Those of you who follow the hardcore investors and finance types on Twitter will recognize the name Dasan. A very sharp and witty guy who manages a portfolio at an unnamed hedge fund, Dasan recently published an analysis of how he is currently investing and how his investment process works. Fascinating reading from an investment professional. Check it out!
Showing posts with label Hedge Funds. Show all posts
Showing posts with label Hedge Funds. Show all posts
Monday, June 08, 2009
Wednesday, April 29, 2009
Eric Rosenfeld Lecture about LTCM
If you haven't yet caught it, you should run - don't walk - over to Zero Hedge and check out this approximately 90 minute video of Eric Rosenfeld giving a lecture about the LTCM collapse back in 1998. Fascinating insider's view. The comments over at Zero Hedge, as expected, are acerbic but many are enlightening and worth a read.
I know I will be revisiting this again shortly, as I found the entire lecture interesting. While I'm sure Rosenfeld mixes and mis-uses some vocabulary and concepts, all in all I think there are definite lessons here. The biggest, of course, as we've learned in the last 2 years, is that in times of stress, all correlations go to 1. However, I want to reconsider the endogenous risks that Tyler @ Zero Hedge mentions. I'll definitely watch this again soon, maybe after my nap this morning.
I think the leverage factor, which has been widely associated with the LTCM implosion, bears added consideration. Recently, Accrued Interest made the point that leverage isn't what kills; bad investments kill. Clearly, this is true. However, leverage has the force multiplier effect and can transfer an innocuous loss into a catastrophe. Eric's lecture covers what he calls the 10 biggest myths and misconceptions about LTCM, and yes, they did hit 300x leverage at various points, according to him. However, it did not occur for the reasons you might have suspected. It adds a bit more color to the whole conversation. I know that, in my own mind, I vilified LTCM for such egregious use of leverage. Seems I was mistaken.
Finally, we're all familiar with the idea of prime brokerages frontrunning their hedge fund clients. As I think I have previously mentioned, I think there may be an opportunity for a 3rd party prime brokerage business to emerge, or even for trustees and custodial banks to subtly move into the space. State Street and Bank of New York Mellon are the obvious candidates, as they already have large custodial and administration businesses, so why not move up the value chain and entrench yourself further with you customers (for additional fees, of course). However, there's a startup opportunity in there too, I believe.
Anyway, go check it out. Good stuff for us finance geeks, anyway.
Until next time...
I know I will be revisiting this again shortly, as I found the entire lecture interesting. While I'm sure Rosenfeld mixes and mis-uses some vocabulary and concepts, all in all I think there are definite lessons here. The biggest, of course, as we've learned in the last 2 years, is that in times of stress, all correlations go to 1. However, I want to reconsider the endogenous risks that Tyler @ Zero Hedge mentions. I'll definitely watch this again soon, maybe after my nap this morning.
I think the leverage factor, which has been widely associated with the LTCM implosion, bears added consideration. Recently, Accrued Interest made the point that leverage isn't what kills; bad investments kill. Clearly, this is true. However, leverage has the force multiplier effect and can transfer an innocuous loss into a catastrophe. Eric's lecture covers what he calls the 10 biggest myths and misconceptions about LTCM, and yes, they did hit 300x leverage at various points, according to him. However, it did not occur for the reasons you might have suspected. It adds a bit more color to the whole conversation. I know that, in my own mind, I vilified LTCM for such egregious use of leverage. Seems I was mistaken.
Finally, we're all familiar with the idea of prime brokerages frontrunning their hedge fund clients. As I think I have previously mentioned, I think there may be an opportunity for a 3rd party prime brokerage business to emerge, or even for trustees and custodial banks to subtly move into the space. State Street and Bank of New York Mellon are the obvious candidates, as they already have large custodial and administration businesses, so why not move up the value chain and entrench yourself further with you customers (for additional fees, of course). However, there's a startup opportunity in there too, I believe.
Anyway, go check it out. Good stuff for us finance geeks, anyway.
Until next time...
Thursday, April 23, 2009
The Hidden Risks of a Central Counterparty in CDSland
If you didn't catch it yesterday, FT.com's Alphaville had a great piece about why a central CDS (credit default swap) counterparty (read: exchange or clearinghouse) might not work as well as everyone thinks it would. While I still think it necessary, it's obvious that the idea needs work. Specifically, it needs to be integrated with existing clearinghouses/central counterparties to make sure that cross-exposures are appropriately netted.
The piece also raises the point that CDS account for only 11% of the OTC (over the counter, or dealer-to-dealer) derivatives market.
Again, putting CDS trading on an exchange or other central counterparty is important, but at most only 40% of trades might move to such a central counterparty. CDS are not standardized, and standardization removes profit which is why B/Ds are loathe to do it. It needs to be done though, to bring as much of the shadow banking system into the light (along with many other moves, however, like re-splitting commercial and investment banks a la Glass-Steagall, as I previously mentioned). The more trades in a central location, the better. There will always be OTC trading, but it should be for the most esoteric and specialized -- and hopefully rare -- trades.
The piece also raises the point that CDS account for only 11% of the OTC (over the counter, or dealer-to-dealer) derivatives market.
Again, putting CDS trading on an exchange or other central counterparty is important, but at most only 40% of trades might move to such a central counterparty. CDS are not standardized, and standardization removes profit which is why B/Ds are loathe to do it. It needs to be done though, to bring as much of the shadow banking system into the light (along with many other moves, however, like re-splitting commercial and investment banks a la Glass-Steagall, as I previously mentioned). The more trades in a central location, the better. There will always be OTC trading, but it should be for the most esoteric and specialized -- and hopefully rare -- trades.
