Ramblings

I have several topics in mind that I want to write about, and each could probably be a separate post. But in the spirit of trying something new and avoiding the creation of a backlog of posts to write, I will write briefly about each topic in this post.

1. “Unethical” Investing

At Madison, we were short a company called DocGo. They are a telemedicine company turned ambulance and remote medical assistance provider, primarily for the homeless and underserved. The short thesis was that the company’s business model was unsustainable – there is no need for a middleman “ambulance provider”, and the rest of the company’s activities were one-time contracts or contract mods resulting from COVID that wouldn’t be renewed. In conversation, I sometimes insincerely remark Madison’s short position felt unethical and bothered me. To an outsider, shorting a company that helps the homeless and provides clear societal value may seem sociopathic, and so I attempt not to poison their perception of me and my moral compass. What I really believe is that there is nothing wrong with the action of shorting a company that provides societal good (arguably all companies provide something that can be interpreted as societal good, otherwise they wouldn’t exist, but I mean companies whose mission aligns strongly with one’s moral compass, beliefs, or emotions: helping the homeless, solving climate change, etc.). A short position expresses a descriptive view, or an account of how one believes a company will look in the future (market price is a function of discounted future cash flows). One could have a bleak descriptive view but a contrary normative view, or view of how things ought to look – these are not mutually exclusive. For example, I could believe DocGo’s business model is unsustainable, and thus there’s a high probability the company is a 0 a few years out, but at the same time believe that, in an ideal world, a company that provides DocGo’s services ought to exist. Insofar as a short position remains an expressive bet, it is not unethical.

What I have described up to this point is short selling in a vacuum, by an emotionless, powerless (i.e., unable to materially influence the operations of a company) investor. In reality, there are complications. When you are short “social good” cos, you could begin to crave harmful societal outcomes in the long term, slowly perverting your own moral compass. In the Big Short, Cornwall Capital managers Jamie and Charlie celebrate when they acquire a short position against triple-A MBS, but Ben immediately tells them to stop celebrating and recognize what their position implies: if their short works, there will be a massive economic collapse. Though not precisely the same as shorting a company like DocGo, my point is that consistently betting against the good guys probably results in perverse outcomes like Jaime and Charlie’s celebration where you begin to cheer on societal failures. You believe something bad will happen and hit the world with an “I told you so” when it does – at worst the outsider perception is correct and your moral compass has become perverted from the constant short selling, at best, your “I told you so” is in bad taste. It’s important to reemphasize that I’m only discussing short selling in the context of “social good” cos – I think it’s easy to see that other types of short-selling, for example, exposing fraudulent companies, are probably less problematic and maybe even a net societal positive from the outsider’s view.

I’ll briefly expand a bit on what I mean by one’s moral compass becoming corrupted from constant short selling. When an investor takes on a short position (or any position really), they struggle with confirmation bias and lean into narratives or ideas that support their view. If I am short company A, a solar components manufacturer, it may be easier for me to acquire the view that climate change is a hoax, as this furthers my belief that company A is a short, because as people recognize climate change is a hoax, they will recognize renewable energy is not worth pursuing. This example is extreme and I’m not completely sure if it really makes sense, but as I write it out, I think my initial hypothesis may have been wrong – maybe one’s moral compass isn’t really influenced by short selling “social good” cos. I felt that while I worked at Madison, the non-investment related discourse surrounding “social good” cos was highly negative – individuals had strong racist, classist, Trump-esque social takes. But it’s possible that these individuals already held unethical viewpoints at their core, and then joined the investment world, an echo-chamber where their views strengthened from bouts of short-selling or discussions with peers.

Sorry if my logic here is hard to follow, because in writing this, I’ve became a bit more confused myself. But the main takeaway I think I have is this: short-selling is at its core expressive, but the people that put on short positions may believe unethical things and spread narratives or discourses around their positions that in part cause short-selling to be perceived as inherently unethical – for the most part though, I don’t think good, intelligent investors fall in this category.

Now a brief sidetrack: I am considering a long in TAT Technologies (TATT), an Israeli aerospace and defense company that provides aviation components to the Israeli army (among many other things). Say I am heavily pro-Palestine (I am not really sure of my views at the moment, but I could envisage myself being pro-Palestine in the future). Is it wrong for me to be long TATT? From the descriptive vs. normative framework, I laid out above, there is nothing wrong with being long – I believe the Israeli army will continue to have an elevated demand for TATT products as a result of the Israel-Palestine conflict, but I also believe Israel ought to stop their attacks. But as an inherently emotional being, if I am long TATT, wouldn’t I root for continued conflict and Israeli aggravation so that TATT performs better, and wouldn’t this “rooting” for Israel necessarily conflict with my pro-Palestine (to draw the contrast more clearly, say de-escalatory) views? I’m not sure, but I am sure that I will be long TATT if further research checks out and I think the idea will make me money.

