Category Archives: Uncategorized

Going through my daily abnormal returns browse these days makes me want to misquote Admiral Beatty at the Battle of Jutland: there seems to be something wrong with our bloody hedge funds. They’re crapping out left and right. What gets me is not just that they are all doing it at the same time, which is astonishing enough, it is that it seems to be getting worse. Given half decent risk management, this should not be happening. I was aware of the existence of hedge fund beta where it comes to Quants, but I had always assumed there was sufficient diversity of opinion within the rest of the popular hedge fund strategies, particularly in equity long short, so that they would have some sort of diversity in their returns. I had also assumed that these guys were smart and flexible enough to be able to stop themselves out, to switch stuff around and refashion their portfolios to find something that works. At the very least, they could have just stopped doing anything, cover shorts, sell longs, and go flat.

This is clearly not the case, and I have not yet found a convincing explanation for it. The Citadels, Atticus(-ses, Attici?), Tontines, Fortresses of this world seem to be deer in headlights. Their performance is deteriorating over the course of this year, not stabilising. September was the worst month ever, we were told, so it would not be a very difficult decision to retrench, take some action, gross down and change orientation some way. Instead we find out that October was worse.

What the hell is going on? Is it just that they are deeply stupid? Like the Janus and Nicholas Applegate long only guys in 2000-2002, holding on to Worldcom and JDS Uniphase until they were carried out? Is it that they are still leveraged? Is it because other strategies are losing much more money than the equity long short guys can be making or not losing? Is it because they are stuck with illiquid positions they can’t exit, or have to slowly and their own selling pressure is bleeding them white? Are they just structurally net long? How and why? Why can’t they change??

I suspect there are 2 main explanations. Firstly, while these big multi-strat managers may not actually be stupid, their problem is more that they are hidebound, cowardly and unimaginative. They are locked in a terrfied protective huddle in the same old positions, that makes them nothing more than a vast target. Secondly, they have squeezed everyone out of the market. Small hedge funds don’t get a look in. Long short equity hedge management as it is currently run is a vast crowded trade, and losses in the weight of money devoted to it outweighs the gains of the very few who are coining it. They can’t bet against the system like the old ones did; they are the system. Continue reading →

Baruch has been forced out of (possibly temporarily) blogging hibernation by this piece, by one Sly Observer, who writes:

Nassim Taleb’s increasingly shrill followers have been yelling “black swan, black swan!” all year. This has irked me . . . I read Nassim Taleb’s book “The Black Swan” mainly to see what all the yelling was about and was unimpressed. The book can be summed up in the sentence “Options are under priced.” I found his open disdain for commerce very distasteful.

Baruch read this post, and got cross; as a fully paid up member of the Talebian revolt, he took it personally. Beware, Sly Observer, irked or not, you have raised the Ire of Baruch!

We can dismiss the “shrill” — a lazy, silly word, a cheap polemical trick unworthy of a response. But I take issue with the ”yelling ‘black swan, black swan!’” It is certainly not what thoughtful followers of Taleb have been doing. In fact we have mostly stayed quiet, as far as I can see, deeply worried in general, and slightly embarrassed at the increasing visibility of what has become a catchphrase.

When Sly says he read Black Swan and thought the main message was “options are underpriced” I am reminded of pseudo-intellectual Otto (Kevin Kline) in A Fish Called Wanda, who says in response to Wanda’s accusation that he is an ape: “Apes don’t read philosophy!” Wanda says “Yes they do, Otto, they just don’t understand it.” “Options are underpriced” was actually a key message of Fooled by Randomness, Taleb’s first book. Black Swan is much more about the Gaussian fallacy, how financial strategies (not just financial) based on bell-curved distributions are not just incorrect but dangerous.

In case you have not read the book, or you did and didn’t understand it, the Gaussian fallacy is the idea that financial markets follow a standard, normal, mean-reverting, predictable distribution we can consistently exploit for fun and steady profit. Taleb would be the first to point out that some things do indeed follow Gaussian bell-curved distributions. Shoe sizes would be a good example. But in terms of trading markets the Gaussian ideal is very often a fallacy; big events, single days with big point moves in indices and stocks tend to be much more important in determining profit and loss over long periods, than the days when not much happens. Taleb’s key point is that very often, relying on a normal distribution holding true to make small but regular amounts of money is a big mistake; while we may only lose money rarely, when we do we can lose more than everything we made when things were good. He uses the metaphor of “picking up nickels in front of steamrollers.” It’s very apt.

