I’ve been a big fan of Mark Cuban’s bog called Blog Maverick for many years.  We recently made this comment which struck a chord with me.

Every CEO tells the same great white lie. It is at the heart of every communication. It is at the heart of every financial decision. It is, at it’s very base, the reason why you all are in the 99pct and they are in the 1pct. The Lie ?

Great CEO  White Lie = “We are acting in the best interests of shareholders.”

When a CEO utters this lie, everyone automatically forgives whatever they do. Add 10k jobless to the unemployment rolls ? Sorry, we did it in the BEST INTEREST OF SHAREHOLDERS.  Merge or buy a company and cut back across the board ? We did it in the Best Interest of Shareholders.

The problem is that unless the company is losing money and it is the only way to keep the company alive, in this era of 9.1pct unemployment  it NEVER is in the BEST INTEREST OF SHAREHOLDERS.

Shareholders , whether they own shares directly or through mutual funds or pensions do not live in a corporate vacuum.  Their lives are impacted by far more than the share price of a stock. Every layoff in the name of more earnings per share puts a stress on the economy, on the federal, state and local governments which is in turn paid for through taxes or assumption of government debt by….wait for it.. the same shareholders CEOs say they want to benefit.

If anyone really wants to change corporate structure and impact the economy, talk to shareholders. Talk to your parents, uncles/aunts, cousins, friends who own shares of stocks either directly or indirectly and have them state loudly and clearly that they would rather have a higher Price to Earnings Ratio and even a lower stock price than have their TAXES increase in order to support all the people laid off from their jobs in the name of shareholders !  

You might even consider buying a share of stock. Just 1. Maybe you can all pitch in and then go to a shareholders meeting and let them know how you feel about the best interests of shareholders.

Good to see this article in the Sydney Morning Herald today, since we’re about to launch our Hedge Fund.

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Investors ploughed more money into hedge funds over the past month, data from hedge fund administrator GlobeOp shows, as hopes of a resolution to the euro zone debt crisis and a rebound in markets boosted confidence after last year’s losses.

Net inflows into hedge funds, as measured by the GlobeOp Capital Movement Index, which tracks monthly net subscriptions to and redemptions from hedge funds managing around $174 billion ($164.7 billion), were 2.1 per cent of total assets over the month to March 1.

While this was slightly down on last month’s 2.22 per cent, it is nevertheless the second-highest inflow over the past six months and above the 1.12 per cent recorded last March.

“Last year was a bad year for markets overall, but people feel a little more settled now,” GlobeOp’s chief executive Hans Hufschmid told Reuters.

“In the last two or three months the whole uncertainty about Europe has settled down a bit and the economic numbers in the US are looking pretty positive, and people are happier to allocate to hedge funds.”

Read more: http://www.brisbanetimes.com.au/business/world-business/investors-back-hedge-funds-as-performance-rebounds-20120312-1ut96.html#ixzz1oqamef7q

This month, a new company that I’m involved with is releasing a Hedge Fund based on Mean Reversion.  As such, I’m constantly looking for research about the pitfalls or otherwise of this strategy.  Bo Peng in his seekingalpha blog article explains more…

By “technical trading” I mean trades based primarily on considerations other than fundamental or apparently irrational (such as divine revelation, planet alignment, or social/moral responsibility) factors. It ranges from high-frequency, statistical arbitrage, pair trade, chart pattern, to certain trades involving highly structured derivatives. There is a gray area where trading is based on well debunked patterns such as Elliot Wave, which I shall simply leave to the reader to decide what to call. Another exception is the kind of technical trading that exploits inefficiencies in the market mechanics or regulatory loopholes, such as flash trades. If you can get into this game in time, congratulations and grab all the money while you can. Such opportunities by definition have very high entry barrier. Only the privileged few can get in.

My theory is that all technical trading can be broken down into a dichotomy of Black Swan and Mean Reversion, though some complicated trades may have both elements. Each has its distinct basic assumption, risk/reward profile, and application. I’ll summarize in the table below:

Now let’s dissect them more closely.

Which Is Superior?
For every Black Swan trade, the opposing side is by definition a Mean Reversion trade whether the trader realizes or not. Is this a random game or does one side have more merit?

The Black Swan trade says either or both of two things:

1. The market is underpricing the tail risk.
2. The market is in transition and will not revert to historical mean.

On the other hand, the Mean Reversion trade says BOTH of the above are untrue.

Therefore, Mean Reversion requires a stronger assumption.

