Why Do Fund Managers Sometimes Resort To Insider Trading?

Firstly, a definition of what 'insider trading' is, is in order:

According to the Securities and Exchange Commission website, "'Illegal insider trading' refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.

"Insider trading violations may include 'tipping' such information, securities trading by the person(s) "tipped," and securities trading by those who misappropriate such information. Examples of insider trading cases that have been brought by the SEC are cases against: Friends, business associates, family members, and other "tippees" of such officers, directors, and employees, who traded the securities after receiving such information."

***

During the latter part of the last weekend, I read a riveting Behavioral Finance paper, authored by Messr. Jing Chen, that is entitled An Entropy Theory of Psychology and its Implication to Behavioral Finance. The paper struck me with an immense force of insight that changed the way in which I perceive insider trading.

In the paper Messr. Jing Chen asserts that "patterns in financial markets reflect the patterns of information processing by the investment public."

Generally, information is the reduction of entropy in a system, and all human activities are essentially entropy processes. Thus, this means that models from entropy theory, cast within a game theory framework, can be used to explain why hedge fund managers sometimes resort to insider trading.

Within the context of financial markets, the value of an information piece (to you) is a function of the probability that other market players, who have investment strategies that overlap with yours (and thus, are best positioned to replicate your portfolio positions), have accessed the alpha enhancing information piece before you.

According to the tenets of Information Theory, information satisfies the following properties (these properties are a verbatim quotation of a section of Jing's paper):

1. The information value of two events is higher than the value of each of them.
2. If two events are independent, the information value of the two events will be
   the sum of the two.
3. The information value of any event is non-negative.
   

The equation that best satisfies the above mentioned properties is Equation 1 below:

H(P) = -log_b P

Where b is greater than zero, and constant.

Equation 1 represents the level of uncertainty in an open system. When a signal is received from the environment, there is a reduction of uncertainty in the system, which, in essence, is the mathematical definition of information.

Now, let us suppose that a random event denoted by the letter X, has n discrete states, x1, x2, x3 …,xn; each discrete state has a corresponding discrete probability that expresses the likelihood of other market players discerning the respective state before you detect it. The probabilities are denoted by p1, p2,…,pn, respectively. (Note: Here I have departed from the syntax in Jing's paper to advance my assertion with clarity).

Therefore, the informational value of event X is the aggregate information value of each and every one of its discrete states. Thus, this gives us Equation 2 below:

H(X)=-/sum_{j=1}^{n}p_jlog(p_j)

The right hand side of Equation 2 is the entropy function first posited by Messr. Boltzmann in 1870s. This is the general form for information. (Shannon, 1948)

Therefore, If your adversaries were to understand the all the discrete states of an alpha enhancing information piece before you do, then all of the individual probabilities from p1 to pn =1. This means that when you plug the value (i.e 1 for each of the probabilities) into Equation 2 to compute the summation of the discrete probabilities, your end result will be: H(X) = 0. Therefore, this means that the information value of potentially profitable events already discerned by a fund manager's adversaries is zero.

Whereas, if a fund manager's adversaries fail to discern all of the discrete states of an alpha enhancing event, its information value is at its maximum. Thus, this implies that as pj approaches zero, the information value of an event tends towards a maximum.

The probability of other market players discerning alpha enhancing information increases as the number of market players (with strategies that overlap with your's) increases. Therefore if NMp is the number of market players, we can safely assert that as NMp increases pj approaches 1, and thus H(X) approches 0.

Thus, If we assume that fund managers are rational, profit maximizing individuals, we can conclude that they have an implicit incentive to trade on information that other fund managers don't have access to.

By definition, information that other fund managers don't have access to, does not exist in the public domain; it is privileged, sequestered and confidential information; and, acting on it is tantamount to insider trading. Otherwise put, trading on such information prejudices market outcomes in favor of a few, and undermines the credibility of the markets.

Hence, we can conclude that insider trading is an adaptive function that helps fund managers to outperform in forbidding market conditions, i.e. conditions in which crowding in strategies exists, and an environment in which replication of a fund manager's trades, by his/her adversaries, is rife.

Thus the answer to answer to the question: Why do fund managers engage in insider trading?, is; to survive.

Schedule 13D Filings Enable Trades to Become Profitable

From my very random weblog at: http://chirinda.tumblr.com/ (I write on a broader range of topics there, e.g. religion, climate change, sex, politics, and I post links to anything I like on the web, plus I also post a plethora of quotes that I find interesting. Please, run along now!) :-)

Note: I'm generally assuming that you know what a Schedule 13D filing is, and that you know what the form looks like and how the filing is made.

Generally, investors earn profits when events that precipitate in financial markets converge with the versions of reality that their trades are formulated to exploit.

Usually, it really doesn’t matter if the convergence is momentary, or sustained; it just has to happen within the envisaged time-frame for a trader’s P&L book to be in the black. (Yes, I know, that this sentence is naively structured, but I will clarify myself later. Please, keep reading.)

