Excerpts From Benn Eifert on the Odd Lots Podcast
An insightful interview with the QVR option fund's founder
About Benn: Founder of QVR Advisors specializing in option-based strategies
I found the transcript here.
The craziest aspect of the investing mania of the last few years was the role of sophisticated instituitions
Benn: I would say actually I found the sizes of the unsecured loans that very large, and you might have thought sophisticated, investors and credit organizations were giving to Three Arrows Capital, two and a half, you know, two and a half billion dollars for Genesis alone with like no collateral. I mean, you come into this just thinking, look, these are big boys. These are wealthy people who’ve created a tremendous amount of money and they wouldn’t just do completely, obviously crazy stuff like that. And then it turns out that the answer is, of course they do…I think retail gets all of the attention and you know, we can talk about that all day and there’s all kinds of interesting stuff there, but I think people forget that the role of institutional investors in this process and the way that institutional investors start to buy into narratives and start to, you know, start to develop this fear that they’re missing some huge technological revolution, and then do incredibly crazy things in huge size, is almost a more interesting story…
I think a big part of the institutional role in that really came from this huge psychology around private assets and private investments being this fantastic place to be, you know, big sources of innovation, stable returns, because, you know, without mark to market volatility, right, you saw just really in the last few years, you see the formation of VC growth funds, right? So you always used to think of venture capital as, you know, these nerdy, weird engineers doing cool science experiments and backing these early stage companies to do really disruptive stuff. Whereas growth funds were all about raising mega institutional scale capital at full fees with long lock and plowing that into companies that were already valued at $200 billion and just had a completely different asymmetry to the return profile.
And you had corporates like SoftBank and hybrid public private hedge funds like Tiger, you know, coming in to compete for deals, to get those deals with startups, by saying, ‘look, we have bigger checks and we’re not gonna ask you any annoying questions. We’re not gonna do due due diligence. Like, I want you to sign the term sheet in 24 hours that I just sent you.’ And that was really, you know, alot of that came from, I mean, and I think I had a Twitter post about this, but you know, 2019, 2020, I would go to conferences with big institutional investors. And the only thing that you would hear about was how big asset owners were taking money out of liquid alternatives type of investments and moving them into privates because the returns in privates had been so high and there was such a perception of such limited risk in practice.
The role of narratives and how the ability to spin them about the future can become a gray area or market failure
Benn: Just to be clear, technology itself is not the problem, right? I mean disruptive technological innovation is what drives the world forward. And, you know, Silicon Valley and venture capital plays a really important role in that. And that’s great, but that technology inherently has this characteristic, right? That you’re not selling a current set of cash flows or a well-trodden path of how, you know, that can be valued by people with spreadsheets in some kind of relatively formulaic way. It’s about selling a vision of the future and a vision of what could be and how that can play into future economics and trying to relate that to past innovation. And that’s a very nebulous thing in the end. And it’s something that is inherently susceptible to hype and narrative, particularly when the, I think, as you’ve seen in recent years, particularly when financial markets set up ways for people to get actually paid and to monetize that kind of narrative and hype, right? As opposed to, ‘Hey, I finished building this company and then it becomes a big company. And then I get really rich,’ right?
When it becomes, ‘I sell this vision of a future that’s really disruptive. And then I can issue a token and I can sell it to retail and I can make a billion dollars just by doing that without actually building anything.’ Or similarly, you know, in technology, if I can create a startup that gets valued at $300 billion, and then I can go into the secondary market and I can get liquidity as a founder and sell a lot of my shares to like institutional investors that want to get some, right? And I think that’s the inherent trick with technology is that it is inherently by its nature, much more susceptible to narrative-driven, you know, valuation and narrative-driven thinking.
And that is what it is, right? That’s not something that’s gonna go away, but it’s something that investors, you know, have to be really cautious about how to differentiate. And you get, it’s like the early phases of a technology cycle. You get those nerdy engineers building really cool stuff in the garage, but then the MBAs start to show upright? That’s kind of a classic line in Silicon Valley. And you end up with a lot of huckster types coming in to kind of ride along the wave because there’s so much money involved and that’s where you get the trouble.
[Me: There’s a bit at the end of the podcast that ties back to this in which crypto which is intellectually seated in unfettered free market ideology ironically self-skewers that ideology]
Benn: But crypto, I think at the core of it, crypto really owned and brought to the forefront, this idea that financialization is first, right? And the use cases sort of follow and that you’re supposed to have, it’s this very like pure Chicago Department of Economics, efficient markets idea, right? That like, if everything is priced a priori, the market is sort of all knowing and all seeing and people will identify the things that are gonna work and they’re gonna finance those. And like the world is gonna be utopia. And it’s completely ridiculous.
It, you know, what actually happens in practice is that if you can create a narrative and create a hype cycle around your company and you get the right VC backing and whatever it is, and then you can create money by issuing a token and you can sell it to retail n humongous size and you can make hundreds of millions or billions of dollars for doing absolutely nothing. And that happened over and over and over and over again. And it was sort of institutionalized as a business model by certain venture capital firms that, you know, are big backers of this space. And I think that’s the core issue.
