The type of assets which usually come to mind when considering investments are stocks, bonds, or cash, but what are the alternatives? And what kind of returns do alternative asset classes offer? In today’s episode, we delve into the returns which can be expected from alternative asset classes such as private equity, venture capital, angel investing, private credit, hedge funds, direct real estate, and cryptocurrencies. Hear an in-depth analysis based on empirical studies to discover whether there is any merit to alternative asset classes as investments. We unpack the extra layer of complexity associated with predicting returns on alternative assets, how to approach calculating returns, and why the associated fees are an essential consideration. We also hear details about an interesting conference Cameron recently attended and briefly recap cryptocurrencies as an investment. You’ll also hear our conversation with our 22 and 22 reading challenge guest David Senra about his reading habits, the books that most inspire him, and his advice for people who want to read more.
Key Points From This Episode:
Outline of today’s main topic: expected returns for alternative asset classes. (0:01:51)
Why predicting returns of alternative asset classes has an extra layer of complexity. (0:03:18)
How to approach estimating the returns of private equity, specifically buyouts. (0:05:04)
We unpack historical data regarding the returns of private equity. (0:07:35)
Calculating the returns on venture capital and reasons to be cautious about it as an asset class. (0:16:35)
The distribution of returns from venture capital based on the market numbers. (0:20:09)
Learn what angel investing is and its associated returns. (0:20:54)
What returns on angel investing are most dependent on and why. (0:22:21)
The different types and the associated returns. (0:25:23)
Hear about the fees associated with private credit. (0:27:42)
We unravel the concept of hedge funds, the associated fees, and expected returns. (0:29:29)
A limiting factor on hedge funds: capacity constraints. (0:33:38)
The takeaway regarding private real estate investments. (0:36:25)
How private real estate is valued as an asset class. (0:37:48)
Cryptocurrencies and the returns to be expected. (0:39:34)
We discuss some of the key takeaways from today’s main topic. (0:43:30)
We follow up on a previous topic we covered: financial literacy. (0:45:10)
Find out about an interesting conference that Cameron recently attended. (0:48:46)
Hear about the recent reviews we have received about the podcast. (0:57:58)
We introduce our 22 and 22 reading challenge guest, David Senra. (01:00:15)
Where David’s passion for reading about founders originates from. (01:02:25)
David shares details about his reading habits. (01:05:57)
His approach to finding founders that he wants to read about. (01:08:49)
David’s approach to note taking while reading a book. (01:11:07)
We learn about the stories that have impacted David the most. (01:13:53)
He explains the benefits of reading a book for a second time. (01:17:11)
Books about founders that he thinks everyone should read. (01:19:20)
David’s observation of the role of luck in a founder’s success story. (01:23:19)
Advice he has for people who want to read more. (01:29:33)
Read the Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.
Cameron Passmore: Welcome to Episode 219. I think, it's safe to say, Ben, this will be the shortest intro we've ever done.
Ben Felix: Which is great. This is the new format.
Cameron Passmore: The only note we have is that we just had an incredible long weekend trip to Maine, to the coast of Maine, which is phenomenal, with my brother and his family and all of us. Perfect weather. Perfect weekend. It's so much fun, that the ocean was actually swimmable. Temperature was in the high 60s.
Ben Felix: Cool. We being you and your family. Not me. I was not on Maine.
Cameron Passmore: Not you. You were not in Maine. Anyways, that's all I got for you. That's what's been a lot of fun lately. Yeah.
Ben Felix: That's great. I think we can jump right into our main topic. As our last episode with the two of us with this new format, where there's lots more discussion and chatter at the end, but we'll keep the intro short as intended and start with our main topic.
Cameron Passmore: On that, I did hear some comments that people who stuck around actually did enjoy the banter. Frankly, I think you and I both felt the same way, which is there's no pressure to get to the main part. We were able to just –
Ben Felix: Yeah, but people notice that. One of the comments that I saw in the Rational Reminder community was that it was nice to have the intense part upfront. Then the back end is like a cozy, wind-down conversation. I agree with you. It felt much more relaxed. It's much more conversational.
Cameron Passmore: All right. With that, let's keep this short and let's go to the main part of the episode. Here we go, the main part of the episode. Ben, you've got your featured topic right at the top.
Ben Felix: Yeah, so we're going to talk about the expected returns for alternative asset classes and alternatives being, of course, are many alternatives. The ones we're going to talk about are private equity, which is a bit of a repeat, because we've given that topic some coverage. Venture capital, angel investing, which is a really fun one to talk about. Private credit, hedge funds, direct real estate, and cryptocurrencies. That was also a fun one. This is a project that we –
Cameron Passmore: You're going to fit all of this in today.
Ben Felix: Well, it's not – Yeah. I mean, we've covered larger topics.
Cameron Passmore: This is awesome. Awesome.
Ben Felix: This is a project that we've been working on, of course, in financial planning, which is a big part of what we do for our clients at PWL. For financial planning, you need to have assumptions about the expected returns of asset classes. While we don't recommend all of the alternatives that we're going to talk about, there are cases where people own them. When that is the case, we can't just ignore them for the purpose of financial planning, so we need to have some assumptions. We tried to get a little bit more scientific about this recently than we've been in the past. It's often easy enough, where these are small allocations in someone's situation that we can either ignore them, or assign a low expected return, and treat them as effectively as a speculative asset class, where if it pays off great, if it doesn't, it's not going to affect the financial plan.
In cases where these assets make up a larger portion of the asset allocation, I think we have to give them more attention, which is why we started doing this. Now, predicting returns for these alternative asset classes, there's an additional layer of difficulty, or uncertainty relative to public equities, because with public equities, we can make an assumption about the market. Even though, we still can't predict the future, you can be pretty sure that whatever the market return is, you're going to be able to get it with public equities, because you can own an index that captures that market beta return, plus whatever factor risk premiums.
With the asset classes we're going to talk about, you can't do that. There is no index fund that captures the aggregate return of private equity, or venture capital. Although, Ludovic Phalippou had a – some machine learning methodology to try and replicate PE returns that we talked about briefly. Anyway, separate topic. I don't think you can buy that as an index fund anyway. The importance of managers becomes a lot more prevalent in these asset classes. There is no beta, so you're by definition required to select a manager that may or may not give you beta plus some alpha for the asset class.
Then the other challenge with a lot of these alternatives is that there's a lot more skewness. Stock, market returns have some skewness, but alternative asset classes have a lot of skewness. We'll talk about the data for venture capital and angel investing. That makes it even harder, because even if we did know what the mean was, and could assume that you're going to get the mean, chances are you're not going to get the mean.
Cameron Passmore: The fat tails can get you.
Ben Felix: Yeah. Anyway, those are just challenges with this. Given all of those challenges, I'll try and walk through how we approached estimating expected returns. We'll start with private equity and specifically, buyouts. We've separated venture capital out. Theoretically, theoretically, you would expect private equity to outperform public equities, because private equity investments tend to be smaller companies, lower valuations. At least historically, we'll talk about how that's changed. And illiquidity, which you might expect to get a premium for.
There’s a 2021 paper from Erik Stafford, who finds that the returns of private equity can be replicated using public small cap companies with low prices and leverage, which suggests maybe there is not an additional premium for illiquidity. Then Antti Ilmanen has a 2020 paper, they argue that the lack of a premium in excess of public equities, they also find that similar to Stafford; suggests that even if an illiquidity premium did exist, they theorized in the paper that it may in practice be largely offset by investor willingness to overpay for the return smoothing effect of illiquid asset classes. That's something we've talked about on this topic in the past and it's something that Cliff Asness hammers all the time.
That smoothing as a service is what Antti called it when he was on our podcast. Now, that smoothing as a service is something that exists only on paper. You're not actually getting economic smoothing. For example, if you tried to sell your private assets, when public assets are down significantly, you would find out that the smoothing on paper is not real. It's not real smoothing, if you had to value that asset at any point in time.
I think, it's pretty reasonable to argue that private assets, private equities, in the case of what we're talking about now, are probably at least as volatile as public equities. Probably more. Probably more. Or at least if we use the small caps analogy, like a private equity is probably at least as volatile as small caps, which tend to be more volatile than the market. Of course, their valuations are not reported daily. They don't have a daily mark to market accounting like public equities do, so they look smoother.
Cameron Passmore: Exactly.
Ben Felix: There's a 2018 paper from Welch and Stubben. They find that after European private equity funds switched to fair value accounting, the reported correlations between private equity and public equity returns increased. In their sample, after that happened, after the correlations increased, private equity funds access to capital decreased, because all of a sudden, it looked less attractive as an asset class.
Cameron Passmore: Come on. Really.
Ben Felix: Because correlations went up. Yeah. It's like, when you take away that illusion of smoothing, the asset class becomes less interesting.
Cameron Passmore: That is fascinating.
Ben Felix: It is. Yeah. I think it's pretty interesting, too. Okay, so historically, start with a historical data, buyouts have had an edge over public equities on average. This is a paper from Harris and some co-authors in 2020. They find an average public market equivalent of 1.18 for a sample of 893 buyout funds with vintages from 1987 through 2014. A huge sample of buyouts. A public market equivalent, it's like a PME of 1.18 means you got in aggregate in total over whatever the holding period was, there was an additional 18% wealth accumulation over the period relative to having gone to public equities over the same period with the same cash flows. You can't calculate private equity fund returns in the same way that you calculate public equity returns, because there's no mark to market accounting, and there's lots of weird cash flows with the illiquid assets. You combine all that together, it's really tricky. This public market equivalent is a method for attempting to quantify performance differences between public and private investments. We'll talk about PME for a couple of other asset classes as well.
Now, PME is related to, or based on a public markets benchmark. The 1.18 that I just mentioned for buyouts historically, that's based on the S&P 500. Now, you can also use benchmarks of smaller and lower price companies, like I mentioned earlier, those are maybe more similar to private equity investments. PMEs typically do start to move closer to one, which would be parity with the public markets benchmark.
We do see that, there's another paper from Harris and co-authors in 2014, and they find that against the Russell 2000 value index, and some other smaller cap indexes that the PMEs do drop. In their sample, the PME against the S&P 500 was 1.2 in this case, in the 2014 paper, against the S&P 500, but only 1.07 against the Russell 2000 value. As you benchmark against smaller companies, the PMEs do tend to decline. In Phalippou’s 2020 paper, which we discussed with him when he was on the podcast, he finds PMEs and multiples of money, which is another method for trying to quantify performance differences between private assets and public assets. He finds for vintages from 2006 to 2015, vintages is when the fund started. The duration of a typical private fund and this is documented in one of these papers, is five years, which is longer than their legal duration. Anyway, that's what the vintage means.
