My Kind of Manager

The name of this manager is David Tepper, founder of Appaloosa Management, who was written about in today's WSJ in the context of the Delphi reorganization . While I am mildly interested in the Delphi reorg I am very interested in David, specifically the attributes that make him both wildly successful and still wildly attractive as a manager even after running many billions of dollars and personally taking home over a billion of those dollars. This is not a normal state of nature and one I'd like to briefly comment on.

The fact of the matter is that, in general, when hedge fund managers become really successful one of two things happen:

1. They become increasingly risk-averse as a massive amount of their personal wealth is tied up in the fund, and they don't want to blow their nest egg by rolling the dice one more time; or
2. They become less interested in investing and more interested in other activities, i.e., politics, going back to school, collecting art, whatever, and take their eye off the ball.

Neither of these two things bode well for investors in the fund, who enjoyed the ride for a while but are now better off taking their chips off the table and switching to another hungry, young, super smart manager driven to produce outsided returns. We've seen this story again and again and again, and is also likely one of the reasons (others are mentioned here) why we see the push towards diversified multi-strategy platforms by "rock star" managers after reaching a certain scale. In most cases motives shift when managers reach the rarefied air of centi-millionaire and billionaire, and these motives frequently fall out of alignment with those of their investor constituencies.

So why am I so enamored of David Tepper? First of all, I have never met David but know people that know him who have given me some perspective on him as a person. He is supposedly a really great guy. Ok, that's nice, so what? Well, he has put up some huge numbers. Both positive and negative. His compounded returns are in the stratosphere, but the ride has been very, very rocky. This is the kind of manager that can drop 50% or be up 150%. Only certain kinds of investors can stomach this degree of volatility. One thing for sure, he is a purist. He knows what he knows and he does well what he does well, and this kind of strategy generates extremely volatile returns. So either accept this and live with it or get out. Again, this is my kind of manager.

But even more importantly, he is a man of massive means who lives like one of (relatively) modest means. He has certainly been very philanthropic, and I respect him a great deal for this. But while he could buy half of Greenwich, he is living modestly in New Jersey. So he is staying laser focused on the task at hand, working to make his admittedly complex strategy successful (at the intersection of securities valuation, corporate law and game theory) and generating eye-popping alpha for his investors (with the collateral benefit of generating eye-popping returns for himself and his capital). Just how focused is he? Well, not that long ago he returned $2 billion to his investors because he couldn't find a profitable way to deploy this capital. Say what? You mean he gave up management fees on $2 billion just because he couldn't find a profitable (or at least profitable up to his standards) way to invest it? Have you ever heard of such a thing? He didn't try and squeeze people out by raising fees. He just gave the money back. Simply astounding.

Now comes Delphi. He invested only $16 million to establish his 10% stake in the company and to secure his seat at the reorganization table. But now it's showtime, and to fully leverage his position in the reorganization he feels he needs the $2 billion back to play the way he wants. So now he asks his super-happy investors for the money back and presto, what happens? He raises the $2 billion in a nanosecond. Surprise, surprise. So, he couldn't use the money and didn't want to collect fees he shouldn't get and degrade returns he has worked so hard to build so he gave it back. Then when he really needs it because of a specific situation he asks for it and quickly gets it. Is there anything we can learn here?

This is the way to play the game - the right way. Here are some of the signs I can see based on my own experience and clearly exemplified by the founder of Appaloosa:

1. The manager runs a differentiated, pure strategy, and pursues it with laser focus, rigor and excellence
2. The manager takes in investors who really understand the nature of his expected returns and are comfortable with the place his strategy will live on the risk-return continuum
3. The manager lives well but is clearly less interested in money than he is in winning, which results in a clear alignment of motives between manager and investor
4. The manager has the confidence to manage the right amount of capital, and this amount may rise or fall depending on market conditions and/or specific investment opportunities
5. The manager is a good guy and a person of high integrity

Come on, am I asking too much here? One of the biggest problems, as usual, is with investors themselves. They often shudder at volatility they consider excessive, and will put pressure on a manager to reduce this lone metric even if it means the manager running a bastardized version of the strategy they are best suited to run. This is simply stupid and is an issue that should be dealt with in overall asset allocation, not single manager strategy. Investors will also frequently accept investing with complete jerks just because of pedigree. This is a short-term decision that may, in fact, come back to roost if problems emerge. Do you really want a manager whose principal refrain is "go f*ck yourself?" Hmmm - not me. Investors will also often want a manager to take more money than he should because they want to secure themselves as much capacity as possible, putting the manager in a hard situation (I mean, it is hard to turn away $1 billion of excess demand). I much prefer a system whereby the manager raises the amount of capital they can comfortably deploy running their pure strategy, and to go back to investors for more if they feel it can be efficiently and effectively invested. If it turns out to be too much, they can give it back. It is this back-and-forth that David Tepper has illustrated works in the real world that I think is so great for all parties involved.

Anyway, I do not frequently find myself a member of one's fan club but I kind of sound that way. I guess I am just royally frustrated with the poor behavior of so many managers and investors alike that when I see a guy doing the right thing and acting in the right way that receives the support of his investors, I just feel compelled to write about it. And this is what we have today with David Tepper. And I hope he makes a slew of cash in the Delphi restructuring. He deserves it.

Why I Love Blogging

Feel free to check out now if you're looking for something of substance. This post is merely a reflection on my past two months as a blogger, what it has taught me and what it has meant to me. Pretty boring stuff - except to me. Probably.

