John Paulson’s Fall from Hedge Fund Stardom
nytimes.com
nytimes.com
There is a perfectly rational strategy whereby you lose a little bit of money every year if you think that the catastrophic tail event is more likely than other people think and so the risk is mis-priced.
One finance professor described it as a "100 year flood that happens every 7 years."
Taleb believes that this is true of markets and he may very well have a similar strategy (consistently buy out of the money puts).
We won't know till a certain amount of time has passed if this strategy is genius or the opposite.
I'm sure there are some fund managers who do follow this strategy - but they also mitigate the risks associated with it, which means their extreme gains are not as extreme as Paulson's, but their losses are not as extreme either.
We hear about Paulson because he's an edge case. We don't hear about the funds that won big, but not quite as big as Paulson but who have had much better risk management practices.
At least we know a bit about their average performance, which has been very poor over the past 5 years:
Eg: quant-driven funds that try to buy/sell the edge then profit the minimum movement 24/7, if those are losing money then they cease to exist - and they haven't done that yet. The minimum investment in those funds is high 7 figures though, and that's out of at least my price range for risk capital(and non-risk capital for that matter).
And my understanding is that no one can invest in RenTec anymore either because they can't scale the strategy.
However, he doesn't have to consciously think of himself as a tail risk fund for an investor to use him as an instrument.
The investor has to believe that risk is mispriced. Paulson is just a mechanism for expressing a short view.
Why not just put it in an index fund? Because Paulson has access to different kinds of shorts (CDS, convincing banks to allow him to short housing and so on).
I have no answer for 18-20%. That is, as you pointed out, unsustainable.
What not enough people consider is the null hypothesis: that he never had any skill in the first place and just got lucky. There's acres of research supporting this.
so -36% vs +13.12% baseline (didnt bother to compound)
So, 4 years of losses and 1 year of profits could be better than 5 years of even (but smaller) gains.
im not sure that statement is an accurate description of Taleb's barbell strategy; for one thing it ignores one half of the barbell
Every bet he's made since has been terrible - I remember him being a part of the "hyperinflation" crowd buying up gold etc.
In general, this points out the flaws in both active management and hedge funds. For active management, we see that someone can have an amazing single year or event and then never perform again. For hedge funds investors, the sad story of the high fees and underperformance continues - it's a heads I win, tails you lose structure for investors imho.
In particular the two guys who I worked for traded subprime mortgages, and they were net short for two years leading up to the crisis. The first got out of his position as soon as he could take a decent profit. As soon as he got paid that year he quit (and I believe left the industry), his parting words were to the effect of "Being told your wrong and you don't know what your doing every week for two years takes its toll. I'm out." The other guy is more interesting. He was very model driven, and kept his trades on longer. Eventually though he began to distrust his model. His models pointed to the market going much much lower, and he didn't think that was possible. His gut told him that his model had become detached from reality, so he took his profit, and put on a much more conservative trade. Turns out his model was right and his gut was wrong.
This was a prop trading desk for a bank, not a hedge fund. In the end, none of it mattered. These two guys showed profits on the order of hundreds of millions, while the bank overall lost on the order of tens of billions, so kind of a drop in the bucket.
The work largely dried up in 2008. We were all laid off. There was still some stuff going on, but between streetwide layoffs, and Bear and Lehman and Wamu and Countrywide and Merrill, there were a lot more people than jobs.
With respect to input to the models the main idea was risk neutral pricing from more liquid (ABX indices) to less liquid (Subprime MBS bonds). But he had special sauce which he kept very close to the vest, and didn't really look for any input (although very open to any pragmatic implementation w/ respect to the software. )
"The Big Short" shows Michael Burry arguing with his LPs as they try to bail too early.
Was Galileo wrong when he speculated that helicopters were possible? Absolutely not. Was Girolamo Fracastoro wrong when he speculated that germs caused illness? Absolutely not.
If you're going to be snarky, at least be right.
If you predict that X will happen, and it eventually does, then sure, you were right about that. But if you take an action that will cause you to profit if X happens within 5 years and to lose money otherwise, you're effectively predicting that X will happen within 5 years. If X happens after 10 years, then to say that you were right, just too early, is misleading: in fact you were right that X would happen, but wrong about when it would happen, and you chose to bet on both of those things.
Maybe this is a bit pedantic, but surely it's at least correct.
Ideas are a dime a dozen. He put his money where his mouth is. There's no shortage of people talking about China's crash and maybe one day it will. But when and are you willing to invest in that idea?
