In this week’s episode, Dan Ferris is joined by the chief investment officer of Logica Capital Advisers, Wayne Himelsein.
Wayne founded the investment advisory firm in 2011. Throughout his 25-year career, he has developed and refined his quantitative-trading methods, risk, and portfolio-management processes. A self-proclaimed “quant trader,” Wayne uses advanced mathematics to help identify moneymaking opportunities in both good times and bad.
So in today’s unforgiving market environment, he’s a valuable guide for novice and veteran investors alike.
When asked to define himself as an investor, Wayne emphasizes how investing should be thought of as “trading your personality.” You should invest in a way that aligns with how you see and understand the world…
What’s funny to me is that people get really… rigorous about their view. If somebody, for example, is not very mathematical and they deeply believe in the fundamentals – understanding the company and talking to management and the whole other side of the world of investing – then I’ve seen, in that framework, them looking down on the quantitative side… like the two worlds have to be bifurcated…
Everybody’s entitled to be who they are and trade that way. You’re going to do better being yourself… Why do you have to speak or look badly at the way other people choose to express their personality in the markets?
Dan and Wayne dig deep into “familiar market signals,” including how to best utilize them for your investing style. They also discuss the importance and influence of market bubbles, the pressures of news headlines on investing, and the need to explore and remain curious as a modern-day investor.
Founder of Logica Capital Advisers
Wayne Himelsein founded Logica Capital Advisers in 2011 and serves as chief investment officer. He is responsible for leading portfolio management and the overall implementation of the firm's investment strategies. Himelsein is also a member of the Investment Committee and Risk Committee. Beginning his career as a proprietary trader in 1995 and launching his first hedge fund in 2000, Himelsein has over 25 years of industry experience.
Throughout his career, he has continued to develop, evolve, and refine his quantitative trading, risk, and portfolio-management processes. Beginning in 2011, Himelsein and his team conducted four years of research and development to solve the problem of pervasive negative skewness inherent in hedge funds, with a quest to produce absolute returns regardless of market regime or stress, which today serves as the basis of the Logica strategies.
Himelsein graduated from the University of California, Berkeley.
Dan Ferris: Hello and welcome to the Stansberry Investor Hour. I'm your host, Dan Ferris. I'm also the editor of Extreme Value published by Stansberry Research. Today we'll talk with Wayne Himelsein. He is the chief investment officer and co-founder of Logica Funds. Very interesting guy, great investor. Can't wait to talk with him. In the mailbag today two Ludvik H. questions and Moby Dick. And remember, you can call our listener feedback line, 800-381-2357. Tell us what's on your mind and hear your voice on the show.
For my opening rant this week, let's talk about cargo cult investing. That and more right now on the Stansberry Investor Hour. So what in the world is cargo cult investing? Well, when I talked about Wayne Himelsein, who we're going to speak with in our interview today, I mentioned Richard Feynman. I think Wayne is the Richard Feynman of the quantitative investors. Richard Feynman was a famous physicist. He was the guy – he's most famous for being the guy who figured out what brought down the Challenger space shuttle and if you Google "Richard Feynman Challenger space shuttle," you'll find the whole story. It was a very ingenious little demonstration that he gave.
So he's just a famous physicist and he's got a lot of books that I highly recommend. Anything written by Feynman that you can find on Amazon I would definitely recommend it. Today, we're going to talk about a story that he tells that's reprinted in a book called The Pleasure of Finding Things Out: The Best Short Works of Richard Feynman. The story is it's this cargo cult story. The cargo cult people were sometime after World War II in the South Pacific on some of these islands apparently there were these, what Feynman called, cargo cult people, these natives who during the war they had seen airplanes landing and unloading huge amounts of various food and clothing and other materials for the war. And sometimes they saw them drop from the sky in parachutes and big boxes and things.
So when the military left, the cargo cult people, they wanted this to continue because they benefited from some. They got some of the food and some of the other supplies and they wanted this to continue. So they cleared a space like a runway and they put torches on either side of it like runway lights and they would have a man in a little hut that they built and they made little coconut headphones for the side of his ears. Then they'd have a little fake microphone in front of them made out of bamboo or whatever and everything was perfect. Everything was exactly the way they had seen it. They imitated it all precisely, but as Feynman points out, the planes didn't land. It didn't work. It wasn't real.
Most of the time – and Feynman's point about telling the story was, he says, "In real science, you're not a cargo cultist. You're really finding out and really understanding things and it's really hard." Being a cargo cult is easy because it's fake, but being a real scientist is really hard because you have to – he says the most important thing is not to fool yourself and you're the easiest person to fool. Just the human tendency to want to fool yourself. So being a cargo cult just means you're fooling yourself and you don't understand that you don't understand, that what you're doing is not going to work. I think there are a lot of people in the stock market like that. In every mania, in every bull market mania, there are people who go through all the motions.
They get a couple hundred or a couple thousand bucks, they open an account. Well, great investors have accounts. I'm opening an account just like them. I'm putting my money in my account. I'm buying stocks just like great investors. I'm selling stocks just like great investors. You're doing everything the same and maybe you're even making money in a bull market. You're buying and selling usually pure garbage. You're buying and selling Tesla and AMC and GameStop and all kinds of other garbage and it goes up and you sell it and you make a lot of money. And you keep buying it and you keep selling it and you keep making a lot of money. So hey, it's all the same, right? You're doing it right. Well, nope.
Not really because what the cargo cult investor usually gets wrong is that fundamentals may be – the fundamentals of the businesses that they're buying pieces of. When you buy a stock, you're buying a piece of a real business. The fundamentals may not matter. They may not matter for years at a time, but eventually, the fundamentals are the force of gravity. You can buy an unprofitable company and you can make money owning it at 10, 20, 50, 100, 200 times sales when it's not making a penny and burning $100 million in cash a year or something. You can do that, and for as long as you can do it, it's great.
