In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Jason Buck discuss:
- The Impact of Moneyball Strategy Across Different Sports and Financial Markets
- How the Four-Quadrant Model Simplifies Asset Allocation
- The Religious Wars of Investing
- The Cockroach Portfolio
- How AI Enhances, Not Replaces, Human Judgment in Complex Systems
- How AI Transforms Prediction and Decision-Making
- Value Investing: Navigating Through a Historic Downturn
- Achieving Portfolio Balance with Stocks, Bonds, and Defensive Assets
- Avoiding Investment Pitfalls: The Drawdown Tax and Behavioral Challenges
- Mixing Domestic and International Assets for Optimal Diversification
- The Spectrum of Volatility Trading: Tail Risk, Gamma, and Relative Value Strategies
- The Minsky Moment in Trading: Stability, Instability, and Tail Risk Strategies
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Transcript
Tobias: This meeting is being livestreamed. We’re legally obligated to tell you that in the State of California. This is Value: After Hours. I’m Tobias Carlisle, joined by Jake Taylor. Our special guest today is Jason Buck, La Cucaracha. How are you, Jason?
[laughter]Jason: I like that. I’m going to start using that. I’m going to try to get my girlfriend to call me that. By the way, your tweet was epic with the Uncle Bulk reference.
Tobias: Ah,– [crosstalk]
Jason: I’ve been trying to get my nieces and nephews to call me that, and it’s just not working out.
Jake: [crosstalk] Toby, I didn’t know that you had to read that disclaimer at the very beginning. I always thought it was just one of this like–
Tobias: I don’t think you– [crosstalk]
Jake: Oh, okay. I thought it was like one of those Ron Burgundy things where he just reads whatever’s on the screen in front of him.
[laughter]Tobias: It is a little bit like that. It is a little bit– But I just do it for fun. I think it’s funny.
Jake: This meeting is being livestreamed.
[laughter]Jason: Yeah. Speaking of which, so would you do another disclaimer? Like, nothing I say is investment advice. Seek out investment professionals. None of us, we’re just some guys on the internet.
Tobias: I think people can tell from watching that that’s true.
Jason: You would think. But as you know, we have to say all that. By the way, there was a– what is it? When Prince Charles was ascending to the throne, there’s all these protests outside of Buckingham palace, and there’s all these signs like, “Not my king,” all these kind of things. My favorite sign of all time, it’s just said, “He’s just some guy.”
Tobias: Yeah.
Jake: [laughs]
Jason: I just feel like that applies to all of us. Like, we’re just some guy on the internet. Don’t take advice from us on anything.
Tobias: I don’t think there’s any risk of that. So, not worried about it.
Jake: Yeah, that’s true.
Tobias: Jason, I called you La Cucaracha, because you run the Cockroach fund. What is the Cockroach fund?
Jason: Man, right to the point.
Tobias: Just let the people know.
Jake: No foreplay here, Jason. We’re just–
[laughter]===
The Cockroach Portfolio
Jason: Exactly. No lube. So, basically, my partner, Taylor Pearson and I built exactly what we wanted for ourselves and our families, and then we just opened it up to outside investors. But the idea with a cockroach is it can survive anything. People think they have broad portfolio diversification when they look at that pie chart, but usually, it’s just purely offensive assets. And then we see in March 2020, correlations go to one, everything goes down together. That shows them that they’re really just long GDP and offensive assets.
So, what we wanted to really bring to market was specializing in the defensive side. And on the defensive side, we used long volatility, tail risk, commodity trend advisors, etc. And the idea is pairing offense and defense will win investing championships over the long run and help you compound portfolios to maximize your log wealth, because you’re reducing that volatility tax or that drawdowns that can make you do stupid things.
So, we like to pair offense plus defense, and then we use Harry Browne’s four-quadrant model that goes back to the 1970s. They’re on the axis’ of growth and inflation, where they’re in growth or recession, inflation or deflation. It’s kind of a Venn diagram, they overlap. But the idea there is that’s the global four macro quadrants that we want to cover and overlay those with offensive defense. And then hopefully, our portfolio muddles along in any macro environment. And like Toby said, it’s cockroach. What survives everything, roaches. Always cockroaches.
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Tobias: Yeah. You need to predict– [crosstalk]
Jake: Yeah. It fits that great racing quote about, “You want to win the race as slowly as you can.”
Tobias: Yeah.
Jake: Just don’t crash, right?
Tobias: Yeah. Who is that? Alain Prost or something like that?
Jake: Ah, Niki Lauda.
Jason: [crosstalk] Niki Lauda? Really?
Jake: Yeah.
Tobias: He wants to win as slowly as possible.
Jason: Yeah. David Dredge, another vol manager has the best one. He’s like, “It’s not the fastest car that wins in F1. It’s the one that the best brakes.” Because in those turns, in those coming out of those turns is when then you accelerate, and then it’s your average speed going to Niki Lauda to average speed over time. And the other one I’ve been using recently when I was just speaking in South Carolina was the Tour de France. And the idea there is like, your average speed over time over those 21 grueling stages. I point out that even Lance Armstrong, over seven titles, only won 24% of those stages out of 147 total stages. And so, nowadays, I think you have the average speed of 26.1 miles an hour to win the Tour de France.
Actually, two people in history actually never held the yellow jersey till the very last day. So, it’s that average time, average speed. What we’re talking about is we’re referencing compounded versus arithmetic returns. The idea of your actual path or your sequencing risk through time compounds, and the volatility tax can greatly destroy your portfolio. But I don’t think a lot of people think about that too much.
Jake: Well, they don’t. It’s one of the, perhaps, most important and overlooked mental models I think in finance honestly.
Jason: Yeah, man. I was listening to a book, like audiobook, earlier and they were talking about alternative investments. I think we lost Toby, so hopefully, he’ll jump back in here. Hopefully, your co-host there. [laughs] They said alternative investments like private equity and real estate, venture capital, I’m like, “What? Those are alternative investments?” No, those are just leveraged up equity. Those are not alternative investments. I think of alternatives are like things that are uncorrelated or negatively correlated.
But yeah, when we look at the offensive assets, PE, VC, real estate and all the different ilks of that, whether it’s private credit, etc., those are just highly levered equity positions. And I think that’s where people think they’re getting that diversification, but like we’re saying, they’re just highly offensive or now just even multiple lever to offensive assets.
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Jake: And how much do you think, Jason, is it–? How many implicit rates bets are being placed and maybe unknowingly?
Jason: [chuckles] Yeah, I think that’s the hard part about any offensive asset is I would say you’re implicitly short volatility. But another way to say is that you’re long GDP or you’re long liquidity, and somewhat within that rate spat’s that liquidity constraint. And nowadays, I think people got accustomed to the last 30 years, 40 years of stock bond correlations being negative. And then now, we seeing inflationary times is usually when they’re positive. And then, so then people are hoping for that rates bet to come back and we’ll see if it happens or not. I don’t have crystal vol, so I can’t predict the future. But like you said, everybody’s pleading for the times to come back that they got used to for the last 40 years.
Jake: Yeah. 2022, I imagine must have been felt a little vindicating, I would guess?
Jason: Yes and no. It’s hard.
Jake: You don’t want to take victory laps ever- [crosstalk]
Jason: Oh, yeah.
Jake: -the Gods, but still, isn’t that exactly what you had in mind when you were building?
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Achieving Portfolio Balance with Stocks, Bonds, and Defensive Assets
Jason: Yeah. We still are very offensive. We still use global stocks and global bonds, and then we just pair that with the defensive assets with the long volatility and the commodity trend. And so, even having that exposure to stocks and bonds, obviously, they had that drawdown at 2022, but then they’re balanced primarily by the commodity trend side and a little bit by volatility. We can talk about their dispersion of returns there.
