What Do You Have To Lose?
As everyone by now knows, Nassim Nicholas Taleb is a Lebanese–American essayist, scholar, statistician, former trader and risk analyst whose books Fooled by Randomness, Black Swan, Anti-fragile have dealt with problems of randomness, probability and uncertainty. The Sunday Times has rated Black Swan as one of the 12 most influential books since World War II. Taleb now serves as a professor at several universities, including as distinguished professor of risk engineering at the New York University’s Tandon School of Engineering. 
 
Taleb is back with another book on a theme that is close to his heart and which he has been expounding for the past few years in his articles and Twitter comments: skin in the game (SITG). The idea is simple. If you grab the upside (of your actions or decisions), you should get the downside too. His argument is that the chances of informed action and prediction can be improved if we better comprehend the multiple causes of ignorance when dealing with everything from health, safety politics, sports, etc. One of the causes of ignorance is that, in an opaque system fraught with uncertainty, there is an opportunity for one set of players to hide risk: to benefit from the upside when things go well but not pay for the downside (Black Swan events) when one’s luck runs out. 
 
Taleb has made a natural progression from randomness to extreme events to, now, what he calls hidden asymmetries. Economic literature focuses on incentives as encouragement or deterrent, but not on disincentives that should eliminate from the system incompetent and nefarious risk-takers who inflict harm. An unskilled forecaster, who, if shielded from financially harmful consequences of his wrong forecasts, would continue to contribute to the build-up of risks in the system. But if he is under a disincentive to do so—the forecaster pays for his wrong forecasts—he would, eventually, be removed from forecasting. This disincentive is simply skin in the game.
 
You can have as good a risk management system as you want, but nothing can be better than an inherent and internal system of risk control exercised by the participants, knowing that they have to pay for it. 
 
This idea is old as the hills. Taleb, who was born in what he archaically calls Levant—a collection of cities on the eastern Mediterranean seaboard. The Levant is a short distance away from the principal centres of several older civilisations—Sumerian, Babylonian, Ottoman, Persian, Greek and Roman and Taleb, proud of this lineage, has always drawn his anecdotes and inspiration from these ‘ancients’. In this book, too, he assembles a lot of historical evidence to show that the ancients were fully aware of this incentive to hide risks and implemented very simple but potent heuristics or rules of thumb. 
 
About 3,800 years ago, Hammurabi’s code specified that if a builder builds a house and the house collapses and causes the death of the owner of the house, that builder shall be put to death—the best risk management rule ever. What the ancients understood very well was that the builder would always know more about the risks than the buyer, and can hide sources of fragility and improve his profitability by cutting corners. The foundation is the best place to hide such things. The builder can also fool the inspector, for the person hiding risk has a large informational advantage over the one who has to find it. Taleb also notes that Hammurabi’s law is not necessarily literal: damages can be ‘converted’ into monetary compensation. 
 
Over the centuries, the idea of SITG has appeared in many forms. The rule under Lex Talionis is “An eye for an eye, a tooth for a tooth.” The 15th Law of Holiness and Justice is “Love your neighbour as yourself.“ Isocrates, a Greek rhetorician, and Hillel the Elder, a famous Jewish religious leader and scholar, have both said: “Do not do unto others what you would not have them do unto you.” Philosopher Immanuel Kant’s Formula of the Universal Law is: “act only in accordance with that maxim through which you can at the same time will that it become a universal.” 
 
What are the modern-day applications of SITG? The best place to apply this is on policy-makers and politicians (though it is unclear who would apply it, since law and policies are framed by them.) One of the most important points Taleb makes is that this idea is not ‘scalable’. You cannot have the players in the national government with SITG; and it is far from international organisations. It is in the small, local, personal and decentralised systems where SITG works best because participants are, typically, kept in check by feelings of shame on harming others with their mistakes. In a large, national, multi-national, anonymous and centralised system, the sources of error are not so visible and pinpointing accountability is not easy. When it fails, everybody except the culprit ends up paying for it, leading to national and international measures of indebtedness against future generations or ‘austerity’ imposed—again by large global organisation run by those without SITG such as World Bank and International Monetary Fund. This naturally means that Taleb is dead against ‘big governments’. 
 
 
After policy-makers come corporate managers, especially the finance people—the ‘agents of capitalism’—for whom Taleb has special scorn. The manager who loses money does not return his bonus, forget about sharing the losses. Taleb has never concealed his hatred for economists, quantitative modellers and policy wonks. These people have no disincentive and are never penalised for their errors. So long as they please the journal editors, or produce cosmetically sound ‘scientific’ papers, their work is fine. So, we end up using models, such as portfolio theory and similar methods, without any remote empirical or mathematical reason. The solution is to prevent economists from teaching practitioners, simply because they have no mechanism to exit the system, in the event of causing risks that harm others. Again, this brings us to decentralisation by a system where policy is decided at a local level by smaller units and, hence, there’s no need for economists. 
 
