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Comment by mathattack | Hacker News Reader

Coming from a CS/Econ/Finance background....

Efficiency as “the market fully processes all information” is decidedly untrue.

Efficiency as “Its very hard to arb markets without risk better than a passive strategy” is very true.

Most professional money managers don’t beat the market once you factor in fees. Many private equity funds produce outsize returns, but it’s based on higher risk and taking advantage of tax laws.

Over time, positive performance for mutual funds don’t persist. (If you’re in the top decile performance one year, you’re no more likely to be there next year)

Despite all of this, there are ways people make money. But it’s a small subset of professionals. It’s high frequency traders who find ways to cut the line on mounds of pennies. It inside information from hedge funds. Or earlier access to non public information. But it’s generally not in areas that normal people like you and me can access.

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It inside information from hedge funds. Or earlier access to non public information. But it’s generally not in areas that normal people like you and me can access.

Asymmetric information is pretty far from what used to be said about the perfect market and rational actors. It's "there's a sucker born every minute" and "if it seems too good to be true it probably is" economics.

I might be misunderstanding what you're saying here, but are you sure you're right? Fama originally predicated the model of the efficient market (the efficient market hypothesis) on the idea of informational efficiency. Information asymmetry is a fundamental measure involved in the idealized model of an efficient market.

What you're mentioning about rational actors is actually a different topic altogether in economics.

Or have I misunderstood what you're getting at?

I was interested, so I did some research here.

Rational Choice Theory https://en.wikipedia.org/wiki/Rational_choice_theory

Rational Behavior https://www.investopedia.com/terms/r/rational-behavior.asp

> Most mainstream academic economics theories are based on rational choice theory.

> While most conventional economic theories assume rational behavior on the part of consumers and investors, behavioral finance is a field of study that substitutes the idea of “normal” people for perfectly rational ones. It allows for issues of psychology and emotion to enter the equation, understanding that these factors alter the actions of investors, and can lead to decisions that may not appear to be entirely rational or logical in nature. This can include making decisions based primarily on emotion, such as investing in a company for which the investor has positive feelings, even if financial models suggest the investment is not wise.

Behavioral finance https://www.investopedia.com/terms/b/behavioralfinance.asp

Bounded rationality > Relationship to behavioral economics https://en.wikipedia.org/wiki/Bounded_rationality

Perfectly rational decisions can be and are made without perfect information; bounded by the information available at the time. If we all had perfect information, there would be no entropy and no advantage; just lag and delay between credible reports and order entry.

Information asymmetry https://en.wikipedia.org/wiki/Information_asymmetry

Heed these words wisely: What foolish games! Always breaking my heart.

https://deepmind.com/blog/game-theory-insights-asymmetric-mu...

> Asymmetric games also naturally model certain real-world scenarios such as automated auctions where buyers and sellers operate with different motivations. Our results give us new insights into these situations and reveal a surprisingly simple way to analyse them. While our interest is in how this theory applies to the interaction of multiple AI systems, we believe the results could also be of use in economics, evolutionary biology and empirical game theory among others.

https://en.wikipedia.org/wiki/Pareto_efficiency

> A Pareto improvement is a change to a different allocation that makes at least one individual or preference criterion better off without making any other individual or preference criterion worse off, given a certain initial allocation of goods among a set of individuals. An allocation is defined as "Pareto efficient" or "Pareto optimal" when no further Pareto improvements can be made, in which case we are assumed to have reached Pareto optimality.

Which, I think, brings me to equitable availability of maximum superalgo efficiency and limits of real value creation in capital and commodities markets; which'll have to be a topic for a different day.

No, I'm not sure. I have ill-informed opinions which go to bad economics and I'd probably be written out of the reddit economics conversation which has a special place in hell for amateurs like me.

So.. I quoted the comment I commented on. What I feel here, is that small traders, at home traders, and people whose investments are managed arms-length by funds, are in a different place to people who operate "in" the market. And to some extent, these things which are driving significantly above longterm trend are things which the market regulator says it tries to limit: that whisper of future intent that three guys get in the mens room, and two women don't get in their other toilet, leads to a distorted outcome: the clients who benefit did not benefit from worked knowledge, they benefited from a point in time creating a distortion in who knew what to expect.

The LIBOR people setting the prices for money who decided to listen to their chinese-walled banker friends and set company friendly price, did everyone a huge disservice, in the act of making some people fantastic outcomes predicated on different knowledge of the process. LIBOR was not setting information, it was a closed-room price fixing game.

I'm a finance professional as well, and I generally agree with you. But every consumer has access to one piece of very vital non-public information, Namely, his or her's personal preference.