Managers of institutionalized capital pools are generally very jittery about making Schedule 13D filings, because they unearth their movements, which thus increases the likelihood of their strategies being imitated by their operational adversaries. Their concerns are not unfounded.

However, Schedule 13D filings may/can sometimes ignite trading patterns that force market events to converge with alpha traders’ anticipated versions of reality.

This usually occurs within an operational environment characterized by:

• High Volatility - When volatility is high, the market is more prone to overshooting in any direction. If it overshoots in the direction that the trader anticipates, the profits that can be reaped on any given trade are amplified greatly.
• Abnormally High Trend Following - In an environment of extreme trend following, the actions of market participants are motivated, not by fundamentals and rationality; they are motivated by ‘Chartism’ that is usually disconnected from fundamentals. In times like these, the markets may overreact to white noise, which may sometimes give birth to prolonged market swings that don’t make sense. When this happens, the gap between market events and reality increasingly widens.
• Strategies Being Affected By Capacity Constraints - When investment strategies are flooded by capital flows that the market cannot sustain, profitable trades become rarer, which makes market participants desperate and prone to irrational investing (gambling); and or, replication of the trades of alpha fund managers.

When alpha fund managers, of the stature of Messrs. George Soros and John Paulson, make Schedule 13D filings within a trading or operational environment that has all of the above-mentioned characteristics, they may/can be, in essence, unintentionally advertising their trading idea, or shepherding other market participants to replicate their trades.

Usually, other market participants will take this as a cue to replicate their trades, which in effect helps market events to converge with the realities envisaged by alpha fund managers. This accelerates the time it takes for trades to become profitable, and magnifies the profitability of a trade (provided that the alpha managers exit the trade before the market movement runs out of momentum).

Hence, it should be evident that Schedule 13D filings can benefit alpha fund managers.

Insider Trading is for Wussies; The Big Guns run Espionage Rings

"Actions speak louder than words"

- Old British Idiom

When Messr. Matthew Miller, a Bloomberg-Tv news anchor, was discussing the acquisition of 3Com (by Hewlett Packard) with his co-anchor (on Bloomberg-Tv's 11th of November 2009 edition of The Final Word), he asserted that the observed irregularities in the market activity, prior to the announcement of the said acquisition, reflected that insiders may have illegally exploited their informational advantage to reap small financial benefits from the transaction.

A few hours after he made this assertion, a blog post at Zero Hedge unequivocally corroborated his thesis.

For your information, the said Zero Hedge blog post states that:

• 3Com's acquisition by Hewlett Packard for $7.90 per share after the close today came as a surprise to many, but not all. Because someone bought three times the open interest in November $5 calls and fifteen times the open interest of the December calls. In summary: 3,961 November $5 calls were purchased today (964 open interest) for $0.65, as were 3,269 December $5 Calls (210 open interest) for $0.85. The profit, assuming the insider action was by one entity, is about $870,000 on the Novembers and $650,000 on the December strikes, for a not too shabby illegal daily P&L of $1.5 million

As Messr. Steven Levitt asserted in his bestseller entitled Freakonomics, numbers never lie, and the numbers in this case clearly show that an entity, or a consortium of entities, may have profited to the tune of USD1.5 million from inside information on the transaction. In short, insider trading may have transpired.

However, I am of the belief that people are rushing to conclusions prematurely; what usually appears at first sight to be insider trading, sometimes isn't insider trading.

Sometimes, information can be extracted from 'insiders' without their knowledge, using methods that are not really illegal or legal per se.

In scenarios like these, the trading activity that ensues such information harvesting activities has economic consequences, that like insider trading, undermine investor confidence in the fairness and integrity of the securities markets.

I'll cite a brief hypothetical example:

As you may already know, in every M&A transaction there is an investment bank that helps to structure the transaction, and a law-firm that lends its legal expertise to the parties involved in the integration process.

Most of the transactions that yield tremendous economic value are usually expedited by law firms and investment banks that dominate the upper echelons of M&A league tables.

Generally, Mergers and Acquisitions transactions are usually the culmination of months to a year of complex negotiations conducted in several meetings between the parties involved in the transaction. In most firms, senior partners and vice presidents in the M&A departments of investment banks are involved in the entire transaction.

Therefore, to get information on possible transactions before they get announced in the media, a hedge fund can engage several private investigators to track the movements of top M&A bankers and lawyers on a regular basis, and to just take note of whom they meet, the people in their entourages during the meetings, how long the meetings last, where the meetings are held, how often the meetings are conducted and e.t.c. .

The raw information can then be relayed to the hedge fund for processing, and basically the hedgie will tally-up the information and roughly categorize it as follows:

• Banker A, from such and such a firm met CEOs C and D in the presence of their CFOs and legal advisers, 4 times a week for the last 6 months, at 11am 90% of the time, at locations X, Y and Z. The meetings lasted an average of 4hrs 90% of the time. There is an M&A team from banker A's camp that is spending a total of 12hrs of week at the company that's managed by CEO D, and their visits usually coincide with those from the CFO and legal advisor of the company managed by CEO C. The company managed by CEO C is financially strong, whereas the company that is managed by CEO D is financially weak. Both companies operate in industries or sub-sectors that are mutually dependent, or symbiotic.

