Avoiding Drawdowns

Letter from Latvia

Today I am writing about drawdowns and market surprises. If you are here for the investment logic jump to the paid section.

---

Happy New Year! A REMINDER, NOTHING BELOW IS INVESTMENT ADIVCE. INVESTING IS RISKY AND OFTEN PAINFUL.

---

I spent New Year’s in Riga, Latvia. I’d never been abroad for New Year’s Eve and many Russians and Ukrainians have fled here to escape Putin, thus my curiosity. Spending time here and listening to the chatter, a few observations:

a) time spent in a place like this is a reminder we are all susceptible to forces well outside of our control

b) accruing wealth is heavily dependent on avoiding drawdowns, by which I mean acute declines in wealth, the risk of which some people sense much faster than others

c) Marxist frameworks (everything can be explained in terms class or race) look particularly flawed on the territory where they have been applied

Big Forces

This town has been over run by empires you know about (Russia) and ones you likely don’t (the Polish-Lithuanian Commonwealth) for hundreds of years. Today, this region of 1.8 million is a part of the European Union and the front line to NATO troops on the Russian border, an effort to not get run over again.

Strolling downtown, it is evident this region was once part of a boom. Specifically, in the period between the first and second world wars, Latvia was a gateway to Russian raw materials (timber) and local agricultural exports. The wealthy poured their money into soaring Art Deco buildings that are slowly being restored.

All that reversed during World War Two. Latvia mostly collaborating with the Nazis, murdering its Jews, then being forcibly absorbed into the Soviet system. Downtown is dotted with monuments to these tragedies, among them the KGB’s former downtown headquarters, now a museum, which I walked past this morning. The garage door to the right was used for trucks to remove the bodies of the people shot inside.

Personal Drawdowns

That bloody history doesn’t seem so distant when you talk to people here today who have fled Putin’s clutch. Kyiv is about 600 miles to the south and was bombed heavily while we rang in the New Year. One man at a party I attended fled a year ago, another the moment Russia seized Crimea in 2014, others in a convoy of cars the day Russia invaded Ukraine.

The moment I heard of little green men without insignias in Crimea, my husband said, ‘we must leave Russia immediately,’ a Russian woman recounted to me. That was 2014. Her husband was prescient, like a trader who smells financial catastrophe ahead of the crowd. Now they need to master Latvian to gain citizenship.

These recent arrivals, one way or another, are suffering a massive personal drawdown due to forces outside of their control. That happens again and again, as my podcast with Prof. Scott Nelson, an expert on the history of grain and its role in Ukraine conflicts makes clear. (You can hear the full episode, here.)

A good trader pays heed to drawdown risk. A key to gathering wealth over time is to avoid sharp losses. If you can avoid the losses, you get to work less hard to earn the same money. The diagram below illustrates the point. If you compound at a steady 10% it isn’t sexy and you don’t need to be too clever to earn your number. If you suffer a sharp decline, however, you need spectacular returns to get back to where you were.

Marxism

One thing I’ve always found fascinating about people from this part of the world is how quickly some of them can see through flawed ideology. It’s a product of growing up in a deeply flawed system. When I was in college, much of the humanities was in the thrall of “Marxist” frameworks to analyze history and literature. This translates well onto identify politics, explaining everything through a prism of wealth or race or gender.

But you can see how poorly those frameworks meet with reality here, a place I first visited in the summer of 1990. In theory, the Soviet Union was a worker paradise, where Latvians were united with their working class Russian brothers. That’s Marxist theory. In reality, the KGB murdered or deported tens of thousands of Latvians over decades and the Latvians also proved quite capable at murdering their own (the Jews).

It’s a reminder seemingly distant philosophical debates on the nature of man have practical implications today. Power does corrupt. People are gullible and easily believe what is on TV or TikTok. Thus, 17th and 18th century Enlightenment era ideas stipulating freedom of expression, religion, press and limits on power are the nuclear energy of modern wealth and the reason why a place like Finland (less deep drawdowns) is so much wealthier than Latvia.

Investment Implications