We, and it seems capitalism itself, have just been flattened by the steamroller. We call our current mess the result of the housing bubble. But we could equally view it as the aftermath of a bubble in Gaussian strategies. The villains we point to on TV are the regulators, the hedge funds, the banks and, my favourite, the over-extended, ignorant home owners, but this is like blaming the water in the tidal wave for swamping the village. The set of ideas that justified their actions, the fake science, the epistemological error was what helped create the conditions for the wave itself. Amazingly, that this is the key error does not seem to be grasped yet, and as such is not going away. This, more than anything is what makes Baruch cross, and as such, focussing his Ire on a hapless blogger, of whom we should not expect too much (and who is a bit nicer about Taleb later in the post), may be unfair. Continue reading →

Last week Felix wrote an interesting post on the valuation of high growth big cap tech, specifically Apple and Google. The debate in the comments was equally interesting. Felix thinks AAPL should not be worth more than GOOG, as recently become the case when the former’s market cap surpassed the latter’s. GOOG grows faster than AAPL, he points out, has higher margins, and is increasing market share in its core (web advertising) market while AAPL is losing share in its (iPod/iTunes); unlike AAPL, GOOG has a dominance in its fast-growing core market that amounts to a monopoly, option value from its many ventures, and finally no management succession risk. That should be worth a premium valuation.

All these points are either true or could be plausibly argued. So how can this be, given that the market prices in all knowable, digestable information (Felix is a great fan of indexation and presumably holds to a very dilute version of the efficient markets theory)? Why is a company with all these attributes trading at a discount to this relatively deficient one?

Baruch knows the answer. He gets paid to value high growth big cap tech. While he personally covers neither AAPL nor GOOG, in the vast expanse he calls his mind this does not disqualify him from opining about both companies firstly from the point of view of a Spinozist but secondly, from time to time, as a stock operator or “punter”. You will remember that from the first perspective, he likes neither of them very much. From the second perspective, Baruch has said he would actually be long AAPL here. In fact, the fund he works for is an owner in size. As for GOOG, it is a smaller position than the benchmark, an “underweight”, in the argot. Had he his druthers, moreover, Baruch would strongly consider a GOOG short.

There are two central concepts to tech investing — expectations, and the 2nd derivative of growth. Both of these concepts combine in interesting ways. Let’s deal with both, the role of expectations first. Continue reading →

TEN SQUILLION GODZILLION iPHONES. That’s how many they are making in the 3rd quarter alone. I only mention this to try to make myself look a bit better after having hung my dirty underpants out to dry this week, for I, Baruch, predicted just this! I am not a complete investment dolt! OK I didn’t give numbers, but I said, in a piece which was long term negative on Apple but short term positive (know, and do not confuse, your time frames):

Apple . . . has a window to build some scale. At the same price as an HTC, hell, I’d buy a 3G iPhone. I can finally see it taking off

and

this is what I imagine will happen: a flattish reception to the 3G iPhone launch in May or June (I hear it looks identical to iPhone v.1, and may not have GPS or a 5 megapixel camera), followed by amazing initial volumes of 3G iPhone.

There was a flattish reception; AAPL sold off a bit after a rally into the launch announcement and everyone seemed more interested in whether Steve Jobs had cooties or not. I hope he doesn’t. “MobileMe” didn’t work (one wag said the Blackberry version of this would be called “RimmMe”). But this 10 million number has blown my mind. “Amazing initial volumes” is an understatement. For context, there will be about 1.1-1.2 billion cellphones sold in 2008, according to like, everybody. So 10 million sounds like small beer. But that’s in one quarter, so really it’s 40 million annualised, which is 3.5% unit share from zilcho (iPhone v.1 was negligible), and then assuming a $550 average selling price — pre-subsidy of course – and a $120 ASP for the rest of the market, and assuming they actually sell them in Q3, well Apple just took a 16% share of the total value of the handset market, give or take. In other words, it just created the equivalent of RIMM’s handset business, Sony Ericsson, the equivalent of LG handsets. In one quarter. Just like that! Continue reading →

I, Baruch, have just had the worst 2 days of my investment career. My biggest short shot up 20%, argh, and my biggest overweight tanked thirty fricking five percent the very next day. As you know, Bento, I am a cheery chap most of the time, bounding out of bed every monday morning convinced that this could be the very best week of my life, why not, and ready, as an american would put it, to bite the ass off a bear. But right now I have to admit to a cold, sick, dread. My karmic cycle has clearly turned down. What else can happen to me, I wonder. Until all my money is gone, I tell myself, it can always get worse. On the occasion of the 1 year anniversary of the Bear Market, I think it is time for some reflection.

We underperforming fund managers generally have 3 distinct responses when delivering unpleasant news to our investors: 1) it’s not my fault, 2) everyone else sucks too, 3) don’t worry, it’s going to get better any moment now. I am no exception, and am going to try these out on you.

