(13) Portfolio

In a period of volatility, investment and speculation are closely paired. During a time of constant change, business building and portfolio development are by necessity conjoined. The digital economy and its phenomena that run parallel, as previously outlined in this series, have set the stage thus.

The current episode elaborates on these notions and raises questions that seem appropriate to ask.

Diversified long-term hold

The links between business strategy and investment, and between investment and speculation — by association, therefore, between strategy and speculation — have always been direct. There are always speculative considerations in strategy just as there are elements of uncertainty in investment. Such connections are always relative and a matter of proportion, and the extent to which secondary or qualifying factors in a stable time dominate a period of instability, is a question of emphasis. The emphasis, today, appears to be pronounced. Two samples follow.

In Warren Buffett’s 2016 letter to Berkshire Hathaway shareholders there is the following commentary, in reference to technology trends that impact us all: “Productivity gains frequently cause upheaval: Both capital and labor can pay a terrible price when innovation or new efficiencies upend their worlds… Investors who diversify widely and simply sit tight with their holdings are certain to prosper…”

There are many (moving) pieces packed in this one blurb, but one feels as though the word “investors” was not arbitrarily selected. In Buffett’s synopsis of the complex situation, speculation can be reduced through diversification, and further mitigated by patience. The idea is not new, but there is novelty in the context.

Around the same time as the posting of the Berkshire letter, an interview with Mark Zuckerberg was published, in which the founder and CEO offers the following about Facebook’s perspective on new directions for the company: “There’s a long-term question and a short-term question… People often say that it is easier to predict the way things are going to be 10 to 20 years in the future than to predict how it is going to be 3 years from now… We are betting that people will always want more immersive ways to express themselves… Soon it will be [virtual reality], I bet.”

It was tempting to highlight the repeated use of the word “bet” in this passage, but maybe that would have been too subjective an editorial emphasis. In any case, the CEO’s uncertainty is explicit in his reference to time horizon, even if speculation is only hinted at by what may be an accidental choice of words. Zuckerberg would seem to agree with Buffett in his favoring the longer term over the short, and both risk-takers appear like-minded in their probabilistic approach to looking out. There is a difference between the two, perhaps, in Facebook’s ability to diversify to the extent that Berkshire Hathaway is able to do, but the social network has been working to change that with new offerings (e.g., virtual reality, as is stated).

The point is this: Where the portfolio manager ends and the business executive begins, where hold period takes over from strategic vision, and the extent to which the job is about (thoughtful) speculation, are questions that flow, perhaps rhetorically, from the cases at hand. As mentioned, the rhetoric may have been less loud in a time of lesser instability.

Concentrated short-term risk

A separate issue — more subtle but more universal — is discernible in the selected passages: That is the evolving dynamic between individual and enterprise, and the emerging profile of the consumer-employee in a new form.

When the nature of the enterprise is perpetually changing, and possibly even speculative, the employee assumes a risk that is itself not far removed from speculation. The skills that are learned and the experience that can be leveraged are both exposed to changes in business direction, to economic transformations, and to industrial disruptions. Were these changes to occur over decades, as had been the rule for some time, the risk would be more purely associated with Buffett’s long-term investment perspective. When changes, however, happen in years, or sometimes even faster, we start to push against Zuckerberg’s short-term concerns. The Berkshire Hathaway passage on investment, portfolio diversification and long horizon, concludes, ironically, thus: “A long-employed worker [on the other hand] faces a different equation.”

The implication is that the difference is not to the employee’s advantage. Perhaps the purest way to illustrate the dynamic is in the interaction of technology founder-entrepreneur and the venture capital syndicate that supports him or her financially. On one side — that of the founder — an investor in a speculative portfolio of one, while on the other side, a diversified pool, with plenty of time, a great deal of updated comparative analysis, and many pearls of wisdom…

Whether in reaction or as a driver, the digital upheaval that gave rise to startups like Facebook, and social media more broadly, has also coincided with new consumer-employee possibilities. Marketplaces, the gig economy, the sharing economy — all popular designations for individual enterprise and forms of labor in which the firm is effectively disintermediated (or more correctly, replaced) — are manifestations of the same event: the investment of the individual in oneself and the beginnings of personal diversification to address the speculative risks involved.

Questions of perspective

As the global economy continues to transition from decades of industrial tradition to one of digitized knowledge and its networked distribution, from a relation between capital and labor that was reasonably well defined to a new digital format of which the full economic impact is not yet understood, the risk-return considerations outlined are likely to assume greater immediacy — for institutions and individuals alike. As this happens, our views and questions would naturally readapt, and answers we invent should probably be framed in a new perspective.

Here is a sampling of some that come to mind, in one way or another embedded in Buffett’s and Zuckerberg’s commentaries, or at least in one interpretation of these, as noted:

  • How would the reclassification of investment and speculation in a time of massive change impact the definition of what is strategy, tactics, and execution?
  • How would portfolio theory be incorporated into business vision, also as distinctions between stages in business life-cycle change?
  • What constitutes a strategic investment if enterprise should assume the profile of a speculative portfolio?
  • What is the new relationship between enterprise and labor when each increasingly becomes a portfolio holding of the other?
  • Can portfolio theory and investment management be expanded from capital to labor, and if so, how does this redefine the financial asset?

The teachings of the trade

Before all that, however, we continue to study and hopefully learn some things, as there is so much that remains a mystery even in basic finance, let alone more heady fields like strategy and economics. While it may seem that speculation is akin to gambling, a matter of chance, there is a lot that we can learn from those who have been very good at it, or their students. For instance, Soros on reflexivity, Dalio on cycles, Icahn on pragmatism, Livermore on momentum, Taleb on “black swans,” Lewis on history, and thus and so on through the canon.

But as this article and the series of which it is a part are principally about fundamental business building and financing rather than the secondary market trade, we close off the discussion with two passages that, I believe, echo a few of the sentiments and ideals that were shared.

  1. Charlie Munger, February 2016 (the context is not important, because more or less universal): “What you have now is sort of a venture capital operation in the software business and the tag-end remnants of [a legacy business] attached. For you Ben Graham groupies, you’re in new territory, [and] if it works you don’t really deserve it.”
  2. Jeff Bezos, frequently and in different settings (although the percentages sometimes rise): “I think there’s a 70% chance you’re going to lose all your money, so don’t invest unless you can afford to lose it… That’s a very liberating expectation, expecting to fail.”

Amazon, like Berkshire Hathaway, has become an enormously valuable portfolio. There are profound lessons to be learned from both, for all of us.

___________________

The next installment will be the last in this 14-part series on digital economics. Its subject, loosely, will be the value of transcending formula in an increasingly algorithmic environment. All past episodes are linked below.

Related archive: