Collecting Pens and Stuff

Auditur et altera pars. (The other side shall be heard as well.)” – Seneca

“There are two types of people: Those who come into a room and say, “Well, here I am!”, and those who say, “Ah, there you are” “- Frederick L. Collins

This update finds me in a grumpy mood. I am sulking at the intransigence of a market which refuses to see the beauty in the stocks I hold. Instead concentrating on the ever so slight flaws in their operations (what’s a profit warning or two between friends?). Of course the flaw of expecting the valuation irrationality (subjective) to suddenly be recognised and rectified due to my participation doesn’t pass me by. Vanitas vanitatum.

Down to business. Last weekend I spent the day sauntering around the UK Investor Show at the QEII conference hall. I can’t help enjoying these events even though I am sometimes left slack-jawed by some of the things I hear. There is much to be learned though, most of it second order. I apologise in advance for the critical nature of this post, my intent was not to pick on one person (MPs don’t count) but to consider the question of impressions using a live example.

Warm Up

It was a beautiful sunny day when we arrived and armed with pastries and coffee, me and my associate The Sheikh, settled into the talk by the Tory MP Sajid Javid. It was doom and gloom scaremongering of the most blah kind. He did redeem himself a touch during the Q&A but I’m not a fan of lowest common denominator politics. Sadly it seems to work. On a general note, on days like these you hear lots of strong views. Holding strong views or talking your own book is one’s right, but perhaps there is a more constructive dialogue to be had if we keep in mind that although our experiences may be real it doesn’t make them true.

Not for Love or Money

We took a short interlude to hear Luke Johnson then we headed to a presentation from a company whose shares I hold. Following the dictum of Warren Buffett to praise by name but criticise by category I’ll leave names out. The presentation itself was a damp squib, the environment far too noisy to hear what was being said and a CEO who presented as if on autopilot. We decided we would go and talk to him afterwards as we both had questions. After lunch (my biennial trip to McDonalds – still terrible, see you in 2017) we went to chat to him.

After some small talk we got down to business, I tried to probe and get a sense of what was what at the company – the narrative is not matched by performance – this is perceived as anl issue with this company. This was the perfect forum for the CEO to disabuse me of my misconception. Anyway we chatted for around 10 minutes where the CEO seemed pretty uninterested, we might as well have been talking about the type of wood for his coffin. He would answer a question with little engagement, clarity or any impression of wanting to present the case for his company.

My thought throughout was why bother attending if you’re not going to bother? Perhaps this is just his manner. To be fair this is a man who has built a very successful company in a tough industry. As a minnow he managed sell the product to large companies, which as anyone who has tried knows is extremely tough.I don’t want to discount him. The Sheikh, had a less charitable opinion of the interaction. For all he knows I could have been holding 2.99% of the shares.

I’ve written before on the importance of management qualities beyond competence, but what aspects are important? Clarity, straightforwardness and aligned interests I would say. I didn’t get any of these from the interaction and that reflects the feel from the reports the company puts out (although to be fair I have become harsh on the content of management reports). Companies, such as this one, that claim short term pressures while claiming medium prospects are excellent leave me with clenched fists. It is like the ‘adverse weather conditions’ get out clause.Fool me once shame on you, fool me twice shame on me.

Post-interview I’ve been asking myself what judgment one can take from these interactions? I was a little leery on the direction of the company before this encounter, what ‘useable’ and ‘robust’ information have I gleaned from the encounter? On this I am not sure. Having some small understanding of the manner in which the mind structures information there is the ever present danger of misplaced inferences. I, therefore, try and create balance by shifting the view. This is a continual and uncomfortable process but fruitful (in the medium term of course). Without it we may end up cementing false judgments through selective memory – fine until the wheels stop turning at which point we have problems. The downside is you have to hold variant views in your mind which makes decisive action taking rather uncomfortable (perhaps …., what if …. etc etc.) .

