The Four People in the Casino: A Mental Model for Public Markets

Every investor has a favorite metaphor for the stock market. My personal favorite is the casino, not because markets are random or because “you can’t beat the house,” but because casinos have a beautifully simple ecosystem. Four distinct roles, each doing something different, each necessary for the system to function.

Once you see public markets through that lens, a lot of behavior that seems confusing becomes almost embarrassingly obvious.

The four roles are:

  1. The Casino Owner: the long-term, qualitative investor

  2. The Pit Boss: liquidity providers and market makers

  3. The Card Counter: quantitative arbitrageurs

  4. The General Customer: unsophisticated or flow-driven participants

Let’s walk through how each one operates and how this maps almost perfectly onto public markets.

1. The Casino Owner: The Long-Term Qualitative Investor

The owner of a casino doesn’t obsess over what happens on a Tuesday. They’re not sweating individual hands of blackjack. Their job is to build and operate a business that will survive competitive pressure, regulatory changes, and recessions. They need capital allocation skill, political influence, discipline, and patience.

That’s exactly what great qualitative investors do. They purchase long-duration assets, manage risk across time, and allocate capital the same way an owner would. They think in terms of:

  • business model durability

  • reinvestment runway

  • management quality

  • competitive moats

  • multi-year variance

Their Sharpe ratio is lower because they absorb real economic risk. But their capacity is enormous. A casino can deploy billions into square footage, tables, and customer experience. A great long-term investor can deploy enormous capital into the productive capacity of the real economy.

Crucially, qualitative investors make money from economic value creation, not from other investors losing. They’re participating in the positive-sum growth of businesses. Their edge is endurance and judgment.

2. The Pit Boss: Liquidity Providers and Market Makers

The pit boss doesn’t gamble. He’s not there to win or lose. His job is to make sure the game runs smoothly: no cheating, no stalling, no broken mechanics. He enforces structure and keeps the whole system functioning.

The equivalent in markets is the liquidity-providing complex:

  • high-frequency market makers

  • wholesalers

  • ETF authorized participants

  • internalization desks

These firms don’t care whether Pfizer or Nvidia goes up or down. They flatten out risk constantly, focus on spreads, and optimize execution quality. Their job is to keep the market operational.

In the casino analogy, the pit boss is employed by the house. In markets, this role is outsourced to independent firms. The economic role is the same. They are the infrastructure. They make the game possible.

Replace Citadel Securities with Jane Street and the market still works. Replace Buffett at Berkshire, and the entire organism changes. That distinction tells you everything.

3. The Card Counter: The Quantitative Arbitrageur

Card counters don’t want to run the casino. They want to extract small statistical edges before the casino notices. They have a high Sharpe ratio but tiny capacity. If they try to scale their strategy massively, the edge disappears.

This describes quantitative arbitrage perfectly. These firms run:

  • statistical arbitrage

  • market-neutral factor timing

  • short-horizon mean reversion

  • microstructure plays

  • cross-asset lead-lag strategies

They trade fast, hedge constantly, and treat risk like radioactive material. Their edges resemble card-counting edges: small, perishable, and dependent on discipline.

It’s no accident that many of the early quants literally came from poker and blackjack communities. They brought with them:

  • expected-value thinking

  • loss-control discipline

  • unemotional decisionmaking

Card counters don’t depend on economic growth. They depend on patterns and inefficiencies. They’re not building anything. They’re harvesting.

4. The General Customer: The Liquidity-Supplying Loser

Casinos need customers. They need the bulk of people who play the games, enjoy the atmosphere, and slowly lose money because the odds are against them.

Markets need this too.

This group includes:

  • retail traders following social media

  • index funds forced to rebalance

  • pensions with rigid mandates

  • leveraged players who get liquidated

  • corporate hedgers with non-economic objectives

  • portfolio managers facing quarterly career risk

They’re not stupid. They just have constraints. They’re playing a different game: liquidity, time, excitement, convenience, mandates. But they’re the reason edges exist. Their predictable flows create dislocations that both qualitative investors and quants feed on.

Without the general customer, there is no card counter edge and fewer opportunities for long-term buyers. They are the raw material of the market ecosystem.

Where Most Investors Go Wrong

Most people don’t know which role they’re playing. They think they’re the casino owner while behaving like a general customer. Or they think they’re a card counter when they’re actually just gambling. Or they think the pit boss is a genius money manager rather than a flow-driven infrastructure operator.

Once you identify your role, everything becomes clearer:

  • your capacity

  • your edge

  • your risk

  • your time horizon

  • your competition

  • your expected variance

A casino owner doesn’t try to play like a card counter.

A pit boss doesn’t try to steal the house edge.

A card counter doesn’t try to deploy ten billion dollars.

A general customer shouldn’t pretend they’re running a business.

Markets punish identity confusion.

Why This Framework Matters

This four-role setup actually explains almost every important dimension of investment strategy:

  • Sharpe vs capacity

  • Time horizon

  • Risk absorption vs risk neutralization

  • Flow-driven opportunities

  • Who benefits from volatility and who suffers

Each group fills a niche:

  • Casino owners absorb long-term risk and get paid in compounding.

  • Card counters extract micro-edges but can’t scale.

  • Pit bosses keep the system functioning.

  • General customers supply the liquidity and noise that make edges possible.

When you misidentify which role you’re playing, you get hurt.

When you understand your role, you can optimize for it.

The Punchline

Markets aren’t a casino because they’re rigged. They’re a casino because the ecosystem naturally separates into these four functional roles. Real investment insight starts with understanding where you fit into the ecosystem.

Book Summary: How Uday Kotak Built a Valuable Indian Bank (Gopalkrishnan 2021)

Most business stories about banking focus on scale, technology, or regulatory capture. This book is about something else. It is about the slow construction of an institution that survived when almost everything around it died. Uday Kotak started not with a universal bank, not with a giant capital pool, but with the old style merchant finance idea. He began by doing very small, very sensible credit intermediation in Bombay in the early 1980s. What makes his story compelling is how consistent his philosophy remained over the next forty years. He grew only where he understood the risk. He sought legitimacy before expansion. He built trust before scale. And he viewed talent not as labor but as co-owners.

Uday grew up in a very large joint family in Bombay. More than sixty relatives living under one roof. Arguments, debates, commerce, family politics. It was an environment where you learn to read people early. His family ran a cotton trading business, but he did not want to inherit a role. He wanted to build something. In 1982, at age 23, he raised the equivalent of about eighty thousand dollars from friends and family and started what was then a non-bank financial company. The first business line was bill discounting. Companies often had receivables due thirty to ninety days in the future. Uday would buy those receivables at a discount and take the credit risk. In developed markets, this is not particularly exotic. But in India at that time, working capital markets were fragmented. Even very high quality companies like Tata were issuing paper that could yield spreads of three to ten percent in a month.

What stands out here, at the very beginning, is his relationship to legality and risk. Bill discounting was not explicitly illegal, but its status was unclear. Most entrepreneurs would have just gone ahead and dealt with problems later. Instead, Uday hired a top law firm and secured a formal written opinion from a former Chief Justice of India, confirming that the activity was permissible. He was willing to take real financial risk, but wanted zero regulatory ambiguity. That distinction shows up over and over in his career.

The second key inflection was the partnership with Anand Mahindra. Uday originally approached Mahindra to finance receivables for Mahindra companies. Anand was impressed enough to offer capital and, much more importantly, the Mahindra name. At that time, private financial companies in India were deeply mistrusted. To scale, you needed credibility. Kotak Mahindra went public early for that reason. The IPO was not really about raising capital. It was about signaling transparency. In India, a public listing was a form of social proof. If you wanted to be taken seriously as a financial institution, you could not remain private. This is the opposite of the Silicon Valley narrative. Context matters.

The bill discounting business eventually became illegal, which forced Kotak to pivot. They entered vehicle finance in the 1990s. Citigroup dominated this market and financed cars one by one for retail customers. The bottleneck was that customers had to wait for the manufacturer to deliver the vehicle. Kotak found an operational angle. Instead of financing cars individually, they purchased thousands of cars directly from manufacturers like Maruti and financed them upon sale. This gave them immediate delivery capability. They took inventory risk, but they unlocked speed. And in lending, speed is a moat.

Around this time, Kotak created two joint ventures. One with Goldman Sachs, which was the first joint venture Goldman had ever entered in its entire history up to that point. The other with Ford Credit. Both were about skill transfer. Goldman helped Kotak formalize systems of governance, capital allocation, and long-term leadership development. Ford helped deepen domain knowledge in vehicle finance. What mattered is that in both cases Kotak retained control. They absorbed capability without surrendering identity.

There is an important pattern here: use partnerships to become better, not bigger. Avoid the trap of letting capital dictate direction.

Kotak became a full-fledged bank only in 2003 by acquiring a small private bank and inheriting its license. Uday was realistic about what this meant. Becoming a bank required more than a piece of paper. It required branches, deposit relationships, and a service culture. For several years, profitability went down. They were comfortable with that. They were building longevity.

