A Time of Gifts

Christmas is here! Yes, it’s that time of year when we hedge fund managers reflect on the themes of charity, compassion, and, most important of all, free loot.

I look around the desks at Sopwith and I see men and women who can easily afford to buy anything they could reasonably desire. Yet every single one of them would rather receive a trinket worth a hundred bucks, no matter how useless a piece of junk it is, provided it’s free, than pay a hundred bucks out of their own pockets for something of actual utility. It’s a very curious phenomenon.

Mind you, there is no phenomenon so obscure, no tendency in human nature so venial, that our modern scientific society won’t take advantage of it. And by ‘modern scientific society’ I refer, of course, to our friends the investment banks.

That’s why at this time of year the offices of Sopwith Asset Management are flooded with greetings cards blazoned with messages of holiday cheer, peace on earth and goodwill to our fellow souls. And nestled underneath these cards are gift baskets packed with tons and tons of free loot.

My broker in Chicago fancies himself an amateur sommelier; he invariably sends me a case of fine wine. My salesman in London says he has an inside line at the distillery; he dispatches a bot or two of aged scotch. My man in Tokyo sends sake and the most exquisite floral displays. As for the New York crowd, they (true to form) outdo each other in sending me all of the above, and chocolates, and cigars, and caviar, and whatever else catches their eye.

It’s a profusion of presents, a glut of gifts, an oversupply of offerings. And to what purpose? Well, each of these bankers fondly imagines that come the New Year, when the time arrives for me to place my first trades of the season, I will remember their contribution with favor, and trade with them instead of with their hated rivals.

Note the economic calculations here. Even the most lavish of gift baskets won’t cost anywhere near as much as the commission from just one chunky trade. What’s more, trading commissions go directly into banker compensation; costs, on the other hand, are rarely subtracted directly from banker salaries. (The same logic, inverted, applies on our side of the equation: I pay broker commissions using my investors’ money, but get to drink the scotch myself).

Of course, the entire exercise is counterproductive, simply because everybody does it. If everybody sends a gift, then nobody stands out. So I end up trading with whoever offers me the best trade terms, expensive gifts be damned.

And the bankers know this. But they’re in a bind. If they, heaven forbid, choose not to bribe me any given Christmas, then they will stand out from the crowd, and I may choose to punish them by not trading with them. They can’t risk that, and so we settle into a happy (albeit unhealthy) equilibrium.

In any case I view the gift baskets as a sideshow. Because I never lose sight of what’s important – our real Christmas presents, and the ultimate in free loot: our annual bonuses. Merry Christmas, everyone!

The Risk Manager

I mentioned our risk manager in passing the other day. This wondrous individual deserves an entire post to himself; here goes.

Once upon a time, Sopwith did not have a full-time risk manager. I don’t know how the CEO managed to get away with this – presumably our initial investors were so taken in by our glamor that the idea that we could actually lose money never occurred to them – but it was never going to last. I still remember the day that the big boss walked up to my buddy Tim (our head of analytics) and asked him to be the risk manager.

Tim, being a smart guy, refused.

I, being a mere junior analyst at the time, was aghast.

Me: Tim, how could you refuse? Risk manager is an MD level job – that’s a major promotion!

Tim: Don’t kid yourself, sonny. Who makes the profits in this firm? The traders, that’s who. And who’s blamed for losses? The risk manager, that’s who. Even you should be able to figure out the power dynamics here. This ain’t no promotion, it’s a death sentence.

Me: But don’t you have the authority to cut trader positions? Surely that gives you power over them?

Tim: Yeah, but why would I ever cut anyone’s position?

Me: Errm, because it’s too risky?

Tim: Look. Where does my paycheck come from? From the profits that our trading team makes. What incentive do I have to limit these profits?

Me: But what if a trade goes sour and the fund goes bust? Wouldn’t you be out of a job?

Tim: Well, if I veto a bunch of trades and we just sit on our hands for a month or two, our investors will get impatient and pull their money, and I’ll be out of a job anyway.

Me: But surely investors should be smarter and more patient and more long term in their thinking?