Earlier in the year I had a conversation with an investor who visits and talks to many companies – he told me something that stuck in my (slightly wine-addled) mind. Meeting companies once is ok but meeting them many times is worth a lot. See someone once and you create an anchor (which is prone to confounding factors). Meet them again and you have another observation point. He gave the example of a company he used to meet where the CEO was dour and cautious in his speech even when they were doing well. One time while visiting, the CEO used slightly more emotive language, ever so slightly. Coming from someone else it would be meaningless, but from the mouth of this particular guy it was a clarion call. I like that, but of course there is great skill in this – good listening is under practiced.

Back to my CEO. This stock was on borrowed time and this interaction just sharpens the claws. There is much to like about the company but my active dictum is “show, don’t tell!”.

So Mr CEO either do more showing or align your telling (please).

The first rule of Dodgeball …

Taking a step back, this mirrors a wider feeling. For the most part I’m lukewarm on too many of my holdings. There is naturally the effect of the too consistent flow of bad news stinking my portfolio, but even in my better performing issues the story vs the valuation is mostly unappealing.

My job is to find the unpopular kid with unrecognised talents; but my judgment on these kids has been so off – it is like Dodgeball without the redemption (or cuddliness). Maybe my meh is just an outward reflection of my feelings on my skills.

There it is, a fun Saturday in Westminster. On a positive note I did pick up enough pens to last a year and some of those squishy balls that you squeeze to release the tension. In tough times you got to take the good where you find it.

Peace and best wishes to you all.

Always Outnumbered, Always Outgunned (Part 2)

Hi all, I hope that the first blooms of spring are brightening your day. I am always touched by the hypnotic joy that takes over Londoners when the first pleasant weather hits. At least before the rage sets in :-)

This is the companion piece to the last post, from my 2014 report. The question I asked was whether there was scope to further improve returns ? I had made the easy steps – reduce fees, lower turnover, maximise tax benefits etc. The unspoken assumption in that is that the extra juice has to be durable.

My answer was that yes I felt there was some extra returns available that would hold true for a good few years. This came from a couple of sources. The first was my excessive caution (more risk, more risk) and the second is below – it touches on the crux of what I stand for as an investor. Analytical skill yes, impeccable process of course …  but beyond that, and crucially, some idea of psychological savvy particularly in a world where we are for the most part outclassed but hold huge advantages in being able to pick and choose where we engage.

Much of this is a repetition of earlier posts. Unsurprisingly as those posts were the thinking process that led to this report. Anyhow maybe a regular reminder is no bad thing.

(By the way when I mention arbitrage I do not refer to it in the classical sense of buy and selling to guarantee profit. I refer to the process of exploiting a finite resource to the point of extinction. Not a classical use of the word but hopefully acceptable.)


Many investors have had hot streaks and performed well for a time, but with an edge that was not durable at some point their advantage fades. It is either arbitraged away; the texture of the market changes (I had this in my CMC day-trading days for example); or perhaps the manager develops hubris, pride, greed, envy or some such leak and topples themselves.

My question is whether I can increase my expected return in a manner that is sustainable (i.e. predictable, available and not prone to being arbitraged to extinction)?

Integral to this thinking is the likelihood that my fellow market participants are almost certainly better informed, skilled, committed and organised. And improving each day. I say this without intention to demean myself, but more with a belief that there is a substantial advantage if the probability of long term success is not dependent on me understanding, timing or executing better than others.

