The Best-Performing Hedge Fund

If there has ever been a money-making machine on Wall Street, it is the Medallion fund. Between 1989 and 2000, it returned 36% after fees. Between 2000 and 2013, it returned 21% after fees, including a 98% return in 2008 when the S&P 500 lost 38%. The fund has managed to extract more than 60 billion dollars from financial markets during its 30-year existence.
The quant fund was started in 1986 by the mathematician Jim Simon. The fund had a strong start by allocating 85% of its capital to trend following models and only 15% to short-term trading models.Then, it had a 25% drawdown in 1989. Simon suspended trading and spent the next six months studying what went wrong. Simon’s conclusion was that their trend following models had run out of juice. Too many commodity funds were using the same systems, which has eroded an edge that used to work wonderfully in the 70s and most of the 80s. Simon decided to make short-term signals the new heart of his trading system. His thesis was that small short-term gains can compound fast.
How did they manage to consistently make so much money for so long when most hedge funds are one-hit wonders or mediocre from the start?
The number one reason is by constantly innovating and experimenting, by creating systems that don’t look intuitive to the human mind. Great computer programs think in a completely different manner than human brains. Medallion has never hired an economist. It prefers to hire PhDs in mathematics, physics, statistics, computer science, chemistry. They focus on developing unconventional edges. Their system trades several hundred different models. The edge of each model is minor when taken individually. But when taken as a whole, the hundreds of minor edges add up to substantial returns.
The number two reason is that Medallion managed to keep its system a secret or at least it has made it so complicated that it is not easy to replicate by ex-employees. The only way to keep a secret is to make your employees rich and incentivize them to keep innovating. Medallion asks their employees to invest 20% of their salary in the fund and don’t let them redeem it for four years after leaving the fund. Also, they have closed the fund to outside investors.

10 Insights from the Book ‘Angel’

This book is brutally honest and a must read for wanna-be angel investors and founders. Jason might sound a little condescending at times, but he is sharing valuable insights earned the hard way.

 

Here are ten of my favourite insights from the book:

  1. What angel investing and the lottery have in common.

I buy lottery tickets for a living, but unlike the normal schmucks on the street, I get to buy tickets that are in the top 1   percent of the winning pool.

2. The people that dare to take more risks intelligently are typically luckier in life.

If you learn anything from this book, it’s that you must take risks as an angel investor and in life if you want at least the chance of an outsized outcome.

You can make your own luck in this life by putting yourself next to the people who are already winning.

3. The business of angels

If these businesses didn’t look completely crazy, then everyone would want to invest in them and there would be no need for angels. In fact, the term “angel” is used because we are the investors who come to a founder’s rescue in their hour of need— when nobody else believes in them.

The best angels in the world have four qualities, giving them the ability to (1) write a check (money), (2) jam out with the founders over important issues (time), (3) provide meaningful customer and investor introductions (network), and (4) give actionable advice that saves the founders time and money— or keeps them from making mistakes (expertise).

Your job as an angel investor is to block out the haters, doubters, and small thinkers, because if you think small you’ll be small. I’d rather see my founders fail at a big goal than succeed at a small one.

Remember there are a hundred reasons why these things fail, so you’re not going to have a hard time saying no, and there are typically only one or two reasons to say yes.

Founders always share investor meeting details with each other and your reputation is everything in our industry. If you are helpful, present, and considerate, then you’re going to get a great reputation. If you are unprofessional, cavalier, or conceited, or use your position of power in any way that isn’t in service of the founder, then you’re toast.

4. The best deals are not available to just anyone.

The best deals are typically not on platforms like AngelList or at incubators like Y Combinator or 500 Startups. The best deals never see the light of day. They’re quickly filled by insiders who are sharing deal flow, and by elite founders with killer startups tapping their existing network.

5. On the best investment, you can make.

I passed on investing in Twitter because I was, at the time, a founder of companies. I stupidly thought that the best investment I could make was in my own company.

It was at that point I realized that I didn’t need to know if the idea would be successful. I only needed to know if the person would be. It was clear as day to me that whatever Ev worked on would be successful, but my own ego and my need to be right and understand everything got in the way of me hitting my first big home run.

6. There’s no difference between the founder and their company

As you go through your angel investing life, take some time to evaluate the person and their motivations. Ask yourself a simple question: “Would I buy stock in this person if I could?” If you wouldn’t buy stock in a founder, you shouldn’t buy stock in their company— because there is no difference between the founder and their company; they are one and the same.

