Monday, March 31, 2008

The gossip and the serious

Looking north along West Broadway from Duane Street. Sunday at 2:00 PM. Photo: JH.
Same old Saturday night; sorta not really. Patrick McMullan and JH and I see each other at parties and events and parties and events and events and parties all over New York, and in Paris and in London and in Palm Beach and in Venice, but there’s really no “social” part to our relationships: it’s all “hi” “goo-bye” as we’re working boys to the point where sometimes it seems like work is all there is (and nobody’s complaining).

  Patrick McMullan and Debbie Bancroft at Ye Waverly Inn
So we decided that we should make a dinner date to compare notes and catch up with everything. Debbie Bancroft who we all see and who sees us all as we cover all those events she attends, joined us ... at Ye Waverly Inn down on the corner of Bank and Waverly in the village.

If you don’t know about the Waverly by now, then there’s no reason why you should. But it is, arguably the hottest restaurant in New York these days. At least for a certain crowd. At least for a certain crowd when they go to the Village. Or who live in the Village. One of its owners, Graydon Carter, editor-in-chief of Vanity Fair, lives just down the street. It’s been there for about a century, on the ground level of an old brick townhouse and it’s seen a lot of New York history come and go. In another incarnation Edna St. Vincent Millay burned both ends of her candle there, and so did many other literary types, not to mention the locals.

Today there are still locals dining at the Waverly although it is not the easiest place in town to get a reservation simply because the whole world wants  in. It’s probably the only restaurant south of 14th Street, maybe the only restaurant in New York these days, where the paparazzi are hanging around outside.
Some of the faces at Ye Waverly Inn on Saturday night.
On Saturday, for example, we arrived for our nine o’clock reservation just as Farah Diba, former Empress of Iran, arrived with her entourage. The place was packed and it stayed that way for the rest of the night (we left about quarter to midnight): Charlie Rose and a very pretty brunette; Dave Zinczenko, editor-in-chief of Men’s Health (who’s rumored to be named “Editor-of-the-Year” very soon) with Hilary Schorr; Calvin Klein holding forth with Toto Bergamo (in from Venice), Ross Bleckner, Christopher Makos; Kim Raver (from “Lipstick Jungle”), Dan Abrams with Jaime Murray (remember her in “Dexter”?), Cynthia Rowley and her husband Bill Powers; Ron Perelman with Danielle Levine and his daughter Caleigh, Matt Blanc (head of Showtime) and his wife Susan; Rufus Albemarle, million dollar model Jessica Stam, Simon Hammerstein, and on and on into the night.

It’s a very cozy, comfty place, with tavern-low ceilings, lots of dark wood paneling and a great wall of a Ed Sorel mural of New York/Noo Yawk then and now. The noise level is music to the ears of these denizens and although it’s not a table hopping place, it is amazing how many pass and stop to say hello throughout the rooms. The menu is chic American comfort; chicken, Dover Sole, Grilled Trout; all delicious, no one complaining.
Outside Ye Waverly. 12 AM.
Back to business: one of my favorite Saturday reads is the Lunch Interview in the FT. This is consistently one of the best interviews you can find anywhere, and the subject is always different, always diverse and always interesting. This past Saturday was with Nassim Nicholas Taleb, the Lebanese author of “The Black Swan; The Impact of the Highly Improbable.” Click here.

Mr. Taleb who once upon a time was a Wall Street trader, has written a best-selling book that is particularly cogent right now. If nothing else, he can give you something to think about. Seriously; just like the times we’re living in.

After finishing the piece, I was reminded of a speech we carried on this site almost eight years ago. It was by a friend of mine, Charles Stevenson, a long time hedge fund owner/operator who had great success for more than three decades and then decided to close down his hedge fund at just about the time many were roaring (to the point of inaudible). Re-reading Charles Stevenson’s speech yesterday, I was intrigued to see how much he and the best-selling Mr. Taleb see eye-to-eye, so I decided we should re-run it.

This is not a subject that is of interest to many people, but it is definitely at this time in our world, something that is important to all of us. Furthermore it is something to consider. A little brain-exercise; always good for your health, mental and otherwise.

  Charles Stevenson
The following first appeared on NYSD on November 17, 2000:

Charles Stevenson is a hedge fund manager/operator who got started in the business serendipitously in the early 1970s. A graduate of Yale and a member of the Viet Nam War generation, he moved to Manhattan after college and supported himself painting interiors of apartments. He proudly lived frugally, often sleeping in a sleeping bag in the apartment he was working on, and saving his earnings. One day, a friend suggested he make an investment in the commodities market, where great profits could be reaped.

