1st June 2013: Proposal for ISA’s 2014 Annual Convention

The International Studies Association is holding its Annual Convention for 2014 in Toronto, Canada.

 

Below is one proposal I have submitted for consideration by the International Political Economy and International Security sections:

 

Geopolitical Flashpoints, Systemic Risk & Distal-Influenced Spatiality

 

Abstract: Geopolitical flashpoints and systemic risk are now global arbitrage opportunities for hedge funds and political risk firms. Bridgewater (Ray Dalio), AQR Capital Management (Aaron C. Brown), PIMCO (Bill Gross & Mohamed El-Erian), Roubini Global Economics (Nouriel Roubini), and Stratfor (George Friedman & Robert D. Kaplan) have each contributed to media, policy, and practitioner debates about the 2008-10 rare earths bubble, the United States pivot toward Asia, and Iran-Syria-Russia oil speculation. This paper uses develops a Bayesian inference framework which emphasizes distal (far away) and spatial cause-effect relationships, in order to explain how hedge funds and political risk firms as non-state actors can enact global arbitrage and actively influence/shape public debates. I integrate analytical research from the sociology of finance (Donald MacKenzie), international security (Stephen G. Brooks), critical world security (Michael T. Klare & Naomi Klein), intelligence studies (Amy B. Zegart, Robert Jervis, & Gregory Treverton), hedge funds (Andrew Busch & Andrew Lo), and fictional speculation (Richard K. Morgan), to develop a new, inductive theory-building alternative to current explanations that emphasize proximate (near) and temporal causes. This paper advances new understanding about ‘casino capitalism’ (Susan Strange), expert networks, hedge fund activism, and political risk arbitrage.

16th January 2013: Herbalife

The hedge fund battle between Pershing Square Capital Management and Third Point Capital over Herbalife is fascinating. Third Point’s Daniel Loeb is long on Herbalife citing the potential for further value creation via a revamped management. Pershing’s Bill Ackman likens the health products distributor to a multi-level marketing pyramid scheme. Slate‘s Matthew Yglesias has a good summary of Ackman’s pyramid scheme allegations and the fallout in the media and financial markets. Loeb and Ackman’s duel is a valuable real-time case study that reveals how hedge funds develop variant perceptions; how they use long and short positions to create zero-sum strategies; how they analyse company management and performance to determine valuation; and how they discover alpha (active investment returns above a benchmark or passive strategy).

24th August 2012: Gawker’s Bain Files

Nick Denton’s Gawker site has released 950 pages of documentation on Mitt Romney’s Cayman Islands private equity and hedge fund investments. Henry Blodget’s BusinessInsider is skeptical, but this cache could keep me busy for months. Dangerous Minds‘ Richard Metzger sums up how I feel: “The idea that these documents are, currently, as I type this, being analyzed by crowd-sourcing is either a fortunate or very unfortunate fact of political life in 2012!” Vanity Fair‘s Nicholas Shaxson has a useful backgrounder on why hedge funds use the Cayman Islands domicile for offshore tax minimisation.

23rd July 2012: Barton Biggs

Money manager Barton Biggs died last week. Biggs worked at EF Hutton, Morgan Stanley, and helped to found several hedge funds. He personified the old Wall Street tradition of research analysts and institutional money managers who were ‘big picture’ thinkers — the forerunners of today’s scenario planners and strategic foresight analysts. Biggs’ memoir Hedgehogging was an enjoyable, insightful entry into the world of hedge funds. I learned from Biggs how hedge fund managers read Barron’s, The Economist, and other publications.

2nd July 2012: Ray Dalio

I’ve spent the past few weeks reading about Bridgewater hedge fund founder Ray Dalio who is notorious for his management principles (PDF). The Economist and Barron’s have profiled Dalio recently and he updated his model of how the economy works. Dalio also did extensive interviews for Maneet Ahuja‘s The Alpha Masters and Jack D. Schwager‘s Hedge Fund Market Wizards. Dalio’s secret is to find 15 different and uncorrelated alpha streams; to separate alpha from beta exposure; to have a 6-18 month timeframe for holding; and to control transaction and execution costs.

