if you can option-fu trade, then you are option trading, not downside protecting...)

 

This is quite high cost.

 

So either you have to spend less than 0.5% or you need to buy a longer puts or ... ???

[Jurgis]

If you buy 10% OTM puts with 0.5% of account and market falls 30%, you will get about 40% return on account from put position (eyeballing at current SPY prices). Assuming your account falls 30% with the market, you would still be ahead. So I guess 10% OTM puts at 0.5% account is not a bad deal in this case.

[racemize]

But how often does the market drop 30%?

[Green King]

But how often does the market drop 30%?

 

One in five years.

So 0.005 to 0.4

          5 to 80

         

[writser]

This might be controversial but what annoys me a bit about a lot of great investors is that they make a lot of money and then feel compelled to spread the gospel of their own 'philosophy' to show that not only they are rich - they are also very smart. As if they feel guilty about their riches and try to make it up by pretending to be the next Plato.

 

Soros - Theory of reflexivity.

Ray Dalio - Principles.

Spitznagel - Dao.

Bill Gross - His cryptic letters about his dog.

Charlie Munger - Lollapalooza, incentives.

Peter Thiel - Zero to one.

Howard Marks - The most important thing.

Nate Tobik - Leverage and succes ( tongue in cheek :P ).

etc.

 

They have all designed their own unique philosophical framework for approaching investing but appararently any of them works. Imho for the average value investor investing is X% boring hard work, Y% complete panic, and Z% blind luck. I feel like these guys mostly come up with their theories after they made a couple of billion and are getting bored of looking for the next mispriced security. Some of these theories are quite interesting but I'm not sure how relevant they all are.

 

I appreciate a guy like Icahn for the simple reason that he just keeps investing instead of trying to become a professor.

[rb]

+1 what writser said.

 

About the book, usually when someone starts pontificating about the Austrian school, I tend to stop listening as I found that they are more motivated by a certain ideology rater than profit.

 

Regarding the options strategy, in my opinion it is not very good. With options just like with stocks you want to buy a mispriced (cheap) security. Options with strike around market and with shorter expiry tend to be quite accurately priced. Options tend to get mispriced the further you get from the market price and the further out in time you get (keep in mind that Black-Scholes is an arbitrage model). So that's where you should look if you want deals on options.

[Guest wellmont]

seems like market timing presented in new wrapping paper.

[JEast]

sounds very similar to that of Taleb's

 

Mark Spitznagel and Nassim Taleb have been partners for hedging in convex tail risk for a number of years.

[Jurgis]

But how often does the market drop 30%?

 

One in five years.

So 0.005 to 0.4

          5 to 80

       

 

I have no clue what you meant by this. :)

 

Assuming 1 in 5 years:

- 4 years you get a return of your portfolio minus 3% annual fee.

- 1 year you get a return of plus ~10% instead of minus 30%.

 

This is actually a good result. :) Which means that I am probably simplifying too much, missing something or calculating it wrong.  ;D

[Jurgis]

Ah, this says that 30% drop happens only one in 10 years: http://investment-fiduciary.com/2011/08/05/how-often-do-market-corrections-happen/

 

This makes the above results worse...

 

9 years of 3% fees + 1 year of plus 10% vs drop of 30% is becoming to look like a wash.

 

Yeah, there are some 10-20% corrections where you would make some money, so more precise model would be needed to see if you come ahead.

 

I also assumed static 10% OTM put pricing which will not be true during corrections.

 

Plus 30% drop is per year. If it does not happen within 2 months you have an option, your return will be worse. I.e. if market drops 10% per month, you will still lose all your option money but your portfolio will drop 30% like the market.

 

So... this does not look very good anymore.

[60North Investments]

sounds very similar to that of Taleb's

 

Mark Spitznagel and Nassim Taleb have been partners for hedging in convex tail risk for a number of years.

 

Yep, Taleb is a "Distinguished Scientific Advisor" at Universa.

 

All in all, thanks everyone for the comments so far. writser's comment seemed especially interesting, can't say I had thought about that before. Though it's probably very hard to know for certain what the motives of those people are but writser's idea makes sense.

 

I'm not sure whether I'd say Spitznagel's ideas are market timing presented in a new wrapping paper. Being 99.5% long and dedicating 0.5% of your portfolio each month/two months to buying puts isn't at least the "boldest" way of market timing in the sense that you're still +99% long. Just an interesting idea I thought, though not really anything new. As Jurgis and Green Kind demonstrated, if the big drops happen often enough (seems like you need them quite often and fast) it'd probably be worthwhile. Not that I'm introducing this to my portfolio now though, currently feel better going to cash if I don't see things to buy.

 

I'd be curious to hear more about people's thoughts on the Austrian School and the problems with it. rb, and others, could you expand a bit on what you see being wrong about their views and thoughts about how the economy works, interest rates etc? I have very shallow knowledge on the topic, but I left the book with the feeling that the Austrian school's view is one of leaving the free market to basically do its own thing (so the idea is that central banks effecting interest rates, government bailing out companies etc in best scenario works short-term but ends badly in the end).

[frommi]

But how often does the market drop 30%?

 

One in five years.

So 0.005 to 0.4

          5 to 80

       

 

It has to drop that much in 1-2 months, so that happened not that often. When you do it every month you are sure to lose money in the long run, because implied volatility is higher than realized volatility. So to be effective you have to have rules in place to not do it every time, but then of course you are market timing.

[Green King]

But how often does the market drop 30%?

 

One in five years.

So 0.005 to 0.4

          5 to 80

       

I have no clue what you meant by this. :)

 

Assuming 1 in 5 years:

- 4 years you get a return of your portfolio minus 3% annual fee.

- 1 year you get a return of plus ~10% instead of minus 30%.

