“New Capitalism” is an oxymoron
The fundamentals of risk taking don’t change with technology
Wall Street and Silicon Valley like to talk about the emergence of new forms of capitalism. It’s understandable that people who follow innovators like to think of themselves as innovators, too. So they label themselves “builder”, or “enabler” to give the impression that investing is something new, something else. Well, what else? What exactly is investing change from form?
I don’t believe the act of investing is changing. Investors are in essence speculators and that craft has not changed much since it was invented hundreds if not thousands of years ago. Think of the Dutch traders in Amsterdam who financed ships to to to India or Indonesia to bring spices Think of the Venetian traders or the bankers from Florence. They were investors, speculators, risk takers. No matter what label you give them, they’re the same as a hedge fund or VC today. They took risk and the art of dealing with risk is not changing. The tools to asses risk do, but the actual act of putting money into a project with future and therefore unsure outcomes doesn’t change much. There is an element of randomness and creativity in the act of investing.
An underwriter in London financing a ship going to India or a VC financing a tech entrepreneur are going through the same emotions. So does a hedge fund manager betting on the emergence of artificial intelligence. You need data and information to asses the risk. But that is not enough. It’s necessary but not enough. You need something more. You need creativity and that is something that comes from experience, ingenuity and luck. You can’t engineer investment success. You can’t be sure. You need to be comfortable with uncertainty, risk and the unknown. In fact, I can’t help but smirk when I hear traders, hedge fund guys or VCs say they use a data driven approach to investing. Like they try to undo uncertainty with data. Data cannot undo uncertainty. At best it is neutral. But more often than not Data gives you the illusion of control or the impression you know something which will directly influence your investment success. In most cases that is an illusion.
The act of investing is deeply involved with risk. The best investors are those who can handle uncertainty and risk. George Soros used to sell all his positions because of his back ache. I’ve heard of macro hedge fund managers traveling in emerging markets and measuring the length of cigarette stumps to assess the health of the economy (the theory being that if people can afford to put out half smoked cigarettes they feel good about the economy).
Today, AI is all the rage. Using statistical models to find information in data, or machine learning, is a very powerful tool. But it won’t change the way people deal with risk. It won’t reduce uncertainty and certainly won’t make it easier for people to deal with uncertainty. Technology cannot make an investor more competitive by the simple fact that everybody else uses the same technology. It’ a necessary but insufficient tool.
The fallacy of algo traders
Take algorithmic trading. Lots of people claim to make money with computer models and hence would argue that technology makes them better investors. In fact, it makes them worse. Algo traders are just glorified scalpers. They front-run regular folks and turn a profit from that. That is not investing, that is scalping. Even worse, when things go wrong algo traders regularly blow up and hence loose more money than they ever made. Algo trading is a strategy that Wall Street calls coupon clipping. You make a little money often and then sometimes, when the models don’t work, loose a lot. Since most of them use a lot of leverage, the losses tend to be much higher than the gains.
As a hedge fund manager I often have to suffer through conversations with people claiming they found a new, better way to make money as investors. The latest rage is AI, and you hear people say things like “We use machine learning to gain an edge over the market”. Such people are at best fooled by randomness (to use Nassim Talebs’ book title) and most likely charlatans. If you come across such people, hold your wallet and run.
If you choose to give your money to others for investing, listen to them carefully. They should tell you something like this: We are speculators. We’re trying to anticipate future outcomes and profit from them. They will also tell you that their most important skill is the way they deal with uncertainty and the inevitable volatility that comes with financial markets.