Friday, March 06, 2009
Selection Bias
Just great!
This is one of the problems with hedge funds. They have a bad year and just stop reporting data to the few databases which exist to collect data about hedge fund returns.
All this does is make overall industry returns look better, because there are fewer negative data points among the data that is reported.
I would imagine most of the databases anonymize data at some point. If not, they should. However, managers need to be willing to step up and let their returns be known (even anonymously if that's the only way) for the sake of the industry. It won't stop the bloodletting, and as some seem to think, we could easily be on our way back to 5000 funds (50% attrition). No matter what, the integrity of the data is of utmost importance to re-establish trust in the industry and in managers. This is one of several market oriented, non-governmental reforms that the global (and especially US) hedge fund industry needs to undertake.
That is all for now. Later!
This is one of the problems with hedge funds. They have a bad year and just stop reporting data to the few databases which exist to collect data about hedge fund returns.
All this does is make overall industry returns look better, because there are fewer negative data points among the data that is reported.
I would imagine most of the databases anonymize data at some point. If not, they should. However, managers need to be willing to step up and let their returns be known (even anonymously if that's the only way) for the sake of the industry. It won't stop the bloodletting, and as some seem to think, we could easily be on our way back to 5000 funds (50% attrition). No matter what, the integrity of the data is of utmost importance to re-establish trust in the industry and in managers. This is one of several market oriented, non-governmental reforms that the global (and especially US) hedge fund industry needs to undertake.
That is all for now. Later!
Wednesday, November 12, 2008
The Effective End of an Industry
It occurred to me yesterday that, as we approach the the $1,000,000,000,000 mark in losses from this mortgage induced economic and credit crisis, the size of the global hedge fund industry is estimated at somewhere between $1.5T and $2T in assets under management. (Or at least, it was prior to this crisis.)
So, if we really do hit $1.5T in losses as some of the extreme estimates have stated, we will have effectively wiped out the ENTIRE hedge fund industry. The ensuing liquidation will drive down prices on many financial assets, and drive quite a few people out of jobs.
Politicians really need to be careful what they wish for.
So, if we really do hit $1.5T in losses as some of the extreme estimates have stated, we will have effectively wiped out the ENTIRE hedge fund industry. The ensuing liquidation will drive down prices on many financial assets, and drive quite a few people out of jobs.
Politicians really need to be careful what they wish for.
Wednesday, September 03, 2008
Investing in Endowments - The Dream that Will Never Be
I LOVE this idea from Felix Salmon about alumni being able to invest in their alma mater's endowments. Its innovative, its different, and it will never happen in our lifetimes. However, I love it.
As John Mauldin is one to point out, regular people should be allowed to invest in alternatives as a way of enhancing returns in their retirement portfolios (or whatever other funds they allocate to the alternatives space). You can find his 2003 congressional testimony on the subject here.
I imagine the biggest problems would be the administration of small(er) investor accounts and the accredited investor rules. You could attack the first problem by allowing minimum investments of greater than 6 figures, say $250K+. The second problem requires US government intervention, which makes it almost impossible to see how one would ever get past this limitation.
I also imagine many larger endowments would want to avoid the kind of incessant inquiries that small investors would bring with them. No matter how experienced those investors are, they are probably going to require or request some level of hand holding, and endowments likely aren't interested in such time sinks. The larger endowments (Harvard and Yale in particular) would not need to resort to this kind of asset gathering; it would purely be a "perk" offered to alumni. There are plenty of smaller institutions, with smaller endowments, that would probably seek to use this re-configuration of the landscape to draw assets and increase their management fees. The new laws would have to take this into account. It makes sense if this structure only imposes fees on profits when the investor withdraws, and reduces the management fees. Endowment investors shouldn't be paying standard hedge fund management fees, especially when the endowments are non-profit organizations and they employ their own managers. A range of 0.5% - 1.25% in fees seems appropriate, based on whether the endowment managers are in-house (lower) or outsourced (higher).
Even so, investing in your university's endowment, with the management fee going to your university, would be a nice way to contribute and still benefit from the expertise the university employs. (That is, if the endowment is large enough to employ in-house investment managers and strategists. If they outsource significant amounts of their endowment management, then this idea is probably unworkable.) Maybe all the drama which led to the founding of Convexity Capital by Jack Meyer could have been avoided if those vocal alumni had been able to invest alongside the endowment, instead of watching from the sidelines. Felix's idea has some obvious tax benefits as well, and if one did not need the money from the endowment, they could let it ride or donate it to the university easily. Brilliant!
Anyway, I had to comment on that idea. I'd love to see alumni offered this kind of investment opportunity. It would sure take a lot of work to make it happen though, which makes me cautiously pessimistic that it would ever occur. (Thanks to Paul Vixie for that phrase, one of my favorite quotes of all time, received from him in personal e-mail!)
Still, how awesome would this be if it became real! A man can dream, can't he?
Until next time, peeps!
As John Mauldin is one to point out, regular people should be allowed to invest in alternatives as a way of enhancing returns in their retirement portfolios (or whatever other funds they allocate to the alternatives space). You can find his 2003 congressional testimony on the subject here.
I imagine the biggest problems would be the administration of small(er) investor accounts and the accredited investor rules. You could attack the first problem by allowing minimum investments of greater than 6 figures, say $250K+. The second problem requires US government intervention, which makes it almost impossible to see how one would ever get past this limitation.