2. Thoughts on Edge

One of my friends has recently developed a sports betting addiction. He seems to truly believe he has an edge over the book in multiple sports, just by virtue of looking up player stats pre-game and having a better feel of the game and its players. In my opinion, he is completely delusional: (1) the sportsbooks probably have significantly better statistical models to set their theos (their expected values) (2) the spreads offered around the theo are exceedingly large, cutting away at any edge a counterparty may hope to have.

His addiction has gotten me thinking though – to what extent I am different from the delusional sports bettor? I believe that I have some positive edge when investing (otherwise I wouldn’t do it). But what evidence do I have that I’m not delusional? Below I will try and better understand and evaluate edge.

First, what is edge? This is the definition that pops up on Google:

A trading edge is a trading method, or approach, that helps to accumulate more profits than losses. An edge can be a strategy, technology, psychological fortitude, persistence, understanding of market movements, risk control, or basically anything that allows someone to succeed in making profits where many others fail.

This seems like an okay definition for me – it’s broad and captures the essence of what I mean by edge. Let’s stick with it for now.

I am primarily concerned with what I’ll call the sureness of edge. Everyone person thinks they have an edge, from the delusional gambler to Warren Buffet – what is the probability that their edge is real?

I want to go through some different strategies/types of people I’ve seen and evaluate sureness of edge (rated from 0 to 10, where 0 is minimal likelihood of edge and 10 is high likelihood of edge) – these are not listed in any specific order; I couldn’t be bothered to make a second pass over this post and rank them…:

• Sports betting – edge = doing “research” on players and watching sports; 0/10

• Professional gamblers – card-counting, exploiting slot promotions, taking advantage of drunk poker players, etc.; 9/10 – there is a strong statistical edge in most of these (aside from maybe a few more qualitative strategies like the poker one). Over a large enough sample, it seems highly unlikely one would lose.

• Insider trading; 10/10 – edge = very clear information asymmetry

• Market making – over a large sample of trades, market makers should be collecting the spread. But they take on inventory risk and can be exposed during large, unexpected moves. There is a large technological barrier to entry for competitors as well, which probably preserve some margin of safety on edge. 8/10

• Madison – assessing the edge of a long-term oriented hedge fund is difficult because it comes down to a subjective assessment of process. Outcomes are few and variable over the short-term and there’s no clear statistical measures of edge. I would nail this at a 7.5/10 – a stringent qualitative process and intense attention to detail creates clear edge but is limited by the nature of being a generalist without significant subject matter and insider expertise in a company or industry.

• Me as a retail investor – ~4-5/10, maybe less? My process is flawed and significantly less detailed than what may pass on the street, but I can identify clear drivers of difference between intrinsic value and market price and sometimes take advantage of them. I don’t have super high confidence edge exists for me, and I attempt to rectify this by piggy-backing on others work (discussed more later).

3. A Framework for Part Time Investing

Once I start working full-time at Old Mission, I will have significantly less time to think about investing. How should I cope with this reality? What changes should I make to my investment process? I attempt to sketch out some tenants below:

• Only Borrowed Ideas (OBI) – unique quality idea generation is a difficult process. Madison was one of the few places that did this, spending hours poring over screens and reviewing under-the-radar names. Unique ideas are time consuming – why not piggyback off others work? Some investors are too prideful to “steal” ideas – I say leave pride aside and focus on making money. While I generally already follow the OBI tenant, I do occasionally pull up Finviz or consider A-Z screening. This should be eliminated.

• Concentration in High Conviction Longs – I don’t want to own names that cause me to accumulate stress; I’ll have enough of that at work. This means I must own positions where I have conviction beyond a certain threshold, which implies that I must be concentrated because otherwise there is too many names to learn/think about. Currently, I really feel like I only have 1 or 2 low-stress high conviction longs – Nagarro and maybe Valaris. While I have a strong level of conviction in TSVT, SRUUF, and some other names, these cause me stress due to various issues, ranging from position sizing to idiosyncratic uncertainty to industry opacity. Ideally, I want my entire portfolio to be composed of Nagarro-like longs, so I don’t have to think much about my holdings, and I can add to them whenever I want (at a sufficiently low price of course).

• Forget Trading – aside from holding period requirements, trading requires too much effort. I am slightly insane and believe that my ROIC from trading may be sufficiently positive such that it is worth it, but I really won’t have the time to trade (if I even could…). So, I need to leave this idea behind entirely.

• Slow Work and Patience – how do new longs get added? There will be bandwidth issues especially when the market gets interesting – I can’t evaluate a lot of interesting ideas at once given I need to have a higher level of conviction in them (relative to what I do now) to invest. I’ll need to be more patient and live with the idea of spending a greater number of hours over a larger period looking at 1 or 2 names. This is different from now, where I can obsess over a name or industry for a few days in a row and get up to speed with it.

A part of me wonders how a part-time investor can really have any edge. Life’s already hard enough as a retail investor – now you must win with a quarter of the time! I think the key will be working with a smaller universe and/or increased selectivity. I may miss out on big winners as a result, but hopefully fishing in the right pools and following the right people (half-blindly…) will allow me to produce above average returns.