The impetus for this post is many-fold:

1. A breakfast yesterday with Howard Lindzon, a fellow blogger, to merely shoot-the-sh@* and get-to-know-ya as well as to discuss his new project, Wallstrip
2. The influx of emails from people who have become aware of me because of my blog, which has happened literally since my first week blogging but has picked up speed in recent weeks
3. An analysis of my readership, which spans both technology and finance worlds and truly represents a global audience
4. Hitting the mythical two-month point in my blog life and still having the same enthusiasm and excitement for adding content as I did upon launch, which didn't seem possible at the beginning

My breakfast with Howard, to me, represents the power of blogs in a microcosm. Howard blogs (and has done so for much longer than I have). I blog. We are both interested in the investment world. We have both flamed and extolled similar blog posts through our commentary. He is based in Phoenix. I am based in NYC. Yet somehow we connected, discussed our shared interests and actually met face-to-face. Did we have a lot to talk about? Yes. Was I thrilled to have met him? Yes. Might we do some stuff together in the future? Yes. Would I ever have met Howard 5 years ago? Probably not. And you know what - we actually know some people in common. He knows some people I'd like to know and vice versa. You get the picture.

Let me also toss in the emails I've gotten by those interested in the stuff I write about, the companies I work with, other finance and technology bloggers and very interesting and highly qualified people looking for a job. Did I ask for people to personally write me? No. Do I enjoy receiving people's notes who really have something to share or want to connect about a shared interest? Yes. Do I get much annoying SPAM that screws up my inbox? Some, but not a crushing amount. Is it worth letting people contact me via email? Absolutely. This has lead to some really great connections and future relationships that I am sure will prove mutually valuable over time.

Then there is the issue of a global audience. I have received notes from people from every corner of the globe. I have also been cited in blogs and linked to by bloggers all over the world. It also seems, interestingly, that I have quite a little following in Germany (maybe from my old Deutsche Bank days?). Also, for some reason, in the UK (because of my lousy fake-British accent?).  In any event, I find this following quite thrillling, quite flattering and, also, quite unbelievable. The blogosphere, its scope and its diversity totally rocks.

I also seem to have a bit of a cross-over audience - investment and technology - which I find really cool. While I occasionally get linked to by sites including Abnormal Returns, Trader Mike, Howard Lindzon, TheStreet.com, and The Ponderings of Woodrow, I also get some coverage from Techmeme, TechCrunch and Silicon Valley Watcher. I'm sorry, but if you had asked me two months ago whether I'd be getting cited and referred to by sites such as these I'd have said you're out of your mind. But here we are. Very, very cool.

Finally, the passion of blogging. I don't know what to say except that nothing (well, almost nothing) feels quite as good as ripping out a really great post. It represents true catharsis. I feel satisfied, I feel fresh, I feel reborn. Sounds trite and corny but it's true. There is something about expressing your feelings through writing that just feels so right. Kind of ties things together. Makes me feel like that missing puzzle piece has found its way home.

But probably the greatest thing about blogging are the dual benefits of validation and community (which are inextricably linked). The fact that people actually give a crap about what you (what I?) have to say is simply awesome. Sure, we all have friends and people that like us, want to hang out with us, go see a show and throw down a few, whatever. But people who actually take their own valuable time to read us (me?)? That is truly nutty and feels great. An extension of this is the sense of community I feel after only a few short months of being an active participant in the blogosphere. It is hard to describe, but there seems to be a kindred spirit among bloggers, especially those in a particular domain that really get to know the styles, humor and intellectual underpinnings of their fellow bloggers. I have found this in both investment and technology realms and view it now as a very real and legitimate piece of my life. If I were to stop blogging tomorrow I'd sorely miss it. No, scratch that. There is NO WAY I would possibly consider stopping blogging. I'm not giving up all the great stuff I just wrote about. No chance.

So, long story short, thanks for taking me into your world and into your thoughts. I truly enjoy the buzz and the ongoing conversations we have developed. Let's keep it going. I simply can't stop!

The SEC and XBRL - A Match Made in Heaven

I'm not sure if you caught this, but the SEC came out with a stunning announcement yesterday: they are going to make the EDGAR database "interactive."

Washington, D.C., Sept. 25, 2006 — U.S. Securities and Exchange Commission Chairman Christopher Cox announced today that the SEC has awarded three separate contracts totaling $54 million to transform the agency’s 1980s-vintage public company disclosure system from a form-based electronic filing cabinet to a dynamic real-time search tool with interactive capabilities.

The major investment in an “interactive data” system signals the agency’s commitment to move away from the model of its current EDGAR database. It also presages widespread adoption of interactive data filing by companies that report their financial information to the SEC — a development that until now has only been a voluntary pilot program.

********************

To date the SEC has not required companies to file their information in interactive format, largely because the XBRL labels haven’t all been completed, and because the SEC’s own database — nicknamed EDGAR — can’t yet utilize the extra capabilities of XBRL. The three contracts announced today will close that gap, paving the way for universal XBRL filings by companies.

So what's the big excitement? What's all the hoo hah about? Well, for those of you who have spent years wading among documents in the EDGAR database, you know it to be a royal pain in the a**. Investors with ample resources have sought to tackle this problem in one of several ways: (1) employ young, comparatively cheap analysts to rip through these documents for salient bits of information; (2) either develop or license high-end data mining programs to linguistically analyze filings as they come in, with speed of extraction and delivery a function of how much money someone wants to spend on the application; or (3) subscribe to a service like CapitalIQ which uses an army of offshore resources to extract relevant information and place it in a homogenous, easy-to-use format. These methods worked pretty well but are either, well, pretty slow or quite costly. But there is no question there is value in the documents - there always has been and likely always will be.

So what of this announcement? Well, what the SEC is saying is that they are going to spend $54 million large to re-do their archive and the method by which firms file documents with the agency. Specifically, they money will be spent on three key initiatives:

1. Modernize and Maintain the EDGAR Database to Use Interactive Data — $48 million
2. Complete XBRL Code Writing for U.S. GAAP Financial Statements - $5.5 million
3. Interactive Data Tools for Investors - $500,000

An extract from detail in the release expands on its implications:

The new system will be completely interactive. Using interactive data technologies such as XBRL (Extensible Business Reporting Language) and XML (Extensible Markup Language), it will allow investors and analysts to search not only forms, but the information within them. It will permit information to be immediately downloaded into applications software. And it will enable anyone to get real-time, streaming data using RSS feeds, ATOM, and other automated Web tools, which could automatically search for newly filed SEC disclosures and deliver the desired data directly to one’s desktop.

