Tuesday, May 05, 2009

Peter Thiel on Financial Markets and The Singularity

I will definitely watch this again, but a few things struck me about this presentation by Peter Thiel. (For the unaware, Thiel was the CEO of PayPal who sold the company to eBay. He runs Clarium Capital Management LLC, a global macro hedge fund, and does early stage investing, mostly through The Founder's Fund. He was one of the first investors in Facebook and a bunch of other well known Web 2.0 companies.)

First, Thiel really is nerdier than I expected. I was hoping there was a suaveness to him, a relaxed confidence borne of his intelligence and success both as an entrepreneur, an academic and an investor. No. There really isn't. He's as nerdy looking and sounding as one would expect from reading about him. I'm not sure what to make of this, and it really means ABSOLUTELY NOTHING, but it caught me off guard. He's also a very unpolished speaker. Again, this is not a problem or a bad thing, but I always find it difficult to listen to people who overuse "ummm" and "uhhh" and "you know" in their speech. In Thiel's case, it is probably a matter of his thinking faster than he speaks, and his speech having to catch up with this (disorganized and chaotic) thoughts. However, it only serves to obfuscate his message and, to me personally, makes it almost painful to listen to him. He should probably spend more time preparing and organizing his thoughts when he is to speak to crowds.

Second, I think Thiel has misunderstood Warren Buffett's investing strategy. Maybe Buffett, and by extension Berkshire Hathaway, has invested in The Singularity better than anyone else. However, I don't think that was his objective. Buffett and Berkshire have been doing the very logical thing - managing risks and probabilities. Insurance is the ultimate business of managing risks and probabilities. The insurance business is basically about probability, and this fits with Thiel's singularity thesis because it comes down to managing the fat tail risks.

Thiel makes the point, several times, that there are all of these potential outcomes in a non-Gaussian distribution of risks, from -- for example -- an investment boom being the beginning of "The New New Thing" which will revolutionize life on Earth to just being an extended investment mania. He uses the Japan bubble of the 1980s, the Internet bubble of the late 1990s, the real estate bubble in the US in the early part of this decade and the pursuit of the control of space in the late 1960s as is representative cases. In most of these cases, there was a span of time during which great wealth (or "wealth") was created, followed by a spectacular collapse -- boom and bust.

Thiel continues on to mention that Buffett, by way of Berkshire Hathaway, is investing in the The Singularity by writing insurance against catastrophic events -- the busts. However, I think Thiel has missed some things. First, Berkshire is not new to the insurance business. Second, insurance -- basically, writing puts against given outcomes, which I think of as the best description -- is a well known business with solid underpinnings. Buffett understands this, and uses this to his advantage. The Berkshire insurance businesses are cash generators, and Buffett has intentionally steered away from certain lines, or approached them carefully. For example, Geico only recently began writing renter's and home owner's insurance, after having been in the auto insurance business for a long time. Geico has also been known as the company that would only take on the best drivers (e.g. the lowest risk drivers) and dropping coverage for drivers after a single accident (cutting losses early). The cash thrown off by the Berkshire insurance businesses has fueled Berkshire's acquisitions of other lowly valued businesses (on a fundamental basis) as well as it's war chest, which in turn had driven it's AAA credit rating (until recently).

Even Warren Buffett's mistimed (?) derivatives bets are nothing more than insurance plays. They are bets on the probability of certain outcomes, including the level of the S&P 500 equity index in almost 20 years. While the positions are underwater now, and Buffett can be considered hypocritical for calling derivatives of all stripes "financial weapons of mass destruction", he is fundamentally making similar bets as any of the insurance lines his companies write.

I say all of this to say that Buffett doesn't invest in insurance businesses due to some recognition of or belief in The Singularity but simply because he recognizes that probability is on his side. Everything has risk, but insurance, such as it is (outside of the realm of catastrophe, for example), is well known and generally a cash cow due to the small payout in claims against the large revenue in premiums. Maybe Thiel knows this, but he seems to express a view that Buffett has some grandiose "black swan" perspective on investing. I, personally, think not.

Anyway, it is an interesting presentation and not a bad way to spend 20 minutes of your time. Will you gain any new insight here? Probably not. But you never know. Maybe something he says will land with you in a way other talks have not. Check it out if you have the time.

Until next time...

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