Risk of Ruin
Audio documentaries about risk takers.
Risk of Ruin
Value Traps
David Orr is a former poker player turned fund manager. He started out investing with a value bias, and then eventually did a 180 and started shorting value traps. He talks about how his strategy evolved and also his plan to grow his fund.
Follow David on Twitter: https://twitter.com/orrdavid
Support the show links: https://docs.google.com/document/d/1YTMUqap_Z0D9832cOl5wYxUs16Byr6xx-iAZzrRL3VU/edit
Follow the show on Twitter: https://twitter.com/halfkelly
Email: risk of ruin pod at gmail
Hey folks, before we start the show, I just wanted to mention again that I recently posted a list of what I call the support the show links. These are referrals for credit cards that I personally have. You know, the idea is that instead of subjecting you to ads... about clippers for trimming your man bush or whatever, it's better to do more of a win-win where you get a sign-up bonus and I get a bonus. It's also been great to hear from listeners that have used these links. It's just very nice to hear that people enjoy the show enough to do that, and I definitely appreciate the points. So far this year, my wife and I have been to Cabo San Lucas, Australia, Singapore, Thailand, Kansas City... And then we also have trips planned to Toronto, Montreal, Nantucket, Portland, Santa Barbara, and Amsterdam. So if I tell you that we really need these points, you'll believe me. Anyway, there's a Google Doc in the show notes that contains the links, along with some of the resources that we rely on to do this stuff. And now, with that out of the way, hope you enjoy this episode.
SPEAKER_00:Poker is annoying because it's an exact number of hand combinations. And basically, once you know how to play a certain situation, you just methodically do it. So you're against a bad player, you're betting a certain size and certain types of hands. You're against a good player, you're betting a different size. That's all the thinking that really goes on there. The amount of unique, interesting situations is few and far between, so it's just a total grind. Whereas the market, you know, now that Express has gone under, now I have to find a new short to replace it with. And it's going to be a bit different situation. It's kind of interesting. And then another nice thing about markets is that, you know, I'm sort of expanding my business, not just improving my own strategy. I'm actually trying to, like, improve the results at the firm level. And that's also been super interesting. So, you know, a lot of things, a lot of moving parts to the market.
SPEAKER_01:You're listening to Risk of Ruin. I'm John Reeder. This is episode 39, Value Traps. On this podcast series, you can probably group the guests into two main camps. We have the people who make a living in the markets, like trading natural gas or managing hedge funds. And also we have people who play casino games like blackjack, sports betting, poker, etc. Then, every once in a while, we have people who have crossed these two worlds. Past guests, Evan Tindall and Jason Strasser, were both poker players when they were young, and they are both in the markets today. When we find someone like that, we're always trying to get at this question of correlation versus causation. Are these people just generally smart? And so they succeeded at gambling for the same reason they succeed in the market, i.e. intelligence is just broadly applicable? Or do games teach you skills that actually translate, like maybe how to deal with variance or how to adapt or how to look through the rules and find loopholes you can exploit? I always try to ask the guests what they think about this correlation versus causation issue, and I've heard various answers. We're going to explore the same idea in this episode because the guest, David Orr, was a poker player before he launched his investment fund.
SPEAKER_00:All my life, I've just played games all day, every day. And for me, this is just a game and basically the best game I've ever played. So, you know, I don't even know if I'll end up getting sick of it ever. It seems like A lot of other investors love it long term, and maybe they weren't even as big on games as I am.
SPEAKER_01:I keep kind of an informal list of guest ideas for the show, and I just go through the list as I have time, trying to do some diligence on each idea. I want to interview people who have credibility on their subject matter, and I also want something that will be a little different. The goal is for each episode to be unique. In David's case, I was aware of his Twitter account, and I'd seen him post some interesting stuff about position sizing, for instance. But I didn't really know much about him. I knew he had played some poker. So I kind of started to poke around. I found a Google Drive, which included the quarterly letters he'd written to his investors. And, you know, his letters weren't just stored on a Google Drive. They were actual Google Docs. As in, he hadn't gone through the basic step of turning them into PDFs, or really tried to dress them up at all. The letters kind of struck me as almost anti-marketing, as if he was trying to put off the vibe of, if you want a shiny veneer, then you've come to the wrong place. And his writing style is what I would call unvarnished. He would say, here are the results, I rounded the numbers to save time, and then he would offer some very brief commentary on a couple of the positions in the fund. Okay, but here's the kicker. In one of the letters, he said something like, Oh yeah, I've hired a second portfolio manager for the fund. This person will be investing some of your money. I found him on Twitter. And that's the thing that got me. I knew we had someone who had played poker, is now investing, and doing it in a way that you had to stop and go, Wait, what? Say that again. On this series, we are always searching for people who are uncorrelated. to convention. Here's David explaining the start of his fund.
SPEAKER_00:In 2019, some friends saw that I was playing the market. And I think at first they just sort of saw it as like a degenerate bet, sort of like, let's bet with Dave and see what happens, right? And if you guys put in 10 grand each, we did this through personal accounts. And so that actually was going pretty well. I mean, I was having a good 2019. And then I could tell that a couple of the guys were skeptical because I was really into that Intel sat short back then. And I was like, pretty sure that this thing is the story here is very flimsy and a lot of asymmetry on the downside. And then once that melted down, people started taking it a lot more seriously between the people who had already been following what I was doing. And then I had a really good COVID quarter, the first quarter. And a bit after that, the first guy reached out to invest from Twitter and And that guy, actually, he runs a billion dollar PE portfolio. So he's a pretty serious guy. So it's like, oh, OK, I'm attracting real investors. And then after the really good quarter two, then this guy, he doesn't run it anymore, but he ran a few billion dollar long-short bond fund. And then he's also interested. And I was like, well, how did you find me? And he's like, oh, well, you just cover the same distressed companies as me, but you're shorting the equity, which I can't do. It's too small for me. And I love what you're doing. It makes sense to me. So, you know, he's, you know, these two guys are a couple of my biggest investors today, but I got a lot of smaller investors too. You know, like, like an options market maker. He, he was a connection through my mentor. My mentor invested with me. A couple of my mentors, friends slash, you know, trading partners, they sort of share ideas. They all invested with me. just random people like an electricity trader. He invested with me. It was mostly professional investing nerds, basically.
SPEAKER_01:The very little effort that David devotes to making his fund seem bright or shiny sends the general message that he intends to grow with returns, not with new money. Although he has taken some money from investors along the way. But maybe even his investors sent the money in with a raised eyebrow?
UNKNOWN:Music
SPEAKER_00:So I have a fund administrator, and he told me that when my fund was first launching, four of the LPs reached out to even see if this was real, right? And he's like, because I was living in Thailand, this is a weird situation. And he's like, nobody has ever called me to see if it's real, like almost ever before. And in your case, four guys did. So they did some due diligence. They didn't tell me they were doing this, but that's fine. But as far as phone calls with me, no, that was like, Yeah, a couple 30-minute phone calls with those guys.
