Development as Freedom

When people hear the word “development”, 99% of them might think of something related to economic growth. That may, however, be too short sighted and perhaps missing the most important aspect of development. Take mortality rate for example. Mortality rate of black men in US is higher than that of Kerala, an Indian state. It may be dubious to see development only as the economic growth.

Amartya Sen, a Nobel Prize laureate, brought about broader view on development. He argues that the purpose of development is to achieve freedom. According to him, Poverty is a problem in that it deprives people of liberty.

Sen sets out his view on development in the book “Development as Freedom”. In this book, Sen said that freedom composes of five aspects:

• Political freedom: liberty of political participation. Rights of expression.
• Social opportunities: opportunities to receive basic education and health care. Social rights.
• Economic facilities: infrastructure, access to finance. Economic rights.
• Protective securities: unemployment insurance and the other safety nets.
• Transparency guarantees: openness to build the trust. Rights to know.

These ideas may have originated from Sen’s personal experience. He lived in an Indian village, which has experienced no famine even though the village was poor. There also was Indian belief that money is not everything – one cannot carry money into heaven. He also studied philosophy, especially libertarianism as the alternative to utilities theory, which has some limitations (the theory often assumes uniformity of personal tastes).

Sen argues that freedom is also the most effective way to achieve it. He strongly believes in the power of people to whom opportunities are given. He says:

“With adequate social opportunities, individuals can effectively shape their own destiny and help each other.”

Freedom empowers people to develop their capability and thus augments human capital. Their collective abilities and decision based on the free market economy would lead to faster growth.

Long before, most of the people thought that freedom such as freedom to have education is the “luxury” that only well-being countries can achieve. The view often justifies “development dictatorship”, the economic model in which an authoritarian government leads the economic growth whose process is sometimes fierce. Sen strongly challenges this view. He quotes some example that even in economically poor countries, prioritizing human development was possible. One example was Japan. In Japan, human development with higher education and well-made health care system came first, and the human capital made the economic growth faster.

His contribution to development studies is huge. The concept of human securities got the theoretical background thanks to Sen’s theory.

Economist this week

From The Economist Apr 23 2011 printed edition

http://www.economist.com/printedition/index.cfm?d=20110423

Libya - Qaddafi's forces intensified in their siege of Misrata, the city now in the rebel's hands. Western worlds and rebels seek for the more aircrafts from US, but President Obama does not make any decision now, partly because of stigma the country experienced in Afghanistan and Iraq, and partly because of the budget constraint. Some strongly argues that US should involve in the process more, given that the operation in Libya is different from Afghanistan and Iraq, that the operation is humanitarian as well as pragmatic. If I were Mr. Obama, what would I do?

http://www.economist.com/node/18586995/print

Chinese in Africa - China is Africa's biggest trading partner so far. Because of no antagonism due to colonial period and the commitment the workers made, Chinese have gained popularity in the countries. However, in these days, the trend is getting to be a bit different, as seen in the miners' case in south Zambia, where they protested against poor working condition. The Africans' recent criticism toward China may be based on disguised protectionism, or it may be due to the impression that Chinese are hoarding African cheap labor forces. Some politicians are gaining political power thanks to the anti-Chinese movements. What would be the lesson for China, and will Japan be able to replace the Chinese?

Japan - the quickest way for the Tohoku region's revival would be to turn the region into a special economic zone, a free trade area with lower tax rate and immigrant workers. The Economist says it's worth a try given Tohoku's devastation, but I'm not sure if that is the right way in terms of both legitimacy and correctness.http://www.economist.com/node/18586786/print

Stoics of the Japanese, called "Gaman", gained admiration from the world, but it is at the same time obstacles for the drastic changes.

Business - due to the decreasing job seats, internship is getting to be a critical first step into employment. It is unpaid labor, but appreciated for both; employers can measure the capability of applicants, and potential employees can see if the jobs would fit to them. However, recently some say that the unpaid labor is illegal in light of labor code. Should the companies pay for students who actually add almost no value to the firm?