Then come the predictors, who rarely pay for their predictions while their precise quantification encourages people to take more risks. The solution is to ask—and only take into account—what the predictor has done (what he has in his portfolio, if he is a stock-adviser), or is committed to doing in the future. Finally, to deal with warmongers, Taleb approvingly quotes Ralph Nader, an American activist who fought many battles for the consumer, and to whom Taleb dedicates the book. Nader has proposed that those who vote in favour of war should subject themselves (or their own kin) to the draft. Beyond all ‘isms’ and theories of how institutions should be run, what we really want is accountability for decision-makers who influence our lives. And that is what SITG suggests. But there are huge practical problems in trying to apply this approach in real life. Who will write out the rules of SITG? Wouldn’t human beings, being what they are, find exactly the same way to game the system to save their skin? 
 
Most importantly, Taleb’s strong, combative, haughty and thin-skinned personality comes through in every page. When he is not delving into SITG theory, he is either mocking someone (academics like Steven Pinker, Thomas Piketty and Nobel Laureate Richard Thaler, journalists, bureaucrats, social science departments, corporate managers, Monsanto and other GMO companies, large corporations, and so on) or praising himself. The number of people, disciplines and institutions that he thinks are charlatans and fools, is astoundingly vast and his rudeness breathtaking.
 
This book is nowhere in the same league as Fooled by Randomness and Black Swan. There are sweeping generalisations also (for example, about the change in public mood in UK, India and the US) that just don’t ring true. All that’s a pity because the core SITG idea is relevant, though with limited applicability. 
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COMMENTS

KARAN GARG

1 year ago

Fooled by Randomness and Black Swan , do we have reviews for these books ?

KARAN GARG

1 year ago

thanks for the review! gets the msg cross to us !

Prasanna -

1 year ago

Another blockbuster from the author of Black Swan.

The Grand Principles of Life & Work
Let me start with a confession. I have read only parts of this book and I don’t think I am likely to go back and read it—at least the 400-odd pages of principles. That is unfortunate because the cornerstone of all consistently high achievers is fundamental principles of thought and action that are consistently applied and explained. Come to think of it, nothing of lasting value can be created without such firm foundational principles.  And, yet, as the writer and hedge fund superstar, Ray Dalio, points out, it is surprising that such few successful people have shared their principles. We would certainly like to know what Steve Jobs’ principles were—that stunningly combined aesthetics and functionality and won the hearts of consumers. Or what principles guided Albert Einstein. 
 
Dalio does not want to make the same mistake; before he leaves this world, he wants to give us two books. This is the first one—on life and work principles. The next would be on investing and economics. The idea—in the mould of Greek classics—is to present to us the grand theories and philosophical ruminations that explain life, investing and the economic machine. This book, bound in black cloth with white lettering, reminds me of Discourses by the Greek stoic philosopher Epictetus. I suspect it will sink like a stone.  I have explained why, at the end. 
 
But what is Ray Dalio’s achievement? What makes him think we want to read his principles running into over 567 pages? Ray was born in a middle-class family in Long Island (USA) as the son of a Jazz musician. He had an unremarkable school record but was a curious boy and got hooked on to stocks in his teens. He started an investment company, Bridgewater Associates, from his two-bedroom apartment when he was just 26 years.Over the past four decades, he has built Bridgewater into, what Fortune magazine labels, the fifth most important private company in the US. Dalio has been called one of the 100 most influential persons (according to Time magazine) and 100 wealthiest (according to Forbes magazine) in the world. Bridgewater, today, is the world’s largest hedge fund, managing more than $150 billion. 
 
The first part of the book is a memoir (Where I Am Coming from) of Dalio’s journey over the decades; the second part discusses his Life Principles; and the third part enumerates his Work Principles. In the first part, over 124 fascinating pages, he narrates how he started his firm in 1975, internal conflicts and various mistakes and failures which convinced him that we learn much more from our mistakes than from our successes. Just a few years after he started the firm, Bridgewater nearly shut shop on bad bets on the bond market and strong belief that the US was heading for a deep recession, possibly depression. 
 
But the economy recovered and the US market went into a 18-year bull market. He writes: “being so wrong—and especially so publicly wrong—was incredibly humbling and cost me just about everything. I saw that I had been an arrogant jerk who was totally confident in a totally incorrect view. I was so broke I couldn’t muster enough money to pay for an airplane ticket to Texas to visit a prospective client.” In fact, from a strength of 20, Bridgwater was down to a single employee—Dalio. He had to borrow $4,000 from his father, until he could sell his second car and raise money.
 