SPEAKER_01:I wanted to start with this idea that David's fund is not what you would expect, because that's my favorite part about making this show. We can have whoever we want. We don't have to stick to managers that look like they were stamped out of a mold from an assembly line. David may not fit a pattern for a typical fund manager, but he definitely fits the pattern for a guest of this show.
SPEAKER_00:At least as a young person, like, basically when you suck at poker and people are really social and poker is booming back then, you just constantly get invited to poker games, right? Because they want to play against you because you're a sucker at first. But then over time, I read these books and the fact that I even read a couple of books put me way ahead of them. So, you know, still go to some games, but it slowed down, which got me into internet poker. So I keep, I just like the strategy game of it. Internet poker was a fair bit harder, but still most people were bad. So I made like It's not a lot of money now, but I made like$5,000,$10,000 in a couple of years playing internet poker in 2004, 2005. And then, yeah, it started getting a little harder. I'd already played enough hands. It wasn't as exciting. So I just sort of stopped playing. And then I finished university, got a job for a little while. I did an internship at a public accounting firm, but I didn't get the job. None of the interns got the job that year because it was the peak of the financial crisis. And then so... I didn't want to have to go move home or something. Job market was really thin, but I could still play poker. And then by that time, there were these poker training videos. So you could see how the top professional poker players were playing online. And it was a lot different than how I'd been playing. But the fact that they had this content out there, you could just sort of mimic what they're doing. And then it was the same thing as the market from there where you could lean into what's working. And poker is really easy to fix your leaks because you can actually see... which exact positions and which types of bets you were losing at and which ones you're winning at. And so over time, you just, you know, get rid of the losing bet. And then over time, the game got more solved by like 2012, 13. People started thinking about the game theory of it more rather than playing just an exploitable manner. So that was sort of a new, harder part of it because you actually had to think about the hand combinations. You had to like balance it so that you had bluffs, the correct percent of the time versus the amount of time you had a real hand. That way your opponent couldn't do anything against it. And then so you basically would learn two styles of poker at that point. You'd learn the exploitable style, which you would use against bad players. And against good players, you'd try to play more of the game theory style. So I actually got pretty good at the game theory style for some reason that I was really good at that. So I actually became like a pretty top professional by 2016. I played the Bovada Anonymous 6-Max game. And yeah, basically, from there, I was just sick of poker. Like I'd already played 10 million hands. It's just like no more of this, please. And then so that's the solvers weren't why I quit. But they actually ruined internet poker just a while later, because people figured out how to use them in real time. And so you can't beat someone that's using a solver in real time. And I actually know a couple people who were using it, I think in 2018 19. So
SPEAKER_01:One of the ways to win really in any game is to just be deliberate about choosing your opponents. So in poker, that means finding people who are playing recreational. I mean, we talk on this show about people who gamble for a living, but that is really not the reason that most people gamble. The overwhelming majority of people are just doing it because they like the basic loop that goes bet money, see result, be surprised, bet more money. Or, if you want to keep it simple, they are doing it to be entertained. Although, sometimes David said he was the literal entertainment at the table.
SPEAKER_00:I played some in America, but mostly in Southeast Asia. I played in Phnom Penh, Manila, and Bangkok. But the funniest story that stood out to me was the one in Bangkok. It was like a private game. My friend, who's actually at an LP now today, And we used to be partners in poker. He got into that game, like a false pretense. He's like claiming to be this businessman doing trade and something. I don't remember. But so he got me invited to this game like a couple of weeks later and I show up and it's just like a bunch of 50 plus year old, super rich Thai guys. And so for example, one owned like the major malls in Bangkok, like own a bunch of them just outright. Um, another owned like a ton of the land in Bangkok. So it's worth a ton of money. And then behind all these guys was sitting like a 20 year old mistress, you know, and they're like ridiculously hot. Like they came out of like, like a couple were in FHM Thailand and things like this. And, uh, and these guys are all drinking and it's just a totally surreal situation. I'm like the only white guy in the room, you know? And then, and then people are drinking. It's Thai. People are really polite. And then, so, but over time they loosen up as they keep drinking. And then, it's sort of like that everywhere in Asia, I think, but it's also like that in Thailand. And so as this one guy gets more and more drunk, he like pulls up a phone, uh, his phone and like has a picture of Mr. Incredible from that, that children's movie. And he starts like pointing at me and laughing. And I don't even know what he's laughing about at the time. Like, okay, I'm just trying to hear to fit in and whatever. And, uh, and then he starts pointing to other guys and they're all just like laughing hysterically. And then they finally show me it's like Mr. Incredible, you know?
SPEAKER_01:I asked David if these guys were any good, like, at all.
SPEAKER_00:No, they are horrible. It was like free money. Also, for any poker pros listening to this, you can't really find a game like that in Bangkok anymore. This was like in 2013 or something, and the games have toughened up a lot.
SPEAKER_01:David also says that part of the bargain when you're winning money from non-pros is that you shouldn't subject them to your stipulations of how smart you are.
SPEAKER_00:Yeah, some people can't do it and they'll even sit there and talk about advanced poker strategy like right there at the table. It's incredibly stupid. You know, for me, I'll even try to like if a guy's drinking, I'll even drink a little bit with him and try to have a good atmosphere and lean into whatever he thinks is fun. It's fine with me. As far as I'm concerned, he's just there for entertainment and I want him to have as good of a time as possible. I don't think a lot of these guys don't even care that you have an edge on them.
SPEAKER_01:If you'll permit me a conceptual discussion here, I want to make a point. On average, poker players lose, right? There's a rake that eats up a percent of the total bets, so there are players that can win, but on average, poker players lose. Actually, on average, blackjack players lose too, even if some can win with card counting or hole carding or whatever. On average, people that sign up for credit cards pay the issuers more in fees and interest than they get back in points or miles. On average, sports bettors lose because the book takes a percent of every bet. The expected value for all of these endeavors is negative, but that expectation isn't uniform. Well, in the market, there's something that's close but isn't a perfect analogy. On average, most investors will not beat the market. So if you want to beat the market, should you give up before you ever try because the average investor can't beat the market? That's not a rhetorical question, it's worth thinking about. And it's specifically worth thinking about in the context that literally every sucker for any of the games that I mentioned earlier, every one of them has an idea in the back of their mind that maybe they can be the exception to the rule. So when you embark on an attempt to outperform expectation, are your chances real or are you fooling yourself? In any event, after David was sick of poker, he set out to beat the market. He had some guidance and and engaged in the same trial and error he'd gotten used to as a games player.