I also imagine many larger endowments would want to avoid the kind of incessant inquiries that small investors would bring with them. No matter how experienced those investors are, they are probably going to require or request some level of hand holding, and endowments likely aren't interested in such time sinks. The larger endowments (Harvard and Yale in particular) would not need to resort to this kind of asset gathering; it would purely be a "perk" offered to alumni. There are plenty of smaller institutions, with smaller endowments, that would probably seek to use this re-configuration of the landscape to draw assets and increase their management fees. The new laws would have to take this into account. It makes sense if this structure only imposes fees on profits when the investor withdraws, and reduces the management fees. Endowment investors shouldn't be paying standard hedge fund management fees, especially when the endowments are non-profit organizations and they employ their own managers. A range of 0.5% - 1.25% in fees seems appropriate, based on whether the endowment managers are in-house (lower) or outsourced (higher).
Even so, investing in your university's endowment, with the management fee going to your university, would be a nice way to contribute and still benefit from the expertise the university employs. (That is, if the endowment is large enough to employ in-house investment managers and strategists. If they outsource significant amounts of their endowment management, then this idea is probably unworkable.) Maybe all the drama which led to the founding of Convexity Capital by Jack Meyer could have been avoided if those vocal alumni had been able to invest alongside the endowment, instead of watching from the sidelines. Felix's idea has some obvious tax benefits as well, and if one did not need the money from the endowment, they could let it ride or donate it to the university easily. Brilliant!
Anyway, I had to comment on that idea. I'd love to see alumni offered this kind of investment opportunity. It would sure take a lot of work to make it happen though, which makes me cautiously pessimistic that it would ever occur. (Thanks to Paul Vixie for that phrase, one of my favorite quotes of all time, received from him in personal e-mail!)
Still, how awesome would this be if it became real! A man can dream, can't he?
Until next time, peeps!
Friday, July 25, 2008
Analyst Arbitrage
Well, not exactly, but it sounded good. :)
Seriously though, I was reading this piece in the SJ Mercury News about Frank Quattrone's return to technology finance, and something that Frank was reported to have said caught my attention. Here's the paragraph from the article:
At first blush, you may agree with Frank. However, that analysis is counter intuitive to me. While what Frank said here may be true (I don't know), it appears to me to offer an opportunity for someone to profit. See, if there is less analyst coverage of smaller tech firms (especially those with real businesses, revenues and profits), then a studious operator can use the lack of coverage to their advantage.
Every trader, portfolio manager, or even small investor, is looking for an edge. The analyst rules implemented in the wake of the Blodget and Grubman scandals create a vacuum of public information around small companies, according to Frank. So the operator who is peering into the cracks, doing the due diligence, and sniffing out the promising companies that have minimal or no analyst coverage, has a better chance of finding a "hit" before the market does. Its a perfect arbitrage play. Of course it takes courage to do, but isn't that the point? The successful operators feel fear like everyone else, but they don't let that fear stop them from making good, well reasoned investments (or trades). So the operator that steps into this information void, spends the time learning about the company, and generates an investment thesis for it is taking a huge risk. However, that risk is mitigated somewhat by the fact that s/he's got a larger margin of safety to work with while the stock is undiscovered.
None of this means that our hypothetical operator can't be wrong. The investment thesis could be bogus. The timing could be sub-optimal. Any number of things can go wrong; that is the risk of the market. However, finding an unloved gem is the kind of investment everyone wants to make. So analysts' failures to cover these small companies creates an opening for the intelligent and courageous operator to profit handsomely. Shouldn't we be glad that these information arbitrage opportunities are being created? If we are the competent and capable operator, we should be giving thanks and showing gratitude for such situations, so I would think.
I don't feel bad for the sell-side analysts. If their work is any good, they'll get known for it. Meredith Whitney and Dick Bove come to mind. The good analysts will have options. Hell, even the less-than-best analysts will probably land on their feet too, usually within a hedge fund or private equity firm, as Quattrone acknowledges, or some other buy-side entity. The analysts creating forgettable research will fade into obscurity within their firms, and the typical retail investor will probably place (misguided) value in/on their work. I don't see how life is so bad for our sell-side analyst. Will it be as easy as it was during the go-go 90s? No. Will it orders of magnitude harder for them to make a living? I doubt.
Its too easy to tag along on the words of the great Frank Quattrone, given his reputation and past success. I think Frank misses the mark on this one, though. However, Frank wasn't a trader. He was a banker. As such, he probably never had to consider this issue too closely. In Frank's world, the sell-side coverage was probably proof that he was doing his job (and well). It probably justified the expense that the IPOing startup went through to work with Quattrone and his gang at CSFB. All of this would serve to burnish Frank's reputation as the go-to banker, which made him more prized and valued by whichever firm employed him.
I don't know if he's just looking at this void through the eyes of a banker, or if he has really evaluated the pros and cons of the reduction in sell-side coverage for smaller stocks (across industries, but especially in technology). I hope he has, and that he saw something I missed. In that case, I would LOVE to know what I overlooked. However, I don't get the feeling, from reading this (very) short article, that he did that evaluation.
Until next time, good people...
Seriously though, I was reading this piece in the SJ Mercury News about Frank Quattrone's return to technology finance, and something that Frank was reported to have said caught my attention. Here's the paragraph from the article:
But the result has been that a large number of analysts have left investment banks to join hedge funds and private equity firms, Quattrone said. The remaining analysts have focused on covering bigger corporations, rather than small start-ups, because there's no money and little recognition in covering the smaller companies, he said.
