Friday, July 26, 2013

About that "Level Playing Field"

Financial reporter Bethany McLean is out this morning with an excellent editorial discussing the futility of trying to make investment world a totally fair place.

McLean wrote her piece in the wake of the government's indictment yesterday against SAC Capital alleging, among other charges, insider trading.

Here's a short excerpt from the New York Times this morning discussing the case:

At the heart of the government’s case is an attack on SAC’s pursuit of an edge in stock trading. Though it has pushed into other investment strategies, at its core SAC has traditionally been an information-driven hedge fund, aggressively trading stocks around market-moving events like earnings releases and merger announcements.

At the height of SAC’s powers in 2006 and 2007, Mr. Cohen is reported to have earned about $900 million each year, helping to give the firm a certain mystique. But it also generated whispers about whether the fund routinely crossed the line.

The idea of eliminating insider trading, or any other activity that seems to give someone an unfair edge, is an appealing one.  All of us were taught from an early age that we should "play fair" in the schoolroom and the playground.

But Ms. McLean argues that trying to make the stock market a "level playing field" where all investors have equal access to information is a fool's errand:

No, life isn’t fair, and as we all know now, the playing field hadn’t been leveled. Individual investors, whether operating via discount brokerages or with the dubious benefit of Street research, were just cannon fodder for the so-called smart money—including, not surprisingly, Cohen’s SAC Capital — which made fortunes by shorting dot-com stocks ahead of the crash. (The “smart money” isn’t necessarily smart, but it is well-connected)....

McLean goes on to discuss how well-connected investors were able to spot problems at Dell, and earlier Enron, well before any individual investor could have known - and it was all legal:

But the line between what’s insider trading and what isn’t is most definitely not the line between what information an average investor can access, and what information a hardworking hedge fund manager who can spend thousands of dollars and hundreds of hours on expert research can access. “I shudder to think how much of my alpha comes from failed individual investors,” one hedge fund manager tells me... 

“Edge,” as they call it in the hedge fund community, can refer to inside information, but it can also be that little bit of knowledge gleaned from incredibly hard work. And within those circles, “edge” gets shared — but not with you.

One of the lessons they teach you in business school is that the stock market is always a place of contrasting opinions.

If you think a stock is a "buy" at $25 a share, for example, there is someone else out there who is equally convinced that the identical stock is a "sell" at the same price.

In order to buy or sell a stock, then, you have to ask yourself:

What do I know that the other fellow doesn't?

And if you don't know the answer, perhaps the lesson from this week's stories on SAC Capital is that maybe you shouldn't be playing the game.