Book Review: The Tao of Wu

The Tao of Wu by The RZA

If you haven’t picked up on it in other posts, I have a moderate interest in eastern philosophy and religion (Taoism, Buddhism, etc.). I also enjoy listening to Wu-Tang Clan. So when my girlfriend bought me The Tao of Wu by the RZA for Christmas I read it in about two hours.

The RZA’s life journey has been truly extraordinary, taking him from the projects of Staten Island to Manhattan sound studios and even Hollywood (among his producer credits is the soundtrack for Kill Bill: Vol. 1). The Tao of Wu describes his spiritual journey.


The Tao of Wu is structured as an autobiography, with occasional digressions into areas as diverse as the theology of the Nation of Islam and its various derivatives, the interpretation of Buddhist koans and chess strategy. To the casual observer this might seem like a gimmick, but I found many of the anecdotes to be thought provoking and evocative of the cyclicality emphasized in Buddhism and Taoism.

Early on there is an anecdote about how, when RZA was young, his family moved into a new home and was almost immediately robbed. The robbery was devastating. However, there was some consolation in that the move allowed RZA to make a great friend–an older neighbor boy. After a couple of years of friendship came a surprising revelation:

‘When y’all first moved in, I robbed your house maaan. I never knew you was going to be a cool family.’ When he told me, there wasn’t much I could do about it, and by then he was my best friend–or as they say in the hood nowadays, my big homie–so in a way it was cool.

That’s just one lesson: Your allies can arrive as enemies, blessings as a curse.

Each chapter of the memoir is devoted to a particular “pillar of wisdom.” These are followed by brief meditations or words of wisdom. At the end of the first chapter, for example, comes a passage discussing the importance of solitude.

“I advise everyone to find an island in this life,” RZA writes. “Find a place where this culture can’t take energy from you, sap your will and originality.”

Who Should Read This Book

Literally everyone. Obviously Wu-Tang fans should read it, and it’s worth a look by anyone interested in eastern philosophy and religion. But beyond those obvious audiences the subject matter is accessible to everyone. If you read fast, you can take a first pass through the book in two or three hours. Given its meditative tone, The Tao of Wu is also worth keeping on the shelf to revisit from time to time.

My Email Reply To A Suspicious Hedge Fund

I thought I found a fraudulent hedge fund earlier today. I will refrain from judgement as there are lots of details arguing for reckless ineptitude versus fraud. However, I will share my response to the fund’s marketing email as a public service since it sheds some light on basic due diligence checks investors should think about when considering investment opportunities.

Since I do not have proof of any wrongdoing I have redacted all identifying information. If this turns out to be a scam I will do a follow-up post with additional details.

Dear (Redacted) –

I took a pass through your marketing material and would like to share some feedback you may find useful as you approach other sources of institutional capital:

1)      Your hedge fund does not use an independent administrator (noted on your ADV and also omitted from your “Third Party Support Services” page). I have conducted due diligence on a number of hedge funds ranging in size from several million dollars to several billion in AUM and yours is the first that has not used an independent administrator. Most of us responsible for conducting due diligence would consider this a major red flag as the administrator serves an important control function where portfolio valuations and trading activity are concerned.

2)      You are the first dedicated distressed investor I have seen with so many outside business activities (firm website lists 7 outside business activities for the CEO). With so many demands on your time, it is difficult to believe you have the time and energy to do the deep credit and risk management work on a distressed debt portfolio.

3)      I find your firm’s web presence a bit concerning, to say the least. (Website redacted) does not shine a positive light on your firm. To be frank, it gives one the impression that you are appealing to unsophisticated retail investors focused on yield. This is not a good look for a hedge fund marketing to institutional investors. In fact, I usually consider this type of marketing a flag for fraud. Furthermore, I find the (website redacted) reference to your track record in the early 2000s a bit misleading. To highlight the performance of a tech-heavy equity portfolio at the peak of the dot-com bubble with no reference to performance beyond that makes that performance data seem questionable at best.

