Financial Essay - Evaluating Performance

Evaluating Performance - Published by Joel Stevens on October 30, 2017

This essay discusses the drawbacks of using trailing returns to evaluate performance and proposes a different statistical method instead. This method is then applied to the investment records for a variety of famous value investors.

Financial Essay: Measuring Returns

Measuring Returns - Published by Joel Stevens on January 5, 2017

This essay discusses various methods of calculating returns--simple rate of return, time weighted rate of return, and internal rate of return. In particular, the essay shows how each return is calculated, discusses common uses of those returns, and provides illustrative examples.

Rational Enlightenment Essay: No Will

No Will

A Path to Right View

Be kind, for everyone you meet is fighting a great battle.
Reverend John Watson

In Free Will, Sam Harris does an elegant job of dispelling the illusion of free will, which I have taken the liberty to dub ‘no will’ for the sake of brevity.  Primarily, Harris presents arguments against our having any conscious control over the actions we take as well as the societal implications of the recognition of that fact, particularly on our penal system.  Although he briefly mentions the positive impact of the framework of ‘no will’ personally, I believe that fully embracing this understanding causes a sea change in how we view the world, akin to the ‘Right View’ teachings of Buddhism.

Summary of No Will

There are three main arguments against free will, each strong enough to dispel it alone.  First, there is experimental evidence that consciousness only reflects decisions that have already been made at a lower level in the brain.  As Harris is a neuroscientist, I believe his summary is better than one I can provide:
The physiologist Benjamin Libet famously used EEG to show that activity in the brain’s motor cortex can be detected some 300 milliseconds before a person feels that he has decided to move.  Another lab extended this work using functional magnetic resonance imaging (fMRI): Subjects were asked to press one of two buttons while watching a “clock” composed of a random sequence of letters appearing on a screen.  They reported which letter was visible at the moment they decided to press one button or the other.  The experimenters found two brain regions that contained information about which button subjects would press a full 7 to 10 seconds before the decision was consciously made.  More recently, direct recordings from the cortex showed that the activity of merely 256 neurons was sufficient to predict with 80 percent accuracy a person’s decision to move 700 milliseconds before he became aware of it.
Thus, it appears that the decisions we make are not decisions at all, but instead the recognition of decisions other parts of our brain have already made. 

However, even if we ignore this finding or it is later refined in some manner, we are still left with the fact that our current state is the result of previous causes and effects outside of our influence.  It is telling that psychologists have argued whether our behavior is the result of nature or nurture, neither of which we control.  We do not have any choice over who our parents were, the particular set of genes we inherited from them, or the manner in which we were raised.  We also have little or no control over the external events that impact our lives.  How can we then say we have any influence over the current state of our bodies or minds, which results in the behaviors we undertake?
Finally, borrowing again from Harris, ‘no will’ can be understood simply through paying close attention to our own conscious experience.  What is the next thought you are going to have?  You don’t know.  Where will that thought have come from?  You don’t know.  Take a moment to try to control your thoughts.  How did that go?  Let’s take it one step further—try not to think about Dumbo for the next minute.  Did you have control over my mentioning a flying elephant?  Were you able to stop yourself from thinking about him?  If we are unable to predict or control our conscious thoughts, how could we be in control of the decisions we make even if we assumed our consciousness were in charge of the decision in the first place?

