Tools, Techniques, Essays and News that will help you pick the best CTAs, Hedge Funds and Alternative Investment managers. No nonsense. No excuses. No easy answers.
Hi! FredGehm.com is on hiatus right now. I’m spending all of my time looking for a job as a Fund of Fund Manager/Analyst and finishing my third book, Trust is Not an Option: The Practical Paranoid’s Guide for Evaluating and Selecting Investment Managers.
That said, if you are interested in evaluating and selecting alternative investment managers, I think my essays are still worth reading. I hope my website makes you money. Enjoy!
Something like Bernie Madoff only more sophisticated
That’s Mr. Ponzi to you.
If the SEC’s statements about Mr. Madoff and his firm Madoff Securities can be trusted, Bernard Madoff has committed the single largest investment fraud in history. Many of Mr. Madoff’s victims were protected or betrayed by banks, brokerage firms, hedge funds, feeder funds, financial advisors and others who should have known better. In my opinion, anyone responsible for placing money with Mr. Madoff owes their clients an apology, a promise to find a new line of work, preferably involving manual labor, and complete restitution or, failing that, then every single cent they have. Please click here to continue reading.
Do Funds of Funds of Hedge Funds Make Sense?
When I first heard about Funds of Funds of Hedge Funds, I thought there was something uncomfortably familiar about the terms and concepts, something along the lines of financial Déjà vu.The problem with Funds of Hedge Funds, according to D’Auriol Asset Management, which advocates such an approach and, perhaps incidentally, an extra layer of fees, is that there are just too many of them, over a thousand by their count.In return for that extra layer of fees, you avoid the hard work of selecting fund of hedge fund managers; they’ll do it for you.Recall that this is also the argument for the second level of fees; the second level allows you to avoid the hard work of selecting hedge fund managers.If a third level of fees is wrong, and most fund of fund managers believe it is, why, exactly are two levels of fees OK or even one?If three levels of fees are OK, what is wrong with four?The problem here is not with the number of levels of fees.The problem is more basic than that.The problem is this: when we are buying fund of fund management, what, exactly, are we buying?And how do we know when we have bought too much or too little?Please click here to continue reading about F3 Funds.
A New Proposal from the SEC. A Good One!
According to the New York Times, “Money managers in the United States would have to provide online brochures describing their services, fees, investment performance and potential conflicts of interest under a proposal approved Wednesday by the Securities and Exchange Commission.” This is good news for investors.
The New York Times also noted, “Commissioner Paul S. Atkins said the revised proposal was much better than the one offered in 2000, but questioned whether the level of detail sought by the agency might produce lengthy, ‘unappealing’ brochures. ‘More disclosure is not always better,’ Mr. Atkins said.” Mr. Atkins simply does not know what he is talking about. More disclosure is always better. It is true, of course, that important details can be hidden in a forest of trivial disclosures, but that in itself is important information. Such tactics may prevent an investor from accurately evaluating an investment manager, but when an investor sees such tactics, he can stop evaluating and go on to the next money manager on his list.
It is important to understand that this approval is not now law and may never become law. As I understand these things, the next step is a sixty-day period in which the public, that means you and me, can comment on the proposal. You can read what the SEC has to say about this here.
Why I am personally responsible for Societe Generale’s $7 Billion dollar loss and what Societe Generale needs to do clearn up my mess. I hate to admit it, but Societe Generale’s losses are all my fault. In 1983, I wrote Commodity Market Money Management, which introduced quantitative technique to what was then the derivatives industry. Judging by recent articles on Societe Generale’s disaster, they were using techniques similar to the ones I advocated, only radically more sophisticated, to manage their risks. I don’t suggest that Societe Generale’s management or traders read my writings or even know who I am. But their attitudes and techniques they used were ones I advocated. Attitudes and techniques, not incidentally, that have become standard operating procedures in the futures, derivatives and hedge fund industries. Please click here to continue reading.
