A Man for All Markets: 📚 Review

Note: for those who prefer listening to reading, Bloomberg’s Barry Ritholtz did a great interview with Ed Thorpe on last week’s Masters in Business podcast.

Ed Thorpe’s recent autobiography is worth reading, just for the first three chapters (50 pages). He tells a vivid story of growing up as an off-the-charts high IQ kid in a normal, lower middle class/working class American family in the 1940s.

Thorpe started speaking late (at age 2.5) but when when he did talk, it was in complete sentences. His family supported their gifted child, but they didn’t always know what programs to get him into, or how to pay for violin lessons on post-Depression working class wages.

After the Thorpes moved from Chicago to southern California, young Ed skipped two grades, while delivering the morning paper and thus being “chronically sleep deprived” as an 11 year old. I can relate as I used to deliver the Washington Post with my mom (impossible in 1994 without a car, so I cut her in 50/50) when I was in the 5th grade. Normally we only handled the Sunday route, but sometimes we’d fill in for the regular paper guy during the week (a retired dentist neighbor who did the job to keep active, and didn’t mind paying us 150% of his wage to take over the route when he and his wife drove up to NYC for a Broadway show). I missed the paper route after we moved house in late 1995, but my sleep thanked me.

Like Thorpe, I saved my paper route money and put it into a savings bond — calling around the local banks to ask their CD rates on five year deposits — can you believe they were 7.5% back then! I remember going through the white pages under “bank” and the “yes ma’am” — not anticipating that an 11 year old kid would be calling around to compare interest rates.

Boys like Rockets 🚀🚀🚀

In his early teens, Thorpe got into explosives (as well as into gas and hot air balloons). He writes in detail, decades later, about putting explosive charges in derby cars, setting them off on the street and seeing them “a block later” as the human eye could not even track that kind of acceleration.

He then moved on to gunpowder, guncotton (cotton swabs soaked in dried nitric acid) and finally he made one batch of nitroglycerine, before having a scare and deciding not to keep going in that direction.

I loved played with explosives at that age too, particularly in the summer of 1994 when we went back to Russia to sell our Moscow-area apartment. Although my experiments didn’t go further than shaving off match heads, soaking a fuse in vodka, and flying home-made rockets either a few stories in the air, or sideways on the ground in a kid-sized fireball.

My mother didn’t support this activity, but she did mention that my father (then and now a physicist) built similar explosive rockets at the same age when growing up in Eastern Ukraine.

I still remember my frustration at not being able to build a slower-burning rocket. At least something that goes up in stages, rather than with a single explosive charge.

By comparison, the young Ed Thorpe kept going. He tracked down library books, ordered chemicals from mail order catalogues, and carved out a corner of his parents’ freezer for his dangerous chemicals. He did all of this without any adult support or much supervision. As he puts it in the book after a couple of close calls, the other kids living in his parents house in the post-war years knew to stay away from Ed’s creations.

Thorpe went to a vocational high school in his working class neighborhood, where kids were “not expected to go to college,” but the teachers treated him differently, as he had “the highest IQ the school had ever seen, or would expect to see in 100 years.” Although he won’t list the number — strongly implying that it was well over the 140 IQ for a smart foreign student whom he tutored in English.

Smart kids stand out.

You’re always going to be a bit lonely, a bit introverted, as a smart kid’s interests will not fit into the interests of most other kids, even fellow good students. The smartest kids, those off-the-charts genius type of kids, will seek knowledge on their own. Maybe sometimes they’ll be in a position to connect with other smart kids at other schools — through chess, debate, theater, what have you. I imagine the internet is huge for that these days. But for the most part, you’re stuck being smarter than your peers, and frankly more interested in things like math and science than most of the adults as well.

That’s what bothers me about movies like Good Will Hunting. You do have geniuses who come from “normal” backgrounds, but these people are not linear combinations of a regular beer-drinking janitor guy and mathematician. TV’s Dr Drew said this better in a podcast — he disliked Good Will Hunting for the same reason — but I can’t find that link online. Please comment if you happen to find it.

Self-selecting

Needless to say, Ed Thorpe found people like himself much more easily at college (first UC-Berkeley, before transferring to UCLA, closer to home). His mother cashed in and spent the war bonds he bought with his newspaper route earnings, so he had to live even more meagerly in college than at home, but at least he was free to finally interact with students and professors who were on his level.