By 2005, Goldman and Ford wanted greater ownership. Uday refused to lose control and bought them out at around three hundred rupees per share. Notably, the relationship with Goldman remained strong. Goldman still handles Uday’s international deals. The point is not maximizing power. The point is stewarding the identity of the institution.

Culture is the real differentiator here. More than one hundred Kotak employees have become millionaires through equity participation. The firm treats rising talent not as employees, but as co-promoters. People stay for decades. Both men and women rise to senior levels. Uday personally engages multiple layers down in the organization. He calls people on their birthdays. He remembers their kids. He does not delegate the human part of leadership. It is not sentimental. It reinforces loyalty, and loyalty preserves institutional memory.

One of my favorite details: when someone consistently outperformed Kotak in the market, Uday tried to hire them. He did not try to beat them or undercut them. He wanted them on his side. Over forty years, this accumulates into an unfair talent advantage.

The clearest test of the institution came during the Asian Financial Crisis. Before the crisis, there were around four thousand non-bank financial companies in India. Almost all of them failed. Only around twenty survived. Kotak was one of them. They survived because they refused to chase high yield, opaque, illiquid lending when it was profitable to do so. They were always profitable from day one in every business line. They grew only where they had an informational and operational edge. They did not try to impress the market. They tried to stay alive. And staying alive is underrated.

The book’s lesson, in my opinion, is surprisingly simple: Compounding is not about growth. It is about not dying. Everyone thinks they are playing for returns. Very few are actually playing for survival.

Kotak is a rare modern institution that survived through discipline, legal clarity, talent ownership, structural advantage, and genuine loyalty. There is very little drama in the story. It is not glamorous. But that is precisely the point.

The quiet institutions are often the most durable.

The Professor Who Taught Prime Ministers and Kept Adam Smith Alive

Walk through Edinburgh’s Calton Hill today and you will see a curious little monument, a circular temple that would not look out of place in Athens. It is not for a general or a king. It is for a professor.

Dugald Stewart (1753–1828) did not command armies or draft constitutions, but he shaped the minds of the people who did. As Professor of Moral Philosophy at the University of Edinburgh from 1785 to 1810, Stewart stood at the podium in a crowded lecture hall, holding the attention of a generation destined to lead Britain into the 19th century.

He inherited a Scotland that had been transformed by the intellectual fireworks of Adam Smith, David Hume, and Adam Ferguson. The Enlightenment’s core ideas of reason, progress, and the importance of education were in the air, but the original firebrands were gone or fading. Stewart became the keeper of that flame.

His style was different from the blunt, argumentative prose of his predecessors. Stewart was eloquent, even poetic. He wove together philosophy, mathematics, natural science, politics, economics, and moral instruction into something that was as much inspiration as analysis. He was not just telling students what was true, he was showing them what kind of citizens they ought to become.

That mattered because his students were not just any undergraduates. They included future prime ministers like Lord Palmerston, literary giants like Sir Walter Scott, and political reformers like Henry Brougham. Stewart’s classroom was a launchpad.

And while he was first and foremost a moral philosopher, he was also one of Adam Smith’s great evangelists. Smith’s Wealth of Nations was still a relatively new book when Stewart took the lectern, and he made sure the next generation of lawyers, merchants, and politicians understood its economic principles. Stewart helped carry Smith’s ideas across the turn of the century, embedding them in Britain’s intellectual bloodstream.

He published widely, including Elements of the Philosophy of the Human Mind and Philosophical Essays, but his legacy was as much about tone as content. He believed that philosophy was not just for ivory towers. It should guide practical life, public virtue, and economic policy.

His Missteps

Even a skilled thinker like Stewart was not immune to misjudgment. In the early 1790s, he welcomed the French Revolution as an extension of Enlightenment ideals. Like many liberal intellectuals of his time, he saw it as a victory for liberty, equality, and the dismantling of entrenched privilege. His optimism put him closer to Thomas Paine’s hopeful vision than to Edmund Burke’s caution.

But the Revolution’s descent into the Reign of Terror, followed by Napoleon’s rise, revealed that Burke’s fears about rapid upheaval destroying social order were far closer to reality. Stewart was never a radical agitator, but his early support for the Revolution drew suspicion from British authorities and forced him to temper his public tone. It was a humbling reminder that brilliant ideas can buckle under the weight of political chaos, and that the pace of reform matters as much as its principles.

Why He Matters Today

In an era when economic illiteracy is still a political handicap, Stewart’s mission feels urgent again. He understood that philosophy and economics were not just academic exercises, they were tools for building a more capable, thoughtful citizenry. His lectures did not just transfer information, they shaped judgment.

That is a model worth revisiting. The ability to think critically about markets, ethics, and public policy is just as valuable in 2025 as it was in 1805. Whether we are training institutional investors, teaching high school students about compounding, or helping people understand the trade-offs in economic policy, the challenge is the same: make the best ideas accessible without stripping them of their depth. Stewart did that two centuries ago.

In many ways, the work I do at TIFF has a similar arc. Stewarding capital across decades means not just finding the best ideas, but preserving the disciplines and principles that allow those ideas to compound over time. Like Stewart, our job is not always to invent the next big theory or source an unconventional idea. Sometimes it is to keep the intellectual capital intact so it can serve the next generation. The monument on Calton Hill is not just a tribute to a man. It is a reminder that the most enduring influence often comes from keeping the flame alive.

Conscience Under Pressure: Katharine Graham and Albert Einstein

I recently had the pleasure of reading Katharine Graham’s biography at Warren Buffett’s recommendation, and I’m immensely grateful for his suggestion because I was truly amazed by her as a human being, both as a writer and as a brilliant thinker, someone I had been unaware of until now. It drove home how important it is to learn about the first female publisher of the Washington Post Company, among the most influential media companies of twentieth century.

Katharine Graham and Albert Einstein came from very different worlds, one covered in ink, the other dusted with chalk, yet their moral compasses share surprising parallels. Both faced prejudice in the 1930s for their Jewish heritage, and both rose to greatness under immense pressure, Graham as the first female CEO of a Fortune 500 company, Einstein as the world’s most famous physicist.

Roots of Resilience

Katharine Meyer Graham, born in 1917 into the Meyer family fortune, learned early that privilege carries burdens. Sexism in the Washington Post boardroom and whispers tinged with anti-Semitism tested her confidence. When her husband and predecessor Philip Graham died by suicide in 1963, she was thrust into leadership without formal training.

Albert Einstein, born in 1879 in Ulm to a modest Jewish family, displayed genius in relativity but met resistance in Germany’s universities. As the Nazis rose, he renounced his citizenship in 1933 and settled in the U.S., turning personal danger into a platform for advocacy.

A Shared Moral Compass

Graham’s guiding star was the public’s right to know. She risked legal battles and investor ire to publish the Pentagon Papers and green-light Watergate reporting. For her, press freedom wasn’t abstract, it was democracy in action.

Einstein’s ethical journey began with pacifism after World War I. Yet in 1939 he co-signed a letter to President Roosevelt urging nuclear research to thwart Hitler, a decision he later regretted. After the war he campaigned for disarmament and civil rights, seeing scientific insight as inseparable from human welfare.

Leading in Uncharted Territory

Graham learned journalism on the job. She balanced legal risk with journalistic duty and became a symbol of female leadership in an industry dominated by men. Her courage was quiet but decisive, a nod to an editor, a firm boardroom stance.

Einstein ventured into uncharted scientific realms such as relativity and quantum puzzles and faced moral paradoxes. As a refugee he championed cosmopolitanism over nationalism. His public persona mingled absent-minded genius with deep moral conviction.

Convergence and Divergence

Ethical Focus: Graham fought for transparency and corporate responsibility, Einstein for pacifism, nuclear caution and human rights

Public Voice: Graham wielded editorials and boardroom speeches, Einstein published papers, letters and gave lectures worldwide

Risk Profile: Graham faced legal and reputational peril, Einstein faced political exile and moral contradiction

Despite their differences, both transformed adversity into platforms for change, with Graham defending a free press and Einstein elevating science as a force for good.

Professional Triumphs and Awards

Katharine Graham transformed the Washington Post into one of America’s leading newspapers, overseeing its growth through the Pentagon Papers and Watergate crises and breaking corporate glass ceilings as the first female CEO of a large American public company. Her memoir, Personal History, won the Pulitzer Prize, cementing her status not only as a pioneering publisher but also as an award winning author.

Albert Einstein revolutionized physics with his papers on special relativity, general relativity and the photoelectric effect, the latter earning him the Nobel Prize in Physics for explaining how light behaves as particles. His famous equations reshaped our understanding of mass and energy, space time geometry laying the foundation for technologies from nuclear power to GPS to black holes to quantum computers. In his spare time he helped invent refrigeration helping to keep the world fed.

