Team Hedge Fund

Archive for the ‘Hedge Fund’ Category

Buyers, sellers and users beware of opposite outcomes and opposing forces. What if the Abacus and Timberwolf synthetic CDO deals had not blown up? Brilliant buyers now gurus for their perspicacious positioning? Goldman Sachs excoriated for not disclosing to shorts that winning longs bet against them? Would there be a case? Would it be on front pages? Rely on dealmakers or do your own homework? The lawyers can figure out if any securities laws were broken but for investors the message remains as always: caveat emptor, caveat venditor, caveat utilitor.

Would Michael Lewis have written “The Big Long” on credit experts picking off bears wandering into the doomsday machine? Or Gregory Zuckerman with the “The Worst Trade Ever” how an obscure merger arbitrage specialist, John Paulson, went out of business style drifting with subprime CDOs? Magnetar sucked into a black hole? Dr. Michael Burry back on double shifts at the hospital? What if Paulson HAD bought and the next day reversed to the other side. Would it have changed ACA’s loan portfolio selection choices or the bond “rating”?

Today I naively took the risk of renting a car. After closing the deal I was shocked to find vehicles moving in the OPPOSITE direction. NO-ONE TOLD ME. The salesperson and documentation had NO disclosure about this risky two-way flow. More due diligence revealed that despite heavy regulation and licensing, these dubious inventions KILL over 1,000 people every day from such collisions! Again zero mention in the legal paperwork. Did the arranger commit fraud by failing to inform of the danger? CDOs can’t be traded by some individuals but calamitous CARs are widely available.

I even saw a “rogue” employee knowingly bet against me driving north while I headed south. Such conflicts of interest and idiotic innovation needs to stop before even more people die in toxic tort products like cars. Ban derivatives trading so ban driving since it is much riskier? Subpoena to Congress those merchants of mayhem and dealers in destruction like car rental firms? The world thrived for a long time before “monstrousities” like C-D-Os and C-A-Rs were created. Get CDOs wrong and just lose money but outlawing CARs would save many lives. If I had an accident could I claim they had specially selected a car they “knew” would crash or would it be paranoid outcome bias?

Wary of negligent misrepresention of risk and non-disclosure of agents of automobile armageddon, I fled to the relative safety of finance. I selected 500 dodgy, in my humble opinion at the time, reference securities to bet against. Luckily some broker’s quantitative geeks had already assembled a structured derivative product for that equity tranche. I short sold the basket portfolio but the intermediary failed to alert longs that I and possibly traders at the sponsoring firm might bet against them. Even the broker herself confided in an email that she was personally bearish but her function was facilitating CLIENT transactions regardless of private or her firm’s market views. Anyone long the SPY ETF asset-backed security and not made aware of this has recourse to regulators?

Alpha capture is war and battles have casualties. Finding alpha is a zero-sum ADVERSARIAL game of losers AND winners. Zero-skill, crowded beta is “cheap” but insightful analysis and variant perception costs 2 and 20 or more. Contrasting views make a market. It is dumb and suboptimal to presume a counterparty is on your side. The juxtaposition of ideas helps prick bubbles earlier than a one-way market. If I buy I want as many smart people as possible hoping I am wrong. If I short sell I am most comfortable and make the highest returns when sophisticated professionals are buying and A-list analysts regard it as a core long.

You can ONLY produce alpha when others lose. Therefore it is essential for others to oppose you. Longs need shorts and vice versa. The most alpha appears when most are wrong. A rating of “strong buy” on a stock or “AAA” for a bond is just someone else’s opinion. It is up to investors to do their own analysis or hire advisors working FOR them. Do your own due diligence or find someone to do it for YOU with rare investment expertise and whose interests and INCENTIVES are aligned with yours. Cheerleaders cheer the team that pays them not necessarily YOUR team.

Harry Hindsight lives. The first casualty of war is truth and the first casualty of finance is memory. Casual emails gain overweighted(?) prominence when LDL conversations aren’t recorded. I wonder about that fateful meeting in January 2007 between Goldman Sachs, ACA and Paulson. Would buyers have walked away if all deal materials had stated in bold red ink “A merger arbitrage manager you likely haven’t heard of with no known expertise or track record in credit may have helped choose the underlying loans and will likely bet against them”. Or “Fabulous Fab and some of the <a href="http://news.yahoo.com/s/nm/20100503/bs_nm/us_berkshire_buffett
“target=_blank>Goldman Sachs GS proprietary credit traders are at this moment in time bearish on subprime credit but they have been right AND wrong in the past”. How might this have changed things?

Deception? Designed to fail? There are always bears on anything. If then unknown Paolo Pelligrini had shouted from the rooftops his negative views on subprime how many would have acted on it? We now know he was correct but AT THE TIME OF THE DEAL this was an outlier opinion ignored by the street. Even I wrote several bearish posts in 2007 and investors that followed that advice made high returns but the general population ignored those too. To make money out of the credit meltdown you didnt have to specifically short subprime. Was Fabrice Tourre wrong in his “smoking gun” email to express his then view that shorts were more likely to win than the longs? There have been many securities constructed on reverse enquiry from hedge funds where the client ended up being very wrong. I also know of IPOs done for “overvalued” companies considered “bound to fail” that have subsequently gone up 1,000% after listing. Everyone including insiders gets it wrong sometimes.

If I buy the more shorts the better since there is higher probability of a short squeeze. If everyone is buying, it is often time to short sell. Rather than being horrified that others think differently, it is excellent and favorable news. When I buy a security I assume and expect people are betting against me. If a market maker has a bid-offer spread and I take the offer, they are often left short temporarily if they don’t have inventory. They are then technically betting against a client but does it matter? Any market participant surely knows there will be opposing positions. Investors are free to choose pure execution-only brokers or investment banks well-known to have large proprietary trading operations that may or may not be betting in a different direction. The only Chinese Wall in the world passes just north of Beijing.

Would regulation and transparency have prevented the credit crisis? There have been many financial panics and real estate crashes in the past. Did CDOs and shorts “cause” those also? Why have there been worse ones where there were no derivatives or shorting? No security EVER trades for what it is worth; differences of opinion fuel all markets. If you short sell something you need as many people as possible to be bullish. Shorting rarely causes a security to go down. When you buy, the preferred situation is that many others are short. Exploiting the madness of crowds is the key factor for alpha. The more investors doing the opposite is POSITIVE if you have an edge. If you’ve done you’re research it ought to increase trade conviction. If you don’t have an edge why are you investing? Some think security analysis is a waste of time and John Bogle was as accurate as usual in ridiculing people who bother with skilled hard work.

All deals produce winners and losers. For every buyer there must be a seller and often a short seller. Is it always necessary to disclose that others including originators might bet against you? And if they do should it change your view or rating given your analytical edge? If you are bullish surely more bears should make you more bullish if you are confident of your ability. Blame the crisis on 2 and 20 and deal structurers or the 2 and 28 ARM lenders? Or on the inevitable boom and bust, greed and fear of the crowd. Manage risk and invest in skill to survive PREDICTABLE cyclical behaviour. Variant perception is what creates value for clients. Some speculate on conspiracy and collusion but it is usually just the Emotional Markets Hypothesis at work. All securities at all times are wrongly priced.

Short selling does not force securities to implode. It can however slow bubbles from turning into superbubbles and potentially worse problems. It may be counterintuitive but short selling subprime may have prevented larger losses and bigger issues. Some argue that credit repackaging exacerbated and perpetuated it but do not explain earlier crashes and meltdowns. With only longs, the Japanese credit bubble of the 1980s happened without CDOs, structured products or hedge funds betting against it. Subprime lending was invented in Japan and the crash’s effects still exist with the stock AND real estate markets 75% below high water marks. Short sellers and transfer of risk are positives not negatives for economic growth. Real estate booms and busts have occured for centuries. Sovereign defaults and bailouts are common yet rookies treat the Greek situation like it is unprecedented. Greece has been bankrupt more often than not since 1810.

One of the strangest results of the 2007-2008 post mortem was the slow motion reverberation from credit to equity. Even if you missed the credit short there was plenty of time to get short of equities. No-one could have predicted the crisis? Really? Many correlation “traders” short sold correlation at 0.3 and watched helpless as it gapped straight up to 1.0. Gaussian copulas absurdly assume constant default probabilities just like gaussian Black-Scholes crazily relies on constant volatility to allegedly “price” derivatives. The added complication with credit is the non-linear binary payoff. Either the debt is serviced or bankrupt. With low interest rates, yields often do not compensate for default risk. All an investor can do is their own analysis or hire an expert whose interests are the same as theirs.

If you need a friend get a dog. Full transparency: at this instant I am short the S&P 500 and numerous other asset-backed equity and credit structured products, however I might reverse and buy between 20 milliseconds and 20 years from now. Whatever or whenever an investor buys or sells, it is certain that others are betting the opposite way. To generate consistent alpha it is necessary to have counterparties with different opinions. It is obligatory for others to disagree with you. Their existence is mandatory for seeking alpha.

by Veryan Allen. Copyright

Go to Source

Buyers, sellers and users beware of opposite outcomes and opposing forces. What if the Abacus and Timberwolf synthetic CDO deals had not blown up? Brilliant buyers cited as gurus for their perspicacious positioning? Goldman Sachs called to testify for not disclosing to shorts that winning longs were betting against them? Would there be a case? Would it be on front pages? Rely on deal arrangers or do your own homework? Caveat emptor, caveat venditor, caveat utilitor.

Would Michael Lewis have written “The Big Long” on credit experts picking off bears wandering into the doomsday machine? Or Gregory Zuckerman on the “The Worst Trade Ever” how a merger arbitrage specialist, John Paulson, went out of business style drifting with subprime CDOs? Magnetar sucked into a black hole? Dr. Michael Burry back on double shifts at the hospital? What if Paulson HAD bought and the next day reversed to the other side. Would it have changed ACA’s loan portfolio selection choices or the bond “rating”?

