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On Minyanville’s Pivot

This week I’m reading Josh Brown and Jeff Macke’s Clash of the Financial Pundits (New York: McGraw-Hill, 2014) during my work commute. Brown and Macke interview financial media pundits and bloggers. Minyanville’s Todd Harrison has overshadowed the book’s release in announcing that the popular financial news site will pivot to financial services:

 

Our current business model does not extend to financial services, and that’s OK — it’s broken anyway. I do, however, believe that what we’ve built is extremely valuable to a broker-dealer looking to leverage a fertile audience, acquire new customers, optimize the social sphere, turn clients into community, market through new channels, engage next-generation investors, and build a lifetime relationship.

This, in my view, can be accomplished by attaching Minyanville to an existing financial services firm as an incubation lab and allocating our assets and abilities across their business model. There are several reasons this makes sense — among them, education, credible content, and creativity are rare commodities on Wall Street.

Financial institutions have been reticent to embrace the online world given regulatory and reputational concerns; they now understand the digital realm isn’t going away and the millennial generation — along with a massive transfer of wealth — is quickly approaching. If they don’t incubate the human capital and creative elements necessary to service the entire vertical across multiple channels, they will be left behind.

Minyanville provides a plug-and-play, end-to-end solution that delivers smart market commentary with editorial rigor through a FINRA- and SEC-compliant mechanism. This is not traditional research; content is the best online currency — engage the audience in a daily dialogue with one foot inside the firewall (give them a reason to stay in the walled garden) and the other foot outside the firewall (broaden the brand shadow and more effectively target the marketing spend).

 

Over 14 years ago when Richard Metzger and Gary Baddeley hired me to edit the Disinformation website they were pivoting to television production, publishing, DVD, and video-on-demand interests. Stratfor’s George Friedman planned the StratCap hedge fund before Anonymous hacked his geopolitical intelligence website.

 

Behind all of these moves are two strategic realities: (1) most web content generates zero income – a painful truth for editors and writers; and (2) value creation often lies in tailored products and services for a website’s audience. Minyanville’s version of (2) was a subscription service for premium content. Disinformation’s version was book, DVD and video-on-demand projects — the site became mostly user-generated content from March 2008. This was all prior to Henry Blodget’s career ‘second act’ with BusinessInsider.

 

I made a series of decisions about these shifts over the past decade. After undergraduate and postgraduate school I pursued a university-based research career from 2004 whilst doing a second editorial stint with Disinformation. I stopped freelancing for magazines during this period due to publishing embargoes that the research consortium I worked for placed on my research. After leaving TDC Entertainment on 29th February 2008, I turned down several offers to edit websites or to be involved in publishing projects. After March 2007, I self-funded my academic research. Today, I blog – as Josh Brown does – primarily for self-education.

 

On the surface Harrison’s pivot decision for Minyanville to partner with financial services as an “incubation lab” looks like an entrepreneurial venture. I’m a little skeptical:

 

(1) As Brown and Macke show in their new book, most financial commentary is noise that is unhelpful to traders. Twitter, Andrew Ross Sorkin’s Dealbook section in The New York Times, and a Bloomberg or Wall Street Journal subscription provides most of the major financial news and the major newswire services.

 

(2) Harrison omits that most website content is usually either for subscription traffic, or is a loss leader.

 

(3) I read Fundamentals of Stream Processing (New York: Cambridge University Press, 2014) and it confirmed that the real alpha is already in complex event processing, machine learning algorithms, news analytics, and high-frequency trading algorithms. This area is at least 4 to 5 years old in quantitative finance already. It may continue to disrupt the broker service model that Harrison has in mind. How many of Minyanville’s customers really have the financial assets to become high net worth customers for a broker?

 

(4) Harrison looks to the Millennials as the new investor class – but most of them can save money and time by paying US$1 for William Bernstein’s monograph If You Can: How Millennials Can Get Rich Slowly; investing in a low-cost index fund like Fidelity or Vanguard; and reading free web commentary for self-education. More Millennials are likely to use mobile services than subscription-based websites.

 

(5) As George Friedman found with his StratCap venture, developing alpha/edge in investment and trading is a very different skillset to financial news or commentary. My experience from several different contexts over a 10-year period is that news arbitrage strategies are hyped by journalists and editors — but have significant alpha decay for traders — particularly in a market dominated by high-frequency trading algorithms and low-latency arbitrage. Brown and Macke confirm that this is the case for retail traders who try to trade the news on Bloomberg or CNBC – and that the major news outlets are set-up with availability and disposition biases in mind.