Eventually, the fundamentals will act like the force of gravity bringing that share price plummeting back to earth. You'll find out pretty quick that sitting in the little bamboo hut with the fake coconuts on the side of your head is not the same as actually communicating with a real airplane that drops supplies. Same thing. I think the cargo cultists have really – they've actually not done well so far this year. A lot of the tech stocks – a lot of the Nasdaq components – we'll just pick on that as an example. A lot of them fell more than 50% and half of them fell 50% or more or maybe it was even 60%, something like that.
So a lot of these growthy, unprofitable companies that they were considered no brainers because they were changing the world or whatever, but not making a dime and burning cash, a lot of those have been penalized. They've been crushed. But so far, the big indexes haven't really been hurt that much. So somebody is still buying something and stocks like AMC and Tesla and GameStop, they're still exuberantly overvalued, exuberantly, just crazy overvalued. Eventually, the force of gravity, the fundamentals of those businesses will find them too and the cargo cultists will be revealed for what they are.
Now most of the time that's why you want to hear the cargo cult story because you're trying to fake it till you make it and then the market finds you out and penalizes you with losses. The problem is we human beings learn by imitation. Now it's interesting. I think Feynman was – as a scientist, he was right to point this story out and say don't do that because in science you can't fake it for long. Maybe you can fake it for long, but you will get found out because the laws of nature will find you if you're faking it. Other things in life though aren't quite like that.
Anything where there's this big human element like in the market, in the financial markets, it's different. There's as much art. It's more of an art than a science. So it's weird. It's weird, this cargo cult thing because all start out faking it until we make it I think in the stock market. Who didn't make their first investment being entirely clueless and not having any idea what they were doing? We were all cargo cultists in the beginning. The task is, the challenge is to not be that as soon as possible, to be informed, and to engage in a lifelong process of learning.
So yes. If you're just starting out, you're faking it, but you got to continue doing that until you make it, until you really become a seasoned, experienced successful investor. It's a story worth knowing and it's in the pleasure of finding things out by Richard Feynman, The Best Short Works of Richard P. Feynman, that book is called. Or I'm sure you could probably Google it because the story is part of his 1974 Cal Tech commencement address. You could probably Google that or something or "Feynman cargo cult story," and Feynman is F-E-Y-N-M-A-N. All right. Well, that's all I want to say about that today.
Let's talk with Wayne Himelsein. This guy is so interesting. I can't wait for you to hear what he has to say. Let's do it right now. One of my biggest fears I'm seeing right now from readers and podcast listeners is that there is no money left to be made in the U.S. stock market, that the extraordinary gains of the past decade are gone for good and that anyone over the age of 50 who's depending on stocks for their dream retirement is out of luck, destined for pain ahead. Look, I'm about as bearish as they come right now, but with the right information and recommendations it simply does not have to be that way for you.
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All right. It's time for our interview once again. I'm really looking forward to this one. To me, this is very exciting. I think we're going to learn a lot today because our guest is Wayne Himelsein. Wayne founded Logica Capital in 2011 and is currently chief investment officer for the firm, responsible for leading portfolio management and the overall implementation of their investment strategies. Wayne is a member of the investment committee and risk committee, beginning his career as a proprietary trader in 1995. Been around the block a few times. And launching his first hedge fund in 2000, Mr. Himelsein has over 25 years of industry experience and graduated from the University of California, Berkeley. Wayne, welcome to the show, man. Really glad to have you here.
Wayne Himelsein: Thank you very much. Glad to be on.
Dan Ferris: So Wayne, I have a confession to make. I hemmed and hawed before inviting you on the show because I've been to the Logica Funds website and what you guys do seems so sophisticated and technical. But the reason I invited you on is because I follow you on Twitter and I'm telling you, to our listeners, I'm telling you, you have to follow Wayne on Twitter because he doesn't post every single day a lot, but when he does it's a really nice nugget about trading or mathematics or quant fund management or whatever. It's – that is really why I invited you on. I thought, "Wow. This is the guy." This is the guy also I've seen you in Real Vision. I was like this is the guy who won't be a jerk like Nassim Taleb if I have questions about quad funds. So welcome to the show with that.
Wayne Himelsein: Thank you. What a nice introduction.
Dan Ferris: So I felt like a good place to start was maybe coming out of something I and our listeners are more oriented to and headed toward what you do. So I've got my trusty copy of the Intelligent Investor here and when people talk about advanced mathematics, using advanced mathematics to manage money and make investment selections I always think of this passage and maybe you already know it. He talks about – this is Benjamin Graham, he says, "Mathematics is ordinarily considered as producing precise and dependable results, but in the stock market the more elaborate and abstruse the mathematics, the more uncertain and speculative are the conclusions we draw there from."
And then he says some other stuff and he says, "Wherever calculus is brought in or higher algebra, you can take it as a warning signal that the operator is trying to substitute theory for experience and usually also give to speculation the deceptive guys of investment." And if I wanted to counter that, I'd probably just show everybody Gregory Zuckerman's book about Jim Simons, who would say nonsense. But you seem to cut it right down the middle. You seem – you're a quant guy, but when you remark about trading on your Twitter feed it sounds very familiar. There's a lot of familiar-sounding stuff there. So if we were talking in a bar and I said, "What kind of investor are you," what would you tell me?
Wayne Himelsein: Yeah. That's a really good question. I like the way you put it. I cut it right down the middle. To say that mathematically, I divide by two or I take the average. If somebody asked me in a bar I'd say definitely I'm a quant investor or a quant trader. That's typically my answer. Of course to your point or to your question, that can mean a lot of things. There's the whole spectrum of quant. I very much agree with that verbiage in the quote you just read in the Intelligent Investor and I've tweeted about that a lot, that there's oftentimes the aesthetic of high mathematics and lot of formulas is oftentimes just a mask of we don't really have great theories, but we do a lot of complex stuff.