If you ask anyone who has ever been confronted with pictorial evidence of his infidelity by his wife, he will acknowledge that information can be gathered stealthy by private investigators. Thus, this means that most of the 'investigations', in the hypothetical scenario above, can be conducted without the subjects ever noticing that they are being tracked.

Hence, from the summary above, the hedge fund manager can ascertain, or infer, that the company represented by CEO C is in the process of acquiring the company managed by CEO D, and can then profit by shorting the shares of the company managed by CEO C, and going long on the stock of CEO D's company.

To obfuscate 'the trail', the hedge funds may use a combination of opaque OTC derivatives - to conceal the short portion of the trades; and, they may execute the long portion of the trade using low-latency trading systems that are so fast, that no one (from the outside) can tell that the transaction is transpiring.

The scenario above may seem like a fanciful suggestion, but ask yourself this question: why do most hedge funds have armies of private investigators on their 'unofficial' payrolls?

Putting D'Wave's 'Orion' to the Test - (Part 4)

....Continued from Part 3

Note: I've heard (today: 26 August 2009) from the folks at Orion web services and they told me that my optimization job failed because it exceeded the maximum quota...for the job run time (10 mins). Looks like I'll have to figure out news ways of streamlining my problems!

As my problem was successfully 'parsing' through Orion, I was thoroughly enthralled by the thought of parallel universes entangling, at that very moment, to wrestle the binary quadratic portfolio optimization problem that I had submitted. Unfortunately, my extreme excitement was destined to morph into an admixture of disappointment and anger.

Approximately ten minutes after I had submitted my problem into the Orion application, I received this message from the application:

Click on Image for a Better View

Hence, I attempted to figure out what went wrong; was there an error in the problem structure, or in the parameters that I set when I submitted the problem?

I revised my problem matrix, and the parameters that I had set, and everything appeared to be sound:

Click on Image for a Better View

This part of the Job status revealed what went wrong:

Click on Image for a Better View

Apparently, Orion's Binary Quadratic Optimization Annealing Solver had completed the process of computing my portfolio optimization problem, but it timed-out just before it could produce the solution... Strange.

Maybe there could be a bug in Orion, or I have just witnessed the effects of decoherence in a quantum system (after all, quantum data is very fragile). I know that Orion is currently powered by an interconnected computing grid that simulates a quantum computer. Maybe something perturbed the grid whilst it was compiling the answer.

I'll try again at random intervals just to make sure.

Putting DWave's 'Orion' to the Test - (Part 3)

....Continued from Part 2

The general assumption underpinning equation 8, is that the asset returns (of what? Duh! the assets in question) follow a multivariate normal distribution.

***

Now, here's a hypothetical problem from which we'll derive the parameters that we'll use in the formulation of a problem matrix for Orion to solve:

Let us postulate that a regulated financial institution is required by law to keep 50% of its capital reserves in liquid risk-free assets like T-bills. The institution is free to invest the entire unregulated half (50%) of its reserves as it wishes. Therefore, the institution's management decide to invest in the stock of Google (NYSE: GOOG) and Apple (NYSE: AAPL). Hence, the management tasks the Chief Risk Officer to calibrate the lowest level of risk (variance) that the institution would be exposed to owing to a 50-50 investment of the unregulated capital in Apple and Google stocks.

The risk manager starts by examining the volatility patterns and the correlation matrix of Google and Apple stock in the following tables that were prepared by his analyst:

Hence, from the data he derives the following parameters:

• Annual Standard deviation of Google shares, σ1 = 0.4926
• Annual Standard deviation of Apple shares, σ2 = 0.5508
  
• Anual Covariance of Apple and Google shares, p12σ1σ2 = 0.1826 (to 4 s.fs.)
  

To conserve computing resources, he decides to treat the optimization problem as a two asset binary quadratic problem, and thus plugs the values he derived from the tables into equation 8, and gets an expression that looks like this (which we'll call equation 9):

min{0.2427(x1.x1) + 0.3034(x2.x2) + 0.3652(x1.x2)}

The risk manager decides that in binary notation, x1 and x2 = 1 and derives the following binary quadratic portfolio optimization problem for DWave's Orion to minimize:


...Not so fast: The matrix above will not work in Orion because The third column in each row specifies the value to be assigned to the selected Q_ij element of the matrix. Q_ij must be an integer value. Therefore, we round-off everything in the third column to 1 significant figure and multiply it by ten to get this matrix (which will work in Orion):


Stay tuned for Part 4 of this installation. It will contain the result of the computation plus an evaluation of Orion

Putting DWave's 'Orion' to the Test - (Part 2)

....Continued from Part 1

Below is an efficient frontier, i.e. the navy-blue continuous curve that passes between points a b c and d. It illustrates the trade-off between return and risk. The efficient frontier is essentially a universe of assets, or a set of portfolios of assets that offer the minimum risk for a given level of return. The black line, that is a tangent to the efficient frontier, and is passing between points c and d is the CAPM line. It contains, at its intersection with the efficient frontier, all iterations of portfolios containing the risk free asset that rational market participants can select.