7. Why are you doing this?

If folks are building a startup for money, they will eventually quit when they realize there are many better ways to make money faster and with more certainty. If you want to make a lot of money, you’re better off being a world-class programmer on a very esoteric and in-demand vertical and getting Google or Facebook to give you $ 1 million-plus a year in stock and cash for ten years in a row. You have no downside, you can work a couple of hours a day, and you get unlimited free food.

8. Why startups fail

The number one reason a startup shuts down is not actually running out of money, which is what most people believe. The number one reason a startup fails is that the founder gives up.

9. On communication between founders and angels

“If a startup isn’t sending you monthly investor updates, it’s going out of business.”

The more concise and professional the updates, the greater the chances that angels will be able to help you, including investing more money and introducing you to their friends as a responsible founder who’s a delight to work with. Angels want to feel needed, and founders who don’t make their angels feel needed have lost their most likely source of follow-on funding— their current investors.

10. The market is constantly changing

What worked when I started investing, when there were one-tenth as many startups being formed every year, doesn’t work today. It was wise to invest in great teams, pre-product back then, where today you almost universally want to wait for the founders to finish their product and get to market before investing.

Source: Calacanis, Jason (2017-07-18). Angel: How to Invest in Technology Startups—Timeless Advice from an Angel Investor Who Turned $100,000 into $100,000,000. HarperCollins. Kindle Edition.

Further reading: Fred Wilson on What It Takes To Be A Great Angel Investor

20 Lessons from Eric Barker’s Book

Some books deserved to be read more than once. Not only to capture and better understand their concepts but mainly to devise a plan how to apply their wisdom in your life. Barking Up The Wrong Tree is Eric Barker’s personal manifesto of how to feel adequate in today’s fast-paced global world. It is not based on the subjective personal experience of one. It is built on top of hundreds of scientific studies.

Here’s are some of the interesting concepts I managed to find in Eric’s first book:

 

“We spend too much time trying to be “good” when good is often merely average. To be great we must be different. And that doesn’t come from trying to follow society’s vision of what is best because society doesn’t always know what it needs. More often being the best means just being the best version of you. As John Stuart Mill remarked, “That so few now dare to be eccentric, marks the chief danger of our time.” In the right environment, bad can be good and odd can be beautiful.”

Focus on strengths

Many people struggle with this. They aren’t sure what their strengths are. Drucker offers a helpful definition: “What are you good at that consistently produces desired results?” To find out what those things are, he recommends a system he calls “feedback analysis.” Quite simply, when you undertake a project, write down what you expect to happen, then later note the result. Over time you’ll see what you do well and what you don’t. By figuring out whether you fall into the filtered or unfiltered camp and by knowing where your strengths are, you’re miles ahead of the average person in terms of achieving both success and happiness.

Pick the right pond

Once you know what type of person you are and your signature strengths, how do you thrive? This leads to Mukunda’s second piece of advice: pick the right pond.

You’ve got to pick the environments that work for you . . . context is so important. The unfiltered leader who is an amazing success in one situation will be a catastrophic failure in the other, in almost all cases. It’s way too easy to think, “I’ve always succeeded, I am a success, I am successful because I am a success, because it’s about me, and therefore I will succeed in this new environment.” Wrong. You were successful because you happened to be in an environment where your biases and predispositions and talents and abilities all happened to align neatly with those things that would produce success in that environment.

Ask yourself, Which companies, institutions, and situations value what I do?

Feeling powerless actually makes you dumber.

Being powerless at the office— having little control or discretion over your work— is a bigger risk factor for coronary artery disease than obesity or high blood pressure. Feel underpaid? That increases risk for a heart attack too. Meanwhile, ass kissing results in a reduction of workplace stress, improving happiness as well as physical health.

Bad behaviour is infectious

Once we see others getting away with something, we assume it’s okay. Nobody wants to be the sucker who plays by the rules when no one else does. Studies show expecting others to be untrustworthy creates a self-fulfilling prophecy. You assume they’ll behave badly, so you stop trusting, which means you withhold effort and create a downward spiral. It’s not surprising that work teams with just one bad apple experience performance deficits of 30 to 40 percent.