It started at that point, and then they tend to exist for roughly five years on average. For vintage is 2006, 2015. Phalippou in his 2020 paper finds that the performance of public and private equities is overall very similar. That's one of the big conclusions of that paper. Now, I think another important qualifier for these data is that in the Ilmanen 2020 paper, they find that the valuation gap between private equities and the S&P 500 has declined over the period 1998 through September 2018. At the end of their sample, the gap is even negative, meaning private valuations at that point in time were higher than public valuations.
Cameron Passmore: Gosh.
Ben Felix: Now, they also document that there's a significant relationship. I don't know. Significant is maybe not the right word. I don't know if it's statistically significant. Visually, it's very obvious, or it seems obvious that there's a relationship between private market valuations and forward-looking returns. You can see, and they have two charts in their paper that show that as the valuation gap narrows, the go forward difference in returns between public and private equities decreases.
When valuations are the same, for example, you might not expect as much, or any premium from private equities. As of their 2020 paper, valuations were very similar. Now in a similar line of thinking there in the Harris 2014 paper, they find that both absolute performance and performance relative to public markets are negatively related to aggregate capital commitments for both buyouts and VC funds.
Now, that's important, because private markets have seen massive inflows in recent years. I think, 2021 was a record year by many measures for new assets being committed to buyouts in venture capital funds. Again, we have valuations increasing, which drives down expected returns. Then there's also a separate, although maybe related relationship between capital commitments and go forward returns for buyouts and VC funds, and we've seen recently large capital commitments. All that to say, relative to history, we may expect lower returns for private equity going forward.
AQR has a, well, they follow Ilmanen 2020’s methodology for expected returns. They find a real expected return of 5.9%, net of 5% fees for buyout funds. There's a 2008 paper from Phalippou, where they estimate private equity fees at 6%. This probably depends heavily on who you are as an investor, and how you're able to access funds. Maybe you're paying closer to 5%. In Canada, you often have to go through an intermediary to access private equity asset classes, or venture capital funds. I would probably err on the side of 6%, or even higher in terms of total cost of ownership for private equity funds.
If we just bumped AQR’s 5% fee assumption to 6%, all of a sudden, we're at a 4.9% real expected return based on AQR’s methodology, which is only 30 basis points higher than AQR’s estimate for US public equities with a multifactor tilt over the same period in their capital market assumptions paper. It's pretty close. 30 basis points difference. I also looked at BlackRock. The two main sources I looked at as a sounding board for this exercise were AQR and BlackRock. I generally trust both of them to think through things thoughtfully.
BlackRock has assumptions for a whole bunch of asset classes that AQR doesn't. Between the two of them, I think there's a lot of reasonable expectations. Of course, this is all really throwing darts here. We're just trying to be scientific about something that's extremely uncertain. Anyway, so BlackRock suggests an expected nominal return of 14.4% for US buyout funds in Canadian dollars, gross of fees, with a standard deviation of 26.6%. If we net out the 6% in fees, the nominal return is 8.4%. For PWL’s expected returns in a most recent update, we had 7.09% for global public equities tilted towards smaller, lower priced companies and profitability with the investment exclusion.
The multifactor tilt, we had 7.09% for public equities. Based on the expected return estimates that AQR and BlackRock have, and combining that with the historical PMEs, at least in recent times, close to one, and currently high PE valuations and flows, and the added uncertainty to the importance of manager selection, which is again, very important in private equity, we assigned for this asset class a return of 50 basis points higher than public equities, than multifactor tilted public equities. Not a huge premium, but we did give it a premium.
Now, I've mentioned that importance of manager selection a couple of times. In Harris 2020, they find that top quartile PE funds deliver PMEs of 1.81, which is pretty significant outperformance relative to public equities. Bottom quartile funds deliver a PME of 0.68. Again, if we assume that five-year duration that I mentioned earlier, top quartile funds beat public equities by 12.47% per year. Well, bottom quartile funds trailed by 7.42% per year. A huge dispersion. How do you account for that in financial planning? I mean, there's no great answer to the question. What we did is bumped up the standard deviation relative to public equities. In the end, our standard deviation is about the same as what Blackrock assumes we had about 29%.
Cameron Passmore: I think, worth mentioning is that I think people expect much higher returns and these handful of basis points.
Ben Felix: Maybe you get them if you can pick top quartile funds. One of the things I haven’t mentioned with private equity is that there's only evidence of persistence in bottom quartile funds. Bad funds tend to continue being bad, but there is not persistence in top quartile funds. if you go and pick up previously top quartile manager in buyouts, and it's different with venture capital, but you go and pick a previously top quartile bio manager, there is not evidence of persistence in good returns, but you can maybe not invest in the worst bio managers, and you can avoid being bottom quartile, which maybe means on average. If we exclude bottom quartile, maybe your expected return is a bit higher, but I still think there's a ton of uncertainty in the asset class.
Cameron Passmore: So interesting.
Ben Felix: Yeah. If you try and get more diversified, like if you go to a fund of funds, for example, then all of a sudden, you're paying additional layer of fees. It's tricky. Anyway, for venture capital, which are, of course, earlier stage investments in company funding, in buyouts, typically, the fund is buying a company, and typically, a more mature business. In venture capital, its earlier stage and not usually buying entire companies that's investing in some of the equity of an earlier stage business.
Now in VC, returns do tend to be quite high on average, but the skewness in VC is massive. I mean, it's very significant. There are VC funds that do exceptionally well. There is persistence in VC, which is that's another interesting characteristic. In the top performing VC funds, there is persistence. We asked Bill Janeway about this when he was on and he laughed and said that venture capital has an adverse selection problem, where if you want to give your money to a VC fund, they're probably not going to take it.
Somebody else gave us – Oh, it was Gus Sauter. If you want to find the best private market managers, find the ones that won't take your money. If you can get in, in some cases, people do have special connections, or maybe a VC fund invested in their business, and therefore, you get access to that fund. There are cases where you can get access, but I think for the average person, even for the average high-net-worth investor, it's not so easy. I mean, again, thinking back to the Gus Sauter conversation, I think he said, you have to be committing billions of dollars to be confident that you're getting in with the best managers and doing this properly in terms of the required due diligence and stuff like that.
Okay. For the Harris 2020 paper, again, they find a sample average PME of 1.22 for a big sample of VC funds with vintages from 1984 through 2014. Another paper from Harris and co-authors in 2014, finds a sample average of 1.20 for vintages 1984 through 2008. Now, the median of that sample, so 1.2 mean public market equivalent, but the median is 0.88. That is an indication of skewness, or there's a relationship to skewness there, where we see such a big difference between the mean and the median. That concept of persistence and adverse selection, I think is really important in interpreting those numbers and deciding which one is relevant to use.
If you could own the VC market, of course, you would use the mean. If you can't, if you have to pick funds, and if you're not sure that you can get access to the best funds, maybe the median makes more sense. In the case of the median, you expect to lose money relative to public markets over the average holding period of a venture capital fund. Again, it comes back to that importance of, if you can access the best VC funds, great. If you can't, it becomes a very unattractive asset class very quickly. That mean PME of 1.2 of the typical fund duration of five years, which is what I mentioned earlier, Harris and co-authors find as the average duration of a fund, that translates to an annual return difference of 3.7% over public market cap weighted equities. It's pretty significant.
I think, if you can access the best funds, I would give that 3.7% a 25% haircut. That's not scientific, but just as an expectation. We talked about the flows into VC driving down expected returns and stuff like that. At the mean, that's 9.87% using the PWL equity expected return as the baseline. As I mentioned before, if you don't have access to the best funds, you just probably wouldn't invest in this asset class. I don't think we need an expected return assumption for that scenario. You just wouldn't do it. In terms of quartiles, the top quartile VC funds deliver PMEs of 2.6. Bottom quartile, 0.41. Again, massive distribution.
Again, using that five-year duration, top quartile funds based on those PMEs beat public equities by 21% per year, on average, while bottom quartile trailed by 16% per year. Yeah, so I mean, that's a tricky one, right? This is why we've not typically assigned expected returns to asset classes like this, because it's like, you really don't know what you're going to get. If we were to assign one, like I said, it's roughly 9.8%. Unless you can't access the best funds, in which case, just avoid the asset class, or assuming negative return, I guess, relative to public equities.
For angel investing, this one's really interesting. There are a few resources and books that I've read on angel investing. I referred back to those. It turned out that they all reference the same, because I remembered reading return estimates for angel investing. I went back to my sources for that to see where they got their data from, or how they modeled it. It all comes from this one guy. Wiltbank is the last name of the author. I can't remember his first name.
He's got two papers that are big studies of the biggest ones that seem to have been done on angel investors. There's a 2007 and 2009 paper. They find average angel multiples of around 2.5X, with an average holding period of 3.5 years. That suggests an average annual return of more than 29%, on average.
Now, again, there's no angel investing index. It's even different from a VC fund, for example, because in a VC fund, you're still getting somewhat of a diversified portfolio of VC investments. With angel investing, typically, you as the person who wants to do angel investments has to go out and do it. Now, there are some angel funds and angel groups and stuff like that, but in a lot of cases, you can end up paying fees.
With angel groups, actually, you don't necessarily have to pay fees to participate. Well, there’s membership fees, but not fund fees. Anyway, harder to diversify an angel investments. More than 50% of deals based on the Wiltbank research result in negative returns. Then another important thing related to what I was just saying, the returns of angel investors are more dependent on the investors themselves than say, a VC investment.
Although, I guess with VC, if you can get access, that is maybe somewhat similar. The actions of angel investors matter a lot more for returns in the Wiltbank sample. I'll explain what that means. Angel investors who spend more time on due diligence have higher returns empirically. Angel investors with more experience in the industry of the deal have higher returns on average. Angels that mentor and coach the companies they invest in have higher returns on average.
Cameron Passmore: Fascinating.
Ben Felix: Yeah. Now, one of the data points that I pulled out, because I just thought it was the most interesting one, is in terms of thinking about expected returns, angel investors who performed less than the median 20 hours of due diligence, earn significantly lower returns. Remember, that average multiple was 2.5X. The angel investors who perform less than the median 20 hours earn 1.1X over a similar average holding period, which is approximately 2.84% per year, as opposed to the 29% of the mean. I mean, to get that 29%, we're talking about having to do significant due diligence, but also, being pretty diversified. Because, well, there's another data point I have on that, actually.