Today I naively took the risk of renting a car. After closing the deal I was astonished to see some vehicles moving in the OPPOSITE direction. The salesperson and documentation made NO disclosure about this risky two-way flow. More due diligence revealed that despite heavy regulation and licensing, these dubious inventions KILL over 1,000 people every day from such collisions! Again zero mention in the legal paperwork of these hazards. Did they commit fraud by failing to inform of the danger? CDOs can’t be traded by some individuals but calamitous CARs are widely available.

Abolish CARs? I even saw a “rogue” employee knowingly bet against me driving north while I headed south. Such conflicts of interest and idiotic innovation needs to stop before even more people die in toxic tort products like cars. Ban derivatives trading so ban driving since it is much riskier? Subpoena to Congress those merchants of mayhem and dealers in destruction like car rental firms? The world thrived for a long time before “monstrousities” like C-D-Os and C-A-Rs were created. Get CDOs wrong and just lose money but outlawing CARs would save lives.

Wary of misrepresention of risk and non-disclosure of agents of automobile armageddon, I fled to the relative safety of finance. I chose 500 dodgy, in my humble opinion at the time, reference securities to bet against. Luckily some broker’s quantitative geeks had already assembled a structured derivative product for that equity tranche. I short sold the basket portfolio but the intermediary neglected to alert longs that I and possibly traders at the sponsoring firm might bet against them. Even the broker herself confided in an email that she was also personally bearish but her function was facilitating CLIENT transactions regardless of private or her firm’s market views. Anyone long the SPY ETF asset-backed security and not made aware of this has recourse to regulators?

Alpha capture is a war and battles have casualties. Finding alpha is a zero-sum ADVERSARIAL game of losers AND winners. Zero-skill, crowded beta is “cheap” but insightful analysis and variant perception costs 2 and 20 or more. Contrasting views make a market. It is dumb and suboptimal to presume a counterparty is on your side. The juxtaposition of ideas helps prick bubbles earlier than a one-way market. If I buy I want as many smart people as possible hoping I am wrong. If I short sell I am most comfortable when sophisticated professionals are buying and A-list analysts regard it as a core long.

You can ONLY produce alpha when others lose. The most alpha appears when most are wrong. A rating of “strong buy” on a stock or “AAA” for a bond is just someone else’s opinion. It is up to investors to do their own analysis or trust advisors working FOR them. Do your own due diligence or hire someone to do it for YOU with rare investment expertise and whose interests and INCENTIVES are aligned with yours. Cheerleaders cheer the team that pays them not necessarily YOUR team.

Harry Hindsight lives. The first casualty of war is truth and the first casualty of finance is memory. Casual emails gain overweighted(?) prominence when LDL conversations aren’t recorded. I wonder about that fateful meeting in January 2007 between Goldman Sachs, ACA and Paulson. Would buyers have walked away if all deal materials had stated in bold red ink “A merger arbitrage manager you likely haven’t heard of with no known expertise or track record in credit may have helped choose the underlying loans and will likely bet against them”. Or “Fabulous Fab and some of the <a href="http://news.yahoo.com/s/nm/20100503/bs_nm/us_berkshire_buffett
“target=_blank>Goldman Sachs GS proprietary credit traders are at this moment in time bearish on subprime credit but they have been right AND wrong in the past”. How might this have changed things?

Deception? Designed to fail? There are always bears on anything. If then unknown Paolo Pelligrini had shouted from the rooftops his negative views on subprime how many would have acted on it? We now know he was correct but AT THE TIME OF THE DEAL this was an outlier opinion ignored by the street. Even I wrote several bearish posts in 2007 and investors that followed that advice made high returns but the general population ignored those too. To make money out of the credit meltdown you didnt have to specifically short subprime. Was Fabrice Tourre wrong in his “smoking gun” email to express his then view that shorts were more likely to win than the longs? There have been many securities constructed on reverse enquiry from hedge funds where the client ended up being very wrong. I also know of IPOs done for “overvalued” companies considered “bound to fail” that have subsequently gone up 1,000% after listing. Everyone including insiders gets it wrong sometimes.

If I buy the more shorts the better since there is higher probability of a short squeeze. If everyone is buying, it is often time to short sell. Rather than being horrified that others think differently, it is excellent and favorable news. When I buy a security I assume and expect people are betting against me. If a market maker has a bid-offer spread and I take the offer, they are often left short temporarily if they don’t have inventory. They are then technically betting against a client but does it matter? Any market participant surely knows there will be opposing positions. Investors are free to choose pure execution-only brokers or investment banks well-known to have large proprietary trading operations that may or may not be betting in a different direction. The only Chinese Wall in the world passes just north of Beijing.

Would regulation and transparency have prevented the credit crisis? There have been many financial panics and real estate crashes in the past. Did CDOs and shorts “cause” those also? Why have there been worse ones where there were no derivatives or shorting? No security EVER trades for what it is worth; differences of opinion fuel all markets. If you short sell something you need as many people as possible to be bullish. Shorting rarely causes a security to go down. When you buy, the preferred situation is that many others are short. Exploiting the madness of crowds is the key factor for alpha. The more investors doing the opposite is POSITIVE if you have an edge. If you’ve done you’re research it ought to increase trade conviction. If you don’t have an edge why are you investing? Some think security analysis is a waste of time and John Bogle was as accurate as usual in ridiculing people who bother with skilled hard work.

All deals produce winners and losers. For every buyer there must be a seller and often a short seller. Is it always necessary to disclose that others including originators might bet against you? And if they do should it change your view or rating given your analytical edge? If you are bullish surely more bears should make you more bullish if you are confident of your ability. Blame the crisis on 2 and 20 and deal structurers or the 2 and 28 ARM lenders? Or on the inevitable boom and bust, greed and fear of the crowd. Manage risk and invest in skill to survive PREDICTABLE cyclical behaviour. Variant perception is what creates value for clients. Some speculate on conspiracy and collusion but it is usually just the Emotional Markets Hypothesis at work. All securities at all times are wrongly priced.

Short selling does not force securities to implode. It can however slow bubbles from turning into superbubbles and potentially worse problems. It may be counterintuitive but short selling subprime may have prevented larger losses and bigger issues. Some argue that credit repackaging exacerbated and perpetuated it but do not explain earlier crashes and meltdowns. With only longs, the Japanese credit bubble of the 1980s happened without CDOs, structured products or hedge funds betting against it. Subprime lending was invented in Japan and the crash’s effects still exist with the stock AND real estate markets 75% below high water marks. Short sellers and transfer of risk are positives not negatives for economic growth. Real estate booms and busts have occured for centuries. Sovereign defaults and bailouts are common yet rookies treat the Greek situation like it is unprecedented. Greece has been bankrupt more often than not since 1810.

One of the strangest results of the 2007-2008 post mortem was the slow motion reverberation from credit to equity. Even if you missed the credit short there was plenty of time to get short of equities. No-one could have predicted the crisis? Really? Many correlation “traders” short sold correlation at 0.3 and watched helpless as it gapped straight up to 1.0. Gaussian copulas absurdly assume constant default probabilities just like gaussian Black-Scholes crazily relies on constant volatility to allegedly “price” derivatives. The added complication with credit is the non-linear binary payoff. Either the debt is serviced or bankrupt. With low interest rates, yields often do not compensate for default risk. All an investor can do is their own analysis or hire an expert whose interests are the same as theirs.

If you need a friend get a dog. Full transparency: at this instant I am short the S&P 500 and numerous other asset-backed equity and credit structured products, however I might reverse and buy between 20 milliseconds and 20 years from now. Whatever or whenever an investor buys or sells, it is certain that others are betting the opposite way. To generate consistent alpha it is necessary to have counterparties with different opinions. It is obligatory for others to disagree with you. Their existence is mandatory for seeking alpha.

by Veryan Allen. Copyright

Go to Source

Hedge fund economic benefits? Foundations invested in skilled strategies have higher performance to support social causes. Endowments properly allocated to absolute return have more for faculty and students. Pension plans with substantial hedge fund allocations have better funded liabilities. Family offices more for donations and grants. Eleemosynary institutions greater cash for charity. Sovereign wealth funds gain sovereign wealth for citizens. Individual investors secure an earlier retirement. Hedge funds provide deeper liquidity and act as a buyer of last resort. Making money in a recession is when alpha is needed most and clients hired managers to do.

$5 slate & chalk = index fund -> $500 Apple iPad = hedge fund. Investors can choose old products or more powerful performance. The billions in “wages” go mostly to philanthropy. Hedge fund pay is a kurtotic variable where fat tails render means meaningless. Rich lists miscalculate “income” and customers ultimately sign all “paychecks”. Those delivering absolute returns deserve a share for making and saving clients far more. Funds below high water marks aren’t paid well in drawdowns as the 20% incentive fee only applies to new profits. Hedge fund clawbacks are coming. Necessity is the mother of invention and we need INNOVATIVE alpha sources and lower risk MODERN portfolios.

By style I’m a macro portfolio manager/value investor and very conservative. I started by purchasing emerging and frontier market debt, equity and real estate far cheaper that its true worth. Also I spent years buying deeply mispriced options, derivatives and hybrid securities in those “unpredictable” and “efficient” markets fantasized about by “Nobel” prize winners. Recently I’ve helped fiduciary organizations manage money and construct portfolios of managers and multimanagers whose fees are a bargain compared to their VALUE. The higher hedge fund manager pay, the MUCH more investors make.

Successful hedge fund managers are entrepreneurs with an essential service in high demand. No matter how long a firm has been in existence I regard hedge fund investing as similar to venture capital. Angels that stake other private business get just 25%, and often less, of gross returns whereas investors in hedge funds receive 75% of gains. Managers retain the balance for sweat equity, 100 hour work weeks and low pay when underwater. Hedge funds make their talents and technologies available for a very competitive price. The value proposition is over three times better and with considerably less risk.