A Tragic Example

Charles Whitman was born in Florida in 1941, the eldest of three children.  He was intelligent, having an IQ of 139 at age six, proficient at piano, and earned the rank of Eagle Scout by age 12.  His father was an authoritarian and often physically and emotionally abused him, his mother, and his siblings.  After high school, he joined the Marine Corps and was reportedly well liked.  During his service, he earned a Good Conduct Medal, a Sharpshooter’s Badge, and an Expeditionary Medal.  Later, he married his wife and enrolled as a student at the University of Texas.  At some point during this time, a tumor began growing in his brain and he became increasingly aggressive.  It seems clear that he was ashamed of this behavior—two of his friends reported that he had told them of striking his wife on two occasions and was “mortally afraid of being like his father”.  He admonished himself in his journal and wrote a daily guide for himself that included: “CONTROL your anger…Don’t let it prove you the fool.  SMILE—It’s contagious.  DON’T be belligerent.  STOP cursing.  CONTROL your passion; DON’T LET IT lead YOU.”  He also visited a psychiatrist to discuss his issues and reported urges to “start shooting people with a deer rifle”.  Unfortunately, this urge was not seen as an imminent threat—he then killed his wife and mother and climbed the tower at UT, killing 14 people and wounding 32 others.  Before doing so, he wrote the following (emphasis added):
I don’t quite understand what it is that compels me to type this letter.  Perhaps it is to leave some vague reason for the actions I have recently performed.  I don’t really understand myself these days.  I am supposed to be an average reasonable and intelligent young man.  However, lately (I can’t recall when it started) I have been a victim of many unusual and irrational thoughts.  These thoughts constantly recur, and it requires a tremendous mental effort to concentrate on useful and progressive tasks.  In March when my parents made a physical break I noticed a great deal of stress.  I consulted a Dr. Cochrum at the University Health Center and asked him to recommend someone that I could consult with about some psychiatric disorders I felt I had.  I talked with a Doctor once for about two hours and tried to convey to him my fears that I felt some overwhelming violent impulses.  After one session I never saw the Doctor again, and since then I have been fighting my mental turmoil alone, and seemingly to no avail.  After my death I wish that an autopsy would be performed on me to see if there is any visible physical disorder.  I have had some tremendous headaches in the past and have consumed two large bottles of Excedrin in the past three months.
It was after much thought that I decided to kill my wife, Kathy, tonight, after I pick her up from work at the telephone company.  I love her dearly, and she has been as fine a wife to me as any man could ever hope to have.  I cannot rationally pinpoint any specific reason for doing this.  I don’t know whether it is selfishness, or if I don’t want her to face the embarrassment of my actions would surely cause her.  At this time, though, the prominent reason in my mind is that I truly do not consider this world worth living in, and am prepared to die, and I do not want to leave her to suffer alone in it.  I intend to kill her as painlessly as possible.
After the local police killed him, an autopsy was performed, and a tumor the size of a pecan was found in his brain.  Experts at the time concluded that “the relationship between the brain tumor and … Whitman’s actions … cannot be established with clarity.  However, the … tumor conceivable could have contributed to his inability to control his emotions and actions”.  More recently, some have proposed that the tumor pressed against the amygdala of his brain, which could explain some of his erratic behavior.

How much control did Whitman have over all of this?  Did he have any choice in the tumor growing in his brain?  Did he have any choice in his father’s abusive behavior while he was growing up?  It is obvious that he desired to behave in a different way and repeatedly attempted to address his own issues, but how could he do so if he couldn’t stop his own “unusual and irrational thoughts” or “overwhelming violent impulses”?

Despite his horrible actions, I have a great deal of empathy for Whitman.  That is not to say, of course, that he is not responsible for those actions—as the entity that performed them, he clearly is. However, this assertion rings rather hollow if he had influence over neither his stimulus nor his responses.  In that case, what is left?  Whitman’s consciousness, which most would characterize as ultimately who he is, appears to have been held hostage in a body and mind that generated irrational and violent impulses—ones that he apparently tried, but ultimately failed, to stop.  It must have been truly hellish to experience.