5th June 2012: Roy Christopher’s 2012 Summer Reading List

Roy Christopher

 

Roy Christopher‘s annual Summer Reading List is a snapshot of “the salient texts of the zeitgeist.” RoyC’s 2012 list continues the tradition: rich insights from netizens, ethnographers, cultural luminaries, mentors and critics on the authors, ideas and frameworks that inform their work. An Edge or Iconoclasts-style dialogue/trialogue between some of these people would be very interesting to witness.

 

I spent a lot of the past year reading about Wall Street, writing draft zero of a political science PhD, and trading a small portfolio. My suggestions this year reflect this personal journey and are different to what I would normally contribute to RoyC’s list (and what other list contributors would probably read and sympathise with). There are books on geopolitical risk and salary negotiation, PhD texts on social science methods, and guides to investment, hedge funds, the visceral feel of trading, and institutional money management. Brenda Jubin’s awesome blog Reading The Markets informed some choices and Tadas Viskanta’s blog Abnormal Returns is now a daily visit. Hopefully, you’ll get a sense of how I approach and attempt to understand a knowledge domain on its own terms, even if some of the material is a very dry read.

 

The joys of this list include uncovering new things, and seeing things you are familiar with from a different vantage point. RoyC pointed out ethnographer and sociologist Tricia Wang‘s contribution to me: Brian Eno and Manual De Landa have also influenced me, and I will be checking out several of her banking and finance ethnographies. Likewise with RoyC, the cultural anthropologists Victor Turner and Arnold van Gennep are influences; I studied Aaron Wildavsky on risk; and I bought a secondhand copy of Anthony Wilden’s Systems and Structure from an old secondhand book shop in Melbourne.

 

I also participated in RoyC’s Summer Reading Lists for 2011, 2010, 2008, and 2007 (I missed 2009). You’ll see how my in-progress PhD project and other interests have evolved over the past five years. RoyC’s annual summer reading list now has a quality like Michael Apted‘s Up series: an unfolding, longitudinal journey through some interesting ideas of the early 21st century.

2nd March 2012: Media Narratives on Traders

Frankfurt Stock Exchange

 

The Baseline Scenario‘s James Kwak observes about financial trading:

 

The main reason why finance’s share of GDP has outstripped its production of intermediation services, according to [Thomas] Philippon, is a huge increase in trading volumes in recent years. Trading, of course, generates fees for financial institutions, with limited marginal social benefits. Yes, we need some trading to have price discovery. But if I sell you a share of Apple on top of the other 33 million shares that were traded today, is that really helping determine what the price of Apple should be? The more that financial institutions can convince us to trade securities, the larger their share of the economy, whether or not that activity improves financial intermediation. [emphasis added]

 

Kwak’s comment interested me for several reasons. I thought immediately of Philip Augar‘s trilogy of books on London’s transformation as a global finance hub (The Death of Gentlemanly Capitalism; The Greed Merchants; and Chasing Alpha). Kwak’s emphasis on intermediation — intermediaries who match lenders and borrowers — reminded me of the Smart Internet Technology CRC’s emphasis on strategies of first mover advantage, disintermediation (removing intermediaries), and end-user innovation. Finally, Kwak espouses a critical view of trading that resonates with Occupy The SEC and other Wall Street critics.

 

Traders’ usual response is that they provide the market with liquidity as well as price discovery, and that estimates of assets’ future values can vary.

 

The media has two dominant narratives about traders. First, traders are American Psycho-like psychopaths that ‘go rogue’. Second, proprietary traders at financial institutions and hedge fund managers can make exorbitant amounts of money. The first narrative occurs during recessions and on the discovery of major cases like Barings’ Nick Leeson or Societe Generale’s Jerome Kerviel. The second narrative occurs during the initial stages of macroeconomic booms and speculative bubbles. A New Yorker profile of private equity maven Stephen Schwarzman in 2007 captures the transition between the two narratives.

