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Playing not to lose sometimes means you lose

Everyone has seen pro basketball players commit fouls early in a game. The coach faces a conundrum. Does he

  1. Leave the player in the game: he may play to full potential and contribute
  2. Yank him: scared of fouling out of the game, he may play sub-optimally

This decision making process has always been kind of locker room chatter.  Until recently.  Earlier this month, 2 researchers from goliath asset manager AllianceBernstein and an academic from NYU Poly addressed solving this issue using financial research in a paper entitled, How much trouble is early foul trouble?

The researchers actually came up with a formula that’s so important, failure to heed it — a single incorrect decision — could decide the game.  The research shows that it is optimal to yank starting players on a “Q+1 basis” (when they commit one more foul than the current quarter.

For example

on January 20, 2007, the Cleveland Cavaliers visited the Golden State Warriors. With 4:45 left in the third quarter, Golden State starter Andris Biedrins  committed a personal  foul. After the free throw to complete the
three point play caused by his foul, the Warriors were leading by two points. This was Biedrins’s fourth foul and he was  therefore in “Q+1” foul trouble and should have been yanked, but Don Nelson decided to keep Biedrins in the game for more than four minutes, only substituting him out with 36 seconds left in the quarter.

Was the coach’s decision to leave the foul-laden player in the game correct?

During that time, Biedrins did not pick up another foul. Biedrins  re-entered the game with 8:20 left in the fourth quarter and the Warriors up 5. Then at the 5:46 mark, he picked up his fifth foul of the game. Again, Don Nelson again kept Biedrins in the game. Finally, with 1:06 left in the fourth quarter and a tie game, Biedrins fouled out.

Cleveland eventually won the game in overtime. And the researchers question Nelson’s decision to leave his player in the game:

Nelson had two chances to  yank  Biedrins when he was in foul trouble but chose not to. As we will see, Nelson’s decision was not an aberration for him;  that year, he rarely yanked foul troubled starters even though they were in foul trouble more  than any other team. But perhaps Nelson’s entire strategic approach was wrong.

Parallels to investing

If early foul trouble means that pro ball players should sit things out for the sake of the team, I think you could draw some parallels to investors running money.

  • periodic performance review: like athletes, investors of all sizes can judge performance at any time (returns, to some extent, are the ultimate performance metric)
  • high stakes, high stress: everyone in this game is playing f’real
  • decision making appears to be serially related: investors behave differently when they’re winning versus when they’re losing.  I remember walking into my portfolio manager’s trading floor to interview.  I waited patiently while he was on a call — after he hung up, he said, “&*(@!”.  I asked what had happened and he said dispassionately that he had lost $6M on a trade.  When I asked what he was doing with it, he said simply that he is selling it and moving on.

Clearly some investors — more traders than buy-and-holders — strike certain rhythmic patterns in their investing.  You have to behave differently when suffering big losses than you would when up big on a year.  The great ones know how to optimize this tradeoff and not simply double-down just to salvage a trade-gone-bad.

Has Harbinger’s Phil Falcone lost his touch?  He’s suffered redemptions, poor performance, trader exodus.  Amidst all this, he has made a career-impacting decision to invest heavily in a huge bet on a private wireless firm.  Is he playing with too-many fouls or is this the master’s equivalent of bench time?  History will certainly be the judge.

Source

Maymin, Allan, Maymin, Philip and Shen, Eugene, How Much Trouble is Early Foul Trouble? (January 7, 2011). Available at SSRN: https://ssrn.com/abstract=1736633

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New study uncovers the ‘new’ influentials in financial blogosphere

Interesting new study (see below) from Mindful Money.  Investors are certainly turning to non-traditional sources of information as inputs into their investment decisions.  But this appears to be the first time that the interconnections within the financial blogosphere have been studied.  The social media train — and specifically, actionable, investable content — continues to chug ahead.

There are few surprises in the top rated/linked-to investment and economic blogs and websites.  Many of them are read by hundreds of thousands of investors daily.  What’s interesting here is to see how these blogs act as sources of information and credibility for the rest of us trying our hands at providing just a modicum of thoughtful investment ideas online.