We Are Automata

My college roommate majored in computer science and had a great number of complex projects.  One of my favorites was on Artificial Intelligence, where he used genetic algorithms to determine the configuration of computer entities for competition against others designed by fellow class members.  These entities competed on a two-dimensional grid that used the trained configurations to determine behavior and outcomes in the grid, which could watched on a screen.  What I found most fascinating was that you could watch the behaviors of these algorithms and how they changed over time.  Initial algorithms might get “stuck”, or generally behave inefficiently, and might not grow to fill up the space.  Others might show promising growth in the space, but had little or no defense against attacking counterparts.  Some might attack well, but might ultimately be outnumbered, losing the competition in the long run.  Or, some entities might do very well against most competitors, but fail miserably against a select few.  Thus, the outcomes for each entity depended on the values stored in its configuration, the rules governing the competition, and the other entities involved. 

I find it difficult to see any real difference in humans.  The same factors are at play, but amplified to a mind-boggling complexity.  We are unlikely to ever know the exact rules that govern our behavior in any given situation nor the environment and series of actions and reactions that got us to that state in the first place.  However, this increase in complexity does not change the reality—we have as little control over our outcomes as the simulated entities at war with each other.

A Path to Right View

At first, these conclusions seem disorienting and depressing, but they can lead to deep compassion.  If we can truly accept that everyone is at the mercy of their own neuroses and environment that they do not control, then it is difficult to remain angry or upset with them.  After all, we are not typically upset with the weather or even natural disasters—we may wish they didn’t happen or that we weren’t around, but it is nonsensical to be angry with the weather patterns themselves.  In other words, we recognize that a hurricane is simply the natural result of a complex series of interactions  of air pressure and temperature that have fed back on each other, so we may be sad when it destroys a beach and hurts the people who live there, but do not have the need to punish it for having caused the damage.  Thus it is with people, we are all just weather patterns—sometimes a gentle breeze and other times a raging hurricane, but never in control.

So if we take the same attitude towards people that we take to the weather or the simulated entities at war, our anger and desire for retribution dissipates.  For example, instead of being angry at the jerk who just cut you off, you can have compassion for him and recognize that he is not truly to blame for his actions.  Perhaps he had a terrible day or was distracted.  Or maybe he is just an unhappy person because he happened to have genes with a high inclination towards depression and might be at a bad point in his life.  Of course, just as you might seek shelter from the rain, you may then avoid being around him in the future.

Similarly, we can have compassion for ourselves.  Everyone has done something they regret, but were they put back in the same place at the same state, they would do it again—how could they not?  Thus, rather than blaming ourselves using the belief we could have acted differently, we have the option to look back with compassion, knowing we could not have done otherwise, and hopefully learn and improve going forward (though we do not have control over that either!).

Thus, if we can embrace ‘No Will’ fully, we are able to have ‘Right View’ by understanding things as they truly are.  With this view, there is no need or even the impulse for anger to arise in the first place, and we can naturally be kind to everyone.

Financial Essays: Price and Returns and Cost of Leverage

Cost of Leverage - Published by Joel Stevens on October 11, 2016

This essay relates to the "Cost of Leverage" of various different leveraged vehicles for investing in common shares, such as using margin or purchasing calls or warrants. Additionally, the essay explores the relationship of Cost of Leverage as the degree to which the call or put is in or out of the money.

Price and Returns - Published by Joel Stevens on December 31, 2016

This essay relates to the relationship between price and returns. In particular, the essay explores how returns develop over different holding periods, underlying value growth, and prices paid relative to that underlying value.

Book Review: Good for the Money

Good for the Money: My Fight to Pay Back America - Bob Benmosche

As an investor in AIG since 2011, I was very interested in this book, which provides the inside scoop (at least from Benmosche's perspective) of the recovery and payback of the bailout money in AIG.  I was impressed with Benmosche during his tenure as CEO as an investor, and after reading this book, I am even more.

Benmosche goes through his career, in a fairly abbreviated form, as a guy that is rough around the edges, but gets shit done.  That characterization seems a perfect synopsis for the AIG recovery, where the government and the press might not be too happy with him, but he got everyone paid back his way.  Although I'm sure it was difficult to see at the time, it does appear that his much slower approach to realize the value of assets as AIG was much better than the originally planned method of selling everything as fast as possible, which likely would not have yielded enough money to pay back the loan from the government.