So a lot of times that's to be highly discounted, but then to your point, to both of our points you come across something like Renaissance or D.E. Shaw or any of the major quant firms out there and they're very wisely using mathematics. So where is this happy medium between the two? And that's something I think about a lot because I love math. I love a quantitative approach and yet I see that the more variables you add, the more precise you try to make it, given the, I'll call it, nonlinear dynamics of markets or the – let's just use English here – the weird behavior of capital markets.
Math doesn't apply the same way it does to, for example, things in nature, to physical properties of the real world or I should say of the natural world. So to find a middle ground there is to say what I interpret is that math is a set of tools and the process should be first have a theory, first be a trader, understand the way markets work or what the edge it is that you're looking at or the thesis that you come up with and then you use your box of tools and say, "Should I use a screwdriver or a hammer?" If the hammer is linear algebra then use the hammer because that's the cool you need to bang in a nail. If there's a screw there then don't use the hammer. Get a screwdriver so you need some calculus.
In that way, I feel like once you have an idea, once you've got a feeling about how to trade from a human perspective, math can be an amazing way to quantify your boundaries, your risk measures, and perhaps the behavior of your portfolio. It's certainly not an all-in solution and can tend to do the wrong thing if you solely – without the necessary thinking behind the process.
Dan Ferris: I just want to look at this one tweet because you said something in it that sort of overlaps with something I said, which is that investing is very personal and you came out and you said, "Yes, we trade our personality. Optimists seek good longs, pessimists seek good shorts. Our style stems from who we are, but from there we add necessary rules and grow or else we lose and quit." So I guess the way you do things, this quantitative way, it just feels right to you in other words? This is not...
Wayne Himelsein: Yeah. It's exactly that tweet. I couldn't have said it better other than my own words which you just read to me. Thank you for reminding me how I said it. Exactly to that point. My personality is one that I love math, so I can't not use it. I can't not see the beauty or the mathematical pattern or relationship in some behavior. I see a behavior and I'm like, "Oh, that feels like blank," or "That seems like I want to use some sort of this type of equation to home in on how I want to deal with that." So that's my natural way. That's my quote, personality. I'm an analytical person. I'm a quantitative thinker.
I'll go back to a situation in my life. All my life I've thought like that. This was really funny. When I was young I was maybe, I don't know, nine or 10 years old, and my parents put me in a tennis lesson. I'm there playing on the court and the coach is showing me how to hit the ball and he's like, "When the racket comes around" – as he's talking I'm like, "Oh, of course. You want to hit it where it's at the maximum right there." It's like as the – I saw that inflection point in my mind. I saw the curve and I'm like, "Of course. That's where the most power is."
Before the coach or the teacher finished saying it, I said to him, "That's the point." He's like, "Yeah. Exactly." I'm like, "Well, that makes sense. That's the top of the curve of the racket." So that way of thinking, if you will, was my personality. I was born that way. I can't extract it from myself. Therefore, as much as I want to do that or as much as I want to be different I'm not going to. I guess going back to trading, when I went to a trading desk, I started trading manually. I started learning the markets as just, we'll call it a typical trader, without quant, and then of course came my personality and said, "Well, that looks like that," and so you start infusing yourself or who you are.
If somebody is not a math person, they could equally do the trading and they'll have people call it gut trading or instinctive trading. At the end of the day, probably, is some form of pattern recognition in their brain, but that's not how they feel about it because they're not a math person. Well, that's fine. But that is generally how I see the markets, how I see the world. So, therefore, that's how I do things.
Dan Ferris: Cool. I wanted to go ahead –
Wayne Himelsein: I guess one more thing – sorry. Go ahead if you're going to say something.
Dan Ferris: No, no, no. You said one more thing?
Wayne Himelsein: Yeah. It was just about other people's personalities. What's funny to me is people get really, not aggressive, but rigorous about their view. If somebody, for example, is not very mathematical and they deeply believe in the fundamental understanding the company, and talking to management and the whole other side of the world of investing, very Graham and Dodd, etc., then I've seen in that framework looking down on the quant side like, "Oh, that's nonsense," or each other calling that. It's like this – that the two worlds have to be bifurcated and in my view, it's just everybody's entitled to be who they are and trade that way. You're going to do better being yourself. Why do you have to speak or look badly at the way other people choose to express their personalities in the markets?
Dan Ferris: It is the strangest thing. I completely agree. Why do you have to tell me I'm an idiot because I came investing from a value investing perspective? It's just – I agree with that. It doesn't seem to serve me at all. I don't get it either. But I want to talk about exactly the type of focus that you have, which is anybody can go to LogicaFunds.com and read your investment philosophy and about your strategies, but correct me if I'm wrong. It is generally accurate to say that most of the folks, and I know most of the folks listen to this, they are what you might call short volatility. They buy stocks and they buy bonds and maybe they do the odd options trade here and there, but they're mostly short volatility. You, generally speaking as I understand it, are pretty much on the other side of that. That's where you spend a lot –
Wayne Himelsein: Yes.
Dan Ferris: Now the thing that gets me, if I read the stuff on your website correctly, you had this viewpoint that when I think of long volatility I think of people who are basically hedging. They're buying some out-of-the-money put options, but they own the equities on which they're buying out-of-the-way put options. It's like protection. But what I got from reading your website was that it's almost like you're saying, "No, no, no, no. There's volatility in the market and you don't have to have this portfolio that's partly short volatility in order to keep from just constantly degrading in value," right? I think I'm getting that right.
Wayne Himelsein: Right.
Dan Ferris: I found that fascinating.
Wayne Himelsein: Yeah. Generally.