SPEAKER_00:One thing I do want to say is I got kind of lucky. I did have a mentor who helped me out. I still have a completely different style than him, but definitely he helped me avoid some pitfalls because short selling is all about just avoiding the mistakes more than doing it right. So it wasn't 100% self-learned. He'd try to warn me like, look, you're betting on the fundamentals of the company. but the bulls only care that revenue is going up, for example. And for a while, I'd try to resist that. But over time, I realized, well, he's right. It's trading on a revenue multiple very steadily. And I do think that revenue is going to keep going up probably. This isn't a short yet. So there were spots where I got helped. But the things that I self-learned, I mean, it's just trial and error, really. Sort of like you try something, you see if you're making money at it. And if it's not making money, then you stop doing it. And if it is, then you sort of lean into it. And market's nice because it gives you... I mean, I was running pretty diversified, right? So I really started putting on more bets at the same time in 2019. I'd have on like 100 at a time. And then you get a pretty good feel for what works and what doesn't when you have that kind of... Or when you have that many positions.
SPEAKER_01:I think that lots of retail investors, or maybe you might say non-professional investing enthusiasts... might start their journey with a book like Joel Greenblatt's The Little Book That Beats the Market. And then they go out and buy cheap slash very questionable businesses. And I'm not picking on Greenblatt's book here. You know, I think just a general rule is that when someone publishes a strategy and then that strategy runs into some headwinds, we can't really know the reason, right? We don't know for certain whether it kind of never worked and it was just the beneficiary of short-term variance or or if the strategy was the victim of its own success, i.e. it stopped working because too many people know about it. But in any event, value investing has had a tough go of it for a number of years, at least when we define value as the companies that trade at the lowest earnings multiples. And there have been various responses to this trend. Some diehards have tried to redefine what value is, some have cried about it, and some flat out gave up. You know, no mas. David says that he actually started out with a value bias, but eventually he noticed that something was off. Some of these companies really seemed like they were on their way to the trash can. So rather than throwing his hands up and writing off value or keeping the faith, hoping it would work again, he did something else. He started shorting the value traps. I think that response is the result of being non-dogmatic. David is non-dogmatic in a way that is common to find among games players. They excel at observing data and then adjusting.
SPEAKER_00:Yeah, like Men's Warehouse, it was called Tailored Brands. That seemed interesting to me because the PE multiple was so low. But Like that one was really bad because they had, I forgot exactly, it was a billion dollars of debt and the earnings trend was clearly negative. And so I just was sort of ignoring that and I was focusing on the PE ratio. And that's another one where I learned to short the types of companies that I do. And that was another stock where like, let's say a short seller was on the other side of the bet. I would have been the sucker there. I'm like, oh, I know about the situation. I know about what the CEO is talking about. I know about this details at the stores and what they're trying and blah, blah, blah. And the short seller's like, dude, the revenue trend and You know, they have way too much debt. This thing's going to go bankrupt. That could be his whole thesis. And that would trump my whole idea. I
SPEAKER_01:need to actually do a little housekeeping here by offering some thoughts on how you should approach anything you hear in this podcast about individual stocks. First of all, this is not a stock picking podcast. David is going to mention a bunch of companies in this episode. And on the day we recorded, you can assume that he was long or short, some of these names. But we have no idea if he's still long or short. And we have no price targets. You don't even know what day we recorded. And considering that listeners often encounter an episode months after release, who knows how stale the info might be at that time. In short, we don't have any of the context that would be necessary to know if these things are interesting at all. So you should never buy or sell any stock based on what you hear on the show. The second thing I want to mention is just this idea of where short sellers fit into the broader ecosystem. The entire point of capitalism is that a bunch of ideas will be tried. Some will fail. Some will go on to become viable businesses. And then eventually, even the successful businesses will Okay, and I have seen some people say that there is something either unethical or gross about Disruptors Disruptors And in fact, startup culture in places like Silicon Valley celebrates not just the creation of new companies, but it also celebrates the destruction of the businesses which are seen as being past their prime. And that's not just limited to Silicon Valley. I think if you were able to take the long investors of a stock like Uber and give them a shot of sodium pentothal and then ask, do you only root for Uber's success or do you also root for the death and destruction of Lyft? you would find that long investors also harbor untold amounts of hate in their hearts for the companies that compete against their portfolio. It's also really not fair to expect that investors will be all kumbaya since every ride that Lyft gives is one that Uber can't. My point is that short sellers are not these uniquely distasteful actors or the only people dancing on the graves of failed businesses. The thing they are doing is which is expecting some companies to fail, is the basic mechanism of capitalism, for better and for worse. Anyway, we're going to be talking about shorting stocks, so I just wanted to get that out of the way. Later you'll hear David say that when he shorts a company, he is often betting against long investors that know more about the stock than he does. I asked him why that's a smart bet to make.
SPEAKER_00:Most long investors, or most of their companies in their portfolio, are pretty reasonable investors. And they actually don't have that much experience with a seriously distressed company. So this specific example, PHI Incorporated, it was actually my first bankruptcy. The symbol is PHII. You can go to Seeking Alpha and type in that symbol and just look at the articles. And people have thousands of comments in these articles. And so one of the titles of the article is On the Verge of a Massive Value Unlocking Transition. Yet bizarrely priced for bankruptcy. This guy has done a lot of work on the stock. Okay. But for me, I just know that my thesis is serious. It's as simple as dude, they're going to go bankrupt in a couple of months. I've done this so much like back then I didn't do it a lot. But now I know my mentor sort of work, walk me through this one. And so now I know that they're talking about something that's like completely different than what I'm talking about. And I have a catalyst. And I have way more experience with that specific catalyst. They can know a ton of details about the company, but it's not going to save them from bankruptcy.
SPEAKER_01:David's time as a short seller has also coincided with the retail apocalypse. I think we talked for an hour or two, and the list of companies he mentioned was like walking through the mall in 2004. It was like Men's Warehouse, Abercrombie& Fitch, Express. All we're missing is the very aggressive smell of Cinnabon and Mariah Carey on a loop. One of these companies, the aforementioned fashion retailer Express, i.e. the uniform supplier to young cell phone salesmen everywhere. Well, they recently filed for bankruptcy.
SPEAKER_00:I just went there randomly. I bought some shirts and then like they were horrible quality. So I was like, OK, well, you know, this seems pretty bad. And the store was pretty empty. So I look at the numbers and they're trending the wrong way, which isn't surprising. I have a lot of different people I ask about different industries. So one of my friends is really good with fashion. And so I asked him, he's like, oh, dude, that totally sucks. They're not going to exist in five years. And this isn't a short seller or anything. I was like, oh, okay, well, he's just given me the short thesis. And so in that case, that was it. I didn't even read the annual report or anything. It's like, why do I want to trip myself up? I mean, I can see that the numbers are getting worse and I know why. That's it.
SPEAKER_01:Express is a good example to talk about because it shows the potential to be absolutely right over the long run and also how difficult it can be to make money as a short seller. Maybe you've heard an earlier episode of this podcast titled Zero by Way of 100. Well, David's bet against Express was kind of like that.