But, unlike others, he took a cold-blooded approach to his mistakes. Dalio came to realise that, if he had to move forward, he needed to do four things. One, team up with other independent-minded thinkers like him, who thought differently, and to understand their reasoning. Two, know when not to have an opinion. Three, develop test, systematise the timeless and universal principles. Four, balance risks in such a way as to keep the big upside, while reducing the downside. He also started writing down his decision-making criteria. With time, he had a collection of recipes for decision-making which gave birth to principles. He then shared his principles with his colleagues and invited them to test his principles in action; this helped him continually refine them. Dalio also converted his decision-making criteria into algorithms that were fed into computers. 
 
Dalio had no interest in sharing these principles because of two reasons: he didn’t like attention and it was presumptuous to tell others what principles to have. After Bridgewater successfully sidestepped the crash of 2008, it started getting a lot of media attention. Dalio felt that a lot of these reports were distorted; so, in 2010, he posted his principles on the Bridgewater website so that people could judge from them. Incredibly, the ‘principles’ were downloaded three million times; thank you mails came from all over the world. Dalio then decided to publish two books enshrining all his principles.  This is the first one.
 
The Culture
The genesis of principles, and the start of the Bridgewater’s unique culture, goes back to 1993, when Dalio was delivered a memo signed by his top three lieutenants that was startlingly honest in its assessment of him. After mentioning his positive attributes, they spelt out the negatives. “Ray sometimes says or does things to employees which makes them feel incompetent, unnecessary, humiliated, overwhelmed, belittled, pressed or otherwise bad,” the memo read. “If he doesn’t manage people well, growth will be stunted and we will all be affected.” That memo hurt and surprised Dalio. 
 
He started thinking of how he approached people and began developing a unique culture at Bridgewater, the keywords of which are: “radical truth and radical transparency.” Dalio claims to have developed a culture of openly and thoughtfully disagreeing on the most important issues; this, he thinks, is the most powerful way of creating meaningful work, meaningful relationships and great outcomes. He wanted his colleagues to get past their ego and put out their honest thoughts, to be able to have thoughtful disagreements. Even if the disagreements remained, he wanted a way to get over them so that no bad blood remains.
 
Indeed, Bridgewater is the target of fascination for the social experiment it runs inside the firm, some of it quite hard for an average person to stomach. The firm explicitly orders its 1,500 employees to follow the rules of behaviour enunciated in the ‘Principles’ which can be very unsettling. One of the principles is “Evaluate accurately, not kindly.” Another is “Recognize that tough love is both the hardest and the most important type of love to give (because it is so rarely welcomed).”As a matter of routine, all conversations and meetings are video-recorded so that employees can analyse them later. Employees are supposed to rate each other—using the principle of ‘radical transparency’; they are known to use an app to score their colleagues’ arguments in real time. Feedback can be blunt and brutal and can come from a junior about her senior. And all this data is then analysed to see how the firm can improve.
 
Among the many other unusual practices at Bridgewater (apart from video-taping meetings) is publicising every employee’s performance review, interrupting investment meetings to provide personal feedback before dozens of colleagues and to openly and critically examine the firm’s practices, to generate high performance. Dalio’s book of principles also formed the basis for nightly ‘homework’ assignments that quiz people on their understanding of the principles. If you don’t fit into this culture, you quit. Staff turnover, especially among the new employees, is high; many leave in tears, according to the media, though Dalio calls such accounts fake and exaggerated. 
 
Dalio believes that everyone can benefit from a meritocracy based on radical truth and radical transparency. While his own achievement is, undoubtedly, great, it is worth wondering whether the culture has led to its success or the success has allowed it to get away with this weird culture. While Dalio does believe that his success flows from the principles, there are many successful and durable organisations with their own culture that are quite different from Bridgewater’s. It could be just a bit presumptuous that there is one correct way, which Dalio has found, and is letting others know it.
 
The biggest problem is that homilies (parts two and three), which will be impossible to apply in real life, are spread over a massive 440 pages. They are heavy, bland and, often, without context. After all, to know “don’t be afraid to fix the difficult things” and “clearly assign responsibilities” is not going to help much. There are literally hundreds of such small and big ideas. It’s exhausting even to glance at them. But I will certainly wait for the second book—on investing and economy—because Dalio’s distilled wisdom on these areas would be worth its weight in gold. 
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Ralph Rau

1 year ago

Mr Dalio has built an organisation of artificial intelligence and automatons. A dehumanised cyborg company. He is in this respect clearly ahead of his time.

