Wednesday, August 01, 2012

Wanted: Humble Investment Experts

Goldman Sachs back 8-10 years ago charged ahead with superior profits and assembled a super duper hedge fund team led by Mark Carhart. They called themselves the Global Alpha team, sounds so Fantastic Four like. 

If you are Mark Cahart, you almost have it all your way for most of your life. Mark Carhart looks out over the packed New York conference back in 2005 and tells investors that Warren Buffett has it all wrong. Carhart, 40 then, co-head of the quantitative strategies group at Goldman Sachs Group Inc., uses his July speech to poke fun at Warren's penchant for investing in market-leading brands like Coca-Cola and Gillette. He cites study after study showing that big-name companies with high price-earning multiples or rapid growth rates make poor bets. Traditional stock pickers like Buffett, a fabled raconteur, do have one redeeming quality, Carhart jokes: ``They tell great stories.'' (Lesson - Don't fuck around with people who have done better and longer than you)


Carhart is one of the world's most successful money managers, a mastermind behind Global Alpha, a US$10 billion hedge fund for wealthy clients and employees of Goldman Sachs. In 2005, Carhart and co-manager Raymond Iwanowski, 40, notched a 51 percent gross return at Global Alpha. Posting that kind of gain requires taking risks -- and last year, Alpha lost 6 percent, its first deficit since 1999. Carhart, a former assistant professor of finance at the University of Southern California, helps oversee other hedge funds, four mutual funds and scores of separate accounts. In all, he and Iwanowski have US$101.5 billion at their command. Carhart and Iwanowski use math-heavy trading tactics that fund consultant Sol Waksman likens to counting cards in a casino. The two lead a corps of computer-loving traders, statisticians and finance and economics Ph.D.s. (Lesson - If you have the scores of Phds, math wizards and other brilliant minds at your disposal, you should generate superior returns... NOT! Be humble with financial markets, once you think you have mastered it, you are fucked. If you approach with the attitude that the more you know, the less you know of it, you stand a better chance of not have egg on your face, and live to fight again.)

Their team makes -- and sometimes loses -- millions of dollars a day. At the heart of their empire is Global Alpha, which generated about US$700 million in fees for Goldman Sachs in fiscal 2006. This money machine hums mostly behind the scenes. Carhart and Iwanowski, friends since their days at the University of Chicago Graduate School of Business, oversee about 10 other Goldman hedge funds, too. Together, they trade everything from Japanese stocks to U.S. soybeans, to Israeli shekels. Global Alpha is part of the richest hedge fund empire the world has ever seen. Last year, Goldman Sachs eclipsed D.E. Shaw & Co. and Bridgewater Associates Inc. to become the largest hedge fund manager, with US$29.5 billion in assets as of Dec. 31, 2006. That figure excludes Goldman's proprietary-trading funds and its funds of hedge funds.


Carhart and Iwanowski hunt for market variables called risk factors that often lead to excess investment returns, or premiums, according to people familiar with the fund. Some, such as a measure called the value premium -- the difference between the return of a group of stocks with high book values relative to their prices and that of a group with low book value-to-price ratios -- have been used by other money managers for years. Goldman Sachs has identified more than 20 new risk factors, which it doesn't disclose, even to its own investors. Carhart never reveals the secrets. Old friends and people who've invested in the fund say they're not really sure how it works. (Lesson - Once you think you have found the key, it will evaporate right in front of you.)


On any given day, Carhart's team of 50-60 investment professionals uses Global Alpha's factors to deploy 20 trading strategies in markets the world over, according to an investor in the fund and Global Alpha documents. During 2006, the fund's picks ranged from Japanese and Dutch stocks to bets on and against the Polish zloty. At the center of the Global Alpha story are Carhart and Iwanowski, devotees of quantitative analysis, or quants, who came to Goldman Sachs from opposite ends of the financial world.

Carhart first turned heads in money circles as a doctoral candidate at the University of Chicago and later as an assistant finance professor at the University of Southern California's Gordon S. Marshall School of Business. Iwanowski, by contrast, has spent his entire career on Wall Street. What unites them is that they're quants, who put their faith in data, rather than human judgment, when deciding what to buy or sell. To money managers like them, what you think about a company's management or products doesn't matter much. ( Lesson - Quants take the human element, the human judgment out of the equation.... well, you can't and shouldn't.)


Jokes aside, Carhart would do well to heed two Buffett rules. No. 1: Never lose money. No. 2: Don't forget rule No. 1. In 2006, Global Alpha went wrong when just about everything else at Goldman Sachs went right. After a roller-coaster ride that included a 10 percent August plunge, Global Alpha ended the year down 6 percent, according to an investor in the fund. The loss, the first since 1999, came in a year when Goldman earned US$9.54 billion, the most in Wall Street history. The investment bank made headlines by earmarking US$16.5 billion for salaries and bonuses, including a record US$53.4 million bonus for Chief Executive Officer Lloyd Blankfein. Carhart and Iwanowski declined to comment for this story, as did other Goldman Sachs executives. It was a rare misstep for Global Alpha. The fund skated through the 2000-02 U.S. bear stock market without a down year and posted an annualized return of 19.75 percent, after fees, from Dec. 4, 2001, to Dec. 31, 2005, according to Global Alpha's 2005 annual report. The average hedge fund returned an annualized 9.1 percent from Dec. 1, 2001, to Dec. 31, 2005, according to Hedge Fund Research. Shares of Buffett's Berkshire Hathaway rose a mere 5.9 percent during the period.


