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.