 

In September 2011, just as the Occupy Wall Street protests were unfolding, Germany’s Der Spiegel cited a study that appeared to prove the first narrative. Pascal Scherrer and Thomas Noll, two MBA students at University of St. Gallen, interviewed 28 Swiss traders, using “computer simulations and intelligence tests.” The study went viral and it was cited throughout the United States mainstream and financial media (including by my old boss Richard Metzger at Dangerous Minds with his acerbic wit). The authors aren’t easily accessible: a Google search brings up other people – an Australian post-doctoral fellow in tourism and a German software engineer. St. Gallen’s MBA program did not release the paper — but sources did reveal it was an MBA student assignment and not peer reviewed academic research.

 

Even without seeing it the Scherrer & Noll’s study raises questions: the kind that get asked in blind peer review and by research administrators and managers. Did Scherrer (“forensic expert”) and Noll (“a lead administrator at the Pöschwies prison north of Zürich”) have the financial markets background to contextualise what the traders were saying and why? Did their background potentially bias how they would interpret the data: looking for or interpolating certain correlations? What specific “computer simulations and intelligence tests” did Scherrer and Noll use? How were these tests framed for the trader participants? Is the data from two different groups — traders and psychopaths — truly, directly comparable? From where, how and whom did the psychopath data come from? Who else, apart from the psychopaths, was the control group? What other competing hypotheses or theories were tested? Are the test subjects institutional or day traders? What instruments and markets did they trade? What range of trading strategies did they use and why? What was their performance like during the study’s time period? You will find these aspects in the methods and research design section of most rigorous academic journal articles. It is why top journals now require academic authors to release the raw, de-identified data for others to examine.

 

Noll’s comments to Der Spiegel are revealing, when the above is taken into account. Some traders are “egotistical”: perceiving themselves to be entrepreneurs in a financial institution. Trading attentiveness can require high ego-involvement. Trading can be a solo activity — affecting the study’s variable of “readiness to cooperate” — although prop firms like SMB Capital do get their traders to cooperate in order to get synergistic, group effects. Traders are usually risk-seeking and aware of time-based competition so of course they were “were more willing to take risks” since careful risk management is essential to arbitrage and trading. Noll expressed surprise that traders sought “a competitive advantage” and “weren’t aiming for higher winnings than their comparison group.”

 

But this a sign to me that Noll misunderstood the traders and also the financial institution they worked in. Prop traders can gain 40-60% of their compensation through bonuses with the institution can change based on risk-adjusted performance. In essence, trading is about gaining competitive advantage in a zero-sum game — particularly in highly stochastic and volatile areas like currencies and commodities futures. This is why many traders read Sun Tzu‘s Art of War and Miyamoto Musashi‘s Book of Five Rings, or study non-cooperative game theory and behavioural finance. Then there’s why University of St. Gallen possibly released Scherrer and Noll’s study to the media: the MBA program emphasises “responsible leadership” and the study nicely fits with this institutional goal. However, it obscures other explanations for ‘rogue traders’, such as Adam Curtis noting in his documentary 25 Million Pounds that Barings Bank management likely knew of and endorsed Nick Leeson’s trading activities whilst they were profitable. For many people, Scherrer and Noll just confirmed what they already felt about Wall Street traders.