Lessons for Today

  1. Purpose under Pressure: Anchoring choices in a clear moral vision turns adversity into influence

  2. Responsibility of Insight: Talent, whether business acumen or scientific genius, carries a duty to society

  3. Adaptable Courage: True leadership means evolving your beliefs when stakes are highest

In reflecting on ink and chalk, we return to our opening image, and we see that both the ink-stained pages of the Washington Post and the chalk-dust on blackboards carry the imprint of conscience shaped by struggle. Katharine Graham and Albert Einstein remind us that when hardship defines our starting point, the moral compass we forge can guide us back to where our story began, stronger and more certain of our purpose.

The Foolish Thing About Real Estate: Why So Many Homeowners Leave Money (and Happiness) on the Table

There’s a baffling mistake I see time and again in the residential real estate market, especially in major U.S. cities. It’s so common that it barely registers as odd. But it is. It’s foolish.

Here’s what happens:

Someone buys a house, often a lovely single family home, and then proceeds to do nothing. For years. The kitchen stays frozen in 1975. The carpet frays into oblivion. The bathroom tile cracks and yellows. Meanwhile, the market moves on. Tastes evolve. Standards rise. But the house stays stuck in a time capsule.

Eventually, they decide to sell. And here’s the punchline: the house lingers on the market and sells for 5 to 10 percent, sometimes more, below the going rate for comparable homes. Why? Because buyers mentally subtract the cost and hassle of bringing the home up to modern standards, and they usually over-discount for it. In some cases, the home becomes so dated and rundown that it can’t rent or sell at any reasonable price. It becomes functionally obsolete.

What’s strange is that this underinvestment hurts the owner twice.

First, they get less enjoyment from the home while living in it.

Second, they get less money when they sell it.

It’s like owning a beautiful garden and never watering it, then wondering why no one wants to buy your wilted flowers.

Now, I’m not saying you need to rip out your kitchen every ten years. But as a rule of thumb, investing one to one and a half percent of your home’s value annually into maintenance and improvements will usually pay for itself in resale value and quality of life. It keeps the home attractive, functional, and liquid when you eventually want to sell or rent.

The Case for Underinvestment (And Why It Usually Fails)

To be fair, there is a logic behind underinvesting.

In theory, if you are a phenomenal investor, and you can consistently generate returns far above what home improvements would yield, then deferring maintenance might make sense. Skip the new kitchen. Put that money into a startup or fund that earns 25 percent a year. On paper, that math can work.

But that scenario rests on two shaky assumptions.

First, that you actually have access to those kinds of opportunities.

Second, that you can execute on them without missteps or distractions.

Even among elite investors, this is rare. And even when they do exist, they almost always keep their homes in good condition. Not because it’s the highest returning asset, but because it’s where life happens. The return on time matters too.

There’s also risk asymmetry. If you overinvest a little, maybe you shave a few basis points off your returns. If you underinvest by a lot, you may destroy value, lose optionality, and diminish your own experience in the space.

Most of the time, it’s a bad trade. The returns from a well-maintained home are modest, but reliable. The losses from neglect are lumpy, unpredictable, and severe.

Full Circle

So we come back to the original puzzle.

Why do so many people let their homes slide into disrepair?

Maybe it’s inertia. Maybe it’s a false sense of frugality. Or maybe it’s the mistaken belief that upkeep is just a cosmetic luxury instead of a form of capital preservation.

But whatever the reason, it’s worth recognizing this for what it is. A surprisingly common, surprisingly costly mistake. One that leaves money and happiness on the table.

In real estate, you don’t need to be a genius to get ahead. You just need to avoid being foolish.

The Diversification Mirage: Why Equity-Based Sizing Fails

Log into most personal finance dashboards like Intuit Mint or Wealthfront and you’ll see a clean summary:

“Your home is worth $800,000. Your mortgage is $640,000. Net value: $160,000.”

It looks tidy. Sensible, even. But it’s wrong.

More precisely, it’s the wrong mental model for understanding financial risk. And that mental model, equity-based position sizing, is not just flawed. It’s quietly dangerous.

The Mental Model Most People Use (and Shouldn’t)

Let’s look at a common household balance sheet:

  • $800,000 home

  • $200,000 in stocks

  • $640,000 mortgage

  • Net worth = $360,000

Most fintech tools will report:

“You have $160,000 in home equity and $200,000 in stocks, so you’re pretty balanced.”

Here’s what that looks like with basic math:

Equity-Based Sizing:

  • Real Estate = 44.4% (160k / 360k)

  • Stocks = 55.6% (200k / 360k)

  • Appears roughly 50/50. Feels diversified.

Gross Exposure Sizing:

  • Real Estate = 80% (800k / 1M, 288k with debt adjustment)

  • Stocks = 20% (200k / 1M, 72k with debt adjustment)

  • Accurately reflects your true exposure.

The former is comforting. The latter is accurate.

Gross Exposure Is What the World Actually Sees

You don’t own 20 percent of a house. You own the entire $800,000 home. And you owe $640,000. If housing prices fall 25 percent, you lose $200,000, which is more than half your net worth. Risk is based on the entire $800,000 exposure, not just the $160,000 you’ve paid in.

In 38 of 50 U.S. states, including Pennsylvania, mortgage debt is recourse. That means if your home sells for less than the loan balance, the lender can go after your other assets. Source: Quicken Loans

Netting liabilities against individual assets creates a false sense of downside protection. For households with no debt, equity-based and gross exposure sizing give the same answer. But 77 percent of American households carry some form of debt, so this framing error applies to the overwhelming majority.

The Professional Investor’s Mental Model

Ask a CIO, allocator, or hedge fund manager how they size positions. They do not care how you financed the position. They care how large your total exposure is.

They look at:

  • Gross exposure (total asset size)

  • Portfolio-level leverage

  • Correlation between your assets and your income

This isn’t complicated math. What is difficult is letting go of the comforting belief that equity equals your true economic stake. It does not. Equity reflects accounting reality. Exposure reflects economic reality. And when you are allocating capital or managing risk, economic reality is what matters.

The Hidden Overweight: Bond-Like Assets

Zoom out. Even beyond real estate, most people are overexposed to bond-like risk without realizing it.

1. Your job is bond-like.

Most salaried income is stable, low-volatility, and sensitive to macro shocks. It behaves like a bond. The exceptions to this are jobs with heavy components of equity upside (start-up employees, pro-athletes, investment professionals, senior management, etc).

2. Your home is a bond-like asset with leverage.

Real estate tracks interest rates and inflation. It does not grow like equity and is difficult to sell quickly.

3. Your portfolio often adds even more bonds.

Robo-advisors and many human advisors still recommend 60/40 or 70/30 portfolios, ignoring your broader exposure. This leaves many Americans structurally overexposed to bond-like assets and underexposed to equities, especially when they are young and compounding matters most. The opportunity costs of an erroneous strategic asset allocation are economically large in magnitude.

A Back-of-the-Envelope Look at the Impact

Let’s estimate the scale of the problem:

  • 70 million U.S. households are between ages 25 and 50

  • 60 percent own homes = 42 million households

  • 30 percent follow human or robo-advice = 13 million guided households

  • Assume each has $60,000 in financial assets

  • A typical 60/40 portfolio = $36,000 in equities

  • A more exposure-aware allocation might be 100 percent equities = $60,000

  • That is a $24,000 equity shortfall per household

Multiply across 13 million households = $312 billion in equity underallocation

Now fast-forward 30 years:

  • $24,000 in equities at 6.5 percent real return = $158,000

  • $24,000 in bonds at 1.5 percent = $31,000

  • That is $127,000 in lost growth per household

  • Total lost long-term wealth = over $1.6 trillion

This is not about chasing returns. It is about avoiding systematic underperformance baked into flawed portfolio design.

A Surprising Mistake

This mistake is especially surprising given the business models of firms like Intuit, Betterment, and Wealthfront. These platforms earn fees based on assets under management, and equity allocations typically lead to higher long-term balances and higher fees. They earn little from real estate and often less from fixed income. So their under-allocation to equities is not due to misaligned incentives, but rather a deeper modeling or framing error.

These platforms optimize the part of the portfolio they can see, the brokerage account, while ignoring the user’s much larger exposures in housing, human capital, and debt. The result is advice that feels prudent and balanced, but overlooks the economic reality that most users are already overloaded with bond-like risk. The software ends up reinforcing the illusion of diversification rather than correcting it.

Concluding Thoughts

Many people think they are diversified because they own a home and some stocks. But once you account for total exposure and how assets relate to income, most are not diversified at all. They are:

  • Concentrated

  • Illiquid

  • Leveraged

  • Tied to a single geography

If your income is bond-like, as it is for most salaried workers, buying a home early adds another large, bond-like asset to your balance sheet, often with significant leverage. A more resilient approach is to rent while young, invest more heavily in equities, and buy a home later, when it represents a smaller share of your total portfolio. Talk to your advisor about managing risk based on total exposure rather than net equity, and looking at your portfolio as a whole instead of by accounts.

