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Saturday, 6 September 2008

Luck or Skill?

The lead from the Guardian was relatively nonchalant. In a very matter-of-fact way it noted that "Hedge fund manager Ospraie Management LLC will close its flagship fund after it plunged 27 percent in August on losses in energy, mining and natural resources equity holdings, in one of the biggest ever closures of a commodities-focused hedge fund."

Staring at that sentence on the screen , however I was stunned. Ospraie wasn't just some wanna be player in the hedge fund world. It was the creme de la creme of commodity money managers. Featured in the House of Money - a seminal book on the stars of the hedge fund world - it enjoyed a golden reputation as a savvy trader of hard assets.

And yet these guys blew 27% in just one month. The reasons for their demise do not matter. Clearly they simply did not manage their risk. In fact they confirmed my suspicion that the money management strategy of most hedge funds is to double down when they are wrong and hope that they have enough capital to weather the storm. Sleek skyscraper offices, richly textured brochures, soothing talk about Phd driven risk control models are all nonsense. Most hedge funds are horrible traders. In fact if all hedge funds had to reveal their trading positions in real time like we do at BKT 99% of them would probably be out business.

Hedge funds hide behind the mystique of competence but the longer I am on Wall Street, the more I am convinced that Nassim Taleb is right - most successful people in finance are simply lucky and are only one bad trade from blowing up your money. There are only two traders that I know of who are truly great - Paul Tudor Jones and Steve Cohen. Both are traders frist and foremost. Both will always take a stop when they are wrong. Both have had more than 200 months of positive returns with only one or two months of negative performance of no more than -1.5%. In fact, if there is a single question that I would ask a hedge fund, would be this - What was you worst monthly performance? If they say 10% or more - run from their office and don't even bother listening to rationalizations.

The Osprie saga only serves to remind us just how difficult this business can be. But it is also a testament to the BS that permeates Wall Street. Making money consistently is not easy and most managers are simply lucky rather good.

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