Positive numbers in 2008 and 2009 is impressive and over 1,000 managers did just that. “Aggregate” hedge fund returns are routinely cited but not AVERAGE hedge fund pay. In finance the average can confuse and disguise risk. Some CDO structurers mixed 700 FICO with 400 FICO scores for “average” default rates and a few managers figured out the dangerous result years beforehand. Some good hedge funds that lost money in 2008 worked nearly gratis last year with the 2% going to employee and infrastructure costs. Much “pay” was capital gains on own cash: shared upside AND downside aligned with investors.

Hedge fund managers able to deliver persistent returns could avoid many hassles by only trading personal, family and friend money. To use up capacity and endure the due diligence and monitoring to accept outside OPM cash it should be financially worthwhile. Many good hedge fund managers like Michael Burry close due to success and before reaching billionaire status. Reverse survivorship bias? Why do so many assume that a hedge fund that ceases to exist must have blown up? Are two of the best shows on TV, 24 and Lost, “failures” because they are also shutting down?

An unbiased qualitative and quantitative analysis of the FACTS shows that absolute alpha is a bargain. I prefer managers to make billions since investors will receive many more billions under that payoff scenario. Hedge funds don’t exclusively trade for the superrich; they manage money or soon will be for most retirement plans and eventually a majority of individual investors of every net worth. Few on the rich list spend much time on static asset allocation. They focus on security selection, tactical timing and, most important, value creation for clients.

In other industries “change in net worth” is not “salary”. Distressed assets trader David Tepper, manager of Appaloosa, apparently received the highest “paycheck” of $4 billion, followed by George Soros at $3.3 billion, James Simons on $2.5 billion and John Paulson with $2.3 billion. They and their teams produced a lot of alpha and rightly received compensation for skill and shared capital alignment with investors. Given the anomalies and inefficiencies created by forced selling in late 2008, I wrote it was obvious 2009 would be an excellent year for alpha just like deleveraging in late 1998 and negative sentiment on hedge funds led to a great 1999. The hot money panicked but sophisticated investors saw the opportunity.

I am typing this post on my newly acquired Apple iPad. That might help Steve Jobs be “paid” more billions but, like absolute return, the product is tangibly useful and fills a need. Similar to proper hedge fund managers, the Apple AAPL people deliver performance that most want so they get paid well. The Masters golf championship is being held today where someone will receive a lot of money for the best putting skill. Putt for dough and perform for dough since investment skill is much more valuable. Unskilled golfers don’t play at the Masters and unskilled fund managers don’t work at GOOD hedge funds. But hedge fund databases list thousands of hedge funds that aren’t good, dragging down “aggregate” returns. Can you imagine the typical score at the Masters if every “golfer” played? 100+?

Performance net to clients is what matters. Wisdom surpasses wealth and fees for expert knowledge are more than justified. 20 years is a long time applicable to most investors. Below is the total return of the MSCI World versus hedge fund benchmark, the HFR Fund Weighted Composite. Clearly consistent outperformance AFTER all fees and the difference will be just as wide in 2010-2030. Considering the 80/20 Pareto rule of thumb I use that 80% of hedge funds do not generate alpha, investors with robust portfolio structuring and manager due diligence processes have done better and will continue to do so. Expertise exists at many levels and has enormous value.

by Veryan Allen. Copyright

Go to Source

Buyers, sellers and users beware of opposite outcomes and opposing forces. What if the Timberwolf and Abacus synthetic CDO deals had not blown up? Brilliant buyers cited as gurus for their perspicacious positioning? Goldman Sachs called to testify for not disclosing to loser shorts that winning longs were betting against them? Would there still be a case? Would it be on front pages? Rely on deal arrangers or do your own homework? Caveat emptor, caveat venditor, caveat utilitor.

Would Michael Lewis have written “The Big Long” on credit experts picking off sucker bears that wandered into the doomsday machine? Or Gregory Zuckerman on the “The Worst Trade Ever” how a merger arbitrage specialist, John Paulson, went out of business style drifting with subprime CDOs? Magnetar sucked into a black hole? Dr. Michael Burry back on double shifts at the hospital? What if Paulson HAD bought and the next day reversed to the other side. Would it have changed ACA’s loan portfolio selection choices or the bond “rating”?

Today I naively took the risk of renting a car. Soon I was astonished to see some vehicles moving in the OPPOSITE direction. The salesperson and deal documentation provided NO disclosure about this risky two-way flow. More due diligence revealed that despite heavy regulation and licensing, these dubious inventions KILL over 1,000 people every day from such collisions! Again zero mention in the legal paperwork of the hazards. Did they commit fraud by failing to inform of the dangers? CDOs can’t be traded by some individuals but calamitous CARs are STILL widely available.

Abolish CARs? I even saw a “rogue” employee knowingly bet against me driving north while I headed south. Such conflicts of interest and idiotic innovation needs to stop before even more people die in toxic tort products like cars. Ban derivatives trading so ban driving since it is much riskier? Subpoena to testify those merchants of mayhem and dealers in destruction like car-rental firms? The world thrived for a long time before “monstrousities” like C-D-Os and C-A-Rs were created. Get CDOs wrong and just lose money but restricting CARs would save lives.

Wary of misrepresention of risk and non-disclosure of antagonistic agents of malice, I fled to the relative safety of finance. I chose 500 dodgy (in my humble opinion, at the time) reference securities to bet against. Luckily a broker’s quantitative geeks had already assembled a structured derivative product for that equity tranche. I short sold the basket portfolio but the intermediary neglected to alert longs that I and possibly traders at the sponsoring firm might bet against them. Even the salesperson herself confided in an email that she was bearish but her function was facilitating CLIENT transactions regardless of personal or her firm’s market views. Anyone long the SPY ETF asset-backed security and not made aware of this has recourse to regulators? Next time you short QQQQ or EEM, take care: others are long.

Alpha capture is a war and battles have casualties. Finding alpha is a zero-sum ADVERSARIAL game of losers AND winners. Zero-skill, crowded beta is “cheap” but insightful analysis and variant perception costs 2 and 20 or more. Contrasting views make a market. It is dumb and suboptimal to presume a counterparty is on your side. The juxtaposition of ideas helps prick bubbles earlier than a one-way market. If I buy I want as many smart people as possible hoping I am wrong. If I short sell I am most comfortable when sophisticated professionals are buying and A-list analysts regard it as a core long.

You can ONLY produce alpha when others lose. The most alpha appears when most are wrong. A rating of “strong buy” on a stock or “AAA” for a bond is just someone else’s opinion. It is up to investors to do their own analysis or trust advisors working FOR them. Do your own due diligence or hire someone to do it for YOU with rare investment expertise and whose interests and INCENTIVES are aligned with yours. Cheerleaders cheer the team that pays them not necessarily YOUR team.

Harry Hindsight lives. The first casualty of war is truth and the first casualty of finance is memory. Casual emails gain overweighted(?) prominence when LDL conversations aren’t recorded. I wonder about that fateful meeting in January 2007 between Goldman Sachs, ACA and Paulson. Would buyers have walked away if all deal materials had stated in bold red ink “A merger arbitrage manager you likely haven’t heard of with no known expertise or track record in credit may have helped choose the underlying loans and will likely bet against them”. Or “Fabulous Fab and some of the <a href="http://news.yahoo.com/s/nm/20100503/bs_nm/us_berkshire_buffett
“target=_blank>Goldman Sachs GS proprietary credit traders are at this moment in time bearish on subprime credit but they have been right AND wrong in the past”. How might this have changed things?

Deception? Designed to fail? There are always bears on anything. If then unknown Paolo Pelligrini had shouted from the rooftops his negative views on subprime how many would have acted on it? We now know he was correct but AT THE TIME OF THE DEAL this was an outlier opinion ignored by the street. Even I wrote several bearish posts in 2007 and investors that followed that advice made high returns but the general population ignored those too. To make money out of the credit meltdown you didnt have to specifically short subprime. Was Fabrice Tourre wrong in his “smoking gun” email to express his then view that shorts were more likely to win than the longs? There have been many securities constructed on reverse enquiry from hedge funds where the client ended up being very wrong. I also know of IPOs done for “overvalued” companies considered “bound to fail” that have subsequently gone up 1,000% after listing. Everyone including insiders gets it wrong sometimes.

If I buy the more shorts the better since there is higher probability of a short squeeze. If everyone is buying, it is often time to short sell. Rather than being horrified that others think differently, it is excellent and favorable news. When I buy a security I assume and expect people are betting against me. If a market maker has a bid-offer spread and I take the offer, they are often left short temporarily if they don’t have inventory. They are then technically betting against a client but does it matter? Any market participant surely knows there will be opposing positions. Investors are free to choose pure execution-only brokers or investment banks well-known to have large proprietary trading operations that may or may not be betting in a different direction. The only Chinese Wall in the world passes just north of Beijing.

Would regulation and transparency have prevented the credit crisis? There have been many financial panics and real estate crashes in the past. Did CDOs and shorts “cause” those also? Why have there been worse ones where there were no derivatives or shorting? No security EVER trades for what it is worth; differences of opinion fuel all markets. If you short sell something you need as many people as possible to be bullish. Shorting rarely causes a security to go down. When you buy, the preferred situation is that many others are short. Exploiting the madness of crowds is the key factor for alpha. The more investors doing the opposite is POSITIVE if you have an edge. If you’ve done you’re research it ought to increase trade conviction. If you don’t have an edge why are you investing? Some think security analysis is a waste of time and John Bogle was as accurate as usual in ridiculing people who bother with skilled hard work.

All deals produce winners and losers. For every buyer there must be a seller and often a short seller. Is it always necessary to disclose that others including originators might bet against you? And if they do should it change your view or rating given your analytical edge? If you are bullish surely more bears should make you more bullish if you are confident of your ability. Blame the crisis on 2 and 20 and deal structurers or the 2 and 28 ARM lenders? Or on the inevitable boom and bust, greed and fear of the crowd. Manage risk and invest in skill to survive PREDICTABLE cyclical behaviour. Variant perception is what creates value for clients. Some speculate on conspiracy and collusion but it is usually just the Emotional Markets Hypothesis at work. All securities at all times are wrongly priced.