It's pretty sad that boring techie prose like this can get me revved up, but it does! I mean come on, how cool is this? By using XBRL, the agency will be tagging key items within these important documents, making them easily searchable and making them available via an RSS feed. So, I can get pinged when there is a new filing about a company I care about, I can rapidly pull up the file, download key pieces and swiftly search it based upon keywords and tags related to my areas of interest. Love it.

Now, this doesn't sound particularly revolutionary to someone immersed in the world of the web (with the related expectations that come along with such knowledge of what's possible), but coming from the SEC news like this is absolutely earth-shattering. What? This project saves companies on the cost of filing and makes the information infinitely more useful and accessible for investors? I've never heard of such a thing from one of our government agencies. Thanks, Chris.

Mr. Cox foreshadowed this announcement in a speech he gave in May at the American Enterprise Institute:

********************

Today at AEI we’re talking about another national movement that was started in the private sector — and that the government will eventually sign on to. It’s the movement to electronic exchange of financial information that will be standardized across many technologies — including personal financial software, corporate financial preparation software, and the Internet.

To make it sound high tech, which it is, it sometimes goes by the name of “XBRL.” In plain English, I call it “interactive data.” Either way, what we’re talking is very straight forward. For users of financial information, we want better access; more accurate and reliable information; and significant new capabilities.

These are really quite simple concepts. But interactive data — which is truly a revolutionizing and exciting topic — is often bogged down by its own terminology. XBRL isn’t an abbreviation that easily trips off the tongue. Not only does calling something “XBRL” make people think you’re talking about the Sci-Fi channel, but then there are “taxonomies.” I learned during 17 years in Congress that people are natively suspicious of anything that starts with the word tax.

It seems to me that we might be approaching this from the wrong end. Instead of talking about all the gizmos that will make markets work better and give investors better tools than they have today, we ought to be starting with the reasons that interactive data will make the lives of investors, companies, and even regulators better. Watchmakers, after all, do not sell their products by talking about tachometers and rotors. They tell you that their watches keep perfect time. You don’t have to know anything about movements to be able to tell time — and to know that it’s always better if your watch hasn’t stopped before an important appointment. With interactive data, the parts and internal movements can be daunting, but the result is to make investing easier and better for the individual and for the market as a whole.

Interactive data is a marriage made in heaven for investing and high tech.

********************

Commissioner Cox, your talk almost brought tears to my eyes. Someone in government who actually gets it! I don't know what else to say except that its great to see that the SEC is getting on the clue bus, and not a moment too soon. This change was sorely needed, and it should have a substantial impact on how investors access this data. Extracting value should become much easier and much less expensive than it is today. And this can only be a good thing.

Monitor110 and Me - A Big Week

Let me start by saying that Information Arbitrage is my personal blog. I write about what interests me, specifically those things that are "burning a hole in my head" that just need to find a way to get out. I have found tremendous freedom, satisfaction and comraderie in blogging - I can't believe that it has only been a little more than two months! Thanks to all my readers, commenters and those who have reached out to me personally. I can't tell you how much I appreciate your becoming a part of the online dialogue that has, in many cases, become an offline dialogue due to shared interests and ideas for collaboration. Whether you have agreed with me or not is not the point; it is your engagement and passion that matters. You all rock.

I do other things besides blog, however. I do selective angel investing both individually and with my partner, Jeff Stewart, through Geometric Group. I also invest in hedge funds. But principally, beyond being a devoted husband, father and friend, I am President and Chief Operating Officer of Monitor110, Inc. This is a role I love and the passion I chose to pursue after leaving Wall Street. It has been a magical 18 months, working with my partner Jeff to build the team, the technology, and the platform to make our shared vision of "Helping Institutional Investors turn Internet information into alpha generation" a reality. We recently came out of "stealth" mode, announcing our financing partners in a press release a few weeks ago. Reflecting on all that has happened since Jeff and I met at the beginning of 2005, I have neither felt so fortunate in my business career nor been so proud to be part of such an amazing group of people. Smart, dedicated, multi-dimensional, and, most importantly, fiercely passionate about our shared vision. In my spirit of blogging, e.g., the things burning a hole in my head, I feel compelled to discuss a little bit of what went on this week with Monitor110.

For starters, our company was discussed on the Front Page of last Thursday's Financial Times, as well as being featured in a detailed write-up that same day in TechCrunch. The FT story actually hit the online edition late Wednesday night, and was quickly picked up by Drudge, Techmeme and many top sites during Wednesday evening and into Thursday. Suffice it to say, this is pretty dizzying stuff. The number of hits on both the Monitor110 website as well as my blog was, at least for us, quite impressive. My blog also got some play around this same time because of comments I had made regarding the Amaranth debacle, which were ultimately linked to by respected finance bloggers such as Trader Mike and Howard Lindzon (both of whom also linked to the FT story about Monitor110), as well as being carried on both Reuters and NPR. I have to say thanks to all of those who reached out to me in the wake of all this exciting news. The well-wishers and excited friends from the past, as well as new friends from the blogger and technology communities were awesome to behold. Whew! What a week...