Social science - Crowds are like molecules, but to model the crowd's behavior accurately, the modeling should count the human nature that people behaves different when they're in fully packed places. Dr Moussaid and Dr Sabatier invented a new model including that factor.

Business - Johnson & Johnson, the health-care giant, is to buy Synthes for $20 billion. J&J recently suffers from its bad performance. Recent years have knocked J&J off its pedestal as one of the most venerated companies. It recalled a painkiller, Motrin, but they announced the fact a month later, the fact that represents striking contrasts with what the firm did for Tylenol. The firm shows the dissonance on the takeover deals as well. J&J said to its investor that the firm would buy-back its shares and that no takeover will be made until it solves its internal problems.

Russia & US - the coalition is strengthened these days. Russia became conduit for US on its operation in Afghanistan. Russia was supportive on UN policy towards Iran. The reset of the relationship is not that easy and simple, ans US may need to seek for the better way to democratize Russia through its foreign policy.

Politics - Golden state is under discussion on its voting system. Direct voting system has its virtue, but it does not necessarily means to give the power to people. The direct voting system makes it difficult for minorities to represent their will. Also, the change in political system is tough to reverse; once decisions are made, change in the new system calls for another voting and thus is difficult.

Singapore - the country is transforming into Aisa's top financial center thanks to its ability to take advantage of global financial upheavals. The recent rise was due to the Hong Kong's handover; it accepted many assets newly booked in Singapore and used the opportunity for the growth of asset management business. The country is eager to build the infrastructure to be the finance center: well-thought regulation, lower tax rate, friendly policy toward foreigners, fast internet, etc, all of which are done by government, not out of the laissez-faire.

What makes the Singapore so successful: language, skilled workers, efficient regulation, lower tax rate (max 20%), access (nice airport location), friendly policy toward foreigners, internet system, and, above all, strong leadership to bring all of them about.

Innovator's Dilemma

There are two sort of innovation. One is based on sustaining technologies and another is on disruptive technologies. Sustaining-technology-based innovation just enhances the function of current products. Disruptive one, which is the main focus of the book “The Innovator’s Dilemma”, changes the landscape of the industries.

The principles of disruptive innovation show that when good companies fail, it often has been because their managers either ignored these principles or chose to fight them. Even successful companies with efficient and capable management team are toppled down with the disruptive innovation. See what happened in TV industry for example. Here is the dilemma: large companies, even with the great management team, cannot rationally follow the disruptive technologies, but those technologies are the critical factors in winning new era. The industry just opened by disruptive technologies is too small to enter for giants, too small to analyze properly, and too small to be accepted or highly evaluated by the large number of customers. However, if you are the managers of large companies, you should follow those technologies so that you would achieve sustainable growth in changing business scenes, even though you face difficulties in explaining to your shareholders on what you do with those disruptive innovations.

Dr. Clayton M. Christensen, author of this book, mentions several way for the successful companies manage disruptive technological changes:

1. They embedded projects to develop and commercialize disruptive technologies within an organization whose customers needed them. When managers aligned a disruptive innovation with the “right” customers, customer demand increased the probability that the innovation would get the resources it needed.

2. They placed projects to develop disruptive technologies in organizations small enough to get excited about small opportunities and small wins.

3. They planned to fail early and inexpensively in search for the market for a disruptive technology. They found that their markets generally coalesced through an iterative process of trial, learning, and trial again.

4. They utilized some of the resources of the mainstream organization to address the disruption, but they were careful not to leverage its processes and values. They created different ways of working within an organization whose values and cost structure were turned to the disruptive task at hand.

5. When commercializing disruptive technologies, they found or developed new markets that valued the attributes of the disruptive products, rather than search for a technological breakthrough so that the disruptive product could compete as a sustaining technology in mainstream markets.

It’s been more than 10 years since the book was issued, but the point that Dr. Christensen made is still valid or even getting more crucial than before. Entrepreneurship would be the key to success even in large organizations.