1) It’s Not My Fault. It really isn’t! Honest. I can’t complain about my big long blowup, these things will happen to us all a couple of times in our careers. As a contemporary of Spinoza put it, writing of the Amsterdam stock exchange in the 17th century:

Even if we assume that the news is good and correct (something which one can only tentatively establish from private letters), that the reports come at the right time, and that they announce the happy arrival of the ships, nevertheless an untoward event occurring subsequent to the acquisition of the news, but before the conclusion of the business may destroy this splendour and contentment. For ships can sink inside a harbour and hopes be thwarted. Continue reading →

I spend my time investing in handset companies Bento: understanding the industry is my job, and I am quite good at it. So I try to educate my public, point out to them that not all about the iPhone launch is quite as it seems, to let them know it’s OK not to be a fanboy. Expecting adulation I receive instead a deafening silence. No calls, no interviews, just a few comments from enlightened individuals. Unlike Spinoza I have no coterie of supporters to cheer me on, no faithful, like-minded friends. Moreover, Bento, I know you are one of the glazed-eyed pod-people (iPod people).

Of all the articles written about this sodding iPhone in the press, most of which are silly, factually challenged Apple fluffer pieces, I have finally found one, ONE, which gets it. Some of the comments are good too. Never mind the editor chose a photo of the author that makes him look like he has busting for a pee, and has just found a toilet:

Why can’t they just have normal, non-smirky photos? I am sure the guy looks quite normal in real life. But never mind! Smirky or not, this guy understands that the iPhone venture is a risky one for Apple, a venture into shark-infested waters, where two types of sharks swim, jealous operators and frantic handset vendors. He writes:

the iPhone’s new business model is an aggressive attempt to place Apple at the center of the consumer wireless market, increase the company’s competitive power and diminish the role of the wireless carriers.

Given the tough dog-eat-dog dynamics of the telecommunications industry, that is a heck of a big bet that even Steve Jobs might lose.

The operators are the main barrier to greatness:

while Apple talks about “partnerships” with carriers, the carrier really is just a necessary distribution mechanism for the iPhone and the Apple brand. In effect, Apple sees the carrier as a competitor for the customer’s wallet whose power will diminish over time as the iPhone catches on. . .

Apple’s battle with the music labels was like a fistfight with neighborhood punks. Taking on the telecommunications industry is more like nuclear Armageddon.

Me, I think the handset competitors aren’t going to go quietly. Neither does Herr Newmark.

The handset business is ferociously competitive. At the high end, Research in Motion and Nokia. At other price points: Samsung, LG, Motorola, Sony, the new Chinese entrants. Today, Apple’s iPhone may have unbeatable design and functionality. And that may be enough to attract loyal Apple customers and the phone-as-fashion-accessory crowd. But it isn’t enough. Apple must win over the mass-market consumer. Here the going will be tougher. . .

It could get pretty bad. Remember the market for personal computers? Crushing price pressure and rapid commoditization left only a few mass-market competitors, such as Dell, Hewlett-Packard and Lenovo, standing. Along with who else? Apple of course–which survived by playing by its own rules and carving out a profitable niche.

Spot on analysis. I wonder if he read me first, one month ago? It is possible to come to the same conclusion independently. Leibniz and Newton invented calculus at the same time, didn’t they?

UPDATE: actually, Felix looks like he is not drinking the iKool Aid, either. Healthy scepticism levels there. I’d probably still buy one, though. Hey, in the UK, you get one for “free” (OK for 45 squids a month). My lizard brain says “oh me get good deal!”

If ever we needed proof that Steve Jobs seems to have put the blinkers on the press, Bento, and somehow persuaded them to withhold the incisive critical analysis they have shown in other issues, such as the war in Iraq, Bento, this is it. The article strikes me as quite, quite wrong; clearly the grasp of basic commerce at the Torygraph is somewhat lacking. They have not been reading the excellent coverage of just this issue at Ultimi Barbarorum. The article is one of those “lead-up to the new iPhone” puff-pieces every serious newspaper feels it has to run ahead of this week’s product release. It states:

In a bid to take the phone to the mass market, Apple chief executive Steve Jobs has dropped his resistance to the sales techniques that have made the mobile phone the best-selling consumer electronics device of all time.

In return for allowing networks to subsidise the iPhone, it is thought that Apple will take a higher proportion of the ongoing revenues from customer usage of the phones.

The mind boggles. Presumably Apple “allowed” its executives to exercise jus primae noctis with the prettier O2 staff members as well.

Cool profile of Taleb here in my sunday paper, Bento.

Did you ever read any of his books yet? I’ve posted on him enough for you maybe to have noticed. I’m quite looking forward to his next book, on the value of aimless tinkering around.

Peter Woit: “The LHC has to have a winter shutdown so that the residents of Geneva don’t freeze to death, and that will start in late November.”

Spinoza wouldn’t have minded a lack of electricity. Oh how modern technology makes us weak and spoiled. Genevois, grow some backbone already for the sake of science.