I always thought Paulson was slimy. After the increased scrutiny it is no surprise to me that his returns have plummeted.
I have mixed feelings about this, when you are dealing with millions of dollars, you should understand what you are buying, you cannot blindly trust your banker.
http://www.zerohedge.com/news/2017-03-28/partner-paulson-com...
Trying to prove he wasn't lucky that one time I guess.
At $7 Billion or so networth he'll be fine, without a job. OK, maybe he might have to skip a meal or two here and there but that's about it :) .
We live in a world where it's possible for a Harvard dropout to start a company with $0 and turn it into a $400 billion dollar company in just a few years.
It's not so far from the idea that under the right conditions, the fluttering of a butterfly's wings can cause a Hurricane on the other side of the world. I don't think anyone can make accurate predictions about the economy, there are too many things to keep track of.
Any perceived trend is rooted in false consensus.
I think that's overstating it a bit. The economy is certainly a complex system, but there are patterns we can understand.
We do understand how something like Facebook can come to pass in capitalism. We just can't predict where, when, what and and who (sorry, ycombinator can do that of course, but that's an exception :).
We do know that debt and leverage comes with certain dangers and also that there are counter forces that mitigate those dangers. We just can't predict very well where and when it gets out of hand.
But to those who reject markets on that basis I want to say that society as a whole is a complex system as well. We can't really get rid of that sort of danger.
Nations and democracies can be stable and peaceful for a long time and then suddenly fracture and drift towards conflict and hostility for no one's benefit.
No one can actually understand or predict the economy. The high-speed traders, battling algorithms like pokemon, are already a non-linear system far beyond control. If you know enough about "systems theory" et. al. it's totally scary, like bug-out-and-go-surfing scary. An intelligent actor, whether human or AI, will eventually compute its own inadequacy and endure a kind of sea change. (Did you ever see the old movie "Wargames"? It has a wonderful illustration of the same process in the context of global thermonuclear war.)
If we were as rational as we like to think asteroid defense would be a bigger thing than it is.
In fact, I recall reading somewhere that they're negatively correlated. If you want to put your money in a fund, your odds are better if you pick one that has just had a bad year.
Everyone - please don't make claims like this on HN. It's not adding value to anyone's life when you speculate incorrectly on financial advice.
I will pay you $500 if you can share serious evidence that the market can be outperformed by buying mutual funds that did poorly the prior year. (I am serious. Though of course, if it were true, you would stand to make billions beyond my $500.)
Though of course one study is unlikely to be definitive. (http://slatestarcodex.com/2014/12/12/beware-the-man-of-one-s...)
Here are 15 more articles on mutual fund persistence: http://www.altruistfa.com/readingroomarticles.htm#Persistenc.... I have not read them all, but my impression of the literature is that:
(1) There is slight positive serial correlation in mutual fund returns
(2) Most of the slight positive serial correlation comes from bad performers staying bad performers (rather than good performers staying good performers)
Theoretically, I find the notion of positive serial correlation far more likely than negative serial correlation. It seems more plausible to me that good fund managers would stay good than that managers would tend to oscillate from good to bad to good on an annual time scale.
In general, negative serial time correlations are generally harder to explain because a negative number squared is positive. Any sort of "rebounding" effect will result in oscillatory behavior, which will only be detectable over a certain time scale. Measuring a positive linear relationship is easier than measuring a negative linear relationship, because the negative solution will have an associated time scale. (That is, solutions that drift/diffuse can be captured over many time scales & sampling rates, whereas solutions that oscillate can only be captured near the rate of oscillation. On time scales that are very zoomed in or very zoomed out, you won't notice that the system is oscillating.) Much of this is handwavy and applies only to linear correlation, but hopefully the point is clear nonetheless.
> That dismal record is a far cry from nearly a decade ago, when Mr. Paulson made nearly $15 billion betting on the collapse of the housing market.
Maybe the pattern is that cynically betting on weakness doesn't work as a long-term strategy.
John Paulson was the man who famously had a bonus of billions in 2008/2009 for his subprime mortgage bets. Since then he's had a pretty tough ride with losses almost ever since.
Sounds like an ethically compromised situation to me.
A privatization of Frannie that involves removing the conditions that led to the bubble, including removing the bailout guarantees, would be a fair policy. However, I believe this will require legislation that Congress will have no appetite for, and which may not be able to pass in the Senate due to filibustering. We should definitely oppose half-measures in this respect; 2008 was too painful to replay.
tldr; risk management and all those boring terms people don't want to think about still apply.