SPEAKER_00:I covered a couple weeks ago and then it actually became a meme stock that one for a while. So I actually have lost money on Express Lifetime. I got promoted in January 2021, where a few things got pretty insane. So it spiked 1000% through that. But I was first short back in 2019. I think I entered the short at six bucks when it spiked on earnings that didn't actually seem good. Yeah, I'd been waiting for a good entry. And then that looked like one. So
SPEAKER_01:I probably don't need to explain what meme stocks are, but just in case I do, I'll say that starting during COVID, some retail investors used online message boards to coordinate buying activity in various stocks. In fact, they were targeting investors like David, hoping to create short squeezes that would push the price up. Some of these meme stock folks went to the trouble of dressing their arguments up as if they cared about the companies, but the vast majority of the conversation was was geared toward manipulating the market and the really bizarre thing is that this mania has the perception of being some kind of a populist thing as if buying companies like amc and gamestop was a way for the little guy to stick it to wall street fat cats it's really amazing because the actual companies seized on the opportunity to sell shares to these suckers so yes The meme stock folks were able to generate some short squeezes, but the real beneficiaries were executives of these zombie companies. They got to dump a bunch of stock on people standing in line to be bag holders.
SPEAKER_00:Normally, I'm actually okay emotionally, but like January 2021 was definitely the one time. Um, I mean, ask any short seller. It was, it was really something. Um, but in that case, I didn't wait for the whole move. You know, it went up 200%. It kept going up. I, I could see that meme stocks were going crazy. So at one point I just covered it all. I was like, all right, well, I covered in like three 50 or something. And it went all the way to like 15 bucks.
UNKNOWN:Um,
SPEAKER_01:so-called value stocks can be great investments and they can also be value traps. Then you can see the same thing on the other side. There are growth stocks that are only growing by overpaying for customers. And there are also growth stocks that have legitimate powerhouse businesses. The fact that you can't easily paint by numbers is the thing that makes the market interesting.
SPEAKER_00:I want to make sure that the variable that I'm talking about is going to overwhelm what they're talking about. Uh, So the one that most short sellers get into the most trouble with is just revenue growth. So it doesn't matter if you think management's fraudulent and the business is horrible at the same time. If they're saying revenue is going to keep growing and you think it is, then yeah, you avoid it. That's sort of the biggest one. But besides that, I noticed that that's why I avoid a lot of growth shorts. Basically, if revenue is growing, I generally avoid it. But besides that, man, if you think a company sucks enough that you're short... and the bull doesn't have some really simple story of why the stock's going to keep going up, that there's no real reason of listening to all their details and finer points about incremental marginal revenue, this tiny little variable. It's like, nah, that's not going to matter. And so I no longer try to understand their stories that way. I just try to look if there's one key thing that seems so obvious it could push the stock price up that they're talking about, then I'll try to avoid it.
SPEAKER_01:I think that when you first get involved in risk and someone talks about bet sizing, it's really like, who gives a shit? You just want to find the right side of a bet and then blast away. So get the hell out of here with your academic discussions of bet sizing. And then eventually you might come to realize, oh wait, actually thinking a little bit about bet sizing might keep me out of some trouble. And so you give it a little consideration. Then it turns out that the way you size bets and the way you manage risk is kind of a pretty big thing. It might be the difference between being able to play a game or having to sit it out.
SPEAKER_00:So I just sort of learned, I learned this all by myself with some help from my mentor. Um, but so for example, I learned I can't have too much concentration. So back in early 2019, I thought, Oh, I can just take these concentrated bets. Like, you know, Joel Greenblatt or Warren Buffett says, cause I have high conviction in the thing. That doesn't actually work if you're using leverage, because what will happen is I'd like a 25% long position. And then the earnings came out really bad, which can just happen kind of randomly, right? But the stock went down 25%. So now I'm sitting on whatever was a 7% loss, something like that. And then it struck me then. So that was like pretty bad. And I didn't have to quite rebalance things just based on that one company alone. But then I realized, well, what if I had like a few of these things? And if you randomly went wrong at once, I mean, the odds of that are not that rare at all. And now suddenly, and then like, let's say at the same time, one or two shorts were squeezing bad. Now suddenly you're talking about a 30% drawdown and this is going to happen pretty often. It just doesn't really work.
SPEAKER_01:It's always worth thinking about what inefficiency you're even trying to exploit. If you believe a stock is mispriced by the market, why does that mispricing exist? David says that one potential explanation for mispricing and also one reason that some investors really struggle is just groupthink.
SPEAKER_00:I'm guessing that like, maybe half of people would have no chance in hell of avoiding groupthink. Because it's such a powerful human thing. It's like, going with the group, what a great survival thing. But yeah, I'd guess that some people could probably overcome. I mean, the thing is, even for me, I'd say everyone does at least a little bit, right? So even I, a little bit, will fall into groupthink. But I think that, yeah, some people can overcome it and some can't. I'd say that's the biggest leak most people generally should work on. If you can't beat the market, try to really get away from the market. You could even just get off Twitter or everything. You could just completely unplug. And I think a lot of people would have a better chance of winning if they just never heard anything people talked about. Maybe that'd be a good way to do it.
SPEAKER_01:Another thing David has brought with him from poker is the idea that these positions are inherently probabilistic bets. And if you're really sure about something, then you're probably overly certain.
SPEAKER_00:I mean, in my opinion, it's the biggest leak. It's going back to what I said about, you know, the people think about investments in black and white terms and you see it on short sellers too. Like they just sort of give you the downside case. They're like, this thing is a hundred percent downside. And then, you know, and you're like, well, what's the upside case? And they don't really, you know, so yeah, if someone thinks in sort of the black and white way and their shorts do go down a hundred percent a few times in a row, you know, Maybe they start leaning into it too much. They get a little too confident, but it's better for them to think about, well, you know, what's the probability there. And I think it is possible to say, get to a point where you're a 60, 40 favorite, and then you can sort of do that over and over again. That's sort of what I do on short selling.
SPEAKER_01:One way that the zombie companies can keep their stock elevated, at least for a period, is just by engineering profits. Maybe revenue is dropping, but they're also cutting costs to the bone, so profits hold up for a while. Until they don't. Well, if those are companies to short, then maybe the inverse of that would be going long a growing company that doesn't have profits yet.