In the 2007 Wiltbank paper, they show that 7% of the exits and their sample achieved returns of more than 10X and account for 75% of the total investment dollar returns in the sample. That's not actually as extreme as I would maybe have – Well, no. That is extreme. I was thinking of the Bessembinder wealth creation papers, but this isn't talking about wealth creation. It's talking about returns. 7% of the exits account for 75% of that mean return. Not so easy to capture.
It's uncomfortable trying to assign an expected return to this asset class. The way that I suggest approaching it, at least for this exercise that we've done here, I gave it a 30% haircut. Again, that's not scientific, relative to the historical mean. Now, that would be what I would consider a very aggressive assumption for this asset class. I would only be using that number if you're extremely well diversified. If you're doing more than the 20 hours of due diligence per deal, or if somebody involved with managing the portfolio is doing that much due diligence. If not, I would revert back to the 2.84% per year with a huge number for volatility.
John Cochran has a paper on venture capital investments, and he estimates, I think, a 107% standard deviation for individual VC investments. I would use something like that for the purpose of estimating expected returns for angel investing. Okay, so that's three different private equity asset classes, buyouts, venture capital, angel investing, and they're increasing in their expected returns and their expected volatility and their expected skewness. Private credit is an excellent and we looked at. This is one that we've heard a bunch about recently. It seems to be a very hot asset class, which typically means it's going to have low expected returns.
What everyone's talking about, it's not a good time to be in it. Now, private credit is varied, as I mean, all of these strategies within each of them, you can find different strategies. In private credit, they can be quite materially different, so there's direct lending, distressed debt, mezzanine debt and venture debt. They've all got different characteristics. The data on private credit, there's not as much of it, or at least there hasn't been the same level of research done on it. In private equity and venture capital, Harrison, Kaplan and Phalippou have done tons of work on this. Private credit, not so much.
There's one paper, a 2018 paper from Munday and co-authors, and they find that, in general, while there may be diversification benefits to private credit strategies based on low correlations with public benchmarks, the PMEs for all of the strategies that they look at, which are the ones that I just mentioned tend to be close to one. You're not necessarily gaining a return edge. Maybe there's a correlation benefit, but I would keep in mind what we talked about earlier, with the illusion of low correlations with private assets.
For the PMEs benchmarked against a business development company index and a high yield bond index, all the strategies underperform based on PME. Although measured against the leveraged loan index, they all outperform. These are all public indexes that often have ETFs tracking them. One of the takeaways is you can recreate these returns with public assets if you're willing to take a bunch of risk in your fixed income.
Now they, in the Munday paper, Munday, M-U-N-D-A-Y. Not the day of the week. That's the 2018 paper. They make an effort to de-smooth the returns, because of the correlation issue. It's still not perfect. In the Ilmanen paper for private equity, they do the same thing, but they give the commentary that, yeah, it's still not going to be as volatile as you would expect it to be if you tried to sell it, back to that comment.
BlackRock for their expected return for private credit, they suggest an 8.8% gross of fee expected return for direct lending. That's one of the strategies that we talked about, with a standard deviation of 10%. Similar to private equity, private credit tends to have high fees. That's 8.8% gross of fee expected return. I didn't find good documentation on total fees that you expect to pay for private credit strategies, like I found for private equity. I don't actually know what the fees will be.
There's a 2022 CFA Institute publication. They suggest an expected return for private credit equal to that of public equity, but with a lower volatility. It's interesting. Looking at high-yield bonds measured by the Bank of America US high-yield index, which remember, gave a private credit PME of around 1 for most of those strategies, when it's used as the benchmark, it underperformed US equities from 1986 through 2022, July 2022, by an annualized 2.63%. Of course, this being a period where bonds performed exceptionally well, relative to history.
Now, private credit does tend to have a shorter duration than high yield indexes, so we might expect lower volatility. Similar to other private asset classes, there's a lot of variability in individual fund returns. Again, these are all shots in the dark, but I think applying a 2% haircut relative to public equity expected returns, and using something similar to what BlackRock had four standard deviation, which was 10%. That ends up being 5% roughly, in terms of expected returns for private credit, with a standard deviation of 10%. Now, I group those all into one assumption that I mentioned, they're all these different strategies. If you're investing in any one of them, maybe it makes sense to be more specific.
BlackRock’s strategic view, so they give strategic commentary and their expected return assumptions is that publicly traded credit and including high yield has attractive valuations and income potential currently, and they say that this makes private credit look much less attractive than it has historically. It’s interesting.
Hedge funds, this is another one that's there’s really interesting data here. Again, hedge funds are extremely varied in their objectives on expected return profiles. There's a whole bunch of different strategies that you can look at with totally different objectives. Some of them might be actually designed to hedge. Some of them are more return seeking. Anyway, as an asset class, they don't tend to hedge as much as investors might hope. Cliff Asness has a fairly well-known 2001 paper on that topic. They apply standard techniques to address the illiquid nature of many hedge fund holdings, and suggest that hedge funds in aggregate, have significantly more market exposure than simple estimates might indicate. That, again, comes back to the illiquidity of these private assets.
Hedge funds, also the big fee problem. This is super interesting. Everyone knows, maybe not everyone. Most people know, especially if you're investing in hedge funds, you're going to pay 2 and 20, roughly. 2% and 20% of any outperformance over a hurdle rate. That's common for most of the asset classes that we've – I think all of the asset classes we've talked about so far, typically, you're going to pay 2 and 20, at least on some level of ownership of these assets.
There's a paper from Ben David and co-authors, 2020 paper, they find that the expected incentive fee on diversified portfolio hedge funds is a lot higher than the contractual fee. The reasons are super interesting. The incentive, empirically, the incentive portion of the fee paid by investors between 1995 and 2016 was nearly 50%, compared to the average contractual rate in the sample of 19%. That's up to 2 and 20. That's the 20. Empirically, in their sample, it wasn't 20 on average. It was 19 contractually, but investors actually pay close to 50% in terms of incentive fees. There are two reasons for that. The reasons are interesting.
The first reason is that the aggregate profits from a hedge fund portfolio combine the results of winning funds and losing funds. The losses produced by losing funds can't be used to diminish the incentive fees owed to the winning funds. That's one.
Cameron Passmore: Wow.
Ben Felix: Yeah.
Cameron Passmore: I truly never thought of that.
Ben Felix: I know. The second one is that most hedge funds have a high watermark provision, specifying that investors need to recover any prior loss before they pay incentive fees to the fund. The protection offered by the high watermark provision is eroded by the behavior of managers and investors, both of whom tend to discontinue investments following losses. When a fund is liquidated, following losses, investors automatically lose the opportunity to earn back their losses without paying additional incentive fees.
Cameron Passmore: They leave missing the chance to get the free ride back up.
Ben Felix: That's exactly right. They go invest in a new fund, which if it wins –
Cameron Passmore: Isn't that fascinating?
Ben Felix: Yeah. In their sample, on average, they find that investors pay 1.51% in management fees, and this is all annualized. Instead of 2%, it's 1.5%, 1% on average. Then the incentive fee, annualized, they find at 1.93%. Now, of the 1.93%, only 0.74 of the fees are justified by excess performance, while the remaining 1.19% have been paid for gains that have been offset by losses. There's an extra 1.19% drag, which is that 50% performance fee, as opposed to the 20% contractual performance fee. Pretty crazy. It's expensive to own hedge funds. More expensive than the 2 and 20 would imply.
Then the other thing that actually, related to one of the points that we just mentioned, is that hedge fund investors tend to be their own worst enemy, more so than in public markets. There's a paper by Dichev and Yu, a 2011 paper, they find investors underperform funds by between 3% and 7%, which is a much larger behavior gap than we see in public equities, like public mutual funds relative to benchmark indexes. There's a larger behavior gap. Hedge fund investors tend to display, again, relative to public markets, much stronger performance chasing behavior, which again, speaks to that much larger empirical incentive fee for the reasons that we just went through.
The other challenge for hedge funds is capacity constraints. I talked about this – I used a different paper as the reference when I did, but I did a video a while ago on the endowment model. I talked about how there's more recent researches finding that historical opportunities that may have existed for alpha and diversification have largely dissipated. The 2021 paper by Bolin and co-authors, they showed that the positive contribution of hedge funds as part of a diversified institutional portfolio has diminished significantly over time, even under the assumption that investors can identify and invest in top performing funds using several predictive characteristics.
Maybe if there were historical diversification benefits, those have gone away. BlackRock for their expected return assumption for hedge funds, they suggest an expected return of 7.8% gross of fees with a standard deviation of 7.7% as hedge funds broadly speaking. The Credit Suisse Hedge Fund Index, which again, contains all different hedge fund categories, have returned 7.2% net of all fees with an annualized standard deviation of 6.7%, from 1994 through July 2022.
Now to keep it simple, similar to what I mentioned with credit and the other strategies, we just assigned one expected return here for hedge funds, as opposed to going through each one individually. Again, if you're investing in one specific hedge fund strategy, maybe you'd want to adjust this based on that. We look at BlackRock’s figure, which is a gross of fees figure and net out the fees estimated in the Ben-David paper that we just went through. An additional reduction for the additional expected behavior gap that hedge fund investors tend to exhibit, which gives us a net expected return of 3.36% net of fee. BlackRock was 7.8% gross of fees, but for all of those layers of fees and errors, behavioral errors that we just saw, we put that down to 3.36%.
Cameron Passmore: I think the big takeaway here too, is to highlight the fees, and how the fees do erode the returns, obviously. I think many people might be surprised at the magnitude of the fees and these different strategies.
Ben Felix: That Ben-David paper is mind-blowing, mind-blowing. Yeah, I agree. Same for private equity. You're paying 6%. Again, that's another case where the sticker price is 2 and 20, or whatever it may be. When you go through all of the layers of fees and costs for investing in the asset class, which is what Phalippou did in that 2008 paper, that's where you get something closer to 6%. Likewise, with Ben-David, you go through the actual experience of hedge fund investors. As opposed to 2 and 20, you're paying what whatever they found, 1.5 and 50. Yeah, I agree. These are very important.
