Hedge fund holdings?
Hedge fund transparency? Alpha can be generated in only two ways. Either work hard to find predictive information ADDITIONAL to the data OR work hard to find predictive information EMBEDDED within the data. Both depend on as little as possible information seeping out to other market participants. You must have an EDGE but that competitive advantage MUST be kept secret or it will cease to be an edge.
Transparency is a hot topic for hedge funds. Investors think they want it but it could be counterproductive to performance which presumably they want even more. If you seek alpha it is probably better to worry less about transparency and perhaps DEMAND opacity instead. Allowing an intermediary to see the portfolio and consolidate risk reporting might make sense but widely available position transparency is sub-optimal. The number of people who know the positions and particularly the strategy must be minimized even WITHIN the fund.
One of the reasons general hedge fund performance has reduced in recent years is due to transparency requirements. There is nothing wrong with being open about the general strategy description, the security universe, risk management and diversification policies. Perhaps also a broad description of why the manager has an edge. But going past that into position level or black box formulae, investors may demand disclosures that damage future performance. Having copycats trying to emulate complex strategies usually ends in disaster - for the copycats.
Arbitrages and black boxes need to be kept secret. Plain vanilla merger arb, CB arb and simple trend following are gone; of course that doesn't mean that sophisticated, non-vanilla, deeply researched ways of making money in these areas don't exist anymore - they certainly do. If an OLD quantitative system leaks into the public domain it is time to move on and develop NEW trading strategies.
Investors often claim they have to "understand" a strategy to invest in it. This presents several hurdles. 1) Some of the best managers and strategies won't be available to them, 2) revealing the edge could dampen performance and 3) the investor needs the necessary knowledge to understand. Please tell me EXACTLY how the computer you are reading this on works or you'll stop using computers?
You can't patent an investment process so the only prudent course is NOT to tell clients the specifics of how you grow their money into more money at low risk. They may not like it but it is in THEIR best interests. Some investors are biased against computer-driven strategies, prefering the "safety" of discretionary human-driven portfolio management while forgetting that the darkest black box of all is that irrational, emotional, carbon-based computer known as the human brain. Due diligence on quantitative investing is a walk in the park, by comparison, to human decision making which is a walk in the dark. Black box strategies can be thoroughly tested on a wide range of historical, geographical and synthetic data sets unlike human-led discretionary systems.
Each quarter, the SEC requires "unregulated" hedge funds to reveal their equity holdings. Phillip Goldstein, after his success in overturning the hedge fund registration nonsense, is trying to get this outdated rule overturned. Stock pickers produce alpha by intensive research and engagement with companies, developing new insights based on legally acquired proprietary information and analysis. Revealing concentrated positions is a trade secret and will likely damage future performance.
Transparency may even lull investors and regulators into a false sense of security. Nick Maounis at Amaranth dutifully filed their long equity holdings with the SEC. No mention of shorts, OTC derivatives and futures though! Transparent portfolios, exposures and notification of future trades hands money to the more nimble. Index changes offer easy profits from arbing the passive managers as they scramble to minimize their tracking "error". Even in currencies, some large orders get telegraphed ahead of time; a well-meaning attempt at transparency but at significant cost to the transactor and its shareholders. Commodity traders know ahead of time when the long only commodity index funds must rollover. Incidentally long only commodities is an even more idiotic idea than long only equity or credit.
Some say the Brian Hunter and Amaranth debacle proves the case for transparency; actually what killed them was that too many other people DID know their exact positions. In 1998 option traders knew Long-Term Capital was heavily short vega and it was the volatility short squeeze that finished them. Outsiders laugh about hedge fund employees being asked to sign thick non-disclosure agreements. It is one way to try to safeguard the best interests of investors. A better but harder way is for not even employees to know proprietary secrets. It incentivizes people to discover new ones.
We all use many things we do not understand. Many people fly in airplanes yet few understand how a 747 actually gets off the ground. Should everyone attend pilot training before boarding? We let doctors treat us, without ourselves going to medical school. We eat in restaurants without a background check on the chef or knowing the precise ingredients in the secret sauce. Perhaps we should all stop drinking Coca Cola until they divulge the recipe? See what that does to KO stock!
What use would Google be if users required FULL transparency of the algorithm or knowing the PRECISE details of the current PageRank calculation? Google's search results would not be useful to anyone for very long. Proprietary intellectual property is THE value proposition of many firms, whether it is the technology underlying how Google brought this site to you or the formula underlying Krispy Kreme makes its donuts. The proprietary processes behind hedge funds generating consistent, risk-adjusted returns needs to be protected. If you desire transparency risk your savings in a "low cost" passive index fund and see where that gets you.