SPEAKER_00:Yeah, I just kept trying things. So over time, there's all these memes and jokes that value investors... are just these like masochists and they never make any money and everything. And I sort of realized there's a lot of truth to that. So in my own results, right. I realized that pretty quickly. I'm like, these companies actually kind of suck. Uh, but there are still some great value investments. Right. And then, so I sort of learned, cause my, my innate bias was that sort of value style. I just wanted as cheap as possible or whatever. But over time I realized that, you know, business quality is actually like way more important than that. And like, if management's dishonest, uh, For me, there's actually not a price that I'm interested in paying on that business. I mean, if you can find a short-term catalyst for a trade, I'll always do that. But for a long-term investment, I'm not interested at all. And then growth stocks, I've started getting into those more because often you don't know. So as a value investor, I really struggled with growth stocks because I'd always say, well, how do you know what the end economics are going to be, right? So thus, I shouldn't invest. But that's not the right way of thinking about it. You can look at that as a range of outcomes, right? There are times when the business grows a ton and it never becomes profitable. But there are other times where it grows a ton and it becomes a wonderful business like Netflix or something. And then so, you know, for me, now that I'm thinking about it in terms of a range of uncertain outcomes, I actually give the bulls a lot more credit than before, where if they're just betting on revenue growth, and it seems like it could maybe work. The bet actually does make sense. So if you think that revenue is going to keep going up in that instance, then it seems like a fine bet to me now. So then now I'll actually bet on some growth stocks too. You know, longs basically just go up with earnings growth, right? That's basically all long investing is. The thing's going to keep trading at a multiple of earnings. Earnings go up, you're going to win. And then it's the opposite with the value trap shorts. That's why they're so predictable. They're such good shorts. You know, I think earnings are going to keep going down and You know, it's a beautiful thing because if you're fundamentally right, then you win. Mostly, I mean, you get some outliers.
SPEAKER_01:There are short sellers that specialize in finding some unknown problem in a company, then publishing that information and making money when the stock gets hammered. But that's not David's flavor of shorting. His shorts have more well-known problems. Although he says that sometimes... Even with a company where the problems are well known, things can change by enough that it's better to just give up.
SPEAKER_00:You wake up and you see like if any shorts are spiking, that's sort of the first thing because that's the most important buyer to put out. And then you check lungs are moving. And then from there, I try to go through my news feeds. So like I go through my Twitter feed, which I have a pretty curated list. I actually like the Seeking Alpha news feed the best. I feel like they've given the best feedback. signal-to-noise ratio. And then the comments there can be really great, too, within the news articles. Yeah, Seeking Alpha is nice because you actually have a pretty diverse group of people on there. It's not like Value Investors Club, which is pure finance bros. Or it's not like Twitter, where, yeah, it's still a ton of people who are trying to be hedge fund managers. Seeking Alpha is like normal people. So you'll get a guy who's like, oh, I've been working in the industry for 20 years, and here's my comment. It's like, oh, that's pretty helpful. So yeah, you go through... I have a huge list of all the companies I have on Seeking Alpha and go through that and go through the comments if something's happening. I don't really even bother with earnings reports that much anymore, except for bigger positions, of course. But for all the smaller ones, I just sort of ignore it. And then for that, I check in like twice a year. So I'm more interested, well, what's been the trend versus my thesis for the last couple of quarters? I don't even look at the earnings report, though. I just look at the financials usually. And then if I need to hone in on something, then I'll go look at the earnings report to save time. Because for me, it's all about the best return on time. And then usually, now that I've gotten better at it, what I'll try to do, instead of trying to dig more into the details of something... So let's say that I've got a 0.4% short position. The revenue has started trending up more than I expected, or it seems to be stabilizing more than I expected for a couple of quarters. And the earnings report, I read that. And let's say that something seems kind of credible there. What I used to do is try to wrestle with it and try to get more into the details. And nowadays, I realize I should just immediately cover and go move on and find a new idea. Because now the edge here is maybe too thin. It's not that clear. So for me, I'm really trying to avoid the tough spots. That was a way you actually could play poker back in the day. You could just play in a way where you never got put into a hard decision. But poker is different because the house fee is so high. It's way higher than markets. And because it's very zero sum. You have to beat the blind that you're paying. So if you're not winning more than the blinds you're losing, which is like an ante for people who don't know Texas Hold'em, if you're losing that money, then you're just going to lose the game. But in markets... I don't have that. I don't have an ante. It's sort of like Buffett's version of no-called strikes. If something's too hard, I just don't have to play. And so I've gotten a lot better at that over the years. If something's up 10%, I just ignore it. If something's up 10% like four days in a row, now it's like, okay, I've got to figure out what's happening here. Because usually, sometimes it'll be like a penny stock promoter. That's probably the most common reason. And then it's fine to just sort of stay short because you know, those guys will dump on their, um, their suckers. And then that's actually a pretty reliable catalyst by itself. Um, but then other times, um, so like the short Dave D A V E, uh, I was short that last year and it went up like, I forgot even how much, but it was just obvious to me that this could become like a real story. Um, and it was some jump one day where I was like, Oh man, this thing could really run. And it went from like a five to 40 bucks. And, uh, Yeah, it was just some piece of news that's like, okay, this is credible seeming enough. So, you know, just get out of the way. And then another thing I do on shorts is let's say it just goes up enough on no news. And I can't even know why it's doing it. This happens. And it's gone up more than let's say the penny stock promoters, because usually they'll dump on their sucker like before it runs up 100% mostly, unless it's something really small, which I don't really do those as much. But you're basically... At some point you just give up. You're like, well, the market's decided that this thing for whatever reason, but it doesn't happen that often. So if you have 200 of these things on, you know, the times where it goes up, you know, 180%, you know, I'll have quit before then usually on no news at all and nothing. It just doesn't, you know, it happens like once a month or something. I don't, it's just not too bad.
SPEAKER_01:David generates most of his returns through shorts, but he has longs too. Actually, he's been writing one of these bets for years. The home builder, MI Homes, which trades under the ticker MHO, was in the 20s when David got involved. As of this writing, it's just over$120 a share.
SPEAKER_00:Probably the MHO had the home builder bet. I've won a lot on that over the years. I mean, I think I first started betting on it in 2019. And yeah, I think maybe I've won 25% on that stock since inception, even though my bet size on it was never even that big. So yeah. Yeah, home builders are like the most, it's sort of changing now, but it used to be like everyone just thought we'd have another great financial crisis. And that was the thing you'd hear over and over and over again about why these things are cheap and why they should be cheap. But, you know, the weird thing is there's so much detail and information about the housing crisis, right? Like basically we know that lenders were giving loans to literally anybody. And that drove the prices of homes up a lot in 2004, 2005. But then nowadays, you can just check that one simple variable and say that actually lenders are super strict today. And there's no reason to think that that same thing is going to happen. But that's what people keep telling me is going to happen. So they're just wrong. And the thing trades for five times earnings and it's growing fast. So that's been my best bet. And I still think there's probably... Some room for them to run, but right now I'm not too heavy in them because they tend to trade on book value. Sometimes they trade over book value. Sometimes they trade under. So I'm hoping it'll get to under book value again at some point.
SPEAKER_01:Some hedge fund managers are well known for 200 page slide decks that lay out the investment thesis in excruciating detail. By contrast, David employs more of a keep it simple, stupid approach.