Tim didn’t even bother replying to this, he just laughed derisively.

Me: Okay, never mind the investors. But couldn’t management do something to fix the incentives? Like maybe making your paycheck independent of the traders’ profits?

Tim: If they do that I’m quitting tomorrow. I didn’t join this business for charity, kiddo, I’m in it for the bonus pool.

Me: What a bizarre situation. But surely this is not a problem unique to us. How do other hedge funds solve it?

Tim: Well, most other hedge funds insist that their traders invest their own money in the fund, so that they’ll be less likely to take wild gambles. But can you see the big guy [our CEO] doing that?

Me: No, I guess not. He’s too smart and too rich to fall for that.

Tim: Precisely.

Me: So what are you going to do? What’s Sopwith going to do?

Tim: I dunno. Not my problem, kiddo.

It was a poser all right. But I should have had more faith in our senior staff. Not for the first time, they came up with a solution to the problem of risk management that was utterly original, and just a wee bit insane.

If incentives were a problem, they reasoned, then why not hire a risk manager who would be immune to these incentives? By happy coincidence, our CEO knew just the man: a professor of finance who was independently wealthy, a figure of immense culture and sophistication, who could be guaranteed not to kowtow to the traders for a few measly millions in bonus money.

Professor Fortescue was as impressive as heck. He had a first-class academic pedigree, with multiple Ivy League degrees and a tenured chair at a top university. His research in finance theory had yielded several seminal papers, and various bulge bracket investment banks and blue chip hedge funds paid him hefty consulting fees to sit on their boards.

But all of that was irrelevant. All that we cared about was the fact that he was rich. Not fabulously so, but rich enough to not really care about his annual bonus. It looked like our incentive problem was solved.

Unfortunately, it was solved a little too well. Professor Fortescue was so immune to the lure of money that he felt no particular obligation to work for it. He accepted the job at Sopwith out of loyalty to our CEO, but his heart was never in it. He would wander into the office at noon, read a couple of papers, shoot the breeze with various colleagues, then head out again no later than 3 pm. A good life; if I hadn’t already had my heart set on being a trader, Professor Fortescue would have been my idol.

Oh, and the crowning irony? Our investors were beside themselves with excitement at the thought that this famous academic would be risk-managing our fund. If only they knew!

Power Corrupts

They say that power corrupts, and that absolute power corrupts absolutely. Nowhere have I seen the truth of this maxim confirmed so utterly as in the saga (ongoing) of Jimmy the Kid.

Jimmy used to be such a nice young boy. Friendly, willing, open, and keen; hardworking and honest; your typical freshly-scrubbed graduate. True, he was not overly blessed with intelligence, but let’s face it, intelligence is a highly overrated commodity. It’s certainly no prerequisite for success, and left to his own devices, Jimmy would have been successful. He would have settled into a career of undistinguished but happy mediocrity at some middling investment bank, with all the trappings: wife, kids, two cars, a cat and a dog. Membership at the country club and vacations in Europe.

But he was promoted before his time, and that was his ruin.

It’s no secret that the finance industry is in a bubble. All around Wall Street there are 20-some year olds with no qualifications beyond bespoke suits and limitless self-confidence, raking in the big bucks. The flow of easy money means that anyone who is not actually comatose is guaranteed a multi-million dollar pay check; you just have to be in the game and success is assured. Never before have so many Ferraris been bought by so many people for so little work.

A few of these prodigies recognize that they’re just lucky to be in the right place at the right time, and they live their lives accordingly. But the vast majority are not so introspective. Most Wall Street employees feel divinely entitled to the richesse that accrues to them; it’s only what they deserve, after all.

Jimmy is at the extreme end of this spectrum. He considers his early promotion to be incontrovertible proof of his exceptional talent. And since he must have been doing something right to get promoted, he sees no need to change. To his incompetence he has added arrogance, stubbornness, and an utter lack of self-awareness.

Yes, the experiment of promoting Jimmy the Kid to management has exceeded my wildest expectations.

If I had a hammer

“To a man with a hammer, every problem begins to look like a nail.”