Transparency is a hot topic for hedge funds. Investors think they want it but it could be counterproductive to performance which presumably they want even more. If you seek alpha it is probably better to worry less about transparency and perhaps DEMAND opacity instead. Allowing an intermediary to see the portfolio and consolidate risk reporting might make sense but widely available position transparency is sub-optimal. The number of people who know the positions and particularly the strategy must be minimized even WITHIN the fund.
One of the reasons general hedge fund performance has reduced in recent years is due to transparency requirements. There is nothing wrong with being open about the general strategy description, the security universe, risk management and diversification policies. Perhaps also a broad description of why the manager has an edge. But going past that into position level or black box formulae, investors may demand disclosures that damage future performance. Having copycats trying to emulate complex strategies usually ends in disaster - for the copycats.
Arbitrages and black boxes need to be kept secret. Plain vanilla merger arb, CB arb and simple trend following are gone; of course that doesn't mean that sophisticated, non-vanilla, deeply researched ways of making money in these areas don't exist anymore - they certainly do. If an OLD quantitative system leaks into the public domain it is time to move on and develop NEW trading strategies.
Investors often claim they have to "understand" a strategy to invest in it. This presents several hurdles. 1) Some of the best managers and strategies won't be available to them, 2) revealing the edge could dampen performance and 3) the investor needs the necessary knowledge to understand. Please tell me EXACTLY how the computer you are reading this on works or you'll stop using computers?
You can't patent an investment process so the only prudent course is NOT to tell clients the specifics of how you grow their money into more money at low risk. They may not like it but it is in THEIR best interests. Some investors are biased against computer-driven strategies, prefering the "safety" of discretionary human-driven portfolio management while forgetting that the darkest black box of all is that irrational, emotional, carbon-based computer known as the human brain. Due diligence on quantitative investing is a walk in the park, by comparison, to human decision making which is a walk in the dark. Black box strategies can be thoroughly tested on a wide range of historical, geographical and synthetic data sets unlike human-led discretionary systems.
Each quarter, the SEC requires "unregulated" hedge funds to reveal their equity holdings. Phillip Goldstein, after his success in overturning the hedge fund registration nonsense, is trying to get this outdated rule overturned. Stock pickers produce alpha by intensive research and engagement with companies, developing new insights based on legally acquired proprietary information and analysis. Revealing concentrated positions is a trade secret and will likely damage future performance.
Transparency may even lull investors and regulators into a false sense of security. Nick Maounis at Amaranth dutifully filed their long equity holdings with the SEC. No mention of shorts, OTC derivatives and futures though! Transparent portfolios, exposures and notification of future trades hands money to the more nimble. Index changes offer easy profits from arbing the passive managers as they scramble to minimize their tracking "error". Even in currencies, some large orders get telegraphed ahead of time; a well-meaning attempt at transparency but at significant cost to the transactor and its shareholders. Commodity traders know ahead of time when the long only commodity index funds must rollover. Incidentally long only commodities is an even more idiotic idea than long only equity or credit.
Some say the Brian Hunter and Amaranth debacle proves the case for transparency; actually what killed them was that too many other people DID know their exact positions. In 1998 option traders knew Long-Term Capital was heavily short vega and it was the volatility short squeeze that finished them. Outsiders laugh about hedge fund employees being asked to sign thick non-disclosure agreements. It is one way to try to safeguard the best interests of investors. A better but harder way is for not even employees to know proprietary secrets. It incentivizes people to discover new ones.
We all use many things we do not understand. Many people fly in airplanes yet few understand how a 747 actually gets off the ground. Should everyone attend pilot training before boarding? We let doctors treat us, without ourselves going to medical school. We eat in restaurants without a background check on the chef or knowing the precise ingredients in the secret sauce. Perhaps we should all stop drinking Coca Cola until they divulge the recipe? See what that does to KO stock!
What use would Google be if users required FULL transparency of the algorithm or knowing the PRECISE details of the current PageRank calculation? Google's search results would not be useful to anyone for very long. Proprietary intellectual property is THE value proposition of many firms, whether it is the technology underlying how Google brought this site to you or the formula underlying Krispy Kreme makes its donuts. The proprietary processes behind hedge funds generating consistent, risk-adjusted returns needs to be protected. If you desire transparency risk your savings in a "low cost" passive index fund and see where that gets you.
© posted by Hedge Fund on 10:29 PM
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