#70 Mark Spitznagel Hedge Fund

Summary Notes


In this discussion, the host delves into the core principles of Mark Spitznagle's book "The Dao of Capital: Austrian Investing in a Distorted World," exploring Spitznagle's roundabout investment approach inspired by an old Chicago trader, Everett Clipp. Spitznagle, founder of Universa hedge fund and known for his association with Nassim Taleb, emphasizes a counterintuitive strategy that involves accepting immediate loss for greater future gain, a concept paralleled in military and entrepreneurial strategies. This approach, though difficult and contrary to human nature, is effective due to its endogenous consideration of time and patience. The host expresses initial hesitance in discussing the book due to its complexity but recognizes its unique and valuable insights, which challenge conventional thinking. Spitznagle's method, akin to tail risk hedging, capitalizes on predictable market downturns often misperceived as unforeseeable events, and is illustrated through examples like Robinson Crusoe's roundabout production for efficiency and Henry Ford's assembly line innovation. The roundabout approach's emphasis on long-term investment over immediate profits is exemplified by successful entrepreneurs like Jeff Bezos, who reinvest earnings into their businesses in anticipation of future opportunities.

Summary Notes

Clip's Paradox and the Roundabout Investment Approach

  • Everett Clipp, an old Chicago trader, articulated the paradox of loving to lose money and hating to make money.
  • The roundabout approach involves seeking immediate loss for greater potential gain, which is counterintuitive to human nature.
  • This strategy is likened to tactics used by military generals and entrepreneurs.
  • Time is considered an endogenous factor, with patience being a key element to the approach.
  • The roundabout method is effective due to its difficulty and misalignment with human instincts.

"You've got to love to lose money, hate to make money, love to lose money, hate to make money. But we are human beings. We love to make money, hate to lose money. So we must overcome that humanness about us."

This quote highlights the core of Clip's paradox, emphasizing the psychological challenge investors face in adopting the roundabout approach, which goes against the innate human desire for immediate gain.

Mark Spitznagel and Austrian Investing

  • Mark Spitznagel is the founder of the Universal Hedge Fund and specializes in tail risk hedging.
  • Spitznagel's investment philosophy is influenced by Nassim Taleb and the Austrian School of economics.
  • He focuses on profiting from predictable market drawdowns, which are often mischaracterized as unpredictable "black swan" events.
  • The roundabout approach is central to Spitznagel's method, which is at odds with conventional wisdom and typical human behavior.

"This is the roundabout approach, indeed central to the very message of this book."

The quote summarizes the essence of Spitznagel's investment strategy, which is the roundabout approach, emphasizing the importance of intermediate steps and patience for achieving greater gains.

Capital as a Process and the Importance of Time

  • Spitznagel encourages a new perspective on capital, viewing it as a verb rather than a noun.
  • Capital is a process involving the positioning and advantage at different points in the future.
  • Time is a defining and shaping force for capital and business.
  • The book discusses the psychology behind human decision-making errors, echoing themes from Danny Kahneman's "Thinking, Fast and Slow."

"At the outset, we must think of capital in a new way, as a verb, not a noun."

This quote urges readers to reconsider their understanding of capital, not as a static asset but as an active process that unfolds over time, affecting its value and utility.

The Dow of Capital and the Roundabout Path

  • The "Dow of Capital" refers to a strategic, circuitous path taken in investing and entrepreneurship.
  • The roundabout method involves going right to eventually go left, focusing on strategic intermediate waypoints.
  • Spitznagel references the natural world and historical figures like Henry Ford to illustrate the roundabout approach.
  • The book aims to show that investing, like other human actions, is intertemporal and must not focus solely on immediate objectives.

"As we think of capital in a new way, we also must think of time in a new way."

This quote connects the re-conceptualization of capital with a new understanding of time, suggesting that both are critical to the roundabout investment strategy.

Historical Roots and Strategic Thought

  • The roundabout approach has historical roots dating back 25 centuries to ancient China and Taoist philosophy.
  • The concept of reversion in Taoism sees everything emerging from its opposite, which aligns with the roundabout approach.
  • The book draws from both Eastern and Western influences, including the Viennese School of Economics.

"Indeed, in the roundabout we find a pillar of strategic thought that goes back some 25 centuries to ancient China."

The quote places the roundabout approach within a historical context, showing its deep roots in strategic thought and philosophy.

The Indirect Route and Human Nature

  • Spitznagel argues that human nature often leads us astray in seeking immediate rewards.
  • The roundabout path is counterintuitive and requires a willingness to adopt an indirect route to achieve goals.
  • The book explores the recurring human mistakes in decision-making and the importance of understanding these patterns.