Who do you admire?

Why I Admire Ashvin Chhabra

When it comes to the world of wealth management and investment philosophy, few names stand out to me as much as Ashvin Chhabra. His insights, rooted in academic research (behavioral economics and chaos theory) and practical application, have changed the way I think about risk, return, and how investors—particularly those with significant wealth—should approach portfolio construction. Chhabra’s contributions, particularly through his groundbreaking work in The Aspirational Investor, have been a guide in my own investment journey.

A Holistic Approach to Wealth Management

One of the key reasons I admire Chhabra is his holistic view of wealth management, which contrasts sharply with traditional portfolio theory. While most investors focus on maximizing returns relative to risk, Chhabra goes beyond the one-size-fits-all model of investing. His Wealth Allocation Framework introduces a nuanced perspective, where wealth is categorized into three distinct layers: Safety, Market Risk, and Aspirational Risk. This layered approach to managing wealth resonates with me because it acknowledges that not all capital is created equal, and different goals require different risk appetites.

Prioritizing Life Goals

Chhabra emphasizes that investment strategies should align with individual life goals. This framework allows for a more thoughtful way to manage wealth across various stages of life. His approach shifts the focus from purely maximizing returns to ensuring the safety of essential resources while still allowing for aspirational ventures that have the potential for higher returns. As someone who balances personal, family, and professional financial priorities, I find this structured framework to be incredibly pragmatic and applicable. It also provides a more relatable framework for high-net-worth individuals or endowment funds like mine.

The Balance Between Risk and Opportunity

What also stands out to me is Chhabra’s recognition of Aspirational Risk. This category encourages investors to take on concentrated, high-stakes opportunities that could potentially lead to extraordinary wealth. Examples of aspirational investments include holding concentrated stock positions, making highly levered non-recourse real estate investments, owning a small business, or leveraging unique human capital, like being a professional athlete or entrepreneur.

These are high-risk, high-reward endeavors that don’t fit within the traditional portfolio framework but have the potential to dramatically increase wealth. Chhabra’s philosophy marries the idea of preserving wealth through traditional investments while also embracing aspirational opportunities—ventures that can create transformative wealth but come with the possibility of significant loss. This resonates with my own thinking as it challenges the more conventional approach and encourages a higher tolerance for risk in pursuit of outsized returns, but only when the downside is clearly understood and accepted.

Insights From the Institute for Advanced Study

One of the most impressive aspects of Chhabra’s career was his tenure as Chief Investment Officer at the Institute for Advanced Study (IAS), a prestigious institution with a unique position in the world of endowments. While at IAS, Chhabra realized the Institute had three incredible advantages that many other institutions could only dream of:

1. Small Size and a Remarkable Brand: IAS’s relatively small endowment was an advantage because it allowed them to invest with top-tier venture capital and private equity managers. Their prestigious brand gave them access to world-class managers like Sequoia, Union Square Ventures (USV), and First Round Capital—managers that larger institutions often have trouble accessing. This access is critical in venture capital, where size constraints and scarcity of opportunities make getting in early with top firms an advantage that compounds over time.

2. Willingness to Utilize the Secondary PE Market: Chhabra and his team at IAS weren’t afraid to overcommit to private equity and venture capital funds, knowing they had the option to sell stakes on the secondary market if needed. This approach allowed IAS to benefit from higher allocations to top-performing funds, giving them flexibility to manage their cash flows without sacrificing long-term return potential. Being able to navigate the secondary market gave them a competitive edge, fully supported by the board.

3. Jim Simons as Board Chair: The involvement of Jim Simons—one of the greatest quantitative investors in history—as the chairman of the board was another significant advantage. Simons’ presence wasn’t just symbolic; it brought a level of expertise and strategic thinking that few institutions could rival. His influence undoubtedly helped guide IAS’s investment strategy, offering insights from the cutting edge of quantitative finance.

Apparently, Simons was so impressed with Chhabra’s performance at IAS that he hired him to manage his personal family office, where Chhabra continues to work today. They apply the Wealth Allocation Framework at Euclidiean Capital, Jim’s family office, and have aspirational bets on in battery technology. He’s had success there too, Jim is one of the largest private funders of science in the US.

A Clever Process Innovation

In addition to these structural advantages, Chhabra did something at IAS that I have yet to see replicated elsewhere in the allocator community. From a due diligence standpoint, he separated roles within his investment team not by asset class, but by analytical method. This separation of roles was a novel approach and, in my opinion, a particularly clever way to manage biases in the investment process.

• Qualitative Team: One part of the team was responsible for the qualitative side of the due diligence process—meeting with managers, sourcing opportunities, asking the right questions, and listening carefully to their insights and strategies.

• Quantitative Team: The other part of the team focused purely on the quantitative side—analyzing performance track records, reviewing the data, and checking whether the numbers matched what the qualitative team was hearing.

This division of labor minimizes the cognitive biases that can enter when one person is responsible for both understanding the qualitative story and analyzing the data. Often, when the same person does both, they may fall prey to confirmation bias, selectively interpreting data to match their positive or negative impressions of a manager or strategy. Chhabra’s separation of these roles not only ensured a clearer and more objective evaluation but also acknowledged the reality that people who are good with data may not be as skilled on the human side of due diligence—and vice versa.

There’s no inherent reason to assume that the same person should excel at both quantitative analysis and relationship management, yet in many allocator setups, these responsibilities fall on the same individual. Chhabra’s process innovation was a brilliant way to limit bias and improve the clarity of decision-making at IAS.

Lessons for My Own Portfolio

Starting in 2018, I implemented Chhabra’s full process, making adjustments for my family’s specific situation. I’ve found this approach exceptionally helpful because it clarifies our goals and emphasizes just how valuable human capital is within our overall wealth allocation. It also encouraged us to take on more market risk than I had previously considered. Clarifying our expectations about aspirational bets has been particularly eye-opening.

Chhabra’s approach has made me realize that the only path to extreme wealth creation often requires pushing Markowitz aside and embracing concentration, no-recourse leverage, or even both. The key is doing this with full knowledge of the downside: if the aspirational bucket were to go to zero, and the market portfolio were to decline by 50%, would we still be comfortable with that scenario? Understanding and accepting this risk has allowed us to be in a good place with our portfolio decisions, aligning our strategies with our broader financial goals.

Conclusion

Ashvin Chhabra has had a profound impact on the field of wealth management, offering a refreshing approach that combines academic insight with practical wisdom. His work not only makes sense on paper but has a real-world relevance that’s hard to ignore. Whether through his Wealth Allocation Framework or his transformative work at the Institute for Advanced Study, Chhabra’s contributions provide a clear, compelling roadmap for anyone looking to manage wealth intelligently. It’s why I admire him and continually return to his teachings.

Summary findings from AEA/AFA 2024

Last weekend I attended the American Economic Association and American Finance Association 2024 annual meeting in San Antonio, TX. I love this event, as its jam packed with thought provoking research with a strict 20-minute presentation, 10-minute discussant structure (where the papers are respectfully criticized).  There were roughly 6,000 economists and practitioners in attendance, and I wanted to share the most thought-provoking papers I saw presented that relate to my day job.

  • Michael Greenstone, AEA Distinguished Lecture, Air Pollution is the most serious issue facing humanity in terms of its ability to reduce the total number of lived years.  The lecture had a number of helpful slides that describe the magnitude of the problem, American Economic Association: AEA Distinguished Lecture (aeaweb.org) (suggest watching at 2x speed); unfortunately, the effects of air pollution are not going to be felt equally around the world, air pollution is will disproportionately and negatively impact countries like India and regions in Africa that have the youngest and poorest populations. 

  • Jeff Meli and Zornitsa Todorova, Portfolio Trading in the Corporate Bond Market, portfolio trading is a relatively recent innovation in the bond market. As we've all seen post 2008, bond liquidity has declined substantially, leading lots of hedge funds to bemoan the dangers of bond ETFs. Portfolio trading (PT) makes the fact that there are thousands of low liquidity CUSIPS less worrisome; and you can request pricing on a broad portfolio of CUSIPs rather than piece meal.  T-costs for PT trading are about 6 bps vs 14 bps for RFQ.  Also, time to execute for PT used to be 45 min to 1 hour, and now fixed income systematic investment firms have gotten PT pricing down to a few minutes.   Prior to 2018, less than 1% of all corporate bonds were traded via portfolio trading, 99%+ were traded as request for quote (RFQ). By 2021 PT accounts for more than 7%.  By trading large portfolios of bonds, you don't need to deal with matching problem on individual CUSIPs, but the ETF inflow linkage drives the benefits of low t-costs and also highlights PT's limitations.  If ETF flows are all one sided (outflows) like in March 2020, internal data from Barclays shows that the t-costs benefit of PT vs RFQ went to zero.