Fascinated by the absurdity of  the possibilities, he took about $18,000 of his savings and put it into one commodity which quadrupled in value in a matter of a very few weeks. Amazed, he re-invested his money and promptly lost more than half of his investment in even shorter time. Intellectually curious by nature, and intrigued by his new experience, however, he set about learning and understanding how these markets worked. He went to The New York Public Library and began reading all of The New York Times financial news between 1927 to 1933, from the height of the boom to the depth of the bust. He then set about learning to trade in commodities futures. His trading expanded into other markets which were also growing commensurately with his knowledge and experience.

During the 1970s, when the American and world stock markets were sagging and stagnating, Stevenson started a hedge fund and made huge profits and built a sizeable fortune. An investment of $10,000 at the inception of the fund, cashed out at more than a million dollars when Stevenson closed it down eight years later in 1980. In 1993 he started another hedge fund, which he called the Navigator Fund.

During this period, one of the Navigator Fund's largest investors was the Archstone Fund, a fund of funds created by Fred Shuman of Bear Stearns. Shuman's method was to pick the ten best hedge fund managers and put his money with them. "Ten best and forget the rest," was the message Shuman exuded. Over the several years, Stevenson worked as one of those managers, and he ran his fund very successfully. However, in the last year, Stevenson, like several of his peers, found himself unable to navigate as successfully in the increasingly volatile markets. Seeing himself down around the lower half of Shuman's managers' performances this past spring, he decided he could manage his funds more profitably by putting it in the hands of those at the top of the list. In July, he closed down his own hedge fund.

The following are Stevenson's remarks about this decision, delivered at a meeting of Fred Shuman's Archstone Fund at the University Club:

My favorite comic strip is The Wizard of Id. In one strip that I remember, the diminutive king has made a  speech. He is asking his advisor, "How was it received?" The advisor replies, "It must have gone well, Sire. The fruit they are throwing is not rotten." I hope I am as fortunate today.

I recall, from the “Journals of Jules Renard,” his witty observation that the chief feature that distinguishes humans from animals is that humans have financial worries. We humans are distinguished by another characteristic feature, and I am not sure whether it is mental or emotional, and that is our desire to know the future.

The trading I did in Navigator Fund implemented an attempt to resist this impulse to know what is going to happen next. It seems evident, if you read financial history or turn on the evening news, that the experts, and it doesn't matter in what field, are frequently expressing astonishment at some new and surprising turn of events. The weatherman is often wrong, and so are prognosticators of every sort. Someone once said that if you lay all the economists in the world end to end, they still will not reach a reliable conclusion. It is an amusing and telling remark.

Not only can we not know with certainty what is going to happen, but I believe we may know less about what did happen and what is currently happening than we would like to believe. We construct a world, based to some degree, on wishful thinking and inaccurate descriptions. We in this country believe Christopher Columbus was not just a bold explorer but also a man of great moral virtue. The myth we have created about him is that he braved difficult, stormy seas for two months in ill-suited boats, suffered from lack of food, resisted mutiny, and finally discovered the New World.

According to a book titled, “Lies My Teacher Told Me,” the truth is that he sailed in well-suited boats with good weather, without privation, for about one month. When he arrived in the Caribbean, he immediately claimed ownership of the land, in spite of inhabitants already living there. He seized some of their property and some individuals, whom he took away with him as possessions. We tend to view Columbus as some kind of moral exemplar. Wouldn't our sense of history and our understanding of the problems of colonialism be more fully developed if we didn't have this tendency to reshape the past?

Most of us really wish to see the world in a way that is comforting. That is to say, we want the world to be comprehensible and to unfold somewhat according to our hopes and desires. We want the nature of reality to be comprehensible, and that means we require it to be somewhat homogenous, so that the future can be extrapolated predictably. However much we want it to be that way, it is actually not.

Einstein said that a description of reality should be as simple as possible, and no simpler. Reality does not yield readily to our descriptive attempts. Look at one such serious attempt at a description of the universe, Stephen Hawking's Brief History of Time. It was widely bought, perhaps started, but remained unread past the first few chapters, because it is to most readers incomprehensible.

Even common explanations of daily life can be quite wrong. Listen to the evening news when the reporter says that investors put money into or fled from tech stocks or cyclicals or whatever kind of stock. Investors, in general, can't put money into stocks or the stock market except by buying the new issues created by investment bankers. And investors, in general, can't flee from stocks because each share sold is bought by someone else. So buyers and sellers are simply exchanging shares and money, and on a net basis money is not being taken out of or put into the market. Prices go up and down, reflecting not money coming into or leaving stocks, but rather the enthusiasm, or in dire cases, the exigency of either the buyers or the sellers.

The price of stocks, indeed the price of all assets, is based on a set of beliefs and expectations about the future. Recent information from Bloomberg values the total US stock market capitalization at around 21 trillion dollars. Short term cash deposits and money market fund accounts total $5 trillion. For twenty years, it has been sensible and rewarding, on balance, to trade cash for stocks. The person who sold his shares and received cash might then wish to still own stocks, which he would buy from yet another person. We can go around this circle as long as we believe that stock prices must rise, feeling richer and richer as stock prices do rise, driven by our bids. What might happen if a change of beliefs and expectations about the future suddenly or abruptly caused a preference for cash? Then the circle would run the other way. I don't think you can rule this out, and as a philosopher or as a hedge fund manager, whatever you can't rule out, you have to rule in.