Dan Ferris: Given the upward – over long term upward bias of the market and how hard it's been to be short the last 10 years mostly. Maybe not the last 10 weeks, but the last 10 years for sure. This fascinates me, Wayne. It really does. And you started in 2011 at Logica. So have you been focused long volatility the whole time since 2011?
Wayne Himelsein: Yeah. So first to be fair with 2011, we started in December of 11. So wasn't the whole 11, but let's say, yeah, roughly. Of course, formally it was 2011, but it was the end of 11. So, 2012, really when we started digging in and researching to be fair. Not that it makes a difference. It's just funny. I think of it – it feels like a whole other year, but it wasn't. So for the most part we started out with this idea. So long volatility, I'll answer you, has been a focus of mine for even before 2011. Going back in 2000 that my first hedge fund launch was a long-vol approach to statistical arbitrage, if that makes any sense.
Most stat arb is mean reversion focused. Stat arb, the thesis generally of stat arb is statistically two names might look like they're separating that have historically traded very similarly, let's say like Coke and Pepsi. So as they diverge, stat arb says, "Well, if they're two or three signals apart they should drift back together." And there's different ways of determining how, quote, far apart they are, different mathematical tools to use co-integration or etc. So that mean-reversion approach is short vol to some extent. And I looked at that and thought well, I want to be on the other side of that, as a contrarian thinker, just the way my mind worked.
I saw that in every portfolio of pairs, Cokes and Pepsis and hundreds of them, they were always names that kept on drifting apart. And I said, well, why isn't anybody taking advantage of those anomalies that continue? So I called it mean expansion stat arb to try to find those pairs that were more likely to continue diverging and go along that spread and so take the other side. The other way to think about that is overlaying momentum with stat arb, if you will. If something is strong enough it's not going to revert. Anyway, so that was going back to the late '90s. That's where I started. So if you ask me was I always long vol? Yes. My way of thinking was always in that expansionary long-vol view.
So shoot forward to 2011, 2012, when I started Logica. That's – I started it to figure out how to be long vol more consistently with optionality without the necessity to short vol. Because I found that most long vol players to pay for that long volatility will take on short legs. So that's the very traditional way to pay and there's put spreads. There's not just long puts and of course it makes sense because the carry, the short vol carry pays for the long-vol position. But from a pure long-vol perspective, I view that as counter thesis. You're doing literally the opposite of what you want to be doing to achieve your goal.
The example I love to give – it's kind of funny. I have this great analogy I always use for that is that if you want to do the high jump you don't put on a weight belt. Your goal is to jump as high as you can. You take your weight belt off. You take everything out of your pockets. In fact, jump naked if you can. Your goal is to jump as high as you can. So with that idea, the years 2012 through about 2015, two, three years of R&D we dedicated without outside capital, just with a team of us, myself, and some other quants of how to solve this problem. How do we be solely long vol without the necessity to take on a counter thesis trade to do so.
And then once we resolved how to do that we started trading outside capital with that idea, first as a risk overlay and then eventually launching our own funds. So yes. It's always been the way I see the world and it took many, many years to figure out how to do that in a way that could be sustainable, exactly to your point given that the market has just – continues to grind up year after year. How do you stay in that position and the pure 100% gross and net long-vol position? Yeah. It took a lot of time to do that, to figure that out.
Dan Ferris: So Wayne, please don't be modest when you answer this question. It sounds like you invented this. It sounds like – are you the pioneer of this, of strictly long vol not having to put on the counter the short vol position, not having to be long stocks if you want to be long vol too. Are you the pioneer?
Wayne Himelsein: Listen, I'd like to think. That sounds wonderful. I'm sure someone before me – I'm sure people have done it. At prop desks, at big banks I know there's been what's called gamma scalping, which is something that we do and I know that exists. So I think I'm probably – although, on the other side of that I've never seen a fund or another competitor or peer of mine that does what we do or rather does it the way we do it. So in that way we're a pioneer of this unique way of approaching this problem, that's for sure.
For sure, 90-something-percent of our peers or competitors or the others out there are doing spread training, are shorting vol legs to pay for long legs whether up and down strikes or across the calendar or term structure. There's all this short to pay for long because it makes sense. So yes, we are pioneers in saying, "We're not going to allow ourselves to do that." In a way, I look at it like I tied one hand behind my back and said, "All right. Now how do I play the game?" I don't know that anybody has sat down and said, "I'm going to do that," because why? It's hard.
I did – I guess to step out and being proud, is we took on a challenge that we believe few have taken on and very proud to say that we achieved a way to do it. So yes. We are somewhat of a pioneer, although we certainly took pieces and ideas from what has been done before because probably everything has been done before in some way or in some magnitude and it's putting it all together that makes it special obviously over time.
Dan Ferris: Right. It also makes it highly unlikely that anyone listening to us is doing anything remotely like it, which I think is cool. I was hoping that this would be a learning experience and it already is a wonderful one.
Wayne Himelsein: Yeah. It also makes it that we don't look like or behave like others out there even in our own peer group. It's one thing to not be correlated with the broader markets or with long equities, but then to not be so correlated with most other hedge funds is also nice. It really helps. So doing something so different, even though it's harder, it has its payoff which is you get a really interesting pure alpha source or return profile that doesn't look like most others because they don't do it that way.
Dan Ferris: Yeah. And a decade on you're still in business and that's something. I feel like 10 years is a milestone these days especially if you're doing something totally brand new like this. I don't know. If Gregory Zuckerman, the guy who wrote the Simons book hasn't started bugging you yet, maybe I will. If you become a gazillionaire like Simons, I got you right here. I should be taking notes, man.
