Black Swans, The End of Jobs, and Long Volatility with Taylor Pearson of Mutiny Fund
Today, we are diving into how to be antifragile with Taylor Pearson.
Taylor’s physical backdrop (a Black Swan montage) is also a background concept for our discussion. The 2008 Financial Crisis set him on the path to explore complexity and antifragility.
Taylor is a principal of Mutiny Fund. Mutiny Fund believes “Offense wins games. Defense wins championships.” This idea is applied to the long volatility and tail risk focused hedge fund. Mutiny’s goal is to maximize the long-term growth of investors’ portfolios.
To start our chat, Taylor explains how he got started in SEO, went on to write The End of Jobs (about complexity and the future of careers), and then became interested in crypto and investing. We talk a lot about long volatility strategy and when it may be better to lose a little for a long time and to (hopefully) make a LOT of money a tiny bit of the time.
Links to Platforms:
Here’s what I learned from the episode:
The internet was a gateway to previously unservable markets. Like for custom cat furniture (seriously). Web3 will unlock even more new possibilities.
Vending machines are like crypto. Vending machines unlock otherwise non-viable economic activity. Vending machines are like rudimentary smart contracts.
Mutiny Fund is a fund of funds. They invest in other long volatility hedge funds and aggregate them together. The idea is to diversify your diversifiers.
With long volatility, the goal is to mostly break even or lose a little most of the time. But then, when everything else goes down, you can make a lot.
The strategy works by using uncorrelated assets with 0% expected return. You can rebalance these uncorrelated assets to create a positive return. (This is what Taylor calls “The Free Lunch”)
The mistake most investors make is they look at their portfolio as a series of line items. Instead, investors need to think more holistically. They need to consider how assets interact with one another; the whole is greater than the sum of its parts.
A White Moose is the opposite of a Black Swan. It’s what happens when you keep betting on a Black Swan, but it never materializes.
People tend to have short memories. They tend to concentrate on assets that did well over shorter time spans. But things change. A broadly diversified portfolio allows you to capitalize on change.
Learn more about Taylor Pearson
Additional episodes if you enjoyed:
Andrew Wilkinson: De-risking Leverage, Investing vs. Operating, and the Best Part About Business
Phil Huber: Crazy Alternative Assets, Crypto for Financial Advisors & the Book Writing Process
Episode Transcript:
Eric Jorgenson: Where are you? Your office looks more and more like a tenured professor every time I see your background.
Taylor Pearson: Do I look smart? Do you want to give me your money, Eric?
Eric Jorgenson: I do, yeah. There's a lot more framed things and books behind you so I feel like you are incredibly intelligent and trustworthy.
Taylor Pearson: Yeah, I'm in, we have a townhouse and I'm in my office, but I’ve got these lovely bookshelves. So, these, the newspapers you see along the back wall, which I'll describe there, the first one is the Kennedy assassination, the second one is the moon landing, the third one is the Wall Street Journal on the day I was born, the 1987 flash crash, University of Tennessee National Championship year, and 9/11. So, this is my Black Swan montage of like the Black Swan over my lifetime and before kind of thing.
Eric Jorgenson: That's awesome. I do feel like that's a good place to start because I feel like you have maybe thought and written more about like the antifragility, Black Swan convexity set of ideas than most other people that I know that aren't named to Taleb. And I'm curious how that changed your, I don't know, how you think about your career or your trajectory or your work, or anything like that. Like why do you have those up on your wall and remind yourself constantly?
Taylor Pearson: I think like the formative adult event for me was like the global financial crisis 2008. So, I was in college in 2008, and it was this very like- I was like why or how does this work? Like I guess it was just I didn't know anything about finance, I studied history. But it was just like, I guess it was a jarring event. It was kind of this idea of no one knows what's going on. Like no one actually understands how this all works kind of stuff. And so, I got really- I mean, I didn't have any finance background or inclinations or anything at the time, but I just read everything. I signed up, this is like Barry Ritholtz, who obviously is not a big thing, but he was like, I think he's like Morgan Stanley, and he was like live blogging; every day he would come home from the Morgan Stanley trading floor and talk about like he was there or somewhere else. And so, I think that was just like a very formative event on me. I found sort of Nassim Taleb’s work. The Black Swan had come out in 2007 just before that. And it just like really made sense to me, this view of I'm going to call it complex systems but thinking about the interconnectedness and how that can cause these huge, unexpected events and what that implies. So that was kind of the genesis for me. And then really, I don't know, the last 14, 15 years, that's the main idea that's been interesting to me and motivating my work, and it's taken a bunch of different forms in terms of like expressing that or whatever, but that's kind of always been the central idea for me.
Eric Jorgenson: Yeah. So, if I ask you what is your specific knowledge, like what are you uniquely good at and excel at, do you think, is that the answer, like expressing this idea of like black swan, surprise outcomes of complex systems?
Taylor Pearson: Yeah, I think so. I guess the way I typically think about it is my first job was in marketing. I worked in marketing and operations with a few startups and did some consulting on that. And then I mostly do- I run a fund now, do marketing operations roles, kind of that side of the fund, with some of the investment strategy, but my partner is the main sort of investment strategy person. But I think that sort of mentality of how I look at the marketing and how I look at everything else, that's the lens that's unique and kind of how I approach it differently. So, yeah, I think that's sort of been the central organizing insight for me.
Eric Jorgenson: It's crazy that whole careers can come out of one insight well understood or one sort of kernel of an idea. Do you mind listing- you said it has like taken a bunch of different forms. I think that's probably a good way to like talk through all of the various stuff that you've done because I think it compiles to a really interesting sort of career trajectory. And I'd love to kind of explore the arc of your career projects and the big ideas that drove each one.
Taylor Pearson: Yeah. So, I started my career in marketing. I was a search engine optimization specialist at a marketing agency in Memphis, Tennessee, which is where I grew up. So, I had a history degree. I moved home after college because I graduated into the global financial crisis with a history degree from a third-tier university, so not a lot of job prospects. I bought a couple books on SEO and read them and I built some websites and ranked them. I was- I decided on college furniture, and I was ranking for a bunch of terms around buying college furniture. And so, I went out of that. I was making 500 bucks a month or something off this website, but I took it to a marketing agency. I was like, hey, I'm like okay at SEO, I built this college furniture website. It was like collegefurniture.net or something. And so, that was how I kind of got my first job and worked there, worked in marketing at a couple- at another startup in California for a few years after that. And I guess kind of maybe the first incarnation of like it's called the anti-fragility, the complexity stuff, was I published a book in 2015, that company I was working for got sold, and it was called The End of Jobs and just kind of looking at the future of work careers. And I think, really, it was like me trying to work out applying this idea of I'm just going to call like complexity as a shorthand for sort of like the thing we're talking about, complex systems, this idea of like complexity to careers. And so, I think one of the things that was interesting for me and motivating for writing that book was I grew up in Memphis, Tennessee. I went to school at like a small school in Alabama and all the career paths were these just like- the things I knew was like lawyer, accountant, work at Wells Fargo as a middleman. That's what most of my- that's what people were doing. They were graduating from there. And I sort of stumbled into this marketing thing and the internet and this whole thing. And I was like, wow, like the economy isn't this like stagnant thing where everyone's just accountants forever. It's this like really dynamic thing where it's like I remember telling my parents, I was like, oh, I got this job doing SEO. And they were like, what is SEO? You know what I mean? Like this is circa, what, 2010, 2011. And I had to like find these articles to convince them this was a real job. It's like, no, I like do these things to websites, and it helps people find them on Google and that's valuable, and people pay for that. I've never heard of it. And I could do that because no one had a degree in SEO. No one in 2008 was offering SEO degrees because just it wasn't a thing. It was totally novel. And so, that was sort of the first incarnation, like, okay, how do we take this idea of complexity and think about like how it applies to careers and how careers are changing. And kind of to your point of leverage, a lot of it was about like, hey, this internet thing is pretty cool. And you can get a lot of leverage doing things here that you couldn't before, all these businesses that were basically serving previously unservable markets. I'm selling this seemingly niche product, which I couldn't open a store in Memphis or something selling custom cat furniture. But like if you can sell to the entire world, custom cat furniture's actually like a pretty decent business. Like you can- a lot of people have cats, and they want to have nice furniture to have their litter boxes in or whatever.