We did have one for direct real estate. I think, I'm going to skip that one. It's not the most interesting. I think the big takeaway on private real estate is that it performs the same as public real estate. Any term expectation for private real estate is not going to be materially different from public real estate. Ilmanen found that in the 2019 paper. I said I was going to skip it, but I'm not.
Cameron Passmore: We knew you weren’t.
Ben Felix: Ilmanen in 2019, they find that private real estate has delivered returns below or on par with publicly traded real estate investments when you make all the adjustments for sector and all that stuff. That's more evidence in their view of a lack of an illiquidity premium. There's a 2018 paper from Peter Mladina, and they find that current and lag to reap betas and factor benchmark betas explained the entire return premium of private real estate, suggesting that private real estate does not offer a unique source of compensated return that differs from its exposure to systematic risk factors. In the case of the Mladina paper, he's not just saying that public real estate explains the returns of private real estate, he's saying that the returns of equity and fixed income risk factors explain the returns of both public real estate and private real estate.
We've talked about that in the past, where it's like, instead of overweighting REITs or private real estate, you could get exposure to the same economic risks by tilting toward small cap value equities and credit fixed income assets. I think that's important. As an asset class, real estate has tended to deliver capital returns in-line with, or slightly above inflation. There's a bunch of really interesting research on that. I've got three different sources that look at very long-term data in different regions have come to the same conclusion.
In nominal returns, the baseline return for real estate is expected inflation on the capital return, and then the rest comes from net rental yield. AQR, this is Q3 2021, so this has probably changed, because prices have come down, rents have gone up. As of Q3 2021, AQR had 2.6% as the expected real return for real estate. BlackRock uses 4.1% nominal gross of fees again. I don't know what exactly makes sense to use here. John Cochran in a 2011 paper shows that at least in the US, high price to rent ratios signal low future returns for real estate, not rising rents or prices.
My rough guideline here is BlackRock seems fine at 4.1%. Nominal for US real estate. Canadian valuations are still high. Net rental yields are still low relative to the US. Maybe take off an additional 1% for Canadian direct real estate. This is different, keep in mind, than the figures that we will be using for well, in Canada, maybe it's not different, because your net rental yield might be close to zero. I was going to say, it's different than what you'd use for the capital return for housing, if you're living there.
Anyway, so net rental yields are really what matter for expected return for real estate. Maybe that differs from deal to deal. Maybe that's how it makes sense to think about it. I would assume the capital return is zero in real terms, and the expected return from direct real estate is going to come from whatever the net rental yield is. That's probably the best way to think about it.
For cryptocurrencies, and this was a fun one to try and think through. Of course, we don't have a lot of data for cryptocurrencies. What is the equilibrium return of Bitcoin? Well, we have data since 2010, or something, I think, is when you can actually get data. Bitcoin traded before that, but no one was tracking it. At least not from price indexes that I found. But even, say, it was 2008. Great. 14 years of data. I mean, we try and use a 124 stocks and bonds when we do our expected return assumptions. Even then, as we've talked about in past episodes, that may not be a great estimate of the equilibrium return.
I thought, maybe we take the demand system asset pricing approach and look at what investors who invest in crypto, what else do they invest in and what can we infer about expected returns for crypto based on how those other asset classes behave. If a certain type of investor has a high propensity to invest in a certain type of stock, and they also invest in cryptocurrencies, maybe the expected return of cryptocurrencies is similar to that type of stock.
Empirically, crypto investors tend to be attracted to stocks with lottery-like characteristics, penny stocks and stocks with high media sentiment. That comes from Tobin Hanspal’s paper that we talked about in our crypto series with him. They also tend to be overconfident and have low financial literacy. There's three papers that I've got to reference for that. Investors that share a lot of those traits tend to invest in small high-priced stocks with low profitability. That comes from Betermier’s 2022 paper that we talked with him about on our podcast a while ago.
Looking at cryptocurrencies directly, there's a paper, 2019 paper from Ling and Zhu. They find that network hype plays a significant role in increasing cryptocurrency prices. Makarov and Shore, we also talked to Igor Makarov in our crypto series. They find that the majority of Bitcoin transactions are related to speculation. There's another paper from Griffin and Shans, which we talked about in our crypto episode with Chris DeRose that released last Friday when this comes out. They find that at least the 2017 price bubble, which is what they studied, was driven by the unbacked printing of Tether, which is effectively fraudulent activity. That's what drove the price increase at that time. Of course, assets driven by speculation hype and fraud, we would expect to have low returns.
As an approximation, we use an index of small stocks with high prices and low profitability, which tend to have lottery-like return distributions to proxy for the expected returns of cryptocurrencies. From 1963 through June 2022, the Ken French small low book to market low operating profitability index returned 1.07% annualized in nominal terms with a 29% standard deviation. Over the same period, the US market returned 10.22%. Meaningful underperformance. We know this. These are the stocks that Dimensional and Avantis, for example, removed from portfolios, because their expected return profiles are so brutal.
Crypto, maybe you do get a lottery-like pay off, which is great if you win. From a modeling perspective, I think we have to try and capture the fact that on average, lotteries are losing games. It’s the most extreme skewness you can buy, I guess. We assign a 1% nominal expected return to cryptocurrencies.
Maybe 2015 is when we have data, or I just choose to use that period. Anyway, from 2015 to 2022, Bitcoin’s annualized standard deviation was about 80%. On the assumption that the crypto market has maybe matured a little bit, we assign an expected standard deviation of 60%, which is roughly double what we observed for the lottery stock index, but also, significantly lower than the historical standard deviation of Bitcoin. Basically, low expected return, high volatility. Maybe some people are into that kind of thing, which is okay. Maybe you win. Maybe you get the lottery-like – the good lottery outcome. All right, so that's it. That's all I got.
Cameron Passmore: That was awesome.
Ben Felix: I hope it was interesting. I mean, I know a lot of our listeners don't invest in alternative asset classes. I know, there's been a lot of discussion in the Rational Reminder community about managed futures, which we did not talk about. In terms of alternatives, maybe that would have been interesting, but for the reason how great we were –
Cameron Passmore: A lot of great takeaways here, right? There's a lot of hype around these different asset classes for a lot of people. I think there's a bit of a cold shower, or at least an appreciation for the fees. I think lower expected returns across the board from your research than people would expect.
Ben Felix: Yeah. Probably lower expected mean returns, but I think that's skewness. It's the –
Cameron Passmore: True.
Ben Felix: Do you use the mean or the median return when you're making assumptions about these asset classes? On a lot of cases, we did use the mean, and then gave it a haircut. Realistically, maybe the median is better. If you look at the median return for a lot of the private asset classes, they're brutal. I don't know what the median return is on cryptocurrencies, but it's probably not very good either. I mean, Bitcoin and Ethereum, for example, have had fantastic returns, but I didn't look for data on what is the median return on cryptocurrencies since I don't know, 2015 or something. I don't know. My guess is it's lower than the Bitcoin return series.
Which even now, I looked at this a while ago. I wish I had gotten this data point for this talk. I just didn't think to do it. For quite some time now, I can't remember what the actual data point was, but I did look at this a while ago. For quite some time now, investing in the S&P 500 outperforms Bitcoin, because Bitcoin has had so many peaks and troughs. If you invested at one of the peaks, and maybe it was 2017 or something like that, by this point, you've significantly underperformed investing in US stocks. It's just an interesting point.
Cameron Passmore: Cool. All right, so you want to talk about or do a follow up on the financial literacy?
Ben Felix: Yeah. Jason Pereira, who's one of our friends in the industry, he sent me a study that the Ontario Securities Commission did. It was an investor knowledge study. I think it came out after we recorded our episode on financial literacy. If it had come out before, or if I'd seen it before, I would have included these data points in that discussion. I thought it was a worthwhile follow up. They tested 27 financial Literacy questions, and this is for Canadians. They tested 27 financial literacy questions covering a whole bunch of investment related topics.
On average, investors answered 53% of the questions correctly. Canadians answering the study that we talked about in our last financial literacy episode, the S&P Global FinLit Survey. Those questions, Canadians got 68% right in that FinLet study. For the exact same questions in this study from the OSC, they also got 68% correct. That was interesting, on average. The two studies just lined up for those questions being tested.
In this OSC study, investors had the least knowledge when it comes to investment costs and investor protections. The fewest correct responses provided were to questions about the investment costs was 36% correct and portfolio protections was 44% correct. About three in 10 Canadian investors self-assess their financial knowledge too highly. Comparing the prior self-assessments to investors’ actual results, about 30% underperformed their expectations, and 14% exceeded their own expectations.
The most financially literate in the sample were self-directed investors, which is perhaps not surprising. They answered 59% of the questions correctly on average. For investors with advisors, they got 52% correct, and the least financially illiterate, which is actually really interesting, where the investor is using a robo advisor. I say that's really interesting, because I mean, it's 49%. They got 49% of the questions correct, versus 59%. That's a meaningful difference for self-directed investors.
That's interesting, because with the robo advisor, you're getting pretty bare bones advice, and you're getting cookie-cutter asset allocation advice, which I believe, tends to err on the side of being conservative, because the robo advisors don't want to get in regulatory trouble for putting people in 100% equity, or like a small cap value portfolio. It is interesting to see that those investors are the least financially literate, and therefore, maybe the least likely to advocate for their asset allocation decisions.
Women, and this is similar to other studies we talked about last time we covered this topic, women were slightly less financially literate than men. They got 50% of questions correct on average compared to 56% for men. This study found that there are effective ways to debias investors in terms of overconfidence. 31% of participants lowered their self-assessment of their financial knowledge after going through the 27 questions in the study.
Ben Felix: Interesting.
Cameron Passmore: Younger investors were more likely to revise down their self-assessment of their financial literacy after going through the questions. That's it. I just thought it was interesting follow up. This had more investment related questions, as opposed to general financial literacy questions. That point about costs, I think being the worst testing area for Canadians. Maybe it's not surprising. We know, Canada is on the higher end of mutual fund fees, and the higher end of continuing to have assets and actively managed mutual funds. Maybe that speaks to part of the reason why.
[00:48:34] CP: Interesting data points. I think we'll skip the book review this week, Ben, and push it forward a couple of weeks just to keep your expected returns part in one bundle. We had a good guest coming up.
I thought it'd be worthwhile to talk about a conference I was at last week now. It's called The Future Proof Conference, which basically, blows up the old model of going to financial advisor conferences that always happen in some hotel boardroom. I mean, I've gone to them for decades. You've gone to a few. They’re so typically, at the vendors outside, you have the coffee stations, you're all sitting in a big room with a chairs staring at the front. You get good speakers, but the overall experience is usually quite boring, right?
