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Ken Fisher hedge fund

Ken Fisher has an excellent new book out, "The Only Three Questions That Count". There is much of relevance to those who manage hedge funds and the subtitle better captures the essence of his argument, "Investing by knowing what others don't". Whatever the strategy, unless you have a competitive edge over other market participants, it cannot be a sustained alpha generator.

The three questions can be paraphrased as 1) What is false but others think is true? 2) What can you fathom that others can't? 3) Will your behavior and emotions mess things up? Fisher correctly sees investing as a science and provides many examples to debunk conventional "wisdom" and how to develop new things that actually work. And he points out the need to innovate strategies, to keep ahead of the pack.

Ken Fisher doesn't use the word but I like the Japanese term "kaizen", constant improvement of a strategy. It is just as relevant to an investment process as much as a manufacturing process. Style drift may be a no-no in some circles but style innovation is a requirement. It is also why there can be no holy grail strategy; even if you came up with one you would have to keep researching to find a new holy grail.

Ken Fisher correctly observes that investing is NOT a craft. It is not like cookery,
driving a car or learning a new language. Crafts have a standard pattern of ability acquisition where if you have the interest and apply yourself during your apprenticeship, you will eventually gain that skill. Investment ability however does not have such a straightforward roadmap. You can pass every educational qualification out there and still be a terrible investor.

You can also trade for decades and still not be any good. Investment success requires HARD WORK and that is why all these "lazy person road to riches" methods can never succeed. Even with hard work, it is the right kind of hard work that is needed. You can get a PhD in finance but that has NOTHING to do with a PhD in making money. Nobel prize "winners" in Economics infamously exhibit a negative correlation to investment skill.

Fisher demonstrates how high P/Es are not something to worry about as well as nicely debunking the nonsense of dollar cost averaging and covered call strategies. He also thinks stop losses are better called stop gains. Virtually everything you hear elsewhere urges the importance of cutting losses but my analysis over the years generally confirm Fisher's assertion though it obviously depends on the strategy. Dynamic position-sizing, hedging and being very diversified are better risk management tools than arbitrary loss-cutting. If the fall changes the investment thesis by all means get out but selling simply because you have lost X% has NO logic to it if, and only if, the reason for owning the stock has not changed.

Fisher also mentions how his inventions like the price/sales ratio and being contrarian to consensus analyst and strategist predictions are now "priced" ie don't work anymore. I simply do not understand why anyone with something predictive or useful would reveal it. He claims it would have emerged anyway. But there is yet another lesson here to keep proprietary ideas secret, as long as they are useful. Opacity is an edge.

As with most books there are some flaws. Fisher employs just enough basic statistics to get into trouble in some places. For example he attempts to show that oil prices have almost no effect on the stock market due to a low R-squared. Unfortunately R-squared is more a descriptive tool than inferential and can often spuriously EXPLAIN nothing. Over many years the oil price was indeed generally benign which results in the seemingly low correlation to equities he gets but the CONDITIONAL or BAYESIAN CORRELATION of the stock market to oil when oil prices are volatile is quite evident in the historical data.

To verify or disprove some of Fisher's analysis you need to employ much heavier statistical artillery. Correlation or lack of it does not necessarily imply causation. And if P/Es don't help how can its reciprocal, the earnings yield, be useful? Some of his more controversial economic, terrorist and natural disaster contentions are also questionable. I can absolutely guarantee you a mile-radius asteroid hitting the earth would have a long lasting, detrimental affect on the stock market and even the utmost faith in capitalism would not cause it to alter its path.

Like everyone else Ken Fisher also has his own cognitive biases. Though he has had success at market-timing over the years, he is usually a long term bull and since most investors are also, this could be inconsistent with "investing by what others don't know". Most people "know" the stock market will EVENTUALLY rise. He emphasizes the importance of benchmarks when surely making absolute returns is much more important. The back of the book reveals managed accounts run by Fisher made just 4.4% per annum over the last seven years including losses in 01, 02 and 03 and no information on the historical volatility path taken to barely match a money-market fund's cumulative returns. Only by including the anomalous mid/late 1990s does he achieve double digit performance.

Personally I am neither a bull or bear, I just believe in and have verified the existence of exploitable market mispricings, anomalies and inefficiencies. As Ken Fisher urges, you must challenge assumptions and rigorously check any investment thesis with modeling, simulations and historical backtesting. So long term bull or bear doesn't make sense to me. Unhedged long only strategies simply do not provide adequate portfolio diversification for investors. Being very risk averse, I am not prepared to bet one cent on the notion that stock markets will go up over long periods of time. Especially when there is money to be made TODAY.

"Three questions" is however an excellent book and does capture what it takes to produce alpha. Hard work, scientific analysis, throw out conventional financial "wisdom" if it does not withstand statistical scrutiny and thinking outside the box. Also it would seem to me the best way to avoid behavioral weaknesses is to involve computers and quantitative methods in developing and implementing investment strategies. It may not have been the intention of Ken Fisher but his book provides indirect support for black box trading strategies.

If you or your fund managers don't know something about the markets that others don't, stop investing RIGHT NOW and hand your money over to the few that do.

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