Episode #427: Mark Yusko – “With Every Investment We Become Richer or Wiser, Never Both”
Guest: Mark Yusko is the Founder, CEO and CIO of Morgan Creek Capital Management and the Managing Partner of Morgan Creek Digital. Prior to founding Morgan Creek, Mr. Yusko was CIO and Founder of UNC Management Company (UNCMC), the Endowment investment office for UNC.
Date Recorded: 8/1/2022 | Run-Time: 59:19
Summary: In today’s episode, Mark covers the evolution he’s seen in the digital asset space and why he likes applying trend-following approach to crypto. Then we hear about his foray into ETFs and a SPAC idea that I love. We also touch on China, the Fed, inflation, and how some of his predictions for 2022 look at the halfway point.
To listen to episode 314 with Mark’s friend and Pantera CIO Dan Morehead, click here.
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Links from the Episode:
- 0:40 – Sponsor: Bonner Private Wine Partnership
- 2:26 – Welcome back to our guest, Mark Yusko
- 4:06 – Every trade makes you richer, or wiser, but never both
- 13:43 – Mark’s interest in digital assets
- 35:12 – Mark’s thoughts adding digital assets to your portfolio
- 40:16 – Historical drawdowns of the best performing stocks
- 44:03 – Looking for asymmetric uncorrelated opportunities through SPAC arbitrage
- 46:18 – Mark’s SPAC ETF: CSH
- 46:38 – Does Mark think investing in China at this time attractive?
- 51:25 – Mark’s 10 potential surprises for 2022 (link)
Transcript of Episode 427:
Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Meb: Welcome podcast listeners, we have a really fun show for you today. Our returning guest is Mark Yusko, Chief Investment Officer of Morgan Creek Capital Management and the Managing Partner of Morgan Creek Digital. In today’s episode, Mark covers the evolution he’s seen in the digital asset space and why he likes applying trend-following approach to crypto. Then we hear about his foray into ETFs and a SPAC idea that a love. We also touch on China, the Fed, inflation, and how some of his predictions for 2022 look at the halfway point. If you enjoy the discussion on crypto early on, be sure to go back and listen to episode 314 with Mark’s friend and Pantera CIO Dan Morehead – either scroll back or check the link in the show notes. Please enjoy this episode with Mark Yusko.
Meb: Mark, welcome back to the show.
Mark: It is so great to be here with you again. It’s stunning, I actually looked it up. It has been six years since we did this, 392 episodes since episode 31. And on top of it, I literally just drove in 10 minutes ago from one of your favorite places, Topsail Beach, North Carolina.
Meb: Is the roller skating rink running? Is it still around?
Mark: It is in fine shape. They were blasting the ’70s throwback tunes all week. There’s a new ice cream shop below the skating rink that is quite good, so you’ll enjoy that when you get out.
Meb: I’ll hit you up for some recommendations later. By the way, we’re recording this on Fed Day, mid-June 2022, listeners. Mark and I were joking about how it’s been too long and how we’re ready for just some quiet time. I thought we were never going to get at the history of markets, but I’m ready for some just chill. Twenty-twenty, 2021, crazy enough, I’m like, all right, we’re emerging out of this pandemic let’s just get a little normalcy. We got a war in Europe and everything else. I just recorded a podcast with my good friend Jim O’Shaughnessy, and you came up a bunch because you’re one of my favorite, most quotable people in the world. It’s to the point now where you’re kind of like Mark Twain because even if it’s a quote that I don’t know if you’ve quoted or not, I just attribute it to either you or Morgan Housel, I said, it’s one of these two guys.
Mark: That’s good company. I appreciate it.
Meb: If it’s more personal finance, it’s him. If it’s more macro stocks, it tends to be you, but anyway, probably my favorite, now I don’t know if this is yours or just a reference. Every trade makes you richer or wiser, but never both.
Mark: Absolutely. And I can’t take credit, I stole that. The famous Picasso line, “Good artists borrow, great artists steal.” I stole that from Bill Duhamel. Bill’s a good friend and hedge fund manager. Interesting background too, his family was a big cable television family. He decided not to go into the family business, became a manager, worked for Farallon, and then spun out into a firm called Route One. And he has that plastered on the cube as you walk through the front door of his office in San Francisco, and I just love that quote because it’s absolutely true. When you make an investment and it works, you learn nothing, you don’t analyze it, you don’t think about it, was that a good decision, a bad decision? Do I get lucky? Was there skill? You just spend no time. When it goes against you, you actually think about it. You’re like, “Oh jeez, did I make a good decision with a bad outcome? Did I make a bad decision with a bad outcome, which is the worst possible thing? Was there other forces that I didn’t anticipate?” Definitely, in this business, you get richer or wiser, never both.
Meb: Six years later, we’ve been getting richer or wiser, a little bit of everything mixed in?
Mark: Look, when we talked about this in the original episode, and my life is just a series of happy accidents. In 2013, I got introduced to digital assets, to crypto, but I didn’t get it in 2013. Now I have the buy Bitcoin sign behind me because I’m all in.
Meb: That’s not the original from the actual testimony is it, that’s got to be a replica, right?
Mark: So here’s the thing. It’s not the original because I was with Christian, “I want to buy the sign.” He says, “Well, I think it should be in a museum.” I’m like, “It will be, my museum. I will put it in my museum and I will lend it out,” and like, “Well, I don’t think I should sell it to just one person.” “No, you should, but okay, I see your point.” So he made a few other, not the original. It’s an original.
Meb: Limited series.
Mark: There will never be more of them, but I own one of those.
Meb: Listeners, you got to follow it up on YouTube to get the reference.
Mark: Especially because it’s Fed Day. So this was another Fed Day, there was this guy Christian and Janet Yellen is up talking about what she can do with interest rates and he flashes this sign over her shoulder, kind of like where mine is. And he did it twice and it went viral and he became semi-famous and the rest is history. But the thing, Meb, is I didn’t get it, in 2013 I was still a hedge fund guy, a venture capital guy, a private equity guy. I joke I was not running drugs on Silk Road, I was not a cryptography student. And my friend Dan Morehead, who I’m sure, you know, runs Pantera and had this macro fund that we helped seed. We were his first institutional check, 22, 23 years ago, and he said, “Hey, I’m shutting down my fund. I’m giving back $1,000,000,000.” I’m like, “Why would you give back $1,000,000,000 charging 2 and 20?” “So I can spend the rest of my career in Bitcoin and blockchain.”