As I was originally, I was again saddened by his cancer and eventual death.  Benmosche's effort at AIG throughout that period was impressive.

Another Slew of Book Reviews

Still falling behind on both reading and writing book reviews.  Hoping to have more time soon.

The Spider's War - Daniel Abraham
This is the final conclusion to the Dagger and the Coin series, which was overall pretty enjoyable.  Pretty good story with fantasy and financial engineering, so how can I complain really?

Gene Wolfe has been recommended to me several times over the years, so I thought I would give this series a shot.  It was very interesting, but a pretty frustrating experience.  Supposedly, it is Science Fiction, but it is written like Fantasy (the reader is left to use his imagination as to how the magical descriptions can be explained by science).  It also uses an unreliable narrator story telling mechanism, and many details are left out all of the time.  Often, I had to figure out whether I missed something or if the story teller had purposefully left me in the dark.  Usually it was the latter.  I didn't enjoy having to work so hard to just try to understand what was happening.

Calamity - Brandon Sanderson
Fun ending to a fun series (The Reckoners)

Both of these were quite good, but of the two, I'd definitely recommend It's Easier than You Think.  

Yet another Epstein book whose premise and beginning is amazing, but who's content is very frustrating.  The beginning and the title are such a good concept for a book, but somehow Epstein spends 33% or 50% of the book talking about how the Buddha was traumatized from his lost mother and pre-memory traumas, rather than focusing on the trauma of "everyday life".  As usual, I wish he had condensed down to a chapter or two.  I don't think I'll bother reading any more of his books, as it is almost always the same situation.

When Breath Becomes Air - Paul Kalanithi
This book is essentially an autobiography of a neurosurgeon who pushes himself incredibly hard throughout his medical training, gets cancer, and dies before he can finally "get" the life he was working towards.  While there are many touching segments, and of course, many sad moments, and while he does have some good thoughts about the interplay of doctors and patients, I can't say I got much out of it.  While dying may teach you quite a bit in a short span, I feel that there is more to learn from the wisdom of a 90 year old than a 36 year old who spent his whole life pushing himself through medical training.

Rational Enlightenment Essay: You Are Not Your Feelings

You Are Not Your Feelings

or Growing Up, Phase II

Now, one who says, 'Feeling is my self,' should be addressed as follows: 'There are these three feelings, my friend — feelings of pleasure, feelings of pain, and feelings of neither pleasure nor pain. Which of these three feelings do you assume to be the self?' At a moment when a feeling of pleasure is sensed, no feeling of pain or of neither pleasure nor pain is sensed. Only a feeling of pleasure is sensed at that moment. At a moment when a feeling of pain is sensed, no feeling of pleasure or of neither pleasure nor pain is sensed. Only a feeling of pain is sensed at that moment. At a moment when a feeling of neither pleasure nor pain is sensed, no feeling of pleasure or of pain is sensed. Only a feeling of neither pleasure nor pain is sensed at that moment.  Now, a feeling of pleasure is inconstant, fabricated, dependent on conditions, subject to passing away, dissolution, fading, and cessation. A feeling of pain is inconstant, fabricated, dependent on conditions, subject to passing away, dissolution, fading, and cessation. A feeling of neither pleasure nor pain is inconstant, fabricated, dependent on conditions, subject to passing away, dissolution, fading, and cessation. Having sensed a feeling of pleasure as 'my self,' then with the cessation of one's very own feeling of pleasure, 'my self' has perished. Having sensed a feeling of pain as 'my self,' then with the cessation of one's very own feeling of pain, 'my self' has perished. Having sensed a feeling of neither pleasure nor pain as 'my self,' then with the cessation of one's very own feeling of neither pleasure nor pain, 'my self' has perished. 
Thus he assumes, assuming in the immediate present a self inconstant, entangled in pleasure and pain, subject to arising and passing away, he who says, 'Feeling is my self.' Thus in this manner, Ananda, one does not see fit to assume feeling to be the self.

