- I was recently reading this piece about Tiger Global and came across a great explanation of HFC investing:
It’s the perfect embodiment of the HFC [hedge fund crossover] strategy. Take a company that was likely solid and in a hot sector. In Jan 2021, markets were already going crazy. You then team up with your friends and pour a bunch of money into it, and then just a few months later, you all pour even more money into it. Everyone happily pays an exorbitant price because it means everyone gets to mark up their books. Everyone could then go out and raise new funds by marketing those unrealized results. In a business where you get paid a percentage of assets under management, it’s a no-brainer. As of a few months ago, you might even be able to flip the company to the public markets at that high price.
You have this behavior in private markets where Tiger Global et al. (their VC/HFC friends) get in on early startup funding rounds, invest more later at higher valuations, and get to mark-up their original investment. They’ve essentially created unrealized gains out of thin air! While the ethicality of such collusion and defraudment of investors is highly questionable, the scheme is brilliant – receive inflows, pour money into startups, mark-up earlier investments, post unrealized results to attract more capital, repeat. There’s no incentive for anyone to bring valuations down: funds increase their AUM and make bank from fees, LPs see tremendous (unrealized) gains, and startups get cheap capital.
But at the same time, it should be clear such a scheme is unsustainable. Private market valuations are based on insane growth assumptions startups will not meet. They will need to go out and raise money. Capital has become more expensive, public tech valuations have been slashed heavily, and the consumer is dead. Clearly, there will be down rounds and markdowns.
What happens when private tech falls? To begin with, Tiger et al. lose tons of money (even more than they’ve already lost in public markets) and partners want to redeem. Redemptions may have already started, but I think private market markdowns will further expedite them. As everyone starts to redeem, there will be forced selling on a massive scale and public tech will fall much further. This will likely create epic opportunities in tech that savvy investors can capitalize on.
I would bet private market markdowns wreck VC. We have seen a culture shift over the past decade from the stereotype VC being a hardened ex-startup genius to a business school new grad that throws money at any startup that mentions machine learning. I think the coming crash will be severe enough to completely reverse this culture shift by resulting in the majority of VC funds shutting down and associates being laid off. As cheap capital diminishes, so will the number of VCs. Even legitimate, diligent firms will suffer as collateral damage from Tiger et al.’s games. It feels like Tiger et al. is a single point of failure where markdowns and redemptions in one place will spread across the market and screw everyone.
SWEs are also going to suffer. For the past decade, the secret formula for new SWEs to rake in cash has been: 1) work at a pre-IPO startup 2) get paid in stock 3) cash out when the company goes public. Overnight millionaire. But suddenly private market valuations are getting slashed and there’s little demand for IPOs – what happens to the SWEs who have 50+% stock-based compensation? And as valuations get slashed across the board, companies have restricted access to capital. The more reliant your company is on external capital (i.e. on their stock price), the greater the magnitude of their layoffs and hiring freezes. SWEs may also have a newfound appreciation for the relative job security FAANG + other mega-cap tech offers.
- A recent quote that’s been floating around is Carl Icahn’s new Twitter bio: Some people get rich studying artificial intelligence. Me, I make money studying natural stupidity.
Beautiful quote. I’m going to dissect it, probably excessively like an English teacher.
Icahn doesn’t have a problem with people that actually study artificial intelligence (professors, researchers, engineers, etc.) – he’s sniping at investors like Cathie Wood who make preposterous claims about AI.
More generally, he’s alluding to the trend-followers with a poor technical understanding of emerging tech like AI but unlimited confidence. You could say these investors are artificially intelligent – they don’t know what they are talking about; their intelligence (insights from knowledge) is literally artificial (plain wrong).
And what about studying natural stupidity? This is the essence of value investing boiled down to three words. The best opportunities out there right now – long energy, short tech – are clearly results of natural stupidity – ESG, Ponzis. Every value investment manifests as a result of market stupidity – who’s stupid enough to sell things below their intrinsic value?
What’s the takeaway from this section – not sure, what’s the point of reading Shakespeare?
- Wise advice I heard recently: Don’t pontificate about being right, focus on making money. Fund managers and large instutions are often wrong. As a retail investor with no formal finance-related experience, I’m going to be wrong significantly more often. If you become emotionally invested in your positions and don’t want to sell them because you’re in denial, especially in the face of new information or mistakes that you made, you will never be successful.
