Dec

20

Strategies, from Jim Sogi

December 20, 2008 |

 Looking back at the year, a down year, what type of strategies worked best? A different question is also, what type of strategies that worked before would have worked this year. All this should be tested of course a la Seattle Phil's methods, but generally, from a qualitative view, it seems that timing worked better than stock picking this year. Secondly, lower leverage seems to have produced better returns. This at first blush seems obvious in a downmarket, but could produce higher profits on profitable methods. A risk return matrix could quantify the sweet point, at least in retrospect, and might be used going forward when a regime is recognized by the pilot fishes' first appearance. The February 2nd outlier turned out to be that pilot fish and the introduction of the new high volatility regime. This last Friday was a low volatility day and volatility levels seem to be dropping. With 8% daily moves in equities, 2% moves in currencies and bonds, who needs leverage?

With the Madoff imbroglio in full bloom, due diligence, apparently sorely lacking, will make a big comeback. I've commented before on the beauty of the markets ability to make large deals in standardized forms without reams of paperwork and lawyers, but the wilt is on that bloom. Now you have to keep a daily eye on the values and balance sheets of the bank, broker, contractors, car repairman, so they don't go bust while holding your stuff. Witness Refco, Lehman, Madoff, Citigroup, WaMu et. al. No wonder there is no confidence. Perhaps some of these funds and banks should have had the lawyers and accountants take a look at these multi-billion dollar investments as they would will any other deal of this size. It shows that the Emperor had no clothes, and no one noticed.

DinosaursLooking forward, the entire industry seems to be changing. The volumes are down leading to big fast moves. Many of the big Wall Street dinosaurs are dead, or dying. I think there will be opportunity from all this, like after the forest fires. Life leaps back. The ultimate slow mover, the government, will provide loads of opportunity. I started my career with the IRS. Fresh out of school I was handling huge deals, cutting my teeth. Typically a government worker is fresh out of school and will be assigned to run GM, or the entire banking system. The boss, the name, will be lunching on the private jet, but the person making the decisions will be a 23 year old kid, smart, no doubt, but still 23 years old. I, when 23, dealt with these old crafty 60 year old guys who made me feel just great, but no doubt made a great deal for their clients at the expense of the government interest.

Next year should be a good year. Just got to survive to see it!

Vinh Tu writes:

It has been an interesting year. That fact timing worked better than stock picking is consistent with the factor analysis that says that beta is by far the most important factor. That lower leverage was better than higher leverage is also very interesting. In part this was due to optimal bet sizes going down as volatility went up. On the other hand, it was also related to the highly-leveraged ecosystem being over-crowded, and the deleveraging becoming a stampede.


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