Drobny, The Invisible Hands

In his preface to the new edition of The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money (Wiley, 2014) Steven Drobny contends that “real money investors remain stuck in their antiquated ways. They will view their investments from a notional allocation standpoint, and diversify their holdings by asset class names, not by underlying risk characteristics.” Investors are unprepared for another crisis, despite the fact that “quantitative easing is coming to an end, and tremendous uncertainty exists everywhere.” Hence the renewed timeliness of the interviews, conducted in the spring of 2009, with traders who managed to navigate the financial crisis of 2008.

With the exception of Jim Leitner, who was also interviewed for Drobny’s Inside the House of Money, the managers—ten who run global macro hedge funds and one real money manager—remain anonymous. Drobny “chose the anonymous route to increase candor as well as keep the focus on the ideas as opposed to the personalities.” (p. xxx)

The Invisible Hands is a terrific book even though many of the strategies described in it are difficult if not impossible for the individual investor to implement. But the thinking behind these strategies and the way their risk is managed are often so compelling that everyone who is active in the markets can learn a tremendous amount from the interviews. Moreover, even though most of the contributors are anonymous their life stories are fascinating, sometimes even inspiring.

Here are just three snippets. They are not representative of the book as a whole because it doesn’t lend itself to such piecemeal extraction.

“The Philosopher” finds opportunities in our flawed attempts to understand an uncertain economic future. “The human brain,” he notes, “is not wired to understand probability very well. We are particularly bad at understanding low probability events, which we tend to think of as either inevitable or impossible. Therefore, a very small change in the underlying fundamental probability can sometimes cause wild swings in sentiment because the potential outcome went from impossible to inevitable, whereas the underlying fundamentals did not move substantially. Shifts in sentiment cause markets to move much more frequently and violently than shifts in fundamentals do.” (pp. 98-99)

“The Predator” always wants to know what kinds of people are on the other side of his trades. “You need buyers to short against at the top of the market and sellers to buy from at the bottom. You have to identify the type of person who shorts at the bottom or the one who leverages on the way up and use the liquidity they provide to do your trades. You need to understand where other people get it wrong in order to see if their errors create an opportunity for you.” (p. 315)

And, finally, “The Plasticine Macro Trader” opines that “even a true contrarian is only really contrarian about 20 percent of the time; it’s all about choosing the right moment to fight convention. The rest of the time is spent trend following.” (p. 344)