Like many children, I loved water and swimming.  When I was young, a friend of ours had a pool, so naturally I begged to go as often as possible.  On one of those happy summer days that my mom took me, after some endlessly entertaining underwater acrobatics, I came up for air.  Unfortunately for me, there happened to be a bee inhabiting that particular spot on the surface of the water, and I was promptly rewarded with a sting to my eyelid.  As you might imagine for any young child, my reaction was loud and traumatic—I was pretty sure my world was going to end, and for several minutes, it really felt like it had.

Later, as an adult, I was playing as a bassist in a jazz trio.  The venue had an outdoor patio looking over the hills of Austin, which was particularly nice at sunset.  After finishing “All Blues”, I reached down to take a sip of my beer (compliments of the house).  In another unfortunate happenstance, a bee had decided to take his own drink!  Mid-swallow, I was alarmed to feel movement in my mouth and, very quickly, a burst of pain.  After successfully removing the bee from my mouth, I soon realized that my discomfort was not yet over.  A bit of oral exploration later, I discovered that the stinger was still firmly lodged in my tongue.  Of course, as soon as I began to pull it out, even more of the toxin was released.  Needless to say, it was not a very pleasant experience; however, I knew that the pain would pass, so after a bit of quiet cursing, we moved on to the next song and finished the set.  

What was the difference between these two incidents?  Why was the first a seemingly earth-shattering event and the second a fleeting bit of pain that left me with a memorable story?  As we mature from children to adults, we almost universally come to the conclusion that most physical pain is not a significant life-event—we no longer react to it in the same way we did as children.  In other words, we understand that we are not defined by our physical sensations; instead, they are simply passing experiences of the body.

This same realization is not commonly applied to emotions, and particularly those that are negative.  In the midst of anger or sadness, we typically identify ourselves as those emotions—we feel that we are that emotion and express it as such (e.g., “I am sad” or “I am angry”).  While we experience them, it is hard to even remember not feeling that way or imagine that they will end.  Indeed, we may often prolong or amplify the feelings by telling ourselves stories about what is happening.  

Imagine a friend dismisses you abruptly, or perhaps you overhear a colleague disparaging your work—for almost anyone, feelings of hurt or anger instantly arise.  Even worse, we might add to these negative emotions by thinking, “How could he have done that to me?”; “She must not like me anymore”; “I don’t deserve this”, and the like.  However, there is no reason for us to self-identify with the emotions we feel, in the same way that we do not identify with the temporary physical sensations we experience.  For example, if we stub our toe, we know that the pain will pass, and our identity is not wrapped up in that physical sensation.  The same can be true for emotions: compare the stubbed toe to the hurt feelings—is either a new permanent aspect of our lives?  The painful sensation of the stubbed toe mostly goes away after a few minutes, and the tenderness is usually gone in hours or days.  In the same way, absent rumination feeding our emotional pain, our unpleasant feelings will soon dissipate. 

As an experiment, take a moment to remember the last time you were upset and how long the original feelings actually lasted; in most cases, it probably was not all that long.  You may even have trouble remembering what happened the last time you were upset!  And, if you were upset for a long period of time, were you continuously thinking about what how you felt or replaying the event over and over in your mind? 

The next time you are feeling sad or upset, consider approaching it the same way you might approach a minor physical mishap: think, “I’m experiencing sadness, but it will pass” in the same way that you might think to yourself, “My toe hurts, but it will be better tomorrow”.  Thus, rather than despairing in a seemingly never-ending emotion, we can understand that it is temporary.  We can also choose not to prolong or amplify the feeling by telling ourselves stories about the emotion itself, the injustice of its cause, or its ramifications in the future.  Remember the advice the sage gave to the king seeking wisdom, “Whatever happens, before you call it good or bad, think ‘This too shall pass’.  That way, you will always be at peace.”