 

(6) Thomas Frank’s One Market Under God: Extreme Capitalism, Market Populism, and the End of Economic Democracy (New York: Doubleday, 2000), Thomas Schuster’s The Markets and the Media: Business News and Stock Market Movements (Lanham, MD: Lexington Books, 2006), and Dean Starkman’s The Watchdog That Didn’t Bark: The Financial Crisis and the Disappearance of Financial Journalism (New York: Columbia University Press, 2014) show that the financial media-retail trader nexus has been a problem noted in the 1995-2000 dotcom and 2003-07 real estate speculative bubbles, and also in the 2007-09 global financial crisis.

 

I will keep an eye on what Harrison’s Minyanville evolves into and what it incubates. However, Harrison’s pivot decision looks like an exit.

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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.

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21st September 2012: Paper Abstracts for International Studies Association’s Annual Convention 2013

Coauthor Ben Eltham (a PhD candidate at University of Western Sydney and rising star in Australian national affairs journalism for Crikey and New Matilda) and I have two papers accepted for the International Studies Association‘s annual convention in San Francisco in 2013:

 

Australia’s Strategic Culture and Constraints in Defense and National Security Policymaking

 

Scholars have advanced different conceptualizations of Australia’s strategic culture. Collectively, this work contends Australia is a ‘middle power’ nation with a realist defense policy, elite discourse, entrenched military services, and a regional focus. This paper contends that Australia’s strategic culture has unresolved tensions due to the lack of an overarching national security framework, and policymaking constraints at two interlocking levels: cultural worldviews and institutional design that affects strategy formulation and resource allocation. The cultural constraints include confusion over national security policy, the prevalence of neorealist strategic studies, the Defence Department’s dominant role in formulating strategic doctrines, and problematic experiences with Asian ‘regional engagement’ and the Pacific Islands. The institutional constraints include resourcing, inter-departmental coordination, a narrow approach to government white papers, and barriers to long-term strategic planning. In this paper, we examine possibilities for continuity and change, including the Gillard Government’s forthcoming ‘Asian Century’ whitepaper and 2013 defense whitepaper.

 

(Thanks to Wooster College’s Jeff Lantis for coordinating the Strategic Culture panel that this paper is on.)

 

Complexity, Model Risk, and International Security

 

International security thinking has evolved beyond initial research in the early-to-mid using the chaos and complexity sciences. Firms including Kissinger & Associates, Pimco, The Prediction Company (now part of UBS), Roubini Global Economics and Stratfor have created new models to understand catastrophic/tail risks, and to profit from geopolitical flashpoints such as the current speculative bubble in rare earths, China’s growth in the Asia-Pacific region, and the greater involvement of multi-national corporations in the international political economy. This paper builds on the work of scholars in international security and the sociology of economics and finance, journalists, and hedge fund and risk management practitioners, to address how these new models have diffused into hybrid academic-commercial environments, how they construct new social realities, and ‘model risk’. We focus on structural micro-foundations: to what degrees and under what conditions do the assumptions underlying these new risk models correspond to real-world phenomena like geopolitical flashpoints? Are these phenomena measurable? Are the relationships between them robust? We examine as a case study the Anonymous hack of Stratfor in December 2011, Stratfor’s planned hedge fund StratCap, and Stratfor’s reaction including its hiring in March 2012 of Atlantic Monthly journalist Robert D. Kaplan.

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6th March 2012: SXSW 2012 Sabbatical

 

I’m taking a sabbatical over the next 10 days to visit Austin, TX for SXSW Interactive 2012 with Rosie X. I’ll be meeting University of Texas at Austin professor Jeremi Suri about his work; and having face-to-face chats with Disinformation‘s publisher Gary Baddeley, and Austinites Roy Christopher and Don Webb. I’m looking forward to the session with Stratfor founder George Friedman: read my analyses of the Wikileaks leaked emails and the planned hedge fund StratCap. In the meantime, you can read my body of work to-date.

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29th February 2012: StratCap

Stratfor Logo

 

Strategic foresight practitioner Stephen McGrail pointed me to a Yes Men press release on Stratfor/Wikileaks, where I found this gem:

 

Among the millions of other leaked Stratfor emails are some that reveal dubious financial practices, including an apparent insider trading scheme with Goldman Sachs Managing Director Shea Morenz, who joined Stratfor’s board of directors and invested “substantially” more than $4 million in the scheme, called StratCap. “What StratCap will do is use our Stratfor’s intelligence and analysis to trade in a range of geopolitical instruments,” wrote Stratfor CEO George Friedman in September 2011. StratCap was designed through a complex offshore share structure to appear legally independent, but Friedman assured Stratfor staff otherwise: “Do not think of StratCap as an outside organisation. It will be integral… It will be useful to you… We are already working on mock portfolios and trades.” (StratCap has been due to launch in 2012, though that could now change.) [emphasis added]

 

I wrote about Stratfor/Wikileaks here. The StratCap documents are here. They reveal plans by Stratfor chief executive officer George Friedman and colleagues to establish an event arbitrage and global macro fund that would trade on the basis of Stratfor’s geopolitical and strategic intelligence. Friedman and colleagues envisioned a $US25 million fund with a 10% equity investment from Stratfor: small for global macro but possible for a boutique event arbitrage or special event fund. The emails deal with the fund’s offshore structure; the service agreement; the role and compensation of Shea Morenz; and Stratfor’s role to provide StratCap with actionable intelligence.