Only now, Carhart and Iwanowski are in a hole. Like most hedge funds, Global Alpha charges an annual management fee of 1.5 percent or 2 percent and takes a 20 percent cut of any profit. Before the fund can take its 20 percent in 2007 -- assuming it makes money -- its quants must first make up the 2006 loss.
 
One of the most-surprising things about Carhart is that for a guy in an industry known for big money and bigger egos, it's hard to find anyone who'll say a bad word about him. Former colleagues, classmates and teachers remember him as one of the smartest people they've known. After graduation, Carhart headed for Yale University, where he majored in economics and served as managing editor of the Yale Economics & Business Review. He also began dabbling in the markets as a director of the Yale College Student Investment Group. After Yale, Carhart set to work on a doctorate in finance at Chicago. He studied under finance professor Eugene Fama, best known for his work on the efficient-market hypothesis, which holds that prices reflect all there is to know about stocks or other securities.

Global Alpha doesn't merely bet on the direction of stock or bond prices. It bets on differences between those prices. Global Alpha employs seven strategies in the bond markets alone, according to Goldman Sachs Global Alpha Fund Plc's June 30 semiannual report. The simplest of them is to buy government bonds of one country while shorting those of another. In the U.S. stock market, Global Alpha might buy oil and insurance stocks and simultaneously bet against semiconductor shares. The fund also allocates part of its US$10 billion to something called ``global event anomalies,'' according to a November 2001 prospectus. With this strategy, the fund attempts to make money from corporate stock buybacks and divestitures and from changes in how market indexes like the S&P 500 are calculated. Carhart and Iwanowski also employ a commodities strategy and an asset-allocation strategy that bets on various mixes of investments: stocks, bonds, currencies and beyond.

Global Alpha quants have designed their fund so that if things go wrong, the probability is low that the 20 strategies will lose a lot money at the same time. That, anyway, is the idea. In the 2005 report filed with the Irish exchange, Global Alpha reported a gross return of 51 percent for the year. The report says only two strategies -- global anomalies and the country bond selection -- suffered losses of more than 1 percent. During the first quarter of 2006, Global Alpha rose a net 9.5 percent. The next quarter, a bunch of the fund's strategies soured. Global Alpha lost 3.5 percent during the period. Its ``developed equity country selection'' fell 2.5 percent, hurt by bad bets on Japanese and Dutch stocks. Its developed country currencies strategy sank 1.9 percent, whacked by a wrong-way wager on the dollar and another against the pound. Emerging market currencies strategy sank 1.7 percent, nipped by short positions in the shekel and zloty.
 
Piecing together the second half of 2006 is harder. A Global Alpha investor who asked not to be identified says the fund's roughly 10 percent slide last August mostly reflected bad bond market investments. Global Alpha also bet that stocks in Japan would rise while those in the rest of Asia would fall -- wrong; that U.S. stocks would stumble -- wrong; and that the dollar would rise -- wrong again. Global Alpha finished November down 11.6 percent in 2006.

Trees don't grow to the sky. Neither do hedge fund returns. Superman exists only in comics.



Where Is Mark Carhart and Global Alpha now?



Goldman Sachs shut down the fund in September 2011. The closure of Global Alpha is a striking reversal for a fund that was once the toast of Wall Street and spawned the careers of some of the most well-known quants in the business, including Cliff Asness, founder of AQR Capital, and Mark Carhart, the founder of Kepos Capital. Global Alpha gained prominence as high-frequency trading, in which computer models execute lightning-fast trades, became a common strategy among hedge funds.
Global Alpha was started in 1995 with just $10 million. Over time its results soared. At its peak in 2007, Global Alpha ran about $12 billion, although that number has dwindled to about $1 billion now in the wake of a number of wrong bets. The fund is also having a rough year, according to a person close to the firm, and is down about 12 percent so far for 2011.

In 2010, Carhart launched his own quant shop (Kepos Capital), now managing just $500m. Let's just say his fund's performance to date have been lukewarm.

2 comments:

Calvin said...

Great article. We should always read Nassim Nicholas Taleb's books, The Black Swan and Fooled by Randomness to appreciate that we can easily be brought back to earth once we think we are invisible. The Chinese words for it seems to match description for "back to earth", i.e. pokai.

Calvin said...

Short review on the book "Fooled by Randomness" by an amateur blogger

http://businessmanagementbooksreview.blogspot.com/2012/06/fooled-by-randomness-hidden-role-of.html

(Dali, the above is a link to my blog which I am doing it out of my passion for reading. I am hoping to improve and therefore, criticism is most welcomed. If you find that the above link is inappropriate to be featured in your blog, please ignore this comment. Thank you for your time).