Thorpe went on to be the first person to “beat the dealer” at blackjack. He and legendary MIT mathematician Claude Shannon then beat the casinos at roulette, before their practice of using a handheld computer for casino gambling purposes was banned by law. Finally, after being a sucker on his first few stock market investments, Thorpe dived into the mathematics of the markets, and became one of the pioneers of the “quant” hedge fund business, while still a math professor at UC Irvine.

The book has many great stories, and more than that, it give a deep insight (perhaps the best I have ever read, comparable to other great business autobiographies like “My Years with General Motors”) — into the evolving mind of a highly functional business person.

I took notes while reading the book (something I recommend, even just in margin notes) and if people find this review interesting, I might write up some of more these in a Part II. Here are a few observations that stood out:

Where do quants come from?

• Page 171 includes a good explanation of Brownian Motion, and why the quantitative hedge funds (these days comprising most of the largest hedge funds in the world) are full of physicists. Many were founded by math professors (Renaissance Technologies, D.E. Shaw, etc).
• Thorpe hired for his hedge fund almost exclusively out of UC-Irvine’s pool of students and young faculty. He talks about how he recruited and managed smart people (“management by walking around”), and a bit about the half-in-half-out door between industry and academia. He remained close to UCI after going into business full-time, and is now the math department’s greatest patron. [In the Soviet way of thinking, he would have been branded a traitor instantly when he left academia part-time to make money beating the market. We’re seeing some of this now with “industry raiding academia” stories in the deep learning field that I am a part of. It’s sad to see this anti-capitalist thinking return to academia. Especially in the sciences.]

Beating the markets

• Thorpe has some strong words for Value at Risk models, for economic “stress tests,” and generally for all risk models that don’t account for black swans and wipeout losses from catastrophic risk. It’s not enough to be very safe in “95% of expected cases,” and adding a third or fourth standard deviation to the same formula doesn’t inherently change the problem.
• The efficient market hypothesis (EMH) can be beaten, and over and over, it has been beaten — as evidenced by Thorpe’s own stories, from blackjack to Warren Buffett to the rise of quant funds. That doesn’t mean that it’s easy or that just anyone can do it. Most people can’t, and they shouldn’t try. Invest in a low-fee index fund and avoid short term capital gains. Although the later also makes it harder for the next Ed Thorpe to start his or her own fund. It’s hard to imagine that new ideas will be both high-Alpha and tax efficient, right out of the gate.
• Throughout his career, Thorpe published about his work. He’d exploit the market for a while, then write about it publicly. Eventually others will figure out your edge. If you don’t publish it… others will. These days, they may even try to patent it at your expense. He notes (without bitterness) that the Black-Scholes option-value model was an extension of the work from his book Beat the Market. If it’s not on ArXiv and the code isn’t on GitHub, it didn’t happen…

Why hedge fund managers trend “libertarian center-left”

• To his credit, Thorpe paints a complete picture of his life and views, including he and his late wife’s charitable and political involvements. He also writes about how he would improve the great state of California (having already done a lot to help UC-Irvine and other local causes).
• Thorpe argues for individualism, hard work, good schools, something like a flat tax, as well as a simplified tax code — libertarian values.
• At the same time, he also argues for top down solutions. States should not having their own tax laws (only being able to declare what % of the federal tax rate to add on to existing filing forms). Companies should not have class A and class B shares, with vastly different voting rights.

At the risk of getting too deep into this: extremely smart, especially math-smart people and engineers prefer the “one good solution.” I’m not a big states right guy, but states *will* pass different tax laws, often to encourage businesses to stay, or to move from another state. Other states, unilaterally, have simplified the tax code: no personal state income tax.

By similar logic, it’s curious to argue that “all shareholders should be treated equally” without considering how Class A and B shares with different voting rights came about. Google went public with the founders keeping enough voting rights to veto any decision… because they could, and because plenty of investors were happy to passively invest in their leadership. All of Facebook’s decisions run through Zuckerberg, despite him owning some small percent of the company — is it even 10%? Last month, Snap went public with similar Class A/B voting rights thus giving control to founder Evan Spiegel — and Snap isn’t even on a path to being profitable. If it’s so unfair… why do investors keep buying into these companies? And why should successful founders give up their disproportionate voting rights, if the market will let them keep control?

I’m not arguing for byzantine tax rules or for founders selling shares while keeping control of their companies. I do note that it’s the way things continue to operate, and that these things didn’t happen by accident. Ed Thorpe obviously knows this. I wonder why he chose not to bring it up.

Overall, an excellent read. Highly recommended!