Last Wednesday was an exciting day for us at Alpha Rock Capital. We took our content strategy a step further by sending the first instalment of our new newsletter (contact us if you would like to subscribe), a newsletter we decided to call “Antifragile”.
Shortly after sending, we received some great feedback regarding the use of this term. We always welcome criticism as it allows us to keep improving. Does it make sense to call Alpha Rock Capital “antifragile”? In this article, I’ll try to explain why we don’t use this term arbitrarily.
It would make no sense to explain why we use a term without first making sure we all understand it, so, what does “antifragile” and its noun, “antifragility”, mean?
This term was developed by Nassim Nicholas Taleb, and detailed in his book “Antifragile: Things That Gain from Disorder”. At Alpha Rock Capital, we tend to agree with the way Taleb thinks, as you may have figured by reading some of my previous articles like Skin in the Game (named after his latest book, which I also recommend), When to Borrow Money, or the one discussing our Principles.
“Antifragility” refers to things that benefit from change. It is the opposite of fragility. While something perfectly robust isn’t affected by change in any way, something antifragile is affected positively, it benefits from change.
Money managers who get a commission on the upside, but don’t lose anything when things go wrong, are antifragile. Society benefits from the innovations that scientists, entrepreneurs, and all kinds of adventurers bring with their experiments. Ideas, processes, systems are constantly replaced by better ones. Society as a whole is antifragile because of those people’s constant tinkering. Bad ideas are discarded and the good ones are incorporated into human knowledge.
Alpha Rock Capital, as of now (and we don’t plan to change our plans soon), only invests in Fulfillment by Amazon businesses. Doesn’t this make us extremely fragile? Amazon could drastically impact our margins by increasing their fees. They could even outright ban third-party sellers. As of now, we can’t avoid the negative consequences that these changes would cause (this may change if we start selling on other platforms). We are, in that sense, fragile.
We are always preparing, but not especially worried about these scenarios since they would negatively impact Amazon itself. Around half of the sales on their platform are from third-party sellers, like us.
Amazon’s main business is increasingly shifting towards being a marketplace and a logistics company, not a retailer.
A relevant part of their earnings come from sellers competing by bidding to be shown on the advertisement slots. They have also slowed down their efforts to launch their own products in order to avoid potential antitrust issues and focus on their core objectives. However, we still understand that there is a possibility that Amazon can make negative changes for third-party sellers.
What this means is that it’s not sensible to invest 100% of your savings in FBA businesses. The same could be said of any other investment. There are always points of failure that make the risk of ruin of any business greater than 0%. That is why an investor must build a portfolio that takes into account the volatility of each of their investments, their individual risk of ruin, and the correlation of returns between them. Those topics were also explained in our article on the risk of ruin linked a couple lines above.
Investing 100% of your savings in FBA businesses makes you fragile. However, as most of our investors have many other more traditional assets in their portfolios, by adding investments to their portfolios that benefit from Amazon, and e-commerce in general, doing well, their portfolio becomes more diversified and valuable when the FBA businesses perform well.
How are we antifragile?
So, acknowledging these risks, why do we still consider ourselves antifragile in our business model and why we decided to go with “Antifragile” for the name of our newsletter? Because of the way we manage our investments, finances, and decision making in general.
First, we diversify our portfolio by investing in many different kinds of products rather than most other e-commerce businesses that focus on single niches. We have seen this make us antifragile during the coronavirus crisis as some of our brands experienced significant declines in revenue, but others skyrocketed in sales and lead us to record two of our best months ever during a time when other businesses were just struggling to stay alive.
Furthermore, when we cannot be antifragile, we aim to be robust. We love buying businesses that sell boring products that new competitors do not usually pursue. We avoid businesses that sell products subject to frequent changes in technology, such as electronics, changes in consumer preferences, such as fashion, or frequently subject to lawsuits, such as cosmetics.
These principles are further demonstrated in the way we manage our finances. We always try to minimize the possibility of not being able to meet financial obligations (robustness) by keeping operating costs and monthly debt payments as a very low percentage of our revenues. This leads us to keep capital reserves, which allow us to seize opportunities that we would have to ignore if we didn’t have any capital available (antifragility). For example, in times of crisis, we may have the opportunity to buy businesses at lower multiples than usual, or whose value is based on a recent past that is artificially low. In this sense, we can significantly benefit from volatility.
In summary, while our business model has its risks, like any other, we do our best to manage these risks in such a way that we may end up benefiting from the volatility that could kill other companies. As we are already experiencing, our portfolio diversification and efficient management of our finances has lead to our best performing months in the face of the global coronavirus crisis. As we continue our pursuit of antifragility, we expect to see its benefits compound significantly in the returns we achieve.