Ah management. Just when you think they can’t possibly make a situation any worse, they proceed to do precisely that. And they do this again and again and again, every single time. It’s uncanny.

Case in point: the ongoing saga of Jimmy the Kid. Contrary to all reasonable expectations, the management’s masterstroke of promoting Jimmy to head of investor relations has worked out very well. Of course Jimmy doesn’t know a thing about finance, but he is very well dressed, he has an expensive education from an elite school, he works very hard, he’s available to handle questions at all hours of day and night, he never lets an email go unanswered, and he can talk the hind legs off a donkey. He’s on the phone to investors from dawn till dusk, holding their hands, massaging their egos, explaining every little fluctuation in the market with reams of jargon and sophisticated terminology.

Most importantly, Jimmy is a true believer. He truly believes in the Sopwith way of doing things – in our traders, our technology, our magical ability to make money. You can’t buy sincerity like that. This sincerity is in fact his main weapon in going out to sell the fund, and it has served him very well. Not that Jimmy has ever actually closed a deal; he lacks the brashness and sense of timing – the killer instinct – required to get a client to sign on the dotted line. But he does enough to keep current and future investors off the traders’ backs and away from the CEO’s desk, which is all that anyone really cares about.

If only matters had stopped there. But no. It appears that senior management, emboldened by their success at promoting Jimmy, have decided to apply the same solution to another pressing problem facing the firm: our abject lack of leadership.

For years, leadership at Sopwith has been minimal to the point of non-existence. Our multibillionaire CEO, at whose desk the buck supposedly stops, is utterly uninterested in the day-to-day grind of running the firm; for him, Sopwith is just a vanity project, kept in place to maintain his self-image as a Wall Street hotshot. The traders, who are the real power in the firm, are likewise disinclined to manage, because frankly it’s boring; playing the markets is much more fun. Other senior figures like the CFO and COO and so on might have been good managers but they have no political power in the firm compared to the traders (who after all are the ones who bring in the dough). So management at Sopwith is a vacuum; in fact, the entire concept of administration is considered a tedious and unrewarding chore, best avoided.

And people know this; it's no secret. Everyone knows it’s an unhealthy situation, but it’s in nobody’s self-interest to do anything about it.

Until now.

You can see where this is going. Yup. The management committee has, as of today, decided to promote Jimmy the Kid to the role of executive manager of the firm.

Let me remind you again of Jimmy’s background. Jimmy is barely six months out of graduate school. He has no experience, no expertise, no credentials, in fact absolutely nothing to recommend him beyond his tailored suit and his perfect set of teeth. Being put in charge of investor relations was already a step too far for him, but now he’s also being put in charge of managing the traders, operations, technology, risk management, settlements, lawyers, the works.

And the amazing thing is, everybody is thrilled with this arrangement. With all the managerial responsibilities dumped onto Jimmy’s shoulders, Sopwith’s other employees are free to do as they please. The traders can trade merrily, the programmers can program away with minimal supervisory intrusion, the CEO can hit the golf course at 11am instead of 3pm, and nobody needs to bother with administration.

In fact, it gets even better. Not only has our management lacuna been filed, but investors, some of whom were beginning to chafe at the removal of their direct line to with the CEO, are now being granted full-time access to the guy who actually runs the fund from day to day. The one, the only, Jimmy the Kid. Needless to say, they are thrilled, when in fact they should be screaming and rushing for the exits.

I will be watching Jimmy’s career in management with the closest of attention. These will be interesting times.

To be continued...

Hot Potato

I have never understood the fascination that investors have for meeting star portfolio managers in person. Okay, sure, I know that human beings like to be dazzled; bumbling amateurs get vicarious gratification out of associating with market wizards, even if nothing productive comes out of the association. And I concede that if you’re going to hand out millions of dollars to a hedge fund then the very least you deserve is a meeting with the principals, not with some wet-behind-the-ears MBA droid.