Short selling does not force securities to implode. It can however slow bubbles from turning into superbubbles and potentially worse problems. It may be counterintuitive but short selling subprime may have prevented larger losses and bigger issues. Some argue that credit repackaging exacerbated and perpetuated it but do not explain earlier crashes and meltdowns. With only longs, the Japanese credit bubble of the 1980s happened without CDOs, structured products or hedge funds betting against it. Subprime lending was invented in Japan and the crash’s effects still exist with the stock AND real estate markets 75% below high water marks. Short sellers and transfer of risk are positives not negatives for economic growth. Real estate booms and busts have occured for centuries. Sovereign defaults and bailouts are common yet rookies treat the Greek situation like it is unprecedented. Greece has been bankrupt more often than not since 1810.

One of the strangest results of the 2007-2008 post mortem was the slow motion reverberation from credit to equity. Even if you missed the credit short there was plenty of time to get short of equities. No-one could have predicted the crisis? Really? Many correlation “traders” short sold correlation at 0.3 and watched helpless as it gapped straight up to 1.0. Gaussian copulas absurdly assume constant default probabilities just like gaussian Black-Scholes crazily relies on constant volatility to allegedly “price” derivatives. The added complication with credit is the non-linear binary payoff. Either the debt is serviced or bankrupt. With low interest rates, yields often do not compensate for default risk. All an investor can do is their own analysis or hire an expert whose interests are the same as theirs.

If you need a friend get a dog. Full transparency: at this instant I am short the S&P 500 and numerous other asset-backed equity and credit structured products, however I might reverse and buy between 20 milliseconds and 20 years from now. Whatever or whenever an investor buys or sells, it is certain that others are betting the opposite way. To generate consistent alpha it is necessary to have counterparties with different opinions. It is obligatory for others to disagree with you. Their existence is mandatory for seeking alpha.

by Veryan Allen. Copyright

Go to Source

Buyers, sellers and users beware of opposite outcomes and opposing forces. What if the Timberwolf and Abacus synthetic CDO deals had not blown up? Brilliant buyers called gurus for their perspicacious positioning? Goldman Sachs called to testify for not disclosing to loser shorts that the winning longs were betting against them? Would there still be a case? Would it be on front pages? Rely on deal arrangers or do your own homework?

Would Michael Lewis have written “The Big Long” on credit experts picking off sucker bears that wandered into the doomsday machine? Gregory Zuckerman with the “The Worst Trade Ever” on how a merger arbitrage specialist, John Paulson, went out of business style drifting into subprime CDOs? Magnetar sucked into a black hole? Dr. Michael Burry back on double shifts at the hospital? What if Paulson HAD bought and then a day later reversed to the other side. Would it have changed the “rating”? Caveat emptor, caveat venditor, caveat utilitor.

Today I took the risk of renting a car. Driving out of the airport I was astonished to see some moving in the OPPOSITE direction. The salesperson and deal documentation provided NO disclosure about this risky two-way flow. More due diligence revealed that despite heavy regulation and licensing, these dubious inventions KILL over 1,000 people every day from such collisions! Again zero mention in the legal paperwork and scandalous misrepresentation of the hazards. Did they commit fraud by failing to inform of the dangers? CDOs can’t be traded by some individuals but calamitous CARs are widely available. Such product alchemy fueled by highly flammable fluid is clearly dangerous and results speak for themselves. Abolish CARs now!

I even saw a “rogue” employee vehicle knowingly bet against me driving north while headed south. Such conflicts of interest and idiotic innovation needs to stop before even more people die in toxic tort products like cars. Ban derivatives trading so ban driving since it is more risky? Subpoena to testify those merchants of mayhem and dealers in destruction like Hertz? The world thrived for a long time before “monstrousities” like C-D-Os and C-A-Rs were created. Get CDOs wrong and just lose money but abolishing CARs saves lives.

Wary of misrepresention and the non-disclosure of risks and agents of malice, I fled to the relative safety of the markets. I selected 500 dodgy (in my humble opinion, at the time) reference securities to bet against. Luckily a broker’s quantitative geeks had already assembled a structured derivative product for that equity tranche. I short sold the basket portfolio but the intermediary neglected to alert longs that I and possibly traders at the sponsoring firm might bet against them. Even the salesperson herself confided in an email that she was bearish but her function was to facilitate CLIENT transactions regardless of personal or her firm’s market views. Anyone long the SPY ETF asset-backed security and not made aware of this negativity has recourse to regulators?

Alpha capture is a war and battles have casualties. Finding alpha is a zero-sum ADVERSARIAL game of losers AND winners. Crowded beta is “cheap” but insightful analysis and variant perception costs 2 and 20. Contrasting views make a market. It is naive and suboptimal to presume the counterparty is on your side. The juxtaposition of ideas helps prick bubbles earlier than on a one-way street. If I buy a security I want as many smart people as possible hoping I am wrong. If I short sell I am most comfortable when sophisticated professionals are buying and expert analysts regard it as a core long. You can ONLY produce alpha when others lose. A rating of “strong buy” on a stock or “AAA” on a bond is just someone’s opinion. It is up to investors to do their own analysis or develop trust in advisors working FOR them. Do your own due diligence or hire someone with rare investment expertise and whose interests and INCENTIVES are aligned with yours.

If I buy then the more shorts the better since there is higher probability of a short squeeze. If “everyone” is buying, it is often time to short sell. Rather than being horrified that others think differently, it is excellent news. When I buy a security I assume and expect people are betting against me. If a market maker has a bid-offer spread and I take the offer, they are often left short temporarily if they don’t have inventory. They are therefore then technically betting against a client but does it matter? Any market participant surely knows there will always be opposing positions. Investors are free to choose pure execution-only brokers or investment banks well-known to have large proprietary trading operations that may or may not be betting in a different direction. The only Chinese Wall in the world runs just north of Beijing.

Harry Hindsight lives. The first casualty of war is truth and the first casualty of finance is amnesia. I wonder about that fateful meeting in January 2007 between Goldman Sachs, ACA and Paulson. Would buyers have walked away if all materials had stated in bold red ink on the dealbook cover “A merger arbitrage manager you likely haven’t heard of with no known expertise or track record in credit may have helped choose the underlying loans and will likely bet against them”. Or “Fabulous Fab and some of the <a href="http://news.yahoo.com/s/nm/20100503/bs_nm/us_berkshire_buffett
“target=_blank>Goldman Sachs GS proprietary credit traders are currently bearish on subprime credit but they have been right AND wrong in the past”. How might this have changed things?

Deception? Designed to fail? There are always bears on anything. If then unknown Paolo Pellegrini had shouted from the rooftops his negative views on subprime how many would have acted on it? We now know he was correct but AT THE TIME OF THE DEAL this was an extreme outlier ignored by the street. Even I wrote several bearish posts in 2007 and investors that followed my advice made high returns but the general population ignored those too. Was Fabrice Tourre wrong in his “smoking gun” email to express his then implied view that shorts were more likely to win than the longs? There have been many securities constructed on reverse enquiry from hedge funds where the client ended up being very wrong. I also know of IPOs done for “overvalued” companies considered “bound to fail” that have subsequently gone up 1,000% after listing. Everyone including investment bankers gets it wrong sometimes.

Would regulation and transparency have prevented the credit crisis? There have been many financial panics and real estate crashes in the past. Did CDOs and shorts “cause” those also? Why have there been worse ones where there were no derivatives or shorting? No security EVER trades for what it is worth; differences of opinion fuel all markets. If you short sell something you need as many people as possible to be bullish. Shorting rarely causes a security to go down. When you buy, the preferred situation is that many others are short. Exploiting the madness of crowds is the key factor for alpha. The more investors doing the opposite is POSITIVE if you have an edge. If you’ve done you’re research it ought to increase trade conviction. If you don’t have an edge why are you investing?

All deals produce winners and losers. For every buyer there must be a seller and often a short seller. Is it always necessary to disclose that others including originators might bet against you? And if they do should it change your view or rating given your analytical edge? If you are bullish surely more bears should make you more bullish if you are confident of your ability. Blame the crisis on 2 and 20 and deal structurers or the 2 and 28 ARM lenders? Or on the inevitable boom and bust, greed and fear of the crowd. Manage risk and invest in skill to survive PREDICTABLE cyclical behaviour. Variant perception is what creates value for clients. Some speculate on conspiracy and collusion but it is usually just the Emotional Markets Hypothesis at work. All securities at all times are wrongly priced.

Short selling does not force securities to implode. It can however slow bubbles from turning into superbubbles and potentially worse problems. It may be counterintuitive but short selling subprime may have prevented larger losses and bigger issues. Some argue that credit repackaging exacerbated and perpetuated it but do not explain earlier crashes and meltdowns. With only longs, the Japanese credit bubble of the 1980s happened without CDOs, structured products or hedge funds betting against it. Subprime lending was invented in Japan and the crash’s effects still exist with the stock AND real estate markets 75% below high water marks. Short sellers and transfer of risk are positives not negatives for economic growth. Real estate booms and busts have occured for centuries. Sovereign defaults and bailouts are very common yet rookies treat the Greek situation like it is unprecedented. Greece has been bankrupt more often than not since 1810.

One of the strangest results of the 2007-2008 post mortem was the slow motion reverberation from credit to equity. Even if you missed the credit short there was plenty of time to get short of equities. No-one could have predicted the crisis? Really? Many correlation “traders” short sold correlation at 0.3 and watched helpless as it gapped straight up to 1.0. Gaussian copulas absurdly assume constant default probabilities just like gaussian Black-Scholes crazily relies on constant volatility to allegedly “price” derivatives. The added complication with credit is the non-linear binary payoff. Either the debt is serviced or bankrupt. With low interest rates, yields often do not compensate for default risk. All an investor can do is their own analysis or hire an expert whose interests are the same as theirs.