So, yeah, it felt vindicated, except at the same time, I believe in absolute returns. And so, even though our portfolio is slightly negative, during 2022, it was relative value dramatically outperformed most people’s 60/40 portfolios. But that’s why you also don’t take a victory lap is, because I still believe in absolute returns. So, it’s like what have you done for me lately kind of thing, but also like, “Oh, you were down too,” but dramatically different exposure [crosstalk] to that down move.
Yeah. And then as you said, the hole to dig out of, if you’re down 20%, you got to go up 25%. If you’re down 5%, you only got to go up a little bit more than 5%. It’s once again that volatility tax greatly reduces the compounding. But then what happens is after 2022, people then forget in 2023. When their stocks and bonds are back up, they forget about the compounding through time. They look at the arithmetic return and they look at what their neighbors getting and they go, “Yeah, we’re crushing that.”
So, it’s also like, that’s the hard part when you’re broadly diversified. You always have a part of your portfolio that you absolutely suck that makes you want to throw up, that you want to just punch yourself in the head for. And then all the news media tells you you’re an idiot for owning it. But that’s proper diversification. If you like everything in your portfolio, you’re obviously not diversified.
And then the other part of it is that to do anything different from your neighbors, you’re going to look like a schmuck most of the time. Like you just said, you’re not going to take that victory lap when you don’t have their drawdowns. You can’t gloat in their face, but they’re definitely going to gloat in your face when [Jake laughs] stocks are ripping.
Jake: When they’re ripping in. [chuckles] Everyone’s a genius.
Jason: Exactly.
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Jake: Yeah. That’s the tough part of this game. How much of the strategy for the Cockroach fund is really about guarding yourself from your own behavioral mistakes?
Jason: You nailed it. So, this one’s I think is one of the hardest things to talk about in finance, especially when you’re talking to financial advisors and everybody is like, “We don’t want to talk about this.” But I’ll talk about freely. It’s like babysitter tax. People use financial advisors a lot of times, so they don’t do anything stupid.
Jake: Mm-hmm.
Jason: I’m sure you guys have seen all the research is like, the average mutual fund owner reduce– They have anywhere from 1% to 6% drag compared to the actual mutual fund if they held it for the majority of the time they were in there, because they’re trying to time the markets.
Jake: Right.
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Avoiding Investment Pitfalls: The Drawdown Tax and Behavioral Challenges
Jason: And so, one, you have the timing aspect of just like good times. And then more importantly, behaviorally, you have that drawdown tax or that drawdown cost that people don’t realize is like– In 2008, when the stock market’s down over 50%, most people capitulated right at the bottom and they said, “I’m never getting stocks again.” They missed all that run up to try to now, like you said, they had to make 100% to get back to even, and they missed out on that, and then they maybe jump in back in 2012.
And so, behaviorally, it’s really hard to handle a lot of these things. So, that’s why we think that adding those defensive sides to the portfolio, if you’re in an inflationary environment, a protracted recession or even a sharp liquidity risk, to have those things in your portfolio that provide the ballast to that portfolio, it keeps you from doing those stupid things.
And so, like you’re saying, it’s that behavioral ability to hold all that is extremely helpful. Now, granted the hard behavioral side like we referenced, is if your neighbors are ripping on stocks, keeping up with the Jones’ is over shorter periods is hard to do.
But then, one is that that allows you to not lose your head and do stupid things. But then two, we rebalance the portfolio monthly, because we offer monthly liquidity to our clients. We can argue over every balancing bands are better or just temporal horizons with monthly rebalancing. But by us rebalancing monthly, that also keeps people from doing anything crazy as far as rebalancing those four return drivers and asset classes.
So, for example, say in March of 2020, stock market tanks off, and pretty much everything else on that offensive side, correlations go to one. Say, if somebody had a tail risk on their books, that tail risk position just convex cash position, now, you’re just flushed with cash. But more important than that, than balancing the portfolio and do anything stupid. If you rebalance April 1st and now you’re buying stocks at that lower nab point, that’s what actually increases your compounding over time.
And so, it’s a little bit of truncating the left tail, so you don’t do anything stupid. But more importantly, buying those offensive assets when they’re on the cheap and the compounding average of that over time is going to dramatically increase your log wealth.
Jake: It’s like, when you force turnovers, you often get good field position.
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Jason: Exactly. Somebody just told me about it at this event called punalytics. Have you ever seen this site?
Jake: No.
Jason: Because I was giving the examples that Chris Cole wrote a great paper on Dennis Rodman to show how he’s the lowest scoring basketball player to ever get in the Hall of Fame, but how much he dramatically improved the winning percentage of any team he played on because of his rebounding ability. And his height, he was six standard deviations better than any other rebounder in the league. He’s truly phenomenal.
And so, this guy was asking me for other examples. I started thinking about what I wanted to maybe do a research on is like punters in NFL, like you’re saying is like, “If you can peg people within that 5 to 10 yards of the goal line, like how much that affects a game over time or the winning percentage of that team throughout the season?” And so, if you have Pat McAfee, a pro-bowl punter, we’re not thinking about that as often as we are thinking about the big plays by the wide receivers or the running backs. We’re not thinking about the validity of that. Although I would argue that in the Moneyball era, I bet the NFL is paying very close attention to that.
Jake: Yeah, they have to be. There’s probably on a per yard basis, you could calculate the slight changes in winning percentage that happen.
Tobias: Didn’t they figure out statistically, you should go for it on fourth down, like you should never punt, you should always–? What was the– [crosstalk]
Jake: I think it was more often than what coaches do.
Tobias: Okay.
Jake: But I don’t think that’s like a blanket.
Jason: The coach from Los Angeles Chargers, he really adheres to that, and people just think he’s a moron half the time, right?
Jake: Yeah.
Jason: That’s like to your point. It’s one thing to do. It’s always interesting to me to see how the pundits, especially the former players come out of the woodwork and they’re like, “I don’t care what the statistics say in that scenario. You don’t do that.” And it’s like, you can feel the game and it’s just like, “Over the long run, he’s right. But over the intervening–” It’s just like, “Yeah, what do you do, short-term versus long-term and being positive expected value.” It’s hard, like we’re saying, emotionality and behavioral changes.
Tobias: I rewatched that on Sunday night. It’s a great movie.
Jake: Which one? Moneyball?
Tobias: Moneyball
Jason: Moneyball?
Jake: Yeah. That is good.
Tobias: Yeah.
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The Impact of Moneyball Strategy Across Different Sports and Financial Markets
Jason: No, it’s the best. I was given other examples like [Jake laughs] Moneyball is the best, but people forget that. It’s about the Oakland As. And then Theo Epstein took those ideas and went to the Boston Red Sox and won the first World Series in 85 years. But then what I point out from there is the owner of the Red Sox at the time was John Henry of Fenway Sports Group. And John Henry’s a trend following managed futures guy, where he understood statistics and probabilities and he was trading over 60 to 80 markets, especially during the great eras of 1960s, 1970s and 1980s is how he made his wealth. But then in 2010, he bought Liverpool Football Club.
Most people don’t like to talk about soccer, because it’s un-American. I get it. I was a soccer player and I get. It’s the most boring sport. Everybody hates it. But John Henry of Fenway Sports Groups buys Liverpool in 2010, and they’re trying to restore this historic franchise. And in 2015, they hired Jürgen Klopp from Germany, who’s one of the greatest football managers of all time, but he’s known as for heavy metal football, they call it. Like, all-out attack. And so, they’re scoring lots of goals, but they’re getting a lot of goals scored against them.
But then 2018, they’re like, “We need to shore up this defense.” So, they went out and got Alisson Becker from Brazil as goalkeeper, at that time, the best goalkeeper in the world, and they got Virgil van Dijk, the best defender in the world from the Netherlands, and he played sweeper for them. So, now they shore up their defense in 2018. So, going into 2019, they end up winning the Champions League which is the most prestigious club trophy in all of soccer. And then the following year, they won the English Premier League for the first time in 30 years.