"The whole point of my approach to investing is that we must be willing to adopt the indirect route to achieve our goals."

This quote encapsulates the foundational principle of Spitznagel's investment philosophy, advocating for the indirect, roundabout path as the means to long-term success.

Overcoming Human Nature and Clip's Paradox

  • Everett Clipp introduces the concept of overcoming human nature to make wise decisions over time.
  • The importance of considering the past, present, and future rather than focusing solely on immediate rewards.
  • The paradox involves resisting immediate gratification to avoid jeopardizing future opportunities.

"So you have to overcome part of Clip's paradox, which is a mentor, and we'll go more into clip later, is the fact that you have to overcome your humanness."

This quote highlights the challenge of resisting human instincts to focus on immediate rewards in favor of long-term benefits.

Importance of Time in Decision Making

  • Everett Clipp emphasizes the significance of thinking across different dimensions of time.
  • The concept of "slices of time" and making choices that do not compromise future opportunities.
  • The idea is applicable beyond investing, as illustrated by the hip hop artist Jay Z's experience with real estate investment.

"You have to understand that this is a way of thinking, and you need to apply it to whatever it is that you're doing. Just understand that you cannot focus on the immediate time."

This quote underscores the necessity of adopting a long-term perspective in decision-making processes.

Everett Clipp's Influence on Mark Spitznagel

  • Mark Spitznagel's early exposure to investing was accidental, through his father's friend Everett Clipp.
  • Clipp's approach to trading was not based on predicting market movements but on having an edge through order flow and discipline.
  • Clipp advised Spitznagel to study subjects in college that wouldn't make him overconfident in his knowledge.

"Guys who know where the market is heading are no longer at the board of Trade. They are either retired or broke, and I can't think of any that are retired."

This quote from Everett Clipp conveys the idea that predicting market movements is not the key to successful trading.

The Edge in Trading and Life

  • Everett Clipp believed that trading was about patience and responding to others' impatience.
  • The distinction between academic success and real-life success, with the latter requiring an understanding of human nature.
  • Clipp's disdain for reliance on data and information in favor of a process-oriented approach.

"The edge to pit trading was in the order flow and in the discipline. It was in a patient response to someone else's impatience, someone else's urgency."

This quote explains that the advantage in trading comes from capitalizing on the impulsive actions of others.

Mark Spitznagel's Trading Philosophy

  • Spitznagel describes his approach to trading similar to the strategy in "The Big Short."
  • His method involves accepting many small, immediate losses for a potential large, asymmetric payoff.
  • The natural human tendency is to seek immediate profits, which is contrary to Clipp's and Spitznagel's strategy.

"Impatience and intolerance for many such small losses, as well as urgency for immediate profits, clip believed dealt a death blow to traders."

This quote illustrates the detrimental effect of impatience on traders' success.

Importance of Long-Term Thinking in Economics

  • Mark Spitznagel discovered "Economics in One Lesson" by Henry Hazlitt, which he considers essential for understanding economics and investing.
  • The book emphasizes the importance of considering the long-term effects of any act or policy.
  • Ludwig von Mises' "Human Action" further influenced Spitznagel's thoughts on productivity and the role of waiting time.

"The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy."

This quote from Hazlitt's book encapsulates the essence of economic thinking that Spitznagel values.

Clip's Market Philosophy and New Opportunities

  • Clipp's lectures to Spitznagel as a teenager highlighted the market's perpetual state of correction and the potential for new ventures due to market imbalances.
  • The market is always in a state of flux, being both "right" and "wrong," which allows for the creation of successful companies.

"In ever searching for and finding a new state of rest, the market was always intermittently and provisionally right in correcting an error, though in never arriving at a final state of rest and in never achieving a synchronized balance and orders for immediacy."

This quote reflects Clipp's view of the market's constant state of adjustment and the opportunities it presents.

Spitznagel's Career and Collaboration with Nassim Taleb

  • Mark Spitznagel's career progressed from being influenced by Clipp to starting his own company and option trading.
  • He joined Nassim Taleb in launching Empirica Capital, bonding over shared backgrounds and perspectives on the stock market.

"I joined Nassim Taleb in 1999 as he was launching Empirica Capital, a mutually obvious relationship from our shared pit trading background and shared view on the certainty of an eventual collapse in the then bubbly US stock market."

This quote describes Spitznagel's partnership with Taleb and their common understanding of market dynamics.