If you need a friend get a dog. Full transparency: at this instant I am short the S&P 500, however I might reverse and buy between 20 milliseconds and 20 years from now. Whatever or whenever an investor buys or sells, it is certain that others are betting the opposite way. To generate consistent alpha it is necessary to have counterparties with differing opinions. It is obligatory for others to disagree with you. I am very appreciative of the many people that provide an essential public service in betting I am wrong. Their existence is mandatory for seeking alpha.

by Veryan Allen. Copyright

Go to Source

Buyers, sellers and users beware of opposite outcomes and opposing forces. What if the Timberwolf and Abacus deals had not blown up? Brilliant buyers called gurus for their perspicacious positioning? Goldman Sachs cited for not disclosing to loser shorts that longs were betting against them? Michael Lewis writes “The Big Long” on credit experts picking off bears that wandered into the doomsday machine? Gregory Zuckerman on the “The Worst Trade Ever” how a merger arbitrage trader, John Paulson, went out of business style drifting to subprime CDOs? Magnetar sucked into a black hole? Dr. Michael Burry back on double shifts at the hospital? Would there still be a case? Would it be on front pages? Rely on deal arrangers or do your own homework? Caveat emptor, caveat venditor, caveat utilitor.

Today I took the risk of renting a car. Driving out of the airport I saw some moving in the OPPOSITE direction. The deal documentation had NO disclosure about this risky two-way flow. Due diligence revealed that despite heavy regulation and licensing, these dubious inventions KILL over 1,000 people every day from such collisions! Again zero mention in the legal paperwork and scandalous misrepresentation of the hazards. Did they commit fraud by failing to inform of the dangers? CDOs can’t be traded by some individuals but calamitous CARs are widely available.

I even saw a “rogue” employee knowingly bet against me going north while I was heading south. Such conflicts of interest and idiotic innovation needs to stop before even more people die in toxic tort products like cars. Ban derivatives trading so ban driving since it is more risky? Subpoena to testify those merchants of mayhem and dealers in destruction like Hertz? The world thrived for a long time before “monstrousities” like C-D-Os and C-A-Rs were created. Get CDOs wrong and just lose money but abolishing CARs saves lives.

Wary of misrepresention and the non-disclosure of risks and other side agents of malice, I fled to the relative safety of the markets. I selected 500 dodgy (in my humble opinion, at the time) reference securities to bet against. Luckily a broker’s quantitative geeks had already assembled a structured derivative product for that equity tranche. I short sold the basket portfolio but the intermediary neglected to alert longs that I and possibly traders at the sponsoring firm might bet against them. Even the salesperson herself confided in an email that she was bearish but her function was to facilitate CLIENT transactions regardless of personal or her firm’s market views. Anyone long the SPY ETF asset-backed security and not made aware of this negativity has recourse to regulators?

Alpha capture is a war and battles have casualties. Finding alpha is a zero-sum ADVERSARIAL game of losers AND winners. Crowded beta is “cheap” but insightful analysis and variant perception costs 2 and 20. Contrasting views make a market. It is naive and suboptimal to presume the counterparty is on your side. The juxtaposition of ideas helps prick bubbles earlier than on a one-way street. If I buy a security I want as many smart people as possible hoping I am wrong. If I short sell I am most comfortable when sophisticated professionals are buying and expert analysts regard it as a core long. You can ONLY produce alpha when others lose. A rating of “strong buy” on a stock or “AAA” on a bond is just someone’s opinion. It is up to investors to do their own analysis or develop trust in advisors working FOR them. Do your own due diligence or hire someone with rare investment expertise and whose interests and INCENTIVES are aligned with yours.

If I buy then the more shorts the better since there is higher probability of a short squeeze. If “everyone” is buying, it is often time to short sell. Rather than being horrified that others think differently, it is excellent news. When I buy a security I assume and expect people are betting against me. If a market maker has a bid-offer spread and I take the offer, they are often left short temporarily if they don’t have inventory. They are therefore then technically betting against a client but does it matter? Any market participant surely knows there will always be opposing positions. Investors are free to choose pure execution-only brokers or investment banks well-known to have large proprietary trading operations that may or may not be betting in a different direction. The only Chinese Wall in the world runs just north of Beijing.

Harry Hindsight lives. The first casualty of war is truth and the first casualty of finance is amnesia. I wonder about that fateful meeting in January 2007 between Goldman Sachs, ACA and Paulson. Would buyers have walked away if all materials had stated in bold red ink on the dealbook cover “A merger arbitrage manager you likely haven’t heard of with no known expertise or track record in credit may have helped choose the underlying loans and will likely bet against them”. Or “Fabulous Fab and some of the <a href="http://news.yahoo.com/s/nm/20100503/bs_nm/us_berkshire_buffett
“target=_blank>Goldman Sachs GS proprietary credit traders are currently bearish on subprime credit but they have been right AND wrong in the past”. How might this have changed things?

Deception? Designed to fail? There are always bears on anything. If then unknown Paolo Pellegrini had shouted from the rooftops his negative views on subprime how many would have acted on it? We now know he was correct but AT THE TIME OF THE DEAL this was an extreme outlier ignored by the street. Even I wrote several bearish posts in 2007 and investors that followed my advice made high returns but the general population ignored those too. Was Fabrice Tourre wrong in his “smoking gun” email to express his then implied view that shorts were more likely to win than the longs? There have been many securities constructed on reverse enquiry from hedge funds where the client ended up being very wrong. I also know of IPOs done for “overvalued” companies considered “bound to fail” that have subsequently gone up 1,000% after listing. Everyone including investment bankers gets it wrong sometimes.

Would regulation and transparency have prevented the credit crisis? There have been many financial panics and real estate crashes in the past. Did CDOs and shorts “cause” those also? Why have there been worse ones where there were no derivatives or shorting? No security EVER trades for what it is worth; differences of opinion fuel all markets. If you short sell something you need as many people as possible to be bullish. Shorting rarely causes a security to go down. When you buy, the preferred situation is that many others are short. Exploiting the madness of crowds is the key factor for alpha. The more investors doing the opposite is POSITIVE if you have an edge. If you’ve done you’re research it ought to increase trade conviction. If you don’t have an edge why are you investing?

All deals produce winners and losers. For every buyer there must be a seller and often a short seller. Is it always necessary to disclose that others including originators might bet against you? And if they do should it change your view or rating given your analytical edge? If you are bullish surely more bears should make you more bullish if you are confident of your ability. Blame the crisis on 2 and 20 and deal structurers or the 2 and 28 ARM lenders? Or on the inevitable boom and bust, greed and fear of the crowd. Manage risk and invest in skill to survive PREDICTABLE cyclical behaviour. Variant perception is what creates value for clients. Some speculate on conspiracy and collusion but it is usually just the Emotional Markets Hypothesis at work. All securities at all times are wrongly priced.

Short selling does not force securities to implode. It can however slow bubbles from turning into superbubbles and potentially worse problems. It may be counterintuitive but short selling subprime may have prevented larger losses and bigger issues. Some argue that credit repackaging exacerbated and perpetuated it but do not explain earlier crashes and meltdowns. With only longs, the Japanese credit bubble of the 1980s happened without CDOs, structured products or hedge funds betting against it. Subprime lending was invented in Japan and the crash’s effects still exist with the stock AND real estate markets 75% below high water marks. Short sellers and transfer of risk are positives not negatives for economic growth. Real estate booms and busts have occured for centuries. Sovereign defaults and bailouts are very common yet rookies treat the Greek situation like it is unprecedented. Greece has been bankrupt more often than not since 1810.

One of the strangest results of the 2007-2008 post mortem was the slow motion reverberation from credit to equity. Even if you missed the credit short there was plenty of time to get short of equities. No-one could have predicted the crisis? Really? Many correlation “traders” short sold correlation at 0.3 and watched helpless as it gapped straight up to 1.0. Gaussian copulas absurdly assume constant default probabilities just like gaussian Black-Scholes crazily relies on constant volatility to allegedly “price” derivatives. The added complication with credit is the non-linear binary payoff. Either the debt is serviced or bankrupt. With low interest rates, yields often do not compensate for default risk. All an investor can do is their own analysis or hire an expert whose interests are the same as theirs.

If you need a friend get a dog. Full transparency: at this instant I am short the S&P 500, however I might reverse and buy between 20 milliseconds and 20 years from now. Whatever or whenever an investor buys or sells, it is certain that others are betting the opposite way. To generate consistent alpha it is necessary to have counterparties with differing opinions. It is obligatory for others to disagree with you. I am very appreciative of the many people that provide an essential public service in betting I am wrong. Their existence is mandatory for seeking alpha.

by Veryan Allen. Copyright

Go to Source

Caveat emptor, caveat venditor, caveat utilitor. Buyers, sellers and users beware of opposite outcomes. What if the Timberwolf and Abacus deals had gone up? Buyers treated now as gurus for perspicacious positioning? Goldman Sachs cited for not disclosing to loser shorts that longs were betting against them? Michael Lewis writing “The Big Long” about credit experts picking off bears in the doomsday machine? Gregory Zuckerman on the “The Worst Trade Ever” how an obscure merger arbitrage specialist called John Paulson went out of business style drifting into subprime CDOs? Magnetar sucked into black hole oblivion? Dr. Michael Burry back on 18 hour shifts at the hospital? Would it be on front pages? Would there be a case? Rely on deal arrangers or do your own homework?

I just took the risk of renting a car. Driving out of the airport I saw some moving in the OPPOSITE direction. Amazingly the deal documentation had NO disclosure about this risky two-way flow. Due diligence revealed that despite heavy regulation and licenses, these dubious inventions kill over 1,000 people each DAY from such collisions! Again zero mention of this fact in the legal paperwork. Did they commit fraud by failing to inform of the dangers. I even saw a “rogue” employee betting against me going north while I was heading south. Such conflicts of interest and idiotic innovation needs to stop before more people die in toxic products like cars! Ban derivatives trading so ban driving since it is more hazardous? The world thrived for a long time before “monstrousities” like C-D-Os and C-A-Rs were created. Get CDOs wrong and just lose money but with CARs it is lives.