Positioning

The central point in advertisement / marketing is positioning. The purpose of position is to occupy a certain part of potential clients' mind.

Since Al Ries and Jack Trout argued importance of positioning in their book "Positioning", the importance is getting larger as our society sees deluge of information. Nowadays, consumers see too many advertisements. Their minds are like sponges fully soaked with water. It is not easy to add new water into it.

If you are an author, think about your clients’ bookshelf. They have a lot of books in their mind to fill the empty space. The author should think about what sort of book is missing in consumers’ bookshelf, or, in other words, what kind of book could be the one to be called “this is it!”.

How can we occupy consumer’s mind? The authors give us a simple answer: be the “First”. You know the highest mountain in Japan (Mt. Fuji), but less likely the second highest one. You may remember the most-selling book in the world (the Bible) but not the second. To occupy one’s mind, what you sell should be the first in something. If you think your product is not the first, maybe you will be able to find “first” in any particular fields, or sometimes you may be able to create the new field in which your product is the first.

The next point in positioning is naming. You should come up with the name that represents what it is. This is not the time when you can go with the name like Morgan Stanley, Harry Winston, etc. Look at the successful companies in this century: Google, Facebook, Twitter, Groupon, etc. They all represent what they are. By naming, tell your position in the market.

The name should also be unique. If you come up with new product, you need to put the unique name. A good example I think is “MacBook air”. If the name was “MacBook thinner”, it would not be sold like MacBook air.

The theory of positioning can be applied to every field. Successful countries need positioning, and successful politicians as well. Just follow the principle: position yourself in the field where you can be the first, and tell the world where you are.

Aging & Skewed sex ratio

Aging society and the skewed sex ratio are the two main topics in population problem.

To the certain extent, aging of societies is inevitable, requiring changes social system and the way of doing business.

Ceteris paribus, in 2050 2.6 Americans need to support one pensioner, and the staggering figures for France, Germany, Italy and Japan will be 1.9, 1.6, 1.5 and 1.2, respectively. Most say that the best way to cope with the disequilibrium is to make the retirement age raised to 70. There are some virtues in raising of retirement ages: first, the old people will enjoy the increase in lifetime income; second, since the working force increases, the government will see the increase in tax revenue; third, the economy grows thanks to the more working force. To me, increase in the retirement age has additional rationale, given that originally retirement is to enjoy the last days of one’s lives. In the societies with longevity, the retirement age should be adjusted based on the life expectancy.

Users of TV viewer are aging more rapidly than the aging societies. In US, the median age of viewers is around 50. Those median people have their own and fixed tastes, and that is why TV programs mainly target at people with age ranged from 19 to 49 in their promotion. Trends are the same in newspaper readers. In US, 45% of newspaper’s readers are over 55, and in Japan the average is circa 50. Big chunk of their sales is coming from subscription of older people. Same are in the music industry. For many of the companies, the aging is realized as costs, but it potentially is opportunity. Some companies succeed in taking advantage of old people as work force. They have knowledge which would not be depreciated shortly, experience and network. If I were an entrepreneur, I will start my business with more than one elderly person. The faster switch across the industries is mainly due to progress of IT. Younger generation switched their source of information from paper-based ones to internet-based ones faster than the older generation. The transition is unavoidable, and the shakeout of the newspaper firms would be accelerated. In the case of newspaper, only those with strong contents (personally speaking, WSJ, FT and Economists are the ones) would survive.

Another serious issue is skewed sex ratio. In China and India, whose population accounts for about one third of the world population, there are more boys than girls, due to gendercide. Cause of the issue is regulation and economics. China’s notorious one-child policy, together with the weaker economic status and rising education costs, is leading to the tragedy. In China, the ratio of boys to girs is 123 to 100, and the figures for India is 1000 to 914. The skewed ratio would have repercussion effects: human trafficking and rapes will be increased as many men cannot find wives.

