Hedges And Edges

More information doesn't always mean more profit

Greetings from the beginnings of tax season, where I’m doing a little less book reading and a lot more cramming on tax rules and wrestling with software glitches. I learn a lot from the money theory I read, but I learn just as much from working with people who are trying to survive. Each year, I’m reminded by how little people live on. I think I’m frugal but not nearly as frugal as many of the people I meet who simply have no choice. The averages for household income that we are told don’t tell the full story of the world, of the people who are visiting food banks and going without health insurance because everything has gotten too expensive.

This week’s read, finished up on a Sunday afternoon before Libby extracted it from my phone, is an uncomfortable juxtaposition; it’s hard not to wonder why the hedge-fund billionaires, no matter how temporary their money is, can’t translate it into good in the world. At some point, there is more money than one person or one family can spend. Capitalism pushed beyond human reason.

If I took only one thing away from Sebastian Mallaby’s book on hedge funds, More Money Than God, it was this: “no system, human or computerized, is correct all the time.” That’s right, even the hedge fund legends don’t have flawless records. Investing is a bit like batting averages, to be incredible you don’t have to be perfect, you just have to be better than the next guy. For the hedge funders, you also have to want money above all things. David Swensen, the hedge fund investor who supercharged Yale’s endowment, refers to his decision to work for Yale instead of becoming a billionaire as a “genetic defect.” In that world, to not want as much money as possible is a flaw.

To be one of these hedge funders, you also have to not mind failing and losing other people’s money. I keep thinking that the success of these billionaires is about risk and that is some of it but the other part of it is lacking shame and guilt, including bearing little to no responsibility when things go belly up. One line Mallaby quotes a couple of times is George Soros saying “go for the jugular” when shorting the British pound. To be really rich in this world and to hold onto it, you must be very lucky and very ruthless. The tale of hedge funds is about intelligence in all forms, but also about caring about the money more than anything else.

Hedge funds, in their purest form, are about making money by finding edges and balancing them against each other. In theory, we should all be hedgers to some extent, noticing where our risks and and seeking to balance them out. Finding the edge that leads to outsized gains is a different matter. Edges can be tricky things, some people are chartists, some are intuitives, some dive deep into a company’s inner workings, some are macro players. Nearly every strategy has been tried, and some worked, and some didn’t. Or some worked until they didn’t. Every chapter of this book was about different funds, each with a variety of strategies involving all sorts of global wheelings and dealings from Kazakhstan to Indonesia.

One of the reasons I’m creating my money library, my own money knowledge, is because I want to understand this thing that runs our lives on both a practical and philosophical level. It is, as Mallaby puts it, it is “a medium through which greed and fear and jealousy expressed themselves; it was a barometer of crowd psychology.” He wrote this about Alfred Winslow Jones and his creation of the first hedge fund. The first advantage was to be aware of what other people were thinking and to catch the tide of the market before it turned. That type of advantage worked well when most investors in the stock market were individuals. When pension and retirement funds became major players, new strategies were needed.

I don’t fully understand a lot of the financial maneuverings of some of these funds. Foreign exchanges and broad macro plays are something I’m still learning about. One thing that is clear is that as these funds got larger, they evolved from market watchers to market movers. I’m going to write more about quants soon (that is something I’m still getting my brain around), but one thing that I’m thinking about lately with regard to my own money is that there may be no way to fully derisk. Often, people chase negative correlation, switching from stocks to bonds or vice versa, thinking that this is protection. Once upon a time, when I was a young wayward soul living in a macrobiotic commune, I was taught that the bigger the front, the bigger the back. This simple phrase has lived with me for decades. This book was all about watching men chase outsized profit and often enduring stomach-dropping losses. Dramatic to read about but it will never be the game I play.

I’m still working through my paperback copy of “Too Big To Fail” but that phrase looms large in this book and in my consciousness lately. The more I look at institutions running the world, I see not just too big to fail but simply too big. When a company has the economic power of a country, it cannot be reined in and yet when it fails it needs to be rescued. When that happens over and over it creates both the illusion of strength and the potential for systemic weakness. In my personal life, I believe we only get so many bailouts; the same should be true for corporations.

Part of Mallaby’s conclusion is that while hedge funds have contributed to various financial big swings, hedge funds in themselves aren’t evil. Small funds taking big risks won’t shake the market. Big funds and banks seeking outsized gains at any cost are what disrupt the market and swamp all of us small fish. At one point in the book, Ken Griffin, founder of Citadel, in an interview with Mallaby, says it’s a pretty bad day when “you realize twenty years of your work now comes down to whether or not some firm that you have no influence over fails.” True for Citadel certainly but far moreso for those of us with far less money and so much more to lose.