I didn’t know what Bitcoin was. Not running drugs, not a cryptography student, didn’t get it, bad decision, up 350X including the recent drop. But when he said picks and shovels I got that, all things of value. Every stock, every bond, every currency, every commodity, every piece of art, every collectable car, every house title, every marriage license, everything that can be titled or owned will eventually run on blockchains. It’s just a technology, but the difference is, in the internet you and I are using TCP IP right now to communicate, voice over Internet Protocol and now images over Internet Protocol. But he couldn’t own that. The guys who invented the internet, Tim Berners-Lee, Vint Cerf, the guys that built TCP IP, they didn’t get rich. Who got rich? Zuck because he built an app that uses the protocols, right? Zoom, the guys who built it got rich because they built an application that sits on a protocol.
Well, in the trust net world, you can now own these protocols, you can own Bitcoin, you can own Ethereum, you can own Solana, you can own Avalanche. And those protocols allow us to transfer value instantaneously and seamlessly. I will tell one funny story. It’s not intended to be negative, it actually turned out to be a good decision for them. But we’re in crypto winter, crypto prices are down just like we were in 2018. In December of 2018, the price had fallen from 6000 bucks to 3200 bucks. The bet between Warren Buffett and Ted Seides on hedge funds versus the S&P was just ending. We decided to issue the Morgan Creek Digital Crypto Challenge. I actually called up Warren, it’s amazing, he answered his own phone. They said, call him after 5:00, Omaha time and he will answer his own phone, and he did. I explained who I was and what I want to do, he’s like, “Well, I’ll think about it.”
He was advised by his two younger guys that would be a bad idea. And he said, “Well, I’m too old.” I’m like, “No, you’re going to be around forever.” So he didn’t take it. And the bet was whoever takes the S&P, we’ll take Bitcoin and we’ll go million-dollar charity bet, each fund half $1,000,000 goes to charity. Warren decided not to take it. He was interested, he thought about it. I was on CNBC the morning of December 6th and I issued this challenge to anyone in the traditional world, you take the S&P, we’ll take Bitcoin head to head. And Jim said yes, he was the only one, the only person. My partner, Pomp, and Jim had a relationship and said, all right, I’ll take the other side. Patrick was like, “Dad, no frickin way. No, we are not taking that bet. There is no upside. If we win, we are supposed to win. If we lose no upside, we are not doing it.” And that was a bummer, and so we couldn’t get anyone to take it even down from 69,000 to 20,000, but it was 3,200. It’s crushed the S&P since 2018 I guess that was.
That’s where I am today is in chapter three. So over the last six years, so since you and I were together a year later, five years ago, we launched Morgan Creek Digital, which is an operating subsidiary of Morgan Creek Capital. So Morgan Creek Capital still exists, it’s the overlying entity, we still do hedge fund stuff, we still do venture capital stuff, we still do China stuff, although no one wants to talk about China anymore, which makes it one of the best investment opportunities around.
Meb: We’ll circle back to that in a minute.
Mark: Yep. I have been spending a lot of time as a venture capitalist. I used to be a full-time allocator, investor, now I’m more full-time. In my chapter three of Venture Capitalist and we’ve raised three funds, raised the first fund in ’18, second fund in ’20, just closing our final close for fund three here this month. I’m having the time of my life. And this is not a criticism of my previous lives, I loved working for not-for-profits, I loved building Morgan Creek Capital Management. But I’m having more fun today than I’ve ever had. Part of it is the talent, the quantum of talent that has come into this technological area is like nothing I’ve ever seen. The Internet was close, this is bigger. And the second part is the impact that you can make with this technological innovation is so much more profound because it’s building on good tech.
Remember Client Server? Was horrible technology. Netflix almost went under twice and Amazon went down 94% because there was no broadband and it was just clunky and you had to wait four days for a video on demand, no one waits four days for anything. Now we’re building on really good technology. So as we migrate into blockchains which are simply public ledgers, code instead of people, which is better, like if you get lost in North Carolina, you do not stop and ask for directions because they say, “Well, go to where the grocery store was and take a left and then go to where the oak tree was and take a right.” “I haven’t lived here for 100 years, I have no idea what you’re talking about.” What do you do? Go on Google Maps or Apple Maps and you trust code.
The same thing is true in the old days, if I want to send you money, you had to have a bank account, I’d have a bank account, they would charge us a fee. Now, if I want to send you value, I don’t have to have a bank account, you don’t have to have a bank account. I can send you Bitcoin for free using the Strike app, of which we’re an investor. That innovation is incontrovertible, like today Jamie Dimon, who used to call Bitcoin a fraud, said, “Yeah, it’s probably going to replace the SWIFT system.” Just the guts of the tech of money. Fedwire, SWIFT, ACH, it’s 75-year-old technology, it needs to migrate to new tech and that’s coming.
Meb: Yeah, it’s still shockingly antiquated. When we first started launching funds, we had to fax in our trades, fax. And this isn’t like 30 years ago, this is like 10. And I’m like, we don’t even have a fax machine, are you guys joking?
Mark: And it’s amazing to think that that’s true. Well, here’s another amazing thing. If you bought a bank loan, a syndicated bank loan, it takes 30 days to settle. Thirty days, how can that be? Because there are seven different systems, some in COBOL, some in C++ that don’t talk to each other. So human beings have to settle this thing, it’s ridiculous. Like a stock trade, if I sold you a share of stock, T plus two, are you kidding? This should be instantaneous. There should be no paper stock certificates at DTCC in Dallas.
Meb: I joke that the most alpha I’ve ever created in my career was trying to do a transfer. A camera goes into or out of Vanguard and it took like four months for some unknown reason. Like during a market downturn, like it sold, and it was sitting there so antiquated.
Mark: That’s the story. The best performing accounts at Fidelity are deceased and abandoned accounts, full stop.