Risk of efficiency

Crisis often unveils unexpected connection of the system. Japan's earthquake buffeted the world's supply chain known for its efficiency characterized by the just-in-time delivery system.

Japanese makers have core technologies in many goods. Nihon seikojo dominates market of the pressure container for nuclear plants. Some chemical makers damaged in the earthquake provides special devices for computers and mobile phones. Now prices of those devices are soaring not only because of the lower mid-term supply but also because of its supply chain with low inventory.

The case could give us some insight on the importance of slack. Perfect systems work perfectly in normal days, but when the regime changes it gets significantly prone to the outside shocks. We'd better to hedge some risk, and as finance theory tells to us, the optimal hedge ratio lies between the both extremes.

Second momentum

Acid rain in Schwarzwald (black forests) was the first opportunity for the Greens to gain its popularity. Here they get next one.

Nuclear crisis in Japan brought about byproducts even in Europe politics. In the recent Germany state election in Baden-Württemberg, the state with four nuclear reactors, the Greens now gain the 24.2% of votes and taking control of the government.

Source: http://www.economist.com/node/18485945/print

Even though the contribution of the Greens is limited in changing energy policy (as nuclear reactors in Baden- Württemberg are under federal control), the votes reflect the change in the wind. Obviously the main reason of winning more seats would be nuclear disaster, but the next reason is said to be that the Greens succeeded in appealing to young generations with high education.

Maybe someone in Japan could establish the Greens at this moment.

Unknown unknown

Today life is divided into three parts. Eukaryotes is the most popular one, and then next Bacteria. The third one, tiny and not visible in naked eyes, is archaea which was recognized only in the 1970s. So the striking question is : wouldn’t there be the fourth? Dr Eisen found that both RecA (genes in DNA combination) and RpoB (genes in translating DNA) have one evolutionary branch that really was an unknown unknown. The fact suggests the existence of new life, but not sure under the current circumstances.

As with archaea whose discovery changed scientist' CO2 forecast (since it generates methane), the new life would have significant impact in understanding the world. To me, the implication is not limited to biology : Distinguishing known unknown and unknown unknown is vital to think about all unknowns. The effect of Tsunami on the east part of Japan was known unknown since long before, and we could prepare for it by adjusting tolerance toward the potential risk. However we could not prepare for unknown unknown, which is totally out of the recognition of human being.

Lords under democracy

UK is to elect Viscount Hanworth as a new member of the House of Lords. By-election is held, but the election is perfunctory under UK’s election system. Before 2007, members of the House of Lords are appointed from itself, and finally in 2007 House of Commons passed a law to require election for the member of the House of Lords.

Seems that the election system is against the principle of democracy, but some admit that there are some values in the upper house. The House of Lords is said to be the best place to hear the great speech, as the members are composed of people with deep / broad knowledge and high profession. The latest member is an economics professor at Leicester University. Though they have no power in policy making, the members sometimes work as a consultative body.

Rumor and openness

After the rumor that radiation reaches to China and sold is good for the prevention of diseases caused by radiation, Chinese rushed into stores. On one day, in Zhejiang, the region where allegedly the origin of the solt-panic and 2,000km away from Fukushima nuclear plant, 4,000 tonnes of salt were sold.

This would be the striking example for the information as a panic preventing factor. In China people may think that the official statements are not trustable, and in fact internet access is limited in the country. That status would make people prone to the rumor.

What I experienced in Japan is that all rumors are vaporized by the scientific voices. You see a lot of rumors in Twitter, but in a few hours they are gone thanks to the remarks from the specialists & insiders. Wisdom of crowd workd and functioned as the information censor. Looks like the openness in information sharing would work as the stabilizer of public opnion formulation.

Third potential bail-out

Jose Socrates resigned as the prime minister of Portugal on Mar 24, 2011 after the parliament rejected the austerity plan that his government submitted mainly because the opposition party didn’t support the plan. He predicts that IMF/EU bail-out plan would be harsher than his government’s austerity measures which included 10% (at maximum) tax on pension.