SPEAKER_00:So I used to read more call transcripts, read more earnings reports and things. But over time, I realized that didn't even help too much. I mean, for the larger positions, of course, I do, because you have a few higher conviction ideas and you want to follow this more closely. But, you know, if you have like a short on for, say, 0.25 percent and, you know, let's say earnings come out and the stock doesn't really do anything. I don't even waste time like looking at what the earnings were anymore. Or especially when the stock is winning. So like, let's say I'm short and you get like a 10% drop. Then again, I'm just, you know, for me, it's like, okay, the short's working. I won't even waste time. But for the big moves, then you go and look at what's going on. So if it spikes 30%, like Abercrombie and Fitch did, or if it drops 30%, then you want to see, well, is this a spot where I can add to the short? Usually you want to add when it has those big drops. So if a stock has a 30% drop, it typically means it's shed a large part of its long-term investor base right there. And if they're giving up and they know a lot about the situation and the stock, they know more than me, right? They've been following it closely. The bulls usually know way more of the details than I do because they're, say, concentrated into 15 bets total. But then I can sort of use their work just because the market told me what the answer is. And usually I boil a thesis down. I try to get it down to even a couple sentences. And so let's say that in the Express example, I thought that operating income would keep trending down. It got a little weird during COVID because you can sort of ignore that. And so I just checked to make sure that operating income kept going down. And as long as it was, there's no reason to change anything.
SPEAKER_01:I once heard a very good argument that if you cover a short, you should probably consider going long at the same time. The idea was that If you think about the range of outcomes that might exist and you're admitting to yourself that the downside is no longer the base case, then all that's left is upside. I asked David about this. You know, does he ever go long when he covers his short? He said very, very rarely.
SPEAKER_00:So I short a lot of turnaround situations, for example. You know, a lot of the great investors have said that turnarounds are no good because they never actually turn around. But obviously once in a while they do. So Abercrombie and Fitch, I was short that. And then they had a really good earnings last year. And very briefly, I actually switched long because the numbers were so good. And the potential for the numbers to keep improving was clearly so high still. But usually, I don't flip long unless there's a fundamental real reason to. If it's more sentiment or story-based, I'm not so good at that kind of investing. So in those instances, I'll just realize the hype is too strong. I don't have a read of when it's going to end. And then I'll just sort of exit the position there.
SPEAKER_01:David is active online where he's often discussing ideas for stocks or portfolio construction. He will sometimes pose a question and then see if the responses generate anything interesting. He also has a group of short sellers that he interacts with on a private forum, and so he gets some ideas from that group as well. I will stipulate again that this is not a stock picking podcast, but it still might be interesting to hear about a short that David recently opened. The company David's talking about makes computer storage.
SPEAKER_00:The most common short I have is the price target is zero. And so like a big one today that I copied is Seagate. This was not my idea. I'd give credit to Grant on Twitter, GLBD. But, you know, this company right now today is trading for like$18 billion, but I'm pretty sure it's going to go to zero, which I know it sounds like pretty extreme. But, you know, like for me, it's like because the market cap is so high and that gives them a lot of runway to figure out something new. It's obviously not like a$300 million market cap that's totally screwed. So these guys are not going to go to zero every time, but the asymmetry is so nice there. Yeah, I don't know. I don't really know why it seems so obvious to me so quickly, but it's going to keep trending to zero because the market cap is so high. I actually said that like today to my friends that were talking about it, I said, this will be the short that we can just keep hammering on for five years. You know, there's no reason to cover like, If any, like I actually said, like right now it's my biggest short, but once it gets into a clear downtrend, I'm just going to even bet bigger than before. I'm going to like really hammer on that one. And I'm just going to keep doing that for, yeah, five. I mean, I can't see this thing going bankrupt before five years. So it'll be five to 10 years. This thing will be a short unless they come up with a new technology or something, but they don't even, they've been cutting their research budget and everything too.
SPEAKER_01:At the top of the show, David said that the game isn't just to pick stocks. and generate returns. He also wants to improve his fund as a business. So let's talk about that. We'll start with the overall structure. David says that at any given time, he might have 100 longs and 200 shorts.
SPEAKER_00:Yeah, so the overall strategy started as 150% long and 50% short. And then over time, you know, as I got more comfortable with it, I just sort of jacked the leverage up. And now I run more like 100% long, or sorry, 200% long. And 100% short on average, most of the time. And then, so there's like a big auto correlation in markets where when something's working, it tends to keep working. And then when the auto correlation has been going for a while, I'll try to just increase the gross leverage a bit. And when it's sort of not working for, it just doesn't work for a few months at a time sometimes. And I'll try to realize that. And then I'll try to cut it down to more like 250% gross leverage. Yeah. And then, The actual like long short targeting. So when I first started, I was just trying to use shorts to get more long. I was just hoping to break even on the shorts. But then after a big enough sample size, I just realized I was actually had a higher IRR on shorts than I did on longs. So now that's why my beta has been running a bit negative. It's a little too stressful to go like negative 0.75 beta or something to the S&P 500. But, you know, I can get away with like negative 0.2. Cause the IRR on shorts is so high.
SPEAKER_01:Earlier. I described David's investor letters as anti-marketing, but he does have investors. And part of a fund manager's job is to ensure that people don't pull their money. It helps if the investors are themselves risk takers.
SPEAKER_00:Yeah. So I met, um, the guy who ran that bond fund, I met him and, uh, yeah, his wife, we had, we had like a double date. So me and my wife and him and his wife went out and, uh, His wife was like, how do you know that this guy isn't just like a scam artist or something? And he's just like, dude, it was like obvious to me that this guy is going to kill it. And then a few people said that. I don't really know exactly what they saw. I mean, if you ask them, I bet they'd all say something different slightly. But I don't really know. And then, I mean, he had like a 30-minute phone call with me. The two examples that I gave so far both started with$500,000. And then after my first good quarter and they started getting the statements from the administrator, then they started adding more. And then one of them actually added even more the next year, I guess, as they got more comfortable. Because, yeah, I don't think the$500K was a lot of money at all for either of them.
SPEAKER_01:If you're doing something where there's variance, then it's just not possible to have a smooth ride, completely void of bumps. Even if you generate great returns, you're still going to get thumped. some days. The market was up a lot last year, so David had some headwinds to keep up.
SPEAKER_00:Yeah, I really didn't do that bad last year considering my beta. I mean, I still generated 15% alpha last year, which is that's better than most hedge funds are doing like almost ever. So, you know, even with my huge mistake in quarter two, you know, I can't. Yeah, it's like you're saying you got to minimize your losses and I pulled the plug immediately. I mean, next day I was like covering anything that was even maybe AI related and everything. And, and then obviously when you have such a big, um, technological shift. So if you, you know, John, I mentioned earlier, John Hempton pointed out, if you've studied one bubble, you've studied them all. So anytime you get these huge technology shifts, you get a huge bubble that like always happens. And so all of my shorts, we're going to rip my face off no matter what, through this at first, because that's just how markets work. And, uh, So, yeah, that part of the loss was going to happen regardless because I wasn't going to like go cover all of my shorts and try to time this whole move, you know, sort of. But the pain would have been a lot less. So I had an 18% drawdown without the AI loss. I would have had more like an 8% drawdown, which doesn't even matter to me. Earlier,
SPEAKER_01:I called David non-dogmatic. So I want to go back to this idea. If you can take some pre-existing position you have, some might call this a prior, and then change your mind in the face of new evidence, then I think that non-dogmatic is a good adjective.