Though hedge funds can’t be purchased by some individuals, calamitous CARs are widely available. Wary of dubious business practices and non-disclosure of risks and opposing agents, I fled to the relative safety of the markets and selected 500 dodgy (in my humble opinion, at the time) reference securities to bet against. Luckily a broker’s quantitative geeks had already assembled a structured derivative product for that equity tranche. I short sold the basket portfolio but the intermediary neglected to newly alert the longs that I and possibly some of the traders at the sponsoring firm might bet against them. Even the salestrader herself confided in an email that she was bearish but her function was to facilitate client transactions regardless of personal or her firm’s market views. Anyone long the SPY ETF asset-backed security and not made aware of this negativity has recourse to regulators? Full transparency: at this instant I am short the S&P 500, however I might reverse and buy between 20 milliseconds and 20 years from now.

Alpha is a war and battles have casualties. Alpha capture is a zero-sum ADVERSARIAL game. Crowded beta is “cheap” but insightful analysis and variant perception costs 2 and 20. Contrasting views make a market. The juxtaposition of ideas helps prick bubbles earlier than a one-way street. If I buy a security I want as many smart people as possible hoping I am wrong. If I short sell I am most comfortable when sophisticated professionals are buying and expert analysts regard it as a core long. You can ONLY find alpha when others lose. A rating of “strong buy” on a stock or “AAA” on a bond is just someone else’s opinion. It is up to investors to do their own analysis or develop trust in advisors working FOR them. Do your own due diligence or hire someone with security selection expertise and whose interests and INCENTIVES are aligned with yours.

If I buy then the more shorts the better since there is higher probability of a short squeeze. If “everyone” is buying, it is often time to short sell. Rather than being horrified that others think differently, it is excellent news. When I buy a security I assume and expect people are betting against me. If a market maker has a bid-offer spread and I take the offer, they are often left short temporarily if they don’t have inventory. They are therefore then technically betting against a client but does it matter? Any market participant surely knows there will always be opposing positions. Investors are free to choose pure execution-only brokers or investment banks well-known to have large proprietary trading operations that may or may not be betting on a different direction. The only Chinese Wall in the world runs just north of Beijing.

Would regulation and transparency have prevented the credit crisis? There have been many financial panics and real estate crashes in the past. Did CDOs and shorts “cause” those also? Why have there been worse ones where there were no derivatives or shorting? No security EVER trades for what it is worth; differences of opinion fuel all markets. If you short sell something you need as many people as possible to be bullish. Shorting rarely causes a security to go down. When you buy, the preferred situation is that many others are short. Exploiting the madness of crowds is the key factor for alpha. The more investors doing the opposite is POSITIVE if you have an edge. If you’ve done you’re homework it ought to increase trade conviction. If you don’t have an edge why are you investing?

All deals produce winners and losers. For every buyer there must be a seller and often a short seller. Is it always necessary to disclose that others including originators might bet against you? And if they do should it change your view or rating given your analytical edge? If you are bullish surely more bears should make you more bullish if you are confident of your ability. Blame the crisis on 2 and 20 and deal structurers or the 2 and 28 ARM lenders? Or on the inevitable boom and bust, greed and fear of the crowd. Manage risk and invest in skill to survive PREDICTABLE cyclical behaviour. Variant perception is what creates value for clients. Some speculate on conspiracy and collusion but it is usually just the Emotional Markets Hypothesis at work. All securities at all times are wrongly priced and skill is rare.

Harry Hindsight lives. The first casualty of war is truth and the first casualty of finance is amnesia. I wonder about that fateful meeting in January 2007 between Goldman Sachs, ACA and Paulson. Would buyers have walked away if all materials had stated in bold red ink on the dealbook cover “A merger arbitrage manager you likely haven’t heard of with no known expertise or track record in credit may have helped choose the underlying loans and will likely bet against them”. Or “Fabulous Fab and some of the <a href="http://news.yahoo.com/s/nm/20100503/bs_nm/us_berkshire_buffett
“target=_blank>Goldman Sachs GS proprietary credit traders are currently bearish on subprime credit but they have been right AND wrong in the past”. How might this have changed things?

Deception? Designed to fail? There are always bears around on anything. If then unknown Paolo Pellegrini had shouted from the rooftops his negative views on subprime how many would have acted on it? We now know he was correct but AT THE TIME OF THE DEAL this was an extreme outlier ignored by the street. Even I wrote several bearish posts in 2007 and investors that followed them made high returns but the general population ignored those too. Was Fabrice Tourre wrong in his “smoking gun” email to express his then implied view that shorts were more likely to win than the longs? There have been many securities constructed on reverse enquiry from hedge funds where that client ended up being very wrong. I also know of IPOs done for “overvalued” companies considered “bound to fail” that have subsequently gone up 1000% after listing. Everyone including deal arrangers gets it wrong sometimes.

Short selling does not force securities to go down. It can however slow bubbles from turning into superbubbles and potentially worse problems. It may be counterintuitive but short selling subprime may have prevented larger losses and bigger issues. Some argue that credit repackaging exacerbated and perpetuated it but do not explain earlier crashes and meltdowns. With only longs, the Japanese credit bubble of the 1980s happened without CDOs, structured products or hedge funds betting against it. Subprime lending was invented in Japan and the crash’s effects still exist with the stock market 75% below its high water mark. Short sellers and transfer of risk are positives not negatives for economic growth. Real estate booms and busts have occured for centuries. Sovereign defaults and bailouts are common yet newbies treat the Greece situation like it is unprecedented.

One of the strangest results of the 2007-2008 post mortem was the slow motion reverberation from credit to equity. Even if you missed the credit short there was plenty of time to get short of equities. No-one could have predicted the crisis? Really? Many correlation “traders” short sold correlation at 0.3 and watched helpless as it gapped straight up to 1.0. Gaussian copulas absurdly assume constant default probabilities just like gaussian Black-Scholes crazily relies on constant volatility. The added complication with credit is the non-linear binary payoff. Either the debt is serviced or bankrupt. With low interest rates, yields often do not compensate for default risk. All any investor can do is their own analysis or hire an expert whose interests are the same as theirs.

Whatever or whenever an investor buys or sells, it is certain that others are betting on the opposite outcome. To generate consistent alpha it is a necessity to have counterparties with different opinions. It is obvious and obligatory for others to hope you are wrong and disagree with you. I need people to disagree with me to generate alpha.

by Veryan Allen. Copyright

Go to Source

Caveat emptor, caveat venditor, caveat utilitor. Buyers, sellers and users beware of opposite outcomes. What if with the Timberwolf or Abacus deals the reverse had happened? Buyers treated now as gurus for their perspicacious positioning? Goldman Sachs cited for not disclosing to loser shorts that longs were betting against them? Michael Lewis writing “The Big Long” about credit experts picking off bears daring to enter the doomsday machine? Gregory Zuckerman on the “The Worst Trade Ever” how an obscure merger arbitrage specialist called John Paulson went out of business through style drift into subprime CDOs? Magnetar sucked into black hole oblivion? Dr. Michael Burry back on 18 hour shifts at the hospital? Would it be on front pages? Would there be a case? Rely on deal arrangers or do your own homework?

I just took the risk of renting a car here. Driving out of the airport I saw some vehicles moving in the OPPOSITE direction. Amazingly the deal documentation had NO disclosures about this risky two-way flow. Due diligence revealed that despite heavy regulation and licenses, these dubious inventions kill over 1,000 people each DAY from such collisions! Again zero mention of this fact in the legal paperwork. Did they commit fraud by failing to inform of the dangers. I even saw a “rogue” employee betting against me going north while I was heading south. Such conflicts of interest and idiotic innovation needs to stop before more people die in toxic products like cars! Ban derivatives trading so ban driving since it is more hazardous? The world thrived for a long time before “monstrousities” like C-D-Os and C-A-Rs were created. Get CDOs wrong and just lose money but with CARs it is real lives.

Though hedge funds can’t be purchased by some individuals, calamitous cars are widely available. Wary of dubious business practices and non-disclosure of risks and opposing agents, I fled to the relative safety of the markets and selected 500 dodgy (in my humble opinion, at the time) reference securities to bet against. Luckily a broker’s quantitative geeks had already assembled a structured derivative product. I short sold the basket portfolio but the intermediary neglected to newly alert the longs that I and possibly some of the traders at the sponsoring firm might bet against them. Even the salestrader herself confided in an email that she was bearish but her function was to facilitate client transactions regardless of personal or her firm’s market outlook. Anyone long the SPY ETF and not made aware of these negative views has recourse to regulators? Full transparency: at this instant I am short the S&P 500, however I might reverse and buy between 20 milliseconds and 20 years from now.

Alpha is a war and battles have casualties. Alpha capture is a zero-sum ADVERSARIAL game. Crowded beta is “cheap” but insightful analysis and variant perception costs 2 and 20. Contrasting views make a market. If I buy a security I want as many smart people as possible hoping I am wrong. If I short sell I am most comfortable when most sophisticated professionals are buying and expert analysts regard it as a core long. You can ONLY find alpha when others lose. A rating of “strong buy” on a stock or “AAA” on a bond is just someone else’s opinion. It is up to investors to do their own analysis or develop trust in advisors working FOR them. Do your own due diligence or hire someone with security selection expertise and whose interests and INCENTIVES are aligned with yours.

If I buy then the more shorts the better since there is higher probability of a short squeeze. If “everyone” is buying, it is often time to short sell. Rather than being horrified that others think differently, it is excellent news. When I buy a security I assume and expect people are betting against me. If a market maker has a bid-offer spread and I take the offer, they are often left short temporarily if they don’t have inventory. They are therefore then technically betting against a client but does it matter? Any sophisticated market participant surely knows there will always be opposing positions. Investors are free to choose pure execution-only brokers or investment banks well-known to have large proprietary trading operations that may or may not be trading in a different direction. The only Chinese Wall in the world runs just north of Beijing.