  • Lily Fang et al, Limits to Diversification, the rise of passive investing limits the benefits of diversification. Correlated investor demand and trading generate excess correlation in asset prices relative to assets not included in index; in particular flows in and out of the index products (ETF/MF) leading to structurally higher correlation across stocks were analyzed using difference in difference. The degree to which passive funds hold a stock strongly predicts its beta and correlation with other stocks, pattern holds even when stripping out the 10 largest stocks. They also were able to rule out that the increased correlation could come from increased correlation of fundamentals, no evidence of it. Rise of passive investing isn't a free lunch, it means more correlation/less diversification benefits.

  • Michele Dathan and Caitlin Dannhauser, Passive Investors in the Primary Bond Market, I was surprised to learn that passive bond ETFs are increasingly active in the primary bond market even though primary bonds generally have not been included in those indices yet.  Moreover, researchers presented evidence that passive funds allocation to primary issued bonds tend to underperform the primary bonds allocated to actively managed funds meaningfully.  The researchers believe the reason for this is that both underwriters and fund families (GPs) are intentionally steering the better issues towards actively managed bond funds and the overpriced/higher risk issues towards their passive (low fee) products.  Meaningful and consistent gross of fee outperformance detected for active bond funds in same fund families with respect to their primary bond market purchases.

  • Hao Jiang et all, The Rise of the Mega Firms and Passive Investing, probably the most controversial paper in terms of number of follow up questions by the systematic investment community over post-meeting coffees.  Monthly flows into passive have been dramatic in the US over the last 10+ years.  The standard view of index flows is that inflows to index funds are neutral with respect to underlying constituent pricing. They develop a theory which claims that passive reallocation is not neutral because idiosyncratic risk is priced differently for the largest firms in the index compared to the hundreds or thousands of smaller firms. They believe this has been a contributing factor to the rise of so called super-star firms, first called, FANG, then FANGM, then Mag 7, etc. Their theory makes four predictions, which they tested in the data; 1. passive flows raise the stock return vol of large firms while barely affecting that of smaller firms; 2. effect of passive flows are more pronounced for over-valued firms among the index's largest companies, this is because investors hold short positions in these firms stocks which get amplified when they cover, 3. flows have an asymmetric effect in the cross section driving the stock market up even when those flows are driven by investors switching from active to passive; 4. when individual firms are added to an index tracked by passive funds, the resulting stock price increase is larger for larger or overvalued firms.  Over coffee, Hao told us that to the extent we believe the reallocation too passive to be fully played out, underweighting the top caps would be sensible, but to the extent you think the reallocation to passive continues as it has, overweighting the top mega caps should be sensible.  Keeping in mind that the expected vol for the top mega caps should be much higher than the overall market.

  • Anthony Cookson et al, The Social Signal, using data from Twitter, StockTwits and Seeking Alpha, they find that after controlling for firm disclosures and news, attention is highly correlated across platforms but sentiment is not.  Social media consumption has been growing over the years, with Americans spending 3.6 hours per day on SM. For investors social media has become a primary source to obtain information.  The researchers wanted to know how similar both attention and sentiment were across platforms (as did many of the stat arb hedge funds in the audience). Attention was defined as volume of post, and sentiment was defined using several different NLP algos. Particularly interesting that sentiment had low commonality across platforms, but attention had high commonality.  Sentiment predicts positive future returns (short term), and attention predicts negative future returns (short term).  The data tables in this paper are fascinating.

  • Sophie Calder-Wang et al, Pricing Neighborhood Amenities, this paper developed a new econometric method to price amenities relevant in the real estate market, like air pollution.  The problem with traditional econometric methods is that if you regress air pollution on home prices, you will find a positive coefficient on air pollution because more desirable places (large cities) tend to be more polluted, this is known as the wrong sign problem, even if you add per capita income to the regression as a control, you still get the wrong sign.  The researchers develop a new method that compares cities using the PageRank algorithm but applied to the migration flow data, such that places where people are moving to get a higher rank, and places where people are moving to from already high ranked places get an even higher score.  The researchers use this new variable as a control, and then are able to recover negative coefficients on air pollution.  The top 20 Geographic Page ranked counties are as follows. 

Bell, Calder-Wang, Zhong (2023); FWIW, I have been on real estate tours in Maricopa, Harris, Tarrant, and Dallas Counties and I can attest that for median-income people, the quality of life is very high.  A 3 bed, 2br in a good school district can be purchased for less than $400k in all these locations, and rents are generally $1800-$2500.

  • Rongjie Zhang et al, Anti-Corruption Campaign and the Resurgence of SOEs in China, a lot of ink has been spilt on the performance of SOEs vs privately owned enterprises (POEs) in China over the last three years. A team of brave researchers at Tsinghua published a compelling paper that the anti-corruption campaign is casually related to SOEs dominance over the POEs over the last few years.  The anti-corruption campaign that began in earnest in 2013, but really got going in 2015-2018 is historically unprecedented. The researchers believe that it is commonly understood that POEs give larger kickbacks than SOEs real estate developers do. In order to avoid being perceived as corrupt, the response among government officials has been to disproportionately favor selling land to SOEs and not POEs even if the project, terms, or proposal were worse in all respects relative to a similar offer from a POE. After the Anti-corruption campaign SOE's saw a 61% increase in land parcels purchased (roughly 406,000 sample size of land parcel data). Keeping in mind that the RE is China's largest sector, the implications of this paper are pretty far reaching and worrying.  After anti-corruption campaign and big well publicized high level arrests, they see the share of SOE developers in residential land significantly increase. They see no effect in the control group, industrial land.  Industrial land is far cheaper than residential.  BC opinion, given the anticorruption campaign is core to President Xi's governance policy, we should not expect POE recovery, at scale, any time soon.

  • Darren Aiello et al, Who Invests in Crypto?, the authors obtain bank and credit card data on 63 million US consumers from January 2010 to June 2023, this data contains labeled transaction level data (i.e. $400 sent to Coinbase, $16 sent to Five Guys, $10 sent to McDonalds, etc.), on average they are observing about 9 million unique consumers per month. About 20% of adults in the sample own crypto and 50% own stocks. Crypto currency owners span all income levels, with the largest investments coming from wealthier individuals, similar to stocks. High past crypto returns and personal income positive shocks tend to lead to more crypto investment. Because they have transaction level data they can calculate individual level inflation measures, individuals with higher household-level inflation, do tend to investment more in crypto, suggesting that people are using crypto as an inflation hedge.  For most US households, crypto investment behavior is similar to traditional investment behavior.

The Path Matters: Corporate vs Personal Finance Strategies

Today, let's unravel a topic that's often the subject of heated discussions in boardrooms and living rooms alike: the contrasting approaches to debt in corporate and personal finance. It's a fascinating contrast, especially for those of us who are able to play both games.

Corporate Finance: Embracing Debt as a Growth Lever

In the corporate world, debt isn't inherently a necessity; it's a common strategic choice. Traditional corporate finance wisdom tells us that to maximize the Internal Rate of Return (IRR), maintaining a significant level of debt is almost a given. This approach is rooted in the belief that the right amount of debt can fuel growth and enhance shareholder value. Think of it as a high-stakes game where companies balance on the tightrope of debt, aiming for greater heights.

The Transdigm Approach to Risk Management

Corporations often embrace this perpetual debt cycle. They're constantly re-leveraging, using debt as a tool to fund new ventures, acquisitions, or expansions. This strategy banks on the idea that the returns will outstrip the costs of debt. It's a bold move, and when it pays off, it can lead to impressive growth.  One of the most conspicuous examples of this sort of approach is TransDigm. TransDigm has consistently used debt to fund acquisitions, expanding its portfolio and market presence. This strategy is a textbook case of corporate finance's perpetual debt approach: taking on debt not as a burden, but as a tool for growth. Of course they combine debt with a cost synergy playbook and wait for a price that gives them an advantage, but without running 7x Debt to EBITDA, they would not be a household name among stock wonks. This feels very much like a “ladies and gentlemen, don’t try this at home” kind of strategy. TransDigm earns 50% of its profit from DoD contracts and they claim that US defense spending almost never gets reduced during recessions. They structured their debt payments such that their DoD revenues alone are enough to cover their interest payments.

Personal Finance: A More Prudent Path

Switching over to personal finance, the narrative changes significantly. Here, debt is often approached with a healthy dose of caution. KOLs like Dave Ramsey encourage cutting up credit cards and prioritizing a debt free life. Consider how most of us handle a mortgage, for instance. The goal is usually to pay it down steadily, rarely if ever considering the option to re-leverage our homes for additional financial risk. It's a more conservative, grounded approach, focusing on long-term security rather than immediate, high-risk gains. When it comes to a personal residence, I am squarely in the Ramsey camp, once paid off, it strikes me as highly unlikely that I would ever consider a cash out ReFi and throw the proceeds into another venture.