The dismal states of Portugal’s economy would be even worse after the rejection. Ten year government bond’s yields are close to 8%, higher level compared with 10% of Ireland and 12% of Greece. The upcoming election will choose the new government, which would inevitably accept the third bail-out in Euro zone.

Opposition party’s myopic actions often take place. They oppose the incumbent’s plan for the sake of getting more sheets at the next election at the expense of national interest. True, the chances are that the opposition has any special plan to get out of the doomy states of its economy, though the probability of success looks very low from my perspective. This sort of myopic action should be punished in the long run, and I’m not sure why Social Democrats dare to do so.

Power shifts after Fukushima

Japan heavily relies on nuclear energy more than most of the others. One reason is its historical discussion on independence. Soon after losing WWII, its leaders thought that no independence can be made if it has no army and depends heavily on the outside energy resources. The discussion paved the way for the birth of "Self-defense" force and nuclear plants industry. Now the industry is feeling pinch.

Now more believe that nuclear energy is dangerous, accounts for small portion of world's electricity and expensive. Before Fukushima in 2011, you remember what happened at Three Mile Island in 1979 and at Chernobyl in 1986. Now that three have done so again, unti-nuclear movements would get momentum. In 2005 only quarter of Japanese felt nuclear plants are safe, and in 2010 more than 40% did, but no longer. To add to that, even now nuclear plants with average age of 27 account for only 14% of world's electricity. The construction is far expensive than the others.

So why do we keep to use nuclear plants? One reason is environment. There is a trade-off between reduction of nuclear plants and increase in carbon dioxide. If we go without nuclear energy, in the first year we would see the carbon dioxide increase which equals to what Germany and Japan emit a year. Although EU asked its members to conduct "stress-tests" on their reactors and the Japan case provoked arguments on nuclear energy in EU countries, the rapid shift in power is less likely to happen. France may see the disaster in Japan as an opportunity. It has AREVA, the world largest nuclear plant maker which covers most of the value chain of nuclear energy industry. You can see world's nuclear usage trend here: http://www.economist.com/blogs/dailychart/2011/03/global_nuclear_power

With that said, the world may turned into less nuclear one. In the new world, gas and renewable energy would be the new leaders. As with others, you need to think of energy portfolio given risks and return, i.e. the trade-offs between economics and potential damage on the environment and human beings. To judge and take the risk is what's Japanese can do better in many fields.

Main source:

http://www.economist.com/node/18441163

Who says the elephant can’t dance?

As an investment professional at a private equity firm, I often hear of the book. According to my friends who are close to him, Louis Gerstner, former chairman and current senior advisor of Caryle, knows every aspect of business.

The book “Who says the elephant can’t dance?” is about what Gerstner has done and learned in reviving IBM which was on the verge of extinction when he took the seat as a CEO of the computer giant.

Turnaround manager is the hard job. With the (often) limited resources, you have to make some measurable results. You work under high pressure of shareholders who relentlessly asks the performance improvements. People naturally don’t like alien who seems to be eager to cut costs. Even if the achievement that turnaround managers make in raising the sun again is great, the contribution tends to be undervalued. The fact that Gerstner kept the firm alive under the circumstances should be success, but some who don’t pay attention to the macro environment denounce him by pointing out that the revenue growth under Gerstner is the lowest. The same story can be seen in Japan.


There are three points I learned the most from the book.

The first is about the organization as a complex organic system. Many say IBM should undergo divestiture, but Gerstner didn’t. I think it is not only because IBM as a total has the huge scale and thus the unique competitive advantage, but also because he knew the organization is complex system and splitting the company could bring about unexpected negative impacts.

Second is about the corporate culture. If you want to make the excellent company with sustainable growth, you have to embed the management system in your company’s culture. He says:

“I came to see, in my time at IBM, that culture isn’t just one aspect of the
game – it is the game. In the end, an organization is nothing more than the
collective capacity of its people to create value.
Vision, strategy,　marketing, financial management – any management system, in fact – can set you　on the right path and can carry you for a while. But no enterprise – whether in　business, government, education, health care, or any area of human endeavor –　will succeed over the long haul if those elements aren’t part of its DNA.”