Social Finance: The New influentials

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Preliminary hedge fund index performance for December 2010

Key highlights for the month:

  • Hedge Funds bounced back after muted performance in November, as the Dow Jones Credit Suisse Hedge Fund index rose an estimated 3.01%. Nine out of ten sectors posted positive performance for the month. The industry is expected to finish up 11.07% for the year.
  • The Event Driven sector posted the strong performance in December due primarily to increased opportunities in the special situations arena. The largest gains were seen in the Distressed and Multi-Strategy sub-indices which were up 2.34% and 5.27% respectively.
  • Global Macro funds were also among the top performers for the month finishing up 2.75%. Managers found profitability in FX trades, where many shorted the USD against other emerging markets currencies. Managers also added alpha via commodities with long precious metal positions.
  • Managed Futures funds posted positive performance of 5.50%, helping the sector to recoup November losses. Performance was largely driven by gains from short term models, which were able to capture strong momentum in both equities and commodities.

Strategy Estimates

Index Dec-10 Nov-10 2010
Dow Jones Credit Suisse Hedge Fund Index 3.01% -0.18% 11.07%
Convertible Arbitrage 1.14% 0.04% 10.95%
Dedicated Short Bias -5.94% -2.36% -22.52%
Emerging Markets 1.71% -0.38% 11.56%
Equity Market Neutral 2.22% -2.51% -0.37%
Event Driven 4.16% 0.15% 12.89%
Distressed 2.34% 0.33% 9.84%
Event Driven Multi-Strategy 5.27% 0.04% 14.90%
Risk Arbitrage 1.24% -1.44% 3.26%
Fixed Income Arbitrage 0.63% 0.74% 12.50%
Global Macro 2.75% -0.52% 13.54%
Long/Short Equity 3.41% 0.46% 9.26%
Managed Futures 5.50% -4.11% 12.28%
Multi-Strategy 1.79% 0.30% 9.38%
Dow Jones Global Index 7.38% -2.16% 11.89%
Barclays Capital Aggregate Bond Index 1.31% -3.81% 5.54%
DJ-UBS Total Return Commodities Index 10.69% -0.35% 16.83%

Source
Early View: Dow Jones Credit Suisse Hedge Fund Index Estimated Up 3.01% in December

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Realtime trading data in the collective tradestream is HUGE

Softly launched a month ago, Yahoo Finance’s Market Pulse is actually a huge f’in deal.  Clearly, the press — and investors — hasn’t really understood what’s going on here.  And I’m not talking about StockTwits’ inclusion in the real-time stream (there are only two sources of data right now).  What’s really huge here is the Covestor feed that’s showing up on stocks.

Market Pulse is a real-time feed — much like Twitter is — on specific stocks.  So, whenever a trader or investor tweets or writes about a stock, it shows up here.  So, everytime someone blabs about $AAPL on StockTwits, investors can follow that stream alongside the other data provided on Yahoo Finance.  Is that interesting?  Maybe.  It is part of the real time conversation and important for hyperactive traders, I guess.

But the big deal here is what Covestor is supplying to Yahoo Finance users.  As a marketplace for investment services, Covestor actually validates/verifies trading activity of its managers.  In turn, Covestor supplies Yahoo’s Market Pulse with a real-time stream of trading activity — real live trades with real money behind them.  Users get a feel for how large a portfolio position is (in percentage basis) and whether the investor is building or liquidating a position.  Where else can you find this in real time? Nowhere.

This is all about the power of the collective tradestream.  This takes everything to a whole new level.

This is a BIG deal.

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Value stocks: Oppenheimer & Co. thinks there’s room to run

Bloomberg’s Dave Wilson produces a daily chart with some commentary.  Today’s chart plots value stock performance versus that of growth and the blended S&P500.

According to Oppenheimer & Co’s chief investment strategist, Brian Belski:

While both gauges surpassed the benchmark’s 88 percent advance from its March 2009 low through yesterday, the value- stock index was 91 percentage points ahead of its growth-stock counterpart, as shown in the chart.

Value stocks are typically more rewarding than growth shares for about three years after the market hits bottom, Belski wrote in a report yesterday.

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Best way to trade the rumors? Bloomberg (and Tradestream) says short ’em

To a philosopher, all news as it is called, is gossip, and they who edit and read it are old women over their tea — Henry David Thoreau

Gossip is called gossip because it’s not always the truth — Justin Timberlake

With stocks, there is so much noise and pumping going on that investors can feel like they’re at a Motley Crue concert again.  So, how do investors using smart strategies and historical data profit from rumors?