So, once again, it was like offense, plus defense wins championships, but we all herald offense way more. They use that Moneyball approach, although I think it’s a lot harder to use a Moneyball approach in things like soccer world. Baseball is awesome, because you have all those discrete events. Basketball, they’re getting a little bit better with all the statistics.
But actually, at the event, I was talking to Joe Peta, who’s a former baseball and sports gambler that used a lot of those theories to measure hedge fund traders, especially in market neutral long short hedge funds, like 0.72. He was there. And so, you have a lot of discrete events with those managers, so you can derive how much alpha they’re using versus the variance of the markets.
It’s just interesting how these things have truly taken off. But he was telling me that he finds even at some of the biggest hedge funds in the world, they’re not amenable to these ideas still too. They still feel like, “This guy, I know he’s going to come back.
Jake: Hot hand.
Jason: He’s a good guy.”
Jake: Heuristics. Galore.
Jason: Yeah. Or, it’s even worse is the intangibles like Toby was talking about from Moneyball is, they used to talk about, “Oh, this guy’s handsome or his girlfriend is ugly.”
Tobias: Good face.
Jake: Oh, yeah.
[laughter]Tobias: Yeah, ugly girlfriend. No confidence.
Jake: No confidence. [laughs]
Jason: Yeah. That’s just crazy. But he was telling me how that still happens at some of the most quantitative hedge funds in the world. It’s crazy.
Tobias: I’ve been watching Full Swing. And they do the same thing in Full Swing when they choose the Ryder Cup. They take 12 players. The top six players, they have the best score over the season. Then the coach gets to or the captain gets to choose six other players. And so, they’re showing Justin Thomas and somebody else, lesser-known player. Sorry, I can’t remember his name. I’ve only seen Part 1. So, I don’t know what happens. [laughs] I haven’t seen Part 2 yet. [laughs]
Jake: Good story, man.
[laughter]Tobias: It doesn’t matter– [crosstalk]
Jason: You trailed off in the middle there. But no,– [crosstalk]
Jake: Yeah.
Jason: It’s gets better. That’s actually a great show. But it is fascinating. Like, yeah, the objective versus the subjective of half and half. And then it’s the other guy, he’s basically had the captain always stay with him on tour and everything. They were like best friends. He’s staying in his house, rent free.
Tobias: Yeah. [crosstalk] Justin Thomas does that. Yeah.
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Jason: Oh, [crosstalk] JT. Okay. Sorry. But yeah, I was like, “And that’s not going to skew his behavior.” It’s just like, my brother-in-law is a surgeon. I remember when I used to spend time with them in New York, and all of these drug companies back in the day or these surgical device manufacturers were taking them out for steak dinners and wine, and he’s like, “It’s not affecting my opinion at all.”
Jake: Yeah, sure.
Jason: I’m like, “You’re out of your mind.” [chuckles]
Jake: You could read a half of a Cialdini book and you would understand how wrong you are. [laughs]
Jason: Yeah. Always benefit of the doubt. If given two choices, the one that took you to steak dinner is going to magically get that benefit of the doubt if you have a choice.
Tobias: I know I’m running pretty systematic. I look at some of the names that go in and I think people are just going to think I’m an idiot for putting this stuff in there. Like, everybody knows what’s wrong with this thing. And so, do I. But the system likes it. So, what are you going to do? And the problem is, as I’ve shown, there are lots of studies out there, not thousands, dozens of studies out there that show every time you pull out the one that you think is the loser,-
Jake: The worse. Yeah.
Tobias: -you’re cherry picking out all of your best returns.
Jason: Yeah. You think yours is bad? We own a quarter of our portfolio in global bonds. Everybody thinks I’m a moron. They tell me every day. It’s great.
Jake: [laughs]
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How the Four-Quadrant Model Simplifies Asset Allocation
Tobias: The four quadrants, I want to learn a little bit more about that too. You don’t need to predict what area you’re in. You’re always keeping a pretty balanced. So, it’s not predictive at all. It’s sort of come what may.
Jake: Agnostic too.
Jason: Yeah. I know you guys appreciate this somewhat. It’s amazing to me that I get invited to speak at events, because I just feel like I’m the turd in the punch bowl, because [Jake chuckles] everybody goes on stage and talks about their hero trade, and I go up there and I’m like, “Look, I can’t predict the future. None of these guys can. It’s all make believe. None of us have crystal vols.” We’re totally– [crosstalk]
Tobias: [crosstalk] it’s a good story.
Jason: Yeah. But I fall for it every time. We were just talking about before we got on, like, our homie, Ian Cassel, I went to lunch with him the other day. He’s telling me about stocks. I’m falling in love with him.
Jake: Yeah. [laughs]
Jason: I’m an optimistic entrepreneur. I fell in love with every stock he told me about. [Tobias laughs] I don’t know how you guys do it. So, yeah, we’re non predictive. So, if you think about what was the difference between like Harry Browne’s four-quadrant model, which Dalio eventually copied but never gave Harry Browne credit and he just leveraged up the bond portion, is then they were trying to leverage risk parity to your variance, or what people called the unfortunate substitute variance with volatility. And so, that’s semi predictive based on variance and correlation is how you would lever the risk parity portfolio.
But I like that Harry Browne just gave them equal weight, because over the long enough time horizon, your returns to risk are going to end up being one over N given the long enough time horizon. That’s why I like to equal weight of that. And if you’ve done risk parity in 1930s, you would be done game over.
So, the idea though with our four-quadrant model is like Harry Browne used stocks for growth, bonds for disinflation or deflation, cash for recession and gold for inflation. And the idea was, he had a rebalancing bands of, if any of them got outside the 10%, then you rebalance. So, he was 25% each. They got up to 35% or down to 15%, then he’d rebalance, which worked out to about every 1.4 years since 1972. And it was just a very– [crosstalk]
Jake: That’s higher than I would have thought actually. Like, more often.
Jason: Really. Yeah. I don’t know. Yeah. What? Who knows? BME probably went years and then those volatility kicks out that yeah.
Jake: Yeah. They cluster together more.
Jason: Yeah. We shouldn’t be talking about averages as we all know, our Taleb, we can drown in a river to average of 2ft deep.
Jake: Right.
Jason: So, the idea with Harry Browne is like non predictive. You’re in the four global macro quadrants as they move around. So, to me, the idea is, if you were alive today and had the tools we have, instead of cash, we use long volatility and tail risk gives you much more like a convex cash position. And instead of just gold for inflation, we like to use commodity trend advisors that can allocate to much many more of those commodity markets than just gold. But the idea like you’re saying Toby, is the idea is we keep those four quadrants fixed. And so, I would prefer rebalancing bands in general, as our good friend, Corey Hoffstein’s written about rebalancing timing luck.
So, I’d either like rebalancing bands or to rebalance much more frequently, but given trading costs, etc., that’s difficult. And then, just because we offer our clients monthly liquidity, we end up rebalancing monthly. So, yeah, it’s non predictive. But any rebalancing frequency or idea of rebalancing is essentially– you could say it’s pseudo market timing. But what I think about is, when you truly have four-global macro quadrants and an idea of rebalancing too is implicitly going to be mean reversionary or implicitly short volatility, honestly.
And so, the idea is, over a long archive of time, those four-global macro quadrants as money flows around the world into different asset classes, should mean revert over time. So, you are making that implicit assumption that you have some form of mean reversion. But I would look at it more as force scale trading. Because when you are off, Jake and I were talking about behaviorally, what it forces me to do is to incrementally scale into positions as they’re going into drawdown and incrementally start selling my winners. So, I’m rebalancing from my winners to the losers. And by doing that monthly, it forces me to do that. I’m not choosing of saying, “Ooh, I don’t know bonds. I should lighten up here.” Because if I predict the future, it’s going to be much worse.