4)      For a hedge fund, your team seems to have remarkably little experience in the distressed arena. Based on your website, your Ops Manager does not appear to have any prior experience in operating a hedge fund or mutual fund. In fact, your Ops Manager seems to not have any financial sector experience at all. In addition, your Fixed Income Consultant and Research Analyst appear to have little specialized background in distressed investing (both seem more suited to serving retail advisory clients).

To be honest, when I initially reviewed your material I felt you might be perpetrating a financial fraud scheme. The fact you did not show regulatory disclosures on BrokerCheck or IAPD reassures me somewhat on that front.

However, as an analyst who performs due diligence on investment managers for a living I remain concerned you are going to lose unsuspecting retail clients a significant amount of money. If you are truly interested in acting in your clients’ best interest, I would encourage you to think carefully about the risks you are taking with your investors’ capital, and to work toward professionalizing your marketing materials and operational infrastructure.

Something I did not tell the fund in my email but I did do on my own initiative was call the auditor listed in the marketing material. The marketing material presented so strangely that I felt there was a non-zero probability the firm lied about having an auditor in the first place. If this were the case I would have forwarded the information and my suspicions to the SEC.

The auditor confirmed the fund was a client, but was a bit cagey as to whether the audits had been clean or not. The audit partner described the operation as “rough around the edges.”

Not something you want to hear as a potential investor.

Every time you want to give someone pushing cryptocurrency the benefit of the doubt, remember this video

As it stands, LFIN has a market cap of about $6.5bn. Average trading volume is 4.5 million shares per day. For perspective, that is nearly twice the market capitalization of aerospace manufacturer Embraer, which does $6bn or so in revenue per year.

We have entered a new phase of cryptomania. This is the part where retail investors start bidding up the prices of anything even tangentially associated with cryptocurrencies, and fraudulent penny stock operators steal from them.

There is blood in the water. The sharks have sensed it. Now comes the feeding frenzy.

Please, please, please. If you are interested in this stuff, stop and think before you buy. Better yet, consult with a trusted financial advisor. Do not become an investing statistic.

No one is looking out for you. That may be painful to hear, but it is true. The SEC is always slow in catching these things and anyway you will never recover your losses even if the scammer is prosecuted. Many of your fellow crypto enthusiasts are incredibly naive about the pervasiveness of financial fraud, particularly in the world of microcap stocks. Do not give penny stock operators the benefit of the doubt.


Thou Shalt Not Covet Thy Neighbor’s Returns

Source: Wikipedia

The most important investing commandment is this: thou shalt not covet thy neighbor’s returns. If there is one thing you absolutely do not do in investing under any circumstances, it is make decisions based on whether other people are making more money than you. This is akin to playing poker on a tilt and should be viewed as a cardinal sin. For those unfamiliar with poker terminology:

Tilt is a poker term for a state of mental or emotional confusion or frustration in which a player adopts a less than optimal strategy, usually resulting in the player becoming over-aggressive. This term is closely associated with “steam” and some consider the terms equivalent, although steam typically carries more anger and intensity.

Placing an opponent on tilt or dealing with being on tilt oneself is an important aspect of poker. It is a relatively frequent occurrence due to frustration, animosity against other players, or simply bad luck. Experienced players recommend learning to recognize that one is experiencing tilt and avoid allowing it to influence one’s play.

People invest on tilts all the time. Most commonly this happens when a particular asset or asset class prints an extraordinary return in a short period of time (*ahem* cryptocurrency). Investors see all the people who made money in that asset or asset class lionized in the media. These people are lauded as geniuses. Some join the pantheon of “legendary investors.”

Meanwhile, the people who didn’t make money are frustrated. They are jealous. They missed out on monster gains and are afraid of missing out on further gains. Their  emotions are further addled by the fact that some of the newly minted “legendary investors” are invariably young and/or unsophisticated. So instead of thinking critically about valuations or the timeless truth of mean reversion new investors pile into the hot asset.