So what to do? Two ideas point the path by two guys who know well enough – Howard Marks and Warren Buffett:

Inefficiencies – mispricings, misperceptions, mistakes that other people make – provide potential opportunities for superior performance. Exploiting them is, in fact, the only road to consistent outperformance. To distinguish yourself from the others, you need to be on the right side of those mistakes. – Howard Marks

Your win-loss percentage in tennis will not be determined by the absolute level of ability that you possess. Rather, it will be determined by your ability to select inferior opponents. If you select with care it will be quite easy to attain a winning percentage higher than, say, Cliff Richey while he is playing on the tour. Application of this principle is the key element in bridge, poker, or investments. (Harder to apply in the latter, however — it is easier to identify a couple of palookas at the bridge table,) – Warren Buffett

There it is – The Loser’s Game, as set out by Charles Ellis, is the equivalent of the tennis player who can succeed only through the errors of his opponent (i.e. most). Top players cannot play this game and win, their opponents are too good. They must play the Winner’s Game and defeat their opponent through superior play. Ellis has this to say on middling tennis players:

He will try to beat you by winning, but he is not good enough to overcome the many inherent adversities of the game itself. The situation does not allow him to win with an activist strategy and he will instead lose. His efforts to win more points will, unfortunately for him, only increase his error rate. As Ramo instructs us in his book, the strategy for winning in a loser’s game is to lose less. Avoid trying too hard. By keeping the ball in play, give the opponent as many opportunities as possible to make mistakes and blunder his, way to defeat. In brief, by losing less become the victor.

Most investors see themselves as winners, we aim to be the best and the ease of participation in the market process encourages our confidence in our ability to win. Unfortunately markets are akin to the Loser’s Game. We face challenges on two fronts:

1. The paradox of skill. If you wish returns above beta (market returns), success is not a function of how capable you are but how capable you are relative to your opponents (i.e. whoever is taking the other side of your trade). Over time as participants improve, skill differentials decrease (less suckers) thus leaving chance as the dominant element in deciding winner and loser.

2. Degree of control. Markets are not tennis or chess. When Federer swings his racket he will know 99 times out of 100 where he’ll connect with the ball and where it will go. When George Soros (the equivalent master) shorts S&P futures he may have reasonable confidence in the outcome but the timing, path and duration are trickier to ascertain. Key to this point is that humans have insufficient appreciation of this factor, and even less appreciation of their control in particular environments.

Overconfidence encourages us to treat investment as a version of the winner’s game. If we are not outdone by skill then we are reliant on good fortune (in time of course as in any shorter timespan anything is possible). All the while we shall be expending blood and sweat. The winners of this game will be few but with large payoffs. The only other winners are those that sell the dream (brokers, commentators etc.). The rest of us are varying flavours of fish food.

The idea of iatrogenics – damage caused by the practitioner (as in doctors causing illness in the course of trying to heal) – is relevant and is discussed in depth by Ellis and Taleb (in Antifragile). The actions of humans trying to outperform other humans becomes the dominant driver of instability in the market. This error is compounded by our blindness to this situation – greater intelligence or resource or motivation only feeds the situation.

My belief is that any advantage I can parse from this theme will be relatively durable.

I identify my transactional advantage in 3 opportunity sets (the assumption is a solid level of analytical skill on my part):

i) Go where it is less crowded – Addressing areas of the market where attention is distributed or participants are less skilled, small caps in particular.

ii) Go where others are too ‘cool’ to go – Mispricing emanating from the incentive structures of professionals. Most are unlikely to take positions with poor narrative that would expose them to benchmark or reputational risk (J.K Galbraith quipped ‘In these matters, as often in our culture, it is far, far better to be wrong in a respectable way than to be right for the wrong reasons.’).

iii) Go where others are too emotional to go – Markets and stocks in the midst of emotional extremes (primarily times of fear and greed). In these cases even the most able and savvy investors will make decisions on the basis of narrowed and affect laden frames (esp. when they are concerned about jobs, reputation and suchlike).

Note that in either of these cases I can go with the flow (trends, momentum) or fade it (mean reversion). Most of the time I err on the mean reversion side but exuberant trends are rich pickings. Also it is important to remember that these are not sure things, we can still be very wrong. Nonetheless instead of a 50-50 bet we perhaps have a 60-40 bet. We also hope that we also increase the potential payoff of the bet. This is a potential double whammy in terms of long term advantage.