For example, say that I own a Tesla car, and think that it's pretty great. That's a very valuable piece of non-public information: I think Tesla cars are good. If one was to act upon this private information 3 or 4 years ago, they would have done very well indeed. Same with Google, or Amazon, or a multitude of other public companies.

I think people overestimate how difficult it is to make money in the public markets as individuals. Hedge funds, and especially mutual funds, are quite constrained in their ability to up size positions and put on profitable trades. They have redemptions, they have to hold assets in cash to liquidate shares (mostly this in a problem for mutual funds, not hedge funds), they might have to hold a long only portfolio (again, a problem with mutual funds, not hedge funds).

Individuals don't really have this problem, since they are managing their own money. If they want to put 50% of their capital into one name, no one is going to stop them. Moreover, they have full transparency into redemptions and inflows.

I have personally have done quite well with my own investments, achieving a better return than the firm that I work at. This has only been possible because I have complete insight into my risk tolerance, and don't have management and performance fees eating into my returns.

Another example. My wife's grandfather's wife in the early 2000s loved books and loved reading. Consequentially, she loved Amazon and what the company could provide for her. She convinced her husband to invest a sizeable chunk of their net worth (while not huge, was substantial, maybe 2 million) in one name, Amazon. They both dead recently, but the estate is very very valuable at this point, all because of that single Amazon investment shortly after they IPO'd.

Just because there are huge players in the market, doesn't mean an individual can't compete. In fact, individuals are probably in the best position to reap the highest returns from the public markets.

The parent comment was talking about risk-adjusted returns. You're talking about inherently highly risky bets "50% of their capital into one name".

I don't think it will surprise anyone that risky bets do sometimes pay off.

>I have personally have done quite well with my own investments, achieving a better return than the firm that I work at. This has only been possible because I have complete insight into my risk tolerance, and don't have management and performance fees eating into my returns.

How do you know it isn't just random luck? Same goes for your suggestions to invest in one "good" stock. Some will pick Amazon and profit greatly and some will pick AOL or Yahoo and be destitute. This is the whole point of diversification and the rise of index funds and I'm a little amazed to see a finance professional recommending things like this when studies repeatedly have shown that picking stocks does not work when you get a large enough sample size.

Exactly. In 1999 I had enough money with AOL that I could have completely paid for my 4 years of college tuition. I knew nothing about financial markets or investing but I thought and was told that AOL was a good company.....obviously that didn't last.

Historically, many funds made their bread on charging management fees for beta, and now that index funds can do the same thing but at a much lower price, they're going to go extinct.

I'm not suggesting that you put all of your money into one name, on the contrary, I think an index tracking ETF should make up the majority of one's portfolio. Maybe 20% should go into bonds or pure alpha and maybe 20% should go into 3 or 4 single name bets.

Institutional investors nowadays are doing something very similar. A core of their portfolio is now cost passive maybe with some smart beta tilt. The rest is allocated into bonds or pure alpha, whill a small portion is put into high conviction equity bets or hedge funds with beta exposure. This allows them to significantly reduce their management feels.

> I'm a little amazed to see a finance professional recommending things like this when studies repeatedly have shown that picking stocks does not work when you get a large enough sample size.

If every financial professional believed that, there would no be finance professionals. With me maybe the quote is true "It's hard to make a person understand something when their job depends on them not." I work at a firm that tries to make money for their investors and if I believed it was impossible, I probably wouldn't be working for them in the first place.

In no way am I an unbiased commentator, my livelihood depends on me believing that I can be smarter, than I can be better than everyone else. And while most people can't, many people can. There are a handful of funds that have demonstrated significant outperformance over a long period of time. Funds like RenTech or Bridgewater.

If you cite a few of the specific studies you're talking about, I'll be happy to explain why they're either 1) not actually concluding what you think they're concluding, or 2) simply incorrect. I can tell you very confidently that there is no academic consensus claiming alpha does not exist. It's rather the contrary, actually, and it's far more nuanced than your comment implies.

Outside of academic finance you can also find pretty obvious indications that alpna exists. Berkshire Hathaway has averaged about a 20% return between 1964 and 2018. Over the same timespan the S&P 500 averaged about a 7% annual return. Smaller funds have done even better than that.

When you actually do the math on some of these firms' performance, you see that the likelihood of their returns emerging by chance is too small to be explained by the number of hedge funds that has ever existed. There are funds which haven't lost money for 20 - 30 years, and whose returns are multiples of the market over the same time.

The question is not only whether alpha exists, though, but whether you can a) identify it, and b) access it.

Berkshire Hathaway’s stellar outperformance seems to have declined in recent years, right, and you and I can’t invest in Renaissance’s Medallion fund.

I’d concur that the individual investor has much more freedom in terms of basic asset allocation than most professional fund managers (except maybe hedge funds), but otherwise the general advice to go for a broad based index fund still stands.

