“It doesn’t matter if…I’m chasing old ideas. It doesn’t matter if…Maybe…We are, We are” – London Grammar
“I want you to notice, when I’m not around.” – Radiohead
Recently I have got interested in investing with a high probability of failure. Why would I be interested in this? Not to avoid high failure industries – but because high levels of failure go hand in hand with creativity. And the bulk of the success in these industries goes to a few hugely successful, well recognised names. “Winner takes all” economics. Examples would be restaurants, music, films, plays, sports but also….technology investing and scientific discovery.
And this seems a completely different type of investing to “value” investing, choosing investments with a high probability of success, but with limited upside. Value investors have a horror of “lottery ticket” style investments, low probability but high upside.
With this in mind I came across an economist called Art De Vany, recommended on this blog. NN Taleb is a big fan.
Taleb normally eats economist for breakfast,
so any economist who has ideas that Taleb quotes, is probably worth paying attention to. De Vany has specialised in the economics of Hollywood. The most important thing to understand about investing in films, according to De Vany is not that it is “risky” – what does that even mean? Instead the key thing is to understand about the distribution of success in the film industry is skewed and kurtotic. The distribution of success in film making means that 20% of the films (1 in 5) make 80% of the revenue.
Intuitively this makes sense – for every Titanic or Star Wars, most films lose money. This seems to be a property of entertainment industries generally. For every band like London Grammar or Radiohead – there are thousands of failures. For every Angry Birds or Facebook there hundreds of thousands, maybe millions of failures.
According to De Vany, whether it is revenue, work, profit or productivity, every statistical distribution for films looks the same. Importantly, despite trying to make a formula for a successful films, famous good looking “stars” – Brigitte, Jack and Kate and Brad, or large budget spend on special effects and marketing, there is no reliable way to improve the odds that a film will be a hit.
I have only read the prologue to De Vany’s book. But I was fascinated by the fact he was using Bose-Einstein equation from quantum statistics to model films. My suspicion is that we should be doing more of this. That is, most books on quantum physics I have read suggest that it is not intuitive, and that it bears no relation to the world we experience. “Well, quantum mechanics is relevant only to atoms and very small objects.” But what if quantum mechanics was the correct way of thinking about uncertainty in our world? The only two people I have found who think this way are Carlo Rovelli and George Soros (who called his fund “Quantum” for precisely this reason). I think this is worth exploring.
My own experience to this high upside, high uncertainty was investing in companies with weak balance sheets in 2009. I bought some Cineworld, the UK cinema company. At the time they had geared up too much and had a weak balance sheet, and were struggling. The shares reflected this and were trading at a very low valuation (share price was £1, dividend yield was 10%). There were structural concerns – would a recession mean that people stopped going to the cinema, especially given that so many huge flat screen TVs had been sold in the years up to 2009. I also bought Cosalt, after it did a rights issue – but this failed after management discovered a fraud.
The point was that I didn’t think there was any way that I could know with any degree of certainty the outcome – I just thought that if I was right the upside looked good. As it happened I was right, although I sold too early after the share price doubled (it has since quadrupled). But even if I was wrong – I’m not sure it makes sense to talk about “right” and “wrong” in a quantum world. Like a card counter at 21, I was only right probalistically. The shares were sitting in a kind of quantum superposition – reflecting a couple of extreme outcomes.
This is the opposite of value investing, where value investors like to invest in companies which have temporarily fallen on hard times, but still with net cash. But that seems easy to do. I wonder if the rewards are much higher for investors where the conventional models fail. How would we do this? Fight fire with fire. Fight one greek word (kurtosis) with another greek word (heuristics).
Fight fire with fire. Fight kurtosis with heuristics.
One idea of Gerd’s is that when you have high levels of uncertainty, heuristics work better than complex mathematics (Bose-Einstein notwithstanding). I invested in Cineworld because I used the heuristic: “Even during the great depression, audiences kept going to the cinema. Cinema is essentially an escape from bleak reality.” There are other heuristics that work for high kurtosis industries. The Lindy Effect “The old outlives the new in proportion to its age.” Taleb explains how the physicist Richard Gott made a list of Broadway shows on 17 May 1993, and predicted the longest-running ones would last longest, and vice versa. He was proven right with 95% accuracy. As a child he had visited both the Great Pyramid (fifty seven hundred years old) and the Berlin Wall (twelve years old) and correctly guessed the former would outlast the latter.
The most sustainable businesses have been around the longest amount of time. The businesses we most associate with “sustainability” The Body Shop, Innocent Smoothie, Green & Blacks – have not proved enduring at all. Instead they have been sold to much longer lived corporations, that we don’t associate with “sustainability”: respectively L’Oreal, Coca Cola and Cadbury’s Kraft. It could be something from Tao T’Ching.
He who clings to his work
will create nothing that endures.
Chasing old ideas. De Vany sees the irony that with all his high brow mathematics, he has ended up proving Goldman’s fundamental truth. Not Goldman Sachs, but William Goldman. The screen writer who said “Nobody knows anything.”