In all other times and areas, the assumption is that markets are generally efficient – my advantages are minimal. In these periods my focus is to try and keep up as best as I may but primarily to minimise errors.

This is a contextual focus, not absolute. The specifics may change over time but the underlying logic holds. The narrative and framework may change but until the participants consider the underlying issue (everyone is trying to beat everyone with the same tools) opportunities will continue to present themselves (assuming I am able to recognise them).


Underinvestment: Baking in Structural Underperformance (Part 1)

I am currently writing my FY2015 Elif Fund Review and referring back to last year’s report. Some of it is worth sharing. First up is the question of excess caution, it is less exciting than the opposite story and that is what makes it all the more insidious (some prior thoughts on this here). Even if it isn’t directly relevant to you, there are lessons here on the narratives that dominate and direct us. Often they are less than useful.


A dominant narrative I hold is that I am a mediocre stock picker and trader who is saved by good structure and discipline.

On closer examination perhaps this narrative is flawed. Here is another possible narrative: I am a competent stock picker and trader who has baked in underperformance through structural under-commitment of capital. This is a much healthier narrative. My invested percentage as shown below tells the story:

456In the table below I have tried to play this out (crudely but to make a point). Compared are:

i) actual returns

ii) implied returns if 90% invested AND

iii) returns if 90% invested but if the marginal return of the extra invested capital was only 60%.

123The caveats in this analysis are many but the point is clear – the benefit of those extra 2-5% per year are huge. There is a cost in greater volatility and poorer risk adjusted metrics but this must be a trade-off I choose all day and all night.

The root cause of this under-investment is most easily traced to good old fashioned over active risk aversion. There is also the issue of narrow framing leading to myopic loss aversion. Greg Davies writes very well on this topic (I think this is in a Barclays white paper but need to track down the source):

It is worth starting with the word that occurs at both the start and end of the chart: reluctance. This is the ‘default’ state of most investors. In normal circumstances we fear taking a risk and getting it wrong, more than we fear missing out. This reluctance to get involved is compounded by another strong behavioural effect: loss aversion. Simply put, when we make decisions, “losses loom larger than gains” – we believe we will feel more emotional pain from losing a certain amount than the pleasure we experience from gaining the same amount.

The cost is double in my case – the Elif fund is risk capital and to be have reduced commitment with capital that is purely for risky investment is pointless. It is one of those absurd stances in life that bring no benefit but leave us satisfied as we are allowed to defer the discomfort of entering the valley of uncertainty and risk.

Back in 2011 I took on the challenge of upping my committed capital. It was a painful process but well worth it (not just in this sphere). The results have been good, the patient survived the operation. There is still more work ahead correcting and adjusting, but the ugliest part is done. In the chart below you see the difference between the past year and 2010/11.


This isn’t about being careless, risk of ruin is not increased. The core task is survival, as it is only time that guarantees a sample size long enough to overcome chance. But it is not survival at any cost. It is survival while ‘in play’. There are obvious risks of commission but more insidious are those of omission. I follow the diktat of Nehru when he said (I know not where):

The policy of being too cautious is the greatest risk of all

‘Nuff said.

A tale of two portfolios

“Never discourage anyone who continually makes progress, no matter how slow.” – Aristotle

What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he or she avoids big mistakes.- Warren Buffett

I’ve been at this game for a little while but as the road unfolds there is the continual reminder how incomplete and patchy is my understanding. It is both disconcerting or invigorating depending on my mood. On the other hand over the past 15 years I’ve hit more high note than duds and done so without too many tears. Somehow or the other I’ve avoided big mistakes. Maybe I am some kind of master of the universe :p

These opposing narratives are perfectly showcased by the divergent paths of my value programs this year – the Large Caps are up 20% (while being only 60% invested) while the Small Caps are down 12% and sinking. Master of the universe or dolt?


