Dylan Grice at SocGen is leaving. He wrote this letter as a final, long winded good bye. He uses the term "cockroach" 31 times...
The whole thing sans some charts:
All good things come to an end, sadly. So it is with my time here alongside Albert, Andy
and the rest of the gang at SG. I’m signing off, checking out, moving on to pastures new.
It’s been a wonderful time. But after three years of trying to sound clever it’s time for me to
do something altogether more difficult, and actually be clever. So early next year, I will join
a small but outstanding investment practice. Naturally, I hope it will be a great success.
But what makes a great success? Since there are few more accomplished species on earth
than the lowly cockroach where better to start looking for an answer?
Cockroaches get a bad press. Theyre pests. We dont want them in our houses. Mainly, we
want to kill them. If you call someone a cockroach, like Tony Montana did to Frank Lopez in
Scarface, its not meant as a compliment. You might think that one of the most successful
species in the long and colourful history of life on earth would enjoy more respect. But no
Of course, you have to be careful in how you define success. Cockroaches dont have iPhones,
space stations or edible underwear. They dont have any of the nick-nacks we have that make
us think were so clever. Theyre not ingenious, like we think we are.
But ingeniousness is over-rated. Cockroaches may not be able to build nuclear bombs, but they
can withstand nuclear war. They survive. Dont get me wrong. Thriving is great. Prospering isnt
bad either. But neither mean much if youre unable to survive. To my mind, therefore, capacity to
survive has to be the starting point when thinking about success. Its all about robustness really,
and on this metric cockroaches are tops.
The oldest cockroach fossil is 350 million years old, which is quite remarkable when you think
about it. We humans have been around for around for a mere fifty thousand years (so were one
seven thousandth as successful as cockroaches). According to the record of the rocks,
cockroaches first appeared just after the second of the earths five mass extinctions (defined as
the loss of 75% of all species). In other words, that means they survived the third, fourth and fifth
mass extinctions which followed, the last one being the Cretaceous event which wiped out the
dinosaurs. They can go without air for 45 minutes, survive submerged underwater for half an
hour, survive freezing temperatures and withstand fifteen times more radiation than humans.
They eat pretty much anything, including the glue on the back of stamps. And when that runs
out, they can last a month without anything at all before finally starving.
But what I like best about cockroaches isnt just their physical hardiness, its the simple
algorithm they use to survive. According to Richard Bookstaber, that algorithm is “singularly
simple and seemingly suboptimal: it moves in the opposite direction of gusts of wind that might
signal an approaching predator.” And thats it. Simple, suboptimal, but spectacularly robust...
Cockroaches prove that what is optimal isnt necessarily robust, that there is such a thing as
being too clever, and that you can thrive with very simple underlying algorithms. As you can
imagine, this is an inspiring and reassuring idea for someone as limited me. And its got me
thinking about what a cockroach portfolio would look like.
When I started work in 1997 equities were the only place to be. The mantra was that in the
long run, you couldnt lose money in stocks. The tech bubble was just beginning to inflate.
Two financial writers, James Glassman and Kevin Hassett, were conceiving of a book called
Dow 36,000 which would be published a few years later, in 1999. This would be close to the
peak of the bubble.
In a sense its easy to see why. The following chart compares the real drawdowns (peak to
trough movements adjusted for CPI inflation) of bonds and equities during the 1990s bull
market. The maximum real drawdown was 17% in the equity market (in 1990) and 13% in the
bond market (1994). These downsides werent a million miles away, but the returns on equities
were much higher. So only idiots would own bonds. This all sounds quaint today. But it
happened and it was real. Institutional investors, pension funds and insurance companies held
about 85% of their assets in equities. They thought it was the prudent thing to do.
As the market rose to the heady valuation peak of the late 1990s, equity investors felt very
pleased with themselves. They understood all the fancy new ideas like collapsing equity risk
premia and productivity miracles. They marvelled at tantalizingly delphic central bankers, and
on good days they thought they were nearly as clever. It would all have been lost on a lowly
and limited cockroach
Over a decade later, and were in a similar place today. Insurance companies have almost
completely sold their equity holdings and they own large bond portfolios instead. The FT
reports that UK pension funds also now own more bonds than equities. In real terms, equities
have suffered real drawdowns of nearly 50% on two occasions in ten years while bonds have
held firm (chart below). Worse, equity returns have been negative over that period.
So .... now everyone knows that only an idiot would want to own equities. Its true that bonds
dont offer much return with yields down here “but at least you don’t lose your capital.”
Theyve had 10% maximum real drawdown, after all. Theyre risk-free. Some economists even
tell us that governments cant go broke if they are in control of the printing press. That your
only risk with bonds is inflation, but let’s face it deflation is the risk here. Look around, we’re
deleveraging! Central banks couldn’t create inflation even if they wanted to!! We’ll be lucky to
emulate Japan!!! according to Nobel Prize winning clever-clogs. I happen to think the
clever-clogs wrong. But I dont really know. Maybe its me thats wrong. What I do know is
that its all beyond the lowly cockroach.