SPEAKER_00:Yeah, I mean, I was short NVIDIA itself because I thought, well, this is just crypto related. And then immediately on earnings, I realized I was wrong. I covered in the after hours there. I was like, oh, crap, you know, something's wrong here. This was not this is the thesis is not on track. But yeah. But yeah, I mean, it's an annoying one because maybe if I'd gotten it in time, you know, last year could have been really good also because that would have been long, all that stuff instead of short. But yeah, my LPs were super supportive. Actually, so I cut some risk there when things weren't going well. And one actually sort of complained. He's like, dude, I want you to have pedals to the metal fully what you're doing. I believe in what you're doing. You're like holding up way better than I would have expected in this market environment. So it was kind of, The only pushback I got was the opposite, where the guy wanted me to put on the gas. But basically, the reason I underperformed was I still had slightly negative beta to the market. So that was one thing. But then the other thing is I just got quarter two fundamentally wrong. So I didn't catch this AI shift. I sort of thought it was a joke. And so, yeah, I just had a bunch of these shorts on that were going to explode if AI worked. And so... You know, in that situation, I lost like 9% in May. And then that forced me to cut risk, which had another further cost. And so that was sort of what went wrong last year. But I mean, I just can't get everything right. You know, whatever, I missed the AI thing. I mean, part of why I was so skeptical on AI is I follow all these AI shorts, right? And it's a joke. It's like once you, I've researched like five in a row, and all they were doing was paying humans to do the work while lying to their backers about their technology. And then this new technology came out you know, the LLMs and everything that works on a totally like different, but real things. But I was just skeptical. I was like, that's probably BS too. And so that's how it happened. I mean, I might've been able to catch that one too, but you know, I'm not going to catch them all.
SPEAKER_01:I became aware of David through Twitter, which for people interested in the market can be a really amazing and really terrible place. You're just going to get this really wide range of ideas. And sometimes it's not easy to tell the difference between the geniuses and the idiots, the very best ideas will seem kind of nuts, and then the most middling ideas will be the hardest to argue against. There's also a crazy thing that happens where you'll have literal billionaires debating an esoteric point about a corporate action, and they're arguing with an account named Warren Buffett 6969, and the really wild thing is that sometimes Warren Buffett 6969 gets the best of it. I once made an entire episode about how great Twitter can be for this kind of thing, but you also kind of have to know how to use it. It's like an old car where you have to jiggle the key to open the door and you have to feather the gas to get it to go. You can't just start tweeting and get value on day one.
SPEAKER_00:You know, like if I know a guy is winning like 30% plus a year alpha at small scale, you know, if he says some idea, it's almost like, okay, you know, does it, does it make sense to me even a decent amount? And then if so, I can go with it. That's why I like to try to figure out what people's results are. A lot of people are really secretive about it because I think because their results suck. And so it's unfortunate. Some probably really great guys are concealing it. Although actually now people have started DMing me when they kill the market and they'll have like 400 followers or whatever. They've already traded their money up to$10 million or whatever. And they tell me like, please don't tell people that I just like you and we trade ideas now. in the same way. So I just like to talk to people who kill the market. For me, it's about people who think differently. So the biggest leak in the market generally, and I'd say the reason maybe 80-90% of people lose, is that they fall into groupthink. So even if I think someone has a lot of really hit and miss ideas, like I don't care if they have five horrific, terrible ideas, but then they have five good, original ideas that nobody's talking about. Everything this guy is talking about is different than what the rest of Fintwit is. And that's interesting to me. So then I'll try to look at the longs and I'll try to understand it better myself in that instance than trying to follow someone in more who I think is really good. I don't do pure following in too much either. It's like, It's more like I need it to make sense to me at least a decent amount, right?
SPEAKER_01:I'm sure you've perused online media and seen something like such and such investor that said to buy Apple stock in 2003 has a hot new pick. And without taking anything away from the person that made that great call, let's just say there's no actionable info there. There are lots of companies with nearly continuous opportunities to buy or sell. So having one great call just isn't that hard. David says that when he's looking for PMs, there's a threshold amount of data that he needs.
SPEAKER_00:Like if someone came to me with a track record where they're making like five bets per year, that's really not convincing to me. That's like, well, that could have just been luck. And interestingly, a lot of people who do have good seeming records who are doing that, they'll put up six good years in a row and their sample size of bets is only 30 now, right? And now they somehow do. Allocators give them hundreds of millions of dollars and this really blows up in their face sometimes. But for me, if I can see that a guy has a couple hundred bets, and every strategy is a little different, but let's say that both their winning percent of these bets is pretty high, and the winners are winning more than the losers are losing, and that's a couple hundred bets. It's like, okay. I know a lot of tickers, so I can sort of go through and see how correlated these seem to me. It doesn't have to be perfect, but if I'm convinced that the sample size is big and they're generating a lot of alpha, then that's pretty much all I care about. If they can somehow do this while working... 10 hours a week, more power to them. I don't care. I care if they win.
SPEAKER_01:At the top of the show, I kind of made a joke about how David found a portfolio manager on Twitter. So I should just clarify to say that it's not like he posted a thread and said, hey, if you're the 100th retweet, then you get to be my next portfolio manager. It wasn't like that. David knew that this PM could pick stocks because they'd been looking at the same companies for years. They'd just been coming at these names from completely different angles.
SPEAKER_00:He had like less than 2000 followers on Twitter until recently, you know, and it's weird because like he had been posting his results and I was pretty sure that they were real based on what like the individual ideas I'd been following with him. This guy had been putting up like 80% of your return for five years straight now. And he had 2000 followers. So he's just sitting there right out in the open. Seemingly, nobody was paying attention. I mean, in some ways, I shouldn't even be talking about this, right? Because like, this is what I sort of want to harvest these guys and bring them into the partnership. But on the other hand, I mean, part of why I'm doing this podcast isn't to raise money. Part of it is so I can hopefully there's a good PM out there, please reach out to me. You know, I'm interested to see any track record anyone can bring me. So And then, yeah, the benefit of doing this, I just actually put a post on Twitter today about what happens to the combined sharp ratio if you combine a few uncorrelated managers. And so my real mission here is to get a fund that can do 300 million of assets under management and still have over a four sharp ratio. And I couldn't do that alone. That's not possible. But the math of it's pretty straightforward. So if you have six uncorrelated guys who each have a two sharp ratio, then the combined Sharpe ratio is nearly five. And then that's a nice margin of safety there on getting to my four plus goal. And then my goal is four because if you can have a four Sharpe ratio at 300 million assets, then that sort of implies that like 1.5 billion or so, it's probably still over three. And three is like really a sweet spot of just a really attractive investment.