Meb: As we think about the digital space, and it’s fun talking to you because you have a curious mind and are always interested in a lot of different things. I also was exposed to crypto in 2013, I got a bunch of old tweets about it. But my path, when you took a left, I took a right. When we had Dan on the podcast he was very thoughtful, one of my favorite voices in the space. As you think about where we are now in this adoption evolution, there are a lot of advisors that listen to this podcast and investors that probably still have no exposure. What’s more interesting to you, is it the companies involved in the picks and shovels and building out all the various parts of this ecosystem, is it the tokens themselves or is it something else?
Mark: It’s such an important question, and it’s the question. It’s why I can’t believe we waited so long to do this. I love talking to you and I love listening to your stuff and questions are way better than answers. Just full stop. The world is full of answers and regurgitation and we ask our kids to regurgitate facts instead of teaching them how to problem solve and to think critically and to think creatively. The ability to structure the right question at the right time is a superpower. What you describe is exactly the question we need to be thinking about, because if we go back to the Internet, which everyone said was worth nothing. Speaking of fax machines, Paul Krugman famously quipped, “Oh, it’ll never be more important than a fax.” Really? Orders of magnitude more important. The problem is, when something is developing, it’s really hard to imagine the unimaginable, so that’s the first problem.
The second thing, it’s really hard to convince people whose livelihood depends on them not understanding something to understand something. The example I use all the time is the buggy whip and the horseless carriage. When the horseless carriage came into being, the buggy whip manufacturers and the horse and buggy manufacturers said, we don’t like this, so we’re going to get a law passed called the red flag law that if you buy a horseless carriage in New York City, you have to hire someone to walk in front of your horses’ carriage with a red flag, which is where the term red flagging comes from, telling people that you’re coming. That’s stupid. Why would you? Well, of course it’s to make it so stupid that people won’t want to do it so they’ll keep buying horses and buggies and buggy whips, which didn’t happen.
And so every innovation cycle has this same challenge, 2013 Dan calls me to San Francisco, tells me on a silver platter, buy this. 50 bucks, yeah, whatever. Don’t get it. Infrastructure, Oh, I get that. Put that in his first fund, that’s up like, I don’t know, 17 times. That’s awesome, but it’s not 350 times. Nine months later is the first quarter ’14, I had done a little bit of work and done much work but I’d done a little bit of work. It’s okay to be skeptical of new technology, that’s natural, it’s normal. Then you have to ask good questions about it. But then I studied it and I wrote one paragraph in a 41-page letter.
Meb: I was going to say, Mark, you’ve never written one paragraph.
Mark: I used to write these really long letters until my wife made me stop. She’s like, “Mark, you are spending way too much time, no one reads them.”
Meb: It’s videos now, right?
Mark: What’s funny is I said it’s not for them, it’s for me. If I can’t read what I wrote, how do I know what I think? And so I didn’t write 41 pages for everybody else, I wrote it for me. But there was one paragraph in 41 pages that said, “Bitcoin is an interesting special situation for all these reasons.” I had clients called and said, “You’re an idiot, we’re going to fire you. Don’t talk about this, ridiculous. Go back and do your job.” The price had gone from 50 when Dan told me about it to 500. Now what’s interesting is from March when I wrote that to September, it went from 500 to 186. I’m like, “Maybe they were right.” And then bang, eight weeks later it was a thousand. No, there’s something here.
So I did a little more work and actually, my son had just graduated from college and I said one word, not plastics like “The Graduate,” blockchain. Go talk to Dan, get a job with one of his companies. So he went out, talked to Dan, looked at Coinbase, interviewed at Coinbase and called me, said, “You know, Dad, I’ve wanted to live in San Francisco my whole life. I’m going to go to KPMG, it’s safe, gets me to San Francisco.” And, look, I said, “You’re going to hate it,” which he did quit after nine months with no job, by the way, this is a millennial thing. You don’t quit without another job, you get another job first, like, “Nope, I hate it. I quit.” No one’s crying for my son, he ended up at Snowflake, so I’m very proud of him. But when Coinbase went public, he called me and said, “All right, fine, Dad, you’re right, I should have gone to Coinbase.”
Back to your question about companies versus the protocol, but you’re not as smart as you think you are. I’m like, “Oh, do tell, I told you to work at Coinbase.” Like, “Yeah, but you didn’t lever up the house and put it on Bitcoin.” “Yes, that is true.” If you think about that first wave of time from 2009 when Bitcoin was created to 2016, ’17, all of the value was captured by the protocols because there were no companies yet. There was no Coinbase yet. I mean, Coinbase had started, but it really hadn’t done much. Kraken and Gemini and all these things were coming. And what’s interesting in the Internet, Tim Berners-Lee didn’t make any money. He invented the Internet, wrote the first web page, used TCP IP, but you couldn’t own the protocols. So all the money went to the app layer, the Facebooks and Googles and the Apples, etc.
Today, if you take that first period of time, we went from nothing science project to a few hundred million of value, it was all in the protocols. So when I launched Morgan Creek Digital in late ’17, ’18, we were going to focus on picks and shovels. So we were going to put 80% of the money in companies, in private markets because there were no public companies and 20% in the protocols themselves, but not as trades, as venture capital investments in businesses’ networks. Because here’s the thing, what most people don’t understand is we’ve moved from a world where it matters what kind of business you are to a world where what kind of network you are. Take Amazon, Amazon is not a company, they don’t make anything. They are a network that matches buyers and sellers and takes a cut and they’re really good at it. And the bigger the network, the more valuable the ownership value.
So if you think about Apple, it’s a network. Now, they do make little things, but it’s really the value of you and I being able to communicate and buy apps in the App Store. Google, just a network, people search on it and they get paid advertising for data, but it’s really the network. So Bitcoin is a network. Well, why does the Bitcoin network matter? Well, it’s a better underlying network than TCP IP. It’s public, it’s immutable, and it will do to financial services what the internet did to media and commerce. So this is a really long answer to your question, but it’s the question which is we invest in businesses, so we own a little piece of Coinbase and we sold some of it, we still own a little bit of it. We own a piece of Gemini, we led their financing round. We own companies like Figure Technologies, which is the guy who founded SoFi and runs that. He’s trying to replace DTCC with something called the Provenence Blockchain.
