Saturday, July 21, 2012

Hedge Fund Money Managers

In Hedge Fund Market Wizards, author Jack D. Schwager explores the trading styles and techniques of 15 current or former hedge fund money managers. The book, provided without charge to this writer by publisher John Wiley & Sons, Inc., presents interviews with each trader featured, along with commentary by the author. The traders, whom the author believes to be highly successful compared to their peers, include some who are well-known in the financial community and others who are not. The interviewees are variously active in one or more of the major financial markets, including stocks, bonds, commodities, and derivatives. Some trade hundreds of times a day, holding positions for as a little as a few moments, while others are value investors, seeking in some cases to outsmart their peers by outlasting them.

The featured traders were asked to explain the keys to their success. Each has a different story. Some got their start as elementary school age kids. Others drifted into trading. Some manage billions of dollars of investor funds. Others deliberately limit themselves to tens of millions. Their ranks include academics, attorneys, accountants and college dropouts. While their paths to success varied greatly, all were persistent, patient, open-minded and willing to learn from mistakes, and loss averse. The last trait may be the one that the ordinary investors have the hardest time emulating. Each trader featured in the book has stringent ways of limiting losses, and learned to pull the plug on losers quickly, even if doing so meant admitting error and taking a few hits to one's ego. Most, perhaps counterintuitively, weren't terribly greedy. They would start taking profits without trying to score the maximum gain possible. Making some gains, and then looking for another good opportunity, is generally preferred over squeezing the last penny of profit from any given position (with its concomitant risk of overplaying one's hand).

Some of the traders employ rigorously defined parameters. Others apparently rely mostly on their intuition. But they weren't all numbers crunchers and screen watchers. One, perhaps not illegally, got some nonpublic information about a public company from a U.S. government agency. Another (mentioned but not interviewed), hoping to profit from the impending collapse of the real estate market in 2007-08, may have convinced an investment bank to create a derivatives based investment relating to real estate assets the trader suggested, believing those assets to be weak and to provide a good shorting opportunity.

Who would benefit from reading this book? Other traders, for one, just to get an idea of what their peers are thinking. Much of the material in the interviews is already well-known to money management professionals, but the ways that successful traders mix and match the kaleidoscopic inflow of information and ideas into the financial markets can be insightful. Of course, one cannot expect that the interviewees revealed everything they know and do. No good trader would do that. Not if he wanted to keep making money in the markets.

Potential hedge fund investors--in other words, accredited investors--would find the book helpful in revealing the enormous variety of money management styles and techniques. As author Jack Schwager emphasizes, you can't rely on past performance as a certain indicator of future performance. You have to look at investment approaches and risk management, and find a manager with whom you are comfortable.

Ordinary investors might find the book insightful, not because they could use most of the trading techniques discussed. Hedge fund managers do a lot of stuff that you shouldn't try at home. But reading the book can help crystallize an individual's thinking about his or her personal investment approach. As Mr. Schwager highlights, it's important to invest in ways that you find comfortable, to learn from your mistakes, to adjust to changes in the markets, to limit losses, and to find out how you personally can be successful.

The book presumes a considerable degree of financial literacy on the part of the readers. The author is an experienced money manager and tosses around many terms and concepts familiar to the cognoscenti that aren't defined in the book. Have a good Web browser handy if you don't know the lingo of the financial markets. In addition, very little math is presented in the book. But mathematical concepts underlie the financial markets. If you don't have a facility for arithmetic and a basic understanding of statistical analysis, you won't follow the discussion much of the time. Beginning investors should start their reading elsewhere.

One limitation of the book is that it casts little light on high speed computerized trading, which comprises the majority of today's stock trading volume. The impact of algorithmic trading by the millisecond, particularly on the perhaps decreasing number of live humans active in the markets, is a crucial question and problem as we look toward the future. Answers are difficult to discern, but badly needed. Humans can't possibly keep up with machines that trade faster than the blink of an eye, especially when the algorithms deployed are dynamic (i.e., they can change on the run). If Mr. Schwager can coax some high speed traders into talking for his next book, he might well do investors and the financial markets a considerable service.

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