There Is Strategy in Art and Art in Strategy
There basically four reasons to entrust your money to any professional investor:
- Sheer charisma — whenever the person talks, you suddenly can’t imagine not giving them your money, but you can’t say exactly what it is about them. Of course, that’s almost certainly a scam.
- Access — this person golfs with Marc Andreessen, plays basketball Saturday afternoons with Tim Cook’s personal trainer, played in the high school band with Lina Khan, and is X Æ A-12 Musk’s favorite godparent. Like the old Chinese proverb: A wise man knows everything. A shrewd one, everybody. This person has a trillion-dollar network.
- Luck — this person reads their horoscope daily, they won the down payment for their house at the slot machines, and their investment strategy consists of their shaman’s favorite dart board, but they still somehow manage 12x pretty reliably.
- A solid investment strategy — this person got an education, reads charts, pays attention to the news, spends a lot of time pacing around their office thinking and learning from others’ mistakes. The result is a practicable strategy that makes sense and delivers solid returns.
In this post we want to discuss #4: strategy. Notice that strategy is the opposite of luck. Strategy works for what falls into luck’s lap. And because strategists know what they’ve done and why, they can learn and improve when things go wrong. The lucky just keep flipping the coin.
The basic strategy in all investing is to buy low and sell high. There’s not a lot more to it. However, different branches of finance have different ways of conceptualizing this strategy.
Traders on Wall St. try to come up with increasingly arcane ways of disguising what’s low and what’s high in order to fool the algorithms. That’s where things like recollateralized subtranches of double-A reverse puts come from. Given what you know, should they be going up or down this quarter? Exactly.
Crypto investors conceptualize the basic strategy temporally: the past and present are always low; the future is always high. So buy now and be rich later. Why? Because blockchain. Because P2P decentralized hashrate smart token. It’s a sure thing. Nakamoto himself/herself/themselves said so.
Venture capital is different. On the one hand, VC is “buy low, sell high” in its purest, most basic form. The whole idea is to find firms with great potential at an early stage, before they realize their potential. We look for firms that are cheap in the present, buy them, and manage our holdings until they fulfill their promise and exit. “Exit” sounds like “out,” but to VCs it really means “up.”
Despite the simple appearance, we VCs are the artists of finance, as lofty as that sounds. What we do is art because, like art, our representations need to display just the right amount of insanity. A VC’s investment strategy needs to sound a little nuts, but not too nuts.
Think about it. Art that is too conventional is not interesting. Whether it’s a Thomas Kinkade print or the latest wedding waltz from Ed Sheeran, it may appeal to the masses, but educated audiences are going to roll their eyes. That sort of thing is fine to adorn the walls of a Holiday Inn or to play at your great uncle’s 50th wedding anniversary, but they attract predictable disdain from anyone with the taste acquired through education and immersion.
But it’s also possible for artists to overcompensate and alienate even the educated audience. Every music lover has heard of John Cage’s famous 4’33”, but I’ve never heard anybody cue that track at a party. Similarly, all art enthusiasts know of Marcel Duchamp’s Urinoir, but when was the last time you saw someone proudly display a urinal in their conference room? At some point, innovation surpasses originality and crashes headlong into crazy or obtuse.
For art to be respected by those who pay attention, it needs to do something new and probably a little transgressive, but it mustn’t go so far that the educated audience can no longer relate. Banksy has turned protest graffiti into high art by blending touching, poetic (sometimes borderline kitschy) motifs that speak to liberal sensibilities with enough criticism of the status quo to make the art feel meaningful. Bob Dylan and Kendrick Lamar have turned folk music/mainstream rap into high art by blending touching, poetic (sometimes borderline kitschy) motifs that speak to liberal sensibilities with enough criticism of the status quo to make the art feel meaningful. (Notice the formula?)
The sweet spot is right between boring convention and alienating transgression.
There are plenty of Thomas Kinkades and Ed Sheerans in finance. Most of them are shopping mall financial advisors, and they are probably having to shill their low-yield mutual funds on instagram as malls die. When it comes to VCs, the blandest and most pedestrian are like those on Shark Tank: they’ll listen to a pitch from anyone, with no filter for sector or business model, and are basically saying “my philosophy is to buy low and sell high!”