At first blush, you may agree with Frank. However, that analysis is counter intuitive to me. While what Frank said here may be true (I don't know), it appears to me to offer an opportunity for someone to profit. See, if there is less analyst coverage of smaller tech firms (especially those with real businesses, revenues and profits), then a studious operator can use the lack of coverage to their advantage.
Every trader, portfolio manager, or even small investor, is looking for an edge. The analyst rules implemented in the wake of the Blodget and Grubman scandals create a vacuum of public information around small companies, according to Frank. So the operator who is peering into the cracks, doing the due diligence, and sniffing out the promising companies that have minimal or no analyst coverage, has a better chance of finding a "hit" before the market does. Its a perfect arbitrage play. Of course it takes courage to do, but isn't that the point? The successful operators feel fear like everyone else, but they don't let that fear stop them from making good, well reasoned investments (or trades). So the operator that steps into this information void, spends the time learning about the company, and generates an investment thesis for it is taking a huge risk. However, that risk is mitigated somewhat by the fact that s/he's got a larger margin of safety to work with while the stock is undiscovered.
None of this means that our hypothetical operator can't be wrong. The investment thesis could be bogus. The timing could be sub-optimal. Any number of things can go wrong; that is the risk of the market. However, finding an unloved gem is the kind of investment everyone wants to make. So analysts' failures to cover these small companies creates an opening for the intelligent and courageous operator to profit handsomely. Shouldn't we be glad that these information arbitrage opportunities are being created? If we are the competent and capable operator, we should be giving thanks and showing gratitude for such situations, so I would think.
I don't feel bad for the sell-side analysts. If their work is any good, they'll get known for it. Meredith Whitney and Dick Bove come to mind. The good analysts will have options. Hell, even the less-than-best analysts will probably land on their feet too, usually within a hedge fund or private equity firm, as Quattrone acknowledges, or some other buy-side entity. The analysts creating forgettable research will fade into obscurity within their firms, and the typical retail investor will probably place (misguided) value in/on their work. I don't see how life is so bad for our sell-side analyst. Will it be as easy as it was during the go-go 90s? No. Will it orders of magnitude harder for them to make a living? I doubt.
Its too easy to tag along on the words of the great Frank Quattrone, given his reputation and past success. I think Frank misses the mark on this one, though. However, Frank wasn't a trader. He was a banker. As such, he probably never had to consider this issue too closely. In Frank's world, the sell-side coverage was probably proof that he was doing his job (and well). It probably justified the expense that the IPOing startup went through to work with Quattrone and his gang at CSFB. All of this would serve to burnish Frank's reputation as the go-to banker, which made him more prized and valued by whichever firm employed him.
I don't know if he's just looking at this void through the eyes of a banker, or if he has really evaluated the pros and cons of the reduction in sell-side coverage for smaller stocks (across industries, but especially in technology). I hope he has, and that he saw something I missed. In that case, I would LOVE to know what I overlooked. However, I don't get the feeling, from reading this (very) short article, that he did that evaluation.
Until next time, good people...
Tuesday, May 13, 2008
Tax the Bastards!
Wow!
And wow again!
I was led to this from Paul K's blog post. I think some of the comments over at Felix's blog tough on some things that Harvard could and should do. First, I'd vote for decreasing tuition even more, so that even more low income students can attend (in accordance with admission criteria, of course). Then taking a high school under its wing, and possibly even an elementary school, would be a great community service.
Harvard has the numbers to make this work without affecting either its asset gathering ability or its endowment size. From what I've heard about it (not much, admittedly), this might position them to take a liability driven investing (LDI) approach which may not necessarily make sense. At least, this is something I could see occurring, the endowment becoming more risk averse to the point of abandoning risk management.
Considering the compensation levels for faculty, I don't really get why there was an uproar about Meyer's compensation, or that of any of his lieutenants. They did good work -- active investment management -- and Harvard needs to put more of that money to use in the surrounding community if they want to keep Congress off their back. However, the 2 go hand in hand, right? More investment in the community, more spending of the funds that come in (or rather, are generated as investment returns) will keep the DC doctors away.
And wow again!
I was led to this from Paul K's blog post. I think some of the comments over at Felix's blog tough on some things that Harvard could and should do. First, I'd vote for decreasing tuition even more, so that even more low income students can attend (in accordance with admission criteria, of course). Then taking a high school under its wing, and possibly even an elementary school, would be a great community service.
Harvard has the numbers to make this work without affecting either its asset gathering ability or its endowment size. From what I've heard about it (not much, admittedly), this might position them to take a liability driven investing (LDI) approach which may not necessarily make sense. At least, this is something I could see occurring, the endowment becoming more risk averse to the point of abandoning risk management.
Considering the compensation levels for faculty, I don't really get why there was an uproar about Meyer's compensation, or that of any of his lieutenants. They did good work -- active investment management -- and Harvard needs to put more of that money to use in the surrounding community if they want to keep Congress off their back. However, the 2 go hand in hand, right? More investment in the community, more spending of the funds that come in (or rather, are generated as investment returns) will keep the DC doctors away.
Tuesday, April 29, 2008
The Good Sense of a Hedge Fund Manager
Thankfully the one interviewed in this series was rather intelligent, because his interviewer was as dense as lead. Reading this was painful at times, given the absurdity of some of the questions asked. Our intrepid hedge fund manager answered each question with grace and poise. I know, had it been me, I'd have been ripping the interviewer's throat out before the end of part I.
I will admit that the best part (and there are many good bits) has to be our hedge fund manager's quote about why Bear Stearn's management took the $2 per share deal from J.P. Morgan. Quote:
Classic!