If they are good at timing momentum (or just lucky) these investors might make a decent chunk of money. But often they pile in at exactly the wrong time—at the peak of enthusiasm for the hot asset. Beyond them there is no marginal buyer and so there is nothing left for the price to do except gap down. Left unchecked this behavior can wreak real havoc on a person’s net worth over time.

Another, far less common manifestation of an investing tilt is the fanatical short bet. This has killed Bill Ackman in Herbalife (I will not recount that saga here). It has also afflicted David Einhorn in Tesla. Dealbreaker writes:

Pitting Einhorn’s frigidly data-driven and Alpha-focused brain against the Church of Elon that is Tesla is inherently hilarious. Tesla stock is essentially impervious to the company’s failures. Neither analysts nor investors hold Elon Musk to his own guidance, Tesla doesn’t deliver on anything its promised, the stock doesn’t drop, and then Einhorn points his fingers and goes apeshit wondering how this isn’t working out as the greatest short position in the history of trading.

See, we’ve been warning everyone that Tesla should be valued as a religion and not as a car company. You can’t look at Tesla’s balance sheet and discern meaning anymore than you can consult The Book of Leviticus for mortgage advice. But this has not yet fully dawned on poor, numbers addict David Einhorn. And it is growing clear that his trade against Tesla is entering a dangerous early stage of what we call “Ackmania.”

As we’ve seen play out over an agonizingly long time with Bill Ackman and Herbalife, hedge fund managers can sometimes fall into a dark corner of their own souls where a short position metastasizes into a true hatred, and the stock becomes a reliquary for all that is wrong with not just the market, but the world at large. It is a form of self-harm that saps you of your energy and steals your reputation. It also allows rivals to torture you from afar.

Of course, there are also holistic benefits to not coveting others’ returns. Life is short. Why waste time and energy resenting people who have had success in the markets?


Portfolio Management Confidential

Bogie and Bacall in The Big Sleep; Source: Wikipedia

I recently had cause to reflect on the difference between a good securities analyst and a good portfolio manager. For a long time I believed a portfolio manager was just a leveled-up analyst. If you could identify one undervalued security, I reasoned, it would be straightforward to manage a basket of them.

Portfolio management and securities analysis are certainly complementary skill sets. But an exceptional securities analyst may only make for a mediocre portfolio manager and vice versa. The roles have certain fundamental differences.

The Role of Securities Analyst

A good securities analyst thinks like an investigative journalist. He should be detail-oriented and skeptical. He tirelessly pursues The Truth about the value of a security and the financial strength of its issuer. Like Raymond Chandler’s private detective, Philip Marlowe, the analyst confronts an indifferent world riddled with corruption and deceit. He faces constant pressure to abandon his pursuit of truth in favor of “going along to get along.” Sometimes this pressure comes from management teams of corporate issuers. Other times it comes from the analyst’s own organization (The Truth can be a considerable inconvenience to the powers that be).

This quote from The Long Goodbye sums up the state of affairs rather nicely:

“There ain’t no clean way to make a hundred million bucks…. Somewhere along the line guys got pushed to the wall, nice little businesses got the ground cut out from under them… Decent people lost their jobs…. Big money is big power and big power gets used wrong. It’s the system.”

The Role of Portfolio Manager

A good portfolio manager is a skilled poker player. Portfolio managers leverage analyst research to place bets designed to maximize expected value. The portfolio manager’s job is not to pursue The Truth, but to ensure her portfolio can withstand the cruelly random vagaries of securities markets. The primary concern of a portfolio manager is to balance risk and reward tradeoffs. In doing so, the portfolio manager is also concerned with the behavior of other market participants. At extremes, the fear and greed of others create risks and opportunities. For example, weak players often fold strong hands too early.

If this sounds a little like gambling, that’s because it is a little like gambling. Susquehanna International Group actually teaches their traders to play poker. However, the most important difference between portfolio management and casino gambling is that portfolio management is a positive expectation endeavor. In the long run, all casino gamblers are losers.