So a little bit about Monitor110. As some of you know, Monitor110 is a company that is working to address some of the passions and possibilities I have been yearning for; namely, a tool for helping institutional investors access, analyze and monetize information from the internet, as a powerful extension of what they are getting from their principal news and market data portal (i.e., Bloomberg, Reuters, and Thomson). Why have we done this? Our fervent belief is that the internet is the next great data set to be monitored, mined and monetized, as has been the case with ticker plant data and what I'll call "Tier 1" news data. Reuters ruled the day in the late 19th/early 20th centuries by leveraging technology - undersea cables (and before that, carrier pigeons) - to transmit news across the globe. This gave them a powerful advantage that was cemented over decades. Bloomberg came along in the early 1980s by giving traders (initially fixed income traders) access to data and tools - utilizing client server technology - that were previously unavailable. They have created one of the most powerful information services empires of all time. We think the opportunity presented by the internet - by leveraging the latest in text processing, signal intercept, machine learning, memory and storage technologies - has the opportunity to be the next great wave in the Information Revolution. And the power of these technologies can and will be harnessed for the institutional investor, and Monitor110 expects to be among the vanguard of this revolution.

Let me say upfront - we've bitten off a lot. As we all know, information from the ever-growing body of the internet comes in a variety of forms and from a variety of sources. These sources can range from Nobel Laureates to stock spammers, from accomplished scientists to shills, from thought-leaders to kids discussing Pokemon. This is why simply having a "fat pipe" is a necessary but insufficient criterion for delivering a useful and powerful tool for institutional investors (or anyone else for that matter). Our clients need data, they need it fast and they need the stuff they're interested in and for it to be easily discoverable. Ok, so how does this happen?

Clients need data. Right. We have focused our efforts on what we call the "dynamic" portion of the internet - those places where content changes on a regular basis. This includes blogs, company websites, Government sites, regulatory sites, union sites and alternative news sites, among many others. So this data set, while a fraction of the size of the Google archive (which amounts to billions of static web pages), is currenly in the tens of millions of sites and pages, and is expected to reach 100 million by the end of next year.

They need it fast. For institutional investors it is all about real-time. So, what you need is the intersection of a ticker plant with the internet. This requires pretty slick architecture together with massive processing power. Check. We've got that.

They need the stuff they're interested in and for it to be easily discoverable. Whoa. Here's where it gets really hairy. The stuff they're interested in...Hmm...That sounds an awful bit like, what's that called, relevance. So, as each piece of text flows through the system, it is given a score based upon its relevance to the query (which is generally either a company or an investment theme our client is interested in). Ok, check. But, as mentioned previously, how do I know that the piece of information in question isn't from a spammer, a fraudster or a charlatan of some stripe or variety? I know there is a word for that, what is it....Right - reputation. So, by using proprietary algorithms to analyze the reputation of the site from which the text is derived the Monitor110 system can help the client decide which of the relevant items it wants to analyze. So, we put relevance and reputation in the control of our clients, giving the them the ability to either shrink or expand the data set based upon the types of data they are looking for and the nature of the online dialogue taking place in a given company or investment theme.

There is one key thing I have neglected to mention. When building systems to extract meaning from data there is one thing above all others that can help increase the value of the system's output. What is that thing? I'll tell you - context. What this really means is domain knowledge, or, in our case, using the language, structure, and taxonomy of finance and investment to train our systems (read: persistent vertical search tool for investment) to assign greater weight to certain types of text. When you do a search in Google, does it know you are an investor looking for investment-related documents? No. As an investor, do you particularly care what the most popular return to a Google search is or do you just want to find what it is you want to find? And, when setting up a persistent search (one that gives real-time notification when relevant documents are identified), are you worried about spam clogging your alerts, or is such a document scored as being low in reputation and, therefore, to be ignored or completely filtered out?

Long story short, we believe that targeted vertical search for areas like finance and investment represent the state-of-the-art and requires the intersection of leading-edge technology and domain expertise. These are the skills resident within the Monitor110 team. Helping institutional investors make money by being on the left hand side of the New Information Dissemination Cycle - this is what we are all about. It's not about being afraid of the crap that we all know is out there - its about developing the tools to identify the good stuff, quickly, and making it readily discoverable for our clients. We are still in beta. But we're almost there. It's getting really, really exciting.

Stay posted for some recent examples of our tool in action. It's pretty cool.

The Implications of Amaranth - into the Echo Chamber

I'm thinking the same thing - what can I possibly add to all that's been written about Amaranth? There have been many excellent pieces across the investment blogosphere, ranging from Trader Mike to The Stalwart, from Barry Ritholtz at The Big Picture to Bill Rempel at Bill aka NO DooDahs! (in fact, I "borrowed" the echo chamber idea from Bill), as well as stories in the top MSM outlets (WSJ, NYT and FT). But I'd like to take this opportunity to step back, take a deep breath, and give you my sense of what went down and the potential implications for both Amaranth and the hedge fund industry (and its investor denizens) going forward. But before that, does anyone find it ironic that LTCM happened in the wake of a crisis in Asia and that today we have Thailand falling under martial law? Strange...

How Could This Happen?

I think a list might be in order here:

Greed. Happens at Wall Street firms all the time where proprietary traders have massively skewed utility functions - I roll the dice big and lose, I may be disgraced and lose my job. I'll just get another one, because anyone who has traded big enough to get ousted must be good enough to work on the Street, right? Alternatively, I roll the dice big and win, I take home $25 million bucks. Sounds like a pretty good and heavily skewed return distribution to me. Even increasingly sophisticated risk management systems and processes are insufficient to stop this behavior from happening from time to time. We just don't expect to see this at a massively successful and massive hedge fund that bills itself as being multi-strategy where the partners have a lot of their own capital in the game. There is much closer alignment of motives between between the principal owner of a hedge fund and his traders than the head of a Wall Street trading department and his traders. It's not house money - its his money (or at least some of his money). One would think it would be taken care of much better than it has been at Amaranth. Why not? The only reason I can think of is pure greed.