 

In reality, ‘traders as psychopaths’ is a media-created narrative. It can be traced to Gordon Gekko (Michael Douglas) in Oliver Stone’s film Wall Street (1987); to Ivan Boesky and Michael Milken; to Michael Lewis‘s autobiography Liar’s Poker (1989) about his time in Salomon Bros as a bonds salesman; and to George Soros and the 1992 United Kingdom currency crisis. In the 1980s, a healthier vision of the Masters of the Universe were traders like Martin Zweig and Victor Sperandeo. A decade later, Frank Partnoy‘s cautionary biography Fiasco (1999) refashioned the image for financial crises in Asia and Latin America. John Perkins’ Confessions of An Economic Hitman (2004) expanded this to the Washington Consensus. CNBC’s Jim Cramer morphed from a successful money manager to a television personality. Satyajit Das transitioned from writing guidebooks on financial derivatives to becoming an articulate media critic. Richard Bookstaber had a more nuanced and systemic view of hedge funds with A Demon Of Our Own Design. The latest addition to this narrative is Jared Dillian’s Street Freak (2011) on his experience at Lehman Bros. and the short-lived BBC series Million Dollar Traders starring Lex Van Dam and Anton Kreil.

 

Scherrer and Noll’s study appealed to people whose self-image of traders came from Gordon Gekko and Liar’s Poker. The collapse of Bear Stearns and Lehman Bros. during the 2007-09 global financial crisis — and the ‘too big to fail’ negotiations with financial institutions — now reinforce this self-image. A more realistic image of traders can be found in Ari Kiev and Brett N. Steenbarger‘s books on trading psychology; in the multi-author ethnographic study Traders; and in Jack D. Schwager‘s interview books which are ‘required reading’ for many traders. I’ve seen footage of traders’ live reactions to the 1987 stockmarket crash: the traders are shocked but they still react. There’s little room for ‘traders as psychopaths’ in contemporary high-frequency trading systems (which created fears around the 2010 ‘flash crash’). But the media narrative serves as a screening mechanism: it prevents people from finding out how trading really works or how its principles can be used elsewhere in their lives. If Scherrer and Noll really wanted “a sober and businesslike approach to reaching the highest profit” then they interviewed the wrong group: they should have talked with pension fund and private wealth managers in Switzerland, or with portfolio managers. This potentially introduces scope and levels of analysis limitations into Scherrer and Noll’s study (since fund and portfolio managers can act differently to traders).

 

Slate‘s Richard Beales illustrates the second narrative: billionaire hedge fund managers. Beales’ target is Ray Dalio, founder of Bridgewater Associates and author of a ‘Principles’ employee handbook (PDF) which The Wall Street Journal‘s Paul Farrell compares to capitalist philosopher Ayn Rand. Beales notes that hedge fund founders usually keep a low profile; are privately owned and more entrepreneurial than banks; and have a compensation structure more aligned with investors. The second narrative is really a subset of the ‘winner-takes-all’ dynamic in superstar economics. Milken, Zweig and Sperandeo in the 1980s, Soros in the 1990s, and John Paulson now are the financial equivaelent of superstars. Beales doesn’t cite hedge fund researchers like Andrew Lo or Sebastian Mallaby. He doesn’t mention the high failure rate of hedge funds or the survivorship bias in industry databases.

 

Which brings me back to Kwak’s original insight. His claim that financial markets are less efficient flies in the face of new systems that lead to smaller bid-ask spreads (high-frequency trading), and more diverse, targeted fund structures (mutual, hedge and quantitative trading). Rather, these developments have led to an interlocking network of funds and financial institutions who trade, at greater volumes and in more liquid instruments. In this network, the fund and portfolio managers, and the traders, occupy highly lucrative niches. Understanding how and why they are successful (or fail) has taught me some significant, actionable, and pragmatic knowledge.

 

Photo: saibotregeel/Flickr.

15th January 2012: Trading Books For 2012

On my possible reading list for 2012 from Wiley Finance:

 

1. Michael Goodkin’s The Wrong Answer Faster: the inside story of the quantitative finance firm Numerix and the physics models that Goodkin developed to model financial markets. I look forward to some backgammon tips.

 

2. Maneet Ahuja’s The Alpha Masters: an insider’s guide to the money management strategies of hedge funds — I hope it’s on a par with Andrew Lo’s research (MIT).

 

3. Jack D. Schwager’s Hedge Fund Market Wizards: the fourth book of interviews in Schwager’s hugely influential Market Wizards series — will it live up to the excellence and insight of the previous three books?