Chandler again (just for fun):

You were dead, you were sleeping the big sleep, you were not bothered by things like that, oil and water were the same as wind and air to you. You just slept the big sleep, not caring about the nastiness of how you died or where you fell.

Your Morning WTF


From the article:

Online pornography is an immense enterprise. Almost 92bn porn videos were viewed on Pornhub, the world’s largest free internet porn site, in 2016 — more than 12 videos for every person on earth. Nearly half of Pornhub viewers visit the site between 9am-6pm.

The US is the biggest consumer of online pornography per capita, and the UK is the third (Iceland, perhaps surprisingly, is number two). Increasingly, porn is viewed on mobile devices. In the US last year, mobile accounted for 70 per cent of hits on online pornography. “I don’t know a single guy who hasn’t looked at porn at work,” says one man who worked in the City of London, describing colleagues taking their phones on periodic “bathroom breaks” during the working day.

“Fail Well”

A while ago I put up a post that may have gone a little off the deep end. It likened investing to a spiritual journey and drew heavily on the example of Bridgewater Associates.

Barry Ritholtz has a neat Bloomberg View piece up summarizing some takeaways from a recent interview with Bridgewater founder Ray Dalio. I love this thinking and it is why I keep an investing journal:

Throughout the book, and in a recent conversation we had, Dalio insists the key to his turnaround was revisiting failure and learning from it. He is enamored of the framework described in Joseph Campbell’s “The Hero with a Thousand Faces.” Campbell’s book examined the evolution of mythological figures, whose failure leads to discovering new wisdom that they use to achieve their goals. Dalio wanted his failures to have the same results, so he created a broad set of rules to do so:

  • View mistakes as opportunities to improve. He calls this “mistake-based learning.”
  • Own your errors. Never hide them, but bring them forward to create a learning opportunity. His advice is to “fail well.”
  • Pain + reflection = progress. The “pain of failure” should lead to reflection, from which your wisdom derives.
  • Track what you do; keep systemizing what you learn from your mistakes.
  • There are many more principles, but this gives you an idea of some of the basics.

Dalio does things that most ordinary people don’t do. Set aside for a minute his remarkable track record as an investor and note the following unusual business behavior: He writes down and reflects on everything he does. Then he systemizes it, eventually turning these into algorithms that his firm’s computer systems help backtest against earlier eras. The end result of this is a hybrid of human creativity and machine learning that produces results better than either could separately.

A Winner’s Curse

I have been having some interesting conversations recently regarding the latest trials and travails of cryptocurrency investors. The issue many of them are facing is what to do now having made returns of 5x, 10x, or more.

Do you let it ride and shoot for 1000x?

Do you lock in your profits now?

Something else?

In traditional markets, such as equity and fixed income, fundamental analysis helps with these issues. If you own Proctor & Gamble (PG) stock, and one day PG falls 50% for no reason other than that traders are bouncing the stock price around, you either: a) do nothing, or b) buy more. Although the market price has plummeted, there is no change in the intrinsic value of what you own (a slice of PG cash flows). In this case your valuation anchors you on what is important (intrinsic value) instead of the noise (the change in market price).

The challenge with cryptocurrency is that there is no intrinsic value for you to anchor on–at least not in the conventional sense. Holding forever and collecting your cash flows is not an option. There are no cash flows to collect. All you’ve got are supply and demand, and supply and demand are notoriously fickle over short time periods.

I have a pet theory that despite the meteoric rise in the price of Bitcoin, the average investor return is much, much lower. This would be consistent with investor behavior in traditional financial markets:


Of the municipal bond category, Morningstar’s Russ Kinnell wrote:

It’s surprising that the rather stable muni-bond fund group could be so misused, but it has been going on for a while. The problem here is that there are very risk-averse investors and a sector with scary headlines. The good news rarely makes headlines. Rather, investors hear about Puerto Rico’s crushing debt and Meredith Whitney’s ill-informed doomsday call. Those news events spurred muni investors to sell, which led to a drop in muni-bond prices and a spike in yields. Thus, they created a buying opportunity just as investors were fleeing. This speaks to the downside of trying to time the market and the benefit of staying focused on the long term.