Eric Jorgenson: So, you can finally live your dream of selling custom cat furniture.
Taylor Pearson: Yeah, actually one of the companies I worked for, we did sell custom cat furniture, so I know a fair amount about the high end cat furniture market.
Eric Jorgenson: Oh, no shit. I really thought you were just making that up.
Taylor Pearson: No, we shared parking equipment and cat furniture was our two main product lines. So that was dynamic.
Eric Jorgenson: You are just living in that long tail, yeah.
Taylor Pearson: Yeah, that's exactly right though. I mean, and that was the lesson. It was like, wow, there's like a whole business, and we sell like cat furniture and parking equipment, like two things I'd never even thought about in my life as like things you could make money doing or whatever. And so, I guess that was kind of iteration number one. I think kind of one of the ongoing projects for me just in general with- at that point, I started doing some consulting. It's kind of similar marketing operations type stuff. And again, just like kind of taking that complexity lens to it. I think that's always been sort of the unique way I've approached things. And then over time, that just kind of branched into investing. I got interested in investing. Particularly, I know like the crypto stuff, I sort of- I went to a meetup, actually, it was when I was moving to Austin, it was like spring of 2014. I was at this meetup at a coffee shop actually that I live next door to now. And there was a guy there who worked for Rootstock, which was one of- it's like a Bitcoin side chain. And I was like, what's this like Bitcoin thing? And anyway, we spent like three hours. I had no idea what it was. He spent three hours explaining it to me. And I got really interested in that as well. So, that's kind of been one iteration. I think like you think about sort of the complexity and the system dynamics and all that sort of stuff. Like crypto, web3, Bitcoin, whatever you want to call it, is like a really interesting expression of all that.
Eric Jorgenson: So, and that's going to be your second book. You're still working on that?
Taylor Pearson: Yeah. So, I started working- I have a 70% done book that was 70% done in 2019 that's still waiting around for finish.
Eric Jorgenson: It's a very annoying question to ask an author, I know, and I should know better, but I remember talking to you about that years ago. And it must be really hard to write about something that's evolving so quickly.
Taylor Pearson: Yeah, it is. I don't- So I wrote, I did write like a summary, the working title of the book is Markets are Eating the World. I wrote a blog post called Market are Eating the World that was kind of a summary of what I want to talk about with the book. I guess this is one particular rabbit hole, but there's this like kind of, I guess, subfield of economics called transaction cost economics. Like the big person everyone knows is Ronald Coase who wrote the papers called like the Theory of the Firm or the Nature of the Firm that was sort of the birth of transaction cost economics. And it's like sort of very relevant to the internet and crypto because his question was like, why do we have firms? Like if markets are so efficient, shouldn't we all just be like engaging in market transactions? Why do we have these like, you can almost think of companies as these like little socialist hierarchies within this broader capitalist system. And his answer to that was transaction cost. That if, theoretically, there's 20 tasks I need done, there's one person that could do each of those the best, but the cost to search, negotiation, and enforcement are like the three major ones. So I have to like find the person who’s going to do it. I have to negotiate the contract for how they're going to do the thing. And I have to enforce the contract. And that was functionally prohibitively expensive. So, it's like you don't hire a new person for every little task done. You hire someone, and even if they're not utilized a hundred percent of the time, it's still cheaper because you don't incur those transaction costs. And so, I got into that idea sort of writing The End of Jobs because all of a sudden, the internet changed a lot. Like we look at Upwork, Uber, like the whole idea of the gig economy is basically a way of saying like transaction costs went down. And so, lots of work that was done via firms became via being marketized, so to speak. And so that was kind of the idea of Markets are Eating the World. And I think if you look at crypto web3 stuff, the whole notion of smart contracts, it just feels like an extension of that same thing to me. It's like now all of a sudden, if you think about like probably the main transaction cost the internet brought down was like search and kind of negotiation. So, it's like I can go to Upwork, and I can type “Excel specialist” into Upwork, and it's going to pull up 50 qualified people with specific credentials, blah, blah, blah. And then if you think about like in a way, Upwork and Uber are really like mini nation states. There's like a rule of law. If you're engaging in it, there's effectively a court system. Like I'm hiring someone on Upwork. We have some dispute about how that contract is enforced, and they functionally have the equivalent of a court. They mediate that dispute. They make some ruling. They assess the [inaudible 11:47] one way or the other. And that kind of goes on. And so that was really interesting. And I think when I saw crypto, I was like, oh, now we could do all that through this notion of like smart contracts, and we could basically lower the enforcement cost. It's like when I engage in some transaction with someone on the Bitcoin blockchain or the [inaudible 12:10] blockchain, whatever, I have all the security guarantees that are inherent in the nature of that blockchain. So, in sense, that is now my court of law or that is now some sort of enforcement mechanism for the transaction I want to do. So that was a long rambling thing, but I guess that was kind of one of the side pieces of like the complexity thing is like how these networks, how work is organized, like the sort of network structure of it and where it goes. And then coming back to the idea of like emergence, just like what new possibilities does this unlock. Like in the same way the internet meant you could sell cat furniture or parking equipment or whatever, I think I got really excited about the crypto stuff, like oh, what new possibilities can we now unlock that I can engage in a transaction with someone that I don't know anything about, I'm not relying on any sort of trust intermediary like an Upwork or an Uber, whoever, to intermediate that transaction. It's just based on the language of the contract and the guarantees of whatever the underlying blockchain are.
Eric Jorgenson: I think that transaction cost economics is a really good lens to look at crypto through. Like that is how I explain it to probably total lay people – like, hey, things that used to be expensive in analog are going to get turned into software. You've seen that happen with the internet and software the first time; it's going to now happen to transactions and financialization of things and hopefully legal contracts through smart contracts in a big way. It is, by measure of actual impact, still really, really, really early in that, but it is a very interesting time to be kind of trying to project out 10, 20, 30 years and see what actually happens. I think I've heard you describe yourself as like softly technologically determinist or something like that. So, like starting with the technology and then thinking about all the downstream implications of it, like economically and culturally is really interesting kind of place to start.
Taylor Pearson: Yeah, that tends to be my bias. Yeah, it's like a very Marxist view. That was Marxist idea. Obviously, you can apply it in a lot of different ways that don't lead to Marxism. But one of the interesting ones with the crypto, the example I was thinking about is like the idea of a vending machine. I think Nick Savoy has a piece on this where he talks about- but like a vending machine unlocks an area of economic activity that was previously not viable. So, you put a vending machine in a hotel, you couldn't afford to staff a convenience store in like Motel 6. Like you wouldn't make enough sales to justify the overall- having someone be there and they have to open the shop up and drive to work, and you got to pay them for that and blah, blah, blah. But it like works fine as a vending machine because like 30, whatever, 20 people a day come and buy a bag of chips or some peanuts, and the vending machine is functionally a smart contract. I put a quarter in, I press Coca-Cola, that initiates a transaction. It checks that the quarter was received. It dispenses the Coca-Cola. And then, there's that big lock on the side that keeps you from stealing the quarter so that it's sufficiently- those are the security guarantees of the vending machine, which vending machines are not super exciting, but it's like I think it's kind of like the internet, Eric. It's like all these niches that just weren't economically viable previously suddenly became viable, and in aggregate, that was huge. I think it's been a while since I’ve looked at the stats, but over 50% of Amazon sales are from third party sellers, which is to say like not stuff they’re stocking or that like a Walmart would stock from Proctor & Gamble or Johnson & Johnson. It's like these people selling weird bespoke dog collars or whatever that in aggregate ends up being a lot.
Eric Jorgenson: I was just looking up – the long tail – I was looking up like a stuffed animal scale phone case because I thought it would be really nice to like, instead of pinching your phone against your shoulder, like just have a whole stuffed animal there, it'd be like really easy. Or like to hold that in your phone instead of like cramping your hand around like a tiny- so yeah, I live in that long tail.
Taylor Pearson: We all do now. That's where it is. We're all, we are all weird.