Tobias: Yeah, I like that approach.
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Mixing Domestic and International Assets for Optimal Diversification
Jake: How do you handle the international versus US? If you weren’t tipped US the last 10 years, that would have been a real headwind. But we look at total market cap versus economic output, and people are way overweight, the US relative to the rest of the world as far as that statistic goes. So, how do you balance those things out by trying to still stay agnostic?
Jason: Yeah. Also structurally, what we do is called the commodity pool operation function you can think of as a hedge fund. But because we set up as a commodity pool or in managed futures– I say that because we use the futures indices for stock and bond markets, because that’s just a specific example. And to do that, we replicate MSCI Acuity. So, we’re 60% domestic, 20% ex-US developed and 20% emerging. And so, the idea is like, we’re using all the different countries to replicate MSCI Acuity.
Jake: Okay,
Jason: And then we do similarly on the bond side. I think you get more of that geographic diversification from the bond side. On the stock side, I can understand the arguments that say like, a US multinational is truly multinational, and you’re no longer are you getting as much diversification. But implicitly, I think without hedging your foreign currency exposure, it’s also an FX bet at the end of the day too, especially on the stock side. Where the bond side, there’s idiosyncratic bond markets in these different countries that may or may not be affected globally by US hegemonic policies. That’s why we diversify.
I understand the argument against diversification on the stock side, but at the end of the day, we just feel it’s the right thing to do. So, we just think like [unintelligible 00:23:53] we can’t predict the future. We want broad diversification. We actually know our Mandelbrot, we want fractal diversification. So, not only we diversified against four quadrants, within each quadrant, we’re using broad diversification as well. Like you said, we’re going globally instead of domestic. But at the same time, going back to everybody hates us, because like you said, US is outperforming. [chuckles].
Jake: Yeah.
Jason: There was a brief period a few quarters ago or a few months ago, where foreign started to jump out from behind the curtain, and we’re like, “Finally,” and then smashed back down.
Jake: Yeah. [laughs]
Tobias: Did you get a chance to rebalance some of that profit away?
Jason: Yeah, of course.
Tobias: There you go. Because some of it.
Jason: Yeah. So, you also get a rebalancing premium too. Well, Corey’s going to beat me up for calling it a premium, but because [Tobias laughs] it’s just what it is. Through diversification and rebalancing, there’s this unique mathematical phenomenon where you can actually derive a return just from rebalancing diversification through time, which can give you an anywhere from an extra 1% to 4% on annualized basis. If your asset classes are fairly volatile and uncorrelated or negatively correlated, you also garner a little bit of rebalancing premium. Even if all those asset classes went nowhere but they were volatile and uncorrelated, negatively correlated, you could still harness that rebalancing premium through time.
Tobias: They can go down too. That’s that Shannon’s Demon.
Jake: Shannon’s Demon.
Jason: Yup.
Tobias: Yeah. Classic.
Jason: Yes. Shannon was like that– I don’t know about you, guys, but that broke my mind back in 2007, 2008.
Tobias: Within Fortune’s formula. That’s where it came out, right?
Jake: Yeah.
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Tobias: Yeah, it’s amazing. So, how are you building the business? You were doing Real Vision for a while. You still doing Real Vision?
Jason: No. So, yeah, I did– In mid-2020, vol got hot. So, they wanted to talk about volatility on Real Vision. And it just so happens, we’re at the nexus of the vol markets. We allocate to 14 volume managers. We track 30 to 40 total. So, I know pretty much anybody and everybody in the vol space, I know all their strategies, etc. And so, when people want to come, they want to know what’s going on in the vol space, they come through us, and they want to talk to me about what’s going on. And so, that’s how that Real Vision whole thing started, just because volatility was sexy again.
And then over the intervening years, volatility hasn’t been as sexy. And now, everybody hates it again, which is great for me, because the price of tail risk is at the lowest point it’s been since 2017 to 2019.
Jake: It’s so cheap now.
Jason: Yeah, it’s great. If you can stay alive, it’s great. And then, Real Vision moved much towards crypto. I miss the old days when it was just more of those long form Grant Williams style interviews about, “Show me how you think, not like what to trade this week.” I miss those days. So, I did a lot of that, as Toby saying back in the day, and that led to a lot of other podcasting, etc. We put out our own podcast for a while.
Jake: Yeah, [crosstalk] had a great work.
Jason: Thank you. Everybody says that. I don’t know, It feels like– I’m always surprised who watches it or said they watched it. It always surprised me come out of the word board, because as you guys know, you’re in your office or your living room talking to your computer. Like, you don’t realize anybody– [Tobias laughs] Those numbers, you see a few thousand people on there, but it’s just a number.
And then especially, like the Real Vision stuff like, my public facing presence came during 2020. So, during the pandemic and everything, I was really just talking to a computer and then coming out of it, going to events and people knowing your name that you don’t know. I’m sure you guys have to deal with this all the time is that weird parasocial relationship where they’re like, “Toby, how are you doing?”
Jake: [crosstalk] [laughs]
Jason: Yeah. They start asking you all this stuff in your personal life and you’re like, “Oh, man, this is asymmetric.” [Jake chuckles]
Yeah. Oh, going back to Corey and I. So, yeah, that had three stages to it. Like, the first one we did is, I had been slowly sandpapering Corey’s vols for a year to do something together. He was against it. And by the way, full shout out to Corey. He had the power dynamic in that relationship. He was the one that has garnered that amazing reputation that, “I can only bring down,” which is probably why we ended it in the long run, because I’m a loose canon.
Jake: [laughs]
Jason: So, what we were doing is like, we were trying to think what we could do together. And it was during the pandemic. People were starting podcasts, even though podcasts are still not as prevalent as they should be in our industry. And so, we were trying to think like, “What could we do differently?” We talked about maybe live podcasting, everything, but you guys already have a lock on that and ReSolve was doing it too. We found out we both had a mutual love–
Jake: Pirates.
Jason: Yeah.
[laughter]Jason: We both had a mutual love for blogging, and these more scripted, more edited vlogs. And we’re like, “Nobody in our industry is doing that.” We go “Let’s try it.” And so, that’s what we decided to do. We actually were an hour before recording our first live podcast and then canceled it and like, “No, let’s do something completely different.” And then we came up with this original concept for Pirates of Finance.
It was a lot of fun, but it happened during the pandemic, so we had a lot more time on our hands. And editing burden of doing those structured videos and putting out one a week was starting to get to be a nightmare.
The positive thing we had that you guys, you know too well, is like we didn’t have to chase guests. We just had to be loyal to each other and be there every week for each other. Because as you know, it might seem simple to get guests, but every week in and week out, those guests drop off, they don’t show up, it’s a nightmare of hurting cats for guests.
So, we were happy to do just the two of us. But then the editing burden got too high, so we had to put a pause on it after we came out of the pandemic. And then Blockworks reached out to us and wanted to do something, and we’re like, “Yeah, we can’t do that again. But maybe we can do a podcast together.” And so, then we started doing that on Blockworks, but that audience was much more crypto and global macro, which as you heard me say, I don’t have a crystal vol. Corey and I are not into that kind of stuff. We just think it’s like masturbation generally, so we don’t even do it. That was the wrong audience for us.
And then we redid Pirates of Finance doing just a live podcast, primarily on YouTube on Fridays. And yeah, we enjoyed that for a nice, long run too and then, life got in the way. I started to get worried that I was going to get Corey canceled.
Jake: [laughs]
Jason: He’s already done me too many favors. Yeah, I don’t want my ability. It always makes me nervous doing these live ones, because I’m like, “I’m going to say something that’s going to get us all canceled.” And thankfully, I haven’t done it yet. But I just feel like– [crosstalk]
Tobias: Let’s stick into that a little bit. What are you going to say is going to get us canceled?
Jake: Yeah [laughs]
Jason: I don’t know.