So we have 69 companies and that’s not a meme, that’s actually the number, I might have to round that up to 70, I’m not a young memer. So we have 70 investments in companies that are all over infrastructure. And not all of them have been successful, we’ve had some bad ones, but we’ve got some really good ones. So we made a lot of money on Coinbase, we’ve made a lot of money in this company called BlockFi, we’ve done some really interesting investments. Now, 20% of the money went into protocols. In 2018 Bitcoin to us was a Series B. What does a Series B mean? A Series B means you think you can still make 20 times your money. So we felt at 3200 ish, we could still make 20 times our money, which was definitely possible and actually happened. We own some Ethereum, which we thought was more like a Series A. The Series A, you think you can probably make 30 or 40 times your money. It doesn’t mean you will, it just means you think you can, and clearly that went from $86 to a lot.
Then we invested in something called Solana and that was a pre-seed, and a pre-seed most of the time makes zero because it goes to zero. But when it wins, you can make 100X and we actually made more than 100X in Solana and then something called the graph. In our second fund in 2020, we shifted the ratio a little bit, we could go up to 30% in protocols and 70% in companies, but we made a booboo, so we became pretty maxi on Bitcoin. My partners who I’m sure, you know, Pomp and Jason, Pomp was very adamant that everything was going to run in a single chain world. And this is the big question I’m struggling with today. I’m 100% confident, which you should never be, but I am 100% confident that we are going to migrate from the internet-based world and the mobile net-based world to the blockchain world, I’m 100% confident of that. The question for me is, are we going to have a single chain world where Bitcoin is the base layer and then Lightning and other things sit on top of it, or are we going to have a multichain world where there’s room for Ethereum, room for Solana, or room for Avalanche?
And the way to think about this is in Web 1 and 2, we have TCP IP at the base layer, we have FTP that moves files, we have HTTP that runs websites, we have SMTP that moves emails and we have WWW dot that kind of ties everything together, that’s web 1 and 2. In web 3 or whatever we call it now, Jack calls it Web5, but whatever, like a skip in the iPhone 9. In the new blockchain era Bitcoin clearly is the base layer. I mean, no question in my mind, it’s the base layer. It’s the most stable, most secure, never, one fraudulent transaction in 14 years, 22 minutes of downtime. It’s amazing, it’s the most powerful computing network on the planet, bar none. But Filecoin kind of looks like FTP, Ethereum kind of acts like WWW dot, it’s kind of like a platform on which you can build applications. And then in the middle, we’re duking it out between Cosmos and Polkadot and Solana and Avalanche for that middle ground. That’s possible, but Jack and others have said, “No, we don’t need these other layer ones and layer twos. We can build it all in Bitcoin and we can put smart contracts on Bitcoin and we can have a single stack.” I don’t know the answer to that and right now I’m making bets on both.
Meb: What do you think is the sign that we’re going to start to see some hints of which way that’s transpiring? Is it talent going to a certain area, or is it the success of the companies?
Mark: So we’re seeing it right now, we’re seeing it in this crypto winter. So if you think about the cycles that we’ve seen in digital assets, so the 2013 cycle, no one even remembers because it was just a bunch of nerds and geeks. I talk about it in, you know the old Gandhi quote, someone corrected me, Gandhi didn’t say… I love Twitter because you always get corrected, so Gandhi didn’t say it, I don’t remember the guy who said it, but it’s the old, first they ignore you, then they laugh at you, then they fight you, then you win. I think Gandhi did say it, but he wasn’t the first. From 2009 to 2015, first, they ignore you, a bunch of nerds and geeks playing with their funny stuff, who cares, right? Wasn’t even worth paying attention to. From 2016 to 21, then they laugh at you, “A bunch of nerds and geeks financing terrorists and drug dealers,” and other stupid stuff.
2022 to 2027, then they fight you, so we’re in the then they fight you phase, which we’ll come back to. 2013 bear market, no one even remembers it because no one was paying attention. 2017, ’18 bear market people remember because we had the big ICO boom. The ICO was a use case theoretically of blockchain that anybody to create a token to go out and sell that token, some probably were securities, but to sell the token and to get capital. But here was the problem. If I sold you Mark Coin and then I went out and took the money and I built a Chuck E. Cheese, and then I come back, I give you the tokens and say, “Hey, Meb, go knock yourself out at the arcade,” like at the putt-putt that you and I go to, which is still as cheesy but awesome as it ever was.
Mark: What you should have said is, “No, Mark, I want to own a piece of that business, I want to own some equity or I want to own some debt or I want to some cash flow.” Well, ICOs was just a bad use case. So what happened in the bear market is all those got flushed and we reformed around this idea of building out better use cases. One use case fully formed is digital gold. Gold has been money for 5000 years. One ounce buys a fine person suit from Cleopatra’s time to suit of armor, to a zoot suit, to Savile Row, one-ounce, fine person suit. But gold isn’t very portable. If I had a bar and I tried to break it in half, I couldn’t send it through this image. If I had Bitcoin, all of it in the world fits right here. No, I don’t have any on my phone, so don’t SIM swap me. But I can send it to you instantaneously. It’s more divisible and more portable, so Bitcoin is better than gold. And that’s why I think over time we’ll see a migration from gold.
There’s a digital divide and you probably see it and advisors that listen to this probably see it. Ask anyone over 35, “Who’s your broker?” “UBS, Merrill Lynch, whoever.” “How much gold do you have?” “I don’t know, 3 or 4%.” How much Bitcoin do you have? ” Oh, are you kidding me? Zero. It’s a Ponzi scheme. I mean, haven’t you heard that guy, Peter Schiff? None.” “How often do you use DeFi?” “What’s DeFi?” Ask anyone under 35, “Who’s your broker?” “What’s a broker? I got a Robinhood account.” “How much gold do you have? “Are you kidding me? Boomer rocks? Zero, haven’t you heard that Peter Schiff guy? Zero.” “How much Bitcoin do you have?” “I don’t want to talk about it.” “Why not?” “Because it’s like a really big percentage of my net worth and I really don’t want to talk about it, I’m kind of embarrassed.” “How often do you use DeFi?” “Every day.”
