Here’s a classic quote from a hedge fund pioneer, Julian Robertson. In brilliant simplicity, he conveys the rationale behind an authentic hedged fund, the long/short breed:
“Our mandate is to find the 200 best companies in the world and invest in them, and find the 200 worst companies in the world and go short on them. If the 200 best don’t do better than the 200 worst, you should probably be in another business.”
—Julian Robertson, Tiger Management
Sensical. Pragmatic. Empirically sound. But, that’s why everyone started doing it. Given all the Tiger Cubs that Mr. Robertson spawned and all the funds that America’s financialization coaxed, should we not expect extreme excesses, booms and busts? There evolves a generally accepted modus operandi that everyone employs–a piling in. Then, the bracket bulges, and everyone piles out at the same time. Long/short, stat arb, modern portfolio theory, value-at-risk (VAR)… they all collapse under the weight of replication and indoctrination. Those scalping High Frequency Traders (HFT) will not be spared.
There is no silver bullet in the business of business–neither the most sensical solution nor the most arcane. “Sure things” are only sure until someone else notices. If you’re cruising by gridlocked traffic in the passing lane of a four-lane highway, other drivers will notice. They’ll switch to your lane, and you’ll end up stuck in their slog. Worst part is: you thought you were on to something; you thought you outsmarted the main stream; but now you’re the epitome of their paradigm.
Mr. Robertson’s quote imparts two lessons. The first, a rational dogma for application in rational markets. The second, a reminder to remain flexible in my approach, constantly adapting and managing risk.