We need more bankers' heads on platters
Q: Was Societe Generale’s Meltdown Preventable? A: Yes.
Hedge Funds, banks and other financial institutions seem to meltdown on an all too regular basis.The available evidence on Societe Generale's meltdown is fragmentary and, probably, wrong in part.That said, the evidence that is available now implies that Societe Generale could have avoided the meltdown.Here is what we think we know. Please click here to continue reading about Societe Generale’s Meltdown.
Note: That's no woman. That's Ann Coulter.
Professor Irwin Corey, The World's Foremost Authority.
Listening to Professor Corey.
Professor Irwin Corey: The World’s Foremost Authority is a wonderful comedian and bullshitter, brighter and funnier than Chris Rock on a good day.Over the years, I’ve worked with a number of Hedge Fund and Fund of Fund managers who really seemed to believe they were The World’s Foremost Authority.My coworker ‘Bob’, for example, was an expert or pretended to be an expert on everything or, at least, everything that affected investing.There was no business fact or investment theory Bob did not know or did not know why it was not important. Please click here to continue reading "Listening to Professor Corey."
Fred Gehm proclaimed the World’s Greatest Investment Authority!
In an email to me dated Wed 1/23/2008 5:57 AM, Professor Irwin Corey, the World’s Foremost Authority, wrote, “You are hereby proclaimed as, ‘The World’s Greatest Investment Authority.’”Professor Corey, now long retired, was a comedian who played a bullshitting college professor.It was from him I learned the rule, “I before e, except in Budweiser” which has since proved invaluable to me.As Jim Knipfel noted in The New York Press “…for the past six-plus decades, he’s been confusing people.” Thank you Professor Corey!
In one of Neil Gaiman’s stories, a young woman meets the fates, the three sisters who spin the thread of your life, measure it and then cut it off.The young woman asks, “Are you going to hurt me?”The fates answer, “Hurt you?Of course we are going to hurt you.Everyone gets hurt.”
John A. Sarkett’s new book, “Extraordinary Comebacks” tells the stories of hundreds of people who came back from defeat and tragedy and pain because they had the courage to try one more time.The stories are short, but that may be an advantage.You will probably reach for this volume more than once. Please click here to continue reading "Extraordinary Comebacks."
Evidence-based Investment Analysis. In his 1996 inaugural speech as President of the Royal Statistical Society, Adrian Smith argued that Evidence-Based Practice should be the standard for all public policy. Mr. Smith used evidence-based medicine as his example, which is fitting because medicine is where these issues were first raised and where most of the development work has been done. Considering the stories we have all read concerning the results of this medical study or that medical study, the reader may be surprised that this is an issue. But in fact doctors often prescribe treatments that deviate from the best medical practices.
Evidence-based medicine attempts to base medical decisions on the best available medical evidence. In contrast to the medical industry, the investment industry has no such standard. I suggest that the investor who has such a standard or who, at least, understands what kinds of evidence must be taken seriously and what kinds of evidence can be laughed at has a considerable advantage over investors who cannot. Please click here to continue reading about "Evidence-based Investment Analysis."
Hedge fund Research, Alternative Investment Research for 2007
Hedge fund Research, Alternative Investment Research for the week December 17, 2007
A Review of Science from Nature.
When I was growing up, science fiction was generally considered little better than pornography, even among scientists. But times have changed; several years back the great science journal Nature started publishing very short hard science fiction on a regular basis. This makes a great deal of sense. Arthur C. Clark, the man who invented the stationary satellite, once wrote, “I do not for a moment suggest that more than 1 percent of science fiction readers would be reliable prophets; but I do suggest that almost 100 percent of reliable prophets will be science fiction readers—or writers.” Continue reading "Futures from Nature."
Social Networking on FredGehm.com I added a Digg.com button to the bottom of this page and from now on, I will be adding one to the bottom of every new page.Digg.com allows members to vote on websites and website pages they find valuable.Presumably, websites with the most votes are the most valuable.This may not be true, but it’s not a bad place to start.I have a purely selfish reason for placing Digg buttons on my website: I hope it will bring me more readers.If you have enjoyed this website, please vote. And thank you.