But insisting that the CEO be at your beck and call, 24 hours a day, 7 days a week, 52 weeks a year, for the entire duration of your investment? That’s not just self-centered, it’s actively perverse. Because of an unintended (but perfectly foreseeable) consequence: if every investor behaves the way you do, the star portfolio manager will end up spending all his time meeting investors, while the actual trading is done by the aforementioned wet-behind-the-ears MBA. As a rational investor, would this be your preferred outcome?

Of course most investors are not rational, and so this is precisely the outcome that eventuates in 9 out of 10 cases. Most fund principals recognize this fact and have made their peace with it, because they also know the answer to a very fundamental question: what is the role of the hedge fund manager? Is it to make money? No, absolutely not. The role of the successful hedge fund manager is to raise pots of money; and, having raised it, to keep it. That’s the way to make fat management fees and fatter bonuses; generating profits is of secondary import. And that’s why most managers are only too happy to spend their days and nights fielding investor phone calls when they could be better served watching markets.

Unfortunately, Sopwith is blessed with a manager who does not feel the need to do this. Our CEO had the good sense or good luck to start a technology company which he took public just before the dotcom crash. He then founded a real estate company which he sold to a bank just before the housing crash. As a result of these two transactions, our CEO is a multibillionaire. In fact, his net worth is more than that of the fund itself, and way more than any particular individual investment in the fund. Naturally he feels disinclined to waste his time mollycoddling investors for chump change.

With the CEO not interested in marketing, the role of investor relations at Sopwith has in recent months taken on the aspect of a hot potato. Our COO would have been perfect for the job – she’s sincere, hardworking and dedicated – but unfortunately she has all the communication skills of a gnat. Our CFO is just the opposite – he’s suave, sophisticated and a slick talker – but he has the minor disadvantage that he does not understand finance. As for our traders, they have zero interest in being torn from their Bloomberg screens to meet investors, and frankly this is just as well. Our traders are a bunch of antisocial misfits united by a single characteristic, the alleged ability to make money. Finally, there’s our risk manager, an Oxbridge don, who is independently wealthy and wouldn’t be seen dead grubbing around for money like the lower classes.

The hot potato has therefore been bouncing around our offices for some time. But finally it has found a home, in the eager and slightly manic hands of the juniormost person on our desk: Jimmy the Kid.

Jimmy is keen. He is enthusiastic. He is sincere. He is motivated. He is also utterly clueless about what it is that we do. But that doesn’t matter; as long as he can keep investors off everyone else’s back we don’t give a damn. And this he proceeds to do, with almost touching enthusiasm.

Wait, I hear you say: isn’t this just the wet-behind-the-ears MBA tactic all over again? Won’t investors be peeved at being fobbed off with a nonentity like Jimmy?

Have no fear, gentle reader: the geniuses in Sopwith’s upper management have already formulated a plan to head off this possibility. The plan is either insanely brilliant, or brilliantly insane – I don’t yet know which – and it can be outlined in one sentence: if investors want to meet a senior employee, then a senior employee is what we’ll provide.

Yes. They have promoted Jimmy the Kid to upper management. This utter newbie is now our "Head of Investor Relations"; a member of the "steering committee"; a managing director and an equity-holder in the fund to boot. Of course these titles are meaningless; none of these positions have any power or any responsibility, but Jimmy doesn't know that – and neither do our investors. I wonder for whom the penny will drop first?

To be continued...

Scenario Analysis

We’ve lost a lot of money in the last month, and the Boss calls me in for a meeting. I’m afraid he might ask me to cut my position, but he wants me to do a scenario analysis instead.

This is great news. I love doing scenario analysis. You can use scenario analysis to prove absolutely anything.

A scenario analysis spreadsheet, as the name implies, is a spreadsheet that analyzes various economic scenarios. For each scenario listed, there’s a qualitative description (for example, “the economy picks up steam, measures of inflation rise, and the Fed hikes interest rates”) followed by impressively precise predictions for various market variables (“10-year bond yields will sell off to 3.59%, the S&P will climb to 1182 and oil will rise to $72.35 a barrel”). Combine these predictions with your current portfolio positioning, plus any changes that you expect to make in the portfolio, and you get P&L outcomes for each scenario. Assigning probabilities to each scenario then gives you the “expected value” of your portfolio, which in turn leads to the most important statistic of all: how much you expect to get paid.

