Christopher Cole – Small Bets, Huge Payoffs - [Invest Like the Best, EP.13]

Episode Summary

Executive Summary: Patrick O’Shaughnessy interviews Chris Cole of Artemis Capital on long volatility, convexity, and why portfolios should profit from change. Cole argues most investors are structurally short convexity, central-bank policy has suppressed volatility and pushed risk into the future, and that combining convex strategies with traditional beta can improve resilience.

Main Topics: Convexity as exposure to change (Priority: 10/5): Cole frames life and markets as linear time plus nonlinear payoffs from small bets. Long vol vs. short vol portfolios (Priority: 10/5): Most strategies earn steadily then suffer rare large losses; long vol seeks the opposite. Crisis, central banks, and hidden risk (Priority: 9/5): Suppressed volatility can create false stability, larger tail risks, and social instability. Portfolio construction and carry (Priority: 9/5): He explains using options, beta, and value to make convexity cheaper to own. Technology as offset and complication (Priority: 7/5): Tech can improve productivity while displacing labor and making old policy tools less effective. Rodman, art, and creativity (Priority: 6/5): Cole uses analogies from basketball, film, and art to explain nonlinear value creation.

Key Arguments: Life and portfolios work like options: small losses can buy large nonlinear upside. Most investors are 97% short convexity and only 2%-3% long convexity. Value investing is short convexity because it still breaks in systemic crises. Central banks have pushed returns from the future into the present, raising fragility. Long vol aims to own cheap upside to dislocations without bleeding out like pure tail risk. Combining long vol with beta or value can outperform hedge fund averages. The bigger danger is social fallout from asset-price stress, not just a market drawdown.

Data Points: Warren Buffett net worth: $66 billion - Used to illustrate that time and health may matter more than wealth. Buffett age: late eighties - Part of the comparison about valuing time versus money. Portfolio mix: 97% short convexity and maybe 2% to 3% long convexity - Cole's estimate of how most investors are positioned. Financial crisis reference: 2008 - Example of a period when long convexity strategies should help. Market examples of crises: 1998, 1928, 2008 - Periods cited where value investing suffered in broad drawdowns. Bond yields in early 2008: German Bund around 4.5%; U.S. Treasury around 4.2% - Used to show how much rates have fallen since then. Today bond yields: Bund negative to flat; U.S. Treasuries around 1.7% - Illustrates diminished future convexity from rates. Pension expected return: 8% - Actuarial baseline returns cited for pension systems. Long Vol Hedge Fund Index members: about 9 or 10 managers - Shows how few dedicated long vol managers exist. CBOE long/vol hedge fund comparison: S&P 500 + long ball hedge fund index beat average hedge fund by 90% since 2005 - Used to argue the power of pairing beta with convexity. Volatility in the late 1990s: vol averaged over 20 - Cole notes that high vol can coexist with rising markets. Late 1990s drawdowns: two 20% drawdowns - Supports the claim that 1997-1999 had meaningful risk despite gains. VIX levels: 38 in 1997 and retested 40 multiple times in 1998 - Example of elevated volatility during a bull market. Rodman rebounding: about 30% of defensive rebounds and 17% of offensive rebounds - Illustrates extreme nonlinearity in portfolio construction. Rodman standard deviations: six standard deviations away from the mean - Shows his statistical outlier status in rebounding. Meditation routine: about 20 minutes a day - Cole's personal habit aimed at nonlinear self-improvement.

Pivotal Quotes: "I think a lot of times life, which can be analogous to markets, is about how do you take this linear concept of time and extrapolate it into nonlinear satisfaction in your daily life?" — Chris Cole: Explaining convexity as a life framework "What they've done is they've taken returns from the future and they brought them to the present." — Chris Cole: Describing central banks and suppressed volatility "The biggest risk is not a 20% or a 30% decline in markets. The bigger risk is how socially we respond to that." — Chris Cole: On why market stress may become social stress

Implications: Investors should test whether their portfolios are quietly short convexity and consider modest, diversified ways to own change rather than just predict it.