Poor risk management. Duh. Most of the what can be said has been said. But let's be clear - this was not the issue of a rogue trader a la Howard Rubin in the Merrill Lynch MBS trade tickets-in-the-drawer scandal in the 1980s or Nick Leeson and the Barings debacle in the 1990s. This was an action taken by an individual where his bosses and risk managers knew EXACTLY what he was doing and didn't curtail his risk-taking, make him size his bets appropriately and wind down positions as they moved sharply against him. "No, we're doubling down, boys. We dropped a billion before and made it right back - we'll surely do it again here." Right? Wrong.

Poor culture. Yes, poor culture. Brian's bosses KNEW he was swinging for the fences, saw the inherent volatility (natural gas, right?) and DID NOTHING ABOUT IT. Any place that lets something like this happen has a real problem, and it goes beyond risk management, it's culture. All hedge funds have some degree of a greed culture, and this is one of the reasons whey they're successful. However, one is truly "successful greedy" if one can continue to play the game day after day, which is not the case when lousy risk management and a culture that supports weak practices forces you to be at the mercy of your creditors, counterparties and the market.

Losing touch with the mission. Amaranth was purportedly a diversified, multi-strategy hedge fund. It's roots were that of a convertible arbitrage/merger arbitrage fund, which themselves are not terribly volatile strategies. It represented itself as being multi-strategy, and took in investor dollars on that basis. Now, their offering document might give them trememdous latitude to basically do anything they want, but that's not the point. Representing yourself as a multi-strategy hedge fund and taking positions akin to the riskiest of CTAs (please, CTAs, don't take that characterization as an insult. I know many of you and your trade sizing/stops/risk management practices are infinitely better than those on display here) is just wrong. Regardless of whether or not Amaranth survives isn't the point. How can the principals look investors in the face ever again?

Desperation. Once you're down and it's really bad we all know what happens. Empirical research tells us what happens. People lose all sense of perspective and logic and begin to gamble irrationally. "How can I face my investors? How can I face my friends? How can I live this down? How? How? How?" It is a rapidly accelerating downward spiral out of which there is little hope for salvation. I was quoted in Reuters as saying that "Fifty percent is a yardstick that some people use to say that once you have dropped that much, the game is over...The next week will be telling because if there are other positions that are directionally similar that continue to move against them, then they are going to be in deep trouble." Well, based upon the recent announcement in Bloomberg that JPMorgan and Citadel are taking over Amaranth's energy trades, I'd say that maximum ugliness has started to set in.

Bad due diligence practices (which was very well discussed by Barry Ritholtz in his post). Due diligence for large funds tends to be pretty pro forma. Well, as with fat tails, black swans and other "chance" occurrences, the Amaranths of the world do, in fact, happen, and certainly not only once in a blue moon. Investors have to bear some of the brunt of criticism here, as they're the ones that let Amaranth have a document that could let something like this happen, as well as supporting a culture that could engage a Brian Hunter and let him trade the way he did. Let's face it, folks, hedge funds are not for kids. If you don't like the results, either accept your fate that stuff like this WILL happen, do something about it or get out. It's that simple.

This certainly isn't exhaustive but gets to the root of the important stuff I'm thinking about. Now what about the implications of this little debacle?

Fund-of-hedge-funds (FOHFs) - maybe two layers of fees are worth it. So, the argument went that as institutional investors became more sophisticated and as large multi-strategy funds became more "institutional," these multi-strats would eventually supplant FOHFs as the primary vehicle for institutions' entry into the hedge fund asset class. You could cut out a layer of unnecessary fees, get the opportunistic asset allocation expertise of a top investment team and start generating alpha. Right? Well... Amaranth really shines a bright light on the definition of "multi-strategy." Should a multi-strategy fund be placing 50%+ of its capital in a single asset class, which also happens to be one of the more volatile asset classes on the planet? No. But how, as an institutional investor, can I protect against such a thing happening to me? The easiest, safest and most defensible way to accomplish this is to engage a FOHF to spread my bets. I really didn't think that the industry would go this way but with this blow-up at Amaranth, I do think that the big winner here (aside from those on the other side of the Amaranth trades) are FOHFs. I guess Christmas has come a little early this year.

New hedge fund offering documents will become increasingly restrictive. I think the market will see a change in the language of documents, particularly those who are targeting institutional investors. I can't imagine that due diligence and document review procedures won't tighten up, and that fund managers won't have sector/concentration/risk parameters of some type embedded in these documents. How else can an institutional investor be comfortable that they're not an unwitting participant in Amaranth, The Sequel? When I ran a large trading business, the documents I had with the traders laid out some very basic and fair risk management thresholds (sector, concentration, position size, etc.) to ensure that things couldn't possibly get way off the rails. It would seem logical that new hedge fund documents would include some of these principles. As for the large, very successful and sought-after multi-strategy funds, they won't have to change anything. Supply and demand is still way out of whack, with much more capital seeking access to top managers than the capacity (or desire) of these managers to take in more funds.

Some large institutional investors agitate for a change in multi-strategy fund documents. Admittedly a low probability, but if we see a few more blow-ups of the Amaranth sort anything is possible. Threaten redemption? Nah, the top funds won't be forced into doing anything. But I thought I'd put this possible tail event on the table, anyway.

The hedge fund asset class loses favor. I can certainly see that those about to enter the hedge fund asset class for the first time might think twice before taking the plunge. Nobody wants headline risk, and I am sure the folks in San Diego (who have more than enough problems already) are rueing the day they put $175 million into Amaranth. However, this is counterbalanced by the pent up demand for exposure to the asset class. This might actually drive those who might have considered going directly into multi-strategy funds into FOHFs in order to get their exposure. It can't hurt to have a fiduciary stand in the middle, right? Can't look stupid hiring one of those, right? We'll see.

I don't know if this has been helpful to you but it has been to me. I truly enjoyed writing this. It has been a constructive way to get a bunch of stuff off my head that has been rattling around for the past 36 hours. Thanks for your support and your eyeballs!