A well-crafted scenario analysis spreadsheet can be extremely impressive. The sheer quantity of detail crammed into the spreadsheet can easily overwhelm the unwary reader: examinations of every possible state of the world, with associated probabilities, market predictions and P&L projections all to three decimal places or more. But where do all these numbers come from? Easy: from a thorough examination of current and future economic conditions, coupled with a deep understanding of market dynamics.

In other words, I pull them out of a hat.

Let’s be honest. I might put hours or days or even weeks of research into building my scenario analysis spreadsheet, but even with the best intentions in the world, there is no way I or anyone else can predict the market. What’s the probability of a rebound – 30 per cent? 60 per cent? 90 per cent? Who knows? Even if I knew for certain that a rebound was on its way, what would that mean for oil prices? Would they go up? Down? Sideways? Who knows? And even if I knew for certain that oil prices were going up, what would that mean for my portfolio? Will I still be long oil at the time? Will I have cut my position in half? Doubled it? Gone the other way and sold oil short?

It’s the tyranny of efficient markets: anything you know, everybody else knows. So if you’re certain a bounce is on its way, then there’s a fair chance everybody else is equally certain, and current market prices reflect that information. Trying to predict the future is a mug’s game; building a complicated spreadsheet based on these predictions is beyond stupid.

So I fall back on the cardinal rule. I build a spreadsheet that will help me keep my position.

Building a good scenario analysis spreadsheet is an art. A common beginners’ mistake is to paint too rosy a picture: assigning too high a probability to the “good” scenarios, or assuming that the market will react to unexpected news in just the “right” way to help you make money. A moderately competent desk head will see right through that, so you have to be a bit subtler in your approach. One good technique is to shovel all the bad news into a scenario that you know your boss does not believe in. For example, if he’s a peak-oil fanatic, then make sure that your worst P&L occurs in the scenario where oil drops back to $20 per barrel. Another tactic is to choose your market outcomes such that your boss’s favorite trade appears mediocre: your overall spreadsheet will then seem suitably conservative, but you won’t be asked to change your position. And of course you can always tweak the probabilities, fudge the predictions and alter the positions (“expected strategic/opportunistic reallocations”) to ensure your portfolio works like a charm in all states of the world.

Armed with these tricks of the trade, I create my spreadsheet. It takes about an hour to build (15 minutes to generate the numbers, 45 minutes to format them), and it’s a masterpiece. It has every single scenario imaginable, including several that are ludicrous in the extreme. Amazingly, my portfolio seems to make money in almost all the listed scenarios, yet there are no clear instances of bias or manipulation. All the numbers are given to five significant figures, and there’s an abundance of extraneous detail. Important cells (profits) are carefully highlighted, while irrelevant ones (losses) are equally carefully downplayed.

The spreadsheet works like a charm. Confronted by rows and rows of densely packed figures, the Boss’s eyes glaze over. He focuses on a cell that implies that we’ll make a ton of money while taking minimal risk, and that seems to please him; he says to me, “Good work!” Then he does what any good manager does when out of his depth. He changes the subject.

Blinking Lights

Last month’s investor meeting merely confirmed what I have long known: financial decisions are rarely made based purely on (or even primarily on) financial merit.

I remember learning this lesson at my very first investor meeting, when I was barely six months into the industry. But we have to rewind a bit. What was I, fresh out of university and ignorant as the beasts that perish, doing at an investor meeting? Surely no rational investor would trust an obviously clueless 22-year-old with their hard-earned moolah?

Ah, but investors are not rational. And this particular 22-year-old had a secret weapon up his sleeve: Das Blinkenlights!

It all began when Professor Q, our head quant, came to me with a new model he wanted implemented. The model was of the type called ‘Monte Carlo simulation’ in the finance jargon. You simply did a large number of trials, and took the average value (of some variable of interest) over all these trials. Nothing particularly original or revolutionary, and a piece of cake to implement.