Therefore, given the objective stated in Part 1, we seek to find point c on the intersection of the CAPM and the efficient frontier.

Click on Image for Better Visibility

As I mentioned before, the optimization problem introduced in part 1 is unconstrained, and generally it is standard practice to trace-out the efficient frontier by introducing a weighting parameter λ (λ is greater than or equal to zero but less than or equal to one), and considering:

We'll call the expression above equation 5 and it is subject to equations 6 and 7 which follow respectively:

In equation five, the case λ = 1 represents minimizing the risk, and when we substitute λ for 1 in equation 5, we get equation 4, which can be expanded into the following expression (which we'll call equation 8), in the case of a two asset portfolio:

Where:

• X1 and x2 represent wi and wj respectively
• σ1 and σ2 represent the standard deviation of asset i and the standard deviation of asset j respectively
• p12σ1σ2 is equivalent to σij and represents the covariance of asset i and asset j
  

Stay tuned for the third part of this installation, where I'll convert the optimization problem into a binary quadratic problem, and plug in variables to generate a problem matrix for DWave's Orion to solve.

Putting DWave's 'Orion' to the Test - (Part 1)

I have been steadfastly tracking DWave Systems's progress for approximately two years now, and I was immensely overjoyed when I discovered that they had opened-up the initial trials of their operating system (called Orion) to the general public.

As you probably know (by now), I am always on the hunt for technologies that have the potential to enhance the quantitative aspects of portfolio structuring decisions, and I was thoroughly ecstatic when I found-out that Orion has a facility for portfolio optimization.

Generally, quantitative portfolio structuring decisions, like most optimization problems, are amenable to quantum acceleration, and thus, DWave's operating system should be able to tackle them (this assertion is underpinned by the assumption that Orion is, in its current form robust).

Yesterday, I decided to put DWave's Orion operating system to the test, and to chronicle every minute thing I did in this, and subsequent blog posts.

I started my journey by visiting DWave's Menu of problem types to select the best algorithm to solve portfolio optimization problems. On the menu the choices included:

• A Binary Quadratic Program (BQP) problem algorithm;
  
• An Ising problem algorithm;
• A Chimera (BQP) problem algorithm;
• A Chimera (Ising) problem algorithm;
• A Maximum Satisfiability (MAX-SAT) problem algorithm;
• A Cardinality SAT problem algorithm;
• A Weighted Maximum Satisfiability (Weighted MAX-SAT) problem algorithm;
  
• A Model Expansion (MX) problem algorithm;
  
• A Maximum Independent Set (MIS) problem algorithm, and;
  
• A Clique (CLQ) problem algorithm.

I noticed that both the Binary Quadratic Program (BQP) problem algorithm and the Chimera (BQP) problem algorithm resembled the general form of Harry Markowitz's portfolio optimization formula.

Therefore, since I desired simplicity, I decided to settle for the Binary Quadratic Program (BQP) problem algorithm which was in the following form:


Interestingly, this particular problem is an unconstrained binary quadratic programming problem of minimizing a quadratic objective by suitable choice of binary (zero-one) variables.

When expressed in mean-variance portfolio optimization parlance, the binary quadratic programming problem assumes the following form (the equations are from a paper entitled Heuristics For Cardinality Constrained Portfolio Optimization by T.J. Chang, N. Meade, J.E. Beasley and Y.M. Sharaiha):

We'll call this new expression equation 1, which is subject to equation 2, 3 and 4 which follow respectively:


Equation 1 minimizes the total variance (risk) associated with the portfolio whilst Equation 2 ensures that the portfolio has an expected return of R*. Equation 3 ensures that the proportions add to one.

Where:

N is the number of assets available,
μi is the expected return of asset i (i = 1, 2, ...... N),
σij is the covariance between assets i and j (i = 1, 2, ...... N),
R* is the desired expected return.

Then the decision variables are:
wi is the proportion held of asset i (i = 1, 2, ...... N), and is greater than or equal to zero but less than or equal to one.

Stay tuned for the second part of this installation, where I'll convert the optimization problem into a binary quadratic problem, and plug in variables to generate a problem matrix for DWave's Orion to solve.

New Terrorist Targets

Psychologists concur that human cognition is fairly fixed. Thus, this explains why we become greatly disoriented in environments with infinite vicissitudes: we are stenotopic by design.

Currently, exponentially compounding technological progression, that is independent to the business cycle, is dramatically altering every facet of our lives, albeit on a subtle level. Generally, this implies that people have a feeling that something is different in their lives, and in the world at large, but they are unable to articulate, in exact terms, the sea-changes they see in the world.