Say it Ain't So, Stevie?

Saturday's WSJ article about the highly-secretive Steven A. Cohen was, well, quite shocking. It was an extremely well-written and informative piece that really humanized the man that has been the subject of so much mystery, admiration and scorn over the past decade. One quote in the story completely blew me away, however, as it seemed so out-of-character for the larger-than-life SAC himself:

That quick-trading game is now over, says Mr. Cohen. With about 7,000 hedge funds competing for investment ideas, good stock investments are getting more scarce. "It's hard to find ideas that aren't picked over, and harder to get real returns and differentiate yourself," he says. "We're entering a new environment. The days of big returns are gone."

To make matters worse, the stock market, he says, is no longer as forgiving for investors. The tailwind of low interest rates, low inflation and strong corporate profits, he says, has been lost. There are no more easy pickings, he says.

********************

"The hedge-fund run is not over," he said. "I think the game is changing, and if it is, I have to react. We won't go off the ledge with everyone else."

This does not sound like a multi-billionaire running an eleven figure sum for some of the most powerful investors in the world. Where's the hubris? What has changed? Is he right that the easy money has been made and it will be tougher sledding from this point forward?

I'm not buying any of this. SAC and its team is way, way too smart to be pigeon-holed by a single strategy. If there is too much money chasing too few ideas, invariably there is a lot of dumb money out there that can be exploited by someone smarter and more experienced. I mean, come on, he is up 18% YTD on a big, big number. That is pretty good based upon the stats I've seen.

Further, what of globalization? I'm not sure that the big money will be made trading conventional strategies in the U.S.; it may be made in Asia and other rapidly-growing parts of the world. As these markets become more liquid, firms like SAC can increasingly deploy larger amounts of capital which is what is often required to get these mega-firms to play. It may also mean that instead of 225 names he will have to follow 500 or even 1000 names to manage the liqudity risks while reaching for alpha. He has great people working with him that can build this seamless global platform, so I am 100% confident that this will be one of the ways that SAC will change with the times.

Then what of technology? As written about previously (most recently in my Lonelygirl15 post), tools now exist to extract, filter, analyze and display information from the Internet in a manner previously unimaginable. Given the trend towards more and better data and information being put out there on the Internet, it will be those with the vision, the brains and the tools to take advantage of this alternative data set that will establish a true edge on the competition. Again, SAC is a very forward-looking organization with the resources and trading acumen necessary to exploit the massive opportunity for discovery that is the Internet, so I am also certain that they will lever their expertise into this area as well.

So, from my vantage point things don't seem so bad for Stevie. Maybe he is showing his soft side so we'll all get complacent and he'll clean our clocks! That seems far more likely than the defeatist attitude on display in the WSJ article.

Fortress Going Public? The Writing's On The Wall

So the New York Times carried the story today that Fortress Investment Group is considering going public at the breath-taking valuation of $5-7 billion. Now, whether or not this will happen tomorrow is not the point. The point, as I've written about in several posts (Hedge Funds as Asset Management Complexes - the Day Has Come, Convergence Redux, Broadening the Multi-Strategy Mandate - Where do Hedge Funds End and Private Equiy Firms Begin?, Where is the Hedge Fund Industry Going?), is that this type of move - hedge funds and private equity firms morphing into diversified asset management complexes (and subsequently going public) is simply inevitable. The potential rewards for the founders combined with the ability to create a sustainable legacy are just too great.  Some of the more interesting excerpts from today's NYT article are below:

If it should go ahead, a Fortress offering would be the first public listing of its kind. A successful offering could pave the way for a stampede of interest from other seasoned hedge funds as well as private equity giants that might be looking for ways to turn their huge hoards of private money into public asset-management companies.

Such a move would go against the grain: companies seem more likely to go private rather than public. But for Fortress, going public would give it another way to raise money to build the business as well as a tool — its shares — to retain talent. Stock would also give Fortress a currency to buy other companies. And it would allow the founders to cash out some of what they have built and create a succession plan.

********************

Going public solves succession and retention issues while creating a more permanent institution. Several major private equity and hedge funds have also contemplated going public, including the Citadel Investment Group, a $12 billion hedge fund in Chicago and the private equity firms Kohlberg Kravis & Roberts & Company and the Blackstone Group.

********************

Fortress is not a typical hedge fund. It manages $24.3 billion and has 500 employees, according to its marketing materials. It calls itself a “global alternative investment and asset management firm.” The description seems apt, considering its size and the fact that it has offices in London, Rome, Frankfurt, Geneva, Tokyo, Hong Kong, Sydney, Toronto, Dallas and San Diego.

The firm is a prime example of convergence in asset management: it operates private equity and hedge funds and it competes against banks to lend money directly to corporate clients. The result is a firm with various lines of business that looks more like Goldman Sachs than a traditional hedge fund.

********************

Assets in hedge funds have increased 3,000 percent since 1990 with almost 9,000 funds now entrusted with $1.2 billion of capital. Once a playground for the rich, hedge funds now have institutional investors, like pension funds and endowments.

That has translated to some transparency and the realization by managers that they do not need to produce 30 percent returns with huge swings, but rather 8 to 10 percent returns without the roller coaster ride.

The game has shifted to gathering assets, making fees from managing those assets and contemplating once-heretical moves like going public. The question, until now, has simply been who would go first. Fortress may be the first to let the drawbridge down.

The bolded text represent major themes across the alternative investment landscape, and directly line up with the themes I've written about in previous posts. Fortress is a fine firm and, assuming Wes, Peter, Mike et al can pull this off, congratulations to all. They are ahead of the curve. The only question is who's next: Blackstone? Carlyle? Citadel? DE Shaw? These are the types of firms who are prime candidates to follow in Fortress's footsteps. Let's see if the equity markets hold up and enable a bunch of these deals to get through. If the macro picture softens, a credit crunch ensues and the taste for alternative assets wanes, the window of opportunity to get these deals done will rapidly snap shut. Just like it will for conventional asset managers. And they're all just asset managers, right?