Picture of my laywer (detail)
Investors Claw Back Almost a Billion Dollars. Gretchen Morgenson writes, "INVESTORS everywhere should applaud the deal struck last week by the UnitedHealth Group to recover nearly $1 billion in pay from former executives involved in the company’s option backdating mess." Continue reading.
SEC Chairman Christopher Cox
SEC to investors, "Shut up! Shut up! Shut up!" Gretchen Morgenson writes, "TALK about a one-two punch. In recent months, owners of many financial stocks have lost billions because the directors who represent them were clueless about risky mortgage operations or toxic loans held by their companies. Then last week, shareholders lost the only shot they had at firing incompetent directors when the Securities and Exchange Commission voted to prevent investors from nominating their own board candidates." Continue reading.
Hedge Fund Research, Alternative Investment Research for the week December 3, 2007
Not my Heged Fund Managers
Avoiding the Self Destructive Hedge Fund Manager: the Gambling Addict One of the fund-of-funds manager’s jobs is to identify and avoid self-destructive hedge fund managers. One of the worst of this species is the gambling addict.The first fund manager I realized was a gambling addict was Ian S., and I didn’t realize that he was addicted until after he was dead. Ian was a talented trader with real insight into the market. Unfortunately, he wasted much of his potential by overtrading, trading too often and trading too large. Continue reading "Avoiding the Self Destructive Manager: the Gambling Addict."
Review of Credit Derivative Strategies: New Thinking on Managing Risk and Return
Futures Magazine has just published a review of mine of Credit Derivative Strategies: New Thinking on Managing Risk and Return.The review follows,
The promotional material for this book notes that it qualifies for 7.5PD credits under the guidelines of the CFA Institute Professional Development Program, and it is easy to see why. This book covers relative value strategies, distressed debt strategies, trading synthetic Collateralized Debit Obligations ( CDO ), managing risk, pricing and valuation. There are eleven contributors, including the editor, all of whom are well qualified. On the other hand, it is more likely that this book will help you lose money than make it.Continue reading this review.
Hedge Fund Research, Alternative Investment Research for the week November 26, 2007
Review of Futures and Options Expo 07
I spent most of this week at the 2007 Futures Industry Association’s, Futures and Options Expo 07.If you don’t have a deep interest in the futures industry you can stop reading now.A late registration for the expo can cost as much as $950, plus hotel, plus airfare, plus time away from work.For which you get 2 and ½ days of speakers, workshops, exhibitors, rich food and free drinks.Whether or not it is worth the money depends on exactly what it is you want to do.I found the speakers uniformly excellent, especially Dianne Garnick of Invesco who was remarkably candid for an investment professional.
The real value of such conferences is the ability to make contact with other people in the industry. Along these lines, I am continually amazed how many rich, powerful, investment professionals are wallflowers.This is silly.Almost everyone there is accessible.I spent hours talking to people who wouldn’t normally take a call from me.The rich and powerful may have to revise their cost/benefit analysis of this conference, but that’s not my problem.
Hedge Fund Research, Alternative Investment Research for the week November 19, 2007
Another Kind of Model Risk
Six Questions and Answers about Model Risk
Model Risk is currently being presented as a new investment management concept, with all the usual hype that entails, but at its base is nothing new at all.Model risk is the risk we don’t know what we are doing, in whole or in part, when we build an investment model. Continue reading "Six Questions and Answers about Model Risk"
Hedge Fund Research, Alternative Investment Research for the week November 12, 2007
You can’t win the cubical wars without this.
Chanukah and Christmas gifts for the quants on your list.