Eric Jorgenson: Let's just all be the free weirdos that we want to be. Let's go back for a second to your first book because I think that I've had a similar experience in the sense of you have an inkling- Like, I guess how much of that book did you learn as you wrote, as you were kind of like I feel like I'm squinting and I can see something and I need to like figure it out, and you're like writing your way towards something? And you ended up kind of like writing the playbook for the rest of your career. I feel like you started to describe that and then we went off in a different direction, but I think that's such an interesting thing.
Taylor Pearson: Yeah, I think it was just such a novel- I mean, just seeing, working with these internet businesses, I just wanted to like explain it to my friends from growing up really. It's like, hey, the world doesn't work exactly like we all thought it worked, it actually works, there's these kind of new, different things you can do. And so, I knew there was something interesting there, and there was like the long tail, I read a bunch about that. And so, I had some sort of like inklings of what it was, but for me, for sure, writing is very much like a figure it out as you go along process. I was like trying to figure out, yeah, what it meant and how it worked, and all that kind of stuff. So, it was definitely sort of an emergent phenomenon if you will.
Eric Jorgenson: Yeah. And was that book, publishing that book a big, I don't know, inflection point in your career or how it worked. It was like your first product. It sounded like you were consulting and working pretty much before that.
Taylor Pearson: That's right. Yeah, I was doing consulting stuff at the time and that was the first sort of product. It was definitely a big inflection point. I think it was, I guess, it put me on the map in some way with a certain subset of people and I think probably gave me a lot of confidence that I could like- about my writing and just general career stuff, like oh, this worked. Like I sold a decent number of copies of this thing and people liked it. And so, I think a big thing in that sense, and I think, too, it was definitely the jumpstart for sort of my- I guess I had a blog at the time. I want to say I had like 250 subscribers or something. So, it was like mostly buddies. So, it was like some of my friends from college and people, like loose professional contacts, and it went to like 15,000 overnight. I was like, wow, that's a lot of people. That's cool. What should I do? So, it was a big inflection point for me in that sense. I was like, okay, there's sort of like a community here or an audience and wanted to sort of nurture that and make something of that and build that out as an asset. So, I think I saw one of the companies that I worked for, the founders had a podcast and I just saw how powerful that was. Like, I just looked at their podcast and all the things that accomplished for them and the people they met and the doors it opened, and I was like- and this was- it was like one of the top 10 business podcasts at the time because like it was 2012, no one had a podcast.
Eric Jorgenson: There were only nine podcasts.
Taylor Pearson: Literally. There were like 32 podcasts in the entire business section of iTunes. Because it was like so clunky and hard to use and people didn’t have podcast players, that kind of thing. And was like it made a huge difference for them, even though podcast work, it's like, I didn't know anyone else that listened to podcasts. I was listening to podcasts, and I was like no one listens to podcast, like what is a podcast? So, I think, it was- it sort of set me on that path, and I've kind of always viewed that as sort of the hub, so to speak, that's kind of like the hub, and then I've branched out and kind of done these other projects.
Eric Jorgenson: Yeah. Your newsletter's still amazing. The Interesting Times I open all the time, just like good length summaries of things. I don’t know. I just feel like this idea that you have been refining is a really interesting way to look at the world, and it kind of explains a bunch of events that you don't really expect to have explained to you, or certainly not in the way that you frame things. So yeah, I've enjoyed it for a very long time. All right, so what are the other branches that we go off from the newsletter? I guess in your mind, what's the next sort of, I don’t know, inflection point maybe after that first book?
Taylor Pearson: Yeah, so I guess kind of chronologically, probably the next inflection point was, so I got interested in the crypto stuff and I started writing about the crypto stuff in kind of early 2017. I remember like, of course, the interest always follows the price action. And so, I think towards the end of 2016, Bitcoin doubled; it went from like 200 to 400 or something. And I owned a couple Bitcoin. I was like, oh, that's cool. Like what happened there? And so I got really interested and started reading a lot about it. And then to become a crypto expert circa mid-2017, you had to like read three blog posts and you knew- The bar was very low.
Eric Jorgenson: You had to actually read the white paper.
Taylor Pearson: Yeah, exactly. If you'd read like the Ethereum or Bitcoin white paper, it was like top 1%. You know what I mean? You could do it in like a weekend. And yeah, so I got really- I started writing about that, and I wrote mostly about crypto stuff sort of 2017, 2018, maybe into 2019 as well was when I was kind like working on the book. And so that was kind of like the next big phase for me. And so that was all the transaction costs and just thinking about how- and that was kind of, again, it’s just like an extension of the same idea from The End of Jobs thinking about how this affects work and how this affects structure of systems and all that kind of stuff. And then that kind of also led me into just investing and trading. I got really interested in finance, and I think you talk about complex systems like ecosystems or cities. And if you're interested in that topic, it's hard to find a more fertile sort of field of study then markets. Like it's just, it's an incredibly complex, super dynamic, always evolving system. It's a really good lens to talk about the things I want to talk about because people like money. So, if you can explain things in a way where like this helps you make better financial decisions, that's very compelling.
Eric Jorgenson: It's quantified in a way that cities aren't and contemporary in a way that history and war isn't, so yeah, makes sense.
Taylor Pearson: And so, yeah, so I got interested and I kind of wanted to do some more stuff in crypto or finance or something in that space. And I was working on my book, and then I met my now business partner who basically had this idea for what became Mutiny Fund.
Eric Jorgenson: How did you guys meet? I'm always curious to hear those stories. I feel like people gloss over that a lot, but it's like a huge blocker for people who have not yet been through that.
Taylor Pearson: A good example of like leverage [inaudible 22:42]. It was like through a friend on Twitter, basically. I co-wrote a post on stable coins with a friend of mine, and he read it. This was like 2018, I think. And so, we started talking about stable coins, and then yeah, anyway, he basically had this- I was looking at investing in a particular strategy that was the first kind of strategy we launched with. He had been trading that strategy and we kind of connected over that and started talking about it and grew out of that.
Eric Jorgenson: What was that strategy?
Taylor Pearson: So, it was long volatility. So, I'll insert my financial disclaimer here, that nothing we say is financial advice. Talk to your financial advisor. Markets are risky. You can lose all your money.
Eric Jorgenson: Especially with stable coins.
Taylor Pearson: Especially with stable coins. Especially with stable coins. So, the initial idea was or the initial concept was sort of very like Taleb-esque approach to long volatility. So, it's basically a strategy where the goal is most of the time you try to break even or just lose a little bit of money. And then when everything else goes down, you make a lot of money. And so all of a sudden, now you're in this very fortunate position where everyone else needs cash and asset prices are depressed, and you suddenly have a lot of cash. And so, we got connected over stable coins because this idea of, I guess, just call it like diversification at the simplest level or like stability through volatility. But if you can take different return streams, different assets, which are all volatile but uncorrelated at one another and combine them, the return stream you produce is very stable. So, the example I typically use with this is there's an approach called the permanent portfolio. This guy came up in the 70s named Harry Brown. It's basically equal part stock, cash, bond, and gold. And it's super simple, 25% of each of those four things, you rebalance it once a year. And if you look at how that strategy performed since he came up with it in the late 70s, sort of the tagline is like stock-like returns with bond-like volatility. So, you get sort of very close, very similar returns you would to an all-stock portfolio with much, much less volatility, even though the underlying components of that portfolio are volatile. And so, that was kind of how we connected over stable coins. And that was our sort of mutual interest in long volatility that you could take these negatively correlated to traditional assets thing, combine it with those, and you could produce a better portfolio. So, part of the initial idea was we would use this to make a stable coin. We'd have this diversified basket, and it would be not stable to the US dollar or something, but relatively stable on like a purchasing power basis. So, that was kind of how it got started.
Eric Jorgenson: And what is Mutiny Fund today? I want to explore a lot of that stuff, but I don't want to skate over the setup for all of these different vehicles.
Taylor Pearson: So, our first product was basically a long volatility strategy. We're basically a fund of funds. So, we invest in other long volatility hedge funds and aggregate them together. And again, we call it diversify your diversifiers. So, if you have- instead of having, going back to the- example, having these four big buckets, it's like what if you could diversify within the buckets, and then, you get more of the same effect. And so, that was the first thing.
Eric Jorgenson: So, well, diversify within diversification. So that's like, what, within your 25% gold, you have like part gold, part nickel, part Bitcoin, part- like sort of all of the- you split up within sort of the characteristics of gold?