What Can We Learn from Lonelygirl15?

My partner Jeff and I spend a lot of time talking and thinking about the impact of the internet on how information is discovered, disseminated, and commented upon. What is clear from our discussions and observations in the real world is that the internet has created a New Information Dissemination Cycle (the "S-curve"), one which has in many ways usurped the primacy of MSM by leveraging the collective intelligence of millions of eyeballs across the globe. And experience has shown that many of these eyeballs are possessed by people with valuable insights, unique positions and perspectives from which to bring newsworthy items to the fore. Once this information cycle gets geared up, there is no stopping it. Rapid feedback loops get created where layers of commentary help weed out the value-added from the crap, eventually leading to conclusions that are frequently correct and arrived at well in advance of being picked up by the MSM. All of this and more was on display during the fascination, suspicion, mystery and eventual busting of Lonelygirl15.

What became clear to me after looking at the exhaust over the past few months is that the MSM got totally scooped by the blog community, and was so late to the party (the party not being Lonelygirl15's popularity but her being a concocted persona) as to have been completely and utterly marginalized. Let me offer the conclusion of this post right here: the world has changed. Why? Because the internet has created a vehicle for information discovery, dissemination, comment and feedback unlike any other, and because of its ability to leverage the combined brain of millions of people with vast experiences, skills, perspectives and positions it simply offers a platform for news identification that is the future. And, as I'll illustrate through a discussion of the "undressing" of Lonelygirl15, the future is now.

Where is the one place where the discovery process for Lonelygirl15 is on display for all to see? You guessed it, Wikipedia. A consolidated view of all the adds, enhancements and edits for the Lonelygirl15 entry can be found here. A more textured chronology across the internet and MSM landscapes is provided below.

Lonelygirl15 post her first of many vblogs – 6/16/2006
http://youtube.com/watch?v=-goXKtd6cPo

Speculation first builds concerning the validity of the videos as stated on Wikipedia’s first entry – 7/24/2006
http://en.wikipedia.org/w/index.php?title=Lonelygirl15&oldid=65496394

NYTimes comments on the vblog’s popularity – 7/28/2006
http://screens.blogs.nytimes.com/?p=46?8dpc

Lonelygirl15 is one of YouTube’s most popular videos as evident by the number of “Reponses” – 8/6/2006
http://youtube.com/results?search_query=What+Did+Daniel+and+Dad+Talk+About&search=Search

More evidence of hoax appears on Wikipedia – 8/6/2006
http://en.wikipedia.org/w/index.php?title=Lonelygirl15&oldid=67944301

Documentary filmmaker Brian Flemming discusses on his blog the phenomenon and why it’s probably fake – 8/21/2006
http://www.slumdance.com/blogs/brian_flemming/archives/002277.html

More speculation from New York Magazine – 8/26/2006
http://nymag.com/arts/tv/features/19376/index.html

Creators admit that the videos are fake on Lonelygirl15.com’s forums – 9/7/2006
http://www.lonelygirl15.com/forum/viewtopic.php?t=36

"Lonelygirl15-obsessed amateur Web sleuths" discover the “show” was created by CAA – 9/8/2006
http://www.latimes.com/entertainment/news/la-et-lonelygirl8sep08,0,5310001.story

Actress identified by Silicon Valley Watcher blog – 9/12/2006
http://www.siliconvalleywatcher.com/mt/archives/2006/09/the_identity_of.php

The MSM eats the story up – 9/13/2006
http://news.google.com/news?hl=en&ned=us&q=lonelygirl15&btnG=Search+News

This is great stuff! To me the most significant thing about the process of discovering the real Bree is that it perfectly conforms to the S-curve, and only serves to reinforce the power and value of the blogger community when a feedback loop (like that provided by collaborative platforms like Wikipedia or widely-read bloggers like Silicon Valley Watcher whose comment threads are a valuable part of the discovery process) is included in the mix.

The beauty of the S-curve, while it appears that information should naturally travel in one direction (from left to right), is that there is an implicit feedback loop. While early discovery might occur by a narrowly-followed blogger who is then picked up by a blogger with a wider audience and eventually finds its way into the MSM, once something is published in MSM it often provides the fodder for commentary in the blogosphere and the process starts all over again. These loops will happen until people are satisfied that the questions asked or the issues posed are addressed; otherwise, the loops will simply pick up steam until satisfaction (read: discovery) is gotten.

As a relative newbie to the tech scene, I have to say that this phenomenon (the New Information Dissemination Cycle) is probably the single most awesome thing I've witnessed. Better than iPod. Better than Zune. Better than Slingbox. Those thing are cool. This is changing the way we think. This is changing the world.

Yahoo! Finance/Seeking Alpha - Turn on the Bright Lights

Very, very interesting. At least to me. Whether or not this deal is truly "disruptive" (per Michael Eisenberg of Benchmark) or "noise" (per Howard Lindzon of financial blog fame) is not the point. I do think the deal is instructive because, at its core, it emphasizes the two key criterion for extracting value from internet content: understanding the relevance of the information being provided to the reader and the reputation of the provider of that content. Without these filters the signal/noise ratio is simply unbearable, and those in the investment business know that information overload is THE problem plaguing investors everywhere. These principles of relevance and reputation apply not only to financial content on the web but to the other verticals as well, but the Yahoo! Finance/Seeking Alpha alliance is a great example of taking highly relevant, highly reputable, specialized content and delivering it to a much broader (and interested) audience. Isn't this what the power of the internet is all about?