This, is in itself very dangerous, and I'll explain why:

A study of history reveals that during periods of rapid societal evolution, a lot of established social institutions crumble, which turns the societal hierarchy upside-down. When this occurs, previously entrenched franchises (and the general masses) are displaced, and they are naturally incensed by their new travails (and the reversal of their fortunes).

Presently, as stated before, the world is rapidly evolving and people generally have a flawed way of relating the causes of the changes to the respective changes. Thus, this essentially implies that displaced individuals have a greater likelihood of venting their anger (about the reversal of their fortunes) towards the wrong constituencies *.

Usually, in these kind of scenarios, the first constituencies in the line of blame are immigrant groups that exhibit the greatest degree of (physical, and cultural) differences to the in-groups of the respective countries they reside in (i.e. unassimilated immigrants), and, segments of the society that are perceived to be profiting, or, deriving benefits from the emergent social order.

However, this time around, the world is much more diverse, racially and culturally, therefore, the majority of the blame for the rapid societal changes won't be shouldered by immigrants; it will be shouldered by individuals and organizations that are perceived to be profiting from the misfortunes of the displaced masses.

Hence, this in turn suggests that the headline risk for wealthy individuals and prominent scientists may be amplified greatly, and thus, any media exposure might inevitably draw them the 'attention' of masses and that are displaced by the sea-changes.

***

Generally speaking, during periods of accelerated change, there is rapid emergence of movements (that are comprised of disenfranchised individuals) that use violent means to resist change (e.g. the Luddites that resisted industrialism during the late 1800s - early 1900s). I speculate that a lot of these movements may increasingly sprawl-up in the near future and they'll cause great tumult in most societies. I also believe that most of these organizations may emerge as religious fundamentalist terrorist groups.

Heretofore, religious fundamentalist terrorist organizations, like al-Qaeda, targeted nations that were prominent on the world stage, but as nation-states progressively decline in influence (owing to rapid globalization that is spear-headed by exponentially compounding technological progression), terrorist organizations may revise their methods and their modus operandi may increasingly reveal a preference for targeting prominent individuals and organizations.

Hence, the new potential terrorist targets may include:

• Prominent scientists that practise genetic engineering and cloning. They'll be targeted by religious fundamentalist groups for undermining, through their work, the widely-held monotheist concept of creation of lifeforms by God (FYI: A menticide of monotheistic religions, also indirectly mounts a formidable challenge to the moral authority of the leadership of monotheistic religions). When stated simply: monotheistic religions may crumble progressively as genetic engineering advances. In response to this, the leaders of monotheistic religions, seeking to preserve the status quo, may mount efforts to curtail advances in genetic engineering (e.g. by sponsoring movements that oppose societal progression). According to Messr. Richard Watson's riveting text entitled 2009+ 10 trends: Predictions and Provocations, 90% of all scientists and engineers with PhDs will live in Asia by 2010. Therefore, we can expect a lot of terrorist activity, that targets scientists, in Asia, especially in South Korea - because it leads the world's genetic science revolution. (Sounds too radical to be true? Keep your eyes open and you'll see that there is at least an ounce of reality in this assertion).
  
• Prominent entrepreneurs and wealthy individuals in BRIC countries and N-11 countries, who'll be targeted for profiting from the global societal upheaval that will ensue the collapse of established societal institutions.
• The perceived enablers and collaborators of the above-mentioned groups
  

Therefore, it is prudent for these groups to exercise caution.

* Whenever you get displaced by a technological development or a new societal development - it is usually your fault - you either failed to adapt, or dropped-anchor in the comfort zone for way too long. Furthermore, change is the only thing that is constant, status is transient, and failure to accept this fact is futile.

I'm slightly Concerned About Covestor Investment Management (CV.IM)

From my new Weblog at: http://chirinda.tumblr.com

Firstly, a quote that sheds more insight on Covestor Investment Management (CV.IM) is in order:

• "The world’s first retail Multi Managed account or MMA. With an MMA you can invest directly alongside professional and retail investors, managing their own money in their own account. It is a new category of Investment product that gives you access to expert managers like a hedge fund with the security and transparency of a managed account."

In short, this implies that the platform will, in a real-time fashion, continuously execute, on the behalf of retail investors, the portfolio positions of Alpha Fund Managers, thus, enabling retail investors to benefit from the investment acumen of alpha fund managers.

Hmm... This does sound like an extremely positive thing indeed; empowerment of the multitudes; decentralization of investment expertise; democratization of premium investment data; rocking the investment world’s underlying social order.

However, this might not be a good thing for both retail investors and the originators of the strategies that they mimic.

I’ll explain why:

Widespread dispersion and mimicry of the trading patterns of alpha fund managers will definitely result in overcrowding in certain trades and strategies. (Generally, the degree of overcrowding in specified trades and strategies bears a direct positive relationship to the popularity of the manager who executes the respective trades and strategies).

Usually, when too many market players crowd into a trade, there occurs an imbalance of the market dynamics that sired the underlying opportunity that the trade is formulated to exploit. In a worst case scenario, this results in the disappearance of the targeted alpha-yielding opportunity; in a best case scenario, the opportunity’s alpha-yielding potential somewhat diminishes slightly.