Taylor Pearson: Yeah. So, I use like long volatility strategy as an example. There's a lot of different ways to trade long volatility. There's- trying not to get like too super wonky here, but you can trade what are called like relative value strategies where you're using the VIX, which is the volatility index that there's VIX futures financial instrument, you can trade options, you can trade those options in many different types of ways. And so, one of the interest things we found when we were researching this space is you had a lot of these strategies that were uncorrelated with each other most of the time, but they all became correlated with each other in the correct way when you had like a major risk off event. And so, by taking them, they were uncorrelated with each other most of the time, and combining them, you could create call it like a ratchet like effect, but basically improve your, if you can do that, it improves your risk adjusted returns. So, this is like a toy example or something, but it's mathematically possible you could have let's say three assets that are fairly uncorrelated with each other. They all have a 0% expected return. But if the path they take is uncorrelated and you rebalance between them, you'll create a positive return. So, I think another example I was reading in a blog post recently [inaudible 27:27] is I think from like 19- these dates are going to be off, but ballpark, 1962 to 1982, the total return on stocks was 4%, and total return on gold was 4.5% or something. But if you just rebalanced between the two every year, your return was 4.9%. So same underlying, you're just talking two things, but because those things are uncorrelated and you rebalance between them, you can improve the risk adjusted returns. So that's, they talk about diversification is the only free lunch in investing, like that's the free lunch. You're not taking any more risk. You're owning the same two things, but your risk adjusted returns, if those things are uncorrelated, ends up being significantly better. That was kind of the organizing insight for how we structured everything. So, we started with the long volatility piece, which we try to take that approach to long volatility of this thing that has that characteristic of it does well when most of the things tend to do badly, but then having diversification within that basket. And then currently our main product is called the Cockroach Fund, which basically takes that to the next level, which is so it combines, similar to Harry Brown's permanent portfolio, which was kind of our inspiration, it combines long volatility, commodities, stocks, and bonds. So, it's different in that it diversifies diversifiers. So, like, instead of using just gold as your commodities, we're trading a hundred plus different commodity markets. So again, you have that same characteristic of there's not a lot of correlation there. And so, you can sort of harvest that rebalancing premium while still serving sort of that fundamental role of commodities in the portfolio. And then you kind of did- stocks and bonds are relatively easy to diversify. You have ETFs at this point. Like sort of combining those all into a bond portfolio tries to get that better risk adjusted return like you would from having these uncorrelated bets.
Eric Jorgenson: So, this is something- I remember, I think I've read all of Taleb’s books, at least aside from the statistical, like incredibly math dense one. And I got really enamored with this idea of like long volatility and started to kind of drink the Kool-Aid of the complex systems. And I went down this path of trying to figure out how to actually, as an individual retail investor, like place that bet. Like I kind of wrapped my head around a long volatility strategy, and I still couldn't really figure out how to either access it or use it in the context of a broader portfolio. Because I think, and correct me if I'm wrong anywhere along here, but it is at least used by hedge funds as a small fraction of their strategy so that they are sort of balanced against some crazy event. It's not like they have a big chunk of it. And I just couldn't figure out how to access it or how to like fit it into the rest of the portfolio. So, how do you see this strategy fit into everything else?
Taylor Pearson: Yeah, so that's kind of part of the reason we started [inaudible 30:15] as it is. There are funds that specialize in this. As with most hedge funds, the minimums tend to be somewhere between $1 and 20 million, and if you want some diversification, you're going to write three $5 million checks and then you don't want that to be all your portfolio. Let's say you want it to be a quarter of your portfolio. So now you're talking about you have to have $60 million to be able to like put some portfolio and size it appropriately. And so that was kind of the problem we were solving with. Long volatility, it was like we would combine these at our level, and we could give much smaller retail investors or non-institutional investors access to these strategies. So yes, and it is super hard. People do try and trade this themselves. You can do that. It's really hard. I've tried to do it. I’ve been on that road. But the people that are doing that fairly successfully are quantitative teams with three PhDs on there that have like a robust order system and all this sort of stuff. So it is, we feel like it is one area where active management still is justified. It's just it's not something that's super retail accessible. And then in terms of how it fits into portfolio, it's interesting, no one- I mean, I think part of the reason the strategy has worked historically, in my opinion, is it kind of like sucks as an investor because you mostly lose money. And if you've read something like Taleb has some lines in his book where he's like, you're just so sick of explaining to all these investors, they're like, oh, well we lost money. He's like, yeah, you're going to lose money like 99 out of 100 months, like that's how the strategy works. And that is how the strategy works. And you can do some things to try to mediate that. But if you look at it, most investors, I think this is one of the biggest mistakes investors make, they look at their portfolios as series of line items, and they want to pick the best line items. And so, this is how you get into return [inaudible 32:05], and on these ten things, and these three things went up the most last year, so I'm going to buy more of those things. And really, you should think about the portfolio holistically of how do these things interact with one another? So, the idea of long volatility in the portfolio is even if it has zero expected return, over the 10-year period, it makes no money. If it makes money when everything else in the portfolio goes down, it allows you to rebalance at the optimal time, basically buy everything else when it's less, and then use some of those profits as those things go back up to get back into the long volatility. So, it's that rebalancing effect that creates the sort of whole is greater than the sum of its parts.
Eric Jorgenson: And the goal that it serves is something I think I've seen you write about a few times, like the thousand-year portfolio or the hundred-year portfolio. Like it is extremely, like it is geared towards people with a very long-term view and a very low- like not active investors. Like it feels like almost a level up from a passive index of like just be a little more deliberate with your portfolio construction and think about a very long-term time horizon.
Taylor Pearson: Yeah, yes and no. So, I think there's- if you look at, this is like a super standard thing. In finance theory, they have this idea of like the efficient frontier. So, it's like what combination of these assets gets me the most return per unit of risk. And usually risk is defined as volatility, which I have some issues with, but we can sort of brush that aside, but just thinking about it basically as like return per unit of risk. So, the optimal portfolio, sort of according to this theory, is you want to get the best risk adjusted returns and you want to apply leverage to get whatever your return targets are. So, it's the best risk adjusted returns is this much stocks, this much bonds, this much gold, which you want to get higher returns, well, then you use a little bit of leverage and you do that. In practice, people- So you kind of have two ways of getting higher returns. You can either take leverage risk. You can have a diversified portfolio that uses leverage. Or you can take concentration risk. You can buy super risky assets that might go up a lot but super concentrated tech stocks and whatever, and the financial theory, everything suggests that having a highly diversified thing and using a modest amount of leverage is a better long-term risk adjusted return than taking a lot of the concentration risk. And so that's sort of the approach we take. And I think a lot of people, I think the strategies aren't super popular because people don't like long volatility because it usually loses money, and people don't like- people generally seem to prefer concentration risk over leverage risk. But all that to say, I think a lot of times, it's like, oh, well diversification is like, that's something I do if I’m going to be conservative and I'm going to be safe, and I'm like not going to try and do super well. And if you do- it's mathematically just not correct actually. It is a log wealth maximizing strategy. This whole idea of the Kelly criterion and bet sizing that was developed by- was the name Ed Kelly? Ed Thorp was the one that kind of popularized it, but he was an engineer at Bell Labs. And he did it with blackjack initially, which I think where he sort of developed. But basically, the idea is if you have a coin flip and you have, let's say, you have a loaded dice, and let's say you have a slight edge in the loaded dice, how much of your bankroll do you want to bet on the dice? So, you're cheating, so you have an edge, but you could still be wrong. So, let's say that six on the dice should show up 16% of the time and you load it so the six is going to show up 25% of the time. So, you have a meaningful edge there, but if you bet everything you have, you're still going to be wrong over the course of the time, you lose everything. But if you don't bet enough, you're hurting your long-term gain. You could be betting more to take more advantage of your edge. So, he basically solved that, that if you know your odds and you know your edge and you know your odds, you can calculate the mathematically correct size of your bank roll to bet. And so that's kind of, in theory, that's what sort of more diversified approaches, like what we do, are trying to achieve. In practice, it's never- if you look at really diversified portfolios’ return sheet, they just do okay all the time, which is like not super cool. It's never the best returning thing. We joke, it's like we try to build the least shitty portfolio we can. And that, mathematically, if you look at that approach, it should be the best sort of long-term wealth maximizing approach. But over any given day, month, week, year, it's going to underperform something. Something else that has more volatility is going to do better. So anyway, yeah, to your- it is a long rambling answer to your question, but to your earlier question, that's kind of the idea.