There were several other interesting points raised in the comments to the Seeking Alpha story, including that of David Jackson himself, CEO of Seeking Alpha (from the story in Venture Beat):

By putting the bloggers on a par with Dow Jones, Street.com and other mainstream sources, Jackson thinks Seeking Alpha will encourage even more bloggers to participate. Seeking Alpha’s aggregated content may soon dwarf the content produced by mainstream sites, the thinking goes.

So now you are getting the full image — the image of that revolutionary, proverbial long tail. “We’re tapping into the long tail,” Says Jackson referring, to the long line of contributors with a good opinion about stocks he thinks will transform analyst coverage of mid- and small-cap companies that newspapers and other sources don’t have the resources to cover.

I think David is onto something here. He's clearly right about the long tail. If you combine the long tail, and the ability to filter by relevance and reputation, you've really got something. Yahoo! Finance and Seeking Alpha have done this, on a small scale. What does Seeking Alpha have, 200 contributors? This a great start, but not what I would call disruptive. My guess is that there is a lot more relevant content out there from reputable content providers that is simply not being packaged in a way that fits the Seeking Alpha mold. What about the tens of millions of bloggers out there whose ranks are growing every day? Some of these people know stuff - good stuff. What about the tens of millions of great web pages from the government, regulatory agencies, unions, special-interest sites and the like? What about the tens of millions of interesting and relevant non-RSS enabled pages? I guarantee you that Seeking Alpha's contributors are not catching and analyzing all this information. Sorry, but the Yahoo! Finance/Seeking Alpha platform, while a vast improvement over MSM and clearly a wave of the future, barely represents the tip of the iceberg. Sorry.

The real juice comes in when you can combine the drivers we've touched on - the long tail (read: the ever increasing body of content across the wide, wide web), relevance and reputation - and combine that with technology that is intelligent (knows finance), scalable (can process millions of lines of text a day in real-time) and robust (Wall Street uptime, my friends). This, from my perspective, is the definition of disruption. The Yahoo! Finance/Seeking Alpha deal shined a bright light on the opportunity and value drivers for those within a focused domain. Relevance? Check. Reputation? Check. Breadth? Well... We are in maybe the second inning of a nine inning game. The question is: who will show up for the later innings?

Sell Side Research in a post-9/11 World

The 5 year anniversary of 9/11 has made me think back to all that has transpired since that tragic and painful day. When my thoughts over this time frame turn towards the profound changes in Wall Street and the markets, one of the biggest shifts that comes to mind is in the realm of equity research. It was not too long ago that research analysts were rock stars, literally, being bid away by other firms and hedge funds for mind-boggling dollars. I remember some of the CEO Internet Roundables during my years at Deutsche Bank when our analysts were the hosts and starred along with the CEOs of the day such as Tim Koogle of Yahoo!, Tom Jermoluk of @Home and George Bell of Excite. Man, those were the days - and we partied like it was 1999 (because it was).

And man, are those days ever gone. The plunge in equity capital markets revenues precipitated by the drying up of the IPO market shined a bright light on that giant research nut, that massive cost center that was only a topic of discussion around bonus time when equities and banking sparred over "You pick up 2/3 and I'll pick up 1/3. No, go screw yourself. It's 50/50."  Without question, sell-side research has seen some bad, bad days since the bubble burst five years ago. It was easy to gloss over bloated cost structures and internecine battles when everyone was minting money, but once that merry-go-round stopped... Not to mention the pissed off investors and the email trails discovered during the Fall of Blodget, the taming of Meeker and the Humiliation of Grubman. Anyway, this is old news.

But what of sell-side research today? A report by the consulting firm Booz Allen titled Saving Sell Side Research highlights a number of the key threats to those who lack the vision and adaptability to change with the market - massively declining research spend due to competitive forces, more robust performance measurement metrics, and a squeezing of the middle (being neither a high-quality, focused boutique nor a global behemoth with the resources to deliver a superior global product). This report outlines three specific prescriptives to the sell side, assuming a rational business case can be made for keeping research at all:

1. Delivery Model Streamlining (more efficient resource allocation, "rationalize" compensation, increase outsourcing)
2. Offering Redesign (expand coverage of small/mid caps, add expert networks, quality models, performance metrics, add a degree of client exclusivity)
3. Differentiated Service Levels and Pricing (calibrating levels for small, mid-size and large firms, hedge funds, etc.)

Wow, doesn't it seem that sell-side research is actually being pushed to be run like a business? I love the way the prescriptives read in consultant-speak: aren't they really saying, in English, "Cut costs and run the business efficiently," "Deliver a product that your customers value" and "Have prices reflect the value of the product you're providing"? Clearly, these things make sense. They make sense for every other industry so why not research?

I'd like to thank reader Yaser Anwar for providing me with the Booz Allen research piece - it got me to put in words things that had been rattling around in my head for some time.

It is interesting to consider where some of those commission dollars previously used to pay for sell-side research have gone? Providers of expert networks, perhaps? Even Bear Stearns has entered the fray. Maybe alternative information providers the extract unique and hard-to-access data from the Internet and other sources? Possibly augmenting in-house research capabilities? I'd argue that it is a mix of these three and more. The buy side knows what research is worth and is done paying for product that doesn't deliver. With Lehman and Deutsche unbundling commissions for Fidelity, it is now possible to truly pay for what you use (as long as you are a sufficiently large client and breaking the soft-dollar chain makes sense for you).

I am convinced that we are entering "the a la carte world," where kind of like SaaS you can pay for only what you need. This will lead, as properly referred to in the Booz report, in a barbelling of the research industry (just like the phenomenon going on in the hedge fund industry). Further, you will see greater use of alternative research methods (expert networks, alternative information providers, financial intelligence tools) as a vehicle for supporting the idea generation that is already taking place on the buy side, continuing to marginalize the value of idea-driven sell side research. It is a train that just cannot be stopped. Just like free markets, efficiency will eventually find its way into the nooks and crannies of the business. "Eventually" just happens to be today.

The change is already happening. Either get on the bus or else....