The Buy & Forget of Coffee Can Portfolio? Forget It!
How many books can you churn out of a simple two-factor quantitative filter, of 34-year vintage, called the ‘Coffee Can Portfolio’ (CCP)? Two years ago, Saurabh Mukerjea, CEO of institutional equities, Ambit Capital, came out with Unusual Billionaires, a 445-page tome that was essentially the story of seven of the eight companies that met the CCP criteria. Mukherjea is back with another book called Coffee Can Investing. But first, what is CCP?
 
In a paper in 1984, Robert Kirby of Kirby Capital had narrated an incident involving his client’s husband who had purchased stocks recommended by Kirby at $5,000 each. He did not ever sell anything. Metaphorically, he stuffed the certificates in a coffee can. (In the 1900s, much before bank branches spread, Americans used to save their valuables and cash in a coffee can.) A decade later, these turned out to have created enormous wealth. One the holdings was Xerox which ballooned to over $800,000 in value. In describing this outcome of ‘buy and forget’, Kirby coined the term Coffee Can Portfolio. Separately, a study by Fidelity showed that there were two categories of people who made the maximum money—those who were dead and those who had forgotten about their investments.
 
Can one create such buy & forget portfolio now? The book suggests select companies with, at least, Rs100 crore of market-cap. Shortlist those which have been around for 10 years. Select companies with at least 10% revenue growth and 15% return on capital employed (RoCE) for each one of the past 10 years. For financial firms, use return on equity (RoE) of 15% and loan growth of 15% every year. Imagine, these few simple steps have yielded at least two books already. 
 
In Unusual Billionaires, eight companies managed to fulfil both, the growth and return criteria, in each of the past 10 years while the list has gone up to 12 in Coffee Can Investing. But will it make you wealthy? The authors promise so. “The CCPs are full of companies that are the Rahul Dravids of the business world—rare, determined and constantly seeking to improve the edge or the advantage they enjoy vis-à-vis their competitors.”
 
Really? The authors, very helpfully, have provided the CCP of each year starting from 2000 in the appendix. What is startling is the frequent appearance of, literally, the dregs of the market every few years in this august list of Rahul Dravids—companies that were accused of horrible mis-governance, including cheating and siphoning money, leaving banks and shareholders in the lurch. 
 
The CCP of 2001, included Roofit Industries, a de-listed company, part of a scam-ridden group that included two other companies (also delisted)— Soundcraft Industries and Kolar Biotech! Its promoter had a non-bailable warrant issued against him and had reportedly fled the country (https://tinyurl.com/ybopcxfx). The 2004 list included Alok Industries an outstanding value destroyer which is under insolvency now. The 2007 list had Aftek, another dubious operation, which got de-listed. The 2010 list had Punjab National Bank (PNB) and Tulip Telecom (also de-listed). 
 
The 2011 list, apart from PNB and Tulip, had Unity Infrastructure (down from over Rs100 to Rs5 now), Zylog Systems, (down from Rs320 to Rs3 and listed only in name) and Amar Remedies which crashed from over Rs160 to Rs6 and in one and half years and got de-listed. The 2012 list had Tecpro, down from over Rs400 to Rs4. It is one thing for a model to pick up occasional laggards. It is quite another matter for the model to serve you a refined list of 8-12 stocks among thousands, some of which get de-listed or lose 99% of value, or are run by scamster promoters. 
 
The first book is about seven stories of the eight CCP stocks and was strangely called Unusual Billionaires. The second book is called Coffee Can Investing but CCP is only a part of it. The book is an appeal to retail savers to plan their finances by avoiding insurance, gold, real estate and fixed-income products for wealth creation. CCP is advocated to be a small part of the financial plan which should be made up of Nifty ETF (exchange traded fund) and mid-cap mutual fund schemes. I am not sure whether it will be easy for savers to digest, and actually apply the strategy, when they see some of their ‘Rahul Dravid stocks’ lose 50%-60% value in a year when the market is actually up. Of course, if they hire Ambit’s financial planners, as seems to have been frequently hinted, it may help. 
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COMMENTS

Kumaraditya Sarkar

10 months ago

Absolutely nailed it. Ignorance is bliss in case of investing. People should just read Benjamin Graham if they have to read anything at all. Pick and Shovel large caps with good dividend yield works best for long term.

Ralph Rau

1 year ago

One should review one's portfolio infrequently - not less than once a year and not more than four times.

If for the simple reason that the good perfomers of a decade ago may be poor performers and may not even be around today.

Just because Dhirubhai did a great job in his choice of business there is no guarantee that the heirs will have a comparable vision or enthusiasm in the way they pursue their own sectors for investment.

Patric

1 year ago

Sir, how have their suggested portfolio done so far?
The ones that have been held for 10 +yrs

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