Eric Jorgenson: You have said it's not super popular, but who has it been- who is attracted to this? Who is using sort of the long volatility strategy and how are they using it?
Taylor Pearson: So, I would say, I think there's one category of people that we don't super try to encourage, it's like the permabear crowd. One of our back-office partners has this idea of the White Moose. So, the white moose is the opposite of the black swan. The White Moose is what happens when you keep betting on the Black Swan and it never materializes, and you just sort of get chipped away. You need to have Black Swan and you need to have White Moose. You need to have things that have that long volatility profile or are sort of crisis assets, but also things that just do well most of the time and are just kind of like chugging along. And so, yeah, one category of people is people that are just like using it as a bet on the end of the world, which I don't think- my opinion is that strategy doesn't work very well because the world usually doesn't end, and if it does then, we all have bigger problems. But I think the other group of people are just people who understand more or less what I just explained, which is, okay, this thing as a standalone investment is bad, but I own a lot of stocks, bonds, private equity, venture capital, et cetera, all those things, if you have a major risk event, tend to be correlated with each other. They all tend to go- if you look at 2008, all those asset classes went down. And so having something else to diversify that with that I can rebalance should improve the overall return to the portfolio. And so, I think that's kind of the core idea.
Eric Jorgenson: Let me see if I can recap a little bit, and again, please, correct me if I'm wrong, but let me- so Mutiny Fund is a fund of funds that creates a sort of anti-correlated asset with the things that most people own, which is like stocks and bonds. So, if you invest in Mutiny, that money ends up split among a variety, a handful of hedge funds that are actively trading a long volatility strategy, which I want to have you explain how that actually works, so that if what just happened a month ago happens again and all the tech stocks that you own go down by 80%, this other asset you've invested in through Mutiny goes up by, I don't know, 3X, 5X, 10X, like I've seen some absurd numbers come out of some of these hedge funds that are like appropriately positioned for crashes. But can you get into the details at all of like what those hedge funds that you invest in are doing? Like, how are they- what does that strategy look like day to day?
Taylor Pearson: Sure. Yeah, so we have one fund that does that; it’s a fund of funds for long volatility. And then we have another fund that invests in the long volatility fund and also does the stocks, bonds, and commodities pieces. That's sort of our total portfolio. That's the Cockroach fund.
Eric Jorgenson: So that's kind of the like if you want Mutiny to execute the whole strategy, you can just go in that. And if you want to do your own rebalancing portfolio, then you provide just that one kind of pure like anti correlated asset?
Taylor Pearson: Correct. Yeah, I guess part of the reason we launched the Cockroach Fund is because no one actually rebalances. Or, in practice, people don't, and so doing it all in one place seems to work better. But yeah, no, I can go into- Yes, we're functionally a fund of funds. We are technically called a commodity pool operator. So, we have different funds we work with. Most of them, we have what are called SMAs, separately managed accounts, where we basically grant them limited power of attorney to trade on our fund's behalf. And then we're monitoring their trading and what they're doing. Within there, we have basically three different sub strategies or different approaches to long volatility. The core of what we do is our long options bucket. And so that's sort of called, that's the purest expression of long volatility [inaudible 40:53]. They're basically going out and they're buying options, and those options should have a convex payoff profile. They're going to lose a little money most of the time and hopefully make a lot of money a little bit of the time. And I guess I could, just briefly to explain what an option is – and you can stop me if this is a old ad for people – but an option is sort of a bet on the future. It's the right but not the obligation to buy or sell a security at a specific price in the future. So functionally for long volatility strategies, you're using put options, which is basically a bet on the market going down, sort of akin to like insurance. So, you say I'm going to buy, the S&P is at 4,000. I'm going to buy a put option for 3,800. And if the S&P goes below 3,800 over whatever time period I specify, I would say a month from now, I earn some amount of profit on that option. And that's vastly oversimplified, but that's the basic idea.
Eric Jorgenson: And you're paying a few dollars, like as a percentage of that, you're paying like a small fraction of what you could earn event happens, right?
Taylor Pearson: Yes. So, options have- they are sort of called the optioned Greeks. So, the primary Greek is called Delta. So, a given option has a different Delta. So, a deep- you can cut me off-
Eric Jorgenson: No, I'm going to need a whiteboard. This is the 301 course.
Taylor Pearson: Sheldon Natenberg Option Volatility & Pricing is on my back shelf. That's the- if you want an introduction, that is the that is the definitive text. So, when an option is- so let's say I use my example of the S&P is trading at 4,000. Let's say I buy a put option for 6,000. So that option is deep in the money already. I'm betting that it's going to be below 6,000, and it's already at 4,000. So, at that point, a $1 change in the underlying, the S&P in this case, tends to create a $1 change or very close to $1 change, it's a one Delta option effectively. You think about it, it makes sense, the S&P goes down by 5%, like it doesn't really change the probability that that's going to finish in the money. Like you're very deep in the money. Now, if you go on the other side, let's say I buy, S&P is at 4,000, I buy a put option at 1,500, way out of the money, that's going to have a very low Delta. Because if the S&P goes from 4,000 to 3,900, it’s still probably not going down to 1,500. The probability of it going all the way there is a lot lower. So, there's a second order Greek called Gamma which is the Delta of the Delta effectively. And like that deep in the money option is going to have sort of like different Gamma properties than the [inaudible 43:33] the money. But the basic idea is options are going to have different amounts of convexity. So certain- like a deep out of the money option is going to have the properties you can- If I buy the 1,500 S&P call, S&P put, S&P 4,000, and the S&P goes down to 1,000, I'm going to make 200X. There's going to be some- there should be some very high return because it was very deep out of the money, but other options aren't that way. So, the long answer to your question, but yes, there are different sort of payoff profiles with options that you can customize.
Eric Jorgenson: Maybe the bigger the Black Swan, the bigger the magnitude of the event that you're betting on, the less you are paying for how much you earn as an outcome to that.
Taylor Pearson: Yes. Yeah, generally, that's true. There's a bunch of caveats about transaction cost and that kind of stuff. But yeah.
Eric Jorgenson: I was trying to oversimplify, so I'm glad that there was caveat necessary, just to sort of summarize. Okay so, I mean, all of this complexity is why these are still actively managed funds. Like there's these, the hedge funds that you're investing in are actively like purchasing, seeking good deals on these options all the time and constantly refreshing and stacking layers of different options and trying to figure out how to cheaply manage the strategy so that they still have a great payoff if things go down.
Taylor Pearson: So, the way you usually look at options prices is they form what's called a volatility surface. So, we'll stick with our example of the S&P at 4,000. You have puts and calls, talking [inaudible 45:03] about puts, but calls are bets about things are going to go up, puts the bets are going to go down, and then you have different strike prices, which is the price you have- We talked about the 1,500 put or the 6,000 put, and then you have different expiries. So, one option could be a one-week expiry. It has to go below 1,500 in one week. And that's the specific bet you make on that option. Another one could be it has to go above 4,200 in 6 months. And you can plot all these things three dimensionally, and it forms a volatility surface, like kind of look, if you look at like a geographic or topographic map with like a mountain, it kind of looks like that. Like it's sort of like ridges and moves. And so, [inaudible 45:42] most managers are doing is they're looking for what their sort of proprietary algorithms experience, et cetera, or the relatively cheap parts of the volatility surface. So, say, oh, this option for the Chinese won, blah, blah, blah, looks relatively cheap compared to this other option, and I think it has this sort of payout profile. And so that's relatively attractive. So, they're all, for the most part, the hedge funds that do this are doing some form of that. They're looking at the volatility surface and trying to look at what are the relatively cheap parts, what are the relatively expensive parts?
