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Friday, June 17, 2011

(Book Review) More Money Than God



More Money Than God is a great book with a distasteful title. It's like You Can Be a Stock Market Genius, once you get past the title, the book itself is wonderful. So what would I name it? Simple:

The History of Hedge Funds: the people involved, the tactics used and the affect on on the markets.

Some points and stories in the book that really struck home:

  • A successful hedge funds worst enemy is their success itself. Either associates in the fund realize they could make more money by striking on their own or other people start to copy their tactics. Generally the founder becomes fat and happy and loses their entrepreneurial zeal to younger and hungrier competitors.
     
  • Certain trades at the beginning are brilliant ideas then slowly dissolve into a "crowded trade."  Eventually the ROIC becomes drastically lower and traders end up using too much leverage to make the trade reasonable. Jut like in Ecology, the trades have a carrying capacity and it's important be aware if the idea is too crowded, because if it is there might be a market event that triggers a sell off and since everyone is trying to delever, the trade officially turns from being brilliant to a disaster.
  • Currency speculators can profit off poorly designed fixed exchange rates. One speculator made money by going long the Riyal and shorting other currencies. His reasoning was the Riyal was undervalued compared to it's fixed exchange currency, the US dollar, and the large trade surplus was not going to end anytime soon with it's vast oil reserves. Saudi Arabia was also fighting strong inflation at the time due to large capital inflows attributed to the fixed exchange rate. Soon after, Saudi Arabia floated it's currency and the speculator profited immensely. 
  • There was also a beautifully detailed account how Soros and Druckenmiller (Quantum) shorted the British pound. Quantum knew there was a fixed exchange rate between Britain and Germany, but at the time Britain was in an economic doldrums and didn't want to raise their interest rates since they needed low interest rates pump the economy up and very importantly, the British householder held mortgages that fluctuated with interest rates. So if the interest rate went up, the average Brit's ability to save decreased since their monthly mortgage payment would increase with an increase in interest rates. Yet, at the same time, Britain had a fixed exchange rate with Germany. Which at the time was experienced some inflation due reunification of East and West Germany. The central banker in Germany had no interest in lower interest rates since it would spur more inflation and the sole purpose of Germany's central bank is to keep inflation in check since thoughts of Weimar were scared in the memory of Germany.   So there was a problem. If you can have higher interest rates in another country and there is a fixed exchange, you can move your capital to Germany and enjoy better rates. This lead to a substantial currency pressure for Britain which was forced to buy British pounds and sell their foreign reserves in order to keep the fixed exchange rate in effect. Yet this whole thing was heavily exacerbated when the Quantum fund heavily shorted the British pound, forcing the British bank to sell even more of their currency and buy more British pounds. Eventually the cost of losing their foreign reserves and keeping up with the fixed exchange rate was too high. Towards the end of this fiasco Britain started to raise their interest rates, which was politically and economically unpopular, yet it was too little and too late and eventually Britain left the fixed exchange mechanism.  Quantum fund made a bundle and thats how Soros broke the Bank of England.  
  • Learning how commodity speculators made money was very interesting. They would made models trying to best determine the supply and demand for a certain commodity. Take cocoa as an example, commodity traders would model out what they thought the demand for cocoa would be based on economic data (richer you are the more chocolate you eat?.) Then they would model out the supply of cocoa based on each producer countries weather, political stability, and farming efficiency.  Knowing how to model the supply and demand for the commodity gave speculators an edge in determining a more likely price.
  • Paul Tudor Jones philosophy seems the most visceral and the one I least understand. Paul tries to sense how other traders react to his presence and plays off that reaction. There tends be a great deal of theory of mind from what I understand. He also uses past charts to help predict future movements in the market. Although his record speaks for itself and obviously must have a lot of experience in the market, I don't understand his philosophy.  I'd suggest for anyone to watch the documentary Trader, it's an old documentary where a young Paul Tudor Jones wears Bruce Willis' shoes to get an extra point in the market....oy vey
  • Michael Steinhardt has an impressive record and benefited from being short when all the original hedge funds were long. He seems like a great investor but not the kind of person I'd like to go to the beach with. He also made money by providing liquidity to large institutional investors who needed to trade out of large positions. Some of what on there was sleazy. He obviously was getting information from brokers about was doing the selling & buying (plodding insurance company = patsy, entrepreneurial hedge fund = watch out.)  Didn't learn much from him other than providing liquidity in the market can be profitable, although you do risk eventually being blown up. 
  • If I could go back in time I would want to work for Julian Robertson at the Tiger fund. He is a hard nosed value guy with the charm of a Southerner. Jim Chanos worked under him and said he was one of the best teachers. Ken Griffin also worked under him for a while. 
  • Ken Griffin from Citidal is a badass. I would wear his shoes for an extra percentage point not Bruce Willis's. Citidal bailed out a couple of hedge funds during critical periods and because of his efficient back office, which everyone else outsources, he is able to make acquisitions and get feedback on positions very quickly and  also was smart enough to get borrow money long term so when the liquidity crisis hit, he was able to stage off the vultures.
  • High Frequency Trading firms or Quants are still pretty much a mystery to me. Lots of their work depends on arbitraging positions with little return but beefing up their positions with leverage in order to get a good enough return. To me, I can't see how Quant firms have a competitive advantage. These firms are constantly being berated by other smart firms trying to figure out their positions/algorithms and their constant use of leverage makes them very susceptible to blow ups. Currently reading another books on Quants, that should clear up some things.

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