I programmed the model in about 20 minutes, put it into a friendly-looking spreadsheet, and was all set to show it to the powers that be, when inspiration struck. I added a cell that showed the trial number. As the program cycled through the trials, this cell ticked upward rapidly. It was a trivial little addition, and it slowed down the computation considerably, but it had this advantage: it made the spreadsheet look very NASA-as-imagined-by-Hollywood-esque. Positively cool, as a matter of fact.

I demoed the spreadsheet to Prof Q. He liked it. He called the Big Boss over; the Big Boss liked it as well. So did assorted mid-level bosses. None of them would admit it, but I could tell that the thing that impressed them the most was the rapidly flashing trial counter, which fostered the illusion that they could actually see the program crunching its numbers. All bow to the power of Das Blinkenlights!

I got more plaudits and “good jobs” for my 20-minute spreadsheet with its 2-minute trial counter addition, than I did for the many hours of complex coding and tedious debugging that went into creating our core analytics system.

And that’s not all. I was asked to make my Monte Carlo spreadsheet the centerpiece of a presentation to some potential investors. Yes, this same spreadsheet that was hacked together in 20 minutes by a rookie programmer with zero financial expertise, was now being touted as the super-secret, ultra-splendid, and utterly unique core of our trading strategy.

I was a bit hesitant initially, but that only goes to show how young and naïve I was. In retrospect, I don’t know what I was worrying about. In the years following that original meeting, I attended other presentations by other fund managers which made my spreadsheet look like rocket science. Incompetence, it seems, was not confined to Sopwith. The funny thing is, many of these other funds raised billions of dollars; some of them are still going strong.

But I digress. Let’s return to my first investor meeting. I’m afraid it was a bit of an anticlimax. Oh, the investors said all the right things, oohed and aahed at all the right places, asked a few perfunctory questions, and were unfailingly polite. But I got the impression the entire process was just an elaborately choreographed dance: the true investment decision had already been made. Looking back, I can’t say I’m surprised. At the end of the day, you have to trust your fund manager. If you don’t trust him then all the models in the world are no good; if you do trust him then that trust will remain even if his trading tools are a wind-vane and two fridge magnets.

The lesson for fund managers, of course, is that their single most important task is to establish trust. I was to learn this lesson again and again in the ensuing years, in the context of investor relations, in the context of trading desk politics, in the context of risk management, and especially in the context of position sizing. Once you have people’s trust, you can get away with anything.

That wasn’t the only thing I learned that day. The second lesson, and perhaps the reason why trust is so important, is that nobody knows what they’re doing. Sure, there are folks who can talk the talk: academics who spout jargon, traders who flourish track records, investors who brandish due diligence questionnaires. But nobody really has a clue. That’s why they’re willing (and indeed, eager) to be taken in by a dodgy spreadsheet and a few blinking lights. All you have to do is say the magic word – money! – and their cupidity will do the rest.

The third lesson was the simplest but in some ways the most useful: I learned that, no matter what the task, the important thing is to look good while doing it. From that day on, all my programs and spreadsheets have had flashing lights, blinking digit counters, sexy graphs and slick production values. I’ve never looked back.

The Show-Off

Investor meeting today. I hate investor meetings.

Don’t get me wrong. Without investors we would have no assets to manage; without assets we would have no profits; and without profits we would have no bonuses. So investors are a necessary evil.

Nonetheless, most hedge fund mangers, your humble narrator included, view investors with barely-disguised contempt, and it’s not hard to see why. Fear and greed are the besetting sins of every participant in the markets, but hedge fund investors embody these two qualities to a greater degree than almost anyone else. Obviously they’re greedy for the juicy returns we promise, else why would they be investing in us? And equally obviously they’re fearful, because they don’t understand what we’re doing (if they did, they would do it themselves, rather than pay us 2 and 20).

We hedge fund managers, of course, like to think of ourselves as far above these trivial failings – no fear and greed in us, no sir – and so naturally we look down on mere investors as lesser beings: emotional, irrational, avaricious, timid and just plain clueless. How galling, then, that we have to go groveling, cap in hand, for the investment millions that these lesser beings happen to control. A healthy contempt is the least we can muster in return.