Joe: Well, I forget who made this point, but yes, you might say that crypto has attracted the best and the brightest of the last several years, but if they’re the best and the brightest, they might be the best and the brightest at figuring out how to make life-changing amounts of money in six months, which is not necessarily the foundation of a sound new industry.
Benn: Yeah. You give people really strong financial incentives and it’s really hard to resist, right? It’s easy to obviously point fingers at the most egregious people in the space and Do Kwon, and all these guys, but like if you create a world in which it’s really easy for charismatic hustle-type people to get really rich by scamming people, they’re gonna do that. And you have to expect that, like, that’s just how the world is gonna be. And I think that’s what the incentives that we’ve set up in crypto have really done.
The challenge of separating hype from real change is hard but it’s easier to rule out than rule in
Joe: How do you know who’s just a storyteller in real time versus someone who is actually correctly identifying a new trend because, you know, you mentioned Warren Buffett in the beginning, he was wrong. Not all of the curmudgeons in a certain area, get vindicated in the end, he was wrong to dismiss the Googles and the, you know, the Facebooks in 2010…so in real time, investors really are faced with a tough decision because sometimes the world changes and it can be really hard to disambiguate in real time between who is a huckster, trying to, you know, sell their token or whatever, versus someone who’s identifying a real change that’s happening.
Benn: It’s really, really hard in real time — to your point. And I think that the reason it’s really, really hard is because again, we talked about momentum is a real phenomenon and structural change in the world. And technological change is a real thing, right? And so you have to keep an open mind and you can’t take the curmudgeon approach, right? Where anything that’s new or anything that people are excited about or that’s going up in price sort of must be wrong. And you see a lot of that kind of thinking, kind of behavior. That’s the wrong mental frame, right? I think it’s easier to think about identifying and screening out the stuff that has a lot of red flags and is fairly clearly actually a bunch of hucksters, as opposed to on the margin, solving the Warren Buffett question. Was there a path for Warren Buffett to figure out that Google and Amazon were real things back in 2010, 2012? There there might not have been. I think that identifying red flags of very likely problems. I mean, I think you get into things like, okay, do we have projections of returns that are way, way above historical equity returns or based on, you know, nonsensical statements like the Cathie Wood one that we talked about, right? GDP growth of 50% because of artificial general intelligence. You can fairly quickly say, ‘okay, I don’t know exactly what’s going on in the world, but like, that’s not real.’
I think another one, and this I think is very important and hits institutions more, but claims of returns significantly exceeding, you know, the risk free rate but with little or no risk. And that’s the one I think that ends up leading to much bigger problems in financial markets and much bigger problems in the global economy, right? Because people with nice suits and ties and very big offices look at an 8% or 9% or 10%, relatively low risk return. And they think about how they can put leverage on that. And they think about how they could have a five year run making really good money and get paid a lot. And that’s incredibly appealing. And that’s actually the nature of a lot of the biggest losses that you saw in crypto and so forth. It wasn’t necessarily folks buying, you know, Dogecoin and losing a catastrophic amount of money. It was people saying, wow, this anchor protocol, this thing yields 20% and there’s like a Harvard professor that wrote the white paper and, you know, there’s all these credible VCs talking about it. And if I can get 20% on that, and then if I can borrow $10 billion to do that, like I can get really rich, really fast…
I think that the things that I always come back to are to really look out for people trying to credibly claim these astronomical return profiles or pretty high returns with very little risk, because you just have to think of it as the world is full of a lot of very smart, very competitive sharks who run very big businesses that really like getting rich. And if there was an opportunity to make 10% or 20% risk-free in front of you, they would’ve already taken that away from you and done it first. And what it means if you see something like that is that it’s not real, you know, and there’s either some kind of fraud or there’s some kind of extraordinary risk that you’re not seeing. You have to be really wary of extrapolation.
You have to really be very skeptical of overly complex investments with non-transparent sources of return, right? Where people are trying to tell you, this is really good, because it’s really smart and it’s really complicated. And I know you don’t totally understand it. And you have to also be ready to recognize the psychological tricks that the investment world plays on you. Again, a lot of these things, it seems like it should be so obvious, but it’s not, right? There’s a lot of laundering of credibility, right? Legitimization of investment schemes by the backing of authoritative people or people you feel like you should trust. Because especially at peak cycle, people are very willing to lend their credibility to, you know, things that are gonna get them paid. You know, think of, again, the Harvard business school, professors writing the white papers for Ponzi schemes, like Anchor. Using social consensus and group psychology to normalize ideas and narratives and to pressure people to stop asking questions, you know, big Twitter mobs telling you you’re an idiot and you’re not gonna make it, right? And then very much so kind of scarcity or immediacy, like, ‘look, you’re gonna miss the boat. You don’t get it. And it’s like time to get on board or miss the boat.’