Hats off to the guys at Ritholtz Wealth Management in New York City, and the organizer of the event, Advisor Circle. They come up with an idea of what to do in a COVID world where you can bring people together. They came up with this future proof idea, which was billed as the first ever wealth festival. It was in Huntington Beach, California, which is dubbed as Surf City USA. It's about an hour south of LA. It was a big risk, because it could have been like being at a fire festival, for those of you who’ve seen the festival documentary. It could have been a complete disaster. Had it rained, or maybe it just didn't work. Maybe people didn't come and maybe the format didn't work. But I can tell you, it created an environment that was phenomenal.
It was completely outside. It was in a lot that was wedged between the Pacific Coast Highway and the beach. Literally, the beach was right there. It makes this phenomenal backdrop. It was four days of perfect weather. They had four stages set up. All the vendors are intermixed. They had food trucks on the outside, so that the physicality of it was really interesting. It was cool, right? You're outside, so it was safe. People were having fun. The people that were there really treated the content seriously. People wanted to learn AI.
You just sit down at a picnic table and talk to people and people were just asking all kinds of questions. The level of engagement, my experience was that it was really high. Even though people were going around in shorts and flip flops and skateboarding – It was fun. They treated the material seriously. Honestly, I got chatting to so many people, I missed a lot of the presentations. The ones that went to, some were really, really good. I don't remember coming away from a conference with as many action items as I did at this event. Because so many people had so many ideas. Maybe it was the type of people who were attracted to this, or just idea machines. It was pretty incredible. They've already scheduled one for next year.
Ben Felix: Well, don't just tell them you get action items. What were they?
Cameron Passmore: Oh, all kinds of action items. I mean, I have a whole list at my Evernote. Things to do about structuring the company. Ideas about guests on the podcast. As you know I got a chance to sit with past guests, Hal Hershfield. He had different ideas about who to reach out to and how he might help us meet people. I got some great feedback from a lot of people on the podcast, which was really cool to hear how people are using the content, particularly the research that you have done. They’ve got a lot of ideas around that.
That did spend a fair amount of time with a good friend of ours, who I'd never met face-to-face before, Brian Portnoy. He's a two-time guest. He was there and he presented. A really great presentation that he did. I met his newest team member, Jordan Hutchison, who, get this, just completed his PhD dissertation about advisors working in flow.
Ben Felix: What does that mean? I know what flow is, but what does advisors in flow mean?
Cameron Passmore: Advisors, just the benefit of advisor getting into that flow state as part of their job. I want to follow up with them to learn more about it. I didn't get a chance to spend a lot of time talking about it, but that was his PhD dissertation. How interesting it cannot be, right? If anyone's looking to learn and have fun and get to Southern California, I would highly recommend looking at this for next year. Kudos to Barry and Josh, the guys at Ritholtz. Look forward to next year's event. I think, next year, we'll have more people from our team going. It's technology ideas. There was a lot of crypto. I think, it could have been perhaps some –
Ben Felix: There was a lot of crypto?
Cameron Passmore: A lot of crypto presentations, which it would have been nice to have some of the counter arguments presented, just to challenge some of the presentations I went to.
Ben Felix: Oh, that's interesting. Well, hold on.
Cameron Passmore: Quite optimistic.
Ben Felix: You may know more about crypto than a lot of people, because we're nearing the completion of this crypto series. Given what you know from the work we've done, what was your take on what you heard about crypto there?
Cameron Passmore: It would have been so great to have people to challenge some of the statements. Someone was asked, what is crypto? It was presented as a huge marketing opportunity for investment advisors.
Ben Felix: Oh, wow. That's interesting.
Cameron Passmore: Yeah. With, you can only lose all your money, but you can make a 100X.
Ben Felix: Oh, yeah.
Cameron Passmore: They were not proposing a huge waiting, but why not go 1%, 2%, 3%, 4% in your portfolio? You got limited downside, but you got huge upside.
Ben Felix: On the basis of it being a marketing opportunity, because you don't have much to lose. If you win, you're going to be the smartest advisor in the country.
Cameron Passmore: Correct. You are doing a fiduciary disservice, because people are doing it anyways. If you can do it better for the people that are doing it anyways, that is your fiduciary obligation to clients.
Ben Felix: Wow. I guess, we'll agree to disagree on that.
Cameron Passmore: That's interesting take. It would have been nice – I'm not saying they’re not entitled to that opinion, but it would have been nice to have more counterbalance, counter debate on that. There may have been. It could have been on another stage. You can't, because there's four stages going all the time for four days. There's, I think they had 200-plus presenters. There's a lot of content there.
Ben Felix: Wow. Interesting. I probably won't go. I like learning, but I don't like having fun.
Cameron Passmore: Just not your kind of event. Trust me on that. It is not your kind of event.
Ben Felix: Just speaking of crypto, we recorded yesterday an episode with Ari Juels, who is a proponent of crypto and blockchain. He's at Cornell Tech. He runs their IC3 research group, which is their crypto and blockchain research group. I don't know what you thought of that conversation, but I thought he's very thoughtful and very articulate and well-spoken. Yeah, we asked him a little bit about what he thinks about the crypto critics who have similar academic training and technical expertise to what he has, and his view is basically that they have a lot of valid points, but they've gone too far with it.
Honestly, I've been getting that feeling, too. Some of the earlier episodes we did on crypto, and then as we've progressed through and gotten more viewpoints and learn more about it, I think that the full-on all of crypto and blockchain is a complete scam. I don't think that's the right perspective. Well, if people are listening to this who also listened to our episode with Chris DeRose last week, I think he made a similar comment where it's like, if you think that all of this is dumb, you're probably very wrong. Likewise, if you think it's going to revolutionize the whole world, you're probably also very wrong.
I'm still highly skeptical of the space, because I do think it's full of scams and bad investments that are being pitched as a good investment. I think, I've softened a bit on the whole space being an objective scam. I don't know if you've changed your view at all after talking to Ari.
Cameron Passmore: Yeah. I mean, I think that's a good way of putting it. Is it as bad as some people purport? Maybe. But it does seem a little extreme? Is it going to be changing the world as we know it? That might be over optimistic, but – It's funny, every interview we do pulls us one way or the other, right?
Ben Felix: Yeah. Maybe it's recency bias. I don't know.
Cameron Passmore: Maybe there's a mean distribution of where it's going to go.
Ben Felix: Ari made the point that – I said to Ari during that episode like, I don't know why I hadn't thought about that before, but all technological innovations have come with scams. A lot of scams. I remember reading, I think it's A Random Walk Down Wall Street, I think, but they go through the history. I talked about this in my video on thematic ETFs, I think, is the one I use all those examples. There's like, you go through the decades and there's the Tronics, boom, the dotcom boom, railroads. You go through all of those cases, and there were a ton of scams, fraud, like outright fraud.
That was Ari’s point. Like, yes, we're seeing a lot of fraud in crypto. Yes, crypto is very well suited for fraudulent activity. But you go through other instances, maybe it's more prevalent in crypto, I don't know. I don't have the empirical data to make that judgment, but I think it's a valid point that you go through all of these other instances of things that did end up being revolutionary. I'm not saying crypto is revolutionary. You go through other instances of things that could have been revolutionary and ex-post and a lot of cases were, and they were full of scams. Full. And asset price bubbles.
I think that is a criticism of crypto. It's valid and it's true. Again, crypto is particularly well suited to be used for scamming people. I don't know if that's a valid reason to say that it's all and forever completely useless technology.
Cameron Passmore: It’s a good way of summarizing it. Let's set up our 22 and 22 challenge reading guest. I think, we'll defer letters and notes and feedback to next time. How's that?
Ben Felix: Do you want to do the reviews quick? Yeah, we got two very nice long-form, one email and one letter that I think we should discuss. I want to give them more thought before, because they're very, very, very warm, thoughtful letters, just about the impact that the podcast has had on a couple of people. Yeah, we'll defer that. Do you want to do reviews quick., and then –
Cameron Passmore: Sure. Got to do reviews. Go ahead.
Ben Felix: OkayDerek from the US said that we’re one of his few podcast descriptions. Great podcast with excellent hosts. Do we decide to stop reading reviews and we're doing it again?
Cameron Passmore: I don't remember. It's all an experiment.
Ben Felix: Okay. Whatever. Then Swedish lawyer from, you guessed it, Sweden, that they're drawn to the podcast, mainly for a thoughtful dissemination of investment research. They've learned a lot over the past years. They were not initially excited with our crypto specials, but it's been great to get different perspectives. The discussions on what money really is has been interesting. We’re the most well-prepared hosts in podcasting. We do try to be. We had a group of advisors from different parts of the world in our office yesterday, as part of a learning, I don't know what do you call that? What's it called?
Cameron Passmore: Due diligence tour.
Ben Felix: Due diligence tour. This is a thing that PWL engages in with other firms to just learn about what other people are doing in terms of best practices. They wanted to know about the podcast. I think that was one of our big messages to them, is we put many, many hours into preparing for our conversations, both between each other and with our guests. Well, David Senra, who we're about to talk to, he talks about this. It's not a job. It's the life of a crazy person.
Cameron Passmore: Yeah. Then so many people in the business, it's been my experience, you're looking for that, what's the silver bullet solution? What can I say? What can I do in SEO that will drive business? We do not do this deliberately to drive business. We try to do the best we can each week to put out content that we find fun and preparing and presenting. That's what we're doing. I think a lot of people are perhaps learning that you have to put the time in. If you don't love doing it, you're not going to put the time in.
Ben Felix: Yeah. It's the thing where I think if this were a job, in the sense of you go to work to get paid, we would be considered unhealthy individuals and having horrible work-life balance and stuff like that, but that's not how it feels.
Cameron Passmore: No.
Ben Felix: But if you were to try and find somebody and say, “I'm going to pay you this amount of money to do exactly what I'm doing now,” first of all, the hourly rate of pay would be horrendous. Because it's, I don't even know. 12-hour a day, every day of the week “job.” But it's not a job in the sense, because I think we both love doing this stuff and reading about it and learning about it and listening to other podcasts.