Some Thoughts On Bitcoin Futures

I am increasingly involved in discussions about how futures trading will impact the spot price of Bitcoin. While I am far from a Bitcoin bull, I have attacked the notion that futures trading will somehow trigger a major correction in spot Bitcoin prices. This post will explain why.

First things first.

This is an intellectual exercise. It is not an investment recommendation. Do not under any circumstances make any decisions with real money (crypto or fiat) based on what you read here. See also my disclaimer at right. If you are serious about putting money into cryptocurrency, do yourself a big favor and consult with a professional advisor who can provide guidance based on your unique circumstances.

Also, if you are not familiar with futures terminology, you are going to have to bone up on the following:

  • Futures
  • Term Structure of Futures
  • Contango
  • Backwardation
  • Futures Arbitrage

Khan Academy has a series of videos that looks decent. I simply don’t have the time to post a comprehensive introduction to futures on this blog. And frankly, if you are not willing to invest some time learning about markets and investing, you probably shouldn’t be spending time reading about digital lottery tickets in the first place.

Now, if you can explain to me why there is no arbitrage opportunity available on a 1-year Bitcoin forward priced at $12,600 with spot Bitcoin at $12,000, assuming a riskfree interest rate of 5%, you will follow my argument.

Why Bitcoin Futures Trading Will Not Trigger A Selloff

Whether the addition of futures trading will be bullish or bearish for Bitcoin depends entirely on the marginal trader of Bitcoin futures. The bear case assumes the market for Bitcoin futures will be dominated by hedgers and short speculators, and that this in turn will exert downward pressure on spot Bitcoin prices.

I disagree for two reasons:

First, market sentiment is euphoric. While there are certainly Bitcoin bears out there, it is difficult to imagine that they will dominate in futures trading. More likely futures will be viewed as a cheap way to get (leveraged) exposure to Bitcoin without the custody issues associated with owning Bitcoin outright in the spot market. I simply do not believe a bunch of professional traders are going to come out of the woodwork to short an asset with no intrinsic value, that people feel justified owning at $10 or $400,000. As a directional short Bitcoin is potentially lethal. Doubly so due to the leverage embedded in futures trading.

Thus, the term structure of Bitcoin futures is likely to be contango. Other than volatility and uncertainty there isn’t much reason for Bitcoin futures to trade in backwardation. If the spot market were wavering there might be an argument otherwise. But as noted above the spot market is euphoric. Therefore, futures traders looking for arbitrage opportunities will most likely be shorting longer dated Bitcoin futures and buying spot Bitcoin as a hedge (the goal being to earn roll yield with no directional exposure to Bitcoin prices). This argues for upward pressure on Bitcoin prices in the short term.

In order for futures trading to pressure spot Bitcoin downward, the term structure of Bitcoin futures will have to backwardate. This will encourage arbitrageurs to sell Bitcoin in the spot market and go long Bitcoin futures, putting downward pressure on spot Bitcoin prices.

What would cause the Bitcoin futures curve to backwardate? The Bitcoin narrative would have to break. Apologies in advance to enthusiasts but Bitcoin doesn’t trade on fundamentals right now. It trades on momentum (a.k.a sentiment). Skilled short sellers are not going to put big positions on unless the narrative breaks and sentiment turns. Otherwise they are going to get squeezed. Hard.

As equity short seller Marc Cohodes puts it:

I never, ever, ever get involved in what I would call open-ended situations. . . . I have avoided pie-in-the-sky names. To use an analogy, I’m not interested in climbing into a tree and wrestling the jaguar out of the tree. I’m interested in someone shooting the jaguar out of the tree, and then I will go cut the thing apart once it hits the ground. Instead of open-ended situations, I like to short complete pieces of garbage with fraudulent management and horrifically bad balance sheets. I look for change, I look for ‘if this goes away tomorrow will anyone miss them’?