Despite the “money printer goes brrr” meme, low rates are not just a “dial that determines the level of speculation”. Although the narrative effect of the meme itself may have been a contributor
Benn: I think there are a lot of different contributing factors. And I think this is usually how things go. So I would say commentators tend to focus very, very heavily on low interest rates and quantitative easing and so forth. I mean, I think there’s a role for cheap money on the margin, especially in areas like real estate. But I think that really the direct role of low interest rates or QE here is very overstated. I mean, you look at the history of interest rates and quantitative easing geographically around the world for the last 20 years. Japan’s been doing QE for a very long time. I mean, we had low interest rates in the US for a long time. Previous manias weren’t necessarily associated with low interest rates. And one way to think about it is like with tech stocks going up a hundred percent a year and crypto tokens paying 20% yield. Like if you have to pay 3% or 4% to get leverage versus 1%, I mean, it just doesn’t matter if you are in the frame of mind, but like you want to do those kind of investments. I mean, the idea, and I joke about this on Twitter a lot, but yeah, the idea that like the Bitcoin folks would’ve just bought a bunch of Treasuries if Treasuries paid 6% or 7% is, on its face, ridiculous. And they would all tell you that.
It’s much more about the collective perception of relative risk and return and the growth of narratives justifying that perception, and then the broad socialization of more and more people into that perception. I do think where rates and QE comes in is perceptions of the role of cheap money coordinating investor expectations or kind of the ‘money printer go brrrr,’ you know, ‘buy everything’ meme. I think that’s actually important. That’s probably much more important than the direct impact of rates being a little bit lower and being able to get leverage, right? Is the contribution to the narrative that like all of this stuff just has to go up.
And I do think, I come back, you know, ultimately, and you pointed out other phenomena, I do think what has been important when you look specifically at retail options trading and a lot of the aggressive market participation that has showed up over the last few years, I do think the pandemic played a real role. I think that there’s a self-reinforcing dynamic to the social internet aspect to it, right? It’s not just people sitting at home in their brokerage account doing stuff by themselves. They’re increasingly in Discords or on Twitter or in some kind of social group or Reddit’s WallStreetBets. That’s like a community that’s fun where people talk about investing and they teach each other stuff and they, you know, they overcome the activation barrier of like, ‘how do you open a brokerage account? And how do you put money in it? And how do you actually click a button to trade?’ and all this stuff. And like once that’s there and once it’s a fun entertaining social thing, and it has a group gambling component to it, it becomes much easier to kind of get out of control and much longer lasting, right? Then, you know, it has all the power of the engagement, you know, clickbait of the internet associated with it. And I think that was really important.
The froth probably isn’t over
Benn: I think there’s plenty of craziness left. So I think both in crypto and in tech, there are many funky crypto tokens that are down 90%… but whose market cap is still billions and billions of dollars. And you know, they’re just jokes, right? So I think, you know, it’s hard to argue that that stuff doesn’t eventually go to zero. And then within what you would think of as like the ARK basket and, you know, the Goldman Sachs index of speculative software stocks, again, there were a lot of companies that experienced valuations in private markets and sometimes eventually in public markets of $30, $40, $50 billion, that just, it’s very hard to see them ever being worth anything. And a lot of those names are down a lot. They’re down 90%, but they’re still worth $5 billion or $3 billion. The things that have gone down the most are not always the cheapest. Right?
Sometimes they are, but in this case, I think that’s not obvious at all. I think there’s a great Kindleberger quote that the period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and mass panic and crashing, driven by the insiders having exited, but the suckers/outsiders hanging on and hoping for a revival and then finally giving up. And it feels like that’s where we are. Sort of the insiders have been kind of quietly and steadily getting out. There’s apparently still quite a lot of demand, for example to sell shares in the secondary market of startups that are down 90%, right? You’ve got founders that on paper briefly were worth $20 billion, and now they’re worth $2 billion. And they’re like, you know what? That’s still pretty good. I want to see if I can turn that into cold, hard cash.
Are you optimistic that there will be like a cohort of you know, people who maybe got scarred or burned, but also learned some sophisticated stuff that will have a good combination of skills and knowledge coming out of this period?
Benn: I really hope so. I mean, I’ll tell you 10 or 15 years ago, I remember working with a good friend who’s now a VC on ideas for investor education. And how do you get people to even care about financial markets and investing and pay attention? Because back then it was totally impossible to get the young generation to even think about this stuff. And it’s really good that individual investors have gotten interested in investing. And I feel like, you know, sometimes I hope I don’t give the opposite tone, right? Because it’s so easy for people to get tricked and all this kind of stuff. But I think a lot of times people have to learn from their own experience. It’s just really hard. I mean, you know, Hegel said we learn from history that we just can’t learn from history. People have to one way or another go through their own experiences of mistakes and things not going well to really internalize lessons. And what I really hope is that people are able to take hold of those lessons and, you know, stay interested in financial markets and stay interested in investing and learn how to make good decisions as opposed to feeling so scarred by it that they just walk away.