But of course it wouldn’t do to reveal our feelings. Instead, we lead investors on a merry dance: teasing them with glimpses of golden apples just out of their reach, assuaging their many worries, mollycoddling them and massaging their fragile egos.

Today’s meeting is a good example. The patsy du jour, Raymond _______, is head of alternative investments for the private wealth management practice of a well-known Swiss bank. How he ever rose to such a position is beyond me; I find in him no discernible trace of investment acumen or indeed, basic competence in finance. But that’s not my problem. All that matters to me is that Raymond holds the keys to the vaults in which are stored the amassed riches of assorted Russian oligarchs, Chindian industrialists, TPLAC dictators, and of course large numbers of Anglo-Saxon CXOs.

This presents an interesting puzzle. Given his position, he is no doubt bombarded with investment proposals all the livelong day. Some of them may even be legit. I have to think carefully about how I’m going to handle him.

Should I go for the hard sell, promising triple-digit returns all but guaranteed by Helicopter Ben himself? Or should I be reticent and mysterious and spy-versus-spy, hinting in hushed tones of proprietary secrets so arcane that I can’t even reveal them to my own junior trader? Should I go technical on his ass, dazzling him with our models, our software, our soon-to-be-multiple-Nobel-prize-winning quant department, or even the honest-to-goodness supercomputer currently gathering dust in one of our west coast offices? Or should I talk about the years of experience (true) and expertise (dodgy at best) of our bloated staff?

It turns out I’m worrying for no reason. Within five minutes of his entry to our premises, Raymond manages to let drop the name of the hotel he is staying at (expensive), the restaurant he dined at last night (exclusive), and the art auction he is going to attend this afternoon (exorbitant). And he complains about all three.

I relax. This is going to be easy. Raymond is a show-off.

I hasten to mollify him. I tell him I never stay at his hotel any more, I find it déclassé and indeed positively blue-collar. Instead I recommend another, even more expensive boutique hotel, in a distinctively unfashionable neighborhood: I tell him it hasn’t yet been overrun by the Wells Fargo crowd. Raymond finds this hilarious; Wells Fargo is about as middle-of-the-road as you can get, solid, respectable and utterly boring. Not in the same league as high-flyers like you and me, is the unspoken implication.

As for his dining experience, I sympathize, but what can you do? That particular restaurant hasn’t been the same since its chef became a celebrity with his own TV show and Vegas chain. These days I only go there with tourists who know no better. But you, my friend, you should try out Restaurant X instead, it’s actually quite good. Oh, Restaurant X has a three-month waiting list and Raymond is flying back to Europe tomorrow? No problem at all. Let me just make a phone call. There you go, a reservation for two for tonight. My pleasure.

I remind myself to tread carefully and not overdo the partners-in-luxury act. After all, I don’t want to undermine his sense of superiority, since that could make him defensive or hostile. So I give him a chance to reclaim the higher ground. To wit: I mention that I’ve been too busy with work to go on a vacation this summer, and ask him if there are any destinations he can recommend. Bingo! His eyes light up, and I’m treated to a 20-minute episode of Lifestyles of the Rich and Raymond. It turns out there is no over-priced and under-valued experience that Raymond has not partaken of, and he’s only too happy to fill me in on every ludicrous detail.

The meeting is going swimmingly well. We haven’t spoken even two sentences about finance, but that doesn’t matter in the least. I know exactly how I’m going to play him.

The trick is to get him thinking of Sopwith as something he can show off, just like his Swiss watch and Italian sports car and Swedish girlfriend. This I proceed to do. I drop a name here, mention a trade there, hint at information received, allude to actions taken. My goal is to provide Raymond with a store of ‘insider’ anecdotes with which he can entertain his clients. (I assume, correctly as it turns out, that Raymond’s clients, like Raymond himself, are more interested in appearing suave and sexy and sophisticated than in actually making money). In every case I include just enough detail for Raymond to repeat the tale (suitably embellished, no doubt), and not a jot more: every statement is vague enough to be easily deniable, yet their cumulative impact is, if I say so myself, substantial.