Of course, if youd been clever (or lucky) youd have owned equities in the 1990s and bonds in
the 2000s. Youd have switched out at the top. But how many did? Some managed to be right
in timing as well as thought and so kept their jobs. But most didnt. For the overwhelming
majority, timing these events is a mugs game. Yet today everyone asks what the trigger will
be for a bond rout. They need to know so they know when to get out of bonds. Its what
theyre paid to do. Again though, its all beyond the lowly cockroach.
A cockroach would avoid playing the game in the first place. Hed accept that he wasnt
clever enough to know when to switch out of one asset class and into another. Hed probably
do everything he could to avoid having to make such horrible decisions. Hed buy bonds and
equities together, ensuring that each year he held them in equal proportion.
The following chart shows what his returns would have looked like, using such a strategy from
the 1990s onward. Not bad in fact.
But how cockroach-like is this strategy really? If we go back to the 1970s and compare real
drawdowns from then, we get a very different picture. We see that during that inflationary
decade the bonds/equity combo didnt really do much to mitigate the potential for capital loss.
A real cockroach would survive the 1970s. It would be inflation resistant, deflation resistant,
credit inflation resistant, credit deflation resistant despite having no view on which
scenario was more likely at any point in time. So lets assume our cockroach has no view. It
doesnt know whats around the corner so it doesnt make any bets. It holds half of its capital
in real assets, the other half in nominal. Of course, being a cockroach, it doesnt know if
capitalism is about to collapse or flourish. So it divides its nominal and real buckets further
into productive and unproductive assets. It puts 25% of its portfolio in equities, 25% of its
portfolio in gold, 25% of its portfolio in government bonds and 25% in cash.
The following chart shows that such a portfolio offers some very real protection against the
vagaries of an unknown future. Real drawdowns during each regime were significantly
mitigated with the cockroach-like strategy of simplicity, agnosticism and robustness.
In 1975 Charles D Ellis wrote about investment being a losers game. He was using the
distinction Simon Ramo drew in his book “Extraordinary Tennis for the Ordinary Tennis Player”
who observed that the game of tennis was in fact, two games. After extensive statistical
analysis, he concluded that professional players win points, while amateurs lose them.
Professional players put the ball wherever they like, at whatever pace they like, with a
precision and consistency which the overwhelming majority of players could never hope for.
The winner of a professional tennis match is the one who makes the most winning shots.
For most tennis players the game is different. Each player tries to make those special shots.
They try to win points. But in doing so they double-fault, miss the baseline, hit the net In
other words, they lose points because they keep trying to hit winning points theyre not
capable of. The winner of the losers game is the one who loses the least points.
I like Ellis categorisation of investment as a losers game. We spend so much time and energy
trying to be clever: what the Fed will do next; what it should do next; where oil prices will go;
what the effect will be on the economy; when the recovery will come; if the recovery will come;
will China see a revolution; will Russia revolt against Tsar Putin; et cetera, et cetera. It may be
better to focus instead on not being dumb. How good are we at making these predictions? Of
course there is a time for going on the offensive, and the occasional opportunity to play
winning shots. In moving to an investment practice I guess Im trying to make one now. Time
will tell on how sound my judgement is. But I think the principle is a sound one.
So its an odd feeling to be drawing the curtain on my time here with Albert and Andy at
SG. The three years have flown and its been both educational and entertaining working with
them. But Ive known them both for years and been close friends with them for years. So while
Ill miss the day-to-day contact, we wont stop being close friends.
But Im going to miss SG too. I know its customary to thank everyone everywhere when you
leave, but in all sincerity, my time at SG has also been memorable because of SG. Its not
been an easy time for banks. Eurozone banks have had a particularly rough time and SG has
copped its fair share of the flak. But Ive met some fine and honourable people here who will
be life-long friends.
Ive come across wonderful people outside of the bank too: readers, clients, journalists. But
the most common question Ive been asked in my time here has been “how do you get away
with writing what you write, while working inside a bank?” Lurking beneath the question is the
implicit understanding that other banks dont allow their analysts freedom of thought and
expression. Yet SG has given us exactly that freedom, along with trust that we wont abuse it.
Such trust is unusual indeed in this industry and without it I wouldnt have had the fun, the
personal growth, the readership, or relationships that the readership has fostered over time. I
am truly grateful and I will always be very fond of this place.
When I resurface on the buy side early next year I will continue to write from my new perch.
Before then I will be presenting at Albert and Andys January conferences in London and
Edinburgh. Hopefully Ill get to catch up with some of you personally then. In the meantime,
anyone whos corresponded with me, met me, or even just enjoyed reading the odd Popular
Delusions and would like to stay in touch, feel free to drop me a line here. To the rest of you,
thank you and farewell!