Cameron Passmore: You mentioned reading and podcasts. That's a perfect segue to the setup for our 22 and 22 guest. I was listening to Patrick O'Shaughnessy’s Invest Like the Best Podcast, I think, it’s two or three weeks ago, and he had David Senra on as a guest. David has a passion for studying company founders and for reading. He has a podcast called The Founders Podcast. I almost skipped listening to him. I'm like, “Ah, I’ve listened to it.” I now listen to podcasts when I ride the Peloton.
I listen to it, and man, he came full game, full energy. I was blown away by the conversation they had. He has an unreal reading habit. He reads half of every day. His job is basically, read half the day, and then spend the other half of the day preparing for the podcast. As Patrick suggested, he suspects there’s probably no other human who has ever read more books, biographies, autobiographies about founders as much as David has.
If you look in the feed, he reads biographies, or backgrounds of Steve Jobs, Bob Dylan, Rockefeller, Jay Z, the list goes on and on, like 300 people he's covered. One book he highly recommended, which I read since then, is a book about Edwin Land who was the founder of Polaroid, which is an unbelievable technology story that goes back to 1937. Discovered the instant camera in 1948. Then it became this, I think, we all know this pop phenomenon in the 70s and 80s, then went bankrupt in the 2000s. It's an amazing story.
The interview with Patrick was super enjoyable, super energy. I reached out to David and he agreed to join us. Here's our conversation with David Senra, and thanks, everybody for listening this week.
Cameron Passmore: David Senra, thanks for joining us on The Rational Reminder Podcast and helping to inspire people as part of our 22 and 22 reading challenge.
David Senra: Thanks for having me.
Cameron Passmore: Awesome. I heard you, as I said, at the top of the show on the podcast with Patrick O'Shaughnessy. I was blown away by your energy that you brought to not just reading, but learning what you read and bringing those lessons to your podcast audience. I was incredibly impressed. Tell us, where did your passion for reading about founders come from?
David Senra: I think, the passion came from reading in general first, since that's the only habit I've had my entire life, that has unbroken. From the time I could read till now. I read everything all the time. I'll walk into a room, I'll read the entire menu. I have no idea where it came from. Then, just being interested in entrepreneurship, I didn't even think of now there's this entire entrepreneurship industry. Back then, it was just like, “How can I make more money?” I need to make money. I was working full time in high school. I was like, okay, the first opportunity I had where it's like, I was working at a carwash. I worked at a carwash for three years and three days actually. I actually got fired from that job.
The first interest in entrepreneurship was like, wait, I'm making what I thought was good money for a high schooler. Then I had clients and customers would – you'd have repeat customers, they'd come in and like, “Hey, will you do what you're doing for me? Just come to my house to do it. Instead of getting 10% or 20% of what I pay here, you get a 100%.” That was my first introduction into entrepreneurship. I was like, “Wait a minute. There's no cap to what you can make.” If you can actually find a way to capture a larger percentage of the value that you create in the world, you essentially have unlimited amount of money that you could make.
When I was in college, I was in a business school. I started reading biographies of at that time, it was really popular. I read biographies of Jack Welch and Jamie Dimon. I just was way more interested in the personalities, in the centre personalities of the people that start the companies. I was actually listening to a podcast long time ago. This was back in 2012, where I first got the idea to focus on entrepreneurs is because there's this guy named Kevin Rose, he was the founder of this company, Digg, and he was one of the big web2 founders. He was probably 20-years-old. They put them on the cover of a magazine. They're like, “Who the hell gave this guy, they raised 50 million dollars.” This is probably 2002-2003, somewhere in there.
He had one of the very first high-quality video podcasts that interviewed entrepreneurs. It's called Foundation. It's still available on YouTube to this day. He interviewed Elon Musk in 2012. They're in the factory of Tesla. I think, Tesla at the time, had just released a Model S. It's not at all clear. They'd sold 2,500 of the Roadster. Now, he took that money, threw it into the Model S, but it wasn't at all clear what the future trajectory of Tesla was.
Kevin was just perplexed. He's like, “You came over from South Africa to Canada, then you emigrated to California, and then you show up, you don't know anybody, you start your first company in your 20s.” A lot of people know, obviously, or don't know obviously that Elon Musk sold his first company, Zip2 when he was 27. He sold it for 300 million dollars. He winds up netting 25, or 30 million dollars. Kevin's like, “How did you figure out how to do this? Did you have mentors? Did you read a lot of books? Did you have connections?” Elon said something I thought was interesting. He's like, “No, I didn't have any mentors.” He's like, “I like to read books, because I found mentors in historical contexts.”
Kevin's follow up question is what gave me the seed idea to do Founders Podcasts later on. He’s like, “Oh, did you read a lot of business books?” Elon was like, “No, I didn't read business books. I read biographies and autobiographies. I thought they were helpful.” Then he goes into admiring Benjamin Franklin and describing what he learned from his life and how you could apply to that. Then in subsequent interviews, Elon would talk about reading biographies of Henry Ford. Every single person who's ever designed a rocket. He just talks about all the ideas that he learned from them building the business and what he applied to his. I was like, “Man, that's a really good idea. I should start reading more biographies of founders.”
Ben Felix: That's really cool. Now, reading has become part of your career. Can you tell us about your reading habit?
David Senra: Yeah. This is a funny thing. There's a fantastic founder. He's a former founder, a guy named Derek Sivers. He founded this company named CD Baby. Most people know him now, because he's a writer and he's appeared on a bunch of podcasts that went viral. His episode with Tim Ferriss was fantastic. I've read his entire blog, because I think he's a very unique thinker. It’s like, who sells his company then puts it into trust for charity, and then lives off the interest of that every year, and then now just writes – he's just a very unique person.
He said something that I think resonates, because a lot of people are like, “How do you read so much?” They expected some complicated process. Derek says like, “If you just love to do something, it's very simple to you.” He compared it to running. He's like, “If you talk to somebody that loves to run, and may run every day, to people that don't do that, they ask like, how do you do it? The person responds, it's like, well, I wake up, I put on my running shoes, and I go out the door.” People ask me that question a lot, where it's like, how do you read so much? They expect, do you speed read? Do you do this? It's just like, I pick up a book, and I stare at it. That's all I do. I just love to do it.
I wake up. I usually work out, do some physical activity for an hour. Then I try to read three to four hours in the morning, because I feel my brain works better. This is actually, Jeff Bezos said the same thing, where it's just, your brain tends to work better after you're well rested in the morning. If I need to really focus and really absorb what I'm reading, I do that for three to four hours, as much as my brain can take. I take a break. Then the second part of my workday is just reviewing all the past highlights that I've read. Those are easy, because instead of reading chapter after chapter maybe, and I actually read a lot.
Yesterday, it took me four hours to get to a 100 pages. Because I'm stopping, I'm reading Cable Cowboy by this guy named John Malone, who's, it's the most recommended book on Founders that I have not read yet. People will not leave me alone. They’re like, “You have to read the book. Have to read the book.” It's really complicated to see how he built that cable company. I'm reading the book, but then I stop, I’m like, “Oh, that's something that's I remember Warren Buffett's and his shareholders.” I'd have to deviate for 20 minutes. I find, go through all the highlights of the Warren Buffett shareholders and find it and then tie it into that book.
What I'll do is I'll take the past highlight from Warren Buffett shareholder, I'll write it out by hand, and I'll put it in the page of that book. That just reinforces what I do. The afternoon reading, when I'm reviewing my highlights in this app called Readwise, those are tweet size, maybe a paragraph, maybe a couple sentences. They're all different books. Because the app, the app presents my past highlights to me in random order. That's easier. My mind is not just good in the afternoon, but it's a lot easier, because it's a little chunk.
Then I just sit there and think. I was like, “Okay, what can I tie that to? What does that remind me of?” Then if there's any notes or anything else, I'll make them for the episode I’m working on that week.
Ben Felix: You mentioned a book that people were bugging you to read. More generally, where do you get your ideas for which Founders do you want to learn about?
Cameron Passmore: I heard, there's a woman named Maria – I don't know how to pronounce her name. Papavov, maybe something like that. She runs the website, it used to be called Brain Pickings. It's called something else now. She's this obsessed reader, too, where, essentially my podcast is my version of what she does on her blog, where she essentially catalogs all the stuff she reads and puts her – adds her thoughts to that.
I heard her on a podcast one time, she said something that was fantastic. She said, that books are the original links. That just like the Internet today will take you from one idea to another, to hyperlink, books served that purpose before the invention of the Internet. You could do that, because you're reading about somebody, and then they'll talk – There's two cases of this. It’s like, they talk about people that are important to them. Then you can also go to the bibliography. I just reread the most famous biography of Rockefellers Titan. Ton of people read it. It's been around for 20 years.
I reread it the second time and did another episode on it recently. Then I went to the bibliography, I'm like, “Oh, I need to find other books.” I found source material that that author used, and I found a little known 40-year-old, 250-page biography of Rockefeller. That was fantastic. Then I did an episode on that. I'm going to start with the example, like Steve Jobs. I read the Steve Jobs book, Walter Isaacson four or five years ago. In that book, Steve tells about – because what I noticed about anybody gets the top of their profession, they all have deep historical knowledge and they're very interested about the people that came before them.
Steve will talk about all the people that influenced his work, the founders of HP and Intel, and Edwin Land, Da Vinci, Michelangelo, Henry Ford, Gandhi, he just goes down the list. Then what I would do is I make a list of all the people they talk about, then I read every single book I could find about them. I'll do that over and over and over again. Then because of the audience, people of my audience, listeners send me books every day. My queue right now, and I've lost count. Last I counted, it was 300 books in the queue that I have to get to.
Cameron Passmore: Wow, I just started managing a queue, because we're getting recommendations. Now, I think I'm up to probably 30 or 40 books that people are recommending. I want to go back to your habit of capturing the information. I also use Readwise. I kept to Readwise from my Kindle digitally. How do you integrate your notes you’re taken by hand, I assume from hardcopy books into Readwise. What is that hack that you use?
David Senra: There is no hack. I do it the hard way.
Cameron Passmore: Just tuck it in.
David Senra: Yeah. I wish I could retain information. Sometimes I have to do an episode off of Kindle, if I'm traveling, or whatever the case is. I'll read the entire book on my phone. I actually got that idea from Elon, too. It's actually pretty easy. It's really fast. For some reason, I have a love affair with physical books. Even though it's much slower, I do it anyways. Basically, I'll start usually with a physical book. I read a lot of old books that don't even have audible, or Kindle versions. What I'll do is I’ll pick up a physical book, I sit down with a ruler, pen, and scissors and post-it notes. I usually use a highlighter, but then I’d go back and reread my highlights, and you can't even tell what's highlighted, because it fades over time. That's why I had stories in the pen.