Tobias: Put a set of our misery.
Jason: I’ve said a lot of things where my business partner is like, “We should have a grandma-grandpa rule. If you don’t want to offend them, then it’s probably not a good idea.” And to me, it’s like, as long as we don’t talk about numbers or returns or irrational promises, we should be able to talk about anything.
Jake: Yeah. Between Bill and Toby and I, if we haven’t got ourselves canceled at this point, it’s probably not going to happen. I don’t know.
Tobias: When the law firm sends you requests for discovery, you just send them so much stuff that they can’t get– You hide the smoking gun-
Jake: Yeah, [crosstalk] blizzard.
Tobias: -and just piles of stuff. That’s what we’ve done, the blizzard approach.
Jason: But I love what you guys are doing. I’m also bipolar about it, because I feel like saying, “Oh, I’m afraid of getting canceled.” It’s like, I’m not that controversial. I just hate when people keep using that now as like some sort of excuse or they think they’re a badass. Like, you’re just not. Nobody cares. [Jake chuckles] But what you guys do that I was really adamant about Corey and I in the third iteration of Pirates is like, I think most of the people in our industry are afraid of being themselves. The bulk of the podcast and everything in our industry is purely interviewing, purely semi scripted, they’re going through the emotions and making sure they touch all the talking points.
Where to come on these live podcasts and just shoot the shit about nothing, we had nothing prepared, you guys didn’t send me any questions, I didn’t send you talking points. [Jake laughs] It’s like, that’s where our industry is headed, if you’re willing to go there, because like we said, those parasocial relationships, people see who you guys are week in and week out. And quite frankly, a lot of times they know you better than your own families because of the variety of things you’re willing to talk about if you go live without an agenda. But it’s fascinating to me, that’s a blue ocean because our industry is so afraid of being themselves or getting found out that maybe they don’t have a crystal vol, like that they are just some guy.
Tobias: Compliance is a little bit frightening in that regard-
Jason: [laughs]
Tobias: -if you get public facing stuff.
Jake: [laughs]
Jason: Yeah. So, to your point, even though you have the step and repeat banner behind you, that’s what we did for Corey’s thing, because we have different compliance, me on NFA and him on ETFs is like, you just can’t talk about what he does. So, that was the other thing like, that would also drove us to talk about other things. It’s like, we can’t talk about what Corey does, so let’s just talk about other things. But I was surprised, like, I get more DMs about like when I would talk about– As my PSA to young men or young women, it’s like, you should cook with unsalted butter and then you salt a taste as you’re cooking. But I would get more DMs about unsalted butter [Jake laughs] than I’d ever get about commodity trend following.
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The Spectrum of Volatility Trading: Tail Risk, Gamma, and Relative Value Strategies
Tobias: Let’s talk about volatility a little bit. I like volatility enough. Chris is a good friend of mine, so I’ve talked a lot of volatility over the years, and I’ve traded it. I don’t think it actually– [crosstalk]
Jake: Flushed a fair amount of premiums down the toilet. [laughs]
Tobias: Flushed a lot of premium– I’ve also had a few big winners that expired worthless. I’m no good at it. I like it as an idea. Can you just run through a little bit–? There’s a spectrum of volatility. I think that people, they either think that it’s like a Taleb type thing where you’re waiting for something to blow up, and that’s when you get this once in 7-year, 10-year, 15-year. I don’t know how long since we’ve had a problem blow up. But there are others. There’s crisis over and just– What’s the spectrum?
Jason: Yeah. So, you guys have talked about it a bit before, and you had our buddy, Jim Carroll on before, talking about volatility. But classically, like you said, the Taleb or Spitznagel type is pure tail risk protection. The idea is like, you’re 97% long S&P and you spend 3% a year premium to truncate your left tail, let’s say, beyond a negative 20% drawdown.
The idea there is just like insurance is your 3% is your premium spend on your insurance, the negative 20% drawdowns, the deductible, and then you’re covering beyond that point. That’s classic Spitznagel-Taleb tail risk protection. We could talk about how they get there, and how people actually trade these to actually get them done right at an institutional class.
Jake: Lower the cost.
Jason: Yeah. Lower the cost at institutional level. But that’s the general idea. And the idea there is like, if Toby is saying these come along once every 10 years, it’s about rebalancing and buying those assets at the lower NAV point that I talked about earlier. And the idea is like, yes, it’s a negative EV trade, especially if you’re, say spending 3% a year for 10 years and then may be only make 20%, 30%, 40%, 50%, whatever it is and sell off, it looks like a negative EV trade, but it’s about the emergent effects of the portfolio over time.
And then more importantly as Taleb said more recently, it’s like, “If you have portfolio insurance, you don’t have a portfolio.” It’s like having a coastal Florida house in a hurricane belt that’s $10 million and not having insurance on it. Well, you better save up $10 million cash if you want to rebuild that thing or more into the future. So, that’s the general idea on classical tail risk.
Like you just said, what we were talking about behaviorally, people didn’t like that 3% bleed. So, then what people and what we locally called long volatility is, I would argue that’s more in the opportunistic tail trading and it could be on the left or the right tail. But the idea is you don’t need to have that permanently on tail risk. You can wait for the right conditions to put that on to lower your cost.
So, the idea is like a forest fire analogy. If we’re looking at wind levels, we’re looking at ground humidity levels, we’re looking at lightning strikes, all those sorts of things, and then we’re going to buy our tail protection on either the left or right tail. That’s the idea of more opportunistic long vol trading. The idea is that they’re trying to lower that cost over time, but then you’re giving up a deterministic bleed for a variable return as you’re trying to lower that, because you might spend more, you might spend less and might have more– [crosstalk]
Tobias: And is a chance you miss it.
Jake: Yeah.
Jason: And is a chance you miss it. And we can get into like, there’s still a chance you miss it on the deterministic ones because you still have to monetize it correctly. So, that’s the difficulty.
So, then you think about that opportunistic and then you can start to think about your paths of moneyness. Like, are you getting closer to at the money? Do you want out of the money? You want deep out of the money? What are you trying to monetize that? So, then you could get into more what’s called long gamma style trading where you’re closer to at the money. You might trade like calendars for that. Like, you might be long a one-week option at the money, short on option three, four months out, maybe 5%, 10% of the money, and then maybe long some teenies on the backend just to protect yourself against try to make it Vega neutral but still stay long gamma. The idea there is you capture more, realize vol, and you get more rebalancing opportunities over time. So, it’s just a different style of doing that trading.
So those are the kind of the options complex. The other one we work with is what we call vol relative value or stat arb in the vol space, where basically, you’re using the differences in the intermarket spread between S&P and VIX both on the future side, the option side, etc., where its pairs trading. So, it’s a form of implicit short volatility if you’re trying to make a little money off those pair trades. We try to use that to cover the cost or the bleed of that premium on that long volatility and tail risk side. So, that’s another way of doing it.
Then the last bucket, the way we do it is just what we call short delta trading or just using those managed futures positions to use intraday trend following. So, the problem is, after that vol spike event happens and let’s say you monetize your tail risk, well, now I’m naked moving forward, so how do I protect myself? If I want to buy more options, the implied volatility spikes so much, it’s going to be really prohibitive that insurance is going to be incredibly high and you’re going to bleed.
So, if you just short the market index futures globally on an intraday basis, you’re not paying up for that implied volatility. It’s a directional bet. You’re just going short delta. Trend following intraday is a really tough job, and very few people have ever pulled it off well. But that’s just another way of covering that bleed.
I will say, I’ll throw it out there. We actually don’t use any shorts equities, because I believe it’s a negative EV trade over the long run for many reasons. One, the whole stock market is set up against you. You put on a tiny position, then you get your face ripped off as everybody saw in short squeezes with the meme stocks. But then even worse is like, 2008 happens, you’re actually up on your shorts. But then, Goldman Sachs either increases your borrow or your margin or just blocks you out of the trades and takes over your books as they did with Marc Cohodes. So, there’s just nightmare scenarios along those lines where I literally like those deterministic puts that you can buy and have that protection across listed exchanges.