Thinkgeek won’t work for all quants, but if you’re buying for a geek—or if you’re one yourself—you’re going to think you’ve died and gone to heaven. I made major points with my geek/engineer/son when I got him the remote controlled helicopter you can see on the left.Also, coffee mugs with graphic representations of the caffeine molecule, water powered clocks, hydrodynamic building sets, levitating desktop globes, abusive rubber stamps, puzzles for the super-intelligent and lots of other cool stuff. Continue reading "Chanukah and Christmas gifts for the quant on your list."
Hedge Fund Research, Alternative Investment Research for the week November 5, 2007
The MFA’s 2007 Sound Practices for Hedge Fund Managers Document
The Managed Funds Association has recently published its 2007 version of Sound Practices for Hedge Fund Managers Document. You can download it free here.The first version of this document was published in 2000, and was revised in 2003, 2005 and again now.I reviewed the 2005 document for MARHedge shortly after it came out.If I had given the document a letter grade, it would have been D.Not incidentally, a D represents a serious improvement.When I started in this business, good practices where almost non-existent; a fair grade for the industry would have been F------. Continue reading "The MFA’s 2007 Sound Practices for Document".
Hedge Fund Research, Alternative Investment Research for the week October 29, 2007
Just part of the problem.
What kind of performance data do investors need?
The hedge fund and alternative investment industries have matured in most ways over the years. A modest number of people now make their living performing due diligence, for example, some of them doing a reasonably good job of it. When I started in this industry, quality due diligence consisted of asking, “Does anyone here know what Frank Pusateri thinks about this fund?” In at least one way, however, the industry has seriously degenerated. Presentation data used to be much, much better. Continue reading "What kind of performance data do investors need?"
Do Hedge Fund Managers Understand Operational Risk?
Ernst & Young recently published a survey of some 100 hedge fund managers’ views on the challenges facing their industry.When asked, “On a scale of 1-10, how big a challenge will the following be in the next ten months?”Managing operational risk came in a poor third after attracting and retaining talent and managing the growth of the business.18% of the managers in the survey gave it a rank of 8, 9 or 10.In terms of relative importance, the industry gave the right answer.But considering how frequently operational risks kill hedge funds, the industry’s answer gives no comfort at all. Continue reading, "Do Managers Understand Operational Risk?"
Hedge Fund Research, Alternative Investment Research for the week October 22, 2007
Merrill Lynch and the Subprime Debacle: Five Mistakes or None or One? Merrill Lynch will have to write off 7.9 billion dollars because of losses in the subprime market. According to the New York Times, when asked how Merrill could lose so much money, E. Stanley O'Neal, Merrill Lynch's Chief Executive, said, "We made a mistake." Mr. O'Neal is probably using language loosely here. He may have made four or five or more mistakes. He may have made none. Oddly, I hope he didn't make a single mistake, which might well be the worst situation of all. I am not privy to the inner workings of Merrill, so, I do not know how deep the rot goes. But if newspaper accounts can be trusted, it goes deep. Continue reading "Merrill Lynch and the Subprime Debacle".
This is a Dendrogram. This is one of the BETTER cluster analysis tools.
Oxford Metrica and Cluster Analysis: Hedge Fund Style Analysis du Jour. Several websites have reported that the Bank of New York Mellon and independent research firm Oxford Metrica have released a study titled, “Rethinking performance in the hedge fund industry.” According to MoneyMarketing, “The convergence between hedge fund and equity market returns could cause confusion on how such funds should be used to diversify investment portfolios, says the Bank of New York Mellon.
“A study conducted by the bank and research firm Oxford Metrica shows that combined with inconsistencies in hedge fund classification, the confusion could result in unrealistic return expectations for investors. "The report recommends that hedge funds be classified using cluster analysis instead of the traditional classification by strategy. Cluster analysis groups funds according to the observed behaviour in their returns, as opposed to management styles.
Investment management is a thinking game and anything that can help an investment manager think better is worth a little, well, thought.Not surprisingly, what you eat helps determine how well you think.Scientific American Mind has a good article on eating smart.Check it out.
Mr. Greg Newton
Some Kind Words from my Competition.