31st December 2011: Trading Books

Market Wizards: Interviews With Top Traders by Jack D. Schwager (Columbia, MD: Marketplace Books, 2006). (TS-3). Schwager’s interviews are frequently at the top of professional traders’ recommended reading lists for their insights into the personalities, backgrounds, decisions and different strategies of traders. Schwager’s follow-up books The New Market Wizards (Columbia, MD: Marketplace Books, 2008) and Stock Market Wizards (Columbia, MD: Marketplace Books, 2008) feature further informative interviews with different groups of traders. Useful for comparison with Brandt, Einhorn, Lewis, and Mallaby below.

 

The Big Short: Inside the Doomsday Machine by Michael Lewis (New York: Penguin Books, 2010). (TS-3). Lewis (Liars’ Poker, Moneyball) profiles the Wall Street analysts and hedge fund traders who foresaw the 2007-09 global financial crisis: Steve Eisman, Mike Burry, Greg Lippman, Charlie Ledley, Ben Hocket, John Paulson and others. The Big Short how credit default swaps and other synthetics of financial engineering were created. Lewis exemplifies how ‘contrarian’ traders think and make trading decisions about financial markets: there is enough journalistic reportage in this book to actually model the trading strategies. For details of J.P. Morgan’s creation of collateralised debt obligations see Gillian Tett’s Fool’s Gold (Little, Brown, New York, 2009). For details of John Paulson’s ‘Soros trade’ see Gregory Zuckerman’s The Greatest Trade Ever (Penguin Books, London, 2009). For the best account of the negotiations behind the 2007-09 global financial crisis, see Andrew Ross Sorkin’s Too Big To Fail (Viking, New York, 2009). For further analysis of the business cycle implications, see Nouriel Roubini and Stephen Mihm’s Crisis Economics (The Penguin Press, New York, 2010).

 

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby (London: Bloomsbury PLC, 2010). (TS-3). Mallaby’s history of hedge funds – financial vehicles that enable pooled investors to speculate on stock-markets – has interviews and historical details which are unavailable elsewhere. More Money Than God explores how hedge funds have evolved over the past four decades, from journalist Alfred Winslow to philanthropy. There are interviews with George Soros, Julian Robertson, Bruce Kovner, Paul Tudor Jones, John Paulson, and details of David E. Shaw’s firm D.E. Shaw and James Simons’ Renaissance Technologies: two ultra-secretive quantitative hedge funds. As with Jack D. Schwager’s series on traders, this is an invaluable book for understanding how hedge funds actually work and the motivations of their founders. For some of the best academic research (and influenced by Isaac Asimov’s Foundation series) see Andrew Lo’s Hedge Funds: An Analytic Perspective (Princeton University Press, Princeton, 2010). For a comparison with ratings agencies, see Timothy J. Sinclair’s The New Masters of Capital (Cornell University Press, Ithaca NY, 2008).

 

Fooling Some of the People All of the Time: A Long Short (And Now Complete) Story by David Einhorn (Hoboken, NJ: John Wiley & Sons, 2011). (TS-4). In 2002, hedge fund manager David Einhorn gave a speech advising investors to ‘short’ Allied Capital. Einhorn’s talk triggered a criminal investigation and maneuvers between Einhorn and Allied Capital. This book can be read as an investigation of corporate governance issues that foreshadowed the 2007-09 global financial crisis. Its primary value lies in revealing the research methods and decisions that a successful value-oriented fund manager uses; the accounting tricks that firms use; and how Kahneman’s biases and heuristics can influence hostile situations. If you want to understand the basics of corporate finance, valuation and fundamental analysis then see the McKinsey model in Tim Koller, Richard Dobbs, and Bill Huyett’s Value: The Four Cornerstones of Corporate Finance (John Wiley & Sons, Hoboken NJ, 2010).