Third, the most crucial to me, is that there is no silver bullet in corporate turnaround management. Gerstner says “I’ve never been certain that I can abstract from my experience a handful of lessons that others can apply to their own situation”. Great company with well-specified business field is superb at execution driven by leaders all over the firm. The point is how you can make that company.

Unique strategy tends to be risky. Therefore, people fight with the same weapon and look at the same KSF unique to the industry. Thus execution matters. To be excellent at competition, you have to make the company superb at every aspect.

“So, execution is really the critical part of a successful starategy.　Getting it done, getting it done right, getting it done better than the next　person is far more important than dreaming up new visions of the future.　

…

Execution is the tough, difficult, daily grind of making sure the machine　moves forward meter by meter, kilometer by kilometer, milestone by milestone.　Accountability must be demanded, and when it is not met, changes must be made quickly. Managers must be asked to report on their performance and explain their successes and failures. Most important, no credit can be given for predicting rain – only for building arks.”

Great companies have world-class process and leaders in every position to undergo the execution. Turnaround managers design the process and let the people accountable for the result and be the leaders at achieving the change.

Reasons of the revolution

What drove the revolution in Egypt and Tunisia? Here are the four factors which may collectively constitute the reason of the movement:

1. Poverty and inequality

No one can be the patriot if she is hungry. In many revoluions, there has been the anger on their living standards, which let people to fight for the better life. In Egypt, 40% of the population is living a day with under 2 dollars. However, although the gini coefficient of Islamic countries looks high, the overall level is lower than some countries which have lower risk of the upheaval (see the map). The inequality and poverty cannot be solely the reason of the revolution.

Source: Economist & UN

2. Lack of democratic process

If you have the proper voting process you can choose the better government through election. But if that is not the case, people have to rely on the violent movement. Still, there are many other countries which don’t have democracy.

3. Illegitimacy of the government

Some people say the revolution is nothing but the anti-American movement. In fact, the potential targets of the next revolution are said to be Yemen and Sudan; Yemen has pro-US government and Southern Sudan’s pro-American rebels just won the independence.

With that said, to treat the movements just as the anti-US movement seems to be too simple. I think, more essentially, the revolution was the action against the illegitimate government. The intervention by US and the other countries would have brought about the issue of legitimacy.

Still, we cannot let the legitimacy alone be the reason of the revolution. There are many other countries which have issues in due process in establishing their government.

4. Proliferation of internet

Some point out the impact of information brought about by wikileaks. Actually the start of Tunisian revolution was wikileaks. Today’s rebels are utilizing SNS which has accelerated speed of people’s action. The rebels mobilize their movement through twitter, Facebook, and the other SNS.

Internet could be the reason of the revolution, but it also cannot fully explain the situation. As some newspapers broadcast, Tunisian knew the corruption of president’s family long before the wikileaks. Also, there are other countries which seem to be suppressed by government and have more access to internet (see the table). The question “why Tunisia, why Egypt?” remains.

Source:

Main table: Economist

Additional column: http://www.internetworldstats.com/stats.htm

Leadership

All the above explain occurrence of the revolution to the certain extent. The poverty, social inequality, lack of democratic process, illegitimacy of the government and proliferation of internet could collectively increase the probability of the revolution. Personally speaking, however, the occurrence and the success of the revolution are ultimately determined by those who lead the rebels. As with new enterprises, what determines the success is the leaders.

More Money Than God

At his death in 1913, J. Pierpont Morgan had accumulated a fortune of $1.4 billion in today’s dollars, earning the nickname “Jupiter”, the king of gods.