Without being so vulgar as to say so explicitly, I contrive to suggest that Sopwith is as far above the average investment firm as Raymond is above the average investment professional.

This approach works a treat. Raymond is an instant convert, convinced that our platform and his money are a match made in leveraged heaven. He toddles off to evangelize the rest of his firm, and I congratulate myself on a job well done. Then, exhausted by my righteous efforts, I slope home to drown my sorrows in Scotch.

Prologue: Sopwith Asset Management

In 199_, a well-known trader from a leading Wall Street firm decided to strike out on his own. Using a combination of his own money and seed capital from various business contacts, he set up a hedge fund. He recruited an all-star team of traders, technologists, quants, academics, lawyers and administrators to staff his creation, and within a matter of months the fund was up and running. Let’s call it Sopwith Asset Management.

Sopwith’s impressive pedigree meant that it enjoyed an unparalleled reputation in the financial industry. Newspaper articles gushed about its sophisticated investment strategies and cutting-edge financial technology. Academics wrote papers quoting the wisdom of Sopwith’s portfolio managers. Investment bankers wined and dined the staff of the firm, hoping thereby to win a slice of Sopwith’s lucrative trading business. Sopwith alumni were eagerly snapped up by other Wall Street companies. Headhunters called day and night, hoping to lure more employees away.

Helped by this flood of publicity, Sopwith went from strength to strength. It grew in size from a few million dollars under management to a few billion; from a half-dozen employees working out of a nondescript office block in a less-than-fashionable industrial district locale, to fifty power-suited hotshots scattered around the globe.

Sopwith proved to be quite a money-spinner for the people associated with it. Over the years, Sopwith paid tens of millions of dollars in commissions and transaction fees to various investment banks and brokerages. And it paid similarly gargantuan amounts to compliance lawyers, third-party marketers, hardware and software vendors, academic consultants, purveyors of market research, and the like.

But of course it wasn’t Sopwith who was paying any of these costs. No, it was Sopwith’s investors. And why wouldn’t they? After all, they were paying for the privilege of investing with the crème de la crème of the finance industry. A high-profile hedge fund, with vast resources of talent and experience to call upon: the very archetype of the sophisticated financial corporation of the twenty-first century. Aggressively managed, razor-sharp, lean and efficient and hungry. Adept at capturing the smallest and most fleeting of opportunities; adept also at rolling the dice for unimaginable stakes. To invest in Sopwith was to be in elite company.

Alas, the investors were wrong. Beneath the glamour and the glitz, the Emperor had no clothes. Sopwith’s vaunted financial models and analytical technology proved incapable of generating sustainable profits. Good years were followed, inevitably, by bad ones; a monkey flipping a coin could have made as much money as Sopwith did over its lifetime. The cause was not helped by the fact that Sopwith's day-to-day management was a shambles, riven by incompetence, egotism and an utter lack of vision. Slick marketing papered over the cracks for a long time, but it couldn't last. And it didn't.

Ultimately, Sopwith was done in by the tyranny of efficient markets. Sopwith’s investment philosophy was based on the belief that its traders could spot opportunities that others could not; when this turned out not to be the case, there was no backup option, no plan B. As a result, the fund suffered a slow decline into mediocrity, followed by anonymity and then dissolution.

So was Sopwith a failure? Oh no, quite the contrary. Sopwith Asset Management succeeded quite admirably in the task it was designed to do: making its partners and employees immensely rich.

For in addition to the large fees (represented as the “cost of doing business”) that Sopwith’s investors paid to brokerages and vendors and service providers, there were even larger fees paid to Sopwith’s traders and portfolio managers. The incredibly smart people who worked at Sopwith may not have been able to beat the market consistently, but they were very very good at extracting every last penny of fees from their investors. In this respect, at least, they represented the apogee of a fine Wall Street tradition.

I joined Sopwith in 199_, shortly after it was launched. I stayed with it for more years than I care to remember. I saw, at first hand, the firm’s spectacular rise to glory and its dramatic fall from grace.

And I kept a diary.