 

Diary of a Professional Commodity Trader: Lessons from 21 Weeks of Real Trading by Peter L. Brandt (Hoboken, NJ: John Wiley & Sons, 2011). (TS-4). Most trading books feature post facto selections of trade examples and market timing. Brandt’s diaries and technical analysis charts convey how difficult trading actually is; the importance of risk and money management; and the struggles to deal with Kahneman’s biases and heuristics. This book dispels the myths of day-trading success and much of the publishing books that Wiley Finance, McGraw-Hill and other publishers release.

 

Thinking, Fast and Slow by Daniel Kahneman (New York: Farrar, Straus & Giroux, 2011). (TS-1). Kahneman (awarded the 2002 Nobel Prize in Economics) and his late colleague Amos Tversky pioneered the study of psychological biases and decision heuristics. Kahneman distinguishes between System 1 (fast, emotional) and System 2 (slower, methodical, logical), and how these different cognitive systems affect us. An excellent primer on how to think, reason, and decide more effectively, which makes accessible over four decades of Nobel Prize-winning research. Effective trading is about making reasoned decisions in a fast, volatile environment. For an example of how event risk and volatility can affect decision-making and financial models, see Roger Lowenstein’s When Genius Failed (Fourth Estate, London, 2002) on the 1998 collapse of the hedge fund Long-Term Capital Management.

 

Unconventional Success: A Fundamental Approach to Personal Investment by David Swensen (New York: The Free Press, 2005). (TS-3). Swensen is the successful investment manager with Yale University’s endowment fund. Unconventional Success distills his insights on the investment process; how to develop an investment portfolio; the different asset classes; and the role of asset allocation over market timing (trading). Swensen — like John C. Bogle (founder of The Vanguard Group), Burton G. Malkiel (A Random Walk Down Wall Street), and others — recommends that you put most of your money into a low-cost index fund like Vanguard or Dimensional Fund Advisers. Swensen’s companion book Pioneering Portfolio Management (The Free Press, New York, 2009) deals with active managers in an institutional funds context. If you want to understand the institutional money management approach, see Richard C. Grinold and Ronald N. Kahn’s Active Portfolio Management (McGraw-Hill, New York, 1999) for quantitative and risk management processes, and Antii Ilmanen’s Expected Returns (John Wiley & Sons, Hoboken NJ, 2011) for asset allocation decisions.

 

The Predators’ Ball by Connie Bruck (New York: Penguin USA, 1989). (TS-3). In the 1980s high-yield or junk bonds led to a mergers and acquisitions bubble. Bruck profiles junk bonds trader and market creator Michael Milken (now a philanthropist) and the major deals that his firm Drexel Burnham Lambert financially engineered. The Predators’ Ball has substantive insights and journalistic reportage on Milken’s thinking and strategies, similar to Lewis (The Big Short) and Mallaby (More Money Than God). This period is also covered in the Adam Curtis documentary The Mayfair Set (1999). This is a cautionary tale of ethics and power: Milken essentially created and monopolized the junk bond market but acted unethically and was involved in the Ivan Boesky scandal. The epochal RJR Nabisco deal is covered in Bryan Burrough and John Helyar’s influential Barbarians At The Gate (Collins Business, London, 2008). For a comparison of Drexel Burnham Lambert with the private equity firm Kohlberg Kravis Roberts see George P. Baker and George David Smith’s The New Financial Capitalists (Cambridge University Press, New York, 1998).

 

Inside Job (Sony Classics, 2010). (TS-3). Charles Ferguson’s Academy Award-winning documentary dissects the 2007-09 global financial crisis and its roots in a housing speculative bubble, the failure to regulate derivatives markets, and a ‘winner takes all’ trading culture. Features interviews with George Soros, Nouriel Roubini, Raj Rajaratnam, and others that summarise complex issues.