On the other end of the spectrum, some VCs take pains to make their strategy sound especially refined and arcane:
“New Rhein’s investment strategy limits science-based risk and concentrates on successful development and execution of product development and commercialization.”
Translation: we try to make money by mostly investing in stuff we actually understand and making sure the companies sell lots of it.
It gets better.
“we work closely with our portfolio companies and syndicate partners to develop and implement strategic plans, achieve key operating objectives, build world-class teams, raise capital, and pursue liquidity opportunities in a manner that optimizes returns to key stakeholders.”
Translation: we play nice with others, and we pay attention to basic business stuff like the bank balance, growth, and staffing, because we’d really like to give our investors a return.
And now for my personal favorite.
“We have a flexible philosophy to investing and, as such, we tend to be nimble and opportunistic in our approach to implementing our investment strategy. We invest using our proprietary capital, which permits for longer investment horizons. While we typically make direct investments on an individual or syndicated basis, we also invest with specialized funds. Depending on the opportunity and asset class, Hedgewood is prepared to make relatively small investments as well as significant equity commitments in any one transaction. As a globally minded investor, Hedgewood actively pursues and engages in a wide variety of investment opportunities in Canada, the United States, and internationally.”
Translation: we’ll invest any amount in any thing any where if we think it’s gonna make a few bucks.
How to Recognize a Sound Strategy
If you want to invest based on luck or charisma, you might as well hit the casino or entrust your capital to your cousin who always has an angle. And since every VC has a valuable network — it’s a basic tool of the trade, like an Uber driver’s car — that leaves strategy. But how can you tell a good strategy from random nonsense verbiage? What separates the Banksys from the Kinkades? Here are five indicators:
- Concision: Concision is not the same as simplicity. A concise strategy can be complex, but it is no more complex than necessary. The VCs have considered it deeply and can express it clearly and briefly. However, the longer they talk, the more the strategy gains clarity and nuance.
If someone needs many words to explain their strategy, and when you ask questions to clarify, it always feels like you’re explaining their own ideas back to them, back away slowly. The same applies if it seems like they answer every question in the affirmative, even though some of the questions seem mutually incompatible. These are signs that they don’t understand the strategy themselves yet. - Face validity: If the strategy seems plausible, if your first reaction is “yeah, good point, that could work,” then it’s a good sign. If the argument relies on being “so crazy it just might work,” then it’s probably just crazy.
- Good data: Michael Burry predicted the subprime collapse that catalyzed the Great Recession by looking at lending and interest rates. That data is public, reliable, and relatively straightforward to analyze. If someone is touting some highly specialized data only available to a select subset of the Illuminati, but the market has disregarded it, chances are that it can be safely disregarded. Analyzing available data astutely usually yields better results than looking for some secret indicator or correlation that will change everything.
- A niche: When good data is analyzed well, it indicates a niche — an investment opportunity that can be concisely expressed and has face validity, but that is not already crowded with competitors. Like ecosystems, finance is dynamic, so while niches always exist, they shift and evolve as other players adapt their strategies and practices. A good strategy will have identified a niche and perhaps also suggest ways that the niche can shift and evolve as circumstances change.
- A little artistry: Whether food, art, music, or an investment strategy, presentation matters. Banksy cares about color and contrast, and Bob Dylan cares about melody and rhythm (if not much about singing). Creative people who care about what they’re doing also care about how their work is perceived.
While the substance of an investment strategy matters more than its presentation, it should be obvious that the minds behind it cared about making it attractive and digestible. The strategy should display “a desire” to communicate, to share its ideas and inspire interest. Investment always involves social relations of trust and reciprocity, and an investment strategy should show that the people behind it understand and care about those who trust them.
There are conventions about how to be (successfully) unconventional. It’s not about charisma or luck, but about sound ideas based on sound data and communicated artfully. There is strategy in art and art in strategy.
