Baruch was amused by the very earnest discussions he read on Abnormal Returns this weekend about hedge fund dudes sharing ideas. The WSJ had a long treatment on this which also quotes Baruch’s favourite quantademic Andrew Lo, who suggests that hedge fund managers sharing ideas may be creating systemic risk in the form of crowded trades and dangerous correlations.
On the same topic, The Rational Walk (again hat tip AR) has a detailed discussion of the possible motivations for investors sharing ideas. Quoting someone called Whitey Tilson, it posits a few viz:
1) It helps clarify our thinking to put our investment thesis in writing, especially on complex and controversial positions . . . .
2) When it is widely known that we have a position in a particular stock, we often hear from other investors who share valuable information or analyses.
3) Invariably, some people have the polar opposite view of a particular stock and, in sharing it with us, they can help us identify things we might have missed in our analysis. . .
4) When we share our ideas, it creates reciprocity and others share their best ideas with us.
How admirable, you might think. How open minded, open handed and collegiate. Bravo, that man.
Bullshit, thought Baruch.
First off, reading an article about how interesting it is that many investors can own the same security at the same time has the equivalent impact as reading an article tha says sometimes many women are interested in buying and wearing the same clothes at the same time. It is merely another revelation of the bleeding obvious, like the Economist last week which said that stocks which have gone up a lot sometimes go up more.
As for the crowded trades argument, well, crowding in illiquid, systemically important securities using leverage can be dangerous (think subprime CDOs), but I don’t think the Fed should lose sleep if 20 big hedge funds are all long VISA. When that tanked I don’t think anyone other than Visa and Mastercard noticed. It certainly didn’t rock my world.
Let’s not be naive. When it comes to the reasons for sharing ideas, there’s really only one, and OK, maybe a second, lesser but linked, reason why investors share their ideas with each other. The first and only real reason is what we call “reverse broking”, the sole purpose of which is to make our stocks go up. The lesser reason is that most hedge fund dudes love to show off to their peers. There’s nothing more satisfying than going to one of those dinners, clarting on about your favourite stock and seeing it pop 3% the next day on no news and knowing it was a whole bunch of supposedly intelligent investors copying you because, you think, they think you’re just great.
That’s basically it; the ancilliary benefits to the investment process mentioned by Mr Tilson may be real, but they aren’t even the icing on the cake — they’re maybe the Hundreds and Thousands.
Frankly, these 2 are the only reasons Baruch ever shares his wisdom on particular positions with his peers, be they brokers or fellow strugglers. And you can be as sure as sure can be that when he does so he has bought his full position.* That’s why Baruch smiled at this, from The Rational Walk again:
. . . when Mr. Tilson published his analysis of BP in June, he took the risk that the response may have pushed up BP’s share price which could have prevented him from building up his position as the shares continued to drop in the subsequent weeks.
Right. For him to NOT have a full position at the time he published his analysis would make me, were I an investor in his fund, very angry. How irresponsible, I would think. I’m not paying him 2 and 20 to strew his pearls of wisdom amongst the Great Unwashed for free!
No, Baruch loves his colleagues and competitors, but as he has written in the past, investing at a professional level is a solitary pursuit. You don’t show your work to others unless you have a good reason to. And when people DO share their ideas with you, you’ve got to be pretty uncharitable in your thinking about that as well, because their motivations may not be pure. When Whitney Tilson publishes his ideas as to why NFLX is a great short — after he has lost just a ton of money on it — can you be sure he’s not just trying to engineer a quick drop in the shares to exit his position with a small shred of honour? Let me hasten to add, I don’t think Whitney Tilson is a bad actor in this way, but trusting the altruism of participants in financial markets is not a well-accepted path to riches.
* this is one of the many reasons that Baruch doesn’t us this blog to pump his stocks. He has too much respect for you, his dear reader, to do that. Note also that if you see anything on this blog which could be construed as positive or negative commentary on a particular stock, it is in no way investment advice. Also you should assume Baruch is long or short to the gills.