Wayne Himelsein: Thank you. Yeah, 10 years, you're right, it's a long time. Time flies. It's amazing when I look back and I was like, "Wow. The first three years were just research." That felt like it would never end and then we got an opportunity. Once we had something developed we weren't quite ready yet to launch our own fund, but we had an opportunity to run our long-vol approach as a risk overlay against a broader portfolio of other managers. So we got to test it. I call it proof of concept in real time with real capital to see hey, we did all the stuff we developed in R&D. Can it actually do what it's supposed to do in the real world against portfolios that have the opposite exposure.
That itself took another three years to prove itself because you've got to wait for not only markets to do what they do on average. You got to go through a few correction phases. I remember August of '15, the market corrected about 10% and then January of '16 and then Feb of '18. And each one of these I was excited because I'm like, "Oh, good. It's another event. It's another proof of concept moment." And after enough of those over enough period you're like, "Now we can go out and launch a fund," because we've seen it through some environments.
It's just amazing when I look back and say and look at really building something robust is never an overnight process. It's years and years and it's especially when what you're building is a function of rare events because then you need a way for them to actually see that it works. It's just interesting. And you say 10 years and it's like I say to myself, wow. It has been, but that's what it takes to do something like this I believe sometimes. So anyway.
Dan Ferris: Sure. By definition that robustness in this type of endeavor must happen – must be built over time. So I want to go back to your Twitter feed if I could because there's a juxtaposition – I think it'll appear a juxtaposition to our listeners that I'd like to talk about a little bit. In one tweet you say, "Over my 25 years in the game of quantitative investing drenched in equations and models I've honed in on the only math that really matters, minimized drawdowns during unfavorable times. The multiplicative nature of positive returns during good times does all the rest."
I bet that sounds very familiar to our listener. We're constantly talking about minimizing downside. Yet there's this other thing. You said, "You're unwinding a quant myth," with this tweet. You said, "Our best efforts are not necessarily in the hunt for new or better signals, but in digging deeper inside familiar ones," and I thought that is interesting to me because what little I know about this stuff I get from the Zuckerman book or other books and things, Taleb, or whoever, or your website. I'm constantly hearing – when we interviewed Jeffrey Zuckerman he says they complain a lot about the signals not working as long and not having to find new ones. But when you say your best efforts are the hunt for digging deeper inside familiar signals. Can you tell me about that in contrast to what I said about how the signals – people are constantly telling me the old signals don't work. What's going on here? What am I missing?
Dan Ferris: Yeah. So this is very much analogous to how we're bifurcating. Originally when we were speaking the use of math versus manual trading or gut trading, it's both work. It just depends on who you are. So there's an answer that brings two opposing worlds together. So in this one, yes, there can be and is signal decay. We'll call it that, which is that people find a signal, an inefficiency, an anomaly, whatever it might be in the market, a pattern, and of course there are hundreds, thousands of other people looking for signals. So other people come across it and everyone starts doing, quote, the same thing.
So the alpha fades over time. There's just too much capital that has found and trying to take advantage of the same inefficiency which then ceases to be an inefficiency. So the signal decay really is a function of chasing capital or large capital chasing signals and everybody eventually finding the same stuff. That's inevitable. So that defines that side of the issue. Now we come to the other side of the issue where, per my tweet, I say it's not always seeking new, but digging deeper into what you're familiar with. What I mean there of course in Twitter you only have 140 paragraphs or whatever to say what you want to say. So it's very generalist and you can't get into describing exactly what you mean.
So what did I mean there is that even those signals that decay or somebody found something or there was something that one was looking for and the research process, somebody believes that there's some inefficiency and they start digging in a direction and they become familiar with that direction. Let's just say, I don't know, let me use – I'm trying to think of an example where in stat arb let's say there's the Coke, Pepsi example I spoke about earlier. So people could look for a signal and they're using some mathematical process to say which pairs have been traded together for a while and then diverging.
Then too many people are doing it so it stops working. That doesn't mean that as a stat arbitrager you should say, "OK. Now let me look over and convert arb," or now let me look over at relative value trade or some other completely different space. Now let me get into crypto trading." My point is, stay in stat arb. Just look at different angles. For example, what I did is instead of going mean reversion I said, "Hey, look, in every standard portfolio there's a bunch of pairs that keep on blowing out wider. What about the mean expansion side of things?" That's digging deeper into the same area. It's just saying, "Hey, how can I approach this from a different angle?"
You already know what you know in that area. There's a lot of accumulated knowledge. So instead of throwing that all out because that signals decay and say, "Hey, let me now know learn a whole new book," rather than, "Let me lean on all the chapters I know and add a new chapter. How can I rethink what it is that's happening here." Even if I wanted to stay in mean reversion, OK, so I approach Coke and Pepsi from this type of model. Maybe are there other markets I can apply the same thing to? Maybe that process works in European markets. That would be digging deeper on something you know. So that's really – what I'm saying is from my experience I have found that when something starts to decay I inevitably or usually find another pocket of alpha around that accumulated knowledge of that thing rather than just stepping out and saying, "Oh, I give up. I'm going to something new."
Dan Ferris: Gotcha. And this – I'm glad that I asked you about this and that was a fantastic answer because for our listener's sake, for example, and I know a lot of our listeners are also readers of Stansberry Researches like dozens and dozens and dozens of different newsletters with all kinds of different ideas. Yet this is almost like the appeal to keep it personal. Stay within what you understand and what has worked for you. Maybe it's not working precisely the same way, but don't go too far afield. If you're really thinking about it and really sticking to your guns, maybe what you've been doing that isn't working will naturally lead you to maybe flip it upside down or see it in a new way. I think that's a really great, great thing for you to tell us if I understand it correctly.
Wayne Himelsein: Yeah. In fact, I'm over here on my desk. It's funny. I have this quote that sits on my desk right here next to me. It's one of my favorite quotes. So I'm going to read it. It's from Marcel Proust. "The real voyage of discovery consists not in seeking new landscapes, but in having new eyes." So along the same lines. Just we don't even need to travel. We can just look at the same location differently.