Ruut Veenhoven said, “The quality of a society is more important than your place in that society.” Why is that? Robert Axelrod, a professor of political science at the University of Michigan, explains, “Not being nice may look promising at first, but in the long run it can destroy the very environment it needs for its own success.”

Givers, Matchers, and Takers

Givers often take it on the chin in the short term, but over the long term— when they can meet other Givers and gain the protection of Matchers— their reputation becomes known, and boom. They go from the bottom of success metrics to the top.

Matchers tend to wait until others do something nice before they respond in kind. This passive attitude drastically reduces the number of interactions they have. Meanwhile, Givers run around handing out favors, losing a little to Takers, getting a fair share back from Matchers, and winning the lottery whenever they meet another Giver. Givers can be great networkers by merely being themselves, while the hesitant Matchers wait for an engraved invitation to the party.

Be likeable

When Harvard Business School’s Deepak Malhotra teaches negotiation, the first thing he says isn’t “Be tough” or “Show the other side you mean business.” His number-one recommendation to students is “They need to like you.”

This doesn’t mean you need to give twenty-dollar bills to everyone you meet. Favors can be quite small. We also often forget that something quite easy for us (a thirty-second email introduction) can have enormous payoffs for others (a new job). Doing quick favors for new acquaintances tells other Givers you’re a Giver and can earn you the protection of Matchers.

Pick your environment carefully

The people who surround us often determine who we become. When we see others around us perform altruistic acts, we’re more likely to act altruistically ourselves.

When you take a job take a long look at the people you’re going to be working with— because the odds are you’re going to become like them; they are not going to become like you. You can’t change them. If it doesn’t fit who you are, it’s not going to work.

About Positive Self-Talk

In your head, you say between three hundred and a thousand words every minute to yourself. Those words can be positive (I can do it) or negative (Oh god, I can’t take this anymore). It turns out that when these words are positive, they have a huge effect on your mental toughness, your ability to keep going.

While you may think that the key to being a good salesperson is people skills or being extroverted, research shows that salespeople can be hired based on optimism alone. Researchers found that “agents who scored in the top 10 percent [of optimism] sold 88 percent more than the most pessimistic tenth.”

 

Pessimists vs Optimists

Pessimists tell themselves that bad events: will last a long time, or forever (I’ll never get this done); are universal (I can’t trust any of these people), and are their own fault (I’m terrible at this).

Optimists tell themselves that bad events: are temporary (That happens occasionally, but it’s not a big deal ); have a specific cause and aren’t universal (When the weather is better that won’t be a problem); and           are not their fault (I’m good at this, but today wasn’t my lucky day).

Optimists told themselves a story that may not have been true, but it kept them going, often allowing them to beat the odds. Psychologist Shelley Taylor says that “a healthy mind tells itself flattering lies.” The pessimists were more accurate and realistic, and they ended up depressed. The truth can hurt.

“We are what we pretend to be, so we must be careful about what we pretend to be.” So instead of merely focusing on intentions, make sure that in your day-to-day actions you are being the main character in your perfect story.

 

Everything we do in life is a trade-off. Choosing to do one thing means not doing something else.

As Henry David Thoreau said, “The price of anything is the amount of life you exchange for it.”

The irony is by not quitting unproductive things ASAP we are missing the opportunity to do more of what matters or try more things that might.

 

As the old saying goes, “You can do anything once you stop trying to do everything.”

There’s a science to luck.

It turns out luck isn’t just serendipity or due to the paranormal. A lot of it is about the choices people make.

Studying over a thousand subjects, Wiseman found that lucky people maximize opportunities. The study showed they are more open to new experiences, more extroverted, and less neurotic. They listen to their hunches. Most of all, Wiseman says, lucky people just try stuff. It makes intuitive sense: if you lock yourself in your house, how many exciting, new, cool things are going to happen to you? Not many. Is this some genetic gift? Hardly. After seeing that luck was largely a function of choices, Wiseman tried another experiment: Luck School. If he got unlucky people to behave more like lucky people, would they get the same results? Turns out they did. Afterward, 80 percent of Luck School graduates felt their luck had increased. And they weren’t just luckier; they also came away happier.

Experimenting and Strategic quitting

The things you should quit, are things you do every day or week that produce no value. What we’re talking about here are limited duration experiments. Giving something a shot. Taking a yoga class— but not signing up for a yearlong membership just yet. This is what spurs new opportunities and creates good luck. As Ralph Waldo Emerson said, “All life is an experiment. The more experiments you make the better.” In other words: Fail fast, fail cheap.