This difference in attitude towards debt in personal finance is partly due to the nature of our income sources. Most businesses have a diverse customer base, which spreads out their risk. In contrast, an individual typically relies on a single primary income source, making their financial situation much more susceptible to idiosyncratic risks.* Unless you feel your income is as certain as a DoD contract, high levels of debt are imprudent. This inherent difference in concentration risk exposure is a crucial factor in how debt is perceived and managed in personal finance. In the personal finance context, I prefer to keep my debt-to-equity ratio substantially below 45% (equivalent to a BBB rating, lowest IG). Once we get into junk land of 200%+ or tread into a negative debt to equity ratio situation like Transdigm, then we are just asking for trouble. Inflexible capital structures like this are not robust enough to survive life’s inevitable crisis periods.

The Path Matters

The principles guiding corporate and personal finance, especially regarding debt, are not interchangeable. In the corporate sphere, debt is a calculated gamble, often supported by thorough analysis and strategic foresight. In personal finance, however, the stakes are more immediate, with direct impacts on individual lives and futures. At least for me, anything higher than 50% debt to equity strikes me as uncomfortable and anything higher than 100%, is shackling. Running the negative equity playbook might work if you had extreme confidence in the certainty of cash flow, but these days, that seems like an overly optimistic perspective baring conspicuous counter examples like obtaining a tenure-based academic contract or a lifetime judicial appointment.   

While modern corporate finance tactics can offer some benefits to corporations (especially concepts like limited liability, not cross-collateralized, non-callable, etc.), they need careful adaptation - or should be IGNORED ENTIRELY - when applied to individual financial decisions. In summary, we only get to roll the dice a few times, and the path matters.

* Dual income, or multi-income households, where participants are in different sectors may be able to diversify human capital income risks, and could rationally prefer higher debt to equity ratios.

Observations and Learnings from India: What’s changed from 2019 to 2023?

I spent a week in India after having yet to visit since 2019.  Naturally, curious to see how business culture and consumer behavior evolved, Indian contacts and friends were happy to share their perspectives. On the one hand, there have been some palpable changes over the last four years, including payments, tech wages, and remote work.  On the other hand, much has stayed the same, including frugality, caste, and chrysophilia.  

Business Culture

  • The Indian government's decision to adopt and implement UPI, an instantaneous cash transfer system similar to WeChat Pay, at this point, largely obviates the need to carry cash.  I feel safer walking around India without taking a lot of cash.

  • Like the US, white-collar workers work remotely about 1/3 of the time, and firms are having trouble getting software engineers to return to the office at all.  This has resulted in significant demand for more extensive flats for additional home office space requirements. 

  • Before COVID, some firms felt that production could only take place from the office and were generally skeptical of remote work. Post-COVID, firms are far more open to the idea of partial or fully remote work than they were previously.  Once you get comfortable with fully remote work, the willingness to consider cost-reduction-oriented BPM increases dramatically. Global companies are even more willing to outsource aspects of their business to Indian business process management firms than ever in the past.  Interestingly, BPM firms are some of the most well-equipped to benefit from recent developments in AI and may be able to handle more business with fewer employees going forward. 

  • Indian tech companies struggle with retention. Top product engineering and research talents effectively command wages like those in leading US firms.  This has made hiring and retaining the best engineers much more costly; however, firms still believe keeping these people is worth it because a top engineer can be more productive than 100 average-quality engineers.  Also, note that graduate degrees are not required for Indians to get paid at the highest wage bands. 

  • Ten years ago, top graduates from IIT would have wanted to move to the US vs. stay in India at a rate of 95% to 5%.  However, now that wage rates for top engineers have normalized with US levels, I learned that the situation has flipped.  Today, about 90% of top IIT engineers want to stay in India, and only those wishing to pursue PhDs in CS or engineering would like to move to the US for further study. It seems that choosing $225k in Bangalore over $350k in Mountain View is an easy decision for most Indians. 

  • We’ve heard that young Indians are more willing to take entrepreneurial risks than their parents or grandparents generations.  Becoming a lifer at Infosys or The Ministry of Railways may have been viewed as the dream job in the past, but that may be changing.  Combined with the relative wage rates, a desire to stay local, and an increased willingness for younger people to take entrepreneurial risks, the prospective environment for venture capital may be better in India than in the previous few decades.

  • The female labor force participation rate has always been one of the biggest challenges for India.  However, in the last five years, the rate has been increasing modestly for the first time since 1994. If India can better enfranchise women into the economy, it could be a tremendous tailwind; however, many sociological and religious barriers remain; from the women I talked to, traditional gender roles and the expectations to conform to them remain very strong in most parts of India.

Consumer behavior

  • Indian consumers remain incredibly conscious of value-for-money tradeoffs. Indians will hunt to save 100 INR and try to take advantage of all possible VC CAC. I heard stories of people taking free trips around India paid for by Uber shareholders; one customer bought 300 cheap mobiles from Jio and received 300 free rides in sign-up bonuses from Uber.  Upstart coffee chains like Third Wave Coffee have grown in popularity specifically because they offer bean quality near Starbucks, a slightly trendier atmosphere, but offer a price point of 10% to 20% cheaper. 

  • While people enjoyed ordering takeout during COVID, with takeout/delivery firms enjoying triple-digit growth for a time, broadly consistent with most other countries, food delivery-related businesses have generally struggled over the last year as people returned to pre-COVID takeout trends.

  • Notwithstanding demonetization and other policies related to limiting gold hoarding.  Indians remain gold-hungry, particularly around marriage ceremonies. Due to gold’s strong outperformance during COVID, many Indians feel vindicated that it can hedge inflation and remain a resilient investment during challenging times. 

  • The Caste system remains alive and well. Marrying outside of one’s Caste remains extremely rare. When I asked friends how often they have seen this happen, the most common response was when an Indian marries a foreigner. Marriage continues to be primarily intermediated by matchmakers within the family, not dating apps as is expected in the US.  Four years ago, dating apps were reputed to be taking share, but it seems it was mostly for casual sex and shorter-term relationships.

  • Coming from Philadelphia, the level of poverty present throughout Mumbai and Bangalore remains overwhelming.  Seeing badly malnourished children sitting in the streets picking trash breaks your heart.  

  • Economic development has certainly improved people's lives in significant ways.  At this point, about 50% of Indians have access to the Internet, and almost everyone at least has a feature phone.  For 3,000 INR per year ($37.00), users can enjoy 2.5 GB/per day of data and 4G service, which is affordable for most Indians.

Observations and Learnings from Israel's Start-up Ecosystem

History

  • The seeds of Israel as a Start-Up Nation were planted in the 1980s with the passing of an innovation authority law.  All resources concerning innovation were to be overseen by a single, non-political authority known as the Office of the Chief Scientist.

  • The law’s text was very forward-looking and mentioned key endogenous growth theory aspects more than 10 years before Paul Romer’s seminal work.

  • Israel provided equity capital to entrepreneurs seeking funding to help catalyze new business formation in the high-tech sector.

  • Overall, Israel’s tech sector grew from low single digits and today accounts for 16% of GDP and employs about 5% of the population.  Israel’s R&D spending as a fraction of GDP is the highest of any country. The start-up nation policies of providing equity capital to start-ups, minimizing frictions, and encouraging entrepreneurship are all fascinating but unlikely to be replicable to other countries for at least 3 reasons:

    • In the early 1990s, after the fall of the Soviet Union, more than 1 million Jews left the USSR and made Aliyah to Israel.  Many of these Russian Jews were highly educated and so were able to move to Israel, bringing world-class technical knowledge, and were poor enough where there was nothing to lose by taking startup risk.  Many of these immigrants were key to founding the first generation of Israeli start-ups between 1990 and 2000.

    • Israel’s government was transitioning from a planned socialist economy to a market socialist economy in the mid-1980s, this was a hard transition, but the country was in such disarray that people were willing to be experimental and try anything to right the ship. There were a large number of engineers in the Israeli SOE sector that were working in inefficient aerospace and defense industries.  Due to the economic liberalization efforts, these engineers were freed to form their own companies.

    • The Office of the Chief Scientist, while wielding a huge amount of power, has been largely insulated from politics. The Chief Scientist tries hard not to pick winners and has invested in many unsuccessful and successful startups.  The expectation is that there will be many failures, and in most countries’ political theater, failure, especially numerous failures, is very hard to tolerate.

The role of the military

  • The Israeli Army (IDF), which conscripts all men and women upon turning 18 for 3-7 years, places its smartest recruits into an intelligence unit known as 8200.  In this unit, soldiers are taught computer engineering and given project-based assignments requiring engineering acumen, resource management, and a sense of entrepreneurship.  The training expenditure on the soldiers’ behalf could range from $500k to $1m, a huge investment given they will only be working in the IDF for a few years.   I spoke with several veterans of Unit 8200 to learn more about their experiences.  Examples of IDF projects might include “using no more than $3 million worth of resources, figure out a way to hack into the enemy’s communication system over the next three months.”

  • The IDF has a culture of practicing post-mortems whenever mistakes are made.  Soldiers must explain to their commander and comrades what happened, how the mistake occurred, and what they plan to do to learn from the experience.  Soldiers are not punished for mistakes, rather, they are process driven to learn from them. 