There really should be a law against people who don't know anything about an industry writing articles about that industry. Really, what's the point? The interviewer is adding no value beyond transcribing words. So entirely sad.
I will admit that the best part (and there are many good bits) has to be our hedge fund manager's quote about why Bear Stearn's management took the $2 per share deal from J.P. Morgan. Quote:
"So I think for these guys it wasn’t just, 'I’m risking 2 dollars if I say no,' it was, 'I’m risking 2 dollars plus anal rape in jail.'"
Classic!
There really should be a law against people who don't know anything about an industry writing articles about that industry. Really, what's the point? The interviewer is adding no value beyond transcribing words. So entirely sad.
Monday, April 07, 2008
David Einhorn's Book
Now this
looks like a good read!
I vaguely remember this story, and have read about it at various points in time. It will be great to see the entire situation chronicled by Einhorn himself.
But hedge funds are locusts, right?
Riiiiiiight!
looks like a good read!I vaguely remember this story, and have read about it at various points in time. It will be great to see the entire situation chronicled by Einhorn himself.
But hedge funds are locusts, right?
Riiiiiiight!
Thursday, January 10, 2008
Non-institutional Prime Brokerage
Looks like I was spot on about this concept. I guess a bit more digging is in order. If there is one, there are probably more. Kind of like cockroaches.
This whole arena seems ripe for competition, given the typical hedge fund concerns about front running by their primes. Also seems like the kind of area a technology oriented investor like Silver Lake, or even the PE or venture arms of some of the bulge brackets, would be looking to get into. They could always take the venture public, sell it off or spin it off it was successful. Hell, I could even see Citadel setting up an arm to do this, although, how many hedge funds would run trades through them?
Anyway, until next time...
This whole arena seems ripe for competition, given the typical hedge fund concerns about front running by their primes. Also seems like the kind of area a technology oriented investor like Silver Lake, or even the PE or venture arms of some of the bulge brackets, would be looking to get into. They could always take the venture public, sell it off or spin it off it was successful. Hell, I could even see Citadel setting up an arm to do this, although, how many hedge funds would run trades through them?
Anyway, until next time...
Thursday, November 08, 2007
Pricing Risk
I don't know who, among my readers, saw this article in the NY Times a few months ago. Most likely, all 3 of you. (What's up, G?!?!) I have to admit to being fascinated by this one. I haven't let it out of my browser since originally reading it, and I'm going to finish reading it now before I go to sleep. Risk management would appear to be the theme in my investing right now.
Tuesday, October 30, 2007
A Few Good Reads
While I know that most of my fanbase (ha!) has probably already dissected these pieces every which way already, I have to admit that they make for interesting reads and re-reads. I've kept them up in my browser persistently since stumbling upon them, and flip back to them regularly to look something up or just remind myself about the tendency of markets to strike when least expected. Minsky moments and all that.
First up is the Malcolm Gladwell piece on Nassim Nicholas Taleb entitled "Blowing Up". I know I don't need to introduce him to most of you. For the rest, well, that's what Google excels at. Start with his website.
Next we have the New Yorker's big spread on Victor Niederhoffer's return to and subsequent dismissal by the markets. Fascinating, in more ways than one. The Gladwell piece looks at Niederhoffer briefly as well, and if I can find it, I'll post the other article I read about him recently. Talk about overexposure.
Finally, The American's Hunt for Black October, seeking to expose the reasons for Black Monday, 1987. An interesting, if speculative, read. I love this kind of history stuff, and I'd rather learn from someone else's mistakes than make my own. I've got enough of those.
Honestly, while I like Taleb's approach to the market, and I respect his vigilance in preparing for a Black Swan event, there's something missing. It actually reminds me of how I drive, and I'll get another post up on how good driving and good investing rhyme in the near future. While we don't want to pick up nickles - or God forbid, pennies - in front of steamrollers, you can't just sit around waiting for Doomsday either. This, in the simplest of terms, is what I imagine doomed Empirica. Whether things are different now with his newest venture, we'll have to see. There has got to be some participation in the market besides collecting premiums on options, because the stability that would allow that to be a viable past-time can disappear in mere moments. Stability breeds instability, right? Or that stability may not generate enough returns to allow your capital base to last until the return of volatility. And what's plan B when instability rears its head?
Of course, you could probably make the argument that by operating in this way, Taleb is playing his intended course perfectly. In stability, clip your coupon (aka option premiums). When volatility returns, hopefully you're on the right side of the trade and that's where the strategy shines -- if you're nimble enough.
*shrug*
First up is the Malcolm Gladwell piece on Nassim Nicholas Taleb entitled "Blowing Up". I know I don't need to introduce him to most of you. For the rest, well, that's what Google excels at. Start with his website.
Next we have the New Yorker's big spread on Victor Niederhoffer's return to and subsequent dismissal by the markets. Fascinating, in more ways than one. The Gladwell piece looks at Niederhoffer briefly as well, and if I can find it, I'll post the other article I read about him recently. Talk about overexposure.
Finally, The American's Hunt for Black October, seeking to expose the reasons for Black Monday, 1987. An interesting, if speculative, read. I love this kind of history stuff, and I'd rather learn from someone else's mistakes than make my own. I've got enough of those.