Then once I go through the entire book, whatever jumps out at me, I don't think at all. I'm just like, “Oh, that's interesting.” Underline it. Then I'll leave whatever note pops to mind. Then I finish the book. Then what I'll do is the night before I record, I like to reread all my highlights. I'll sit down, it usually takes maybe an hour, whatever the case is. I'll reread all the highlights and all the notes. Then I record the next morning. As I'm recording, I edit based on the flow of the conversation, because the way my podcast is set up is I wanted it to be like, hey, what have you had – you met up with your friend that reads a lot and you met up with dinner once a week and he told you the stuff that was interesting.
During the conversation, the flow of the conversation, I don't know what I'm going to say, and so I'm editing on the fly. I was like, I'll go to another page. You’re like, “Oh, you know what? I'm not going to include that part, because maybe I already covered it, or it just doesn't fit in the flow of the conversation, or whatever the case is.” Then I finish that.
Then, I listened back to the podcast before I publish it. That's the fourth time I've gone over the highlights. Then the fifth time is I go through on the Readwise app, on the iOS app, they have where you could take pictures, it automatically reads the text. You got to fix some of it, but it's really actually good. Then you go through and literally take pictures of every highlight, then type in whatever note I have on the post-it note, I put into Readwise as well. The reason I don't believe in hacks or shortcuts, is because the longer the podcast goes on, I don't just talk about oh, I just did a podcast yesterday on Thomas Edison. I talked to probably about half a dozen, or maybe a dozen other founders that thought like Thomas Edison, or something in that book related to past episodes and past highlights. The reason I'm able to recall of that stuff is because I'm, first of all, reading every highlight five times, and then I'll wind up rereading that highlight in the future.
To me, that's the equivalent of practice of an athlete, lifting weights, or running sprints, or shooting free throws. That's what I consider is the first part of my day is work. The second part of my day is practice. I do that seven days a week.
Ben Felix: Are their founder stories that have been particularly impactful for you?
Cameron Passmore: A 100%. What's fascinating to me is, every single person to get on Founders Podcast, think about how crazy it is. They have to be so good at what they did for a living that somebody wrote a book about them. That's the smallest percentage of anyone's ever lived. What I find is most of them, these are imperfect human beings just like everybody else, right? Most of them make the mistake of over optimizing their professional life to the detriment of their health, their happiness, their family life, just overall. They're completely obsessed.
Out of about the 200, I think yesterday it's 270 something, maybe 277 biographies I've read, the only one that I found that the one person that I want to try to be the most like is this guy named Ed Thorpe. This book is called A Man for All Markets. Ed Thorpe is still alive. He just did a fantastic interview. Tim Ferriss on Tim Ferriss’s podcast, Ed Thorpe is 90-years-old, and you can watch this interview on YouTube. I've sent it to friends. I asked my wife. I'm like, “How old do you think this guy is?” They’re like, “65?” It's remarkable.
What Ed Thorpe identified is what makes a truly happy human being. Ed Thorpe is also a genius, so he’s way smarter than me. I'm not trying to compare myself to him. I could read for the rest of my life and I'll never be as smart as that guy. What he identifies is like, okay, I want to be wealthy, right? He's an inventor of the first quantitative hedge fund. He's like, “I want to take care of my health.” He worked out. He says, every hour that I spend working out, I look at one day less I’ll spend in the hospital later to my life. He was a great father. He actually knew his kids, which a lot of the entrepreneurs that I studied, including Edison, his kids are in that book. We never saw her dad. We didn't really know. They knew him later, because they start working in his company, but kids. He just wasn't around. He's working. Essentially, if his eyes are open, he was working.
Then he had fun. He lived a life of adventure. There's crazy stories in A Man Of All Markets. He has dinner with a 38-year-old Warren Buffett. He leaves the dinner and he tells his wife, “I'm pretty sure that guy's going to be the richest person in the world one day.” It was immediately, he's like, “This guy's a genius. If he keeps at it and he keeps compounding, he’s going to become a rich person.” He went to building the first clutch and is the founder of information theory, I also read his biography. Ed Thorpe and Claude Shannon build the world's first wearable computer, because they're trying to figure out, can you use computing to predict where to get an edge in casino gambling games, whether it's be Blackjack, or what's the one where they roll the spins around?
Ben Felix: Roulette.
David Senra: Roulette. That’s right. Yeah, roulette. He identified a handful, maybe five things that are important to human beings that when you get into your life like, I'm glad I didn't miss my kids’ childhood. His wife winds up dying of cancer, unfortunately. After she dies like, “We had a great marriage. We spent a lot of time together.” He found a way to use leverage in his business, and I don't mean financial leverage, where he'd work. I mean, he had, essentially, an automated hedge fund, towards the second edge hedge fund he did. He worked 40 hours, maybe 50 hours a week, but he wasn't working a 100 hours.
That's the thing. I work every day, but even if I only work eight hours a day, that's only 56 hours a week, I still have plenty of time. You sleep for eight hours, work for eight hours, and you get eight hours to do whatever else you want.
Cameron Passmore: I agree. That was a great interview with Tim. One of the things you said to Patrick I found interesting is that you will often reread books, and that there is tremendous power in doing that. Do you read that book differently the second time?
David Senra: Yes. Because the words on the page don't change what you do as a person. I mean, essentially, the conversation we’re having right now is the importance of reading. Reading changes you. Humans by nature are going to imitate anything around them. I know, I'm very selective on what I let into my brain, because I know it's going to influence me, whether it's a TV show, whether it's a friendship, whether it's a book. I'm not doing all this work to say the same, right?
What I'll find is, if I go back, and let's say reread – I just reread Henry Ford's autobiography. From the first time I read it, I think the first time, it was Episode 25 or something. Since that, the first time I read Henry Ford's autobiography, I've read another, let's say, 250 biographies, right? Everything I've read up until that point there had all these life experiences over the last couple years informs who I am as a person.
The book is the same. I pick up the book as a different person. Therefore, one of the things I believe is we don't see things as they are. We see things as we are. That book and that understanding, now I can have a much deeper understanding, because then I'm like, “Oh, wow.” One examples is Ford, as his business scaled, he was obsessed with eliminating any waste. Because he says, “If I can eliminate 10 steps from each employee, and I got 200,000 employees.” He actually did the math in the book. I just eliminated 25 miles a day, or whatever, and saved this amount of time every day. I was like, “Oh, that's exactly what Rockefeller said.”
Rockefeller was obsessed with he sees his person taking the barrels of oil and saying, “Hey, we used 40 drops of solder, or whatever it's called to seal it. Have you tried 38?” They tried 38, and the barrels leak. He's like, “Okay, try 39.” They tried 39 and it's the same as 40. Then he does the math. He's like, “That saved me $2,500 the first year.” That business kept growing larger and larger. He’s like, “By year 10, it was saving me hundreds of thousands of dollars.” You realize, oh, this is the thing that's most fascinating to me. It's like, I love finding ideas, where the people didn't know each other. They lived at different points in history. They worked in different industries. They arrive at similar conclusions. That's how I know the idea is good.
Ben Felix: Are there books on founders, or otherwise, that you think everybody should read?
David Senra: Yeah. I hate to say this, because the book is – there's very few copies in print, and I keep trying to buy all the ones that are there. Because I won't shut up about this book. I used to be able to buy the book for $15. I just checked yesterday. It's $75. If I can only read one book out of every single book that I read, and I've read the book I think three times. I'm planning on reading it every year. It's James Dyson's autobiography, the first one. The second one's good, too, but he's a 70-year-old guy. It's completely different.
Where the first one he writes, he's in his 40s. He had just gone through 14 years of intense struggle. He doesn't know what's ahead of him. The business that he has is fantastic, but he's only selling vacuums. He has one product in one market, and he's still doing 300 million a year. You fast forward, he didn't interrupt the compounding, kept going. Now, I think he owns a 100% of business that probably valued at 20 or 30 billion dollars. The reason I think that's so interesting is one, it's a short book. You can read it in a weekend. I think, there is something to be said.
I just discovered this other author named Paul Johnson. What Paul Johnson does fantastically, he's written 10, or 12. I don't even know how many biographies. A ton. But they're all a 180, 200 pages. It's like, if you want more after that, go find a bigger biography. I think there should be more of these – Paul Johnson's book on Winston Churchill is fantastic. I think it's a 190 pages. I've read, I think, two or three biographies of Churchill. That's the one I’d start with, because then you like, do you want more, then you can go deeper. Not everybody wants 700 pages. Then a complete breakdown of what their great grandfather was doing last Tuesday. That's just not interesting to most people.
James Dyson, you can read in a weekend. He's funny. It's also, it’s like, oh, there was so many times in his life that it was rational for him to give up. He's in pain. He's crying. He's got two mortgages on his house. There's just so many times where it’s like, why is this guy not giving up? You realize that in every single life story. In our lives, you're going to be presented with opportunities. If you're trying to do something difficult, there's going to be many times where the rational thing is to quit, and you don't quit, because you love what you're doing, or you're determined to see it through.
On the other side of that pain and agony is everything you're going after. You just imagine, there's so many times when you're rereading that book, because you know how the story ends. Like, “Oh, if he quit here, we don't know who he is.” He doesn't have a 30-billion-dollar company, or even a billion-dollar company, or any – He doesn't even have a company. Maybe he's an engineer in somebody else's company and he's just deeply unhappy, because he knew he was destined to be an entrepreneur. He wanted to be a maker of products, and he wanted those products have his name on them. That's a line from the book. That's a book that is absolutely fantastic.
I'm shocked at how few founders and entrepreneurs and even investors read is Estee Lauder’s autobiography. I think it's called a success story. Really hard book to find. Another one that's probably 40-years-old, because when she published it, she was still alive. Estee Lauder was a private company. You could read that book in a weekend, too. I think it's 220, 250 pages. Very simple language. She just lays out the exact same thing. She had a dream. She was obsessed with beauty. She had all these times in life where she had to put the wants and desires of other people ahead of her own. She got married in a time in history, very few women were starting companies. Then she had to raise her sons.