Furthermore,

1. History shows the market tends to underprice tail risk except at the height of crisis
2. If you agree that the current price is the best prediction of future risk/reward expectation, then you’re saying the market is Martingale. In reality, arguments can be made that markets are “Martingale like” in the sense that any argument for the existence of a constant mean requires some strong assumptions about market mechanism, macroeconomic behavior, or even sociopolitical structure that have been proven repeatedly by history to change over various timescales.

So it would seem that Black Swan is right. In fact, both are right, but at different timescales. For a given market and trading strategies with similar lifespan, Black Swan works on a longer timescale while Mean Reversion works on a shorter one.

But there’re two fundamental problems with Mean Reversion:

1. You never know when a black swan will swoon down. You know it will come, but don’t know when or how big. You could resort to fundamental analysis for prediction, which can be a solid strategy but then it’s no longer technical trading. You could try to use technical indicators to predict disaster but then it’s no longer a Mean Reversion trade.
2. At the beginning of a black swan event, the market always appears to be out of place, which by definition presents a fantastic Mean Reversion opportunity. But in fact it’s a trap. In theory you could set up various kinds of stops to prevent stepping too deep into such traps. But the temptation is huge and the required discipline can be very painful.

Two spectacular failures of classic Mean Reversion: LTCM and Merrill Lynch’s bond-CDS basis trade near the end of 08. In fact, in some sense the entire subprime CDO/CDS trade that dragged the world into the crisis was a gianormous Mean Reversion trade by the CDO buyers and CDS sellers. But why didn’t the opposing side, CDO sellers and CDS buyers, win? Notwithstanding AIG CDS counterparties’ huge win, at the macro level the Black Swan trade didn’t win the equal amount of losses only because of the massive deliveraging and default/bankruptcy/foreclosure. Trading is a zero-sum game, until it’s not.

But…

Black Swan usually incurs a relatively large number of small losses before hitting the jackpot. It’s very painful to take a large number of small losses. Nassim Taleb, father of the term “black swan”, had limited success running his hedge fund. You may have the emotional discipline and strength to stick to the strategy. But it’s impractical to ask your clients/investors to do the same.

On the other hand, Mean Reversion can easily produce a steady stream of consistent gains. It’s easy to sell to clients and investors. Then one day it’ll blow up. But hopefully it’s not your money by then.

This is why I said in the table above that Black Swan is suitable if you trade your own money, while Mean Reversion is for trading others’.

Timescale And Risk Limits

Of course, when you drill down to details, things are never quite that simple or cynical.

Taleb’s hedge fund took years for the black swan to make up for the losses. He was hunting for huge, rare birds. But black swans come in all timescales and sizes, from milliseconds and fractional pennies up. If you target the right timescale, it’s possible to lose most trades but win most days. And once you catch a black swan, don’t be afraid to ride it for as long as you can. This is what you count on to make up for the consistent small losses. Black Swan can be an easy sell.

On the other hand, the downside of Mean Reversion can be limited with careful risk management strategies and strict discipline, at least in theory. If an arb looks too good to be true, it probably is. Be quick to cut loss. Complement your Mean Reversion trade with certain combination of fundamental analysis, common sense, and a healthy dose of paranoia. Mean Reversion can be good for your own money.

In summary, Black Swan calls for erring on the greed side while Mean Reversion traders should be fearful and not too greedy.

This article is from Henry Blodget from BusinessInsider.com

Henry can be very opinionated and I’m usually not agreeing with him.  Today I am.

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“If you’re an individual with some money to invest, the first thing you need to know if you want to invest intelligently is that you shouldn’t play the Losers’ Game.

What’s the Losers’ Game?

The game that 99.9% of the people who talk about investing appear to be playing: Namely, following global economics and markets and investment advice and trying to make smart decisions along the way.

If you play that investment game, you’re almost certain to lose.

And the sooner you understand that, the sooner you’ll be on your way to investing intelligently.

In other words, if you want to invest intelligently, the first thing you should do is ignore 99.9% of what you hear in the financial media.

Why?

Because, if your goal is to invest intelligently, what you hear in the financial media is mostly distracting noise that will trick you into making expensive mistakes.

That doesn’t mean that the people in and on the financial media are stupid–they aren’t. It just means that almost everything they talk about is irrelevant (or worse) if your goal is to invest intelligently.

Specifically, you should ignore:

• Market news
• Market forecasts
• Economic news
• Economic forecasts
• Bull/bear debates
• Stock picks
• Stock pans
• Technical analysis
• Quantitative analysis
• Generic “advice” (buy this, sell that)
• And so on…

Even if what you hear in the financial media occasionally proves to be “right,” you should still ignore it. Because as you’ll learn the hard way if you consume enough financial media, there will be no way to tell in advance which of the many things you hear will turn out to be right. And the ones that turn out to be wrong will cost you a lot more money than you will make from the ones that turn out to be right.