That digital divide is only going to get bigger. Clients like me, boomers, we’re going to transfer $37 trillion to the echo boomers and those kids are not going to buy boomer rocks. They’re not probably going to have traditional brokerage accounts, they’re going to be digital natives. And my 11-year-old, for sure, has nothing that is physical the way my older kids have it, everything he does is digital. If we come back to this idea of what do you do? First is zero exposure. Wrong answer. I used to say five years, now we’re down to two. I believe two years from now it will be deemed fiduciary irresponsible to have no exposure to digital assets, the same way it was fiduciary irresponsible to have no exposure to equities in the seventies than no international equities in the eighties than no hedge funds and private. The tech that we use as investment advisors evolves. No exposure to digital assets is wrong.
Now you can do it through the public market, now the problem with the public markets, it’s like the cannabis companies. They got to stupid valuations because there was no free flow, look at the public mining companies, they tried to ETF them, they created BLOK and BCLN and they tried to buy Microsoft. It’s a play on blockchain. No. “Let’s try to buy IBM.” No. “Nvidia?” Sure. They make GPUs, pretty good play, AMD, pretty good play. Buy those, and own them for the long-term, volatile but great assets. And I think those are basically a backdoor play. So you can buy those types of companies. Coinbase was the first publicly listed company at the IPO price, probably not a good buy, today at sub-two times revenue, probably interesting, probably really interesting.
In terms of protocols, you have to own some of the protocols because here’s why. Five years ago, if you took one person out of a stock and bond portfolio, 60-40 took half percent from stocks, half percent from bonds put it in Bitcoin or GBTC, whichever. Your portfolio would have done 250 basis points per year compounded better with the same volatility, so the shark ratio goes up because it’s a perfect asset in the sense that it has great returns. Now it’s highly volatile, but the thing that people forget is Bitcoin has the same volatility as Amazon.com. Amazon stock, been a public company for 26 years, has the same volatility as Bitcoin, 80%, eight zero. Here’s the thing the most people have no idea, Amazon, in every year of its 26-year history has had a double-digit drawdown, every single year, including this year. This year, it’s down 37% peak to trough, the average is -31%. So on average, every year for 26 years, Amazon loses a third of its value, five times more than 50%, twice 90. When is the right time to sell? Well, that will be never.
Who bought 26 years ago and held to today? Jeff, mom, dad, ex-wife, Bill Miller. That’s it, no one else. Why? Because the volatility is too high. People can come up with all kinds of reasons not to own digital assets but none of them makes sense to me, it’s highly uncorrelated. You know, since November, it’s perfectly correlated. Yes. In liquidations, which is what we’re going through, we’re going through the greatest liquidation in history. We had the highest debt, margin debt, corporate debt, and personal debt in history that is now de-leveraging. In deleveraging, what do you have to sell? You have to sell what you can sell, gold, bonds, Bitcoin. You can’t sell the stocks because Peloton went down 90 plus percent. You can’t sell that, it doesn’t cover your margin call, you can’t sell Zoom, it’s down 90%, you can’t sell Cisco, it’s down 70%. Those don’t help you so you sell what you can sell. Correlations all go to one in liquidation environments, which is what we’re in.
If you zoom out and you look at the long-term correlation, it’s uncorrelated because it generates its return from different places. Stocks and bonds come from GDP growth, interest rates, Fed Day, they raise interest rates that hurt bonds, and potentially help stocks. Not really, although today it did, then you got inflation and then you got productivity, that’s what drives stocks and bonds. Digital assets aren’t driven by that, they’re driven by millennial adoption, by the technology itself, by regulation and by use. If you chart the usage of these assets in terms of the networks, they grow according to something called Metcalf’s law, which is very easy to chart. The problem is the price gets set by human beings and prices get above fair value and below fair value, and they tend to overshoot.
In 2017, the fair value of the network was 10,000 for Bitcoin, the price got up to 20. Guess what? Then we went to three, so the value is still 11 so then we got cheap. So then we went all the way back to 70, the value today is about 32-ish and at 70 we’re overvalued, at 20, we’re way undervalued. What does all of this mean? It means that the technology of blockchain and blockchain adoption is inevitable. The use cases of cryptocurrencies either as a store of value, or medium of exchange, payments network, inevitable. Here’s an example, if I had a mother-in-law in El Salvador, I don’t know where yours is, but mine’s actually in Tulsa, Oklahoma.
Meb: It’s here, I’m homeless. I picked the worst time in 20 years to renovate a house. And so you can see the background is my wife’s Nietzsche, Heidegger, and whatever German philosophy she studied.
Meb: If I look homeless, it’s because I am homeless. But soon, we’re talking July 4th, I’m hoping to be back in. I’m in the mother-in-law’s house currently, keep going.
Mark: If I had a mother-in-law in El Salvador and I sent her a dollar, she would end up with 70 pesos because Western Union takes a cut, and the Bank for International Settlements, takes a cut because it goes across international borders, the Rothschildes got to get paid and then there’s some local transaction cost. If I sent her a Bitcoin, she’d get a dollar. If I sent her a dollar using Strike, which uses the Bitcoin blockchain to transfer money, she would get 100 pesos, no slippage. Zero is the wrong cost for Strike, but he’s trying to build a use base just like Facebook did. Facebook didn’t charge anything, and then they monetize later. I mean, people forget Facebook went down 50% on the IPO, Google went down 50% post IPO. People said it was a horrible business. No, it was a growth business that had to mature.
Crypto right now and businesses around crypto are high potential, low capability. I always use the example, which people don’t like sometimes. How much would you pay for nine-year-old LeBron James’ future earnings? Now, if show you a picture of nine-year-old LeBron James, you’re going to say he looks like a normal kid. Well, I wouldn’t pay very much for that at all. He wasn’t the monster, I mean monster in the best possible way. He is a monster athlete, he’s an entrepreneur, he was a normal-looking nine-year-old, he wasn’t even that big. The potential to capability ratio was huge in nine-year-old LeBron so you should have paid for that. And the same thing is true of digital currencies today, of cryptocurrencies, of digital assets and the surrounding companies, and the ecosystem that’s going to get built out. Remember, Pets.com?
Mark: Pets.com is the poster child of the failure of the internet, went to zero. Everyone said, “That proves the internet’s a bust.” Chewy.com is the same company, exactly the same, worth $20 billion. Now, the problem is we needed broadband, we needed everybody to have a mobile phone to order, we needed GPS tracking so we could get the stuff in time at a low cost and now it works. Webvan poster child for the failure of the internet, now we have DoorDash, it’s the same business.
