Mad Money Machine

Austrian Investing Means Investing in Capitalism

I was talking with Mark Hebner today about this idea of Black Swan investing. As I mentioned in show 141, I read an article entitled “Is There Such a Thing as Austrian Investing?” by  Sterling T. Terrell. He talks about the differences between passive and active investing. But then he talks about their similarity: they both realize small gains most of the time and large gains very rarely. He says an Austrian approach would embrace the fact that the future is unknowable. He says the way to invest in the unknowable is to do Taleb’s approach of putting most of one’s net worth in low risk assets, perhaps money markets or short term bonds, and then with a small amount invest in options. The idea is that most of the time one would lose a little amount of money but on rare occasions, when there is a shock to the market, the strategy would make a large amount of money.

My comment upon his article is that it needs to be fleshed out more. Simply saying that one would follow this approach because the future is uncertain leaves a lot of arguments untouched. For instance, the article does not show how one would implement it, how it would have performed in the past, and what mathematical basis it has upon reality. Show me how such a strategy would have performed over the last 10 years. 20 years. Rolling periods. What amount of one’s investment would be eaten by fees and bid/ask spreads on these options? Can an individual actually implement such a plan or must one be a hedge fund with millions rolling around?

Wouldn’t investing in capitalism be closer to the Austrian ideal rather than speculating in financial derivatives? And particularly investing in ALL of capitalism and taking out the “controlling” decisions of some fund manager to select which companies may do better than others. This means investing in index funds. This means buying baskets of as many companies as possible, with some rational due diligence hopefully embedded in the process. By this I mean, if a company comes out and says, “We intend to close our business in the next couple of years” then by all means the index manager could have leeway to pull out of that stock.

Perhaps an important aspect of Austrian Investing was something else Terrell mentioned, 

To further explore Austrian investing, one might look at the nature of Austrian Business Cycle Theory: how can the role of the Federal Reserve in setting interest rates, causing shortages and surpluses in the market for loanable funds, the nature of malinvestment, and the inevitable boom and bust that follow, be formulated into a successful investment process?

That’s definitely something to take into consideration. Peter Schiff, Nouriel Roubini, Ron Paul, James Grant, Jim Rogers and many, many others are trying to do this too. Still, applying it to investing is akin to licking one’s finger and sticking it up to the wind. I need something more scientific, more measurable, more definitive so that I can take the belief factor out of the equation and instead invest rationally. In fact, maybe rationality is the real key to Austrian Investing after all.