SPEAKER_01:David is talking about Sharpe ratios, which we can just simplify by saying that it's a measure of return per unit of risk. And we'll forget about any discussion of whether there might be better measures because at that point we're kind of in the weeds. But if you hold returns constant and reduce the amount of risk required to generate those returns, that's a good thing. So that's where you get this focus on diversification. Well, David has been very diversified. Remember, he might have 300 positions at any time. But that's also fruit of the same tree. All of his positions flow from the strategy he's developed. He wants to increase his firm's Sharpe ratio by stacking unique edges on top of each other.
SPEAKER_00:Yeah, so I just started backing my second portfolio manager. And in both cases, those guys are good at what I suck at. So earlier you asked about... Like, could I switch from short to long? And these guys aren't actually doing that either. But what they do is they specialize in the long situations of the types of companies that are typically short. So, you know, for some reason, the first portfolio manager, he's so damn good at catching these inflections on stories. So like the story, let's say, had been trending down or nothing exciting has been happening and say margins have been shrinking gradually. And this to me looks like a great short. And, but then he'll just know something and he follows so many of them too. He is like, he was like 50 bets on and somehow they just obviously jump out at him somehow. And those inflections are nice, you know, cause you catch that inflection, you get a nice a hundred percent jump within a, within a year or something. So for some reason I just can't get that. And I've even like looked through a bunch of his pics and like, what the hell does he see here? I don't get it. I try to reverse engineer it. I still don't get it. Um, but yeah. And then, And then obviously the thing I'm really good at is short selling. So I don't know why it comes so easy to me. You know, usually it's just like the one sentence thesis pops into my head within like a minute or two. And then that usually ends up just being right most of the time. So I really don't know why I'm so good at it.
SPEAKER_01:David talked about the Sharpe ratio, which is based on pretty simple math, but is also kind of an academic way to think about risk. But one of the first things gamblers learn is to internalize this relationship between what can go right and what can go wrong. It's like a scale constantly working in their head. And I think the other thing is that they are pretty good at divorcing their estimation of risk from whatever conventional wisdom might have to say about what's risky.
SPEAKER_00:So there's sort of two pieces to this. First, these are small scale guys. I'm pretty sure if that like they had a strategy that clearly had their same edge that could run with like$500 million, they would be found, right? Ken would not let these people go. Uh, but you know, if I'm talking about backing them with a, we're only starting with a$5 million portfolio and then, you know, I'm going to bump them up to 50 million after a couple of years, if this all goes according to plan. Um, but then on my side, it's very low risk because I'm essentially just risking 7% of my fund on a guy who, And then I risk 7% bets here and there all the time. I don't even think about it. So this to me is just like, okay, this is another 7% bet at first. It's almost like the riskiest point in this is when I upsize them the first time to say 20 million after a year, because now it's like a bigger chunk of the fund and maybe I'm missing something. But I think after that, if I can just see that what they've shown me was real and they still have this huge edge and we're two years in, I don't really think I'm missing anything at that point. And You know, even then it's not catastrophic because in real time I can see what they're doing. So let's say they start doing something really bad, like 500% long, or they should not be doing this. You know, I can shut it down real fast too. So, um, yeah, I don't really see that much risk. I just, I don't, it's really asymmetric, you know, like heads. I'm going to lose, like, you know, the guy will have somehow tricked me and I'll lose a few percent before I realize it and shut them down. And then tails, you know, I'm going to have a guy who can boost our sharp to four plus.
SPEAKER_01:I like that David experienced some success with his fund and then immediately turned his attention to how he could grow it beyond his own strategy. But will it work? I mean, that's the billion dollar question.
SPEAKER_00:I sort of wrote a fund explanation all the way back in 2020, and I thought that this would scale worse than it has been. So basically my alpha in the three years since I've launched the fund is the same as the alpha as it was, you know, way smaller scale. Part of that's probably because I improved, but Part of it too is because it's just the edge is not degrading with what I'm doing as fast as I thought it would. So to that end, I think that I could probably personally run more like 150, 200 million and still have a really high edge. It would fall off like a little bit, but not too bad. And then, yeah, part of why I'm backing these PMs is if I can find a similar kind of guy. And my goal is to find five of them. So it'd be a six-man team. And then if like their strat, I'm trying to, every time I, get a new track record, I try to put it through the filter of how is this going to scale longer term. So let's say someone's doing really well, but they're day trading super small micro caps. It's like, okay, well, that's not so interesting. But I'm trying to find a guy who can run with also 150, 200 million because he focuses on the same company size types of things as me, same types of liquidity. And then, yeah, if we can have this total of a six-man team, then And each guy can do 200 million and still have a really big edge. That means the fund should be able to be like a straight line up to$3 billion or something. That's sort of my goal.
SPEAKER_01:I would guess it's nearly useless to try to copy someone else's positions. You're just never going to have a real-time update of the estimated edge of the bet. But I do think it's helpful to try to understand how they got to their position. And it might be even more valuable to understand how they got to their process. In David's case, we can take some clues from this episode. He had a little help in the way of a mentor that taught him some basics. He got lots of reps in. He tried different things. When he found something that worked, he did more of that. And if it didn't work, he stopped. He was also obsessive. He spends all of his time on this stuff. And he seeks out other obsessives that he can bounce ideas off of. Also, he is not afraid to break from tradition. Markets are known to be hard to beat. And I think if you have listened to this episode, you can tell David doesn't think it's that hard. I actually asked him about this. I said, you know, I think people will hear this and think you just look at some top line revenue numbers and short some companies with falling revenue and then profit. So is it that easy? My sense is that it's David's approach as a games player, which taught him the basic skill of how to adjust his strategy, which actually drives his perception that this isn't very hard. Although he is from the world of variants. So he admits you can't completely dismiss luck as an explanation.
SPEAKER_00:I think that this is like a talent game. And so for some guys, it's naturally way easier. And then for other guys, it's like basically impossibly hard. And poker was the same thing. So I got good at poker really fast. Or there's like other card games. So when I was like 15 years old, was playing in a national tournament for a card game similar to magic the gathering and it's all in my opinion the same skill set it's like a game of imperfect information um and so i've just always been really good at them so i think i think like when like if you ask like a really talented basketball player like lebron james or something well why are you so good why do you make this look so easy and it's like he can't even really answer that i think it's like Also, maybe it's just some fluke. Maybe this has just been a ridiculously lucky run. You know, it's only been six years, so maybe we'll see that way too. Maybe I've just been incredibly lucky. That'll happen. Millions of people are trying to play this game, right?
SPEAKER_01:Risk of Ruin is written and produced by me. Special thanks to David Orr for taking the time to do this episode. Bye. Bye. Bye.