Meb: As your fund three, and congrats on the closing when that happens, you talk a lot to institutions, a lot to professional advisors as well as individuals. A lot of the professionals I talk to, especially on the older side, the want is there, I think they struggle with the actual how with the implementation.
Mark: So true. So our fund is a venture capital fund and that’s hard for a lot of people, particularly advisors who have non-accredited investor clients. You know, the SEC said if you’re not rich, you’re not smart. You and I have railed against this for 20 years, it makes no sense. It’s not to protect the small guy, it’s a walled garden to protect the big guys so they get all the best stuff. The challenge is adoption is better but still bad. In ’18 when we went out for fund one, we’d make 100 calls, and 90 would say, “Don’t call me back, you’re a complete idiot.” Of the 10, 9 out of 10, no. So we got 1 out of 100 and we end up with 30 investors, we made a lot of calls. Two years later, it was up to 70, said, “Don’t call me back.” We make 100 calls, 70 were like, “I told you, you’re an idiot, don’t call us back.” But there’s a three times increase, that’s pretty good. Now, still, 9 out of 10 said no, so we ended up with 3%, and we ended up with 90 investors instead of 30. Fund 3 it’s about 50-50, about half the time people will call us back. But it’s still a very low conversion rate.
We got a little more… I presented to CIBA, the Council on Investment Executive Benefit Associates. So 120 of the largest pension funds in the world, tens of trillions of dollars on the line. And I asked them five questions. What’s your exposure? Zero, 0-1, 1-3, over 3. If you have zero, why? What are your plans for the next year? And then a couple of other questions about logistics, 83% zero. So we’re still so, so early. And the crazier one was 63% said no plans to change. So despite all the stuff that’s gone on and all the progress they’ve seen, again, even with the downturn, our funds are up 5X on fund one and 3.5X on fund two in less than four years, it’s really good returns. So one of the things we did, two years ago we heard a lot from people, “We love the venture capital stuff, but we’re just not going to get the private in the portfolio. We just want to own Bitcoin, but it’s too volatile.” We said fine, we’ll create a low volatility Bitcoin. So we created something called risk-managed Bitcoin.
Pretty simple idea, take CTA strategy, Commodity Trading Advisor strategy, simple trend following which you love and you wrote about in your great book. It’s a really powerful idea, but in the traditional world, trend following isn’t as effective because of decimalization and because of high-frequency trading. In Bitcoin, it’s unbelievable because Bitcoin is still run by human beings, greed and fear and the trends go too far to the up and go too far to the down. We cut the volatility in half from 80 to 40 and we outperform holding Bitcoin meaningfully. We don’t outperform in the up markets, of course, but we crush it in the down markets. We’ve been out of the market since 42,000, so we’ve made people, “a lot of relative return” and that’s a hedge fund structure. So somebody came to us and said, “I can get in hedge funds.” So we actually launched in May an ETF called CRYP, and it is the same strategy. You’re either in or you’re out. It’s not 100, zero, we can also be where we are today, we’re at 50-50. We’ve been half exposed to the markets, and part of this is we launched after the drop started. Basically what we do is we compete against just holding the ITO or BTF to be out in the event of a rally off the bottom, you know how it works, make most your returns on a few days. So we launched fully exposed just to mitigate that risk. But as the trend continued to get negative, we went down to 75% invest, down to 50% invest, where we stay today. So we’ve generated 2,000 basis points of alpha over the period, but we’re so oversold today that I can’t go all the way out. The long-term trend is negative, the medium-term trend is negative, but the short-term trend…
Meb: Short-term trend is barf. Your local academic, Cam Harvey, he just came out with the paper on trend as applied to crypto. I didn’t read it of course, but I saw it.
Mark: Cam is great.
Mark: He also got a new book out that talks about some of the vulnerabilities in the Ethereum-based world. There’s so much work to do, but it’s kind of like the work that there was to do in 2001 and ’02 in the Internet. It was still early and the best results came in the waves following. This came out in 2007 and Apple stock went down 40%.
Meb: My buddy had one. I was sitting at a pool in Las Vegas and he was showing me how you could look at your fantasy scores. I said, “Why would I want that? Look at this beautiful razor that I have. It’s much more sleek and sheen.”
Mark: Yeah, flip phone, so much cooler. Can flip it open.
Meb: Speaking of Apple, though, when you’re talking about drawdowns, Apple stock every decade, maybe with the exception of the last one, I’m not sure, had at least a 75% drawdown. World’s biggest company, but they’ll hold that. And so this applies to what you’re talking about, too. I struggle a lot with this and talking about stocks using the same story all this time with investors chasing what’s hot, this is another Mark-ism, something about the rear-view mirror and the windshield, I can’t remember.
Mark: It’s worse for guys because we’re more left brain, more right-handed, more analytical. So we tend to constantly focus on that rear-view mirror and look at data and analyze, and as soon as the road turns, we’re right off the cliff. Women, there’s actually a great study on this called “Boys Will Be Boys.” Women actually are a little better, it’s called women’s intuition for a reason, for three reasons. One, they don’t overtrade, two, they only invest in what they know, and three, they’re not so overconfident. Men tend to be a little more overconfident and it’s partly because we are so analytical. What you need to do, in fact the best book I’ve ever read on investing is called the “Tao Jones Averages” and Dow is Tao, and it’s all about whole brain investing. Using a little bit of your creative and intuitive side. The book is dedicated to those who have the guts to trust their gut. That gut instinct is really important in investing.
There are a couple of things that I think are critical to right now. So, one, we launched a strategy a number of years ago when the whole SPAC thing was going on, two different strategies. One that tried to buy the post-merger combined entities, basically what Cathie Wood does. She buys high-tech, high-growth companies of the future. The problem is innovation tended to work really well, got really highly overvalued and has just gotten crushed. So that ETF that we launched, SPXZ is down 34%, now that’s down way less than ARK this year, right now, ARK is down 58. So we have to be up 50 to get even, she has to be up 140 to get even. But we own the same type of stuff, we’re just more equal weighted than super concentrated. But we invest in innovation and high-growth innovative companies use SPACs to go public, but there’s a different strategy related to SPACs called SPAC arbitrage, like merger arbitrage or convertible bond arbitrage. If I buy a SPAC and I hold it when it’s a SPAC, like Virgin Galactic is not a SPAC, DraftKings is not a SPAC. They went public using a SPAC, but they’re not SPACs. That’s like calling Amazon an IPO or calling Coinbase a direct listing. They’re not, that’s how they went public.