Eric Jorgenson: Yeah, interesting. Okay, so the other thing that I- when I was reading more about this, and this is a few years ago now because it was before Mutiny Fund existed, and I was just like, why is there not a resale accessible version of this? And then I just kind of gave up. But I was like- I was reading about- it seemed to me that there should be a simple enough strategy. I was like, why isn't there like an index fund for this? And then someone was like, have you heard of the VIX? I was like no. And so, I went and was like, oh, this is an index for this. And then every single article I read about it was like do not invest in the VIX. It will eat your face. This is a terrible way to execute this strategy. Like, don't do it. I don't know why anyone does. Because that's what you're like competing with basically. Like that's the other option that's accessible to retail investors. Like what is wrong with it? What is it? How does it work? And what's wrong with it?
Taylor Pearson: So VIX stands for volatility index. If you like pull up YCharts, whatever, Market Dashboard, you can look up the VIX, you can see what it is in real time. It gets called like the fear gauge, is like the general idea. But it's a calculation based on various option prices, S&P option prices that could fit in. And generally, the way it works is if people are worried about bad things happening, they're willing to pay more for options, which means the VIX goes up, or if people are less worried [inaudible 47:38] for options, the VIX goes down. The biggest misconception of the VIX is that- so you actually cannot trade the VIX. It's an index. You can't trade the VIX because no rational counterparty would ever take the other side of the trade because typically the VIX stays at a certain level and it only goes up. It like never goes down below a certain level. So, the CME, Chicago Mercantile Exchange, developed VIX futures, and VIX futures forms what's called the VIX curve, but it basically has different expiries on the VIX. So as an example, the standard, sort of the standard structure of the VIX is let's say the VIX index is at 20 right now. One month out, the futures contract for the VIX might be at 22. There's a month between here and there. Something bad that we don't foresee could happen, so people are willing to pay a little bit more. And then over that month, either something bad is going to happen, the VIX goes up and the price of the futures converges with the spot. Or nothing bad happens, and the price of the futures falls. And you have, I think it goes out nine months. I can't remember how many months out the expiry goes, but the general structure of the VIX is it's a little bit higher every month. So, it's 21 one month out. It's 22 two months out, and 22.5 and so on. And then if something really bad happens, the shape tends to invert. So now the VIX is at 50 and it's like, well, some crazy stuff has happened, but like we probably can't keep doing crazy stuff forever, so the next month is 45 and 40 and so on. But your question about trading the VIX, yeah, I mean, it's extremely volatile. So, it's very easy to get your face ripped off if you don't know what you're doing. It's very easy to get your face ripped off if you do know what you're doing. You have to really, really know what you're doing. But the typical challenge with a lot of passive volatility strategies historically has been they lose so much most of the time that even when they do well, it doesn't compensate. So, you do have to have some balance. Something that loses a little bit but then makes a lot is okay. But something that loses a fair amount and then only makes back a fair amount, it doesn't really work. So, most of the- historically, if you look at just like a naive approach to like there are various ETMs and stuff that do this, it's just hard to make the math work where like, yes, is it negatively correlated, but it just loses so much most of the time that it doesn't really work.
Eric Jorgenson: Yeah. I mean, back to the transaction cost idea, it has to outperform by enough. And the same is true of the fees involved in some of these funds, too. Like they have to outperform and outperform their own fees in those sort of adversarial environments. Which I'm sure is part of the math. Does that add anything? Actually, I don't know how the fund of funds things works. Like, do you get negotiating leverage over the hedge funds that you work with so that it kind of nets out for clients? Or is it like fees on fees?
Taylor Pearson: Yeah, both. Yeah, we do get some negotiating leverage. But obviously, we assess a fee at our level as well. So yeah, I guess the reason we started this is we looked at net of all fees, what is the best solution? And we think net of all fees, an ensemble of active long volatility hedge funds is a better solution than passive approaches. But it is, yeah, we can do a whole conversation around passive investing and why that makes sense or whatever, but it's not- if your goal is to minimize fees, you're probably not ending up in long volatility. But if your goal is to maximize risk adjusted returns, then it might make sense.
Eric Jorgenson: Yeah. I mean, as far as I can tell, there is no non fee way to access the strategy really. You're the first person or the first way that I know of for retail to do it at all. And the hedge funds are doing essentially the same thing and still outperforming in a lot of cases.
Taylor Pearson: Yeah, I mean, there are various ETFs and ETMS, but as I said, historically, it just hasn't worked super well as a passive strategy. It's kind of the conclusion we came to.
Eric Jorgenson: Interesting. Are there future products in the funnel from Mutiny, or do you feel like this is the suite that you wanted to do and now you're just sort of executing and growing?
Taylor Pearson: Yeah, I think our vision was always, I talked about like the permanent portfolio and our sort of Cockroach Fund is like our implementation of that that we feel like is just a more modern and robust version. We know we're just using tools. Long volatility hedge funds- The VIX wasn't like tradable, like there wasn't enough liquidity to trade the VIX until like 2010. So, it's really only been around for 10 years. I think the oldest fund we invest in started in 2012, and that's like ancient in the long volatility world. Like most of the funds are much newer than that. There were some funds before that in like the- but it has historically been just like a very niche strategy.
Eric Jorgenson: Universe is kind of like the classic in this sense, right?
Taylor Pearson: Yeah, so Universe was the firm Taleb was associated with, they've been around one of the- I can't remember how long they've been around, maybe since the 90s or something. I don't know exactly when they started with it, but they're certainly one of the older ones. Most of the older funds tend to have very high minimums. So, most of them are exclusive institutions. I think you probably- there's articles in March that like CalPERS, the California pension retirement, was one of the big Universal clients which ended up pulling out and missing out on a bunch of- I think they pulled out in like January, and they would've made a billion dollars if they'd stayed in through March. But most of the older funds that I'm aware of tend to service like large institutional clients.
Eric Jorgenson: That's amazing. So, CalPERS is one of the biggest, I think, I don't know, pools of money in the world, functions still exactly like you described a retail investor of like looking at them all as line items and pulling out at the exact wrong time, losing patience with-
Taylor Pearson: When we started this, I was like, oh, all these institutional people must be so smart in everything. And broadly, my takeaway has been people are people and sort of the same psychological- We have retail investors we talk with that are super savvy and really understand everything and institutional people that you're like, did you find your money in a bag in the alleyway? Like how did this work? So yeah, just people are people.
Eric Jorgenson: Yeah, so, I mean, it's your job, from what I understand, now to evaluate hedge funds and sort of assemble this super team of super people who you know are going to execute. I'm sure there's layers to the evaluation of what's the strategy, what's the approach, how's it executed, who are the people. But what is that process like for you? What do you look for in the hedge funds that you assemble?
Taylor Pearson: Yeah, so one of the first things you want to know is how it- we kind look how, again, we always start from this like sort of holistic portfolio view. So, we always, in the context of long volatility specifically, we want to look at like how it compares to the other managers. So, I mentioned, I said we have three different buckets. The one I mentioned was long volatility. We have another one that's called volatility arbitrage. It's going long and short volatility. Again, so to find the relatively expensive volatility and sell it and the relatively cheap volatility and go long so that it can make money in both up and down volatility environments. And then we have a short futures bucket. So, all those, and then within each of those buckets, there’s diversification. So, there's different ways. If you're going to trade, you can trade at the money, you can trade near the money. You can trade deep out of the money. You can trade short term expiry. You can trade long term expiry. There's a bunch of different ways to trade each of those strategies. So, the first thing is, does it have some wrinkle? Are they doing something unique, something different, something from other major [inaudible 55:20] in our portfolio where that sort of has two big advantages? In our view, one is it creates something else uncorrelated. So, it's like we're adding another uncorrelated return stream into the portfolio. And then it also covers like another path dependent. So, when we talk about portfolio construction and we're looking at the portfolio, we basically never talk about like – I don’t want to say never – but the conversations are [inaudible 55:43], oh, I think this thing is going to do really good. Because our honest thing is like we don't know, and we don't think anyone knows certainly at like a macro level, what are stocks going to do, all that kind of stuff. We want to look at does this cover some path that is not covered by the rest of the portfolio? Does this cover some contingency, some Black Swan or some White Moose that the rest of the portfolio doesn't cover? So again, like this idea of building the least shitty portfolio. We want to cover as many of these possible path dependencies as we can so that sort of however things play out, it should do pretty good. So that's sort of the first thing. And then after that you get more into just like, I guess, operational and technical due diligence of are they doing all the regulatory things, and do they seem like they know what they're doing, or do they have a track record and that kind of stuff.