Thus, this implies that when good trades increasingly become overcrowded, they progressively morph from alpha-yielding trades into either beta-yielding trades, or gamma-yielding trades; something that is not in the best interests of alpha fund managers and those who seek to replicate their trades (who I assume to all be rational, profit-maximizing people).

(Another related point: it is also difficult to maneuver your assets in a crowded trade; entries and exits are difficult to execute when everyone else is mirroring your moves.)

Hence, for this reason, I’m not too ecstatic about CV.IM platforms, or other-like technologies: they create parasites (retail investors) that violate the host-parasite balance by butchering their hosts (alpha fund managers) - which also inevitably results in the death of the parasites.

Bernie Will Never Co-operate

Frankly speaking, Messr. Bernard 'Bernie' Lawrence Madoff doesn't have an incentive to co-operate with the investigators.

Firstly, he is a septuagenarian, thus, he is edging closer towards the end of his Earthly existence. (This assertion is underpinned by the assumption that he is not immortal). To him, a 25 year sentence is equivalent to a 50 year sentence, and a 150 year sentence: they are all life sentences. Therefore, it is unrealistic for anyone to expect him to co-operate, as he'll be spending the rest of his life behind bars, irrespective of whether he co-operates or not. (It is asinine to try to bargain with Bernie on the basis of a lesser sentence.)

Another related point: Let us postulate a best case scenario, where Bernie's normal life expectancy is 120 years. This means, given Mr. Bernie's current age, that he would have, ceteris paribus, close to 50 years left to live. However, according to The Christian Party, each two years in prison shortens a man's life expectancy by one year. Thus, this implies, based on a 120 year life-span, that Bernie can expect to live another 25 years in prison, in a best case scenario. Therefore, to encourage Bernie to negotiate, they'd have to offer him a prison sentence of less than 25 years, which they can not afford to do, as this would contradict their key goal to use Bernie's sentencing to set a loud and clear example to all would-be Bernies. Simply put: they have nothing tangible to offer Bernie, and since Bernie is evidently an astute person, he already knows this.

Furthermore, Bernie Madoff's epic grift scheme aggrieved a lot of powerful and 'well-connected' people. By now, he should know that he is not safe roaming the streets; in the 'free world', some vigilante-mercenary-type dude/dudette might be contracted to deal with him. Or, to state it explicitly, Bernie knows that he is safer in prison than in the free world.

Clearly, Bernie has no incentive to co-operate.

As my grandfather used to say, "A man who has lost everything has got nothing more to lose; he is bolder, irreverent and pays no attention to right or wrong."

A recommendation: They should put him in the most notorious penitentiary, where the most hardened, die-hard criminals are kept. Trust me, if they do that, he'll opt to co-operate, with the expectation of being placed in a 'better' prison.

Why Health Advice on 'Oprah' Could Make You Sick

Note to Reader: I will never blog about this nonsense again, but, as a good citizen of the world, I am duty bound to comment

Whenever my schedule is congested, I suffer from a mass disconnection from everything else that is not on my 'to do list'. Hence, this sometimes causes me to be ignorant about important events precipitating in the world at large. (Or, otherwise put: When I am busy I pay limited attention to things I should focus intensely on.)

For instance, when I saw the cover story on the current edition of Newsweek, which is entitled Why Health Advice on 'Oprah' Could Make You Sick, I skimmed through it in a hasty fashion, and failed to distill key insights from the article, which were subtly emitting hints about an industry that is manifesting itself in our midst: the life extension industry.

Ever since the dawn of civilization, people have had an atrocious obsession with preserving their youth. Underlying this obsession, are deep desires for vitality, strength, aesthetic finesse and immortality. This seemingly primordial desire, has, over countless millennia, fueled quests for youth potions, and it has also created mythological realms and landmarks, like the fountain of youth, that supposedly possessed the powers to restore one's youthfulness.

However, until now, the promise of everlasting youth could only be satiated by myths (and not reality).

As you know, exponential technological progression, which has been a quintessential feature of the majority of the 20th century, has given us the knowledge and means to manipulate the aging process. Most of the technological breakthroughs that gave us this power occurred less than 30 years ago, and understandably, there is currently a spectre of uncertainty surrounding them. Hence, everything that has been written and said about them is largely speculative.

Having said that, I have some views that I have to state, and it is my sincere hope that they'll help someone.

Most of my comments are centered on this part of the said article:

• "Each morning, the 62-year-old actress and self-help author rubs a potent estrogen cream into the skin on her arm. She smears progesterone on her other arm two weeks a month. And once a day, she uses a syringe to inject estrogen directly into her vagina. The idea is to use these unregulated "bio-identical" hormones to restore her levels back to what they were when she was in her 30s, thus fooling her body into thinking she's a younger woman. According to Somers, the hormones, which are synthesized from plants instead of the usual mare's urine (disgusting but true), are all natural and, unlike conventional hormones, virtually risk-free (not even close to true, but we'll get to that in a minute)
  

• Next come the pills. She swallows 60 vitamins and other preparations every day. "I take about 40 supplements in the morning," she told Oprah, "and then, before I go to bed, I try to remember … to start taking the last 20." She didn't go into it on the show, but in her books she says that she also starts each day by giving herself injections of human growth hormone, vitamin B12 and vitamin B complex. In addition, she wears "nanotechnology patches" to help her sleep, lose weight and promote "overall detoxification."