Honestly, while I like Taleb's approach to the market, and I respect his vigilance in preparing for a Black Swan event, there's something missing. It actually reminds me of how I drive, and I'll get another post up on how good driving and good investing rhyme in the near future. While we don't want to pick up nickles - or God forbid, pennies - in front of steamrollers, you can't just sit around waiting for Doomsday either. This, in the simplest of terms, is what I imagine doomed Empirica. Whether things are different now with his newest venture, we'll have to see. There has got to be some participation in the market besides collecting premiums on options, because the stability that would allow that to be a viable past-time can disappear in mere moments. Stability breeds instability, right? Or that stability may not generate enough returns to allow your capital base to last until the return of volatility. And what's plan B when instability rears its head?
Of course, you could probably make the argument that by operating in this way, Taleb is playing his intended course perfectly. In stability, clip your coupon (aka option premiums). When volatility returns, hopefully you're on the right side of the trade and that's where the strategy shines -- if you're nimble enough.
*shrug*
Monday, October 01, 2007
Prime Brokerage Disintermediation
This is what I am talking about! I'm not the smartest guy on the planet, but this area -- prime brokerage -- looks so susceptible to being broken up. First, I can see an increase in credible competition to Goldman Sachs, Bear Stearns and Morgan Stanley. The credit crunch has shown that, as the big commercial banks with big balance sheets - Citi, BofA - have made inroads in this area. The European banks will be next. However, it will eventually become an issue of service optimization. Plus, there are the competition issues like front running that hedge funds just don't want to deal with. Services will probably peel off into independent providers; that's what makes sense to me.
Sunday, September 09, 2007
Why are there no independent prime brokers?
After seeing the recent Economist.com article on conflicts between hedge funds and prime brokers, I started thinking about what would be required to build an independent prime brokerage.
There's been a lot of noise about prime brokers front running their clients, hedge funds, and otherwise trading off information that funds would prefer was a secret. Considering that the prime brokers are just divisions of global investment banks, that shouldn't surprise anyone. There's also the competition between the trading desks at the banks and the fundamental business of many (most?) hedge funds -- trading. What kind of sense does it make to use someone who may be on the other side of a trade with you as your lender, clearing house and possibly an administrative services vendor. (Prop research has also been cited as a benefit for some of the larger primes.)
The smaller funds don't have much choice with this arrangement, obviously. At the other end of the spectrum you have Citadel, which is reported to be pursuing a broker-dealer license and is known to make a pretty penny lending shares to other funds (for short sales). However, I imagine that even a player like Citadel would like to see more autonomy and less competition with its primes (until it can settle its own trades anyway).
Now, the crossing networks and dark pools probably take some of the edge off of these potentially volatile relationships, because there are multiple options (besides having 2+ primes) for trading, and with anonymity and less market impact to boot. However, the primes do provide some services that most hedge funds can use on some level, or so it appears. So my question is "why not?" What are the upsides or downsides of an independent prime brokerage operation that was not competitive with its clients? Does the potential exist for this to be a viable business model? Why hasn't it already been done? Is it because of the "need" for a balance sheet to support customers? Or is the reason that it hasn't been done merely along the lines of "its never been done like that"?
Inquiring minds want to know. Ok, maybe not really, but I do...dammit.
There's been a lot of noise about prime brokers front running their clients, hedge funds, and otherwise trading off information that funds would prefer was a secret. Considering that the prime brokers are just divisions of global investment banks, that shouldn't surprise anyone. There's also the competition between the trading desks at the banks and the fundamental business of many (most?) hedge funds -- trading. What kind of sense does it make to use someone who may be on the other side of a trade with you as your lender, clearing house and possibly an administrative services vendor. (Prop research has also been cited as a benefit for some of the larger primes.)
The smaller funds don't have much choice with this arrangement, obviously. At the other end of the spectrum you have Citadel, which is reported to be pursuing a broker-dealer license and is known to make a pretty penny lending shares to other funds (for short sales). However, I imagine that even a player like Citadel would like to see more autonomy and less competition with its primes (until it can settle its own trades anyway).
Now, the crossing networks and dark pools probably take some of the edge off of these potentially volatile relationships, because there are multiple options (besides having 2+ primes) for trading, and with anonymity and less market impact to boot. However, the primes do provide some services that most hedge funds can use on some level, or so it appears. So my question is "why not?" What are the upsides or downsides of an independent prime brokerage operation that was not competitive with its clients? Does the potential exist for this to be a viable business model? Why hasn't it already been done? Is it because of the "need" for a balance sheet to support customers? Or is the reason that it hasn't been done merely along the lines of "its never been done like that"?
Inquiring minds want to know. Ok, maybe not really, but I do...dammit.
Sunday, September 02, 2007
Thoughts on the Quant Crunch
Ok, maybe that's a bit extreme, I don't know that recent events in quant land can or should be called a crisis. Problematic - sure, especially if you're an investor in a fund that recently got hit. However, that's how this game works, right? There is inherent risk, no matter how much we attempt to mitigate it. Otherwise, we'd be discussing buying US Treasuries of varying durations, right? (Hell, there's risk there too but I really don't feel like attempting to have that discussion now.)
There was an interesting post recently over at AllAboutAlpha including interviews with professors David Hsieh and William Fung. Now, the part that grabbed me was the bit about the wide dispersion of a strategy giving rise to a factor or alternative beta. That is to say that when you have a small group of operators successfully using a strategy, the result is alpha generation. However, once that strategy becomes popular, the returns become due to alternative beta as opposed to alpha. I'll buy that.
Now, all of this discussion was taking place within the realm of hedge fund replication. However, the implications are pretty interesting. A crowded trade leads to alternative beta, thus shrinking the average returns that the strategy is responsible for. The once proprietary component of the model thus becomes yet another factor which can be included in a replicator's model. So now we start generating alternative beta without the need for the compensation overhead standard in the HF world. Why pay 2 and 20 for beta of any kind?
