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Chris DeMuth Jr.
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"It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a misplaced bet - that they can occasionally find one." - Charlie Munger I look... More
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Rangeley Capital on Harvest
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Rangeley Capital Best Investment Ideas
  • Book Ideas For The Thoughtful Investor With William Poundstone  7 comments
    Feb 4, 2013 3:02 PM

    Conversation with the author of Fortune's Formula: The Untold Story of The Scientific Betting System That Beat The Casinos And Wall Street

    Chris DeMuth Jr:

    What has changed since you published your book? It seems to me that it has stood the test of the time thus far, but do you have any second thoughts? Anything that you would add if it were published today?

    William Poundstone:

    I think there has been much greater awareness of the fallibility of human intuition and expertise-the Nate Silver revolution, you might say. One reaction to the Kelly criterion has always been, "I don't need it; my intuition tells me how to size bets." I think more people are open to the idea that even experts need all the quantitative help they can get.

    In 2011 Ed Thorp, William Ziemba, and Leonard MacLean edited a volume of all the important Kelly criterion papers (The Kelly Capital Growth Investment Criterion, World Scientific Publishing). I think that was an important event insofar as so many of early papers appeared in journals where those most interested wouldn't have seen them-a telecommunications engineering journal, in the case of Kelly's article. It's been hard to search for articles because authors used different terms (Kelly criterion, capital growth criterion, etc.)

    Chris DeMuth Jr:

    Are there any specific investments that you have made or would make today as a result of your ideas? What are you doing as a practitioner beyond thinking and writing?

    William Poundstone:

    I'm not really a practitioner so I don't have much an answer to this one. It has however influenced my thinking about asset allocations. Small investors are told that allocations should be determined by "risk tolerance," as if this is a fixed personality trait. But actually risk tolerance is contingent: everyone becomes a lot less risk tolerant after they've lost money! It's useful to know, first of all, that there is such a thing as too much risk, in that it decreases long-term capital growth. It's also useful to know that Kelly betting/investing is emotionally difficult for many people, and it's okay to dial down the risk. This isn't hugely costly: half-Kelly betting has 3/4 the return. Knowing a few mathematical facts can help clarify the emotional/visceral understanding of risk.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital, a partnership that invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our partners, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.

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Comments (7)
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  • Thanks for this Chris. Good stuff.
    4 Feb 2013, 10:16 PM Reply Like
  • Author’s reply » You're welcome. I am a huge fan of Bill Poundstone's, so I am thrilled that he was willing to answer some questions of mine for this blog. I can't recommend his book highly enough. It is impossible to say this without sounding cheesy, but it changed my life.
    4 Feb 2013, 10:28 PM Reply Like
  • I am actually trying to master Kelly myself. I have a practical question about implementation.
    When the stock price rises, obviously further upside is reduced accordingly, yet at the same time, by it's very nature, has organically increased in bet size. According to Kelly, one ought to adjust the position size to conform to it's current risk/reward situation. However, if you do so, then you are thereby preventing your original thesis from playing out, and the upside was never really what you projected it to be, as it is doomed to diminshment as it increases in size. If so, the original Kelly "upside" should take in to account when you are going to re-evaluate, and not give credit to upside that will not be allowed to be realized. How do you resolve this paradox?
    19 Jul 2013, 03:00 PM Reply Like
  • Author’s reply » I resolve this paradox by using "original invested capital" instead of marked to market capital. I let them play out, once my thesis is prepared and research is done. Only when it has moved 5-10% (not 5-10 bps) do I reevaluate. Also, it is frequent that more premises than simply the price have moved in the interim.
    19 Jul 2013, 03:13 PM Reply Like
  • But isn't 5-10% of an increase a disservice to your best ideas? You wouldn't have wanted to miss out on the 100% increase or so on GKK/GPT at full size capacity ? Or is that just the statistical way to go?
    Also, what did you mean when you said you don't risk more than 3% of invested capital- isn't that contrary to Kelly, that we should take risks, even big ones, when the odds are in our favor?
    BTW, I am humming the tune of "I'm glad , I'm glad, to have, to have, a friend, a friend, like Hercules" with your name substituted! (remember that show?)
    19 Jul 2013, 03:52 PM Reply Like
  • Author’s reply » I do not end the position; I just take a new look at assumptions every 5-10%. But I frequently simply let things play out. Kelly is the system that we use; 3% of original invested capital at risk is the size that we tend towards; that is simply a description. But we love positions that are far bigger than 3% where there is a lot of safety.

     

    Absolutely: we should take risks, even big ones, when the odds are in our favor. Over time, we should get as much positive expectancy as possible without blowing up in the interim.
    19 Jul 2013, 03:58 PM Reply Like
  • Thanks a lot and have a great weekend!
    -Barry
    19 Jul 2013, 05:06 PM Reply Like
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