Eric Jorgenson: That sounds interesting. Tough, but interesting. How long have you been building up this core of knowledge? I mean, this all seems so detailed and arcane to- I mean, I've read a fair amount about this, at least at a high level, and it's still, like I've only understood like 40% of the last 20 minutes, I would say, with like high conviction.
Taylor Pearson: Yeah, which speaks to how well I can explain it, which is not that good at this point, but I'm working on it.
Eric Jorgenson: No, I mean, like I get it, but like I understood the example that you were giving me, but I know that there's a lot of depth to the idea that I just don't grok in the way that you do who's been thinking about it for, yeah.
Taylor Pearson: It's interesting. I'm working on a white paper on diversification, which diversification is like the most boring, tried topic in investing, where everyone's read something about diversification being good. And my opinion is like almost no one actually gets it. It's just like, you pay lip service to, but like no one actually gets really the underlying why it's so compelling and that kind of stuff. But it's really- it's hard to do in a podcast. You’ve got to have some graphs or something to sort of make it make sense.
Eric Jorgenson: Yeah, absolutely. I mean, it's one of those things that everyone tries to do, but then kind of like points at themselves for doing poorly. Like, we were all really excited that crypto was going to be this non correlated asset class and we would be able to diversify into it, but it basically so far seems to perform almost the exact same way as tech stocks, which may or may not be reasonable. It may turn out to be true over the long term. And then there's the- I don't know, I'll be interested to see your take on it because I feel like it's just one of those hotly debated things. It's interesting to hear you describe it as like a dial with sort of concentration risk and under performance risk on either side of it. So, it was like the Munger idea of the more you know, the less you diversify, but I don't think he's- I think he's talking about owning a few good companies, not a hundred-year portfolio of like if you were in a coma, it would still outperform.
Taylor Pearson: Yeah, I think- you can go back, if you just like take Berkshire stock and you combine it with some commodities and some other diversifiers, it's better because those things are uncorrelated to the- So I think even if that, some people, it’s like, oh, I'm really good at- you know what, I want to do this specific area of investing, it's like, cool, do that, and really go focus on that, and then diversify the rest of your portfolio and to do that. And I guess that's where you get back to sort of the genesis story, at least for my partner, was he was a real estate developer in the 2000s, and he was a good real estate developer. But when 2008 hit and the entire- it didn't matter how good of a real estate developer you were. Like there's a macro crisis that hits your industry, like my wife works for an events company, it didn't matter how good of an events company you were in March of 2020. It's totally irrelevant. You could have been the best events company in the world, your revenue went to zero, and that was sort of the nature of it. And so, that's kind of been- that's how we think about it. Like, yeah, go find your thing that you're really good at and like spend your time and focus on that. But I think most people tend to be like, oh, I run an Amazon business, so I understand Amazon, so I also invest a lot in Amazon stock, and they end up like triple levered to one very specific sort of bet, which when it works well, it works really, really well. If you're extremely levered to a very concentrated thing, you're going to have high volatility in your returns. It could be up, it could be down, but you're going to have high volatility in returns. And high volatility tends to hurt in the long run because losses hurt more than gains. So, a 5% loss, you only need a 5.3% gain to get back, but a 50% loss, you need a hundred percent gain to get back. A 75% loss, you need a 300% gain to get back. It's not one to one. The losses hurt more. So, that's kind of how we think about it.
Eric Jorgenson: How do you know – and this may be more of a career question than a portfolio size question, but either answer would probably be interesting – how do you know when to kind of shift focus between, hey, I need to be more in- I understand this thing really well, I need to exploit it maximally mode versus I’m in wealth preservation and like slow growth mode when you start to think about some of these things that are more portfolio construction and loss aversion, instead of like just executing and the things that you know and can control?
Taylor Pearson: Yeah. So, I think that's kind of a false dichotomy. But to go back, the optimal long run portfolio is always to have the most efficient mix of assets. And you could include assets as your skills, your network. We could lump all those things in there as well, and then sort of lever them in the appropriate way. So, I guess, it's like it's kind of never too early to think about the diversification component of it. I think just from a pragmatic, yeah, I don't know if you have like 200 bucks, should you think about like what hedge funds to invest in? Probably not. You know what I mean? Like there's some financial threshold or something where there's enough assets that you don't think about it that way. But I just finished reading, I read last year this book called The Origin of Wealth, which I bet you would like it.
Eric Jorgenson: It's a great book. I've read bits and pieces of it. I haven't done cover to cover, but I really liked it.
Taylor Pearson: And a bunch of other books talk about this idea of thinking in bets or applying portfolio strategy to your life, like Taleb, one of the examples he gives is Microsoft – I'm trying to remember the exact story – but Microsoft basically had- like Windows was one of like six different projects that Microsoft was running in parallel because they didn't know what was going to work. They were like doing MS-DOS and they were doing Windows, and they're doing all this other stuff. And so, it gets reported, like these stories get reported like, oh, this brilliant person saw that this was the future and built the thing. But like really, I think you look into all these stories and it's almost always the same thing. It's like these companies that last, it's like, no, it was super hedged. They're like, okay, there's six possible ways things can develop. We're going to have something industry, we're going to see what takes off, we're going to put assets behind that, that kind of thing. So, I think you can apply that same sort of logic of diversification, all that stuff, to other things you're doing. Which is like how do I sort of have a portfolio of bets, and what does that look like? So, yeah, I don't know. I think when it comes to your time, you do functionally get like, I guess you run into like a transaction- Like you can't work on like seven businesses at once. Like you end up-
Eric Jorgenson: I've tried it. It's very hard.
Taylor Pearson: You can’t switch between seven things, and yeah, it's very hard. So, I do think, yeah, at a certain point, you do need to sort of focus your time on one thing. And then I think, honestly, for a lot of people it's like they’re not trying to do the long-term wealth maximizing thing, they're trying to do like what they want to do with their life that's fun and whatever, and like, that's cool.
Eric Jorgenson: Okay, this is a question that I just like to ask a variety of people and I feel like you might have a good answer to since you're very, I don't know, a theme of a lot of what you talk about is like the long game, the long perspective, focus on compounding. I'm always on the hunt for who is playing the longest possible game and just like more and more examples of people who are thinking over like decades or even generations. Are there like heroes in your life or people that you've read or investors that you've studied that are really good examples of playing in an absurdly long game?
Taylor Pearson: Yeah, I mean, obviously we're trying to do that. I'm trying to think of other- I think like the story of Ed Thorp is really interesting. If you look at like he was- he sort of like took the Kelly- there's actually one of like- I would love to write a book on alternative histories of different things happening. So, Ed Thorp was, I forget exactly his relationship to Kelly, but he was like one of the early practitioners of the Kelly criterion. He had a hedge fund. I think he lived in Newport Beach, California. But it was like, I think the hedge fund, I'm going to miss some of these, but the hedge fund ran for 15 years or something. And he was like smoking Warren Buffet, like smoking Warren Buffet. And basically, his partner ended up engaging in all this fraud. The fund got shut down in like the late 80s, and it never went anywhere. And I want to do this alternative history of like, if he was still around today, would we talk about Warren Buffet or would we just talk about Ed Thorp? Because he actually was, he actually performed- I'm trying to- I'm saying he was smoking more, but I don't know if that's necessarily true, but he was performing extremely well over extremely long periods of time.
Eric Jorgenson: I think this is the second podcast in a row that Ed Thorp has come up. I was just talking to David Senra about him too. He's just like, I think he restarted with a separate fund that was smaller, but like had his own track record. There's just like he worked on a computer with Claude Shannon when he was trying to do Roulette. Like if I remember, it's a wild story.
Taylor Pearson: Yeah, he has a crazy story. There's a book called Fortune’s Formula that's like a really good- it's like Thorp and Kelly and all those guys and-
Eric Jorgenson: A Man for All Markets is his book, right?
Taylor Pearson: Yeah, that's his like biography. Yeah, I think my sense is like when the fund closed down, he'd already made an insane amount of money and he was like running in mansion in California.
Eric Jorgenson: I'm good, I'm good. Okay, so what is the long game for Mutiny? How do you see this playing out?