Having a good product is no indication that the stocks are good.

- Stock price can be overvalued, even for that good product

- A costly proccess to make that fancy product could eat up the margins

- Company strategy, investment in the future etc need to be considered.

Basically you need to know how much a company is really worth to buy stocks, not just "I like their product"

And yet...his wife's granny ended up investing a couple of mil in a stock priced in the single digits that is now worth over $1500/share. Don't overthink things.

Btw: if you actually knew what happened to the share price at that time (it was probably down 90% in a year) then you wouldn't call it anything other than what it is...a good decision.

This is pure anecdata and survivorship bias. I like bitcoin, and yet...

Holding amazon through a 90% decline is having nerves of steel.

Liking bitcoin, that's just stupid.

Hindsight is 20/20. Investing 2 mil because "I like books" is never a good decision. If it works, you were lucky, not smart.

Exactly. It’s “Is your view of the product quality and it’s impact on the company, industry and stock market price better than the aggregate wisdom of everyone betting on it?”

Historically the answer is “Less than 49% of the time for most people, including professionals”

This was Peter Lynch’s theory.

But that one piece generally doesn’t beat the market.

It can’t. In aggregate we are average.

I think your comments are true though. Risk tolerance plus a long timeline is good for long term returns.

A similar story: I bought AMZN because I thought the Kindle was amazing. I correctly foresaw that it would get cheaper and better (despite people sneering that $400 for the gen 1 was obscene and that they preferred paper), and that AMZN could become one of the biggest sellers of books just like AAPL became one of the leading sellers of music with the iTunes store.

At the end of the day though, I think I made money on the stock for other reasons (AWS; Prime; AMZN eating all of retail).

Similarly, your family member seems to have made a good bet for all of the wrong reasons.

So I'm not sure your example is a great one.

Maybe, but delivering exceptional value in one area (books), is probably correlated to providing value in other areas (AWS, retail, etc).

You could imagine a similar situation with Google. You buy google stock because they created a really good search engine. But being able to deliver a great search engine also, it seems, is correlated to providing great advertising services, cloud computing, and email.

Being good at one thing is probably correlated to being good at other things (especially if they are related). While being bad at one thing is probably correlated with being bad at other things.

>Efficiency as “Its very hard to arb markets without risk better than a passive strategy” is very true

Isn't that the best we can hope for though?

The inefficiency is basically not knowing how to price something, which on some level is always true. At the moment a giant meteorite strike is priced at a level that is probably wrong? Tomorrow the meteorite will or won't strike and tell us which way we were wrong.

Essentially outperformance is down to being quicker on the trigger.

Edit: Or as you say, guessing whether the meteorite will or won't strike.

Most professional money managers aren't trying to beat the market. Distribution is way more important than performance. Trying to outperform the market is risky. Even if you have a good fund manager, they will eventually go elsewhere (if you look at most of big managers, but not all, their business model is turning a 0x employee into a 1x employee...10x employees get paid their marginal product).

The key to running an asset management business is marketing, and building assets with unsophisticated clients that won't sell (mainly retail investors/advisers). This doesn't work as well anymore but it is very weird to argue that mutual funds are meant to beat the market. That was never the pitch.

It is also fairly straightforward to outperform the market if you are a retail investor, you have a huge edge: size. You have just to look at the stuff that no-one else is looking at. I am not sure why but people have extreme amounts of difficulty with this concept.

People become investors because they want people to think they are big time, they want respect...they don't really care about performance. I remember a few years ago, when I worked in the industry, I came across a one-month 15% arb. My job at the time was to pitch ideas, and no-one was interested..."it isn't what we/I do". I cleaned out my account, sold everything, borrowed a substantial amount...99% of people won't do that. It is crazy to them...but investing is simple: look at what everyone else is doing, and don't do that because it is fucking dumb.

Also, most HFs don't have non-public information...sorry, they just don't. Some people are just genuinely better at making decisions than other people - 95% of people make the same mistake over and over, regardless of intelligence...ppl who are too smart usually do worse imo - and the most successful get around the problem of scale (a good example is Baupost: they invest in complex stuff that no-one else is trading).

Pursuit of efficiency is a common mistake. I believe, though I could be wrong, that Bridgewater concluded the only goal in investing is to make the correct choice more than 60% of the time though greater than 80% is extremely stellar. So long as you make the correct decision more than the wrong decision and account for the degree of risk you can afford to be inefficient and still outperform the competition by an order of magnitude.

Sometimes it is hard to know what the right decision is when current market forces suggest you should make the wrong decision or when every decision is apparently the right decision. In those cases you need historical data to compare against. The way they describe it it isn't any different than writing a basic algorithm, except there are many more variables to consider.

That’s actually a huge opportunity though. If you have a small edge in information, you can make millions.