Bloomberg is out with proprietary data today that suggests shorting stocks caught up in merger rumors is a viable, profitable strategy.

Electronic news services, brokerages and newspapers reported at least 1,875 rumors about potential buyouts of 717 companies between 2005 and 2010, according to data compiled by Bloomberg. A total of 104, or 14.5 percent, were acquired, the data show. While stocks that were the subject of takeover speculation initially jumped 2.9 percent, betting on declines yielded average profits of 1.2 percent in the next month, an annualized gain of 14 percent.

In Tradestream, I devote an entire chapter, Grind the Rumor Mill, to rumor mongering and how that plays out for investments – essentially short-selling a basket of M&A rumors.  This strategy works because while real acquisition targets see above-average appreciation, most rumored M&As don’t actually come to fruition.

I included a rumor model developed by Nudge’s Cass Sunstein that he used in his recent book, On Rumors: How Falsehoods Spread, Why We Believe Them, What Can Be Done (affiliate link).  This included identifying propagators, qualifying their prior beliefs, and predicting the cascading effect from any change/reinforcement of those priors.

Much of the guts and data behind this strategy was documented by Gao and Oler in “Rumors and Pre-Announcement Trading: Why Sell Target Stocks Before Acquisition Announcements?” (June 2008)

Data

The Strategy

  • Research: Scan the WSJ’s Heard on the Street for reported, but unsubstantiated merger and acquisition rumors
  • Adjust for market cap: The strategy works better when you remove companies with market cap >$20B
  • Short basket trade: Short sell a basket of these rumored targets and hold for 70 days after the rumor first appeared.  Cover.  Hedge if you like.
  • Timing best for hot M&A years: if M&A heats up (like now, right), the data show the strategy works even better

Last thing

The Bloomberg research found that this short-the-rumor strategy worked (+14%) even when it coincided with other contradictory bullish signals like call buying.

Call volume in New York-based Jefferies Group Inc. jumped amid unconfirmed takeover reports on Feb. 27, 2008. Calls on the company changed hands 12,692 times that day, 24 times the four- week average and the most in almost a year, and the shares gained 3.7 percent. A deal never occurred and Jefferies dropped 3.4 percent the next day, 10 percent the next week and 20 percent in 30 days. The S&P 500 lost 4.7 percent in a month.

Caveat emptor: I have not actually used this strategy in portfolios (I’m pretty much long only) and I think it would take balls of steel to really stick to it.

Further Reading on Investing and Rumors:

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Is patent peace good for NVDIA and Intel?

While giant chip maker Intel ($INTC) has continued to make the best mass-market PC based semiconductors, it’s had lots of smaller competition nipping at its heels throughout its history.  My favorite has always been NVidia ($NVDA) — a maker of great cutting-edge technology used in high-end computers and game consoles.

The two firms (Intel is 10X in marketcap) inked an agreement in 2004 to share some technology that Intel felt needed to be updated as new technology came to market.  Well, they finally agreed on a new structure entitling NVDA to $1.5B in licensing fees over the next 5 years and providing access to each others’ new technology.

This agreement signals a new era for NVidia. Our cross license with Intel reflects the substantial value of our visual and parallel computing technologies. It also underscores the importance of our inventions to the future of personal computing, as well as the expanding markets for mobile and cloud computing — NVidia president and chief executive officer Jen-Hsun Huang (Xinhuanet)

The market liked the news and NVDA has seen its stock rise 34% in 2011 alone.  But is inking this deal with the 800lb Intel really good news for NVDA?

