This week’s episode of Tradestreaming Radio is up and ready for listen. Let me know what you think and if you have ideas for future shows. You can listen below, find the transcript below or download directly to you iPod/iPhone via iTunes — search for Tradestream or go here.
With the daily news of hedge funds being raided and expert networks being investigated, I wanted to put together a resource sheet for those looking to delve a bit further into the insider trading game.
Decoding Insider Trading (Cohen): This new paper looks at a methodology to isolate insider traders acting on good information from noisy trades. By looking at individual trades — versus looking at all insider activity — investors can mimic better-performing trades, boosting performance of insider trading strategies.
Law and Economics of Insider Trading: A Comprehesive Primer (Bainbridge) 84 pages of insider trading awesomeness. This 2001 paper deals with everything from the origins of current laws prohibiting insider trading to defining an insider to making a case for and against regulating insider trading. For a smaller, more concise paper on insider trading, see Bainbridge’s Insider Trading: An Overview
How Informative are Analyst Recommendations and Insider Trading (Hsieh, Ng, and Wang) Evidence points to insider trading and analyst recommendations giving conflicting signals. This paper documents that and provides theory why this may be the case.
What Insiders Know about Future Earnings and How They Use It: Evidence from Insider Trades (Ke, Huddart, Petroni) Insiders do trade on this stuff up to 2 years before public release.
Do Insider Trades Reflect Superior Knowledge About Future Cash Flow Realizations (Piotroski, Roulstone) Short answer: yes.
Insider Trade Disclosure, Market Efficiency, and Liquidity (Buffa): Policy implications after finding that informational efficiency and liquidity are lower in more transparent markets
Institutional Investors and Insider Trading Profitability (Markarian, Bricker) Insider profits are inversely related to presence of institutional ownership. Hedge funds/mutual funds may provide monitoring effect.
Unless you’ve been living in a cave last week (i hear it’s nice there this time of year), you’ve probably seen/heard/felt the aftereffects of the WSJ article U.S. in Vast Insider Trading Probe.
What’s going on
The short of it is:
the U.S. suspects the existence of multiple insider trading rings
the size of the impact of this net would vast eclipse previous insider trading networks
ensnared are consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts
holy mackerel, batman
Interesting for readers of Tradestreaming and my book is the focus on expert networks. As per the WSJ
One focus of the criminal investigation is examining whether nonpublic information was passed along by independent analysts and consultants who work for companies that provide “expert network” services to hedge funds and mutual funds. These companies set up meetings and calls with current and former managers from hundreds of companies for traders seeking an investing edge.
These expert networks are de facto for most large investment funds. As I wrote, expert networks like Gerson Lehrman provide unique research experiences, connecting fund analyst with industry experts for one-off interviews.
Not all bad
Unlike traditional sell-side research that is distributed to many investors and loses its value with greater distribution, expert networks provide extremely valuable interactions. My book includes an interview with a senior GLG executive. Much of our time spent together was spent dissecting the compliance engine the leading network had put together and I believe this was as much for PR purposes as much as it was for legal purposes.
It is clear that expert networks have been cited numerous times in the past few years as potentially being involved in facilitating investors’ access to material nonpublic information. However, we are convinced that the financial markets are better off using “best of breed” expert networks than without them — Integrity Research
Other insider trading rings busted recently (like Galleon) were their own creations. I have to agree with Integrity Research‘s opinion — this wasn’t by chance. If Galleon’s vast web of insider information had existed on GLG’s platform, there would have been a clear audit trail of who was involved and to what level. That didn’t occur — instead, by using individual contacts, Galleon was able to obfuscate its activities for years.
That wouldn’t have happened using a professional expert network and markets are better off by having these. That said, it’s clear why GLG isn’t able to go public and we’re probably looking at increased regulation of these platforms (which would push more investors to skirt their use).
Heavier hand add more carrying costs
What might happen, regardless of the outcome of this particular probe, is
increased scrutiny into the investment research space
some type of oversight/regulation of expert networks
more distrust of Wall Street by people on Main Street
employers continuing to crack down on employee participation in expert networks
formation of ad hoc expert networks (LinkedIn + phone)
prices going up on expert networks because of increased oversight
…The fund has also had strong relative performance during extremely challenging times in the financial services sector, outperforming its benchmark by roughly 80 percentage points since inception in November 2005 (positive 34% cumulative net return for Castle Point since launch vs. negative 46% for the XLF).
Nevertheless, we are happy for Todd, who has an incredible opportunity to work for Warren Buffett at Berkshire Hathaway. Todd is an extremely talented investor and we wish him much success in his new position…
A take-off of his great blog, Jay at MarketFolly has produced a quarterly newsletter that looks at entire portfolios of hedge fund gurus (like Seth Klarman, Bill Ackman, Warren Buffett) and analyzes their quarterly moves. The premium newsletter also identifies 3 different individual stocks and breaks down the thesis, examining why the guru investor is buying a particular stock, what the catalysts are and importantly, what’s the bear case. These stock picks are the hidden gems of the newsletter and are written up as a hedge fund analyst would present these ideas to a portfolio manager.
Research shows that piggybacking certain professional investors does work and investors who subscribe to this methodology will find the Hedge Fund Wisdom newsletter a good resource.
All in all, you’re looking at 75 pages of investing goodness — priced for early sales at a nice introductory offer.
This post was originally included as part of an ebook that I published alongside the launch of my book, Tradestream, entitled “Tradestreaming and the Future of Investing”. The content was so good I wanted everyone to have access to it. 🙂
Piggyback investing is about following the “right” people. In a lot of ways following overall sentiment of an online community is exactly what you want to avoid. The simple premise is that “crowd sourcing” is only valuable when you are able to accurately define and isolate the right crowd. Accepting this as essential first, then any application that then can overlay real-time information about the “right crowd’s” moves is valuable. Here are just a few applications that can benefit from real-time information gathering:
Manager selection: The AlphaClone platform allows you to tap the collective intelligence of groups of managers that are either predefined by us or defined by the use. Some of our groups are dynamic in that the list of managers that make up the group change ever quarter based on some criteria. Take our High Concentration fund group: it selects the 25 managers each quarter that have the highest disclosed market value spread over fifty positions or less. I could see a dynamic group that is constructed of the 25 managers that have garnered the highest votes for inclusion amongst the AlphaClone user community or the 25 managers whose fund page has had the highest visitor traffic over the past 30/60/90 days.
Stock selection: our platform uses quarterly public filings to select the holdings that make up clone portfolios. A real-time overlay that precipitates intra quarter changes in portfolio weightings for securities in the clone would be really interesting. Real-time sources could be intra quarter public filings from the manager or managers in a clone (13G/13D filings), real-time analyst consensus recommendations (especially upside and downside “surprises”), or real-time events (bankruptcy, M&A).
Strategy selection: our platform allows investors to create and backtest clones based on different “clone strategies” (Top Holdings, Best Ideas, Popularity in top 20) and customize clones by employing hedging options and rebalance options. We consider that simply a starting point. I can see our community providing feedback on new clone strategies they’d like to see as well as tips on implementing clones.
I see the real time web as a new communications medium that definitely has relevance for investors and investment services but just like any new communications medium, how useful it will be will largely depend on how it is applied and by whom (i.e. yahoo stock message boards vs. twitter feed from “pro investor here”).
Mazin founded AlphaClone in 2008 with the simple purpose to empower the average investor by giving him intelligent, instant and transparent access to the world’s best fund managers. Mazin was a 12-year veteran of technology-driven media businesses including roles at Time Warner and OpenTV.