So, I think that gives you the broad gamut there, Toby. We could talk about, like you said, on tail risk, it’s really easy I think if people read Spitznagel or Taleb. Actually, Jesse Felder wrote a great blog post about how to do this yourself. But the problem is, I find– if you’re buying that deep out of the money tail risk, like a lot of people buy three months out and they’ll roll it every two months, and the idea there is- So, one, you’re not really looking at the vol surface as much as an individual trader as professional institutions are, and you’re getting picked off. You’re probably the most expensive part of the curved vol surface by doing it systematically. Those people are constantly getting picked off, especially even the ETFs doing their collar trades, etc.
The other thing is that people don’t realize is the execution costs for an individual to put on those trades. If you’re buying teenies and they’re anywhere for two cents to four cents and you have to cross that spread, that’s the difference between a 50x return and a 25x return. That’s dramatically going to protect your protection over time. So, actually, the trading costs are more in that 20%, 30%, 40% for individuals trying to pull these trades off. And then the hardest part, even if the institution gets all of those execution, they get all that right, when do you monetize? How do you monetize? How do you roll these positions? That’s easier said than done.
People use different monetization heuristics. That’s why we use an ensemble of them, because like you said, if this happens once every 5, 10, 15 years, we got to make sure we capture the meat of that move. If three or four of our managers say, “Oops, sorry, I didn’t monetize it correctly.” Well, we still have another dozen managers to monetize that correctly, because we don’t want egg on our face. And that tends to happen over time.
Then the other thing that people hate about tail risk hedging, as we saw in 2023, and we already knew this would happen is, or sorry 2022, is if you have a really low volume environment and the market just grinds lower and lower, and Jim talked about this on yours, it’s like you’re not going to get that pop in volatility. So, you’re going to spend all that premium, you’re not really going to catch the short deltas. And so, the market’s down and your tail risk is down. And so, then people have a hard time dealing with it. But this is why everybody’s gotten rid of tail risk insurance and why it’s so much cheaper now, which excites me. But to give you an idea, across our ensemble of managers in 2022, there’s about a 65% dispersion. Our top manager was up 35% in 2022, our bonder manager was down 30%. And so, this is– [crosstalk]
Jake: This was probably just whoever had the most convexity on probably they didn’t get paid. Is that right?
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The Minsky Moment in Trading: Stability, Instability, and Tail Risk Strategies
Jason: Yeah. The one that was down didn’t do anything wrong. It was a pure long Vega play. But then the long gamma guys did well. Or, then, as Toby actually referenced earlier, short Delta guys did okay. But then also you have cross asset vol.
So, the other thing is, most of our clients are tied to S&P. So, when the S&P vol is incredibly high, you still have to pay that premium if you want that deterministic protection. But you can what we do around the edges is we sprinkle in cross asset vol looking across asset classes around the globe and use a manager that uses 7 to 10 year leaps on cross asset vol. And that really helps in a 2022 scenario, where you’re getting pops in rate volume, you’re getting some pops in commodity vol and FX vol.
So, you want to be able to make a little money on those at the timeframe but you can’t use those liberally, because now you have basis risk. Because once again, if the S&P crashes and you’re like, “Oh, sorry, we were in this exotic pairs trade over here,” it doesn’t work.
Tobias: Do you want to predict where volatility is going to be for [Jake laughs] over a period of time?
Jake: Have you been listening this whole time, Toby?
[laughter]Jason: My favorite question. I have no idea, nor does anybody else. But what I do love is what we’re referencing is, there’s this Hyman Minsky moment where stability breeds instability. And the beautiful thing about tail risk protection, it gets the cheapest before the event. So, you go, “Great. I should be loading up on it now. It’s cheap.” And I go, “Whoa, not so fast.”
Brent from SpotGamma put out a great chart the other day on Excess Returns that was showing– It’s been just until the other day, we’re over 400 days without a move larger than negative 2% S&P, right?
Jake: Yeah. It’s a basic– [crosstalk]
Jason: So, you go, “Wow.” But then this is gambler’s fallacy, you’re like, “Oh, I’ve had 400 reds. Time to bet on black.”
Jake: Yeah. [laughs]
Jason: Because before Volmageddon, February 2018, we had gone 500 days. And then the one that’s even more interesting is going to GFC in 2007, we had gone almost 1,400 days. So, just because vol’s cheap and that stability breeds instability, it doesn’t make it predictive of when it’s going to happen. What it does though, it allows us to load up. Especially, if you’re doing a fixed spend, you can be over leveraged to that event and then you’re just waiting and waiting, and it keeps getting cheaper for us. So, I keep buying more on that fixed spend basis, which helps me, once again scale trade in that position.
Then my buddy, Jerry Haworth at 36 South set of bets. He’s the only predictor of when of all events going to happen is when he’s getting a lot of redemptions. So, as we all know, the CalPERS thing like that sort of thing.
Jake: [laughs] Yeah, it’s about to– [crosstalk]
Jason: Exactly.
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How AI Transforms Prediction and Decision-Making
Tobias: JT, do you want to squeeze in some veggies?
Jake: I will. Yes. So, I try to avoid doing book reports when I can, but this one’s a bit of a book report and it’s this book called Prediction Machines: The Simple Economics of Artificial Intelligence. Written by three professors at the University of Toronto’s business school. And it’s a little dry, like you would expect from professors and academics. So, I’m going to try to spice it up with a little bit of storytelling here.
So, our story opens in 1850 with an infant girl. She’s just five months old. This girl’s father, who’s 27 years, kisses the baby and slips away, never to see her again. It splitsville with his 23-year-old wife, and the father goes on to have many more adventures. But he’s already achieved rockstar status in England at that point for his poetry. He’s eventually known for his excesses, his huge debts and his love affairs. He dies during the Greek War of Independence against the Ottoman Empire in 1824 at just 36 years, probably likely of malaria. But his name was George Gordon Byron, AKA Lord Byron.
And his daughter Ada grew up with no father and an aristocratic hypochondriac mother. And Ada’s childhood was this isolated, experience of really full of very rigid, enforced education. At 17 years, she happened to meet this local inventor, an engineer named Charles Babbage. And apparently, she charmed him enough that he invited Ada and her mother to see this demonstration that he put together. He built this 2,000-piece brass parts assembled into a hand crate contraction that when he could turn it, he could actually raise numbers to the power of square, or to the power of the third or take the root of a quadratic equation with this brass machine that you crank on.
So, seeing this early mechanical calculator sparked Ada, an interest in mathematics. She continued intense study while she also got married, had three kids. And then in 1838, she met Queen Victoria, who was just 18 years at the time. And Ada’s husband was made an earl for his government work that he was doing, and Ada then became the Countess of Lovelace. And so, history now knows her as Ada Lovelace.
Her work in developing a calculator– She helped to develop a sequence of rational numbers, actually Bernoulli numbers for Babbage’s machine. And so, she’s considered actually to be the first complete execution of a computer program is her in a mechanical version. And really before anyone else, she understood the machine’s potential for universal application. It could be programmed to do virtually anything. She wrote and I quote, “We might even invent laws for series or formulae in an arbitrary manner, and set the engine to work upon them, and thus deduce numerical results which we might not otherwise have thought of obtaining.” And yet, Ada also saw the intrinsic limitations of this type of machine. “The analytical engine has no pretensions,” that’s what it was called, “to originate anything. It can do whatever we know how to do in order to perform.”
And so, really, she said, “Only when computers originate things should they believe to have minds.” And Alan Turing, then later, you guys have seen the Imitation Game, he called this Lady Lovelace’s objection, basically, “Computers don’t think. They just do things that we already know how to do.” Sadly, Lovelace died at age 36 years of cancer.