This advice has in part made me reflect on my uranium position. I still believe uranium prices have a long way to go – 150+ is likely, and I think we settle at a base of $80-90. But how do you play this trend? You could buy equities, but immediately you’ll find most are way overpriced on a P/NAV basis. Some investors justify buying equities with inflows –
“When the market wants into gold stocks it’s like trying to force the contents of Hoover Dam through a garden hose. In the case of uranium stocks, it’s more like a soda straw. It’s a very small market.” – Doug Casey
This is a compelling argument for exponential upside, but it tells us nothing about downside risk. There is near zero downside protection for junior uranium equities – most of these companies have POS management and a crappy deposit that will never get mined. They are long-term zeroes.
I realized this while investing in uranium, and threw out most of my shitcos (DNN, FCU, etc.) for a slight gain. But I still bought and held a bunch of URNM! The reasoning: a basket of equities should outperform because the gains from the leaders will offset the losses from the poor companies. The problem here was I ignored downside risk: a basket overweight uranium shitcos is still a long-term loser. URNM has massive downside risk and diluted torque to underlying. It’s not worth owning, and I have been selling, often at a loss.
Lesson learned: investments must have downside protection. Focus on cash flow. Focus on balance sheets. Don’t get lured into theses that rely excessively on “inflows” or hope – they might work in good times but they will unwind quickly in bad. You have to be disciplined about this.
- You may notice I didn’t talk about physical uranium above. That’s because I wanted to dedicate an entire, separate section to it. SPUT remains my largest position and as I said above, I am long-term bullish on uranium price. But a recent Twitter exchange made me rethink downside risk on SPUT.
SPUT is a financial entity whose units are intended to track spot uranium price. However, the units cannot be redeemed so unit price cannot truly be arb-ed with physical uranium. Even if they could be redeemed, spot price is unreliable in such an illiquid market. The point I’m getting to here is that when inflows dry up, SPUT could trade at an arbitrarily large discount. I contend there’s still long-term intrinsic value to SPUT units – they’re backed by a strategic physical asset that governments or funds would likely pay a premium to takeover. But there’s no short-term downside protection.
Say you buy SPUT at 3.75. You believe SPUT has long-term intrinsic value of $20 (at 0% discount). Do you hold through a 60+% drop just to have a 2x? And over what timeframe does this happen, 2-3 years? Meanwhile, you could buy coal/oil/ag/other commodity companies gushing cash for cheap multiples with better downside protection and greater upside potential. SPUT has relatively less asymmetry compared to other opportunities out there… Why go through so much pain for relatively less return? Now buying SPUT after it falls is another story, but the relative risk/reward has waned in my opinion, especially considering holding SPUT makes it harder to sleep at night knowing it can trade at an arbitrarily large discount.
If the goal is to build a portfolio of uncorrelated high conviction asymmetric bets, SPUT may still have a place in it. But being way overweight SPUT like I currently am is not the right approach.
Again: don’t focus on being right, focus on making money.
- The Luna/Terra collapse was really scary to me. Not because it impacted my portfolio in any way, but because of the impact it had on crypto investors. I saw tons of Reddit posts from Luna/Terra investors saying they’d lost their life savings on the project and were contemplating suicide. That left me deeply sad and disturbed. What’s going to happen when Tether goes to 0? Or when Tesla gaps down? How will retail investors cope with the emotional and psychological consequences of losing so much money?
The somber reality is that markets are highly cyclical, and when a cycle turns, a group of investors will be left holding the bag. Unfortunately, that group is almost always retail.
There’s something to be said about the irresponsibility of the media and sneaky snake oil salespeople like Raoul Pal at Real Vision who lure retail into trades. I think the solution here is proper financial education from a younger age, so that retail becomes smart enough to not fall for Ponzis. But then how would the majority of Wall Street make any money?
- I’ve commented previously that I think stop-losses are useless. The reason I thought this is because if you buy a long-term investment and it drops in price, it’s stupid to sell it and rather makes way more sense to load up and lower your cost basis. While I still think this is completely true for Buffet-style buy-and-hold investments, I don’t think stop-losses are useless anymore – that comment was arrogant and based on a narrow-minded view of what a successful market participant looks like.
Stop-losses clearly have value in trading because they allow you to control risk. And as I wrote in an earlier piece, if you have a clear set of rules and discipline, you can be a successful trader.
All investors don’t have to conform to the Buffett model – you have to find a style that fits you best. And the best way to do that is to try a variety of strategies and be open-minded.
So, I might put on a few shorter-term trades and mess around with stop-losses in other contexts as well, like using them on volatile longer-term holds.