Dan Ferris: That would be a radical interpretation of that, but who knows. Given –
Wayne Himelsein: Yes. Of course. I'm just – to make the point. Of course.
Dan Ferris: And yet, given how we've been locked down for a good part of the past two years, that's a pretty valuable insight, I think. Could have kept you from going stir crazy.
Wayne Himelsein: Yeah. There were parts of our house that we never knew existed.
Dan Ferris: There you go. Right. So Wayne, I'm wondering as I think about the type of events that really prove your concept and make your strategies shine, they arrive at all kinds of – under all kinds of circumstances and all kinds of markets and you never know what the headlines are going to be. You just never know where it's going to come from. It makes me wonder how much attention does Wayne Himelsein pay to the headlines and to what the federal reserve says it's doing or is actually doing even.
Wayne Himelsein: Yeah. The broad answer is not much. Headlines – I don't watch CNBC. I don't read headlines. People have told me way too often that, "Really? You don't know what's going on?" No. I really don't. That's not one of my focuses. There's only so much time in the day to focus on things and to learn and to grow our minds on stuff. So I grow my mind on stuff I care about. I would rather all day long read another interesting white paper or dig into some concept I'm working with rather than read headlines because I find that every day it's effectively or every month or every year it's the same headline. Just take out the country name and replace it with another. And X, Y, Z suffers. Yes. That happens. That's going to happen. That's the way of the world.
I don't mean to minimize it. I'm a caring person of course. I care about what's happening in the world from a human perspective, but how it effects the markets, I find the markets tell me that. And I find that the alpha sources we look for shouldn't rely on what's happening out there because the next thing that happens won't look like the last one. So if I rely on the prior one for behavioral characteristic, I'm going to fall short the next time. So I want to build something that's not reliant on what the specific headline was, that's robust enough to be agnostic to the type of event and therefore I don't want to know the type of event. I just want to build something that behaves in the right way most of the time.
Dan Ferris: I think I might go farther than you although I understand the point about not wanting to suggest that you don't care what's happening to other human beings in the world. I get that, but I would go further and I would almost say that the extent to which you can avoid, let's say the overwhelming majority of news, is it's directionally proportional to your abilities to compound real, useful knowledge over time I would say. I don't think that's unfair at all.
Wayne Himelsein: It's just noise. There's a lot of noise out there. Compounding real knowledge necessarily means removing the noise. Knowledge is signal over noise. So if you want signal, ignore the noise and you'll get more signal or you'll get a better signal to noise ratio.
Dan Ferris: Yep. I think that's signal to noise. I often think of trying to learn anything is a mining operation. You've got a ton of earth for a half-ounce of gold or something. So that separation – yeah.
Wayne Himelsein: Totally. Totally. It's actually – yeah. Absolutely. So much so with investing. I have a lot of people come to me at different times with different investment opportunities and I ignore them. I'm not interested. I had – just two weeks ago a friend of mine was telling me about something and, "Not interested." He's like, "He's not interested in these things." I'm like, well, I don't understand them enough. Why would I risk capital on something that I don't totally understand? People look at it, "So you're totally concentrated?" Yes. I'm concentrated in my accumulated knowledge.
Dan Ferris: Right. And where else can you be? Where else can one be effective? In fact, you addressed the answer to that question and the mistake people made. There's a white paper on your website and I had it in front of me, but the title I thought was interesting. It's a topic, it's called The Illusion of Skill and there's a lot of complicated math with funky, foreign characters in it that people like me don't get. But this idea, the illusion of skill, separating skill from luck has become – when I grew up and went to college and everything nobody ever talked about any of this. Maybe they did in finance, but nowhere else.
Now we talk about it in a lot of different disciplines and occupations and things. Maybe you could tell us in a way that folks like me would understand. What have you learned about the illusion of skill? I know your paper is about evaluating hedge fund returns. What is that paper about? What was your insight there?
Wayne Himelsein: Yeah. There's so much to say there. There's just so many ways to answer that. I want to think of the best. The illusion of skill is that obviously let me use an easy example. It's easy to look like a good trader in a bull market. So you get a lot of these traders and it's buy on tip – buy on dip. Sorry. I said buy on tip. I meant buy on dip. I guess both things. So buy on tips or dips, either way you can get these upside results that hey, I'm great and I get great tips or I buy on good dips. And the market rewards you for that. Of course, it's been consistent or it's been enough of a bull market over so many years that it starts to give you the illusion of skill. It's hard to say otherwise because people say, well, that's what the market does. It's resilient. It comes back. So we just buy the bottoms.
Yes, that's true a lot, but there's been long periods of markets where that has not been the case. It can go on – bear markets can go on for years. It's hard to keep on saying that story or that narrative fades as the bull market continues. The point is that it can look like skill where really somebody is just buying in a bull market. So how do you – how you assess that versus somebody who truly has skill and they will do well now and if the market should turn they will continue to do well. That's the key point... is how do you differentiate the two.
Really we found that we could do that mathematically in the shape of the distribution. This has a lot to do with what's called skewness, which is a distribution that has a fat tail in one direction of the other. If you use an example of long vol, which is of course what we do, long volatility is a more right skewed versus short volatility can be more left skewed or markets can be left skewed, can be negative skewed. They can go up for a while and it can be this big event that takes you down aggressively, a big-magnitude drawdown very quickly.
The easy example is COVID. So you're making money on bull market, you're buying on dips, and then S&P cracks 5%, 10% and you buy that dip and then that floor falls right from under you and there's another 20% downward move that takes out your entire portfolio. That's the negative skew event that where all the previous dips you bought, the floor didn't fall. This time it did. So the illusion has broken. You didn't have skill. You were just buying a risk. Whereas, for example, in long vol, use the example of us where we're buying puts against the S&P and being effectively short the market while it's climbing, but making money along the way is, "Well, how do you do that?"
