As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”
– Berkshire Hathaway Chairman’s Letter (1987)
This is the ur-quote. The True Source from which all hedge fund investor letter quotes spring.
I’m not criticizing. It’s a great quote. I’m also not pointing fingers. We’ve used the true-to-Buffett ‘patsy’ version of the quote at least once in past Epsilon Theory notes. We have used the ‘sucker’ version at least six times, by my count.
Funny thing about this quote, though. It means something different depending on who’s saying it.
It is used most often by Very Smart People to wave indistinctly at a crude straw man in the distance they call Most Investors. This straw man is clothed with all sorts of really lamentable traits, you see. He buys when everyone else is greedy. He sells when everyone is fearful. He hates value stocks and he always pays high active management fees. If you ever happen to play poker with Most Investors, just remember that he is always, always the Patsy.
Slightly less often, it is used by equity investors and fund managers in reference to reasons they have incorporated some acknowledgment of behavioral finance, sentiment, consensus views or momentum into their thinking or their process. It’s the calling card of the Wise-Sounding Skeptic, who can always get some street cred for telling you that there’s no free lunch, or that anything that seems too good to be true probably is. Again, before you hit the search window up there, remember: I’m not pointing fingers.
Ironically, in both of these cases, the focus of the aphorism is about you or about them. The other people at the table, who are sort of the whole point of the thing, are rarely more than an abstraction of individual actors into some archetypal idea of “the market”, if not another layer of abstraction into that loosely related piece of conceptual art called Most Investors. Hell, even Uncle Warren’s original bit was about Mr. Market.
You know who gets it, though? Debt guys.
No, not universally. Contrary to popular opinion (see, I built my own Most Investors, too), there’s no ‘smart’ part of the market. There are plenty of lousy credit long-short PMs, and even more dummies who’ve made a nice living getting pensions locked up in sidepockets or second extensions on way too much of NAV because of poorly executed loan-to-own strategies. But the guys who are actually in the business of worrying about where the rights that matter sit in the cap structure are the guys who are also in the business of understanding who is sitting at the table with them.
Not in some abstracted Mr. Market sense, but in the real-world sense of “Hey, who else actually owns this shit?”
In practice, most modestly shrewd equity investors can get away with abstracting the poker analogy to Mr. Market without worrying too much about who else actually owns what they own and why. There are generalizable archetypes of behavior and preferences. We kind of know how the academic factor quants are going to respond to this or that. We kind of know that there are knowable quantities of price-indifferent passive money. We suspect there’s a certain amount of contrarian capital ready to BTFD, and a certain amount of CTA money ready to take one on the chin when they do. We let that one guy at JPMorgan throw a dart to be breathtakingly wrong again about how much risk-targeted AUM is ‘in motion.’ Whatever mental model we have isn’t going to be anywhere close to perfect, but it’s usually going to be good enough for Bayesian work.
But if anyone is willing to tell you that they have a view on how a speculative asset (see here for the particular definition of this term I mean) will perform in a period of stress for risky assets, or that it should have a weak or negative correlation to, say, equity markets, and if their analysis is based on some trait or analysis of the asset itself and not the behaviors of the specific people who own the thing, they are probably raccoons.
And yeah, there are a lot of suspects for this particular crime. Folks selling you crisis risk portfolios holding selling something other than long USTs? Crypto “hedge funds” with correlation matrices in the deck? They deserve your skepticism.
No, not all of them are guilty.
But if a fund manager, salesperson or consultant tells you they know of an asset class that will buck the trend if and when risky assets deflate, here’s a tip: ask them who the other people sitting at the table in that asset are. Ask them to be explicit. Ask them to tell you why they believe those people will respond that way and not in the price-sensitive way Most Investors respond to broad-based risk aversion.
When you do, if they can’t answer, or if they start talking ‘fundamentals’ of the asset, please call your local animal control.
Smart stuff: " But the guys who are actually in the business of worrying about where the rights that matter sit in the cap structure are the guys who are also in the business of understanding who is sitting at the table with them."
And that is true when there still are some drops of blood left in the stone and Rome isn’t burning around you, but the thing I learned from '08/09 and Stockton and Puerto Rico and…is that NOTHING matters when the Warren Zevon moment happens - then even the legal documents don’t really matter much as it moves to the world of courts, judges, politicians, negotiations-without-precedent, which is when and where anything can happen.