Here’s a primer:

  • Intel needed access to NVidia’s tech, too

…the agreement shows that Intel sees the importance of the graphics processing technology that Nvidia dominates. Those sorts of chips are used in everything from smartphones to automobiles to television sets (San Jose Mercury News)

…Nvidia’s own graphics processing units are now challenging Intel’s chips as all-purpose processors and Nvidia is moving towards greater involvement in mobile computing, with chips based on the architecture of the UK’s Arm, rather than Intel’s x86 processor designs (FT)

…Microsoft ($MSFT) in turn, announced that its next version of Windows would be ARM compatible. Whether that turns “Wintel” into “Winvidia” won’t be known for several years when Nvidia’s ARM processor is ready for the market, but the announcement did strike a psychological blow against the old order of things (Fortune)

  • Certain analysts are focused on what wasn’t part of the deal

But the subtext of what wasn’t part of the deal is also compelling…Nvidia has long been rumored to be trying to dip its toes in the processor market. The fact that Nvidia didn’t get the rights to Intel’s processor designs reinforces that Nvidia plans to take a different path to take on Intel. That path involves licensing a different design that is already popular for phones and other mobile devices. (NPR)

  • It’s now all about mobile computing

As computing becomes more about entertainment and less about productivity a host of companies are making their moves to make computing, fun, mobile and power efficient. But don’t expect Intel to give up its dominant role in the industry any time soon. (gigaOM)

  • INTC validating NVDA’s parallel processing tech

Nvidia specializes in processors that are ideal for processing complex graphics and has been promoting them to be used for other complicated mathematical tasks, such as medical imaging and weather forecasting. While traditional central processors found in PCs are designed to make huge calculations very quickly, one after another, graphics processors, or GPUs, excel at carrying out several small calculations at the same time, which makes them handy for specific kinds of tasks. Nvidia has been talking about the world needing a parallel processor and it seems Intel is validating their technology (CNBC)

Regardless, most analysts see this as a win-win for both firms with demand for next-generation chips ramping as mobile computing sucks up existing supplies.  Whether it’s for offensive or defensive reasons, with this new agreement in hand, both INTC and NVDA look to benefit going forward.

photo courtesy of JD Hancock
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The Future of Investing, Startups, and the $11,000,000,000,000 Question

Online finance lags

The news of personal finance tool Wesabe shutting down last year made it pretty clear that Mint.com is on its way to fully owning the online personal finance space.  The company’s port-mortem pretty much capitulates that.  But personal finance is just a small part of a much larger, overarching problem that affects all of us: planning for a financial future.  While this certainly includes managing household cash flows, it also involves buying a home, choosing 401(k) plans, putting money into the stock market and fixed income investments, and planning for retirement.

This begs the question: with so much money at stake, why does online finance continue to trail other industries like travel? When planning an international trip online, I know exactly whom to trust for advice and why they’re trustworthy, where to look to compare similar products, and have transactional platforms into which to submit my order.  But in finance, most people still don’t even know where to begin.

Hedge fund traders are using supercomputing high-frequency trading tools to make money in good markets and bad while we still can’t even decide which mutual funds are right for us. We require truly comprehensive solutions instead the current piecemeal, silo-based approach in online finance.  At stake is our future and over $11 trillion of mutual fund assets in the U.S.

