Thread by @itsTarH

Its the weekend!

Grab a cup of coffee, in this thread I will explain

1. What is Proxy Investing?
2. How to apply it?
3. What are the benefits of Proxy Investing?

Thread includes examples of few famous proxies from history.

Lets dive right in.

The famous example of proxy investing always quoted is the California Gold Rush

In 1848, approximately 300,000 people migrated to California from various parts of the US to dig for gold
The news was, Cali was rich in gold and almost everyone who was digging was able to find it.

This sudden influx of migrants digging for gold meant demand for certain commodities went through the roof.

These commodities included
- Daily Ration
- Picks and Shovels
- Denims

Yes, Denims!

Denim is a hardened material, originally developed for miners and doesn't tear easy.

Very few who rushed to California in the mid 1880s got wealthy by hunting for gold.
But, almost everyone who was supplying to the needs of these gold-diggers, did!

And one company particularly stood out.

You and I, today know this company by the name of Levi's or Levi Strauss & Co. - The world famous maker of denims.

Fun Fact: The horses shown in the logo was an actual test for the strength of denims made by Levi's. Even the strength of two horses couldn't tear them apart!

Here is a quick origin story of Levi's, if you're interested. .

So what does this story teach us (apart from the fact that Levi's denims are very strong)
and
what does it have to do with proxy investing?

In the story above, someone hunting for gold during California Gold Rush had better chances of getting wealthy if they opened a daily needs store, a lodge, a picks and shovel business or like Levi Strauss - a denim business, than digging for actual gold.

Similarly in today's world, you are sometimes offered opportunities that have a better chance of generating returns than by investing in the gold rush of our times.

This is known as proxy investing.

In a proxy investment - you do not invest in the main opportunity (the gold rush from our earlier example) but in opportunities that support that gold rush (picks, shovels and denims).

An inherent benefit for proxy investing is the possibility of higher and stable returns with a lesser degree of risk, than actually investing in the underlying gold rush.

Here is one more example to help you understand this.

In the early 1900s there was another gold rush so to speak - this time it was in the field of automobiles.

In 1902 people travelled around in carriages driven by horses.
By 1913 everyone had transitioned to an automobile.

This 10 year long transition and automotive gold rush - sparked a frenzy and everyone rushed to set up an automobile manufacturing plant.

By 1905 there were 100s of automobile manufacturers just in US alone.

You know how many survived?

Just 1.

Here is a list of all the automobile manufacturers that went bust.
Pick a letter and you will find hundreds of companies starting with that letter that went belly up.

en.wikipedia.org/wiki/List_of_d…

Here is the only company that survived from that era to today.

You and I know this company as Ford Motors.

But, while all these automobile companies were going bust.

You know how many tyre companies that supplied to these automobiles went bust?

Almost none.

This is the inherent benefit for proxy investing.

Picking 1 car company out of 1000 car companies during automobile gold rush of 1900s is nearly impossible.

But, if you had invested in a basket of tyre companies during that time, you probably would have done okay for yourself.

Before we further proceed with examples of proxy investing.

I want to highlight a mental model I have borrowed from psychology that will really help you in evaluating proxy bets for yourself.

The mental model is called - second order thinking.

Second Order thinking states that for every first order consequence, there are second and third order effects.

Here is the legend, Howard Marks, explaining the concept of second order thinking.

To help explain this further, lets draw parallels from our automotive example above.

First Order : Demand for automobiles rising
Second Order : Demand for tyres will rise
Third Order : Demand for rubber will rise

By applying second order thinking, you can evaluate the consequences of the first action and extrapolate the second and third order effects from it.

This can help you identify and decide the proxy investments for the gold rush of our times.

Now, lets explore a real world example.

Similar to 1900s there is a gold rush happening today.

It's called electrification of cars or EVs.

There are 100s of EV manufacturers already and some of them have gone public.

Just like 1900s most of the will go bust.

But what are the second and third order effects of this EV gold rush?

This is just my view but most likely batteries will be the second order effect

Batteries are hard to manufacturer & IPs of most battery manufacturers (esp. the new ones) is a guarded corporate secret

For every 1000 EV manufacturers you may find only a handful battery companies.

What about third order effects?

This is much clearer.

Commodities like copper and rare earth metals that find an application in EV and battery manufacturing will certainly benefit.

Here too, for every 10 battery manufacturers you will find maybe 1 rare earth extraction company

As you scale down the value chain, you will find competition reducing and there by reducing the risk on your proxy investment.

EV Company : High Competition & High Risk
Battery Company : Medium Competition & Medium Risk
Rare Earth Company : Low Competition & Low Risk

I hope this thread helped you understand proxy investing and added value to your learning. If you found this helpful, please retweet the first tweet in this thread for broader reach.

I help explain investing concepts via Twitter Threads with a new thread published every Saturday. Follow me if you want to learn along.

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Thank you for reading.

If you have made a proxy investment, leave a comment below on what it was and how did it play out for you.

See you next Saturday.