 

Million Dollar Traders (BBC2, 2009). (TS-3). European hedge fund manager Lex Van Dam and ex-trader Anton Kreil supervise 8 novices who run a hedge fund in London’s Cass Business School for two months. Several weeks into the project, the 2007-09 global financial crisis begins, and each trader reacts in different ways. Interesting for its use of simulation learning, event arbitrage and how the various personalities deal (or don’t) with stressful situations and uncertain decision-making. In one sequence, the cameras reveal that Kreil is having instant chat messages with outsiders using a producer’s account: Van Dam may actually be trading against the novices.

 

The Mayfair Set (BBC, 1999). (TS-3). Adam Curtis (The Century of the Self, The Power of Nightmares, The Trap, All Watched Over By Machines of Loving Grace) profiles a group of entrepreneurs associated with London’s Clermont Club, including Jim Slater, James Goldsmith and Tiny Rowland. The Mayfair Set documents their stock-market deals and internecine fighting from the late 1950s to the 1980s mergers and acquisitions bubble in the United States. Curtis links together fears about national sovereignty, business cycles, financial innovation, media battles, and luck. Jim Slater’s Return To Go: My Autobiography (Weidenfeld & Nicolson, London, 1977) recounts the Slater Walker years whilst Geoffrey Wansell’s Tycoon: The Life of James Goldsmith (Grafton, London, 1987) is an insightful, semi-authorised account of how Goldsmith pioneered mergers and acquisitions raids and asset management techniques.

Foreclosure Of A Hedge Fund Dream

Media personalities who took a career detour into managing hedge funds are the latest casualty of the subprime fallout, reports New York Times journalist Andrew Ross Sorkin.

Sorkin profiles Ron Insana the former CNBC news anchor who founded Insana Capital Partners at the height of easy credit in 2006 and closed ICP in August 2008.  Insana raised $US116 million from major investor Deutsche Bank and media contacts.  Rather than invest directly in complex financial instruments Insana chose an intermediary position: a fund of funds investor in a diversified portfolio of hedge funds.

Insana made several errors that led to ICP’s blow-up.  Sorkin notes the US$116 million was a smaller capital raising than its blue chip competitors.  The fund of funds positioning meant a rational herds strategy on the hedge funds that ICP invested in.  Subprime-caused market volatility set off a cascade: the hedge funds didn’t make alpha returns above the market and ICP didn’t have the diversified portfolio to weather the volatility.  Consequently, ICP still had to pay out investors in full for their original investments (the ‘high water mark’ rule) before it could earn its ‘1.5 of 20’ fee (1.5% management fee on funds and 20% of fund profits).

Sorkin is insightful about the cost structures of hedge funds:

That would have been enough if it was just Mr. Insana, a secretary and
a dog. But Mr. Insana was hoping to attract more than $1 billion from
investors. And most big institutions won’t even consider investing in a
fund that doesn’t have a proper infrastructure: a compliance officer,
an accountant, analysts and so on. Mr. Insana had seven employees, and
was paying for office space in the former CNBC studios in Fort Lee,
N.J., and Bloomberg terminals — at more than $1,500 a pop a month —
while traveling the globe in search of investors. Under the
circumstances, $870,000 just wasn’t going to last very long.

This ‘contrarian’ observation highlights the leverage of institutional investors, and, in contrast to the usual media portrayal, the regulatory burdens of institutional compliance on funds.

Sorkin’s profile raises some interesting questions beyond his comparison of Insana and the media-savvy millionaires who blew-up after the April 2000 dotcom crash.  Did ICP adopt the trend following strategy from CNBC’s media coverage and Insana’s popular books?  If so, could Insana distinguish between market noise and critical events?  How did Insana grapple with the career change from CNBC news anchor to hedge fund head?  What risk mitigation steps did ICP’s investors demand, and did Insana exercise prudential caution? When he had to close ICP was Insana able to be self-critical about his past decisions and errrors?  Are there firm-specific, operational and positioning risks for fund of funds?  That would be a really interesting post-implementation review for aspiring hedge fund mavens.

Don’t expect to see it in CNBC European Business or Bloomberg Markets anytime soon.