That's more, in my view, skill based because you're literally going against the grain and then you're making money. And then COVID happens, you make more money because that's the payoff you've been waiting for. So that seems harder to assume that as illusion because it's very hard to do that. It's hard to argue with that. How do you do that? So there's of course the common sense where people can look at that and say, yes, that seems like it'd be hard to do to stay short and make money while the market is climbing. That must be skill, people would say, thinking about that usually.
So you could look at that as common sense or you could look in terms of the shape of the distribution and say, "Oh, if somebody is more positive skewed, they tend to have a skill and have these upside payoffs versus a negative skew is someone who's taking too much risk with a pending crisis on the way and that illusion will break when that event happens. Therefore, it wasn't skill while you were waiting.
Dan Ferris: Yeah. This topic calls to mind, I fear there's a whole generation of very small, we might say thinly capitalized, but small retail investors who have huge positions on things like Tesla and AMC and GameStop and whether they ever learn these terms, boy, are they going to learn the meaning of it in their lives and in their investing.
Wayne Himelsein: Yeah. What's interesting, for me what had such a big impact was being at the tail end of the dot-com bubble. So when I started trading in the mid-'90s, it was one of these raging bull markets and '99, I remember, was one of the best bull years ever. Nasdaq was up like 75%. It was just incredible. I remember making a ton and then all of a sudden comes March of 2000 and all of these names across the board, everything that was dot-com and names that were $300 a year later were $2 and not just one of them, but dozens and dozens and dozens.
Dan Ferris: All of them.
Wayne Himelsein: All of them. All of them. It's like there was no floor. It just – it ended in such a blow that I think having that happen to me and seeing that early on in my career really just crystallized this concept. We have to – I had to understand the difference between illusion and skill or what was illusion and what was skill. Maybe partly I was already long-vol positioning, but it just further crystalized how powerful this idea is to see that is what somebody is doing actually alpha, or is it just what I call risk transfer, which is alpha that will one day be ripped away from them.
Dan Ferris: Right. Alpha that will one day be ripped away. That's what it looks like to me and given my bent is to look at fundamentals and given what's the reality of the industry and the particular business in GameStop and AMC, the evaluation is like they've come way off, but they're still way too high.
Wayne Himelsein: Sky high.
Dan Ferris: So many people have so much conviction about it though very much like the Internet is going to take over the world by, whatever it was back in the day, JDS Uniphase and you'll never lose money.
Wayne Himelsein: Right, but the irony is that both can happen. The Internet did take over the world, but JDSU was still – is at a dollar. So both things aren't co-dependent.
Dan Ferris: That's right. The bubbles, I forget, I think it was maybe Galbraith or somebody, the bubble is rooted in truth. It's valid, but it doesn't mean you're going to make any money.
Wayne Himelsein: Right or it doesn't mean that company will continue to lead that for the rest of time or for that much longer. So that's the issue of course and it's so hard to not only differentiate, but it's so hard I find to – I have a lot of conversations with young traders who get very emboldened by early success or buy the dip success. I don't want to be the naysayer in the room so I'm like, "Oh, that's great. Just make sure you watch out for" – I put it in my subtle years of experience. People have to learn it and over time markets teach them. That's the best thing I can say. It's almost inescapable.
Dan Ferris: You know what's interesting to me, Wayne, is that I've interviewed probably, I don't know, a couple hundred people must be on this podcast over the past couple of years and the story of, "My career started around the time of the dot-com boom and I got wiped out," and the next thing that I usually hear is, "I learned how to think about evaluation better and I learned to spot better companies and not buy garbage," and all this stuff. That's what I hear actually from everyone but you. Everybody else says, "I learned what to buy," and you're like, "I learned how to exploit these enormous negative events," which I find very cool. Have you always had a contrarian bent? Were you a hard kid to be a parent and teacher to when you were young?
Wayne Himelsein: Absolutely. Yes. I was the skeptic. I was once told by a teacher why I asked so many questions, could I stop asking so many questions. I'm like, "Well, what – I can't just listen to what you say." Yes. I actually got in trouble for that and was asked to be quiet. It's not like – I'm not talking to my buddies. I'm asking genuine questions, but it was too much for the teachers who wanted to just teach what they wanted to teach, which I understood, but yes. I was always that kid. I guess it's funny. I don't know if I'd call it a contrarian bent because I feel like it's more just relentless questioning or skepticism to some degree about why should things work the way they work and who says that this should be the way it is. It's just a sense of wonder and curiosity really has driven it.
Dan Ferris: Right. It reminds me of Richard Feynman and his emphasis on true understanding. If you don't truly understand it and you just have formulas memorized and you're doing – he had that bit about the cargo cult and cargo cult science.
Wayne Himelsein: Absolutely. That's such a great thing.
Dan Ferris: Wayne Himelsein is not a cargo cultist. He's the genuine article, folks. So we've been talking for a while here and it's time for my final question, which is the exact same question for every guest no matter what the topic, even if we're not on a financial topic. And you don't have to answer – it doesn't have to be a finance-oriented answer. Any answer, whatever is on your mind. The question is simply, if you could – you have a chance here to leave our listeners with a single thought today and what would you like that to be?
Wayne Himelsein: Wow. All this, a single thought to collapse all possible into a single thought. That's tough. I'm going to go with what it is that we were talking about. What you just said about Feynman. I love Feynman. I love all of that way of thinking and the curiosity for the world. Half of what we've said today, you pulled up the tweet earlier about digging deeper. The thought therefore I leave everyone with is just ask more questions and don't accept what's said or what's written. Think about things from different angles. We talked about turning upside down from reversion to expansion. Look at things differently. It's the perused quote of seeing the same land with different eyes.