 

“From where I sit, this deal is dead,” Friedman wrote on 23rd July 2011. The deal show-stoppers included Friedman’s discontent with attorney Bruce Herzog‘s handling of the service agreement and anger over a $US200,000 fee (“for Bruce’s clumsy attempts to undermine the process”); an immediate tax liability that impacted on the initial investment capital; potentially adverse effects on Stratfor’s publishing business and working capital; and the potential for Shea and StratCap to bankrupt Stratfor through demanding potentially unlimited strategic intelligence. These show-stoppers made the deal non-viable: it exposed Stratfor to credit and transaction risks.

 

Friedman explained in his 23rd July 2011 email to Stratfor colleagues:

 

I can imagine easily a scenario in which StratCap’s demands outstrips Stratfor’s means to the point that StratCap would hold Stratfor in default and even push it into bankruptcy with StratCap the major creditor. Nothing in the course of the negotiations gives me the slightest hope that Bruce would not do this in a heart beat and that Shea wouldn’t let him. I regard the proposed service agreement as a threat to the survival of Stratfor as a company under Don and my control. [emphasis added]

 

Friedman notes: “I have no intention of being the Chairman of a failed investment fund . . . I will not be the public image of StratCap, ridiculed for the failure of an enterprise that was built to fail.” (A reference to Jim Collins and Jerry Porras’s influential management book Built to Last.)

 

StratCap may have run into other problems if the fund had launched. In 2002, Goldman Sachs paid a $US110 million fine to separate its sell-side research from Goldman’s trading activities. So did dotcom era analyst Henry Blodget. Morgan Stanley paid  $US125 million in fines though analyst Mary Meeker escaped prosecution. It’s possible that Friedman and Stratfor may have faced similar fines or regulatory threats if they had proceeded with the StratCap deal.

 

Want to start your own event arbitrage fund? You might start with Robert Webb’s Trading Catalysts (London: FT Books, 2006) and Andy Busch‘s World Event Trading (Hoboken, NJ: John Wiley & Sons, 2007) on event arbitrage and special event strategies. On hedge funds, read Sebastian Mallaby‘s excellent history More Money Than God (London: Penguin, 2011), and for the best academic research, Andrew Lo‘s Hedge Funds: An Analytic Perspective (Princeton: Princeton University Press, 2010).

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28th February 2012: Wikileaks & Stratfor’s Emails

Stratfor in December 2011

 

Yesterday the activist site Wikileaks prepared to publish 5 million emails from the Austin-based private intelligence firm Stratfor. Anonymous hacked Stratfor on 24th December 2011 and gained access to client passwords, databases, and internal emails. Wikileaks claims the emails: “reveal the inner workings of a company that fronts as an intelligence publisher, but provides confidential intelligence services to large corporations, such as Bhopal’s Dow Chemical Co., Lockheed Martin, Northrop Grumman, Raytheon and government agencies, including the US Department of Homeland Security, the US Marines and the US Defence Intelligence Agency. The emails show Stratfor’s web of informers, pay-off structure, payment laundering techniques and psychological methods.”

 

The leak prompted some hilarious and insightful responses from political pundits. “That @Wikileaks thinks publishing @Stratfor emails matters is a big compliment for Stratfor, biggest sign yet that Wikileaks is clueless,” tweeted Dan Drezner, and then he wrote a Stratfor/Wikileaks critique. “Statfor is on the mild end of the scary shadow CIA/stodgy think tank spectrum,” observed Dan Murphy for The Christian Science Monitor. “A friend who works in intelligence once joked that Stratfor is just The Economist a week later and several hundred times more expensive,” noted The Atlantic‘s Max Fisher.

 

I briefly subscribed to Stratfor so am probably on the leaked email/credit card list. I found many of Stratfor’s weekly reports to inflate threats. I got Friedman’s first book America’s Secret War during the book buy-up for my PhD but found it to be sensationalistic. Several Stratfor analysts contacted me whilst I edited the alternative news site Disinformation and claimed to be ex-psychological operations people.

 

I seriously considered developing a private intelligence capability on two occasions.