Would regulation and transparency have prevented the credit crisis? There have been many financial panics and real estate crashes in the past. Did CDOs and shorts “cause” those also? Why have there been worse ones where there were no derivatives or shorting? No security EVER trades for what it is worth; differences of opinion are what fuels all markets. If you short sell something you need as many people as possible to be bullish. Shorting rarely causes a security to go down. When you buy, the preferred situation is that many others are short. Exploiting the madness of crowds is the key factor for alpha. The more investors doing the opposite is POSITIVE if you have an edge. If you’ve done you’re homework it ought to increase trade conviction. If you don’t have an edge why are you investing?

All deals produce winners and losers. For every buyer there must be a seller and often a short seller. Is it always necessary to disclose that others including originators might bet against you? And if they do should it change your view or rating given your analytical edge? If you are bullish surely more bears should make you more bullish if you are confident of your ability. Blame the crisis on 2 and 20 and deal structurers or the 2 and 28 ARM lenders? Or on the inevitable boom and bust, greed and fear of the crowd. Manage risk and invest in skill to survive PREDICTABLE cyclical behaviour. Variant perception is what creates value for clients. Some speculate on conspiracy and collusion but it is usually just the Emotional Markets Hypothesis at work. All securities at all times are wrongly priced and skill is rare.

Harry Hindsight lives. The first casualty of war is truth and the first casualty of finance is amnesia. I wonder about that fateful meeting in January 2007 between Goldman Sachs, ACA and Paulson. Would buyers have walked away if all materials had stated in bold red ink on the dealbook cover “A merger arbitrage manager you likely haven’t heard of with no known expertise or track record in credit may have helped choose the underlying loans and will likely bet against them”. Or “Fabulous Fab and some of the <a href="http://news.yahoo.com/s/nm/20100503/bs_nm/us_berkshire_buffett
“target=_blank>Goldman Sachs GS proprietary credit traders are currently bearish on subprime credit but they have been right AND wrong in the past”. How might this have changed things?

Deception? Designed to fail? There are always bears around on anything. If then unknown Paolo Pellegrini had shouted from the rooftops his negative views on subprime how many would have acted on it? We now know he was correct but AT THE TIME OF THE DEAL this was an extreme outlier ignored by the street. Even I wrote several bearish posts in 2007 and investors that followed them made high returns but the general population ignored those too. Was Fabrice Tourre wrong in his “smoking gun” email to express his then implied view that shorts were more likely to win than the longs? There have been many securities constructed on reverse enquiry from hedge funds where that client ended up being wrong. I also know of IPOs done for “overvalued” companies considered “bound to fail” that have subsequently gone up 1000% after listing. Everyone including deal arrangers gets it wrong sometimes.

Short selling does not CAUSE securities to go down. It can however slow bubbles turning into superbubbles and worse problems. It may be counterintuitive but short selling subprime may have prevented larger losses and bigger issues. Some argue that credit repackaging exacerbated and perpetuated it but do not explain earlier crashes and meltdowns. With only longs, the Japanese credit bubble of the 1980s happened without CDOs, structured products or hedge funds betting against it. Subprime lending was invented in Japan and the crash’s effects still exist with the stock market 75% below its high water mark. Short sellers and transfer of risk are positives not negatives for economic growth. Real estate booms and busts have occured for centuries. Sovereign defaults and bailouts are common yet newbies treat the Greece situation like it is unprecedented.

One of the strangest results of the 2007-2008 post mortem was the slow motion reverberation from credit to equity. Even if you missed the credit short there was plenty of time to get short of equities. No-one could have predicted the crisis? Really? Many correlation “traders” short sold correlation at 0.3 and watched helpless as it gapped straight up to 1.0. Gaussian copulas absurdly assume constant default probabilities just like gaussian Black-Scholes crazily relies on constant volatility. The added complication with credit is the non-linear binary payoff. Either the debt is serviced or bankrupt. With low interest rates, yields often do not compensate for default risk. All any investor can do is their own analysis or hire an expert whose interests are the same as theirs.

Whatever or whenever an investor buys or sells, it is a certainty that others are betting on the opposite. To generate consistent alpha it is a necessity. It is obvious and obligatory for others to hope you are wrong and disagree with you. I need people to disagree with me to generate alpha.

by Veryan Allen. Copyright

Go to Source

The social impact and economic benefit of hedge funds? Foundations heavily invested in skilled strategies have higher returns on capital for good causes. Endowments properly invested in absolute return have more for students and spending policies. Pension plans with substantial hedge fund allocations have better funded liabilities than solely long only. Family offices have more for donations, grants and charitable trusts. Sovereign wealth funds gain sovereign wealth. Individual investors an earlier retirement. Hedge funds also provide liquidity and act as a buyer of last resort. Making money in a recession? That is when alpha is most needed and clients hired managers to do.

$5 slate & chalk = index fund –> $500 Apple iPad = hedge fund. Investors can choose old products or more powerful performance. Those billions in “wages” mostly go to philanthropy. Hedge fund pay is a kurtotic variable where fat tails render means meaningless. Rich lists miscalculate “income” and customers ultimately sign all “paychecks”. Those delivering absolute returns deserve a share for making and saving clients far more. Funds below high water marks aren’t paid well in drawdowns as the 20% incentive fee only applies to new profits. Necessity is the mother of invention and we all need INNOVATIVE alpha sources and lower risk MODERN portfolios.

By style I’m a value investor and very conservative. I started by purchasing emerging and frontier market debt, equity and real estate far cheaper that its worth. Also I spent years buying deeply mispriced options, derivatives and hybrid securities in those “unpredictable” and “efficient” markets dreamt up by “Nobel” prize winners. Recently I’ve helped fiduciary organizations manage funds and construct portfolios of managers and multimanagers whose fees are a bargain compared to their VALUE. The more hedge fund pay, the MUCH more investors make.

Successful hedge fund managers are entrepreneurs with an essential service in high demand. No matter how long a firm has been in existence I regard hedge fund investing as similar to venture capital. Angels that stake other private business get just 25%, and often less, of gross returns whereas investors in hedge funds receive 75% of gains. Managers retain the balance for sweat equity, 100 hour work weeks and low pay when underwater. Hedge funds make their talents and technologies available for a very competitive price. The value proposition is 3 times better and with considerably less risk.

Positive numbers in 2008 and 2009 is impressive and over 1,000 managers did just that. “Aggregate” hedge fund returns are routinely cited but not AVERAGE hedge fund pay. In finance the average can confuse and disguise risk. Some CDO structurers mixed 700 FICO with 400 FICO scores for “average” default rates and a few managers figured out the dangerous result years beforehand. Some good hedge funds that lost money in 2008 worked nearly gratis last year with the 2% going to employee and infrastructure costs. Much “pay” was capital gains on own cash: shared upside AND downside aligned with investors. Proper hedge funds are actually more MUTUAL than many mutual funds.

Hedge fund managers able to deliver persistent returns could avoid many hassles by only trading personal, family and friend money. To use up capacity and endure the due diligence and monitoring to accept outside OPM cash it should be financially worthwhile. Many good hedge fund managers like Michael Burry close due to success and before reaching billionaire status. Reverse survivorship bias? Why do so many assume that a hedge fund that ceases to exist must have blown up? Are two of the best shows on TV, 24 and Lost, “failures” because they are also shutting down?

An unbiased qualitative and quantitative analysis of the FACTS shows that absolute alpha is a bargain. I prefer managers to make billions since investors will receive many more billions under that payoff scenario. Hedge funds don’t exclusively trade for the superrich; they manage money or soon will be for most retirement plans and eventually a majority of individual investors of every net worth. Few on the rich list spend much time on asset allocation. They focus on security selection, tactical timing and, most important, value creation for clients.

In other industries “change in net worth” is not “salary”. Distressed assets trader David Tepper, manager of Appaloosa, apparently received the highest “paycheck” of $4 billion, followed by George Soros at $3.3 billion, James Simons on $2.5 billion and John Paulson with $2.3 billion. They and their teams produced a lot of alpha and rightly received compensation for skill and shared capital alignment with investors. Given the anomalies and inefficiencies created by forced selling in late 2008, it was obvious 2009 would be an excellent year for alpha just like deleveraging in late 1998 and negative sentiment on hedge funds led to a great 1999. The hot money panicked but sophisticated investors saw the opportunity.

I am typing this post on my newly acquired Apple iPad. That might help Steve Jobs be “paid” more billions but, like absolute return, the product is tangibly useful and fills a need. Similar to proper hedge fund managers, the Apple AAPL people deliver performance that most want so they get paid well. The Masters golf championship is being held today where someone will receive a lot of money for the best putting skill. Putt for dough and perform for dough since investment skill is much more valuable. Unskilled golfers don’t play at the Masters and unskilled fund managers don’t work at GOOD hedge funds. But hedge fund databases list thousands of hedge funds that aren’t good, dragging down “aggregate” returns. Can you imagine the typical score at the Masters if every “golfer” played? 100+?

What matters is NET performance to clients. Wisdom surpasses wealth and fees for expert knowledge are more than justified. 20 years is a long time applicable to most investors. Below is the total return of the MSCI World versus hedge fund benchmark, the HFR Fund Weighted Composite. Clearly consistent outperformance AFTER all fees and the difference will be just as wide in 2010-2030. Considering the 80/20 Pareto rule of thumb I use that 80% of hedge funds do not generate alpha, investors with robust portfolio structuring and manager due diligence processes have done better and will continue to do so. Expertise exists at many levels and has enormous value.

by Veryan Allen. Copyright

Go to Source

High frequency hedge funds? Ironic the best long term returns came from short term strategies. Buy and hope is riskier than HFT as basic Sharpe ratios will confirm. The favored holding period may be forever but in reality it’s rarely feasible and never optimal when economic volatility, creative destruction, innovation and instability are persistent phenomena. The emerging markets blog was on SPACE – invest in good opportunities anywhere. This is about TIME – invest across the holding period continuum. Buy and hold and low frequency don’t diversify enough so investors also need higher frequency strategies. New time horizon alphas REDUCE portfolio risk.

