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The Patsy, Revisited

Summary:
As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.” – Berkshire Hathaway Chairman’s Letter (1987) This is the ur-quote. The True Source from which all hedge fund investor letter quotes spring. I’m not criticizing. It’s a great quote. I’m also not pointing fingers. We’ve used the true-to-Buffett ‘patsy’ version of the quote at least once in past Epsilon Theory notes. We have used the ‘sucker’ version at least six times, by my count. Funny thing about this quote, though. It means something different depending on who’s saying it. It is used most often by Very Smart People to wave indistinctly at a crude straw man in the distance they call Most Investors. This straw man is clothed with all sorts of really

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The Patsy, Revisited

As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”

Berkshire Hathaway Chairman’s Letter (1987)

This is the ur-quote. The True Source from which all hedge fund investor letter quotes spring.

I’m not criticizing. It’s a great quote. I’m also not pointing fingers. We’ve used the true-to-Buffett ‘patsy’ version of the quote at least once in past Epsilon Theory notes. We have used the ‘sucker’ version at least six times, by my count.

Funny thing about this quote, though. It means something different depending on who’s saying it.

It is used most often by Very Smart People to wave indistinctly at a crude straw man in the distance they call Most Investors. This straw man is clothed with all sorts of really lamentable traits, you see. He buys when everyone else is greedy. He sells when everyone is fearful. He hates value stocks and he always pays high active management fees. If you ever happen to play poker with Most Investors, just remember that he is always, always the Patsy.

Slightly less often, it is used by equity investors and fund managers in reference to reasons they have incorporated some acknowledgment of behavioral finance, sentiment, consensus views or momentum into their thinking or their process. It’s the calling card of the Wise-Sounding Skeptic, who can always get some street cred for telling you that there’s no free lunch, or that anything that seems too good to be true probably is. Again, before you hit the search window up there, remember: I’m not pointing fingers.

Ironically, in both of these cases, the focus of the aphorism is about you or about them. The other people at the table, who are sort of the whole point of the thing, are rarely more than an abstraction of individual actors into some archetypal idea of “the market”, if not another layer of abstraction into that loosely related piece of conceptual art called Most Investors. Hell, even Uncle Warren’s original bit was about Mr. Market.

You know who gets it, though? Debt guys.

No, not universally. Contrary to popular opinion (see, I built my own Most Investors, too), there’s no ‘smart’ part of the market. There are plenty of lousy credit long-short PMs, and even more dummies who’ve made a nice living getting pensions locked up in sidepockets or second extensions on way too much of NAV because of poorly executed loan-to-own strategies. But the guys who are actually in the business of worrying about where the rights that matter sit in the cap structure are the guys who are also in the business of understanding who is sitting at the table with them.

Not in some abstracted Mr. Market sense, but in the real-world sense of “Hey, who else actually owns this shit?”

In practice, most modestly shrewd equity investors can get away with abstracting the poker analogy to Mr. Market without worrying too much about who else actually owns what they own and why. There are generalizable archetypes of behavior and preferences. We kind of know how the academic factor quants are going to respond to this or that. We kind of know that there are knowable quantities of price-indifferent passive money. We suspect there’s a certain amount of contrarian capital ready to BTFD, and a certain amount of CTA money ready to take one on the chin when they do. We let that one guy at JPMorgan throw a dart to be breathtakingly wrong again about how much risk-targeted AUM is ‘in motion.’ Whatever mental model we have isn’t going to be anywhere close to perfect, but it’s usually going to be good enough for Bayesian work.

But if anyone is willing to tell you that they have a view on how a speculative asset (see here for the particular definition of this term I mean) will perform in a period of stress for risky assets, or that it should have a weak or negative correlation to, say, equity markets, and if their analysis is based on some trait or analysis of the asset itself and not the behaviors of the specific people who own the thing, they are probably raccoons.

And yeah, there are a lot of suspects for this particular crime. Folks selling you crisis risk portfolios holding selling something other than long USTs? Crypto “hedge funds” with correlation matrices in the deck? They deserve your skepticism.

No, not all of them are guilty.

But if a fund manager, salesperson or consultant tells you they know of an asset class that will buck the trend if and when risky assets deflate, here’s a tip: ask them who the other people sitting at the table in that asset are. Ask them to be explicit. Ask them to tell you why they believe those people will respond that way and not in the price-sensitive way Most Investors respond to broad-based risk aversion.

When you do, if they can’t answer, or if they start talking ‘fundamentals’ of the asset, please call your local animal control.

Rusty Guinn
Executive Vice President of Asset Management, Salient. Rusty Guinn is the executive vice president of asset management at Salient. He oversees Salient’s retail and institutional asset management business, including investment teams, products, and strategy. Rusty shares his perspective and experience as an investor on the Epsilon Theory website.

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