So that’s the first thing you should do if you want to invest intelligently: Recognize the financial media for what it is–financial media.

(And what exactly is the financial media? Play-by-play coverage of the most exciting global sport in the world.)

George Soros wins again! (Funny–you could have predicted that.)

The second thing you need to understand if you want to invest intelligently is that if you choose to play this global sport, you will not be playing in a special Little League or low-stakes table with the folks like you who just aren’t that good at it. You will play in the same league as the best professional players in the world. And you should expect to do as well against them as you would do against the PGA Tour players at the Masters or the Green Bay Packers in the Super Bowl or the Yankees in the World Series or grand masters in chess.

Because the third thing you need to understand is that the only way for you to make money trading versus investing intelligently (owning low-cost index funds) is to out-play these top professionals.

Got that?

The global active trading game is like a big poker game.  The “pot” the players are playing for is called “alpha”–the total amount of performance that exceeds the performance of the index. This pot, the alpha, that is won by some players, equals the amount lost by other players. To make it smart to play the trading game, therefore, you have to have a good reason for thinking that you are going to be one of the alpha “winners” instead of one of the losers.

And when you soberly assess your competition–massive global institutional investors with decades of experience and tens of billions of dollars to spend on research, traders, trading systems, information, advice, access to companies and governments, and a hundred other advantages that you’ve never even heard of–you will (or should) gradually come to the conclusion that this competition is pretty fierce and that your chances of winning that alpha pot instead of contributing to it with losses are small.

And if you don’t begin to realize that, you should at least remember the old poker adage:

If you don’t know who the sucker is at the table it’s you.

And then there’s one last thing you should understand about your global trading competitors, folks who are very glad to see you show up (because if you’re arrogant enough to think you can compete against them, you’re easy pickings):

They’re all paid to manage money.

Why is that important?

It’s important because, in most cases, it means they will personally do fine regardless of how well they manage money. As long as they don’t screw up too badly, they’ll be able to collect big money-management fees year after year from suckers like you, even if they do worse than the market index–which, over the long-term, more than 90% of them will.

You, meanwhile, won’t get paid a cent to manage your money. You’ll invest tons of your valuable time and effort in playing a game you are almost certain to lose. And, over the years, in addition to the amount you lose competing against the world’s best investors, you’ll lose a ton of money in time and opportunity that could better have been spent elsewhere.

So, then, how do you invest intelligently?

Financial advisor Carl Richards, who just wrote a book about this, explains how here.

Here are the key points:

• Invest in a diversified portfolio of low-cost index funds
• Rebalance automatically when the allocations get out of whack
• That’s it. That’s how you invest intelligently.

But wait.

How can it be that simple? And if that’s how you invest intelligently, why don’t you hear more about that in the financial media?

The reason you don’t hear more about it in the financial media is that it’s boring. The financial media need to make a living, too, and covering the 24/7 market game is exciting. And there are lots of people who like following the markets minute-to-minute 24 hours a day, and the financial media competes for their eyeballs and ears.

But that has nothing to do with intelligent investing.

And just because the “magic formula” of intelligent investing is simple doesn’t mean it’s easy to do. In fact, it’s very hard.

The reason it’s hard is that it’s hard to understand and believe that this strategy will guarantee that you will outperform about 75% of all investors, including the professionals, over the long haul.

Why will you outperform 75% of all investors using this strategy?

Two reasons:

• Lower costs
• Fewer mistakes

By forever trying to chase the Big Prize–alpha–most investors make lots of mistakes. They buy high and sell low. They pay too much for bad investment advice. They pay big taxes. They get fearful when they should be greedy, and greedy when they should be fearful.

They fall in love with assets at the exact worst time (when they’ve been going up) and fall out of love with them at the exact worst time (when they’ve crashed). They pay big fees to mutual funds, hedge funds, and other stock-pickers that may turn in some nice returns some years but then will lose all those winnings and more in other years.

They “get out of the market” just when things get really scary (cheap) and get in when things seem safe (expensive). They hire and fire a series of financial advisers, incurring huge tax penalties in the process.

And so on.

When you add up all those mistakes and costs over the years, and you include the cost of taxes (which generally make losers out of even the folks who think they’ve won), the odds are extremely high that you will end up being one of those suckers who gave “alpha” to the winners.

But, for most people, it takes years and years to really understand that–and to believe it and act on it when everyone you know including bad advisors and the financial media are telling you something else.

So, yes, investing intelligently sounds simple. But it’s hard to do. And that’s why most people don’t do it.

So if you are smart and disciplined enough to do it, hats off to you.  Enjoy the time and money you would have lost if you had spent your life playing the Losers’ Game.”