The moral of the story would appear to be that you have to keep those proprietary factors fresh. There are only so many original ideas; most success comes down to the execution of the idea. The quant analysts will have to keep constantly on their toes in order to bring new strategies to the table which can successfully generate alpha.
As for the matter of hedge fund contagion which has come up recently in many venues, it appears to me that the NY Times is off the mark. The illiquidity of investments in hedge fund portfolios caused those funds to sell off liquid investments in order to cover redemptions and margin calls. At least, its a reasonable guess that seems to fit the observations of hedge fund professionals who have commented on the matter. Maybe I missed something, but it looked like they were a bit wide on that shot.
As for this piece over at the FT, we again see the need for refreshing the prop factor pool, and I'm sure people smarter than me are looking at how to model the perturbations caused by all of those operators crowding a strategy. The last thing any HF operator wants is his prop factor to lead to alt beta, right?
In the end, it looks like a lot of quants got caught for various reasons. Some were probably legitimately in the wrong place at the wrong time. Of course, aren't they paid to be elsewhere at the wrong time?
*shrug*
This reminds me of Finbar's recent note wherein he said:
Others probably were swimming naked when the tide went out. I guess time will tell who falls into each category. But everyone takes a loss sometime. I should know.
Time to get to work on my trading model...
There was an interesting post recently over at AllAboutAlpha including interviews with professors David Hsieh and William Fung. Now, the part that grabbed me was the bit about the wide dispersion of a strategy giving rise to a factor or alternative beta. That is to say that when you have a small group of operators successfully using a strategy, the result is alpha generation. However, once that strategy becomes popular, the returns become due to alternative beta as opposed to alpha. I'll buy that.
Now, all of this discussion was taking place within the realm of hedge fund replication. However, the implications are pretty interesting. A crowded trade leads to alternative beta, thus shrinking the average returns that the strategy is responsible for. The once proprietary component of the model thus becomes yet another factor which can be included in a replicator's model. So now we start generating alternative beta without the need for the compensation overhead standard in the HF world. Why pay 2 and 20 for beta of any kind?
The moral of the story would appear to be that you have to keep those proprietary factors fresh. There are only so many original ideas; most success comes down to the execution of the idea. The quant analysts will have to keep constantly on their toes in order to bring new strategies to the table which can successfully generate alpha.
As for the matter of hedge fund contagion which has come up recently in many venues, it appears to me that the NY Times is off the mark. The illiquidity of investments in hedge fund portfolios caused those funds to sell off liquid investments in order to cover redemptions and margin calls. At least, its a reasonable guess that seems to fit the observations of hedge fund professionals who have commented on the matter. Maybe I missed something, but it looked like they were a bit wide on that shot.
As for this piece over at the FT, we again see the need for refreshing the prop factor pool, and I'm sure people smarter than me are looking at how to model the perturbations caused by all of those operators crowding a strategy. The last thing any HF operator wants is his prop factor to lead to alt beta, right?
In the end, it looks like a lot of quants got caught for various reasons. Some were probably legitimately in the wrong place at the wrong time. Of course, aren't they paid to be elsewhere at the wrong time?
*shrug*
This reminds me of Finbar's recent note wherein he said:
The nearest rebellion I have seen is when one of my quants on 16 August told me he was switching all the long and short signals because he knew all the other models were tightly correlated. He made the fund 13% in one day and is now the proud owner of a Porsche (which he sold as he doesn't have a drivers license and bought at auction an early IBM 86 PC with box and instructions).
Others probably were swimming naked when the tide went out. I guess time will tell who falls into each category. But everyone takes a loss sometime. I should know.
Time to get to work on my trading model...
Friday, August 17, 2007
Quant Correlations
Sorry, but I found this one quite funny. Even though I was out of it last week, as I get caught up, this story stays on my mind.
So if all of these quant funds are sitting on proprietary models, where was the protection? Where were the hedges? How much leverage was/is in play? Liquidation obviously spread to other markets so that these funds could meet margin calls and generally de-leverage.
From my reading, the valuation factor was what kicked most of these in the ass. Stat arb plays got reversed, shorts had to be covered while longs got whacked. Beautiful! Now, I recall seeing an article that mentioned comments from someone at Goldman to the effect that they had too much weight on the valuation factor and not enough on their proprietary factors. So here's a stupid question - why? Aren't the proprietary factors what earn you your money? I mean, it doesn't take a genius to figure out that most of the quant funds were executing similar strategies and even similar models. How much originality can there really be? No idea is original, in my opinion. However, everyone can tweak their models in various ways, and that should be where the money is. So if Goldman had proprietary factors in their model(s) which were not being weighted as heavily as standard valuation models, you really have to wonder what you're paying for.
Don't get me wrong. This is not simply a Goldman issue. It looks like lots of quants got dinged on this one. Highbridge, AQR, Campbell & Company and Renaissance are just a few of the names I've seen reported. Clearly there were more, although some probably got out sooner, or have held on longer. (Even though I doubt that last one, because anyone who got whacked for a larger percentage than Goldman was going to be outed by an investor.)
Anyway, I have to admit that although I am taking a serious hit in my portfolio, I am enjoying watching this credit crunch and sell-off. Do I like losing money? Oh hell naw! However, the day of reckoning was long overdue. Thankfully I have some cash available to put to use. I've been waiting for this, particularly in the housing market, for years.
Until next time...