Greg Newton, former publisher of MARHedge and now the miscreant in charge of nakedshorts.typepad.com has a nice blog post about me titled, "The Word According to Fred" Thank you, Greg!
Greg covers some of the same turf I do.But he’s funnier and his articles are more topical.Check him out.
Hedge Fund Research, Alternative Investment Research for the week October 15, 2007
Six Questions to Help You Evaluate Investment Gossip.
The other investor leans closer, looks you straight in the eye and says, “Don’t repeat this to anyone.See that money manager over there?He doesn’t know how to trade.I wouldn’t put your money with him.”Despite our pretenses of rationality, we gossip, some of us all of the time.We may call it something else, networking, for example, but we gossip and we use the information we pick up to make investment decisions, to decide which investment managers to hire and which to fire.It is another question entirely whether this is a good idea. Continue reading "Six Questions to Help You Evaluate Investment Gossip."
This doesn't work.
Is Your Investment Manager Lying to You?
Several decades ago, I attended a security analysts’ society luncheon that featured a talk on selecting investment managers. The speaker was from Frank Russell and Company, then and now the world’s largest investment consulting firm, so, presumably, he knew something about his subject. When question time came, I asked him how often investment managers lied to him. The audience laughed, uncomfortably. The speaker said, “Never. By the time I visit them they pretty much have their stories straight.”
I have thought about the speaker’s reply a lot over the years. Perhaps all he meant was that he almost never caught anyone lying, so how could he know? On the other hand, if the speaker meant that investment managers are invariably honest and trustworthy, then I envy him, although I doubt his competence. Perhaps this is unfair. Perhaps the world of investment managers is more trustworthy than the world of Hedge Fund and Alternative Investment managers, which is the world I have inhabited, off and on, for some twenty odd years. All I can say for sure is that I get lied to all the time and I don’t like it at all. Continue reading "Is Your Investment Manager Lying to You?"
Hedge Fund Research, Alternative Investment Research for the week October 8, 2007
Four Questions that will allow you to do your Due Diligence over the Phone.
Last year Deloitte Financial Services published a report titled, Precautions that pay off: Risk Management and Valuation Practices in the Global Hedge Fund Industry. If we can believe what the report says, the hedge fund industry is doing pretty well; most of us are following industry best practices. For example, 86% of the hedge fund companies surveyed have position limits. This should not only give investors comfort, it suggests that due diligence need be little more than a phone call and a check list. Any firm that does not have position limits, for example, can be written off as amateurs, wannabes, losers. As a matter of fact, there are questions that you can ask over the phone that will let you avoid losers, not all losers, but some. Continue reading "Doing Due Dillegence Over the Phone"
A Version of Artificial Intelligence that Works!
This thing thinks?
I’m not a big fan of AI (see my review of Evidence Based Technical Analysis to see some of my reasons.) But if I were trying to sell AI on Wall Street, I would definitely buy a toy called 20Q by the gross and give them to anyone who even vaguely resembled a customer. Remember Twenty Questions from grade school? You think of an object and 20Q gets to ask you twenty yes or no questions. You push a button that says ‘Yes’ or a button that says ‘No’ or one of a small number of other answers and the toy asks you another question or guesses what you have in mind. If the toy figures out what you are thinking of before the game ends, it wins. A Version of AI that Works!
Hedge Fund Research, Alternative Investment Research for the week October 1, 2007
A few kind words for Ayn Rand.
You can expect to see a number of articles on Ayn Rand and her novel Atlas Shrugged over the next two weeks and for two reasons. One reason is that October 12th will be the 50th anniversary of her novel. The second is that Atlas Shrugged is a favorite among the rich and powerful or, at least, among rich and powerful businessmen. Many hedge fund managers love it, at least, if my talks with hedge fund managers can be trusted. You can expect to see turf fights over the book among conservatives. Continue reading "A Few Kind Words About Ayn Rand"
Few questions are more revealing—and few questions are so likely to get you looked at as if you were a moron—than asking a hedge fund manager under what circumstances you should take your money out of his fund. Should you, as an investor or fund-of-funds manager, have a stop-loss point? Are there any other situations or conditions that should prompt you to remove your money? Continue reading "When Should You Pull Your Money Out?"