One year is neither here nor there. 3 yrs + is more aligned to my average intended holding cycle (see below t0 = 1):


Nearly good. The Small Cap Value program (SCVp) has a 3yr CAGR of 9% (vs.15% if it had been a breakeven year) while the Large Cap Value program (LCVp) 3yr CAGR is 20%. Long term expectations are 15% for the SCVp and 12% for the LCVp.

It is review time. What to do with this information?

I can give you story: that for the SCVp the music stopped while the rest of the market hummed – just in the past few weeks we’ve had a profit warning from LRM (Lombard Risk Management) and meh finals from FCCN (French Connection) rocked the boat. While writing this last week SAL (SpaceandPeople) fell 15-20% on inline results and prospects. I have other stories as required but what is it worth? I’ve written on the pitfalls of reviews here and it is all still applicable. In my year end review I’ll keep the following in mind:

1. My intended holding period is 3 years even though the discussion is this past year.

Without care I look at the one year chart above and derive inferences of what went wrong or right based on that frame. Rather I must look at last year through the 3 year picture that I have decided is more relevant. Myopia is a favourite subject of this blog and operating on inconsistent time frames can leave you ever so muddled (unintended consequences et al). This is helped if the framework and intentions of the programs are clear.

2. These are concentrated portfolios with high idiosyncratic risk

Each position is a probability-payoff bet, there is no certainty although I hope there is mispricing. In addition I give positions a lot of breathing space.  I’ll let you into a secret, things will vary and shit will happen. To structure as I have and then bemoan the fact that results weren’t to my liking is churlish.

3. Good performance does not automatically mean good process or decisions and vice versa.

We tend to be driven to action when faced with what we consider to be ‘bad’. On the flip side we give little thought to areas that are ‘good’. This seems arbitrary. Review should encompass all programs of a similar nature equally.

4.  Review should concentrate on elements where I have control

Not ex post dissection of decisions involving coulda, woulda, shoulda’isms.

Where do I have control:

1. Design and structure of the program

2. Planning and execution

3. Analysis (Trade Selection)

I’ll ignore one as it is too important for 100 words. This leads us to:


There are two questions:

1) did I have a clear plan for each position?

2) did I follow it impeccably?

I feel my facial muscles tighten as I consider this as I’ve been extremely poor on these grounds. My levels of distraction and sloppiness have been higher than usual. Usually I get away with it. Sometimes I don’t.

Trade Plan – every important element of the investment should be specified before the action happens. Sizing, investment thesis and ‘hooks’, entry and selling criteria, targets and what to do when the unexpected hits. It isn’t set in stone but changes must happen outside the action.

Execution – If my planning phase has been incomplete when it is time to act I am stuck trying to decide what to do. I end up chasing and reacting. This has been too common the past year.

Impeccable isn’t an ideal for me, it is critical.


I am a believer in a forecast-lite heuristic analytical framework over detailed valuation (more here).

Was my analysis flawed in the SCVp (and therefore good in the LCVp)? It is tricky to know this – how to disentangle the random coin flip elements from the quality of analysis?

Let us sidestep this question as it is the wrong question.

The SCVp portfolio does what it says on the tin (value, small cap based on broad strokes and behavioural edge). If I think that is wrong then I should look at that.

My initial inclination was to lay the blame with the quality of my investment selection and undoubtedly there are elements that can be tightened. But otherwise this is mostly unfair – the quality of analysis has never been strong; the design of these programs are predicated on never needing to be strong.

Analysis is not the problem. The problem is the planning and execution missteps.The programs requires that element to be watertight.

They aren’t. And that dear friends won’t cut it!