Then eventually, I think she starts the company when she's 40. The crazy thing is now, me and Patrick are actually going to do an episode on Estee Lauder on his show business breakdowns in a few weeks. Because the crazy thing is he was telling me the other day, I think they're doing tens of billions of dollars in revenue. It's a giant company. That started out with one 40-year-old lady with a dream. The first Estee Lauder product line was at a counter in a beauty shop. Then just her relentless obsession with not only she loved her work, but all the advice that she gives to future generations of entrepreneurs, is just perfect. Again, her simple language and the way she tells stories, these ideas get in your brain, and they stay there. I just think that's a really good use of a few hours of your time.
Ben Felix: Those stories sound like they have a lot of dedication and grit. Do you have any observations from the research that you've done on the role of luck that is played for these founders?
David Senra: Yeah. I think, Charlie Munger has that saying. It’s like, you need to master the big ideas in a handful of subjects, like physics and all these and probability and everything else, because he says, they carry the most freight. The line I use after seeing all this is time carries the most weight. You just have to stay in the game long enough for luck to be an asset to you. Where there's no possible way. I just reread another – the best biography on Steve Jobs. I've read a dozen books on him. To my opinion, is becoming Steve Jobs, the evolution from a reckless upstart to a visionary leader, I think is the subtitle.
The reason that's important is because 20-year-old Jobs was building great products. The Apple 2 was a phenomenal product. You go from zero to – within four years, they're a public company. That one product. That's fantastic. Think about all the other products that he made after the fact, but he had to go again to 12 years of struggle when he gets kicked out between – when he gets kicked out of Apple and then goes back, which actually is today, the day we're recording this. I just saw somebody tweet that the day he got kicked out and the day he returned, I think happened on the same day 12 years apart. I didn't know that before. I hope this guy did his research and is accurate and not giving you bad information.
Of course, the world is complex. If you have a good business, time is an ally, so stay in the game as long as possible, so you can get lucky. He says this. He’s like, you can't predict things looking forward. You can only connect the dots looking back, is the Steve Jobs quote. It's like, all the stuff he learned from building the Apple 2. His first product is a smash. Then his next few, the Lisa, flop, the Apple 3, flop. The Macintosh, which is beloved now and had a huge marketing push had good one year or two years of sales and then fell off a cliff. That was a flop, too. Then he goes through 13 years of struggle, winds up accidentally discovering Pixar. Then that was evolution.
Pixar, the role that Ed Catmull and John Lasseter, which are the co-founders of Pixar played in Steve Jobs’ life can't be understated. Then he has to go through that. Then he comes back, starts making better laptops and desktops for Apple. Then has the idea, random ideas, like maybe we should make a music player, then the iPod, smash hit. Then he's like, oh, well, they have the idea, actually, to do the iPad before the iPhone. Steve Jobs shelved that. He tells Jony Ive, he’s like, “I don't know if I can convince people to buy a new form factor. I know, I can convince them to buy a better phone. Let's put all of our energy into that.”
My point is think about the string of luck and circumstance he had to go through for 30 years. Starts building products when he's 18. His very best product, the iPhone wasn't made for 35 years in the future. It plays a huge – and what people call luck, I call randomness. It's just life is full of randomness and complex. That's why I've had people – I've had a bunch of publishers approached me. They're like, “Hey, we want you to write a book, and do your top 10 lessons that you learned.” I refused, because that's dumbing down what is an extremely complex endeavor.
Building a company is building a complex adaptive system, but it's just a microcosm of the complexity of life. You can't say, oh, if you do these 10 things, you're going to succeed. No. Part of it is like, that's why I'm so obsessed with the personality types, because they're crazy people. They're fundamentally crazy. It's so much easier to just go get a job. You know what I mean? Go to an already existing – That's why I feel founders are the most important people in the world. When I say founders, I do not just mean people that start companies. I mean, people that start anything, an idea, a charity, a movement, a religion, a company. It's like, you have to be a crazy person and be like, “Hey, I have this idea in my mind. It has to exist in the world.”
I know, creating new things and making them exist in the world is extremely difficult and strenuous and stressful, and it may be this agonizing, inducing experience and they do it anyway. Yeah, again, I think a lot of this is just how can I figure out to make randomness an asset? That's why I think I like a lot of the writing of Nassim Taleb, because that's his whole thing. It's almost like, when I say time carries the most weight, it's almost a flip on his idea where it's like, he has this great book. They're all really good, but called Anti-Fragile. He said something one time that was fantastic. They're like, “Hey, how would you describe the concept of anti-fragility to a five-year-old?” He said, “Time is smarter than you.”
Everybody's like, “Hey, do a book on the Uber founders, or the WeWork founders.” I'm like, “No, no.” I like setting dead entrepreneurs, because I don't know if somebody's operating today, if they're going to be successful in the future. I use time as my filter. I know, the ideas that Henry Ford had when building his company were good, because time proved that. I know, Steve Jobs, Rockefeller, all these people, because you allow time to filter through that. I don't know if that the new wave of some people are doing things are actually going to work out.
Cameron Passmore: That's so interesting. One of your recommendations on that podcast was the book called Instant, to the story of Edwin Land, which is an amazing story. Talking about perseverance and luck and vision. It's just unbelievable to read what happened. I didn't know that story at all.
David Senra: Yeah. I didn't either. Books are the original link. I didn't know who Edwin Land was, until Steve Jobs would not shut up about the guy. I was like, oh, in my opinion, Steve's the greatest entrepreneur ever do it. I was like, if the greatest entrepreneur who’d ever do it is telling you, “Hey, this guy's a hero. This should be who we aspire to be.” I think it'd be professional malpractice for me not to go and chase down every single book that I can find about Edwin Land, then I'm not doing my job, and then I'm not serious about it.
Cameron Passmore: Fascinating. This is really fascinating. Last question for you, David. What advice would you give to someone who does want to read more?
David Senra: That's a hard question for me to answer, because no one would have to give me advice on how to read more. Just, if you want to do something, you'll do it. My favorite maxim of all time is actions express priority. It's like anything else in life. If you really love to do it, you can't wait for somebody else to tell you, “Oh, you should read more, you should exercise more, you should be a better father.” You should just do it. If you actually love to do it, then your actions will express that. There's a lot of people, one of my oldest friends, same thing. He's like, “I want to lose weight.” He's been trying to lose the same 30 pounds for a decade. You don't actually want to lose weight. You want to sit on your couch, drink whiskey and eat chips. There's nothing wrong with that. Don't delude yourself into saying that this is what you want to do, because your actions tell other people what you want to do. The big easiest thing is if you want to read more, pick up a book and read more.
Cameron Passmore: Great advice. David, this has been fantastic. Thanks so much for coming on.
David Senra: Yeah, of course. Thanks for the invite.
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Books From Today’s Episode:
Cable Cowboy: John Malone and the Rise of the Modern Cable Business — https://amzn.to/3SiHTE0
Titan: The Life of John D. Rockefeller, Sr. — https://amzn.to/3QWNFdj
A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market — https://amzn.to/3rePsAl
Estee: An Intimate Memoir Hardcover — https://amzn.to/3f1ZHVz
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'Replicating Private Equity with Value Investing, Homemade Leverage, and Hold-to-Maturity Accounting' — https://academic.oup.com/rfs/article-abstract/35/1/299/6136189?redirectedFrom=fulltext
'Demystifying Illiquid Assets: Expected Returns for Private Equity' — https://jai.pm-research.com/content/22/3/8/tab-article-info
'Private Equity's Diversification Illusion: Evidence From Fair Value Accounting' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2379170
'Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3736098
'Private Equity Performance: What Do We Know?' — https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12154
'An Inconvenient Fact: Private Equity Returns and the Billionaire Factory' — https://joi.pm-research.com/content/30/1/11
'Private Equity Performance: What Do We Know?' — https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12154
'2022 Capital Market Assumptions for Major Asset Classes' — https://www.aqr.com/Insights/Research/Alternative-Thinking/2022-Capital-Market-Assumptions-for-Major-Asset-Classes
'The Performance of Private Equity Funds' — https://academic.oup.com/rfs/article-abstract/22/4/1747/1567648?redirectedFrom=fulltext
'Capital Market Assumptions' — https://www.blackrock.com/institutions/en-us/insights/charts/capital-market-assumptions
'Has Persistence Persisted in Private Equity? Evidence from Buyout and Venture Capital Funds' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3736098
'Returns to Angel Investors in Groups' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1028592
'Business angel investing – promising outcomes and effective strategies' — https://business-angels.de/wp-content/uploads/2013/10/siding_with_the_angels.pdf
'Returns to Angel Investors in Groups' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1028592
'The risk and return of venture capital' — https://www.sciencedirect.com/science/article/abs/pii/S0304405X04001564
'Performance of Private Credit Funds: A First Look' — https://jai.pm-research.com/content/21/2/31
'Asset Allocation to Alternative Investments' — https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/asset-allocation-alternative-investments
'Do Hedge Funds Hedge?' — https://jpm.pm-research.com/content/28/1/6
'The Performance of Hedge Fund Performance Fees' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3630723
'Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1354070
'High-Water Marks and Hedge Fund Management Contracts' — https://onlinelibrary.wiley.com/doi/abs/10.1111/1540-6261.00581
'Hedge Fund Performance: End of an Era?' —https://www.tandfonline.com/doi/abs/10.1080/0015198X.2021.1921564?journalCode=ufaj20
'Liquid Alternative Beta and Hedge Fund Indices' — https://lab.credit-suisse.com/#/en/index/HEDG/HEDG/performance
'Real Estate Betas and the Implications for Asset Allocation' — https://joi.pm-research.com/content/27/1/109
'The Rate of Return on Everything, 1870–2015' — https://academic.oup.com/qje/article/134/3/1225/5435538
'Discount Rates' — https://www.nber.org/system/files/working_papers/w16972/w16972.pdf
'The Characteristics and Portfolio Behavior of Bitcoin Investors: Evidence from Indirect Cryptocurrency Investments' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3501549
'Bitcoin Awareness, Ownership and Use: 2016–20' — https://www.bankofcanada.ca/wp-content/uploads/2022/04/sdp2022-10.pdf
'What Do the Portfolios of Individual Investors Reveal About the Cross-Section of Equity Returns?' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3795690
'Blockchain Analysis of the Bitcoin Market' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3942181
'Is Bitcoin Really Untethered?' — https://onlinelibrary.wiley.com/doi/full/10.1111/jofi.12903
'Investor Knowledge Study' — https://www.osc.ca/sites/default/files/2022-09/inv_research_20220907_investor-knowledge-study_EN.pdf