Monday, December 13, 2010

Review of Diary of a Very Bad Year: Confessions of an Anonymous Hedge Fund Manager

At the very beginning of the credit crisis, a magazine called n+1 published an interview with an anonymous hedge fund manager [HFM], about the business of investing money. The writer, Keith Gessen, ended up continuing these interviews throughout the credit crisis, and they were compiled into a book called Diary of a Very Bad Year: Confessions of an Anonymous Hedge Fund Manager.

Throughout the interviews, HFM ran the emerging markets desk (i.e. portfolio of investments) at a hedge fund in New York. For someone who is involved in emerging market [EM] investing, he is actually pretty astute. I appreciate, for example, that for HFM investing is "not a social event but an intellectual vocation".

This book does not have any really useful investing insights, but it is interesting if you read it as a Wall Street anthropologist.

HFM raises an interesting point about the hubris - as Taleb would say, epistemic arrogance - of people that trade the most liquid currency markets, like the most-liquid "crosses" (currency pairs) between the G-7 countries. He says, it's "amazing how many brilliant investors have gotten so much egg on their face trying to trade the G-7 crosses."

Anyway, it's no wonder it was a "very bad year", because the HFM in the book seemed way behind the curve as the credit crisis started and even into late 2008. In fact, throughout the entire crisis, HFM was pretty sanguine about the crash and about the way that Wall Street and banks handled themselves during the bubble.

He says "the fact that we've been able to confront these problems so quickly is exactly why I am in the long run optimistic." Really? In what ways have the problems been confronted rather than being swept under the rug?

I think in general there is an optimism bubble and a complacency problem in American life. As I mentioned in a post about Ken Fisher recently, the baby boomers seem to believe that because their generation never experienced adversity, it follows that adversity has been banished from history.

One of the important observations that HFM makes about the 2008 crash is that "any trade you had on that other hedge funds had on, that was a popular hedge fund trade, performed poorly because there were other hedge funds that were forced to unwind that trade."

I will often shy away from a trade because I perceive it to be "over-done" by other hedge funds. Recently, this has included the long-gold and long-inflation trades.

HFM talks about this monoculture effect among funds: "if you're trained the same way as everybody else, in general you're all going to behave the same," and also "the DNA of a lot of these [quantitative trading] models is very, very similar it's like an ecosystem with no biodiversity..."

The group-think in Manhattan is an incredibly powerful force. I wrote a post a couple months ago about how hard it is for these people to think clearly. There was a time when having an investment operation based in Manhattan made sense. You were at a physical crossroads of information, which was really important before telecommunications advances like the internet.

Now information doesn't have to be printed and can be distributed instantly, so there's no advantage to concentrating operations on one tiny island. Instead, it has turned into a disadvantage: parasites have gathered to tax you, and there's no space for independent thought.

One concrete suggestion for reducing group-think is to avoid the mass media like CNBC. I've written what I think about Jim Cramer, and it's amazing to me that he is still on the air. People have to realize that CNBC is owned by one of the world's most leveraged financial institutions, and all of its key advertisers are mutual funds and brokers whose businesses are correlated with market advances.

As HFM puts it, "We don't have TVs"! Institutions that allocate capital to hedge funds should really check trading floors for the presence of televisions, and probably also the employees' houses. A hedge fund manager should own at least 50 books for every diagonal inch of television screen that he owns.

Overall I give this a 3.5/5 - it would have been a 3 but I add a half-point because it was pretty short and a breeze to read.

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