The Genesis of Empirica and Universe Investments

  • Everett Clipp discusses founding the first formalized tail protection firm, Empirica, and its role during the 2000 equity collapse.
  • After parting ways with Empirica in 2005, Everett went on to establish his own firm, Universe Investments.
  • Nassim Taleb joined Universe Investments in an advisory, passive capacity.

"We were indeed the first formalized tail protection firm ever see." "I went on to form my own investment firm, Universe Investments, moving beyond the basic mandate at Empirica." "After I started, Nassim joined me again, but in a strictly hands off, passive capacity."

These quotes highlight the pioneering establishment of Empirica as a tail protection firm, Everett's subsequent creation of Universe Investments, and Nassim Taleb's advisory role.

Understanding Black Swans

  • The concept of a "black swan" is typically seen as an unforeseeable event; however, Nassim Taleb views it as a foreseeable event that is considered remote.
  • This perspective shift emphasizes the predictability of certain extreme events in the stock market that are not accounted for due to their perceived improbability.

"The real black swan problem of stock market busts is not about a remote event that is considered unforeseeable... It is rather about a foreseeable event that is considered remote."

This quote explains Nassim Taleb's redefinition of black swans, focusing on the misjudgment of the likelihood of certain events rather than their unpredictability.

Learning from Nature

  • Nature is seen as a valuable teacher due to its longevity and evolutionary success.
  • The conifer tree is used as a metaphor for strategic growth, emphasizing avoidance of direct competition and taking a roundabout path to success.

"Nature is our greatest teacher." "The patient and persistent conifer teaches us that it is far better to avoid direct, head-on competition for scarce resources."

These quotes illustrate the importance of learning from nature's strategies, such as the conifer's approach to growth and competition, as a model for human endeavors.

The Roundabout Path to Success

  • Everett Clipp advocates for a roundabout approach to achieving goals, which involves taking indirect means to reach ultimate ends.
  • This strategy is likened to a tortoise that eventually becomes a hare, gradually building strength and accelerating over time.
  • The roundabout path is contrasted with direct routes or "false shortcuts" that may seem faster but overlook greater opportunities.

"The gospel of this book is the strategic positional advantage gained in the roundabout way." "Unweg... translates literally as detour, indirect or roundabout route."

These quotes emphasize the strategic advantage of the roundabout approach and introduce the term "unweg" as a metaphor for this concept in entrepreneurship.

Roundabout Production in Entrepreneurship

  • Roundabout production is a key concept in the book, spanning various fields and historical examples to demonstrate its effectiveness.
  • The entrepreneur is portrayed as a figure who assembles inputs into a capital structure over time, focusing on satisfying consumer needs.
  • The final goal for successful businesses is not the product itself, but the satisfaction of the consumer.

"By exploring universal strategic thinking, we build a structure of understanding from many sources." "The constantly stalked strategic advantage toward the ultimate end of satisfying the consumer."

These quotes discuss the importance of strategic thinking and the ultimate goal of consumer satisfaction in entrepreneurship.

The Parable of Robinson Crusoe and Roundabout Production

  • Robinson Crusoe's survival strategy on a desert island exemplifies roundabout production by initially reducing immediate satisfaction to invest in tools for future gain.
  • Entrepreneurs must consider the time, cost, resources, and payback period when engaging in roundabout production.

"Crusoe ultimately catches more fish by first catching fewer fish, by focusing his efforts in the immediate toward indirect means, not ends." "Entrepreneurial ventures naturally do not come with any guarantees of feasibility or profitability."

These quotes explain the concept of roundabout production using the example of Robinson Crusoe, highlighting the strategic investment for future benefits and the inherent risks of entrepreneurship.

Henry Ford and Roundabout Production

  • Henry Ford is presented as a prime example of a roundabout entrepreneur who revolutionized car manufacturing with the assembly line and vertical integration.
  • Ford's commitment to long-term investment and continuous improvement is emphasized, as well as his initial failures leading to ultimate success.

"He is the quintessential roundabout entrepreneur in the Austrian tradition." "Ford Motor Company would not have prospered had the founder not committed to continuous long-term investment in improvements and roundabout production."

These quotes highlight Henry Ford's embodiment of the roundabout entrepreneur, his innovative production methods, and the importance of long-term investment in entrepreneurship.

Henry Ford's Vision and Production Innovations

  • Henry Ford's objective was to create affordable, high-quality vehicles for the general working population, not just luxury roadsters for the wealthy.
  • The Model T, introduced in 1908, was met with great enthusiasm from the public, who had not previously realized their desire for automobiles.
  • Ford's company transitioned from being an assembler of cars to a manufacturer, which involved controlling every step of the production process to reduce costs and increase efficiency.
  • The fully vertically integrated system allowed for cars to be produced in minutes, exemplifying the roundabout production process and its long-term benefits.
  • The roundabout production process seemed slow and costly at first but resulted in significant time and cost savings in the long run.