No One Actually Understands Correlation, But (Hopefully) Now You Will

It is a common refrain these days among investment managers that “fundamentals don’t matter.” The market does what it does because of ________. (possible answers include: easy monetary policy; tech bubble v2.0; passive investing bubble) This makes all stocks go up together. With stocks so highly correlated it is impossible for a stock picker to succeed because “bad stocks” get rewarded just as much as “good stocks.” That is why passive investing is so popular. It is all one big, self-reinforcing bubble. When the pointy reckoning finally arrives all of us fancy active manager types will laugh our way to the bank.

I admit I am guilty of saying some of this stuff myself. Which I suppose makes me extra guilty because I understand correlation and how to interpret the statistic and am still using the term imprecisely.

Here is a good analysis by Aaron Brask on the Alpha Architect blog refuting this argument. He argues from first principles and even conducts a simulation to show that mathematically, correlation does not impact the expected returns of individual stocks. I will steal his chart because it is a convenient summary:


Mathematically, Brask’s argument is irrefutable. That’s the nice thing about mathematics. When you’re right, you’re right.

I will go further and argue that all this confusion about correlation stems from the fact that many finance professionals don’t actually understand it. They use a heuristic: “correlation = perform the same.” That is how they are used to explaining correlation to clients (and each other). The heuristic is fine for generic spiels about portfolio diversification but it can be dangerous when applied to actual portfolio management decisions.

I have encountered this on several occasions. For example, a colleague once asked if there was a mistake in a chart that showed the S&P 500 correlated nearly perfectly with a 50/50 blend of T-Bills and the S&P 500. My colleague was using that heuristic of “correlation = perform the same.” The two portfolios are indeed perfectly correlated. However, the historical return of the blended portfolio is much lower because T-Bills tend to return much less than stocks over time. This is exactly what Brask illustrates in his simulation.

Look again at his chart. Instead of focusing your attention on the return, compare the shapes of the line graphs. Pretty close, right? That visual similarity is indicative of high correlation. That’s because correlation measures similarity in the variation of returns, not similarity in returns themselves.

To illustrate further, here are three more visuals, graphing relative outperformance/underperformance of different portfolios over time.

The first is the S&P 500 versus itself (perfect correlation = 1):


The next is the S&P 500 versus the Bloomberg Barclays Aggregate Bond Index (correlation = basically 0 but in fact is slightly negative):


The final comparison is S&P 500 versus a 50/50 blend of itself and T-Bills (correlation = very near 1) :


Notice how in the first and third charts, the points plot in a straight line, while in the middle chart they are an uncoordinated blob. In this visualization, the more the plotted points resemble a straight line, the higher the correlation. The third chart shows a strong linear relationship but with much higher returns for the S&P 500 over the blended portfolio.

An improved heuristic for correlation is to think about the extent to which two assets share common risk factors. An investment grade bond index is mostly exposed to reinvestment and interest rate risk (seasoned with a pinch of credit risk). A stock index has little direct interest rate risk and almost no reinvestment risk. It is more exposed to the business cycle and economic variables such as real wage growth. Intuitively, you would expect very little correlation between stock index returns and bond index returns.

T-Bills have very little risk of any kind. Some people think of them as risk free. That is not entirely accurate but for this exercise it is a safe assumption. When you combine T-Bills with the S&P 500 the only relevant risk exposures are those of the S&P 500. They will drive 100% of the variation in portfolio returns over time, despite the fact that 50% of the portfolio is risk free. You can therefore expect high correlation with the S&P 500.

So when someone in the investment business says, “high correlations are bad for stock pickers,” she isn’t actually talking about correlation. What she actually means is, “market environments where investors don’t care whether they own good businesses or bad businesses make it difficult for active managers to outperform their benchmarks on a relative basis.” Hopefully she understands the difference intellectually and is just speaking imprecisely, using the “correlation = perform the same” heuristic for convenience. But you never know. People will trot out some pretty silly stuff when billions of dollars of fee revenue are on the line.

(Incidentally, if you are the type of person who likes to give prospective financial advisors quizzes before hiring them, this is a good topic to add to your list)