Our Criminals Dress Better.
The Kroll Fraud Report
Kroll, a subsidiary of Marsh & McLennan, has just published its annual Global Fraud Report, which is based on a survey of 892 Senior Executives, of which 18 percent were in the Financial Services industry. According to Kroll, “Eighty-one percent of firms report that their exposure to corporate fraud has grown.” Considering the number of new entrants we have in the hedge fund and alternative investment industries and the lack of seriousness with which we take these problems, I see no reason to believe our own percentages are not higher. Read more about "The Kroll Global Fraud Report."
New Taxes on Private Equity?
As is well known, many investment managers pay a smaller percentage of their incomes as taxes than their secretaries do. Because the money the government can collect from us is immense, because the money politicians want to collect from us is infinite, many politicians naturally want to increase our tax rates. Well, to the extent anything politicians do is natural, that is. Right now, the gun is pointed at private equity managers, but that will change. Sooner or later, probably sooner, the gun will target other types of hedge fund managers. Read more about "New Taxes on Private Equity?"
Hedge Fund Research, Alternative Investment Research for the week September 24, 2007
Does An Investment Manager Have to Make Sense?
Perhaps because of our need for certainty, current fund of funds industry practice is to ignore hedge fund managers who cannot explain what they are doing or worse, do a bad job explaining. Current practice is legally safe and, let us say this quietly, emotionally and intellectually satisfying. Who doesn’t enjoy being one up on someone else? It’s another question, however, whether this approach makes investment sense. Continue reading "Does an Investment Manager Have to Make Sense?"
Five Things the August Meltdown Should Teach Investors
The best available evidence and arguments suggest that the Quant Meltdown was caused by someone dumping a lot of the stocks quant traders liked and buying a lot of the stocks quants didn’t like. Quant theorists believe this person did so because he had to finance positions in a wholly different sector, sub prime loans, perhaps. This theory may not be true (click here to see my analysis of the theory) but the theory and the supporting evidence is certain enough to tell us, at least, five things. Continue reading "Five Things the August Meltdown Should Teach Investors"
An Explanation for the Global Quant Meltdown?
E. Khandani and Andrew W. Lo, two financial engineers at M.I.T, have written a paper on the August 2007 Quant Meltdown. This is a paper that should give quants a great deal of comfort. Even better, it should give those quants hurt by the meltdown an excuse. Whether or not this paper should give them comfort, much less an excuse, is another matter entirely. Continue reading "An Explanation for the Global Quant Meltdown?"
The World's Stupidist Economic Theory.
Several weeks ago I drove my one and only son up to Milwaukee to start his first year in college. Looking east from Route 94, I saw a sign on a dilapidated barn that suggested I study natural law. A hundred yards further or so I saw a sign for University Lawsonomy and realized with a thrill of horror that here was the last center of study for one of the stupidest economic theories in modern history, a theory which, if it were known wider, would also be one of the most hated. Continue reading "The world's Stupidest Economic Theory"
Hedge Fund Research, Alternative Investment Research for the week September 17, 2007
Not MY employees.
Chris Mushell and the PRMIA "Frontiers in Operational Risk Management" Symposium.
On September 28, 2007 the New York chapter of PRMIA is hosting a symposium titled, “Frontiers in Operational Risk Management.” There are a number of interesting panels and a number of heavy hitters on the panels. I won’t be going and I regret that. One of the panels is moderated by Chris Mushell, Global Head of Operational Risk for Bear Stearns. The panel is titled, “You’ve calculated capital, now what do you do with it?” Of all the questions Mr. Mushell might answer, that is certainly the least interesting. Continue reading "More on Operational Risk Management"
Still More on Operational Risk: Last week I published an article titled, “Operational Risk, How Big is the Problem?”But I didn’t say how big the problem was.I talked about techniques for estimating how big the problem was.This is just another example of an operational screw-up.Unfortunately, it will not be my last.
