"Why are 25 Hedge Fund Managers Worth 658,000 Teachers?"
Tuesday, May 4, 2010 at 8:36AMWritten by Michael Bigger. Follow me on Twitter.
This was the poignant question asked of Umair Haque by one of his Twitter followers. Haque answered this question in a thought-provoking blog post: The Efficient Community Hypothesis (ECH).
Haque starts his analysis with the Efficient Market Hypothesis: "the prices of securities reflect all known information that impact their values. The hypothesis does not claim that the market price is always right."
Then he goes on to propose his own hypothesis. He states, "Call it the Efficient Community Hypothesis. It says: where efficient markets incorporate 'all known information,' efficient communities incorporate 'the best known information.'" Brilliant!
Think about it this way: an efficient community is an effective community of ants that extracts the best-known information from all available information.
Haque continues, "Organizations that can seed efficient communities stand to gain a disruptive information advantage" More brilliance!
Haque concludes his post with the following statement: "In markets alone, assets are never priced correctly, and fund managers earn mega-bucks. But in a market embedded in a community? Well, the tables might turn: Maybe 658,000 fund managers are worth 25 teachers."
I don't think the tables will turn. Fund managers are already seeding more efficient financial communities.
I can think of many ways to incorporate Haque's ECH into my trading algorithm. What about you?
Reader Comments (9)
Some are truly talented (James Simons or David Shaw) others are feeding of the information they pay for with soft money, kill the stock (or inflate), feed the press the story then give it to their offspring (smaller funds) who start to do their own damage (I think you know who those guys are). You can't predict the future, you can only manage your risk. I read his article, and the problem with those "communities" is that information will not given to every member of that community, well it might, and it does, as long as there is limited number of spots in the community. I met those people, and that's why I was surprised by your sentence "if you need any help, let me know...." In contrast the community (at least when it comes to market) where the intelligent and filtered information is, will never offer that help, because its never enough ( Every time I speak to these people I have this old rap song in my had "Let the ni.... o.d. cause its never enough" . Further, if everyone gets a voice in the community there become an abundance of misinformation that for most part is irrelevant,
I actually liked some comments and after reading it, Asaad put it much more eloquently. Also, after speaking with Lucas at Chicago I realized that EMH is misunderstood by most people (I was trading first and than went into learning, and was laughing when I heard the EMH, I thought it should be illegal to teach it in schools).
"In contrast the community (at least when it comes to market) where the intelligent and filtered information is, will never offer that help, because its never enough" very true. I was thinking about something like my research on Crocs (CROX). I got many people that got interested and asked me questions about it. The door has never been closed to anyone to discuss CROX with me. And I have learned good stuff from other people who look at the company from a different angle. It has been very fruitful to post the research for everyone to see. Yes, the EMH is misunderstood.
Regarding the Community Efficient Hypothesis....How to take advantage of this? Someone will figure out how to do this and I would rather start thinking about it now. I wrote a piece about John Paulson and information and what he says about why wealth will be created by the people who know how to interpret massive amount of information might be related in some ways to this post. They could be joined at the hip.
This not helping part I call: "Combination of genetic dysfunction with delusion of grandeur". Paulson is not unique example. If a graduate student with his real estate professor at Fordham (not Harvard or Stanford) could figure out that the collapse is eminent, just based on the simple ratio of salaries vs. the cost of the real estate (except I had no idea how to profit from that info except by shorting home-builders, and why? because all I was exposed to prior to that was equity, and besides Walter Bruan who died recently, no one would not teach anything to anyone (you should've seen the emails I wrote to volunteer at any fund, WITH NO PAY, just so I can learn something) than the big boys knew exactly what will happen. I told this to one director at Lehman and he said "everyone knew it was just too late to turn back".
By definition community will always be wrong, majority is always wrong in the market, if that was not the case there would be no speculation.
You raise a very good point. I need to think about it more.
Please, don't. I am wrong most of the time. If it wasn't for stops I don't know what I would do. In fact I told one manager the best thing wold be to listen to me and do the opposite.
I am still thinking about the point you made regarding community. It comes back to what John Paulson said which I talked about in a previous post. I am wondering what kind of process brings the best information to the surface!
Hi Michael, love the wide-ranging themes you cover on your blog...
"the prices of securities reflect all known information that impact their values.The hypothesis does not claim that the market price is always right."
This seems to be the go-to defense for the EMH as I've seen it crop up a number of times. A couple problems... it assumes that investors who act on this known information are rational and therefore any errors they individually make from not being able to process all the info will be "canceled out" in the aggregate. I could go on about how even if we grant the EMH this and other unreasonable assumptions it still suffers from logical inconsistencies, if not outright, then implied (arbitrage impossible because of the efforts of arbitrageurs?). But I'm sure you're well aware of all this, whether you agree or not (I'm guessing if you trade then you agree on at least some level). With that said, the EMH is the theory I love to hate, because it certainly has stimulated a lot of new ideas and its always good to have another mental model (a la Charlie Munger) in one's toolbox.
As far as that guy's community hypothesis goes, it suffers from similarly flawed logic. If the current market price reflects all known information, then it isn't even coherent to ask how we can find the "best information". There's no such thing as good or bad information. There are opinions and facts, and the philosophers among us would argue there's really only opinions. So which opinions are the best? And how do we define best? Is it the opinion of someone who got the last call right? Is it the opinion of a major market mover? Should we discount the crowd's opinion on one timeframe but give it a higher weight on another?
Would be interested in what you think and if you've come up with anything since you posted this.. Just found your blog the other day. Great stuff!
Joshua,
Thank you for your comment. The way I think about this is to experiment with different concepts and methods and figure out how I can make money with this. How you make money with all this depends on your personality and utility profile.
Example: I usually do very well making 1 big investment (long term investment portfolio) every 3 to 5 years. If I compress my time horizon, I tend to do poorly. So in essence I don't benefit from opportunities at shorter intervals. That does not mean the opportunities do not exist. It has more to do with my personality or inability to develop an Investment framework that works on that time horizon.
Knowing myself very well and experimenting with all kind of concepts are the drivers for how I squeeze $ out of the market.