Current Players

You can look at the way competition is shaping up online in various silos:
  • Personal Finance: Startups in this space are focused on developing value-added services to help users track and manage money flows.
    • Tracking/Tweaking: Mint.com has done really well capturing new users to adopt web/mobile tools, just as Quicken was a similarly powerful force on the PC.  Intuit, which now owns both products, is positioned really well for future expansion.   Personal finance is a huge problem to tackle and it’s really early in the game.
  • Investing: The investing process involves researching various options, transacting, and ongoing portfolio management with analytic tools.
    • Researching: Investors begin the investment process with idea discovery, bubbling up ideas to populate their portfolios.
      • Piggybacking investment ideas: New services like AlphaClone not only make easier tracking of the investment activities of storied investors like Warren Buffett but also provide portfolio development tools to backtest and manage entire portfolios made up of piggybacked ideas.
      • Long tail of financial content: As the costs of publishing have been pushed to zero, we’re enjoying a bull market in investment content.  Sites like Seeking Alpha and StockTwits provide great tools to plug into the collective tradestream. Wikinvest has taken more of a collaborative approach with its content and data.
      • Screening 2.0: Smarter tools like Validea help investors filter through large numbers of stocks using algorithms and artificial intelligence to identify worthy portfolio prospects.
      • Crowdsourcing stock picks: Sites like Piqqem allow investors to tap the wisdom of the investment crowds.
      • Expert networks: SumZero is an online investing club of super-smart people sharing really good analysis on stocks.  Other Q&A tools like those at LinkedIn and Quora and even Facebook are enabling the sourcing of ideas from domain experts.  With the FBI/SEC’s crackdown on offline expert networks, investors will look more towards these tools for help in sourcing and validating investment ideas.
    • Transacting: Once an investor knows what action he would like to take, execution comes next.
      • Online Brokers: E*Trade, TDAmeritrade, and Schwab still dominate the online brokerage space (with recent news that Merrill Lynch is getting back into the game).  It’s interesting to watch as online brokers woo existing traditional brokerage clients with automated, professional-grade services delivered online, blurring the line between full-service and DIY investing.
      • Hybrids: Covestor and kaChing (now Wealthfront) are the eBays of investment advisory services — marketplaces of investment services.  Users synch their online brokerage accounts to mirror the portfolio models managed by advisors on these platforms.  In a move to the mainstream, Covestor’s tradestream now includes the real time audited trades from participating investment managers.  This is a big fuckin’ deal and it’s freely available through Yahoo Finance’s Market Pulse.  Newer entrants like Tech Crunch Disrupt finalist Betterment provide automated investment services.  Other investment advisors like Formula Investing provide a mixture of full service and DIY tools.
    • Managing:
      • Ongoing monitoring:  As markets undulate and investors’ financial health changes, tools help automate changes that should be made in portfolios.  A number of new professional-grade, automated tools are helping head this cause.  Firms like MarketRiders help with ongoing changes in asset allocation and services like Goalgami help address life’s incessant barrage of financial goals that need planning.
      • New asset managers: Fusing the low-cost distribution model that social media affords with new methodologies to manage funds for clients, both old and new asset managers are launching all kinds of new securities in an attempt to capture part of a huge pie.  With actively managed ETFs in the infancy and good comps for successful exits, new asset managers like GlobalX are growing AUM and positioning themselves well for future growth.
      • Analytics:  Like Google’s Urchin/Analytics acquisition, analytics are core to the effective management of any platform.  TC Tear Down star, Steve Carpenter founded and sold Cake Financial to E*Trade earlier in 2010.  Cake helped investors make more sense of the activities in their portfolios. With Cake Financial bowing out, the market is wide open.  Look to Wikinvest’s recently launched Portfolio tool to take off where Cake left off.

Why there is still a huge window of opportunity

In spite of the flurry of activity, most of these startups haven’t even begun to dent the market for financial services.  Some of these verticals are so narrow that participants need to expand horizontally  into other silos, which both incumbents and startups are racing to do.

Some firms have advanced product-based approaches, trying to build better mutual fund mousetraps and have enjoyed a modicum of success. Next-generation mutual funds, exchange traded funds (ETFs) have almost $800 billion in assets, an increase of 34% over 2009 levels, but that’s still only 7% of all invested assets in the U.S.  In spite of all the high quality content, investors still struggle with basic financial concepts, portfolio management, and continue to make bad decisions.  The flurry of activity has unleashed a bull market in financial content; We’ve gone from scarcity to too much content.  We now require tools to cut through the data smog and help us with comprehensive solutions to make better decisions.

The $11,000,000,000,000 Grand Prize goes to…

The market size of the investment industry is so big that there is room for multiple players to establish hugely profitable businesses.  Look for large incumbent players, most specifically Bloomberg, to expand their businesses through acquisition in an attempt to capture more marketshare.  Bloomberg’s multi-billion dollar empire of financial hardware and data recently purchased BusinessWeek in an attempt to move downstream toward retail investors.  The giant investment expert network, Gerson Lehrman Group, may get deeper into online expert Q&A sourcing as the firm continues to enable person-to-person expert research for professional investors.

Real-time transparency is making  its way to the online brokers.  E*Trade joined TDAmeritrade in recently announcing upgrades to its own API to allow 3rd party software developers and services to reach investors through their brokerage logins – the holy grail for the entire value chain.  Investors get access to new apps, software developers can finally tap online brokerage clients through trading platforms, and the online brokers can provide value-added services without having to develop them.

The fact that we’re beginning to seeing ivory-tower asset managers make their way onto Twitter is, in fact, a good sign of things to come in the future.  But the field is still wide open for comprehensive solutions.

photo courtesy of frankblacknoir