Spending 5 percent of your time trying new things, knowing you will quit most of them, can lead to great opportunities.

Positive thinking by itself doesn’t work

Not only did dreaming not bring you your desires; it actually hurt your chances of getting what you want.

When you dream, that grey matter feels you already have what you want and so it doesn’t marshal the resources you need to motivate yourself and achieve. Instead, it relaxes. And you do less, you accomplish less, and those dreams stay mere dreams. Positive thinking, by itself, doesn’t work.

After you dream, think, What’s getting in the way of my fantasy? And what will I do to overcome that? The fancy psych term is “implementation intentions.” You and I can just call it “a plan.”

How to be a leader

Research shows that you don’t actually need to know more to be seen as a leader. Merely by speaking first and speaking often— very extroverted behavior— people come to be seen as El Jefe. Meanwhile, other studies show that those who initially act shy in groups are perceived as less intelligent. As Pfeffer pointed out, to get ahead you need to self-promote. This comes naturally to extroverts and is actually more important than competence when it comes to being seen as a leader.

Mark Granovetter’s groundbreaking work on the importance of “weak ties” showed that you don’t usually find out about that next great opportunity from close friends. You tend to hear about the same things they do. People who have more peripheral acquaintances are more plugged in and learn about emerging possibilities. Having a big network also pays off when you get that job.

 

Choose your company wisely

“The groups you associate with often determine the type of person you become. For people who want improved health, association with other healthy people is usually the strongest and most direct path of change.”

Over and over we’ve seen that the people around you affect you. They can make you happier, healthier, and more successful— or the opposite. Most of this influence is passive and gradual. You won’t notice it. Mom told you not to hang out with the bad kids, and she was right. Research by Nicholas Christakis at Yale shows a network amplifies anything in it, good or bad. So surround yourself with the people you want to be.

Why self-compassion is better than confidence

Many studies show faking it also has positive effects on you. In Richard Wiseman’s book The As If Principle, he details a significant amount of research showing that smiling when you’re sad can make you feel happy, and moving like you’re powerful actually makes you more resistant to pain. Other studies show that a feeling of control reduces stress— even if you’re not in control. The perception is all that matters.

On the other side,

Faking it can be a very bad strategy because when you fool others you can end up fooling yourself.

Overconfidence makes you feel good, gives you grit, and impresses others— but can also make you an arrogant jerk who alienates people, doesn’t improve, and possibly loses everything because of denial. Being less confident gives you the drive and tools to become an expert and makes other people like you . . . but it doesn’t feel so good and can send a lousy signal to others about your competence.

Compassion for yourself when you fail means you don’t need to be a delusional jerk to succeed and you don’t have to feel incompetent to improve. You get off the yo-yo experience of absurd expectations and beating yourself up when you don’t meet them. You stop lying to yourself that you’re so awesome. Instead, you focus on forgiving yourself when you’re not. Research shows increasing self-compassion has all the benefits of self-esteem— but without the downsides. You can feel good and perform well while not turning into a jerk or being unable to improve. Unlike self-confidence, self-compassion doesn’t lead to delusion.

Hard Work Doesn’t Always Mean Good Work

Author Tony Schwartz says, “Energy, not time, is the fundamental currency of high performance.” It’s a qualitative lens instead of a quantitative one. All hours are not created equal. We’re not machines, and the time model is a machine model. Our job isn’t to be a machine— it’s to give the machines something brilliant to do.

Expectations vs happiness

 

You need a personal definition of success. Looking around you to see if you’re succeeding is no longer a realistic option. Trying to be a relative success compared to others is dangerous. This means your level of effort and investment is determined by theirs, which keeps you running full speed all the time to keep up. Vaguely saying you want to “be number one” isn’t remotely practical in a global competition where others are willing to go 24/ 7. We wanted options and flexibility. We got them. Now there are no boundaries. You can no longer look outside yourself to determine when to stop. The world will always tell you to just keep going.

Source: Barker, Eric (2017-05-16). Barking Up the Wrong Tree: The Surprising Science Behind Why Everything You Know About Success Is (Mostly) Wrong. HarperCollins. Kindle Edition.