Virgin Galactic is a company now. Whether they do well or not, I don’t know how many space tourists will there be in the future. Not going to be me, I don’t know about you, but I’m not going. There’ll be more than zero, but it’s not a SPAC. A SPAC is a pool of money that sits in a trust earning T-bill interest, and then you as an investor get to decide, when they announce a deal, do I want to go into the new company, the post-merger combined entity and it de SPACs, the SPAC disappears. Or do I want to take my cash back? Well, there’s an interesting strategy that we run where you buy the SPAC, you make your interest guaranteed T-bills, no default risk, no duration risk because it’s short duration. You make that return and then you get warrants for free. The warrants may be worth something, maybe not, but on average they’re worth a couple of percent. So we make a mid-single-digit return and we run a hedge fund version that has leverage, which is compounded at high teens, and we run an unlevered version in the public markets called CSH, a cash alternative. It’s not a money market, it’s not pegged to a dollar, it has fluctuations, but it’s outperformed in the bear market of course.
Meb: I love this strategy and it’s one that… it’s got a great wedge because it’s too hard for most investors to consistently monitor. Like, I’m going to spend all day mucking around with these warrants and if I don’t elect to give it back, it’s too much.
Mark: Exactly. It’s a lot of work.
Meb: It’s perfect for a fund. And it’s perfect because you’ve been doing this your whole career, but looking for either asymmetric or just arbitrage-y, oddball things that don’t correlate to anything else. And to me this is one of my favorite strategies, we don’t have exposure to it but would like to.
Mark: No, we’d love it. Merger arbitrage is a pure arbitrage. You don’t have market risk, you have event risk. Convertible bond arbitrage is pure arbitrage. SPAC arbitrage is arbitrage. There are a lot of things that people say are arbitrage that aren’t. When people go long and short, long growth, short value, that’s not arbitrage, that’s not market neutral. You’re making two bets and you can be wrong twice. Or like what happened with Luna, calling it an algorithmic stable coin. There’s nothing stable about betting on a digital asset appreciating more so you can make your pool stable. A stable coin is something that owns cash or bonds, that’s a stable coin, USDC, that’s a stable coin. Isn’t it ironic that Luna went to Terra? The moon fell to the earth and lost $40 billion because it was an unstable strategy. It was not an arbitrage, it was like long-term capital. When long-term cap did convergence trading, pure arbitrage. You take a 30-year bond called on the run, it trades five basis points rich to an off-the-run, a 29-year-old. What do we know in 365 days? The 30-year bond becomes a 29-year bond. There’s no debating that that happens. So you can make that five basis points absolutely guaranteed and you can lever it up. And they could even lever that up maybe 30, 40 times. Great, but take 30, 40 times leverage and put it on merger arbitrage? Are you high?
Mark: And that’s what they did, and that’s what took down long-term capital. Wasn’t the convergence trading, that’s a total pure arbitrage. There are very few pure arbitrages in the world, and SPAC arbitrage is one because the trust is inviolable. Once the money’s in the trust and it goes into Treasuries, no one can touch it. Not the sponsor, not the investor, no one. And so guaranteed, and you can’t use that word very often in our business, but you’re guaranteed to get your cash back, plus interest and the warrants. Now, the warrants don’t have to be worth anything, but on average they have been.
Meb: I love the idea. We’ll add some show note links for you guys to check out as well on this topic from Mark’s ETF and some other research pieces, it’s super cool. Before we let you go, we definitely got to hop around to a few macro topics because it’s always great with you like a happy hour or coffee discussion. We could just chat forever, but you mentioned China. There’s a couple topics for me, if I mention on Twitter or elsewhere, it’s a great sentiment check because at certain points in time in China, probably more than just about anything, people are clamoring over each other to get exposure to the BRICS and China and emerging markets, and other times they’re extremely despondent. I did a tweet the other day talking about Chinese valuations because more than anything, all over the place, up, down, up, down, and they’re pretty low again.
Mark: Really low. Yep. So they’re saying they’re uninvestable.
Mark: There are consultants that want to take China out of the benchmark.
Meb: What’s your thesis? Do you think it’s attractive? Do you think there’s progress, you think there’s risk to be had?
Mark: Longer tail and happy to do it some other time. But the short version is, I believe, and it’s not popular, and Kyle and others don’t agree with me. I think China’s playing go while the rest of us argue about how to set up the checkerboard. I think they’re playing a 30-year game to become the dominant superpower. I think they want the renminbi to be the world reserve currency, and I think everything they’re doing from shutting down their ports on the zero COVID stuff to messing up the supply chain, to exporting the propaganda on the virus, all of it is to create this massive alliance that they have created called the Belt Road Initiative from China all the way up into Russia and into Western Europe. They’re basically creating a bipolar world, and you’re going to choose. They’re the leaders in the world in 5G and AI, we’re the leaders in social media. We rock at Instagram and Facebook, but they are the leaders in AI and 5G, which I will argue are more important. They have this long-term plan, it’s why they’re far ahead on digital currency for the Central Bank Digital currency, why they’re far ahead on the digital economy.
When you look at the technology companies there, they’re so incredibly cheap. Why? Because the CCP did beat down a couple of things in national interest. The education businesses, they wiped them out. Tal education, EDU, new oriental down 99%. Political reasons, Didi, they basically wiped it out. They didn’t put it out of business, but they wiped out the equity because it was mostly owned by U.S. hedge fund managers. We slapped tariffs on them, they wiped out massive amounts of wealth, and it was U.S. mostly owners. The Chinese investors had already made their money. They took their money off the table, and these were all owned by big mutual funds like BlackRock and others. And I believe in response to the tariffs, they said, screw you, we’ll hit you where it hurts.