  • Upon graduation from 8200, these engineers are heavily recruited by existing startups (40% of Israeli startups came out of 8200), found their startups with financing from VCs (many of whom also came out of 8200), or join one of the 400+ MNC research and development offices based in Haifa (proximate to Technion, Israel’s MIT).  Some 8200 veterans do attend university after their military service, but by and large, their training is considered so strong that additional formal education isn’t necessary.   

Current situation

  • Prior to 2016, there were fewer than 100 R&D centers in the country, and the only way to make a lot of money was to launch your own start-up and hope your firm is one of the 10% to 20% that generates a successful exit.  However, now that R&D centers have proliferated from 100 to 400, the war for talent has gotten out of hand.  Engineers can expect to earn >$300k with just a few years of experience from an R&D center. 

  • As MNC R&D centers have grown in the count, the number of start-ups has declined meaningfully from around 1200 in 2016 to about 300 in 2022.  The decline in start-up formation does trouble the government to an extent and the Office of the Chief Scientist is closely studying the issue.

  • After years of cyber warfare and recruitment from units like 8200, some of the largest internet security companies have matured. Mobileye is the most prominent example, resulting in a $10+ billion takeout.  Other examples like Waze and Fiverr have been successful outside of security.

  • One of the disappointing aspects of the high-tech sector in Israel is that its success has not had meaningful spillover effects on other sectors of the economy.   Israel’s non-tech sectors are still meaningfully less productive than OECD averages. Increasing traditional sectors’ productivity through tech enablement remains an elusive goal.

Venture Capital Ecosystem and Migration

  • Israel has a vibrant Angel, Pre-seed, and Seed stage VC market.  There is much less domestic VC capital focused on the later-stage rounds.  This results in Israeli entrepreneurs moving to the US to pursue later-stage capital and scale their businesses in the US. 

  • While moving to the US has long been viewed as positive for the ecosystem as a whole, particularly its valuations, some in Israel are concerned.

  • One of the reasons that tech tends to employ relatively few people concerning its GDP contribution is that when Israeli firms are successful, corporate headquarters are moved to the US.  Following the HQ relocation, Israeli firms tend to fire their local sales, marketing, human resources, and finance, functions and move these jobs to the US.  This means that the biggest beneficiary of Israeli start-ups from a jobs perspective tends to be the US.  The government is now considering further incentives to encourage companies to stay in Israel, but it is likely to be challenging until the Israeli VC market matures enough to provide ample late-stage liquidity.

Areas of opportunity

  • Unlike Jews, Israeli Arabs are not drafted into the IDF.  Instead, they have the option of attending university when they turn 18.  Interestingly, over the last 20 years, Arabs have made great academic strides.  Today, roughly 30% of Technion’s student body are Israeli Arabs.  2/3 of this 30% are women. 

  • Arabs historically have been very underrepresented in the start-up ecosystem.  Arabs founded fewer than 1% of Israeli start-ups. 

  • Some in Israel are trying to change this, Takwin Capital has been operating in Haifa, Nazareth, and is intentionally trying to fund Arab-led startups.  Early results seem very promising.

What has changed about China since the pandemic began?

I’ve tried to present a balanced perspective that offers opportunities for further improvement.

  • Chinese people seem dramatically more critical of China’s decision to maintain pandemic controls that primarily protect aged senior citizens from early death at the expense of young working people who want to pursue their dreams. 

  • International students who had intended to return to China after spending time in the US are more frequently choosing to remain international knowledge workers.  Many of these students are China’s most talented that have won scholarships to pursue their intellectual passions.  

  • The gaming industry, one of the most honored past-times for the younger generations, has been prevented from releasing most newly developed titles.  China should recognize its gaming industry as a national source of strength. Strategic game development should be encouraged to cooperate via partnerships with the former after-school tutoring industry to redevelop the Chinese education system into an incredible in-game experience.  Currently, the public-education UX in China is tough to scale as teacher-student ratios are high by international standards.

  • High youth unemployment is one of the highest-skew trends I see in China today.  Millions of college graduates are having trouble finding jobs this year.  The government must prioritize education and training of the younger generation to re-adjust skill sets to be more marketable or foster new company and social enterprise formation to increase economic output.

Arbitrage in the Philadelphia Housing Market

After nearly six months of searching, my wife Sophie and I recently bought a home in Philadelphia. Over this period, we learned about each other’s preferences and how to communicate those preferences peacefully. To prioritize our time, we decided to develop a checklist to evaluate each house. We developed a more nuanced understanding of what we were looking for through many conversations and property tours. In response, our checklist grew from eight criteria and ended with 14. For simplicity, we equal-weighted our checklist criteria and focused our list on immutable aspects, things that cannot be changed with money. Our final checklist is described below:

  1. Location

  2. Neighborhood

  3. Immediate surroundings

  4. School quality

  5. Commuting to Radnor and Wharton

  6. Southern exposure

  7. Layout of home amenable to kids, remote work areas, guest room

  8. Outdoor space

  9. Parking

  10. Distance to a Park

  11. No obvious water damage

  12. Owner-occupied

  13. Proximity to grocery store

  14. Noise level

Tactically our approach was to use Zillow at 6:00 am every morning and monitor for homes that met at least 80% of our checklist criteria. If we found a home, we’d try and see it that day. Apparently, other buyers had a similar approach. For example, we identified a home in Fitler Square early one Saturday morning in June that met about 90% of our criteria. We toured the property later that morning and made an offer by late afternoon. Two other buyers made offers, which triggered escalation clauses, and another buyer was willing to pay more than we were.

Somewhat discouraged, we continued looking. About two months later, Sophie happened to stumble across an intriguing opportunity. While reading an email from Redfin suggesting a few homes that met our browsing pattern, she found a home that looked interesting. She cross-referenced it with Zillow and to her shock, realized that the home was incorrectly listed almost a mile away from the actual location, in a different (and incorrect) school zone. After finding this data inconsistency we immediately went to tour the property, found it met more than 90% of our criteria and made an offer for the asking price later that day. The next morning, the seller accepted our offer. We had no competition, there were no other offers.

After finding this inconsistency, we further cross-checked the USPS Address data and Philadelphia Property Tax data. Again, both of these data sets had substantial inconsistencies. Even Google Maps did not have a record of the property. After speaking with our agent, we learned that many properties in historic neighborhoods like Logan Square, Old City, Rittenhouse Square, and Fitler Square exhibit this pattern. Because Philadelphia is hundreds of years old, and many plots have been subdivided many times. There is no complete unified database of all subdivisions. When subdivided plots go on sale, Zillow pulls data from MLS and occasionally parses the locations incorrectly. When this happens, you should move fast!

Red circles indicate potential arbitrage opportunities.

Red circles indicate potential arbitrage opportunities.

Now that we purchased the property, we are going to do a bit of shareholder activism to effectuate a liquidity arbitrage. We need to update Google Maps and fix the inconsistencies that lead to Zillow misidentifying the home. Assuming we fix the data errors, we can greatly improve the odds that more potential buyers will see the home relative to when we purchased it. More buyers means more liquidity and as Sam Zell always says, “liquidity equals value.”

141-A.jpg

Regaining Taste

While recovering from COVID, I lost my sense of taste and smell for 35 days. Over this period, I lost weight at a rate of ~ 1.5 kg per week.  I lost weight because I enjoy eating.  When you are sick with COVID, food tastes like water.  Drinking water past the point of feeling full is unpleasant.

Normally, eating provides two distinct benefits, nourishment and pleasure. Once you lose your sense of taste, eating past the point where your stomach is full feels downright nauseating.   I realized that less than half of what I ate when I was healthy was required to fuel my body. The rest was simply hedonism.

For the first two weeks, I thought I’d try to use my lack of taste to my advantage by eating cleanly.  Not surprisingly, after about two weeks, I caved in and went to grab a slice of pepperoni pizza.  I sat down outside in the make-shift booths erected for outdoor dining to comply with COVID restrictions, ordered a slice and water, and once the server arrived, I sniffed the pizza; nothing.  Still optimistic, I folded the slice and took a bite; nothing.  Undeterred, I ate more, hoping for a glimpse of something other than the taste of water.  Deliberately, I used my tongue to explore all around, longing to detect a trace of the pleasure that I knew was in there. Nada. Water, water, everywhere and only it to drink.

Last week, I prepared dinner for Sophie and quickly noticed a change. I could smell the mapo tofu I had boiling on the stove! Just like that, out of nowhere, my sense of smell came back.  I grabbed a spoon and sampled the sauce. Wow, I used way too much salt! 

Though I could only taste the tofu at about 10% of my usual taste clarity, I knew I turned the corner. At this point, I have about 60% of my taste back.  My normal appetite has returned, and I’m regaining some of the weight that I lost.  I’ve learned that smell, taste, and body weight are deeply related.  Weight gain is a side effect of our tastebuds and our will to indulge them.