Update: I found one of the articles talking about these "crowded factors".
So if all of these quant funds are sitting on proprietary models, where was the protection? Where were the hedges? How much leverage was/is in play? Liquidation obviously spread to other markets so that these funds could meet margin calls and generally de-leverage.
From my reading, the valuation factor was what kicked most of these in the ass. Stat arb plays got reversed, shorts had to be covered while longs got whacked. Beautiful! Now, I recall seeing an article that mentioned comments from someone at Goldman to the effect that they had too much weight on the valuation factor and not enough on their proprietary factors. So here's a stupid question - why? Aren't the proprietary factors what earn you your money? I mean, it doesn't take a genius to figure out that most of the quant funds were executing similar strategies and even similar models. How much originality can there really be? No idea is original, in my opinion. However, everyone can tweak their models in various ways, and that should be where the money is. So if Goldman had proprietary factors in their model(s) which were not being weighted as heavily as standard valuation models, you really have to wonder what you're paying for.
Don't get me wrong. This is not simply a Goldman issue. It looks like lots of quants got dinged on this one. Highbridge, AQR, Campbell & Company and Renaissance are just a few of the names I've seen reported. Clearly there were more, although some probably got out sooner, or have held on longer. (Even though I doubt that last one, because anyone who got whacked for a larger percentage than Goldman was going to be outed by an investor.)
Anyway, I have to admit that although I am taking a serious hit in my portfolio, I am enjoying watching this credit crunch and sell-off. Do I like losing money? Oh hell naw! However, the day of reckoning was long overdue. Thankfully I have some cash available to put to use. I've been waiting for this, particularly in the housing market, for years.
Until next time...
Update: I found one of the articles talking about these "crowded factors".
Sunday, August 12, 2007
In Search of New Employment
I have finally decided to pursue the dream of finding employment in the world of alternative investments. It has not been easy to make this decision, since it is completely foreign to the world with which I am familiar (technology). However, I have felt myself stagnating in the technology realm since leaving California in 2002. Now I look up, 5 years have passed, and its all a blur.
I miss the excitement, the energy, the fear of working in a startup. As much as I would love to find something similar in the technology arena, I'm not sure such exists in the Washington, DC metro area. Pretty fuggin' sad, actually, but wholly unsurprising.
Finance has always been a personal interest of mine, literally since I was a kid. I mean, I had the audacity to attempt to calculate the value of the contents of Scrooge McDuck's money bin using the prevailing per-ounce price of gold in the mid 80s. Of course, I was guided into other arenas by well meaning but unfamiliar people in my life but such IS life. I've maintained my interest in markets, finance, and how money works through all of those changes and it has even grown significantly. The whole "game" (if I may use that word) is fascinating to me.
It has become clear that a new challenge is in order. I like what I do (whom I do it for, that is another story). However, among other things, writing this blog has shown me that I need to actually start playing full on w.r.t. to this "hobby". Consider this the first step.
I would love to find an analyst position within a hedge fund or PE firm, although after this past week, employment with the former may be a bit difficult to come by. I'd even consider a technology position within one of these entities, as a stepping stone to becoming an analyst and then into portfolio management. I'm completely open. What I do know is that my current situation isn't working. So, with that said, from time to time, don't be surprised if I use this space to document my trials and tribulations in searching for employment in the world of alternative investments.
Until next time...
I miss the excitement, the energy, the fear of working in a startup. As much as I would love to find something similar in the technology arena, I'm not sure such exists in the Washington, DC metro area. Pretty fuggin' sad, actually, but wholly unsurprising.
Finance has always been a personal interest of mine, literally since I was a kid. I mean, I had the audacity to attempt to calculate the value of the contents of Scrooge McDuck's money bin using the prevailing per-ounce price of gold in the mid 80s. Of course, I was guided into other arenas by well meaning but unfamiliar people in my life but such IS life. I've maintained my interest in markets, finance, and how money works through all of those changes and it has even grown significantly. The whole "game" (if I may use that word) is fascinating to me.
It has become clear that a new challenge is in order. I like what I do (whom I do it for, that is another story). However, among other things, writing this blog has shown me that I need to actually start playing full on w.r.t. to this "hobby". Consider this the first step.
I would love to find an analyst position within a hedge fund or PE firm, although after this past week, employment with the former may be a bit difficult to come by. I'd even consider a technology position within one of these entities, as a stepping stone to becoming an analyst and then into portfolio management. I'm completely open. What I do know is that my current situation isn't working. So, with that said, from time to time, don't be surprised if I use this space to document my trials and tribulations in searching for employment in the world of alternative investments.
Until next time...
Wednesday, August 01, 2007
Citadel Loves a Company in Misery
How interesting that this piece should run in today's Journal. (WSJ.com sub req'd)
From the sound of it, Citadel is definitely moving to become a market maker. You have to wonder when it will go for its broker-dealer license.
From the sound of it, Citadel is definitely moving to become a market maker. You have to wonder when it will go for its broker-dealer license.
Tuesday, July 31, 2007
Sowood Collapse
Not much to say about this one (WSJ.com sub req'd), other than the fact that I have so much admiration for Citadel. Not because I like Ken Griffin, however. (I don't know the man, so I can't like him.) However, as an operation, the vulture tactics are beautiful. People always gripe about vultures, but they're part of the food chain too. If weaker players die off, someone has to pick up the pieces. In recent memory, that someone has been Citadel many times (think back to Amaranth). Its a lovely strategy, IMO. So I have the utmost respect for how Citadel operates their business goes about accomplishing their goals.
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