Inside Hedge Funds
O'Reilly director of market research Roger Magoulas wrote me this morning: "You may want to look at today's New York Times Magazine Money issue, chock full of interesting articles about hedge funds and serial entrepreneurs." He was right. Roger Lowenstein's "See a bubble? opens the issue. Joseph Nocera's article on the inner workings of hedge funds, "The Quantitative, Data-Based, Risk-Massaging Road to Riches" answers that question:
"There are plenty of people, even in the hedge-fund world, who are convinced that we have entered bubble territory. Their secrecy, their power, the incredible amount of money flowing into them, the sense that everybody on Wall Street is trying to start a hedge fund and of course the staggering riches: it all seems a little crazy and out of control. Hedge funds right now feel a little like mutual funds in the late 1960's, or junk bonds in the 1980's, or dot-coms in the late 1990's. You just assume they are going to get their comeuppance eventually. Isn't that what always happens?This is also the premise of the book Technological Revolutions and Financial Capital, which makes the case that every major technological revolution has been accompanied by a financial bubble, and shows the complex relationship between advances in society and the ebb and flow of capital. (Well worth a read.)
But do you remember what happened after the mutual-fund boom burst? Or after the junk-bond craze? Or even after the dot-com insanity? It turned out, in every case, that underneath the craziness, something enduring was being created. The modern mutual-fund industry emerged in the wake of the early 1970's mutual-fund crash. Junk bonds today are a critical part of the world's financial scene. Amazon and eBay and lots of other real, profitable companies emerged from the dot-com mania, after all the pretenders were swept away in the rubble of the collapse.
There are other great articles in this week's NYT Magazine as well.
tags:
| comments: 3
| Sphere It
submit: 
Subscribe to Comments on this Entry:
0 TrackBacks
TrackBack URL for this entry: http://radar.oreilly.com/mt/mt-tb.cgi/7672
Comments: 3
This is a remarkable set of articles (on the NYTimes) for anyone who is interested in mathematical modeling, artificial intelligence, finance, and technology. My MathematicalAnalysis.com site was started as a site that presented mathematical models for investing (the primary report illustrating my findings, "Stock Market Modeling Techniques and Potential Applications", is still available at money.MathematicalAnalysis.com/report1/report.html). Unfortunately, starting a business such as a hedge fund takes more than just inventing a mathematical model that beats the market!
It makes sense that technological revolutions are accompanied by a financial/economic bubble of some sort. Innovators begin something. At first the ideas are scoffed at: "Yeah, right! Like horses are going to be replaced by motors!" Then some rich people (who else has lots of available capital?) decide take a risk and invest in start-ups. Early investors get in at bargain prices. Then the technology begins to gain traction. Lots of money is being made by the early investors! Then the news of all the money being made is in the media, at the same time that more and more regular people are experiencing the technology. Suddenly, it becomes "obvious" that investing in this new technology looks lots like a lot easier way to make money than Vegas or the Lottery! Has anyone yet lost money by investing in the technology?
Now we have people who have never invested in the stock market pouring money into the companies that produce the new technology. It's such a sure thing that people are even borrowing money on their houses. They have heard of and know people who have done this and who have doubled, tripled, quadrupled their money in 6 months or less! It's so easy!!!
Has the technology gotten less important? No. It's just become another tulips fantasia. With the same end. Except that tulips aren't new, the new technology is. It will move forward, like automobiles did and still do.
This is a remarkable set of articles (on the NYTimes) for anyone who is interested in mathematical modeling, artificial intelligence, finance, and technology. My MathematicalAnalysis.com site was started as a site that presented mathematical models for investing (my primary report illustrating my findings, "Stock Market Modeling Techniques and Potential Applications", is still available at http://money.MathematicalAnalysis.com/report1/report.html). Unfortunately, starting a business such as a hedge fund takes more than just inventing a mathematical model that "beats the market".
It makes sense that technological revolutions are accompanied by a financial/economic bubble of some sort. Innovators begin something. At first the ideas are scoffed at: "Yeah, right! Like horses are going to be replaced by motors!" Then some rich people (who else has lots of available capital?) decide take a risk and invest in start-ups. Early investors get in at bargain prices. Then the technology begins to gain traction. Lots of money is being made by the early investors! Then the news of all the money being made is in the media, at the same time that more and more regular people are experiencing the technology. Suddenly, it becomes "obvious" that investing in this new technology looks lots like a lot easier way to make money than Vegas or the Lottery! Has anyone yet lost money by investing in the technology?
Now we have people who have never invested in the stock market pouring money into the companies that produce the new technology. It's such a sure thing that people are even borrowing money on their houses. They have heard of and know people who have done this and who have doubled, tripled, quadrupled their money in 6 months or less! It's so easy!!!
Has the technology gotten less important? No. It's just become another tulips fantasia. With the same end. Except that tulips aren't new; the new technology is new! It will move forward, like automobiles did and still do.
"See a Bubble?" talks about one of my all-time favorite mathematical analysis stories: Long-Term Capital Management, which induced a financial crisis in 1998 that almost caused a meltdown in the world's currency markets, prompting intervention by Alan Greenspan and the world's financial institutions.
How did they do it? They applied some mathematical modeling techniques to 5 years of currency data, came up with a formula that produced incredible returns over the historical test period, then began playing the markets with enormously leveraged currency derivatives (for example, putting up $1M to wager on $20 of currency action) .
Unfortunately, the geniuses forgot to read the standard investment company disclaimer that "past results do not guarantee future results", and by 1998 the equations that worked for their 5-year historical data period began producing huge losses...
Where are the geniuses now? Still rich, I think...