That quoted part made me pause for a while, and after a few moments of suspended animation, I realized that Ms. Somers' beauty regimen has a lot of similarities with the demented 'buffing' regimen used by professional bodybuilders. The only difference being that she uses estrogen in her regimen, whereas professional bodybuilders use testosterone and testosterone mimicking substances (otherwise known as 'anabolic androgenic steroids' or just 'steroids').

If you'd like to see the effects of this kind of lifestyle, you only have to look at what has happened to professional bodybuilders of the steroid generation, i.e. from 1975 onwards. Most of them never made it past 55 years of age; the major cause of their deaths is cardiac arrest during sleep; and, the use of human growth hormone has caused most of them to have health problems that are associated with having enlarged internal organs (HgH causes internal organs to grow as well).

Thus, what I am simply saying, in layman's terms is: "beware of celebrities bearing/peddling miracle solutions".

Usually, when man fights nature, he may win a few battles, but he inevitably loses the war. If you love life, and being healthy, stay away from the 'Somers mania' and use the tried and tested methods: a balanced diet, exercise with progressive intensity, laughter and a productive 'labor of love'.

Otherwise, you're just f***ing (read: messing) yourself up.

Mining the Twittersphere

Twitter or a Twitteresque technology will, in the not too distant future, emerge as one of the most disruptive Web 2.0 technologies to be ever created. Why? Because Twitter enables one to instantaneously decipher, from discernible trends, topics and subject matters that are saturating (at any given time) the collective consciousness of a diversified mix of people from across the globe.

Interestingly, this trait not only enables marketers to understand their target audiences better; it continually gives the human race an enhanced understanding of itself, which may at a certain point, consequentially enhance the quality of the choices that are made by the global society as a whole. (After, all knowledge is power, and self knowledge is infinite power - which contributes inordinately toward better decision making.)

Currently, my dominant passion is Artificial Intelligence. Although it might seem like an insurmountable goal, I envision bringing into being, at some point in the future, a trading and investment artificial intelligence that has the aggregate trading skills of the best traders in the world, and lacks the weaknesses of human beings.

Surprisingly, I was utterly clueless on how such a trading system could be designed, until I became acquainted with Twitter. I shan't go into the particulars, but from Twitter, one can collect volumes of time-series data from hundreds of thousands of individuals. This data is particularly useful in the realm of investments, and can be used for an infinite range of alpha-enhancing purposes, including the design of smarter investment algorithms.

Late at night yesterday, when I was extracting trends from the Twittersphere, I discovered that people Tweet about Money in a stable unvarying pattern (see Chart Below). I also discovered that people Laugh Out Loud (i.e. Lol) in their Tweets most between 6:30am - 7:30am. (see Chart below). Now, I need to figure-out the driving force behind these discerned trends, and I also need to find out how I can use the derived underlying insights to create robust quantitative trading algorithms.

Click On Image For Better Visibility

Enough said.

Michael Tsarion is Afflicted with a Potent Type of Romanticism

Late last night, because of my unquenchable fascination with conspiracy theories and fantastical realms, I had the opportunity to peruse through Mr. Michael Tsarion's fantastical and eccentric text entitled Atlantis, Alien Visitation and Genetic Manipulation.

When I completed the text, I came to the realization that Mr. Michael Tsarion is afflicted with a potent form of romanticism, and I also concluded that his whimsical, eclectic account of the history of mankind should simply be regarded as Fiction.

Mr. Michael Tsarion writes authoritatively (and in a bombastic tone) about concepts he clearly does not comprehend fully, and thus, he leaves the reader with the indelible impression that he (i.e. Mr. Michael Tsarion) is either discombobulated, or demented.

For instance in Chapter 12 of the text, which goes by the title Stargate and Quarantine, Mr. Tsarion alleges that the moon is a recent feature in the heavens, and that it was put in place by extra terrestrial beings to forever imprison an alien diabolical race that was using this planet as a hideout.

According to French astronomer Dr. Jacques Lasker, if the Earth did not have a large moon, it would not be able to sustain life. Dr. Jacques Lasker conjectures that if the moon were to be obliterated, the Earth's axis would oscillate between zero and fifty-four degrees, which would trigger (or precipitate) extreme weather conditions that are incompatible with, or hostile to, life. Simply put, the moon's existence contributes inordinately towards the Earth's ability to sustain life.

Therefore, this point discounts Mr. Tsarion's assertion that the moon is a recent ethereal body that was put in place by extra terrestrial beings to imprison diabolical aliens who sought refuge on Earth. Why?

