Playing the Long Investment Game

The first 20 pages of Michael Lewis’s wonderfully written book, Flash Boys, follows the secret project of a company called Spread Networks to lay 840 miles of “a-one-and-a-half-inch wide black plastic tube” in the most direct path possible between suburban Chicago and northern New Jersey. The sole purpose of this endeavor was to transmit data back and forth three to four milliseconds faster than any existing alternative. The owners of this cable project were able to spend nearly $200 million of their investors’ money because they were in contact with people willing and able to pay almost anything to access that four millisecond advantage.

The lucky customers of Spread Networks were smart and sophisticated investors who wanted to exploit a loophole in the existing regulations that would allow them to legally “front run” trades (i.e., have advance knowledge of other investors’ pending orders). Front running is the Wall Street equivalent of shooting fish in a barrel or having an extra key to the Bureau of Engraving and Printing. Spread Networks’ new fiber optic cable delivered incredible leverage to its customers, hitting the ultimate investment trifecta: riskless trades, huge profits and complete legality.

This is the short game: Get in, get out—make your profit, repeat as needed. Enormously attractive to the vast majority of investors, it eliminates the one thing investors are most uncomfortable with: uncertainty. It doesn’t matter if the profits are large or small (large are preferred) as long as the transaction is quick and done.

The bad news about the short game is that since everyone wants the same thing the pickings tend to be slim, and the few that are found either don’t last long or require a substantial combination of creativity, sophistication, opportunism and money. The enormous profits made by high-frequency traders only reinforced the lure of the short game. When the payoff is large enough there will always be people willing to risk whatever it takes—irrelevant either to the odds or the ethics.

For the rest of us there is the long game. Success at the long game requires overcoming considerable emotional and behavioral challenges; so it is far less popular among investors. But that means its abundant rewards haven’t been picked over.

Deep Time

Darwin’s last work was a 336-page book on worms and vegetable mold; an effort that some critics considered “a harmless work of little importance by a great naturalist in his dotage.” But Darwin was a keen observer. He wrote, “A worm’s work, when summed over all worms and long periods of time, can shape our landscape and form our soils.” Stephen Jay Gould argued that Darwin chose worms because they were the perfect way to reinforce the central thesis of his life’s work: “If they [worms], working constantly beneath our notice, can form much of our soil and shape our landscape, then what event of magnitude cannot arise from the summation of small effects.”

The San Andreas Fault runs 810 miles up the western side of California from the Mexican border ending just south of Oregon. It is formed by the boundary of two massive tectonic plates (Pacific and North American) as they move in opposite directions. The movement itself is barely enough to be measurable (less than an inch and a half each year)—geologists euphemistically call it “slippage.” A more popular and descriptive label is earthquake.

Here in Southern California, in the back of all of our minds is the knowledge that at some point “the big one” is going to strike. In human terms it is a legitimate and scary proposition. But from a geological perspective a single earthquake however large is a tiny cog in a big wheel. In eight to 10 million years and about 10,000 more “big” earthquakes, Los Angeles (or what’s left of it) will ultimately slide by San Francisco as the Pacific plate continues on its northwest journey. The leverage of deep time is what drives mountains into the sky and brings them down again in the perpetual remodeling of the earth.