Best hedge fund for the decade? The chances are that fund is not yet in existence though I met some good startups recently. What about the best strategy? That has also likely yet to be invented. Some trends are certain like growth of alpha vendor industry AUM from the currently tiny $2 trillion to over $10 trillion by 2020. Some $100 billion hedge funds will emerge, most not established or well-known today. High frequency trading was the top category in the 2000s but it will NOT be the winner again with many entering the field dragging down “aggregate” returns. The obscure is now mainstream but the best will thrive extracting alpha out of high frequency wannabes and has-beens.

To hedge or not to hedge? That is the question. In March 2000 I presented at a conference on “whether” institutions should invest in skill-based absolute return strategies. The key takeaways from some others also speaking then were that investors didn’t need hedge funds and likely didn’t even require long only active managers since “cheap” passive index funds were bringing in +20% a year and could be “assumed” to return +10% in the long term. Fundamental and quantitative analysis were a waste of time as was paying the “cost” of hedging. Be satisfied with “market” returns? Asset allocation was risk management!

What market returns? I prefer absolute returns and hedging risk. Apart from public markets are “efficient” and there is no such thing as investment skill(!), I heard other themes:

1) the apotheosis of risky buy and hold to its exalted and unjustified status
2) hedge fund capacity was “limited” and $1 billion was “too large” AUM in one firm
3) “high” 1 and 20 fees were “certain” to drop. They are now typically 2 and 20
4) after a weak 1999, CTAs, global macro, vol arb and short sellers were “finished”
5) long only private equity and real estate were “independent” of the stock market
6) short term trading “didn’t work” and was “unnecessary” for long term investors
7) large cap equities in major markets were “always” efficiently priced and offer no chance for sustained alpha capture so forget about high frequency trading(!)

Those ideas were wrong and high frequency trading went on to be the top strategy in the 2000s. Long term performance doesn’t require a long term holding period. Most of the people in high frequency until a few years ago were good but copycat rookies are crowding into an area they think they have the expertise to compete successfully. This creates more trading opportunities and greater AUM capacity for the best players. Contrary to common theory, the more liquid and number of participants the more INEFFICIENTLY and WRONGLY priced the securities become. Irrationality does not cancel out so there are more anomalies and mispricings than ever before. Alpha is abundant but the skill to find it is rare.

The evolution to very short holding periods is the inevitable progression of Grinhold and Kahn’s Fundamental Law of Active Management equation: IR=IC.TC.SQRT(breadth). Translating the formula, if you have an investment edge then apply it as often and as widely as possible. The transfer coefficient is how efficiently active bets can be implemented and lower trading costs helps increase that. Breadth is the number of securities to which you can apply that edge. Stocks, bonds, currencies and commodities all have GROWING numbers of liquid securities suitable for HFT.

The more skilled bets you can make the better the information ratio. Ipso facto an active manager delivers the MOST value to clients by trading as many securities as frequently as their competitive advantage allows provided they have talent, excellent execution and are UNCONSTRAINED as to longs AND shorts and what they are mandated to do. Hire managers to make money how they see fit not to just give you unhedged exposure to the ups and DOWNS of an asset class.

Absolute returns are spendable cash unlike in the relative return universe. Higher frequency of investment decisions matters. We know from failed investment policies that rebalanced beta asset allocation is not sufficiently reliable if you seek to fund future retirement liabilities. What works is the dynamic triple alpha process of ongoing portfolio structuring, strategy selection and manager due diligence. We might not exist were it not for the triple alpha of nuclear fusion and the chances are portfolios will not perform over the long term without skill fusion. Real ultra low latency high frequency execution: it takes less than 200 attoseconds for the triple alpha process to complete.

Technical analysis supposedly doesn’t work so fund managers employ semantic arbitrage and refer to it as <a href="http://www.forbes.com/2010/02/10/sec-trading-stock-market-business-oxford.html
“target=_blank>pattern recognition instead. The seminal studies are correct: publicly disclosed technical indicators and “charting” methods are useless. However proprietary predictive black box models and artificial intelligence systems continue to perform outstandingly as many quantitative hedge funds have demonstrated over the long term.

The move from glacial milliseconds to measuring execution latency in microseconds was inevitable but now people are even talking about nanoseconds. Light takes more than one nanosecond to travel from the screen you are now looking at to your eyes. Picoseconds next? At least Planck time and Einstein relativity put a physical floor on how fast trading can ultimately get. With colocation competition, the time arbitrage arms race is reaching its zenith which puts the emphasis on developing better intellectual capital.

Despite being considered “new”, temporal arbitrage has been utilized for centuries. There is nothing modern about exploiting time advantages. Didn’t the Nathan Rothschild credit hedge fund make money out of slower investors in 1814 with early news of the Battle of Waterloo outcome? He short sold consols, the CDSs of the day, then went long and short squeezed the crowd the tried to follow him. Worked well ever since. Munehisa Honma’s managed futures CTA hedge fund back in 1753 constructed a high frequency data transmission and execution platform by stationing village runners as information conduits from where rice was traded to where it was grown. Momentum, mean-reversion, trend following and statistical arbitrage have been around a very long time and work on numerous time frames.

Samurai trading: the time between the decision to trade and executing that trade must be minimized. The quicker and better you are at information gathering and analysis then the higher the performance. The edge in high frequency is often slippage minimization and better transaction technology. Robo-traders and bid offer spread capture blurs the line between market makers and market takers. The fractal nature of markets means that the main constraint on capturing opportunities from microstructure and macrostructure were trading costs which continue to fall. Long term = investing, short term = speculation or vice versa? Buy and hold for years or milliseconds? They are structurally isophormic with time the only variable but the LONGER you hold a security the MORE risk you take. Ask General Motors and Japan Airlines stockholders about that. There are no blue chips, anywhere.

There is still plenty of money to be made out of the unskilled in high frequency strategies and capacity is expanding rapidly. Very liquid ETFs like SPY, QQQQ, EEM, IWM, UNG, EWJ and XLF already have most of their volume from shorter term strategies. Foreign exchange, the E-minis and KOSPI futures are probably the best equity trading vehicles on the planet and being the most liquid are of course the most wrongly priced which creates a lot of alpha opportunities for talented traders. FX offers a vast range of alpha capture opportunities as do the more liquid bond and commodity futures. The more liquid the more alpha available.

When you buy a security you might hope to hold the stock for decades or the bond to maturity but the reality is that a short term outlook is usually necessary for risk management. Commodities and currencies are fantastic for trading but never for buy and hold. Long only commodities is one of the oddest ideas out there. Long/short commodities should be core in any portfolio. The many gold bulls might recollect that GLD remains mired in a six hundred year old BEAR market and nowadays there are more sophisticated and lower tracking error ways available of hedging inflation or for difficult times.

There is a strange populist idea circulating that short term trading serves no economic purpose. The investors that DID allocate to high frequency are today better funded than those that concentrated solely on long term stocks and bonds. Alpha always has superior risk-adjusted returns than beta. Surely added liquidity is good for everyone. Those markets that heavily tax trading or ban short selling have deeper drawdowns and higher volatility than those that do not. Investors gain from lower transaction and slippage costs. The events of 2008 would have been worse were it not for the liquidity provided by automated and systematic traders. If you MUST make a fire-sale during a crash, the presence of buyers is essential. High turnover of a portfolio isn’t bad and is often essential to control risk.

Whether carbon-based or silicon-based, sapient entities of all kinds can succeed in quantitative short term investing if they work hard enough and spend many years building core expertise in the hard sciences without the luxury of a steady salary. Get fluent in C++, Java, Matlab, Mathematica and building an ultra low latency execution and market impact minimization infrastructure and anyone can be an HFT player provided you are also better than 99% of the other people trying to do it. A cheaper and quicker way for most is to hire a skilled manager to do all this for you.

The returns can be high but the cost of getting good are very high. Hidden Markov model speech recognition and compressed sensing can help determine the probability of near future moves when you have methods to analyze recent history and are able to identify order embedded in chaos. Sparsity of data is an occupational hazard in the prediction of financial markets but tick data provides large information sets to detect hidden structure. Hidden to the ridiculous random walk ranters that is.

Low frequency managers need to invest for years before we can be sure it wasn’t luck. The more trades you do, the shorter the track record needs to be to demonstrate skill. Rightly or wrongly the world increasingly functions on short term factors. Therefore as an investor you have the choice of fighting the trend or accepting the high frequency attention span of most market participants and mainstream media. We live in a Twitter world where what is hot today is not tomorrow. Stock trading is already a level playing field. Algorithmic execution systems are arbitraged by better algos.

Flash orders and sniper, guerilla or ninja algorithms are available to anyone prepared to pay the high price of access, hardware and software development costs. Dark pools lose out to darker pools. This also creates opportunity for long term investors that have the ability to find good securities amid the fluctuations. Make money from the volatility (HFT) or through the volatility (LFT)? Both but one firm cannot be good at everything which is why broad manager diversification is necessary.

There are very few long term winning securities and price predictability declines sharply with time horizon. Consistently accurate forecasting is extremely difficult but investing with a 30 millisecond outlook has more probability of success than 30 years. Amazingly brilliant are the clever clairvoyants that “know” the stock market will “definitely” be higher in 2040 than today. Wish I also had a time machine that could look ahead that far. Considering the 1910-1940 and 1810-1840 eras I wonder why they are so confident this time around. They must know something I don’t.

You need 10,000 dedicated hours to get good at something. To get basically competent at investing probably takes 10,000 separate trades or at least the thorough analysis and due diligence of 10,000 different investment ideas. As a researcher at Renaissance Technologies recently noted, “We try to find these very obscure patterns hidden in a lot of noise”. There is also a vast amount of noise in portfolio construction and fund selection but one signal is clear. Strategy diversification with many different managers whose holding periods range from femtoseconds to decades.

The solution for consistent capital growth at low volatility already exists and investors need high frequency trading strategies if they want good risk-adjusted returns EVERY year. High frequency trading is a must for every portfolio. Skill based spatial and temporal alpha is the way to go.

by Veryan Allen. Copyright

Go to Source