 

 

 

 

About Fat Tails and Market Timing

Morgan Housel has an interesting post comparing investing in startups with investing in established publicly traded large-cap companies. To summarize his points:

Both types of investing rely on a small percentage of positive outliers that will account for most of the profits. VC investing is considered riskier because of the velocity of the wealth creation and destruction involved. A VC fund can lose everything or make a 10X return on capital in a few years:

A VC portfolio can go from a standing start to a point where two-thirds of your companies have whiffed and one or two knock it out of the park in three or four years.

In public equities that same distribution can take 10 or 20 years to play out.

That’s the risk difference between the two asset classes. It’s not how the individual companies perform. It’s the amount of time it takes for those companies to log their performance. VC is just like investing in public equities, but at 5x speed.

If VC generates higher returns than large-cap public equities, it’s not because investors have to endure more risk. They just have to endure about the same amount of risk crammed into a much shorter period. Which is hard. There’s a cost to it. You pay for it, not with money but with worry and doubt.

I want to make three points that add to his analysis:

  1. It is not that private startups grow wealth a lot faster than publicly traded large caps. The first are apples, the second are oranges. It’s a lot harder to achieve a 100% annual sales growth when you are already a 100-billion dollar company. Startups are by definition smaller companies and can grow a lot faster. Yes, some startups go up 100X in a few years and publicly traded companies might need 20 years to achieve similar returns, but the former enrich only a small number of people and the latter provide that opportunity to millions of investors.

2. Investing in startups does not necessarily involve more volatility and stress for any of the sides involved. VCs don’t need to report quarterly earnings. They have the luxury of a long-term capital. Yes, they send the occasional annual letters to their general partners, but no one expects from them wonders in a short period of time. Their investors know they might need to wait seven to ten years before they see a substantial return or any money back.

Compare VC partners’ situation to publicly-traded large caps. The latter give detailed reports on a quarterly basis and are covered by hundreds of analysts on a daily basis. Meeting Wall Street’s short-term expectations is a priority for most. Public companies’ investors have the luxury of liquidity, which is a double-edged sword if you don’t know what you are doing.

3. Timing matters a lot, in both private and public investing.

One of the most important questions that angel and VC investors ask startups is “Why now?”. Is the world ready for your product or service? There were hundreds of internet video startups in the late 90s and early 2000s, but most of them failed, because the tech infrastructure was not ready to support them. Youtube was founded in February 2005 and it was bought just a year and a half later by Google for $1.65 billion. It was an all-stock deal, so Youtube’s founders had the opportunity to make even more money. Google went up 250% in the next ten years.

You can achieve angel investing returns in public markets after big corrections. The bigger the correction, the bigger the opportunities afterward. If you look at the best-performing stocks of the past 10 years, you will notice that not a single one of them has delivered a 100X return. Netflix went up 44X, Priceline went up 30X, Amazon went up 20X. Only 29 stocks went up more than 10X between 2007 and 2017. Public markets were close to all-time highs in 2007. If you measure performance since the financial crisis lows in March 2009, you will find hundreds of stocks that went up 20x, 30X, 50X in the next five to eight years. There are some that even went up more than 100x.

Two Themes Have Defined Trading In Early 2017

The major stock market indexes continue to consolidate mostly through time. Small caps are underperforming large caps, which has made chasing breakouts challenging in many occasions. We haven’t seen any strong buying pressure so far in 2017. There has been a little uptick in selling pressure, but nothing major.

sp500-vs-sp500-stocks-14d-rsi-above-70-params-x-x-x-x
sp500-vs-sp500-stocks-14d-rsi-below-30-params-x-x-x-x

Two major trading themes have defined 2017 so far. I don’t know if this will continue to be the case in the near future:

  1. Weak U.S. Dollar, strong emerging markets. The U.S. Dollar is down 2% year-to-date. For the same period, emerging markets (EEM) are up 5.5%, Brazil (EWZ) is up 13%, China (FXI) is up 5%, gold (GLD) is up 5.6%, gold miners (GDX) are up 14%.
  2. Large-cap tech stocks are significantly outperforming. The Nasdaq 100 (QQQ) is up 4% while Russell 2000 (IWM) is down 1% year-to-date.

We have just entered a new earnings season. Thousands of companies will provide new information about the state of their business. As a result, we will see the formation of many new trends, both up and down trends. New trends mean new opportunities.

Check out my latest book: Top 10 Trading Setups – How to find them, when to trade them, how to make money with them.

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