Q2 2025: 37.1% YTD, embrace the bugs, bugs in capitalism
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Year |
Return |
2024 |
46.6% |
2025 YTD |
37.1% |
Embrace the bugs
I was a very dumb 18 year old. However, when we were that age, we’re tasked with choosing a life changing decision: what to study. I chose electrical engineering because I liked breadboarding (wiring up circuits). What followed was years of learning something I neither had the talent nor interest in. Thankfully electrical engineering is somewhat adjacent to a field I did love: software engineering.
It was not all a waste however. Some principles of engineering translate well regardless of area. Engineering is applied science. It is the practice of taking an ideal, theoretical understanding and applying it to real world constraints. The real world is messy. Where math and science are “pure”, engineering embraces the mess. This was especially true in software. I recall many times the hardware or partner APIs we depended on had bugs. The first intuition many software engineers had was to file a bug with a partner (*cough* Apple *cough*) and uselessly shrug. Often times the more pragmatic solution was to embrace reality and work around those idiosyncrasies in a codebase we controlled.
When I read Buffett and Graham, the spirit animals of value investing, I read about an ideal. Buy $1 for $0.50. What could be more intuitive and satisfying? Mr. Market gets it wrong but you can get it right and make money. Unfortunately, the application of those principles is easier said than done. The reality is, markets tend to reward growth to nonsensical valuations, believes charlatans, and, to the chagrin of value investors, dismiss true/intrinsic value for many years. To do a “pure” form of value investing without taking into account real world constraints would likely underperform. Oftentimes, I see investors think like those software engineers that uselessly shrug their shoulders when they experience a “bug”. “Not fair, I am smart, the market is wrong” is a common thought. There is a gap between the “science” of Buffett/Graham’s principles and the real world that I believe makes the difference between a subpar and a great investor. That is, to be a great investor, I’d argue we must think like engineers and bridge Buffett/Graham’s science to the real world.
As an example, the historical theology of value investing is littered with incredibly high IRRs from investors buying low PE equities. And yet if you look at the real world today, there exist plenty of examples of high multiple equities that have given stellar returns over many years. There is much evidence that the so-called “value premium” has gone away. Anecdotally, I see it first hand however it is also evident in broader data. Professor Damodaran of NYU, the guy who literally wrote the book on valuation, has done some great work on the topic: https://aswathdamodaran.blogspot.com/2025/01/data-update-3-for-2025-slicing-and.html. It would be a foolish thing to do if one just blindly followed the traditional canon of value investing. However, to be clear, I still follow the tenants of value investing. I still do DCFs and attempt to buy assets at a discount to intrinsic value. To bridge the gap between the traditional canon and the real world, at least one of these factors must exist: high probability of visibility (such as a catalyst), growth, or return of shareholder capital.
Bugs in capitalism
I am a card carrying capitalist and yet to have heard of any alternative large scale system that has created prosperity for its constituents for any extended period of time. History is littered with failure, death and despair in attempts at implementing alternatives. Though I think capitalism has bugs, it is still the best known system that galvanizes society to be productive and allocate capital efficiently. However, there are plenty of edge cases where bugs exist. One bug I have been thinking a great deal about is how the social contract has been broken. I think this presents both investment opportunities as well as dangers. There are many ways broken social contract manifests, but some of it is seen in stress in the healthcare system, unaffordable housing, declining education KPIs, increases in crime, breakdown in social cohesion, weakened international ties, mercantilism, and so on. These symptoms can be seen broadly in many OECD countries (and beyond). As a new father, I can’t help but wonder what can be done so my son can have a better future than I have.
So what are potential causes? The right tends to blame immigrants, high taxation, overrepresentation of minority interest groups, laziness, overregulation, and so on. The left tends to blame greed, underregulation, underfunding, short term capitalism. Obviously the issue is complex and can’t be simplified in a few paragraphs.
There was a fantastic show on Netflix called Altered Carbon released in 2018. In the show, the writers theorized individuals could become immortal. In that world, capital can be allowed to compound forever, and a ruling class owns a disproportionate amount of the societal pie. In history, this is not exactly an uncommon phenomenon. The French Revolution, Russian Revolution, Chinese Communist Revolution, World War 2, are all examples of historical events that were, in part, catalyzed by enormous wealth inequality. In today’s day and age, we essentially have that story. Families can pass on wealth from one generation to the next and that wealth can continue to compound forever. In history, where wealth would have been stored in land, in undiversified local assets, modern financial infrastructure allows a family to own a diversified set of assets all over the world at a click of a button. War and revolution might not necessarily be the end of a family’s wealth as it would have been in past cycles.
One way to view capital is that it’s a race. Economies grow at some rate. A family’s assets can grow at a faster rate. If enough families grow their assets at a rate faster than the economy expands, their percentage ownership of the economy increases. That’s a critical bug with capitalism if enough time has passed and I believe some of the societal issues we’re seeing today are a result. It's a risk to businesses/investors from the standpoint of potential government intervention. However, it's an opportunity with respect to anticipating what the wealthy will do. There is only so much consumption that can be had by an individual on a unit time basis. 3 meals in a day. One bed per night. And so on. So the marginal utility of capital for a sufficiently wealthy person is minimal. If that capital is not consumed, it is rational for the wealthy to invest it. Going forward, I suspect asset prices will rise not just because of intrinsic value, or because of inflationary monetary policy, but because a large percentage of compounding capital won't be spent on consumption and thus will create demand for assets.
An example is in housing, a particular sore spot in my native Canada. By most fundamental metrics one can value housing: cap rates, price to income, price to rent, etc. housing is, on average overvalued in Canada at the time of writing. It is, I would argue, partially because housing is a default investment vehicle, especially for those who aren't familiar with investing. Another bug. To be clear, I do not think Canadian housing is a great investment opportunity. However, I believe there are suppliers that may be.
In March 2025, Mark Carney took on the role of Prime Minister of Canada. Though the language on his published materials have softened, I believe earlier material is indicative of his intentions.
Many OECD country government income statements are quite constrained. Despite this, individuals in many OECD countries have a great deal of wealth. In the US, the baby boomers who represent ~20% of the population have ~51% of the wealth. It seems rational for those with wealth to fund the needs of broader society in exchange for a reasonable return.
The opportunity is vast. Housing affordability in many OECD countries has been a sore spot for years. In the example above, 227,000 homes at an average price of $691,299 CAD is ~$157B. New houses/neighbourhoods require electricity, water, road infrastructure, malls, restaurants, public transport, and so on. Governments (especially Canada) are certainly not going to fund this all on their own. The opportunity more broadly can be seen in alternative investments, in homebuilders, in semiconductor manufacturing, in energy, and so on. Bugs, just like in software, can be features.
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