 

This is actually a good result. :) Which means that I am probably simplifying too much, missing something or calculating it wrong.  ;D

 

Your result should be independent of your portfolio.

He is simply framing it the way mentioned to sell the idea.

When taking it on you are not buying insurance on the portfolio.

You are making a bet on the market dropping 30%. Assuming you have not make a mistake on your investments. The drop in market prices should be only be paper losses on the value of your portfolio. Therefore the returns should be calculated as return on premium invested.

[peter1234]

The book is just very long.

Some interesting thoughts, but might get message across better if it was only one third as long.

Agree, the Puts seem expensive, especially considering that they do not protect against slower downward trends.

I do not think that this is what he does at Universa.

Remember, Taleb worked as an option trader for years.

;)

[thepupil]

I only have Feb 1988 - today but in that time period 22 / 323 (6.8%) rolling 3 month periods experienced a >10% drop. Rolling short term puts makes you look like a genius if you happen to pull a Paul Tudor Jones and call a big short term drop.

 

Otherwise, the pennypicker beats out the steamroller any day. In the words of my friend at an options market maker /trading firm "sell the preem, live the dream"

[Guest wellmont]

Yep, Taleb is a "Distinguished Scientific Advisor" at Universa.

 

All in all, thanks everyone for the comments so far. writser's comment seemed especially interesting, can't say I had thought about that before. Though it's probably very hard to know for certain what the motives of those people are but writser's idea makes sense.

 

I'm not sure whether I'd say Spitznagel's ideas are market timing presented in a new wrapping paper. Being 99.5% long and dedicating 0.5% of your portfolio each month/two months to buying puts isn't at least the "boldest" way of market timing in the sense that you're still +99% long. Just an interesting idea I thought, though not really anything new. As Jurgis and Green Kind demonstrated, if the big drops happen often enough (seems like you need them quite often and fast) it'd probably be worthwhile. Not that I'm introducing this to my portfolio now though, currently feel better going to cash if I don't see things to buy.

 

I'd be curious to hear more about people's thoughts on the Austrian School and the problems with it. rb, and others, could you expand a bit on what you see being wrong about their views and thoughts about how the economy works, interest rates etc? I have very shallow knowledge on the topic, but I left the book with the feeling that the Austrian school's view is one of leaving the free market to basically do its own thing (so the idea is that central banks effecting interest rates, government bailing out companies etc in best scenario works short-term but ends badly in the end).

the nyt piece said one guy estimated it would cost 8% a year in insurance to get the kind of results he is promising. this guy is a bearish market timer who thinks there is going to be a crash. but instead of setting his fund up like hussman, he is trying to be long as well as have insurance. apparently his audited results are theoretical. I see him as very similar to hussman. both saying stocks are way overvalued. both predicting a crash. they just have different strategies to execute till that happens. this guy philosophically wants to be in cash until the crash and then buy. but that's a non starter in today's world if you wish to manage opm.

[racemize]

But how often does the market drop 30%?

 

One in five years.

So 0.005 to 0.4

          5 to 80

       

 

Do you have data to back this?  I can run some calculations to check, but just want to verify.

[Green King]

But how often does the market drop 30%?

 

One in five years.

So 0.005 to 0.4

          5 to 80

       

 

Do you have data to back this?  I can run some calculations to check, but just want to verify.

 

Nope nothing backing this :) just assuming a market crash is 30% and it happens once in a business cycle and a cycle is around 5 years. This is not my area of expertise. So far i have only brought out of the money calls on under value stocks only. http://en.wikipedia.org/wiki/List_of_stock_market_crashes_and_bear_markets

The odds are stated from the discussion above and keep in mind you should also have a margin of safety when doing this. So you should have a view of over all valuation. Or maybe Buffett says the market is over prices. :)

 

I think when Taleb is doing this he is buying short dated out of the money options that he believes is undervalued based on his analysis.

[InvestingOnSale]

This might be controversial but what annoys me a bit about a lot of great investors is that they make a lot of money and then feel compelled to spread the gospel of their own 'philosophy' to show that not only they are rich - they are also very smart. As if they feel guilty about their riches and try to make it up by pretending to be the next Plato.

 

Soros - Theory of reflexivity.

Ray Dalio - Principles.

Spitznagel - Dao.

Bill Gross - His cryptic letters about his dog.

Charlie Munger - Lollapalooza, incentives.

Peter Thiel - Zero to one.

Howard Marks - The most important thing.

Nate Tobik - Leverage and succes ( tongue in cheek :P ).

etc.

 

They have all designed their own unique philosophical framework for approaching investing but appararently any of them works. Imho for the average value investor investing is X% boring hard work, Y% complete panic, and Z% blind luck. I feel like these guys mostly come up with their theories after they made a couple of billion and are getting bored of looking for the next mispriced security. Some of these theories are quite interesting but I'm not sure how relevant they all are.

 

I appreciate a guy like Icahn for the simple reason that he just keeps investing instead of trying to become a professor.

 

It is frustrating as an investor to read many different approaches to investing, each of which were apparently successful for their practitioner, but which are all different from one another in some way. But I am thankful each of them took the time to put their thoughts on paper (or give interviews, etc.).

 

Where would many of us on this board be if Buffett had never put his thoughts down in annual letters or given university talks or media interviews?

[NewbieD]

I enjoyed the book, especially the analogies used (conifers after forest fire, false humility, finnish winter war tactics, daoist sage).

There is not much concrete investment advice here but for me as (a newbie investor) it reinforced the importance of interest-rate sensitivity.

Also the connections he made regards to land use was something I never considered. I.e. given a patch of land, planting forest is relatively better in a low-interest rate environment, while barley is better in a high-interest one because of discounting effects.