01/04/2015 – minor editing for grammar and clarity

Trust your dance

A centipede was happy – quite!
Until a toad in fun
Said, “Pray, which leg comes after which?”
Which threw her mind in such a pitch,
She laid bewildered in the ditch
Considering how to run.
– Katherine Craster (attrib) [but I read it in Alan Watts The Way of Zen]

For the past year I, like the caterpillar, have zigged and zagged trying to consciously align legs and propel myself onwards. It has been useful, not elegant :-)

In the meantime this blog has sat in patient silence. I have been writing. But when the thought came whether to publish, I would hesitate long enough for the moment to pass. My justification was two fold: I don’t want to belabour the same points if I only tell more of the same without showing or adding (esp when many of these topics are covered so well elsewhere); and my writing was to help and inform my perception and decision making in the moment. I felt uncomfortable sharing the messiness of more personal, raw and incomplete thoughts (even if it is a real expression of the process of dealing with decision making into an unknown world).

But I missed this. I find it extremely valuable outside of the question of whether it is valuable for anyone else. The act of publishing helps tighten focus – I think more carefully, ask better questions which aids clarity and (hopefully) helps me do a better job. The difference is between dancing in the privacy of your living room against dancing in a disco. To dance only at home is to not trust your dance. Life is so much finer if you trust your dance.

Returning to this blog syncs with a challenge to myself, namely to practice natural expression. I am shy of words, they hold such power and as a race we seem generally blind to that power as we spew forth. But skillful expression is a beautiful thing, so I practice here. And trust that what I put out into the world isn’t merely pollution.

My plan with this writing is to start the clunky old engine – let the exhaust choke out the smoke with the hope that beyond lurks a gently purring high performance machine. That’s the hope at least. In terms of the writing I have a leg up on many investment writers (and practitioners) in that I have no reputation or job to protect, no need to look good, and no requirement to justify or hold consistent views. This is a practice with a wildly positive profile, invoking the ghost of Paul Samuelson when you see a good bet you gotta take it! [1]

What of markets and the Elif Fund?

The end of March heralds the end of the fund fiscal year. I’ll be writing my end of year report and it is likely to be lukewarm in feel. Not so much with the outcomes, returns were sluggish but performance in this type of market and over one year is of no concern. My portfolio positioning tries to include the possibility of other possibilities and this type of diminishing value mid-late blush bull market is not a type of market in which I have a discernible advantage – this is coin toss land. For now it is a case of hanging on while avoiding gross error.

And to remain focused. Focused yet relaxed.

It is this portion on which there is room for actionable improvement. Investment (nay life) is enhanced significantly by the skillful integration of contrasts / paradoxes. In this case it is to be present, focused and committed while simultaneously relaxed, fluid and spacious. This combination mixed with technical aptitude is the ultimate (in my perception). I preach the gospel of serenity and ease but within that is the requirement to bring to bear directed forceful action when required. There is the determination of patience and endurance but there is also the determination of committed application. On the first count I am fine but on the second less so. (I have a theory on this, something to discuss when I am clearer).

Like the caterpillar, in considering the elements, I have stumbled over myself a little. This has led to poor process and stilted decisions. The broad strokes of what I do are in place (good) but the quality of application at the detailed level is lagging.

Investing thankfully is an incredibly forgiving enterprise. If we are willing to keep an open mind, diagnose, test and correct then we give ourselves every possibility of better days. Time is the friend of the investor, just staying in the game will be more than enough. That is a base level. I look at the next level – if we can be operate and execute well at all levels  in the right manner we shall probably be better than fine. If not maybe that engine is not strong enough to take us where we want to go and we need to make some tough decisions.

Peace and best wishes.

[1] Risk and Uncertainty: A Fallacy of Large Numbers –


Less is more, more or less

Steady, average, middling – these are dirty words in the investment community. Instead the narrative expounds the wonder of ‘excess returns’, ‘beating the market’ and ‘being the best’. This narrative leaves out much, particularly the elements of time and availability. Actually it doesn’t, it assumes we shall deliver these returns in all accepted time frames (that is to say the time frames arbitrarily delineated as accepted). And that we can choose to be one of the chosen who through skill and hard work can realise these outsize returns.