Financial markets seem to behave more like weather systems, involving fluid flows where cause and effect is ambiguous, than they do like machines, which have gears and levers and where cause and effect is more certain. Weather systems have frequent, small uncertainties (for instance, we can't know today what tomorrow's temperature at noon will be), and large, abrupt discontinuities (for instance, out of the blue, you suddenly have a tornado). Neither can we know today the level of the S&P at noon tomorrow, nor whether a massive sell-off or rally might occur.

In their unpredictability, to make another analogy to physical systems, markets behave like piles of sand, onto which one is dropping a stream of additional particles. As the sand grains pile up, avalanches occur. You can never know in advance which grain will cause the next avalanche (markets are unpredictable), and you also can't know in advance which avalanche will be small (as most are) and which will be big (as every once in a while, the whole pile suffers a real structural change).

Navigator fund was an attempt to execute a strategy of adapting to conditions as they unfold, rather than of taking a definite view of the future and of future values. The strategy was responsive and adaptive, rather than ratiocinative and predictive. The idea was to look at the world's financial markets, currencies, equities, debt, and commodities, to see where the surf was up, and then to try to catch those waves. This is an appropriate metaphor, because the surfer, unlike the oceanographer, does not concern himself with predicting when waves may occur or why; rather, he exploits the conditions that present themselves. This was a phenomenally effective strategy during the dollar-weak environment of the seventies, since it avoided holding the dollar as a currency and also avoided holding equities. This was especially helpful in the 1973-1974 period, when stocks were down forty percent. When the results of my adaptive strategy were measured with the shrinking dollar ruler, they were truly impressive. Let me say parenthetically that wealth-holders may wish to be ready to act upon a strategy for getting out of dollars should the dollar one day again begin to decay in value against alternatives.

The strategy of adapting to conditions as they unfold is based on the proposition that the future is essentially unfathomable. Those who think they can know the future get dressed for tomorrow's weather before going to bed. If they are right, the rewards may be great. My strategy was more conservative. I chose instead to get up in the morning, look out the window, and then get dressed accordingly. In the recent period, however, the financial weather has changed with increasing frequency. If you dressed in the morning for morning sunshine you were soaked by a late morning shower. If you dressed for foul weather, you soon were too hot. I am talking about the increasing volatility that has been so obvious, the startling number of days in which the equity market has moved more than one percent during the past year, for instance, compared to all known prior years.

Perhaps this has to do with the more rapid dissemination of information in an increasingly wired world. I do not know. This is the core business reason for which I closed the fund. Volatility spikes made it impossible to both hold positions and to control risk. The surf became too high to go surfing.

I believe that as hedge fund managers, we must continuously maintain an awareness of our process and question whether our actions and results correspond to our best ideas. My process is to be adaptive and responsive. Yet the increasing volatility and deteriorating signal-to-noise ratios that have characterized the environment in world financial markets lately made it difficult for my strategy to achieve significant capital gains without exposing our capital to expanding risks. I did and do not see any sign that the increased volatility is abating. Although we were not much more than six months from new high ground when I closed the fund, nevertheless, I was no longer confident that our trading program had an exploitable edge in the new environment that now prevails.

It does not seem sensible to expose money to trading risks without the highest level of confidence in a successful outcome. Neither did it seem sensible to keep the fund alive, with trading suspended, while waiting for the environment again to become more favorable. If we all had an infinite amount of time, perhaps that would have been a possibility. But we do not.

I have been using a lot of metaphors, and I will not stop now. Hedge fund managers are driving a vehicle. The manager and his investors look at the track record, that is, they focus on the miles traveled and the current speed. These odometer and speedometer readings are the performance indicators, long term and current. But at some point, the driver may start to look at the fuel gauge, he may start to consider the amount of fuel left and may also wonder where the road is going. I am saying, stated another way, that there are two piles of energy in front of you. One is the amount of money you have. You want that pile to grow. The other is the amount of your remaining vitality. At some point, you have to be concerned that if you focus too much on the first pile, you risk discovering that the second, more important pile, has dwindled away. Having riches and having a rich life may not be necessarily connected. Our lives, which we live in relationship to our friends and our families, are so precious, and yet so ephemeral.

One thing I can state for certain is that it is the nature of things to change. We cannot order anything to remain the same, neither financial markets, the weather, nor our own bodies. Everything created is an aggregation that will fall apart. We share with each other and with all creatures a common destiny, which is dissolution.That is the nature of reality, and in that reality we must all make our own way.

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