All of that is just think more widely about stuff and ask more questions and don't accept what is in the media and what people say. Just always think about what am I not seeing and I guess have a drive to learn and know. That's what's served me the most in my life. That's what – without that way of thinking I certainly would not be where I am. I just I see other people get into grooves and do the same old thing and not sit back and either ask why or want to dig deeper or challenge further and get into trouble later on. I've seen that happen over and over.
So I want to leave with people, don't let that be you. It's not difficult. It just starts with asking more questions and deeper digging. Usually you'll find something more interesting and go down different paths that you never might have. So that's my, I guess, final thoughts or final words of wisdom if they are – if you could call them that.
Dan Ferris: I would call them that. That's great. Thank you for that. Thanks for doing this, man. I really appreciate it. I think I know I learned a lot and I'm sure our listeners did too and I hope maybe in – I don't know – six or 12 months or something we can check back in with you.
Dan Ferris: Yeah. No. It was very nice. Thank you for having me and yeah. It was a pleasure.
Wayne Himelsein: Thanks, Wayne. Bye-bye for now. Well, as we often say here on the podcast, I hope you enjoyed that has much as I did. As I said, Wayne is a very – he's a very different kind of investor. He's sort of on the other side of everything almost everyone does and I thought of all the people who – all the quants and things that I maybe either follow on Twitter or have met at conferences over the years or just know, he seemed to be the one who could really talk to us in plain English better than 99% of them and I thought he did a great job of that. By all means, check out LogicaFunds.com. There's some more of the same there and I'm telling you, the real thing to do is follow him on Twitter if you liked what he had to say because that is where he puts his best plain English nuggets about what he does.
All right. That was great. Let's check out the mailbag. Let's do it right now. Gold just passed $2,000 an ounce setting the stage for a historic new bull run. Multiple billionaire investors are loading up on gold including hedge fund founder Ray Dalio and real estate mogul Sam Zell, meaning now is the time to own gold. One pressure metals expert is stepping forward with a big prediction. He believes we could see gold reach as high as $3,000 by the end of the year, possibly higher. Find out why and get instant access to his number one gold investment for 2022. It's not bullion, an ETF, or a mining stock.
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In the mailbag each week you and I have an honest conversation about investing or whatever is on your mind. Send questions, comments, and politely worded criticisms to [email protected] I read as many e-mails as time allows and I respond to as many as possible or you can call our listener feedback line, 800-381-2357, tell us what's on your mind, and hear your voice on the show. We have two, count them, two e-mails from Ludvig H. this week, our faithful listener and frequent correspondent. The first one, Ludvig says, "I have some questions. What do you think about the sanctions against Russia? Is this not the perfect moment to acquire Russian stocks, mainly resources and military industrial complex?"
Ludvig, I'm going to answer that one right away. I have thought Russia was uninvestable for some time and you just never know. You never know when any government is going to just decide to pull a fast one on you and seize a bunch of assets or raise taxes or do whatever it's going to do. But Russia has been I think more capricious than most. So to me, it's uninvestable. Ludvig's next question, his second one, "Hi, Dan. Regarding the market and what is happening in the world is it not best to exit, sell everything, store it in silver, gold, optional bitcoin, position yourself for the market crisis/crash and to buy for pennies on the dollar when all hell breaks loose?"
Ludvig, I don't see the necessity of selling everything in order to position yourself for a crash. So my answer is no, don't sell everything, but yes, you can position yourself for a crash. You can own silver and gold and some bitcoin maybe and maybe you can own a few out of the money put options on the S&P 500, maybe the Nasdaq, definitely the Nasdaq, maybe the Dow Jones industrials, maybe the Russell 2000. You can position yourself for a crisis and you can also – you don't have to buy puts. You can just hold plenty of cash. That is really the best way, that and holding gold and silver. If you have plenty of those three you're positioned for a crisis. So no, I don't think you need to sell everything. Yes, definitely position for a crisis.
Finally, this week Kevin D. writes in and says, "Good luck with Moby Dick. It's a 500-plus-page whale anatomy lesson masquerading as a revenge tale. I broke my streak of reading every book I started cover to cover. After halfway through I started skipping every chapter unrelated to the main story." Kevin D. Well, Kevin, I want you to know I have no problem not finishing books that I started. I've not finished most of the books I've started. I'm a phenomenal – I'm a world-class book starter, but I don't think it's necessary to finish. The time of your life is precious.
You all may remember, just in case you don't, last week I said you should read some fiction and I had Moby Dick that I had read the first few pages of. And I thought, "OK. Maybe I'll give this a shot." I haven't given it a shot yet, but I feel like Kevin is challenging me here. So maybe I'll have to do that. I do still believe that reading fiction is really important. Like I said, it's the things you learn from it, you don't know you know them up till you call upon them. It's strange to me how that's worked out for me. I think I'm going to guess it's worked out like that for other people because you read fiction because it's pleasurable, it's fun, it's interesting. Then one day you realize you learned something from it because something happened to you and you called upon this knowledge that you picked up from some work of fiction.
At any rate, thank you, Kevin D. That's it for the mailbag and that's it for another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as I did. We do provide a transcript for every episode. Just go to www.InvestorHour.com, click on the episode you want, scroll all the way down, click on the word "Transcript," and enjoy. If you like this episode and know anybody else who might enjoy it, tell them to check it out on our podcast app or at InvestorHour.com.
And do me a favor, subscribe to the show on iTunes, Google Play, or wherever you listen to podcasts and while you're there, help us grow with a rate and review. Follow us on Facebook and Instagram. Our handle is @InvestorHour. On Twitter, our handle is @Investor_Hour. If you have a guest you want me to interview, drop us a note at [email protected] or call the listener feedback line, 800-381-2357. Tell us what's on your mind and hear your voice on the show. Until next week, I'm Dan Ferris. Thanks for listening.
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