Undoubtedly, there can be no such thing as perfect market efficiency because information takes time (even in our interconnected age) to travel, be grok’d and then acted upon.

Companies that focus on building an edge on either analytics or an edge on information gathering are where the real money is.

While a lot of people can acquire a lot of money by being a slightly better predictor of what the short term market thinks is the the future cash flow of public companies will be, it is a bit sad that this skill is valued so highly. So many really smart and hardworking people spend their whole lives doing it. They can end up with a lot of money, but I don't think they produce much wealth. Similar to how getting people to click on ads is really lucrative but also is more of a zero sum game than productive.

Not sure how to get more people to work on more interesting things like fusion power, rocket ships, electric powered transportation, etc. instead of skimming off of zero sum transactions. Just taxing the rich at high rates also kills the few golden geese.

> If you have a small edge in information, you can make millions.

This is one of the misnomer. Economics has enough random stuff and complexity that small edge doesn’t make huge difference. For example, you can get satellite photos of 100 sample Walmart stores and observe it’s parking lot to conclude that perhaps their quarter would end in negative side. But you might not be aware that the slack is being picked up more than enough by their online operations or that they have new deals for partnerships or some law about to be passed that taxes competition more.

To be fair, if you are making huge trading decisions like this on consumer retail, and ignoring the online component of the third largest online retailer in the US, you're going to lose all your money eventually anyway.

Uh, no.

The key word in the parent poster’s sentence was “can”. You only need one example to prove it - tons of failing examples do not disprove it.

For example:

If you lived next door to the head server guy at Wells Fargo, and the other night his wife called you to cancel their dinner with you because “there is some big problem at work that he’s dealing with and he has to work thru the night”, and then you decided to short WFC that next morning, then you would have done quite well, but importantly, the information edge would be not only small, but also non-specific.

Well, the guy could be some manager of some small project with some release deadline on his head. This may not have any impact on quarterly financials of $10B company. Big companies like this are very complex creatures and trying to bet because you had glimpse on one data point is trying to predict weather for next month because you felt breeze on your walk.

You're correct - I should have been more clear on the titling - when I think head server guy, I'm thinking a VP or above level.

> That’s actually a huge opportunity though. If you have a small edge in information, you can make millions.

Also, if you can act on public information faster than others then you effectively have that edge in information.

If you don't mind sharing, how did you turn your CS/Econ/Finance background into a career? Feel free to be vague, but I'm curious as to how you make a living. Thanks!

Started in CS, became a database programmer, went to grad school in Econ and Finance. Spent some time in Capital Markets after school, but realized I liked tech more. (I liked studying Econ and Finance more than working in that environment. The opposite of CS. Maybe I identify more with programmers than financiers?) I combined the two in Fintech as a way to get back into technology. Now I work in the business side of tech.

Thanks for sharing! Hoping to follow in your footsteps, except with ds/ml instead of database. Nice to hear it’s working out for you.

If you don't know about him already, you might find Martin Armstrong interesting.

https://www.armstrongeconomics.com/blog/

How's the sovereign debt crisis coming along? We're what, 3 years late at this point?

People can still make money because it’s still a rolodex game.

Most hedge funds are making worse returns than average investors. They only funds that are consistently making money are highly sophisticated quantitative top-down systematic traders. And their returns having nothing to do with their rolodex. Names like RenTech, Bridgewater, AQR, 2 Sigma.

I think people in our line of work can easily beat the market because we know how a lot of money is being spent and is going to be spent, well before finance guys do.

I made huge returns buying amazon and nvidia 5 or 6 years ago because I worked for a big tech company just beginning big moves into aws and machine learning and everyone I knew at other companies was telling me the same story. I bought amazon at $300 and nvidia at $30.

When people say you can’t beat the market, I think they’re wrong in that you can be well positioned to see large amounts of money being moved around well before the market becomes aware of it, if you’re in the right position.

I think you just have to think hard about how well distributed the knowledge you have is.

For example— I think we all know kubernetes is going to be a big big thing and it’s only getting started— I don’t think the market as a whole knows anything about it — my only question is which companies are set to profit from it? I suspect that commodity providers are going to slowly eat away at aws’s profit margins as people move to k8s hosting. But I don’t know who is going to be the big winner yet.

What else did you own in those 5-6 years? What was your overall performance vs. the market?

Up about 350+% over all over the past 5 years even with some losers in there. I’m just picking stocks for fun and never put any more money than my initial stake. I recognize that there’s luck and risk involved. I’m just saying that if you think carefully and have access to information that’s not widely distributed, you can make money.

I think one thing you have to get over is assuming that because everyone in your professional circle knows something, that everyone knows it. It can take years before disruptive change gets noticed, even while you’re working on it every day.

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