Six, seven weeks ago, I went in pretty big personally and bought a lot of these things. When you can buy some of the largest tech companies in the world like Alibaba and Tencent and JD.com and Pinduoduo and Meituan at fractions of their former selves. There’s 1,000,000,005 people in China, 700 million of them in the middle class, they’re not going to spend less eating out, they’re not going to spend less on e-commerce, they’re not going to do less in payments, just not happening. So for me, it was a slam dunk. Now there’s still risk and there’s going to be volatility. But the negativity towards CCP reminded me of 1998 negativity around Russia when Russia defaulted. I didn’t have very much money back then, but I remember being with George Rau, a very famous Russian manager in the LaGuardia American Airlines Lounge, and he had a piece of graph paper where he was plotting the RTS and it was down 95%. And you have the great rule of 90, when you’re down 90, you got to do something. There’s been down 90, and down 95 as you’ve lost half your money. But at down 95 to get even, you’re up 20 X. He said you got to buy. I said fine. So I went out and I bought a thousand shares, the only Russian-listed company for my kids who were young at the time. And it was only like $4 top, it’s called Aota. So it wasn’t a lot of money, but it went up 40X because those barrels of oil were valued at $0.03 when Exxon’s were valued at $11. It was a barrel of oil, it’s the same stuff. Tencents’ tech is no different than Google’s tech or PayPal’s tech. Their population’s bigger, it’s growing faster contrary to our president claiming we have the fastest growth in the world, which is boggling my mind.
Anyway, I love talking about China, growth equity investing in China again, private companies, one of the best risk rewards on the planet because they’re going through the middle classification of their world the same way we did in the seventies and eighties, and there’s bigger. I mean, there are 700 million people that they pulled out of abject poverty over the last 30 years. And it’s not that they’re all gazillionaires, but they’re all middle class, 700 million people is a lot of people.
Meb: Your video which we’ll link to, the top ten surprises of 2022. What’s your favorite on the list? What’s one you want to talk about real quick?
Mark: It’s been a tough year because remember, the surprises are things that we think only have a 50-50 chance of happening if they happen. You have a really good chance to make a lot of money, so they’re anti-consensus, this has actually been a pretty interesting year for consensus. The consensus was that interest rates were going up. I would have taken the under, I thought no way he raised 75 basis points today. He did. I’ve been wrong on that one, I still think long bonds as a deflation hedge have a little role in your portfolio, not a big one. Things start to break once these trades get to a certain level, but that’s again, a topic for another day. One of the surprises is that China would be the hottest market in the world this year and it still has a chance to win that, so I think that one’s a decent one.
The only other one, we always talk about Europe and Japan, those are both boring. Japan is in such a bad place. The yen went from 108 to 135, the Nikkei should be up 40% based on that relationship over the last ten years. It’s not. That’s disconcerting, the fact that they’ve lost control of their currency, they’re trying to do yield curve control. All bets are off, but I would have said if they would have gotten the yen over 125, the Nikkei would be up 25, 30% and it’s just not so, there are some really, really, really cheap companies in Japan, particularly in the tech side. They’ve been throwing out babies with the bathwater, so I might go shopping there a little bit.
European banks is another surprise that I think if they don’t go bust like if Deutsche Bank doesn’t go bust, it probably quintuples. It’s super cheap relative to something like JP Morgan. I’ve had this trade for probably two years, long Deutsche, short JP Morgan, it’s up nicely, but it was up a lot more because when the Russia, Ukraine thing happened, people punished European banks because there’s risk there. The one I didn’t do this year was an oversight because I didn’t really have one on commodities. Commodities has been the surprise, natural gas at nine bucks is insane. I did do an oil surprise, which I’ve been totally wrong. I 100% said the surprise this year would be going into the election, Saudi would announce a massive increase in supply to crater the price because the number one indicator of whether politicians win is the price of gas. There’s a perfect inverse correlation between gas prices and incumbent popularity, particularly presidential popularity, $5 gas, it’s going to be a blow-out.
Meb: Five-dollar gas Mark, I’m in L.A., man. Right down the street from me is the one they always put on TV. I said, when this ticks over past ten because it’s at seven, it might have even been eight the other day. It doesn’t have a ten digit.
Mark: The sign doesn’t work. I was out to see a friend out in L.A. I grew up in Seattle and I ask people all the time, so what’s the lowest price you remember for gas? I remember $0.33 Totem Lake in Kirkland when I was a kid and I bought the same gallon of gas and it cost me $7.33. It’s the same gallon of gas. It does the same and actually it’s not as good because there’s ethanol in it now. But the gas didn’t get better, the currency got worse. And that’s the myth of inflation. It’s not that stuff gets better, it’s like my house in North Carolina in theory went up 40% in the last 12 months. My house did not grow, it did not get more efficient. It actually wore out, I had to put money in because my HVAC went bad and it’s costing me money. Theoretically, I could sell it maybe, but it’s not that the house got better or that the gas got better. It’s in our currency because of profligate spending and bad central bank policy got devalued.
This is the dictator playbook, I tweet about this all the time. The dictator playbook in every banana republic in history is once you get massively in debt, you got four choices. You can pay it back, you can tax everyone’s wealth in this country, you could not pay back the debt, can’t do it. Then you can restructure it, no one would take the other side. We already had, no one wants to buy our bonds. You can’t default because then you’ll get kicked out of office and no one’s going to do that or you can devalue your currency. So we are going to debauch the currency. I still think QT is a myth and even if they try, I think the balance sheet will be materially higher because Japan said they were going to end QQE in 2007 at 80% of GDP. Now there are 136, we’re at 85 or something like that, we’ll be at 130 some day, I mean, there’s no question in my mind. But in the short run, applause to J. Powell for being back to Jerome the Hawk when he came in, he was Jerome the Hawk, and then he was J the dove, and then he was J just the letter J the pusher, like he was giving everybody stimulus. Now he’s back to Jerome, and yeah, he may cause the great depression part two topic for another day, but we’ll see.
Meb: Takeaways, it’s a good time to go visit Japan. Let’s go skiing over there, listeners, go eat some sushi.
Mark: I would love to do that. All right. When you’re out at Topsail, hit me up, we’ll do a round of putt-putt. But thanks for having me back.
Meb: It’s been a blessing. Mark, thanks so much for joining us again.
Mark: Thanks, Meb.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening friends and good investing.