Sure, I’d rather have the kill-their-own-mother hedge fund guys on my side, but still, “rich Wall Street” will lose to “Joe Sixpack union guy” or (hear the angles sing) “the teachers” almost every time. Usually the taxpayer will be slaughtered quietly, but even he/she trumps “rich Wall Street.”
Maybe gold, maybe quality real-earnings/real-cash-flow companies (down, who knows, fifty or more percent), maybe US Treasuries (very probably short-duration US Treasuries, albeit with devalued dollars) will be good to have the next time we stare into the systemic abyss, but looking at page 128, paragraph nine of a bond indenture ain’t going to matter one bit even if super smart Wall Street guy is on your side.
You’ll get zero argument from me on any of that. No intention to make a connection between the ‘debt guys’ analogy and any semblance of order during the shit-> fan phase on my part.
(Separately, Ben’s Blockbuster stories always remind me of this kind of hilarity)
“Ask them who the other people sitting at the table in that asset are”
Great point AND I would add.
Ask them who the other people sitting at the table in that asset are and what other assets they have to sell when the need for liquidity calls
Right on.
I’m sorry, I must be dense, as I don’t understand the following: "Sure, I’d rather have the kill-their-own-mother hedge fund guys on my side, but still, “rich Wall Street” will lose to “Joe Sixpack union guy” or (hear the angles sing) “the teachers” almost every time. Usually the taxpayer will be slaughtered quietly, but even he/she trumps “rich Wall Street.” It’s my strong impression that Joe and Sue Six-Pack and the “teachers” get it without lube every time and the reason any of the Democrat candidates are gaining any popularity is that they are promising to bail those folks out as Vikram Pandit, Jaime Diamond, et. al. got their bailout last time. Free tuition, free everything. Print or really add digits and blow the whole chess game with Death the Hell up. The debt will never be paid so why don’t the masses get their bailout? The Estate Tax used to apply to 2% of all estates, now it’s down to about .5%. Lots of crimes gone unpunished. There is a warm place in the Panopticon of the afterlife for all of those (Chicken) Deficit hawks, where is Grover Norquist now? Newt? Stockman, who got Religion late in life? Dick “5 deferments” Cheney, saying Reagan proved deficits don’t matter? Rand Paul “balancing the budget” with his own virtues signaling against the 9/11 First Responders? He got paid $600k for some broken ribs. They’re not. Even. Pretending. Anymore.
Hi. I was referring to debt obligations in bankruptcy proceedings, for example, municipal bonds. When there simply isn’t money to pay off everyone, it becomes a political event as much as a legal event and, at that point, the politicians (and judges, especially if they stand for elections) will try to prioritize the municipality’s union contracts and teacher pensions over the “Wall Street” bond holders (even if there are also a lot of mom and pop retirees holding the bonds as well) regardless of what the bond indenture says (for example, legal commitments of certain cash flows “100% dedicated” to a type of bond have, often, been abrogated in bankruptcy proceedings with that money distributed to other creditors). And, as I noted, the taxpayer will usually get the shaft as well because the concentrated voting blocks of union workers and teachers will be most important to elected officials.
Lima Charlie, just ask GM bondholders ca. 2008. My readings of the two best writers and their (our) posse far surpass everything I read in finance, maybe everything except maybe Yuval Noah Hariri, whose views and observations fit nicely into the topics discussed here what with the slavery caused by the “agricultural Revolution, Industrial Revolution”, etc. Capital triumphs over labor, IMHO. Just have to read it twice at least to get all of it. refreshing change from Stansberry, Casey, even Mauldin, though Grant Williams is a gem. Rusty, Ben, this means you.
“Contrary to popular opinion (see, I built my own Most Investors, too), there’s no ‘smart’ part of the market. There are plenty of lousy credit long-short PMs, and even more dummies who’ve made a nice living getting pensions locked up in sidepockets or second extensions on way too much of NAV because of poorly executed loan-to-own strategies.”
Ugh. Tell me about it. As I am now fond of saying, it is a fine line between “optimistic” and “completely full of shit.”
Really grateful to have you both here. Thanks, guys.
The trick is to dance between the two like Dave Chappelle’s character in Men in Tights. (I’m on the east bank. I’m on the west bank.)