So, there’s lots of hype around AI right now. Why I like this book is because it took some basic economic first principles and then applied it to AI. So, the main thrust was that AI is going to lower the cost of prediction. And lowering the cost of any input has very understandable consequences. So, they point out that the rise of the internet led to a drop in the cost of distribution, communication and search. So, without the internet, it would be really expensive for the three of us to go and put on a show that people could watch. It would cost a fortune. We’d never be able to do it probably. No one would want to watch. [laughs]
So, they reframe this technological advance as a shift from expensive to cheap and scarce to abundantly. When computers started getting cheaper and more reliable, easier to use, the cost of doing arithmetic fell dramatically. And then humans found new ways to use arithmetic that no one had dreamed before. So, they substituted basically chemistry solution of photography for arithmetic based solution of digital imaging. So, we take our tools and we figure out how new ways to do it.
So, a lot of times, you’re thinking that AI means like Skynet and robots taking over the world and WALL-E, where machines are– They’ve removed all the need for humans to think. But what they’re pointing out is that that thinking will remain actually a very dear resource. But what’s getting cheap and ubiquitous will be the predictions.
Just to show what does a prediction really mean, it’s simply the process of filling in missing information. It takes the information you have called data, uses a model to understand it and then generates information you don’t have. So, cheaper predictions will mean more predictions and more compliments to those predictions, like the economic sense of the word, complement.
Complements are data, judgment, action and then outcomes that are fed back as information and like feedback loops. But it also diminished the value of substitutes, which often means human prediction. So, maybe an easy-to-understand version of this is, if a cabbie in London for instance has all of this knowledge, all this information in their head about how to get places, well, along comes Waymo or Google Maps or whatever it is, and now, all of a sudden, the value of their predictions of how the best way to get there, has dramatically dropped. But yet, everyone else can do it for much cheaper now. Everyone gets the same experience, but at a much lower cost.
So, [clears throat] predictions can then facilitate decisions by reducing uncertainty like, what time should I leave for the airport? It’s going to help me understand that. I guess reading a five-day weather forecast is now as accurate as a one-day forecast was 15 years ago, which is pretty big advancement.
Tobias: That’s amazing.
Jake: I know, isn’t it? One of the key complements of prediction is judgment. And judgment is the skill to determine payoffs, utility, reward, profit for a particular action. We have to still be able to tell AI like, what do we want to maximize for. A prediction of rain doesn’t really mean much if the AI doesn’t know how much you like staying dry or how much you hate carrying an umbrella. So, judgment as a complement prediction then will increase in value. And the more predictions will then mean that we have more opportunities for judgment. So, judgment is actually going to be an increasingly important asset to bring to the equation, in addition to having more predictions from the machines. So, there’ll be more decisions to make than ever, actually.
So, we as humans, we do a lot of satisficing, which is like, let’s make a quick decision, pick the most likely satisfactory option and then limit the amount of brainpower that we need to expend. But as prediction gets cheaper, it’s going to reduce the need for us to satisfice and cause us to rethink many of our daily commercial decisions that we make.
Some of these are very counterintuitive. So, let’s take airport lounges, for instance. They exist only to make it less of a pain to arrive too early for a flight. You didn’t know what time you should show up, so you go early and then you sit in the airport lounge. Well, that airport lounge is a solution to a poor prediction. But if we get better data about when you should leave, when you should arrive, tighten up those time schedules, get better predictions, we can cut out our arrival time to a much closer level and then we reduce the value of the airport lounge. So, there’s all these little things of how it’s going to change the world. But I don’t think it’s probably not going to be robots crushing your skull or whatever at the beginning of Terminator.
So, anyway, hopefully a little bit of a fun story of Lord Byron, Ada Lovelace and some more practical takeaways for trying to understand how AI is going to impact us going forward.
Jason: Man, there’s so many things in that I want to pull out. One, have you guys read your Rory Sutherland, Alchemy and stuff like that-
Jake: Oh, yeah. So good.
Jason: -where they’re trying to make a faster train, and he’s like, “Why don’t we slow down the train and make a better experience,”
Jake: Yes.
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How AI Enhances, Not Replaces, Human Judgment in Complex Systems
Jason: -like that sort of thing. Like you said, we have emotions that we have to tend with. The other one was, I think about everything in life is like, we unfortunately only understand the world through closed loop systems. That’s the way our brains work and how we understand complex systems. And yet, the whole world is open loop. It has a permeability to it. And so, it always makes me wonder like, everybody’s worried about AI. But it’s going to reduce tasks, not jobs. Like, you’re saying, people have judgment and they won’t have to– It’s advanced spreadsheets, they’ll get better and better those predictions on things they can use, but it’s never necessarily going to take away our jobs of judgment in the sense that–
The problem I started with is like the markets are non-ergodic system due to our individual path dependencies through life or our sequencing risk. And then more importantly, we have nonstationary of data. It doesn’t matter if you feed 100 years of data into an AI. And that just came after the Spanish flu, so it didn’t have a COVID like pandemic in its data set. You need the judgment of the human that knows crazy shit can happen that aren’t in that data set and then can shift markets dramatically, because there’s a non-stationarity issue with that data that the AI is never going to really probably overcome. Maybe I’m just saying that solipsistically, because I want to have a job, but like, you know. [laughs]
Jake: Yeah. You also have the problem too, is that if that kind of observer effect that if the AI is in there doing things, it changes and makes the data from the past when it wasn’t there no longer a relevant reference case.
Jason: No. Toby, I’m sure you have to deal with this. They’re still finding errors to the CRISPR data. Can we just get that right?
Jake: Right. [laughs]
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Tobias: Yeah, ongoing. It’s amazing. The law of ever-changing cycles is something from– I forget whose book it is now, but it’s a great story about– [crosstalk]
Jake: That’s like Will Durant type of thing.
Tobias: No. He traded for Soros. He wrote a book. I can’t believe that I can’t remember his name. But he talks about going to the racetrack at the start of the season and he bets. He’s not looking for the winner. He’s looking for the best odds. And the odds shift over the course of the season.
Jake: Oh, that’s Jim– What’s his name?
Jason: Rogers?
Jake: Rogers. Is that what it is?
Tobias: Oh, it’s not Druckenmiller’s. Somebody, hive mind. Tell me who that is. The book is, Education– It’s Victor Niederhoffer, Education of a Spectacular.
Jason: Oh, Victor. Yeah.
Jake: Oh, yeah. Okay.
Tobias: Law of ever-changing cycles. I don’t know whether the introduction of a lot more AI or faster decision-making loops means that our cycles are faster. I feel like our cycles have been a little bit faster recently from– I feel like we had COVID crash, pandemic bubble, value cycle, back to end of cycle, boom. We had it in-
Jake: Then value sucking– [crosstalk]
Tobias: -like four years. Yeah.
Jake: [laughs] You had a lifetime in four years.
Jason: Yeah, you get the Lenin quote. But to your point though, that means using our judgment or imagination and substitute for the word judgment is like, you can imagine that the liquidity cascades could get worse as algorithms become more prevalent. We go through these cycles at a more rapid pace, there’s probably a larger opportunity for left tail liquidity cascades, potentially. And that would require judgment or creativity or thinking through like what’s possible that hasn’t happened before.
Jake: I think you see that quite a bit even with– It feels to me like that there’s still a lot of spoofing of bids in the market where you’re like, “It looks like liquidity, but then if you actually try to buy or sell something, it’s no longer there at that price.” I think this high frequency– It’s probably those guys, but I’m not sure. I think they just unplug the machine anytime and it’s starts to get a little too crazy and it’s like [Tobias laughs] all this promise liquidity disappears.
