When I read a book on general business subjects or investing, I usually have two purposes. First, I’m always on the prowl for an idea or an approach that might help me in my own investing. Second, I enjoy reading these books because they reflect life. A book about Starbucks (NASDAQ:SBUX) can not only contain business lessons, it can relate to things that you see every day. You may read about a strategy and think to yourself how you’ve seen that very strategy executed (or botched) the same day.
More Money than God by Sebastian Mallaby was rewarding on both counts. But I will go in reverse order — enjoyment and general learning first, investing tips second.
More Money than God, published in 2010, has quickly gained status as one of the definitive histories and descriptions of hedge funds. In rough chronological order, Mallaby traces hedge funds from the first “hedged” fund of Alfred Winslow Jones, through the Quantum Fund of George Soros, the stock-picking Tiger Fund of Julian Robertson, the Medallion Fund of Jim Simons, David Einhorn’s Greenlight Capital, and many others.
I was pretty ignorant about hedge funds before reading this book. I had no idea there were so many of them (thousands). I had no idea how successful many of them have been, having in the past been more intrigued by spectacular blow-ups. (One of my all-time favorite books is When Genius Failed by Roger Lowenstein, about the explosion of Long Term Capital Management.) I had never appreciated the incredibly wide range of strategies employed by hedge funds — from relatively straightforward stock picking to long-short hedging strategies to huge bets on utterly obscure events that can turn illiquid quickly if the bet goes the wrong way. I did not know that thousands have failed over the years.
Despite their reputation for misusing leverage to highly risky degrees, most hedge funds fall well short of investment banks on that score. Banks have been much more highly leveraged, risking OPM (other people’s money) in extremely leveraged activities, either by their proprietary trading desks or in the quasi-hedge funds housed within their walls. The author, in fact, makes a fairly compelling case for light regulation of hedge funds, pointing out that they fail regularly without requiring government intervention or taxpayer bailouts, whereas the too-big-to-fail banks, when they fail, create threats to the worldwide financial system. Most hedge funds are “small enough to fail.” By the end of the book, I found myself agreeing with the argument, although I started out quite skeptical about it.
The author gives a good description (in his statement on Amazon.com (NASDAQ:AMZN)) of two reasons why so many hedge funds have been spectacularly successful. First, they often trade against parties who are buying or selling for some reason other than profit. For example, a central bank may be buying its own currency because it has a political mandate to prop up the currency. A pension fund’s rules might require them to sell bonds of companies in bankruptcy. These are called “forced sellers,” and they create what the author calles an assymetrical risk/reward relationship: Much more potential reward than risk. Second, the typical hedge fund’s incentive structure, combined with the fact that partners have their own money in the fund, tends to make them manage downside risk more closely. As a group, hedge funds were up in 2007 when the markets were down, and they lost only half as much in 2008 as the S&P 500.
A fair amount of the book’s promotion has been based on the book’s story-telling and drama, “a rollicking good read” about the “colorful characters” in “the mysterious world of hedge funds.” I did not find those qualities in it. Instead, I found a good balance between telling the story of hedge funds through tales and hard information. I’m probably not the best judge on the dramatic qualities of the book; I utterly failed to see the dramatic possibilities in The Blind Side. I just saw it as the football equivalent of Moneyball — which is also being made into a movie, last I heard.
As to investment tips, I came away with three things. First, many of the techniques and resources of some hedge funds are simply unavailable to the individual investor. At Simon’s Medallion Fund, they gathered a team of mathematicians, astronomers, code breakers, and computer translation experts to find pattern clues in charts. I can’t do that. They gave up reading academic finance journals altogether as useless and well behind what they were doing.
Second, as if any more proof was needed, the book throws the last few shovelfuls of dirt on the Efficient Market Hypothesis (EMT). There is simply no way to read about all the avenues for success of so many different hedge funds and come away still thinking that the markets are efficient. There are degrees of efficiency, of course, and the more obscure strategies — including the trading of things for which there is no established exchange — tend to exploit larger inefficiencies than more common instruments, such as stocks that are studied to death.
A potentially more useful “tip” may be found in the number of funds that use some sort of trend-following strategy. I’ve read a fair amount about trend following, but I was surprised at how many hedge funds follow this approach with success. I found that heartening, as I believe that successful trend following is a potential avenue to success for individual investors.
Given its subject, this book is a pretty easy read. You may not understand all the subjects (I certainly did not), but it is not an academic yawner. At nearly 500 pages, it held my interest. A great appendix charts the relative performance of several of the most famous hedge funds over the years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.