 

Supply Curves and Cycles

While most goods and services have an upward sloping supply curve, there are several informative exceptions to this pattern. This post will explore the shape of the supply curve of four different assets, bicycles, residential real estate in Las Vegas, residential real estate in New York City, and bitcoin.

Bicycles are widely understood to be a normal good produced in a competitive market. The supply curve for bicycles is upward slowing and elastic. For any given shift in demand, producers can quickly increase or decrease production in the short-term.

Unlike bicycles, the supply curve of residential real estate is kinked at the origin. The supply curve for housing has a kink at the existing level of housing because housing is durable and does not diminish quickly when demand falls. (Glaeser and Gyourko, 2005) The slope of the supply curve for residential real estate to the right of the origin is related to the ease with which developers can increase the housing supply in the short to medium run. Building in New York is far more difficult due to land scarcity, zoning, and regulatory complexity among other factors relative to Las Vegas.

Bitcoin’s supply curve is among the most inelastic of all known assets. This is because the supply schedule of bitcoin is fixed. Even if additional miners enter the market, the mining difficulty will increase, slowing the subsequent rate of new production.

Supply Curves (Red), Demand Curves (Black)

Supply Curves (Red), Demand Curves (Black)

If we assume an equivalent rightward shift in the demand curves for the four assets depicted in the chart above, we can conclude that the steeper the supply curve, the greater the expected increase in price.

Supply Curves (Red), Demand Curves (Black)

Supply Curves (Red), Demand Curves (Black)

If we assume an equivalent leftward shift in the demand curves for the four assets depicted in the chart above, we can conclude that the steeper the supply curve, the greater the expected decrease in price.

As is clear from the above two charts, assuming an equivalently sized shift in demand to the right, bitcoin’s price volatility is expected to be the largest of the four assets. Assuming an equivalently sized shift in demand to the left, bicycles exhibit the smallest price decline. This is because bicycle manufacturers can easily cut production to limit price declines. On the other hand, bitcoin and real estate should experience comparable price declines that are far steeper than that of bicycles. Unless cities resort to large-scale demolition programs, real estate supply persists through time even if demand falls. Like real estate, bitcoins persist through time. In fact, the only way for bitcoin’s supply curve to shift to the left is for private keys to be permanently lost.

Unlike real estate and bicycles, we also know the shape of Bitcoin’s long-run supply curve. The number of bitcoins will continue to increase at a decreasing rate until such time that the number of bitcoins reaches 21 million around the year 2140. In the early years, bitcoin’s supply curve was moving to the right rapidly, but at this point, only about 900 newly mined bitcoins are produced each day (26 million USD at current prices).

Cycles are caused by both changes in fundamentals and changes in expectations about future fundamentals. In the case of bitcoin, supply fundamentals and expectations about future supply fundamentals are both known with a high degree of accuracy and precision. Therefore, all future price changes will be caused by changes in demand fundamentals and expectations.

Like real estate and public equities, bitcoin markets have both short-term traders and long-term investors. As the proportion of short-term traders grows, the higher the probability that there will be a reduction in prices, once these traders decide to “take profits” or borrow to engage in short selling.

Unchained Capital, using data from bitcoin’s blockchain charted what they call HODL Waves. As the percentage of bitcoin that has transacted recently increases relative to the share that has been dormant for long periods, we should be wary of a bubble.

The colored bands show the relative fraction of Bitcoin in existence that was last transacted within the time window indicated in the legend. The bottom, warmer colors (reds, oranges) represent Bitcoin transacting very recently while the top, cooler…

The colored bands show the relative fraction of Bitcoin in existence that was last transacted within the time window indicated in the legend. The bottom, warmer colors (reds, oranges) represent Bitcoin transacting very recently while the top, cooler colors (greens, blues) represent Bitcoin that hasn’t transacted in a long time. The chart has been normalized by the BTC in existence at each date (left y-axis). The black line shows the USD/BTC price (logarithmically, right y-axis).

As is evident in the far right of the chart above, it looks like another bubble is in the early stages of forming. However, we don’t know whether recent buyers are likely to hold for many years or sell in a few months. There is some reason to suggest that the composition of buyers these days may be more long term oriented relative to the previous cycle.

Nonetheless, Google Trends data and Twitter Trends data below also suggests that hype is growing materially.

Bitcoin is about 31% as searched relative to its peak search interest in late 2017. The data suggest a clear upward trend.

Bitcoin is about 31% as searched relative to its peak search interest in late 2017. The data suggest a clear upward trend.

Bitcoin is about 50% of its Tweet frequency as the peak of the previous cycle. The data suggest a clear upward trend.

Bitcoin is about 50% of its Tweet frequency as the peak of the previous cycle. The data suggest a clear upward trend.

Overall, we have strong theoretical reasons to believe that bitcoin prices will be cyclical over time. However, if we expect high price volatility and cyclicality, perhaps our expectation of the events will serve to attenuate them. I believe we are entering the early stages of a cycle which will likely lead to a meaningful increase in price. However, along with this belief, I understand that a 50% decline in price is entirely possible and well within expectations. I’ll be watching the Google trends, Twitter trends, and HODL Wave data closely.

“The secret to happiness is having low expectations.”
— Warren Buffett

BYD's Blade Battery

In consumer surveys, the two biggest concerns people have when considering an EV are safety and range. Any firm that can solve both of these problems will be poised for meaningful success.

In March BYD published the following video explaining their breakthrough battery design known as the “Blade Battery.” The primary purpose of the blade design is its superior safety relative to the two other primary EV battery designs. The Blade is so safe, that you can drill a nail straight through the battery and the surface temperature will not rise above 60C. If you were to conduct this test on NCM Lithium Batteries or Cubic Lithium Iron Phosphate Batteries, they would instantly explode or heat to 200C to 400C degrees, respectively. Causing enormous auto damage to the car and possibly killing the passengers.

In addition to a huge improvement in safety, the Blade has the added effect of compressing 50% more energy into the same amount of space relative to previous-generation batteries. Increasing the average range from 400 km to 600 km. Keep in mind that the average gas-powered car has a range of 400 km.

Recharge time, while important, is not as critical as safety and range. Nonetheless, Blade can be charged from 10% to 80% in about 30 minutes. With a range of more than 50% greater than the average gas-powered car, and safety greater than any other EV on the market, and a fast-charging time; BYD may well be able to convince consumers to switch to an EV.

The video begins with Wang Chuanfu explaining the high-level development, followed by He Long giving a technical explanation, and then they conduct a live nail test.

The Federal Reserve's Balance Sheet

Every Thursday the Federal Reserve releases its balance sheet. It is a trove of information and especially interesting to compare over time. I also wanted to compare the Fed with one of the largest US banks, JP Morgan. A leverage ratio is a measure of how much equity capital a bank has relative to its assets.

During the current recession, the Fed’s leverage ratio has increased to an all-time high of 178x. For every $1.00 of equity capital, the Fed has $178.00 in assets.

Fed 2020.png

四个月的新型冠状病毒 - Reflection on COVID 19

去年十二月份我去了中国出差。我去了北京， 上海，苏州和深圳。以前对于病毒的情况中国人的感觉很放松，因为经济发展的很快，所以每个生意人都觉得贸易战很快会结束。我回到美国，感到乐观。但是两个星期以后，早上我在我的厨房喝了咖啡，看了南华早报。在南华早报，我读了一个令人不安的故事；在湖北省，武汉市很多的人感染了病毒，跟萨斯病毒很像。

八年前，我住在深圳。我记得我的同事们告诉过我萨斯病毒的故事。在萨斯病毒的期间所有的广东人都很担心，他们很长的时间不能出去，并且每个人需要带口罩。   虽然很多人带口罩，但是还是有一千个人死亡了。死亡了的人不但有老人还有小孩儿。从那时起，我知道病毒会坏社会。

在一月九号，我的 同事问我：“大宝宝，你觉得新型冠状病毒严重吗？” 我告诉他：“我觉得会有一万多的人死亡。“ 他说：“不可能！如果有一万多的人死亡了，那么我们的世界张会有经济危机。” 不幸的是，他说的很对。

在过去两个月中，世界出现了很多健康危机。无数的企业破产了，成百上千的人感染了病毒，数十亿人被隔离。每个人都至少有一个生病的朋友。每个人的内心都感到担忧。

最后一个月，我每天在家，不能出去。我不仅在家工作，而且在家做饭，还要在家锻炼。这是我第一次在家工作。与在办公室工作相比，在家工作有一些好处。比如在家我会开始做工作比较早，能做更长时间的工作。因为不用浪费时间去办公室。我也会在家里做健康的菜。希望病毒结束以后，我也能一周几天在家工作。

在投资方面，我拥有大量现金流和少量债务。我希望我的投资能够保持偿付能力。因为我的投资组合公司有超过两千亿美元的现金。我希望我的投资组合公司能够找到投资机会。