Activist investing looms large in the future of the alternative investment industry. Indeed, the future has already begun, in battles to control corporations and in skirmishes between managements and stockholders. Carl Icahn is just the best-known alternative investment manager active in this arena today.
Because the profit potential is huge and the risks and technical issues are relatively small, I expect activist investing eventually to become the single largest growth area in the alternative investment universe.The business issue is this: With all too few exceptions, corporate managements seem to run their corporations for their own benefits first, and second and grudgingly, for the benefits of the corporations’ stockholders. Continue reading "Corporate Combat."
Another pair of scales
Quant Watch: An article in a recent Wall Street Journal reported that there was no generally accepted explanation for the quant meltdown.Some members of the quant community think that one of their members had to dump stocks to meet a margin call in some other investments.This is a reasonable explanation and, if true, quant strategies should be profitable again soon, if they aren’t already.On the other hand, this explanation does not have to be true and, as far as I’ve know, there is no evidence supporting it.There are and can be no guarantees that the quant meltdown is temporary.The future is forever unknown.
Hedge Fund Research, Alternative Investment Research for the week September 10, 2007
A few weeks ago, Brett Arends, mutual fund columnist at The Street, reported that Alan Greenberg, Sam Molinaro, James Cayne and Warren Spector had dumped Bear Stearns’s stock when it was selling at $172.On the day before Mr. Arend’s article was published, the stock closed at $117.78.A gift of prophecy, perhaps?Dumb luck?Inside information?All four were Bear Stearns’s executives.According to Mr. Arends, Bear Stearns declined to comment.
As far as I know, these people did nothing illegal.The law, correctly, presumes innocence.In my opinion, however, an investor or fund of funds manager should never be so generous.In my opinion, an investor should always presume that the nice man on the other side of the desk would sell the investor’s children into sexual slavery if he thought he could get a dollar and a quarter on them. Continue reading "Lock Down Your Money Manager: A Technique for Getting Them on Your Side."
An operational failure is a mistake in execution such as placing a buy order when you meant to sell or buying 10,000 contracts instead of 1,000.‘Execution’ here refers to the entire investment plan, not just individual trades, which is why very few operational mistakes are as obvious and trivial as these examples imply.For example, a natural disaster that completely wipes out a hedge fund’s trading records and computer systems is, in part, an operational failure.It is management’s responsibility to provide backups and redundancy.
According to Capital Market Group’s widely sited and widely believed study, operational failures are the cause of 50% of all hedge fund breakdowns.Even if this study is off by an entire order of magnitude; that is, even if the percentage of failures is 5% rather than 50%, this is a number well worth paying attention to. Continue reading "Operational Risk: How Bad is the Problem?"
Quant Watch: An article in last Friday’s Wall Street Journal reported that there was no generally accepted explanation for the quant meltdown.Some members of the quant community think that one of their members had to dump stocks to meet a margin call in some other investments.This is a reasonable explanation and, if true, quant strategies should be profitable again soon, if they aren’t already.On the other hand, this explanation does not have to be true and, as far as I know, there is no evidence supporting it.There are and can be no guarantees that the quant meltdown is temporary.The future is forever unknown. Amaranth Watch: Hilary Till ofPremia Capital Management has written a paper on the Amaranth meltdown worth reading.There is also an article in the current issue of Futures Magazine.
Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street, By William Poundstone, Hill and Wang, 2005, $27.00
Several years ago, one of the popular investment magazines presented a list of the most important books for speculators.At least one of Ralph Vince’s books on fractional f trading was on the list.The article noted, however, that while a number of people in the industry greatly admire Vince and his work, a great many—how shall I put this—do not.A lot of people in the industry have told me that they think Ralph is crazy and so is fractional f trading. Which means I’m crazy too, I suppose.Vince got the basic idea from me. Continue reading "Fortune's Formula."