Jason: Yeah. Because in a way, they’re great– I’ve seen people that try to invest in Virtu and others just a long volatility play, because as market become more volatile and expand, they have more dataset or opportunities. But then more importantly, if they unplug the machine, because they can get blown out and then they wait for it to expand and they still retain some of that fresh capital, they plug it back in, margins have increased, [chuckles], they’re good to go. But they’ve got to survive that interim period when we go from low volatility to high volatility.
Jake: Yeah.
Jason: if they can, like you said, they can unplug and replug in at the same– That’s their market timing is who’s got the finger trigger on the plug.
Jake: Yeah, you don’t want to night capital yourself over the afternoon.
Jason: Exactly. Toby, you know what do you miss? My favorite part of this show is when you say where people are watching from. Now nobody’s watching, I’ve just [unintelligible [00:55:14] [laughs]
Tobias: Let me give a shoutout, because I do feel bad that I had to go and return some video tape halfway through the call.
Jason: What? You went to blockbuster?
Tobias: [laughs] I had to get them back. Santo Domingo. San Diego. What’s up? Highland Park, Illinois. Valparaíso. Ericeira, surf town, Portugal. Nice one. Yeah, going to come and visit you. Rijeka, Croatia. Scotland. What’s up? Camas, WA. Savonlinna, Finland. Aloha, Honolulu. Cromwell, New Zealand. Brandon, Mississippi. Sarasota, Florida. Good racetrack out there. Sooke, British Columbia. Viginia Beach.
Jake: Just what I thought the show couldn’t get more disorganized. We’ve now moved the more where’s everybody from to the end of the show. [laughs]
Tobias: Barcelona. Teslacrashville. London. BaconMemes has been on fire. I just haven’t been able to call him out, but I’ll give you– [crosstalk]
Jason: Quite hilarious. Yeah.
Tobias: Some of these have been good.
Jason: Yeah. Well, that was part of the fun when Corey and I did Pirates of Finance live on YouTube is the same thing. It’s the chat was just insane. If we want to get canceled, we would just read the chat. The chat would just get devolved into this the craziest, most hilarious stuff. And then, Corey would block it off and I was trying to just in case there’s questions in there and I would be so distracted by the chat every time. You just see me looking over and laughing hysterically.
Jake: I don’t know how Toby does it, honestly. I have to keep it off otherwise I’d be so checked out from the conversation. [laughs]
Tobias: Bacon says, “Pirates of Finance was too pure and beautiful for this world.”
[laughter]Jason: See? Yeah, I love it too.
Tobias: I got another good one too. “Volatility, it can revert to the mean and it can cluster, but what happens when volatility meme reverts?”
Jason: Nice. I like it. I’m going to use that one.
Tobias: Bacon’s, “If artificial incompetence rises, then worried I’ll be replaced.”
[Jason laughs] Yeah, Bacon’s on fire.
Jason: Toby, obviously, I was watching some of your other interviews the other day and the Einhorn thing comes up, nonstop. I’m sure for you guys have to just contend with it all the time. I can’t remember if it was in that interview or another one. I’m curious your guys’ thoughts is thinking about Rory Sutherland and behavioral biases is I think Einhorn said, I think it was him and I think it was in that interview, he was saying that, when his fund was open for five years, he couldn’t raise any capital. And then when he closed it down for 10 years but reopened [crosstalk] it like four times, he’s raised billions of dollars.
Tobias: Yeah, behaviorally.
Jason: Yeah, behaviorally. Because everybody likes walking through a [unintelligible [00:57:44] private, I guess. I struggle with that question. It’s very interesting.
Jake: How do you put the vol at rope up in front of an ETF? [laughs]
Jason: Yeah.
Tobias: I somehow managed to make it very exclusive.
Jake: Yeah, it’s very hard to get– [crosstalk] [laughter]
Tobias: Very, very exclusive.
Jake: Just a handful. There are dozens of us. [laughs]
===
Value Investing: Navigating Through a Historic Downturn
Tobias: It’s been a tough run for value. It just cannot get out of its own way. I don’t know, just terrible stocks or something actually doing what they– That’s not true. That’s not true. The performance sucks so bad. It was like the worst in 200 years, according to Mikhail Samonov, who produced this 200 years of value. Great chart.
Jake: I didn’t [crosstalk] that claim though, Toby. It’s relative though. Like, absolute, it’s been just fine.
Tobias: That’s true.
Jake: It’s hitting the vol down the fairway.
Tobias: That’s true. But then late September 2020, it definitely seemed to turn around and it’s been working since then. It’s still in a drawdown. It hasn’t recovered from the drawdown. And it’s going to be a long time. It’s funny that the smalls are so smashed up now too relative to the bigger stuff. I think what has traditionally happened at the end of a cycle is there’s been a big flush. And the flush is the thing that just reminds everybody that there’s downside and they become a little bit less aggressive on the mega multiple investing. But we just haven’t had a flush.
Jake: [crosstalk] toilet’s clogged right now.
Jason: Yeah.
Tobias: We haven’t had a flush for a long time.
[laughter]Jason: As you know, that’s what people don’t realize. Like, people are always like the S&P 500, just growthy MOMO index is like, you can be all value. It’s just the cataclysmic shift that’s going to happen is going to be really painful to then. And then all of a sudden, the Spy will look like a value investing index. But to get there, it’s brutal.
Jake: At someday, value will be momentum, those names.
Tobias: Yeah.
===
The Religious Wars of Investing
Jason: That’s obscene. Exactly. It comes around– I haven’t flushed this out, so give me some grace on this. Toby, like you’re saying, 200 years, maybe worse than 200 years, it’s like you have to hold the faith and hold the line. I was thinking like, I studied comparative religions in college and eastern philosophy. I was thinking about our portfolio being generally agnostic is I’m also agnostic to all of the faith-based investing protocols.
Whether you’re a growth investor, you’re a factor investor, you’re a value investor, you’re a trend follower, it always goes through any of those, go through a period of like 10 years of underperformance where they’re just toeing the line. But it’s a faith-based investing practice. I think that’s fascinating. It’s like, you guys congregate together, because in a huddle and a mass, [Tobias laughs] you can keep each other warm during those lean years and you keep each other involved and invested. But it really is a faith-based exercise.
Jake: Oh, and it’s religious wars too, between the– [crosstalk] [laughs]
Jason: That’s obscene. That’s why people, “Yeah, go head-to-head to hard,” because it’s like, “No, my God is better than your God.”
===
Jake: [laughs] Yeah. It’s wild.
Tobias: And on that note, that’s time. Thanks, Jason.
Jason: Well, thanks, guys. I appreciate it.
Jake: Yeah, that was great.
Tobias: Jason Buck Cockroach Portfolio, how can folks follow along with what you’re doing or get in touch with you?
Jason: Yeah. Go to mutinyfund.com. We just rolled out our new website. And unlike everybody else we have everything’s on there. You can track everything we do. We’re really proud of what we rolled out there. And my business partner, Taylor Pearson, does all this great writing that I’m stealing and referencing on this podcast. But yeah, you can find us at mutinyfund.com. On X/Twitter, you can find me @jasoncbuck and my partner’s @taylorpearsonme.
Jake: Both, very good follows.
Tobias: Yeah, I [unintelligible [01:01:04] that. How about you, JT? How folks might get in touch, follow along?
Jake: Don’t worry about it. Oh, well, we should say though that Berkshire coming up. I don’t know if we’ll– We won’t have a live audio version out until after Berkshire.
Tobias: Oh, that’s good point. Yeah.
Jake: This is the closest one to that. So, I’m sure-
Tobias: We’ll be there.
Jake: -we’re going to do something again. Probably check Twitter. We’ll post something and we’ll hang out after the show. But if you see Toby, come say hi to him.
Tobias: And JT.
Jake: [laughs]
Jake: Toby will be that very tall, handsome looking one. And then I’ll be the guy hobbling behind him.
Tobias: With a big crowd of people around him.
Jake: Yeah. Right.
Tobias: All right, folks.
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