A Persistent Edge: Kant, Soros, and the Physics of Investment

  

I found this recent article from the Financial Times, about an Asian Hedge Fund called Persistent Edge, to be enlightening, and useful in its description of real-world investment strategies.

http://www.ft.com/cms/s/0/d7d65152-21b1-11de-8380-00144feabdc0.html

I find the article particularly useful, especially when we consider the flack that the Hedge Fund industry in particular, has been receiving during the recent global financial stresses. The Author, Andrew Wood of the Financial Times in Hong Kong, interviews Eric Xu and Huang Xin, the fund managers of Persistent Edge.

“Persistent Edge has a reputation in the Asian hedge fund industry for taking aggressive, highly focused unleveraged bets and for some nimble footwork getting in and out of investments at the right time. Its Asia Partners Master Fund returned 4 per cent in 2008, according to InvestHedge statistics while the AsiaHedge composite index dropped 13.9 per cent. The fund showed annualised compound growth of 20.2 per cent since it opened in January 2004.“

They made money in 2008, wow! You can’t really argue with these results, now can you?

“We have a different way of seeing the market that’s quite foreign to other people in the market,” says Mr Huang, the chief investment officer… Persistent Edge looks at the “mood” of markets when allocating and moving capital: are they acting in accordance with traditional theories of how they should work? Or is there an unrealistic optimism or pessimism that is driving the markets’ direction?

Interestingly, and quite revealing I think, the principals happened to have “cut their teeth” in the good ol’ US of A, and in Silicon Valley in particular.

“Both Mr Xu, the managing director and chief risk officer, and Mr Huang are from mainland China. They trained in engineering and science, and met while working in Silicon Valley. Mr Xu founded a hi-tech company in 1989 which he sold in 1994. He turned to investment because he wanted to do something with his money rather than “spend it on fast cars”.

“They developed their ideas about fund of fund investment after a meeting with Henry Green, a physicist turned fund manager, who died a few years ago. Mr Green had used his experience in fluid dynamics to set up Jacobson Asset Management. “In 2002 we had a long conversation with him about the investment world,” Mr Xu says. “We are his prodigy.””

Physicist turned fund manager? Fluid dynamics? I always thought that getting your brokering license or a CFA designation was the prerequisite for a successful investing career. As Bob Dylan said: “Times they are a changin”.

“One way to look at markets is to argue that fundamentals drive everything. “The mainstream thinks markets move towards equilibrium, and that any fluctuations are random noise,” says Mr Huang. Prices should converge on the intrinsic value of the underlying asset.”

Indeed. It’s also one way to look at economics too, a very out-dated and unrealistic way to do so, that serves to distort the complexity and the emergent nature of complex systems.

Other times, such as in the past few years, “reflexivity” seems to make more sense – a concept publicly championed by the billionaire investor George Soros since the late 1980s.

Anybody ever heard of a guy named Soros? 

“Reflexivity is the idea that relationships between cause and effect can be circular.”

This idea alone would knock most economists, accountants, and CFA’s off their respective rockers. Oh wait it already has… perhaps that’s why the contrarian’s with a deep understanding of complexity, are the one’s winning in the modern investment markets.

“Mr Soros has made a lot of money by applying this to his investment decisions. His idea is that rapidly rising or falling prices can affect investors’ perceptions, and therefore fundamentals… For example, if a share price rises, an investor can use that increase in his or her wealth to borrow more money and invest it in the stock market… As a result, expectations change, and so do prices, in a self-reflecting way that distorts markets. Vicious circles of feedback destabilise markets, so traditional theories of how they should behave seem to make little sense.”

And if the accountants, economists, and CFO’s of the world weren’t already reeling from the bends, the prodigies at Persistent Edge give us this:

“This is where the philosopher Kant, and his idea of antinomy, comes in. He pointed out that two people can come up with apparently valid conclusions that contradict each other from the same logical starting point…“They are both right but they depend on the time and the conditions,” Mr Xu says.”

Hold on Sir, wait a minute, how can two different things be “right” at the same time? That’s not what they told me in my Economics text book or in the GAAP Accounting rules? This must be some kind of heresy or voodoo clap trap passing for wisdom... That’s akin to saying that light can be both a particle and a wave at the same time… oops. Exactly!

“Mr Xu says for now, the world’s markets “are still in a reflexivity mode. This year we are going to experience quicker changes in market sentiment.”

“We live in an uncertain world”, says Mr Huang, “and the only way to understand it is through statistics and philosophy.”

And thus, we have established the contours of the new curricula for the next generation of investors.