Answer: If the moon did not exist during antediluvian times, the Earth would have been uninhabitable to all forms of life, including the diabolical alien beings that Mike wrote of, and thus, the said alien race would not have sought cover on this planet in the first place. Furthermore, if the moon did not exist during antediluvian times, there would not have been any single trace of life on this planet. Thus, the diabolical aliens that supposedly fled to this planet, if they managed to survive the harsh climatic conditions that would have been caused by Earth's being "moonless", would never have encountered any intelligent life or non-intelligent life on Earth thereof. Therefore, the corruption of the Neanderthals' genome by diabolical alien beings, that Mike alleges, would have been a non-event. Thus, evidently, the moon is not a recent feature in the heavens; Mr. Tsarion's assertion, that the moon is a recent feature in the sky, is logically flawed.

Hence, this all serves to illustrate that Mr. Michael Tsarion's florid conspiracy theories are just plain fiction!

The Hedge Fund Fool of Randomness Hypothesis

...The Hedge Fund Fool of Randomness Hypothesis

"The hedge fund managers, with a track record of less than 10 years, who receive the greatest amount of press coverage when the SP500 and the Dow Jones reach all time highs, are fools of randomness: they will blow-up spectacularly, or experience the greatest declines in AUM in a secular bear market."

~ Craig Chirinda

The Executives of African Airlines Should All Be Fired!

“As of a couple of years ago, there had been zero money made from the aggregate of all stock investments in the airline industry in history."

- Warren Buffett

I spent the greater part of today perusing through a voluminous collection of reports and investment research papers on the African airline industry, after which, I came to the conclusion that it is more prudent for one to invest in nascent ventures located in war-torn African countries than in African airlines. Simply put, the risk of investing in African airlines is astronomically higher than the risk of investing in a diversified portfolio of emergent ventures located in turbulent African zones.

African airlines have appalling capital structures; their balance sheets indicate that they have a burdensome debt-load. Given the high risk environments that airlines operate in, it would have been more prudent for African airlines to be predominantly (and conservatively) financed through equity instruments, and a minute admixture of the most junior debt securities.

The general rule of thumb when financing any venture is: the risk in the capital structure of the entity should be inversely related to the risk in the business environment of the venture (for the venture to be financially strong). However, with African airlines, the risks in their capital structures are directly related to the risks in their business environments: they are poorly financed. Hence, it should come as no shock that most African airlines are perennial loss-making ventures. Furthermore, it should also come as no surprise that most African airlines are in a comatose state: they are currently teetering on the brink of insolvency.

What this indicates to me, is that the functionaries of African airlines are discombobulated by issues of capital structure. They do not have a single clue on how to finance their ventures optimally. Thus, they should just be fired, as their actions, i.e. loading airlines to the hilt with the most inappropriate senior debt securities, are not in the best interests of shareholders (i.e. maximizing shareholder value). If African airline shareholders knew just how dangerously capitalized their ventures are, there would be a shareholder revolt!

...Solution

In the short term, African airlines should use the capital markets to deleverage, as was done (according to Michael Milken) by US airlines in the 1970s, by paying off these debt securities at lower, discounted prices through tax-free exchanges of equity for debt, debt for debt, assets for debt and cash for debt. Evidently, while this move would undoubtedly dilute the existing shareholders of these airlines, it would help to avoid default; which would, in turn, save the jobs of thousands of non-executive employees of the airlines.

Interestingly, if a de-leveraging exercise were to be carried out by African airlines, their share prices would rise (and not fall). This peculiar share-price dynamic can be ascertained from the de-leveraging exercises that were recently undertaken by Alcoa (NYSE:AA) and Johnson Controls (NYSE:JCI). As you probably know, both these companies were perceived to be high credit risks, and contrary to normal 'signaling dynamics', their share prices actually ROSE sharply after they issued new equity! In his essay entitled Why Capital Structure Matters, Mr. Michael Milken gives a very interesting explanation for this share price dynamic when he says: "When a company uses the proceeds from issuance of stock or an equity-linked security to de-leverage by paying off debt, the perception of credit risk declines, and the stock price generally rises." F.Y.I.: The empirical illustration with the relative price histories of Alcoa and Johnson Controls can be found below:

Click On Image For A Better View

Explanation of the illustration: The point marked a, depicts the high of the rally that immediately ensued Johnson Controls' equity issue. The point marked b depicts the high of the rally that immediately ensued Alcoa's equity issue.

Therefore, we can reasonably expect the stock of African airlines, that currently have a perceived high credit risk, to behave in a similar manner after a new stock issue.

In the long term, I believe that it is imperative for the African airline industry to consolidate intensively. I think that what Africa needs are just four good regional airlines; one that caters for North Africa; one for East Africa; one for Southern Africa, and; another for West Africa. If that is done, I am positive that the consolidated airlines would be positioned to benefit from greater economies of scale than the fragmented airlines, and would, ceteris paribus, be able to access more attractive (and sound) funding options from the capital markets.

Otherwise, the executives of African airlines should all be relieved of their duties!