I’m a quantitative analyst—Trust me, I know what I’m doing. Judging by the Hedge industry’s advertisements and job listings, until very recently quantitative analysis was the hedge industry’s answer to all of the investors’ needs.For example, I recently heard a marketing manager talking with a potential client.The client said, “But your system is based on statistical analysis and statistics lie.”The marketing manager corrected him, “But our system is NOT based on statistical analysis.It is based on Quantitative Analysis, which doesn’t have the same problems.”
As a quantitative analyst, I suppose, I should pump my fist into the air and shout, “YES!”Unfortunately, the marketing manager wasn’t just wrong, but stupidly wrong and, perhaps, legally liable. Click here to read more about the problems of quantitative analysis. Book Review: Frequently Asked Questions in Quantitative Finance, by Paul Wilmott, Wiley, 2007
I have never met Paul Wilmott, but I have a feeling that I would like him a lot.On the back of this book, he has a picture of himself looking like Jerry Lewis trying to look like a mad scientist.Pretentious, he isn’t.Knowledgeable, he is.The book contains chapters on popular probability distributions, models and equations, ten ways to derive the Black-Scholes formula and, of course, frequently asked questions.I can’t see this book making any money for you, but if you have some basic questions about numerical quantitative analysis you want answered, here is an easy, friendly place to start.
My Own Private Sentinel Management Group Story. Some years ago, Sentinel Investment Management and I talked about doing business together.The talks wandered around and around until I eventually realized that we were never going to do business. I think all they wanted from me was free consulting.I stopped talking to them.
Strictly speaking, nothing Sentinel did to me was illegal.My mistake. I trusted them.I have not talked to them since.By my standards, what they did was unethical and I do not work with people with optional ethics. In Sentinel’s case, this was the right move, but it didn’t have to turn out this way.
Just so you don’t miss my point, I know all too many unethical hedge fund managers.In some cases, I have known the managers for decades.It is not impossible that they will all retire happily and never, ever spend a moment in jail.For the sake of their customers, I hope they never do anything that would deserve jail. Still, I wouldn’t put my money with any of them; that is a risk I see no reason to take. The Global Quant Meltdown. The latest hedge fund debacle is the meltdown in quantitative funds.In some ways, this meltdown is much more surprising than the sub-prime mortgage meltdown.Quantitative analysis was supposed to prevent these kinds of problems, at least, according to some of its advocates. Read more about The Global Quant Meltdown.
Abnormal Distributions and Substandard Deviations.Article on the problems non-normal asset distributions cause the hedge fund and alternative investments industry.Also includes a short review of Fat-Tailed and Skewed Asset Return Distributions by Svetlozar T. Rachev, Christian Menn and Frank J. Fabozzi. Read more.
Artificial Intelligence.As one-upmanship goes, this stuff is hard to beat.Post-human investing, data mining, illusions of the mind and more. Read More. Managing yourself and others: An article, Containing a Good Idea, But One You Had Better Sleep On.The bad news is that there is an upper limit to how much we can work.The good news is that for some analysts and managers, it is possible to work less and accomplish more. Read more. Humor, Time Wasters and the Just Plain Weird. Greg Newton, the former publisher of MARHedge, writes a funny and perceptive blog at www.nakedshorts.typepad.com covering whatever investment topics interest him when he sits down at his computer. His latest postings include well-deserved drop kicks to Sentinel Investment Management. Check him out, he’s worth reading. The only problem I have with Greg is his obvious lack of judgment. He hired me as a columnist at MARHedge, for example.
A review of The Barracuda.What a REAL man would have done about Enron.If, like me, you enjoy a good meatball revenge fantasy, if you like reading comics, and if you don’t mind your comics violent, sexy and grim, you might want to read this review. Read more. Reviews: The Misbehavior of Markets by Benoit Mandelbrot and Richard L. Hudson.An article on the non-normal distribution of asset prices.Mandelbrot is the man who discovered the problem. Read more.