"The Model T was introduced in 1908 to an enthusiastic public that just a few years before, did not even know they craved cars."

This quote highlights the public's unexpected demand for automobiles, which Ford capitalized on with the Model T.

"The company made the roundabout transition from assembler to manufacturer in every process along the way in order to reduce costs, gain more control over supplies, and eliminate unnecessary inventory, thus making huge gains in efficiency and innovation."

This quote explains the strategic shift Ford made in production, leading to significant improvements in efficiency and cost-effectiveness.

The Roundabout Process and Its Paradox

  • The roundabout process involves significant initial investment and appears to be a step backward due to the lack of immediate profits.
  • Ford's competitors continued with more direct production methods, while Ford invested in a system that would eventually give him an unmatched advantage.
  • The paradox of the roundabout process is that the initial slowness and investment result in greater speed and efficiency later on.

"Ford realizes that takes a step back, looks like he's going backwards, are making no progress, and foregoing immediate profits that other car makers are getting to build."

This quote emphasizes Ford's strategic decision to forgo short-term gains for a more efficient production system that would later yield a competitive advantage.

Mass Production and Exponential Growth

  • The River Rouge plant was the flagship of Ford's roundabout production, featuring a fully integrated production facility with everything from raw materials processing to final assembly.
  • Ford's patience with the roundabout process paid off with the Model T's production increasing from 500,000 vehicles in 1916 to 2 million just five years later.
  • The roundabout approach is not easy, which is why it was rare and provided a strategic advantage. However, over time, it has become a standard in the automobile industry.

"Annual output of Model T rose from 500,000 vehicles in 1916 to 1 million in 1921."

This quote demonstrates the rapid growth in production and efficiency achieved through the roundabout process.

The Psychology of the Roundabout Approach

  • The roundabout approach is rare due to the psychological tendency of people to focus on immediate results and procrastinate on actions that provide long-term benefits.
  • Mark Spitznagel's ideas about the roundabout approach resonate with the psychology of overcoming short-term thinking, as exemplified by Steve Jobs's relentless pace at Atari.

"The reason why, once you're explaining these ideas, they make sense, but why do not? Why are they so rare?"

This quote points out the logical appeal of the roundabout approach and questions why it is not more commonly adopted, suggesting psychological factors at play.

Mark Spitznagel's Investment Strategy

  • Spitznagel applies the roundabout approach to investing by using options, particularly tail hedging, to capitalize on foreseeable yet considered remote events.
  • The real problem in the stock market is the failure to expect events that should be anticipated, which is the basis of Spitznagel's business strategy.
  • His investment strategy involves spending a small percentage on puts each month while keeping the majority invested in the S&P index, providing a form of insurance against market downturns.

"The vast majority of market participants fail to expect what should be, in reality, perfectly expected events."

This quote reflects the core of Spitznagel's investment strategy, which is to anticipate and prepare for events that other market participants overlook.

Roundabout Investing and Temporal Structure

  • Roundabout investing focuses on the temporal structure of productive capital, meaning the value changes of money over time, and does not prioritize immediate profit.
  • It involves building indirect means or positional advantages toward long-term profits, which may not be immediately visible but can be foreseen with insight.
  • The most productive capital and businesses are those that adopt the most roundabout approaches.

"Roundabout investing is all about temporal structure of productive capital, meaning the changes in value of money over time."

This quote explains the core concept of roundabout investing, emphasizing the importance of considering the temporal aspect of capital and production.

Entrepreneurial Long-Term Vision

  • Entrepreneurs who reinvest earnings into their business with a long-term vision, like Jeff Bezos with Amazon, have a greater opportunity for substantial returns compared to those focused on short-term projects.
  • The roundabout approach is exemplified by entrepreneurs who patiently build their businesses with a focus on distant profit opportunities.
  • Next week's podcast will delve into Jeff Bezos's investor letters, further illustrating the roundabout approach in practice.

"The entrepreneur who foresees a profit opportunity in the distant future and who patiently reinvests earnings into his business year after year in anticipation has a much greater opportunity for eventually posting an enormous return than entrepreneurs who are engaged in short term projects."

This quote captures the essence of the roundabout approach in entrepreneurship, highlighting the potential for significant returns through long-term strategic planning and investment.

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