Taylor Pearson: I mean, I think the way we think about things is it really isn't like we're talking about the portfolio and stuff like a hundred-year timeline. It's like, okay, we can invest in this thing, and if this thing is going to blow up in the next hundred years, like that's a non-starter for us. That's too- we can't- we don't want to take that sort of concentration risk or that sort of risk. I guess that's like the frame we tend to operate in, trying to build that into how the business is run, how everything is operating, making the parts redundant, I’m a big SOPs guy and procedures and all that kind of stuff. So that's kind of a big part of how we operate. But I think sort of our broad view of things is people tend to have short memories. People tend to look at what did well over the last year, three years, five years, ten years, and things tend to get concentrated into those assets. And then things change. We have these phase shifts in markets where dynamics change. And so having this broadly diversified portfolio is essentially allowing you to capitalize on that. You own some of the thing that is doing well and outperforming, and as it's going up, you're selling some of that and buying a thing that's underperforming in the belief that at some point the story is going to reverse. And so, I think like, I mean, commodities are like a good- like commodities did so bad. Commodities trend is sort of the standard approach to- the common approach to trading commodities where you're looking for commodities with strong price range and you're going along to short them, and that strategy did really well in 2008. It was like it got built [inaudible 1:07:14]. It was exciting. And then from like 2010 to 2020, basically, it just sucked. It just like- it went nowhere. Everyone hated it. No one wanted to do it. And then, I think sort of late 2020 to present, we've all seen the commodity stuff in the news, oil prices, blah, blah, blah, it's doing great. And our view is like did we predict that? Did we foresee that? No. But that tends to be how the long-term history goes. You have these rotations between assets that come in and out of favor. And so, the optimal way to do it in our view is to have a balanced portfolio with exposure to all these different pieces.
Eric Jorgenson: So, you're like- I mean, when you're rebalancing these, are you just kind of betting on a reversion to the mean basically?
Taylor Pearson: Yeah, kind of. If you look like the permanent portfolio is a really interesting way to look at it. If you look at, you can Google examples, like the history of the permanent portfolio and like how the individual pieces perform versus the underlying pieces. And if you look at the individual pieces, like they're pretty- gold is pretty volatile historically, stocks are pretty volatile historically, bonds and cash not so volatile historically. But the combination of all of them, just it looks like it's just a straight line. It's just like a really smooth straight line. I think it's like, if you like run all these model portfolios, I think it's like the only thing that had positive returns in each of the last six decades or something, but it like never shoots the lights out. Like you're never going to make 50% in a year with a permanent portfolio because you're super diversified. But also, the hope is you never going to have a 50% draw down either like you would in a more concentrated portfolio. And so, that's from a portfolio construction perspective, like that's how we think about it. We want these diversified and correlated things with different return drivers that can combine to form a better long term compounding growth rate.
Eric Jorgenson: This is a very- I mean, over and over again, I feel like I've heard you say something like most people think X, we think Y. How have you like cultivated and how do you entrain that unique mindset to kind of hold your line and your set of beliefs when the world is kind of shouting something else at you every day? I feel like that's a very unique skill.
Taylor Pearson: I mean, I do think I have like a very high degree of- I think in 99% areas of my life, I just kind of go along with those- Like I have contrarian ideas about very few things. Like there's just a couple small things that- I'm not sure I'm particularly good at that. I think in this specific instance, there's like a lot of things, I guess, probably like you and probably like most people, I'm curious, and I want to figure things out. And I think with this sort of thing, I just kept trying, I'm always just trying to like prove it wrong. Like I'm probably trying to like, am I wrong about this? That's always the paranoid concern in the back of my head. And I'm like talking to all these people that are- I'm like, what do you know that I don't know? Like I love that, there's a famous scene in the Big Short movie where he's like trying to find his counterpart, Michael Burry that Steve Carell plays is trying to find- or it’s not- who is it that Steve Carell plays? I forget the guy's name, but he's trying to find his counterpart on the trade. Like he's shorting all these mortgage bonds, and he flies out to this conference in Vegas, and he meets with like this guy, his counterpart is this guy in New Jersey who is a total douche and is like not taking care of his investors. And so, as soon as he finds that out, he's like I want to load up on this trade as much as possible because now I know who I'm trading against and the guy's an idiot. And so, it's like, I'm always like who's the other person? Someone's taking the other side of the trade, and do they know something I don't know? And so, I think that's kind of like the constant thing. Like, who's taking the other side of this trade? Why are they doing it? Do they know something I don't know? Where does that go? And so, I think in this instance, it's like I've been asking that question and trying to get to the root of it for like four years. And I think the answers are most things, it's like people don't like- people tend to look at their portfolios as a series of line items. They don't like when this one thing goes down. They want everything to go up at the same time. So, I think some of it's just like, I guess, call them like psychological biases or just sort of like decision tendencies.
Eric Jorgenson: I think that was a part of the Big Short, if I remember right too, part of the short thesis was the people on the other side of this trade don't want to imagine what this failure is like because it's painful. It is like conjuring up an apocalyptic event, and then you have to believe it enough to bet on it. And there's very few people that can psychologically like do that.
Taylor Pearson: Yeah. And I think even like use- the big short is not the best- there's actually an interesting follow-up paper that looks at like how the big short funds performed after the Big Short. And they all kind of did bad. So, it's like it goes back to the White Moose kind of thing. It's like you can't bet on the bad thing happening all the time. You sort of need to have both those things. But yeah, I think like a lot of it, I think it's just like a short-term memory. It's like no one remembers, like I give the commodities example, but people like what's been doing well.
Eric Jorgenson: Especially for negative events. Every time I get in my head that like something did well and then I go back and check, it did less well than I thought it did that I had been like telling myself in my narrative in my head. My entry price is always higher than I remember it if I don't check it, like always. Okay, last question. I feel like I've learned so much about all of these things. What is the mental model or aphorism or heuristic that you think you reference the most frequently?
Taylor Pearson: Reality has a surprising amount of detail.
Eric Jorgenson: That is a very good one. I think I got that from you. I use that often.
Taylor Pearson: Yeah. There's a guy, I think there's a software engineer that wrote a blog post and I loved it. I wrote another post about his post, but yeah, he coined the term. I think his name is John Salvati or something. But yeah, I don't- an example I use is like, this is actually a fun thing, like you do it after the call or something, take out a piece of paper and try to draw a can opener, like how a can opener works. Like this is the handle, this is the blah, blah, blah. And you're like, it’s a can opener. How complicated- I use a can opener all the time. It's so simple. Try to draw it. You can't do it. It's super hard. You will not be able to draw a functional can opener, the way the gears intersect with the handle and the pins that go into the gears, and a can opener is like the simplest thing in the world. There's like five pieces to the whole thing. And so, as soon as you get into anything else, how to run a business, biology, your health, whatever, it's like infinitely complex. And I think I'm constantly reminding myself and trying to remind others to have some humility around that respect. And I think that comes out, this comes back to the antifragility, and it's what the famous Mark Twain line of its not knowledge that you don't know that hurts you, it's what you know for sure that stings. And so, if you realize that you don't know very much, you can avoid a lot of those things that really get into you. So, yeah, I end up talking about it all the time, and I'm sure you’re like, my God, this work project, this will take like a week. I'll just like knock this out. And it's like two months later, I'm like, holy crap, there were so many details to execute on this thing. And that was way harder than- And that happens over and over.
Eric Jorgenson: I love it. Yeah, and the less- the more outside your wheelhouse you are, the less of those details you know are going to be there going in. And the expert is the person who knows where the details lie and how to navigate them. Yeah, I've used that idea a lot. I remember reading it in your blog post, and I think I went back and read the original that you linked to. And yeah, it's an exceptionally helpful and, to your point, humility inducing idea, which is something that's good for all of us. Thank you so much, Taylor, for taking the time and at least attempting to teach me some things that I wish I understood better. And I'm very glad and grateful that you are building Mutiny Fund because I think it's something that the world needs. And it's just exciting to catch up and see what you've been working on. I appreciate you taking the time.
Taylor Pearson: Yeah, this was super fun. Thanks for having me. I feel like I rambled and was mostly incoherent, but hopefully people get something out of it. And yeah, man, always a pleasure to catch up.