Today, hedge fund managers earn more money than god. In 2006 Goldman Sachs awarded its chief executive, Lloyd C. Blankfein, an unprecedented $54 million, but the bottom guy on Alpha magazine’s list of the top twenty-five hedge-fund earners reportedly took home $240 million. That same year, the leading private-equity partnership, Blackstone Group, rewarded its boss, Stephen Schwarzman, with just under $400 million, but the top three hedge-fund moguls each were said to have earned more than $1 billion.

Why they got that much? The answer lays in the fee system. Most of the funds have incentive fee, normally 20% of the profit they made. If they buy equity at $100 million and sell it at $200 million, the fund operating companies get $20 million. The company usually pays out all profits as salary every year.

The history of hedge fund started when Alfred Wilson Jones started his investment company. 20% of incentive fee, long & short strategy, leverage, and changing investment methodology to seek for alpha – these four characteristics remain the essential concept of hedge funds. Like most financial institutions, Jones took clandestine approach. Hedge funds have been cutting edge of finance theory.

The book titled “More Money than God” is the precise dictionary of the hedge funds at cutting edge. The book covers the following gurus and their hedge funds:

- Michael Steinhardt (Steinhardt, Fine, Berkowitz and Company): contrarianism based on intellectual confidence and intuition / father of blocktrading

- Julian art Robertson (Tiger Management): shot-seller based on his skeptic characteristic / one of the most long-lived hedge fund

- George Soros, Jim Rogers and Stanley Druckenmiller (Quantum Fund): belief in reflectivity - finding market distortion and make profit out of it / macro bet based on the view on how the world would turn out to be

- Paul Tudor Jones (Tudor Investment Corporation): Betting on the deals where the potential loss is limited while potential gain is large – earned from black Monday and Japan bubble

- John Meriwether (Long Term Capital Management): Investment based on financial theory – belief that in long term market is efficient ; asked investors long-term commitment of three years / too high leverage

- Tom Steyer (Farallon): Merger arbitrage and the other event driven style / man with frugal living

- Jones Simons (Renaissance): Quants fund established by mathematician & code-breaker / hired no economists but scientists

- Nick Maounis (Amaranth) : Multi / changing strategy (MA arbitrage, Convertible bond arbitrage, bond, etc)

- John Paulson (Odyssey Partners): Loner and Contrarian / Capital structure arbitrage – shorted mortgage securities believing that subprime was the 21st century-version policy error

- David Einhorn (Greenlight Capital): shorted financial institutions / battle against Richard Fuld of Lehman Brothers

There have been arguments on their compensation. They do provide liquidity to the market and enhance market’s price adjustment mechanism through the trading. In that sense hedge funds take positive role in the market. The question is whether the high compensation is justifiable for the sake of market stability and efficiency they allegedly provide. Not sure the answer for now, but I think the key is incentive and information. Bad incentive and information induce bad behavior. If we want to alter the current compensation scheme, do not jump into the naïve / straight-forward regulation but into the revision of incentive scheme.

Two key lessons to me:

1. You may be able to beat the market for a while, but almost impossible to beat it forever unless you’re always the smartest in the market

The art of speculation is to develop one insight that others have overlooked. When Alfred W. Jones started his business, it took 20 years until he is caught up by the market. Now that information technology progressed, competitors immediately catch you up even if you come up with the new investment methodology. The golden time is getting shorter. If you manage much money, it’s more difficult to be clandestine. That is why George Soros said on Apr 28 2010:

“We have come to realize that a large hedge fund like Quantum is no longer the best way to manage money.”

2. Rough correctness is better than accurate wrongness

Taleb mentioned this point too. When you look at the collapse of LTCM and relative longevity of Tiger Management and Quantum Fund, you may sense that we need some sort of slack (which is reflected in D/E ratio). We human being with limited ability make decision based on limited information. We may be right more cases, but cannot be always right. Need the slack for rainy days.

Reference:

Sebastian Mallaby, “More Money Than God: Hedge Funds and the Making of a New Elite”, Penguin Press HC, 2010

Picture source:

http://www.life.com/image/50681355