 

The first time was at Disinformation in 2000, I pitched a subscriber service to publisher Gary Baddeley that would do for the nascent conspiracy industry what Nikki Finke’s Deadline Hollywood does for the United States entertainment industry. I also had in mind the subscriber services that do 5-8 page summaries of business books. Baddeley wasn’t interested and the nascent conspiracy industry evaporated after the September 11 attacks.

 

During my postgraduate studies I studied under David Wright-Neville, Andrew Newman and Philip Gregory, and wrote essays on Ulrich Beck‘s world risk society (PDF); Rupert Murdoch’s use of game theory (PDF); considered the developments circa 2002 for news publishers (PDF); explored the collapse of the hedge fund Long-Term Capital Management (PDF); outlined the post-September 11 changes to intelligence services (PDF); and evaluated DARPA’s Terrorism Information Awareness system (PDF).

 

The second time was at the Smart Internet Technology CRC (SITCRC): I scoped out a project for Canberra firm The Distillery and looked at the major international and Australian firms that provided market intelligence on information technology trends. I proposed a market intelligence capability for the Smart Services CRC successful bid that would use strategic foresight and strategic intelligence methods. However, this remained scoped out work only for the unfinished Disruptive Internet project, although I did trial the methods in a public blog for a month. I left the CRC in March 2007 due to infra-team conflict.

 

During preparation for my PhD studies I considered several topics. One was on design patterns and counter-terrorism. A second idea was ‘The Markets for Political Risk: An Analytic View’ modelled on the research of Deborah Avant (The Market For Force) and Andrew Lo (Hedge Funds: An Analytic Perspective). I outlined the historical precursors to Stratfor (RAND, Royal Dutch/Shell, and Kissinger & Associates); found six market segments; considered risk arbitrage, securitisation and trading applications; and began to develop contagion/rumour models. I noted that Friedman “may cultivate ’boutique mystique’ as reputational capital.” In 2009, I began reading the hedge fund and trading literature, and decided it was easier to develop a personal capability for market arbitrage and trading (reflected on during an October 2011 visit to Tokyo’s Stock Exchange). In March 2011, I began a part-time PhD on the strategic culture debate and counter-terrorism studies (2011 initial proposal PDF).

 

Stratfor’s chief executive officer George Friedman is scheduled to speak at SXSW Interactive 2012 in Austin. I’ll definitely be attending.

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Errors In Quantitative Models & Forecasting

Could the roots of the 2007 subprime crisis in collateralised debt obligations (CDOs) and residential mortgage-backed securities (RMBS) lie in financial analysts who all used similar assumptions and forecasts in their quantitative models?

Barron’s Bill Alpert argues so, pointing to a shift of investment styles after the 2000 dotcom crash from sector-specific, momentum and growth stocks to value investing.  Investment managers who prefer the value approach then constructed their portfolios with ‘stocks that were cheap relative to their book value.’  In other words, the value investors exploited several factors — the gaps in asset valuation, asymmetries in public and private information sources, price discovery mechanisms and market participants — which contributed to mispriced stocks compared to their true value.

However, the value investing strategy had a blindspot: many of the stocks selected for investment portfolios also had a high exposure to credit and default risk.  The 2007 subprime crisis exposed this blindspot, which adversely affected value investors whose portfolios had stocks with a high degree of positive covariance.

Alpert quotes hedge fund manager Rick Bookstaber who believes that financial engineers have accelerated crises and systemic risks via the complex dynamics of new futures contracts, exotic options and swaps.  These new financial instruments create interlocking markets (capital, commodities, debt, equity, treasuries) which have the second-order effects of larger yield curve spreads and trading volatility.  Alpert and Bookstaber’s views echo Susan Strange‘s warnings a decade ago of ‘casino capitalism’  and ‘mad money’ as unconstrained forces in the international political economy.

Quantitative models also failed to foresee the 2007 subprime crisis due to excessive leverage, difficulties to achieve ‘alpha’ or above-market returns in market volatility, and the separation of risk management from the modelling process and testing.  Other commentators have raised the first two errors, which have led to changes in portfolio construction and market monitoring.  Nassim Nicholas Taleb has built a second career on the third error, with his Black Swan conjecture of high-impact events, randomness and uncertainty (see Taleb’s Long Now Foundation lecture The Future Has Always Been Crazier Than We Thought).

Alpert hints that these three errors may lead to several outcomes: (1) a new ‘arms race’ between investment managers to find the new ‘factors’ in order to construct resilient investment portfolios; (2) the integration of Taleb’s second-order creative thinking and risk management in the construction of financial models, in new companies and markets such as George Friedman’s risk boutique Stratfor; and (3) a new ‘best of breed’ manager who can make investment decisions in a global and macroeconomic environment of correlated and integrated financial markets.