It seems unbefitting of such noble ideals for reality to intrude. That clumsy interloper flinging off muddy shoes, wafting smelly feet and squishing our carefully arranged cushions as they flop on the sofa. Reality, and I say this with deep sadness, has little respect for our ideals.

In the world of investing, most of us are offered an unpalatable truth: that it is insanely difficult to outperform consistently over longer periods and multiples more to do so on multiple time frames. Sorry.

“But how about person x or fund y.” we counter, they do it? If them why not us? And with these exemplars we relegate reality and end up with the following de facto profile: striving for market beating returns with a hope of avoiding the larger losses that are more likely with that territory.

There is a balancing act here which doesn’t work for me.

Base rates (and the zero sum nature of the system) tell us few are good enough to pull this off through skill. This may well be you but if so you are an outlier. If it isn’t then ‘beating the market’ becomes predicated on luck. (think of this as a distribution with widening variance the further from market returns our desired returns).

What then to do? My desired returns (over the long term) may in excess of market returns but my skills, knowledge and tools are middle of the road. If I go with the default structure the only chance I have of achieving excess returns with consistency is if a) I improve a lot or (more likely) b) hit on a rich and long lasting seam of luck.

One is slow, intensive and uncertain and the other is out of my hands.(read the part about Andy Zaky in this post if you want a bit more)

There is an unglamorous alternative. Take a look at the returns of two investors below. Which of the two does better after 5 years?



They both average 12.8% per year but it is investor B who makes the best returns.


She is the greater success even though it is investor A who would garner all the plaudits. This example is over-the-top as the large losses incurred by investor A would raise eyebrows, but the point is made.

At the end of the five years when investor B shows excellent returns everyone may coo with admiration at their achievement. But over the course of the journey their eyes would have been on the magic dust of investor A.

Such are the differences between arithmetic and geometric means. Arithmetic means are useful for ‘advertising’. Geometric shows us the money.


This is a handy blueprint for how I structure my investment practice: if I avoid large losing periods then I need not care about ‘beating the market’ in good times. In fact in any time period I need achieve slightly above mediocre returns.

This is rather profound. And less susceptible to arbitrage.

This way of going about the business of investment is not an interesting or exciting profile.Being middle of the pack will not get us noticed. For the most part the industry is structurally incentivised to do better than average (not of just the market but also benchmarks).

This sets up a potential contradiction. In previous posts I have written about the structural value on offer from not being concerned about shorter term volatility (here for starters). In this piece I say I want to limit downside volatility. The answer is in levels – on a trading program level I do what the system demands volatility or not. At an aggregate level the intent is that each program balances the others. Operations are structured to round off the sharp edges and curtail portfolio level losses.

There are numerous methods of smoothing downside volatility – diversification, timing filters, arbitrage, position sizing or other risk mitigation methods for starters. Few of these schemes are poor if used well. Where they fail is when we take 2+2 and get 22. Charlie Munger warns:

It is easier to make a mistake with a good idea because a bad idea is quickly rejected

There is no free lunch. There is a strong incentive to supercharge what works. Wiser heads try and maintain perspective by considering a world including counter-factuals.

That being said the investment game is incredibly forgiving.

We need only be ok at all this to come out well ahead.

The caveat, and isn’t there always a caveat, is that the durability of your methodology is determined by the weakest element. And that weakest element is almost always the same. The one in the mirror, that clump of electrical pulses, chemicals and tissue known as us.


Here is another example for you. Consider carefully the fact that without ever achieving over 15% investor B trumps investor A. Naturally if investor A could curtail those losing years their results would be spectacular BUT as we move up the returns curve we introduce a larger element of noise and luck. There are areas such as HFT and arbitrage where this is less so but their challenge differs in that the predictability of their returns renders them liable to be dissipated as new entrants feed off the carcass.