Detecting different information or return potentials and combining that information, differently, and  before others do is crucial to investing.  Rumors are rife, and there has so much competition to fill twenty-four hour business news services with feed that the media has become prone to be duped into publishing unverified information that, often, is not quite accurate, complete or true.  In that regard, we must not only collect information but we must also continually monitor the source for accuracy and the information for corroboration.

After working on a PhD in mathematical physics, my first career on Wall Street was, naturally, to compile industry, financial, and economic data and to make predictive models for key variables, like GDP or computer sales.  To do that, I had to develop sources of information, in government departments, industry groups, companies, and other investment firms.  I also majored in linguistics with an emphasis on psycho-linguistics, in college.  I took graduate level courses, studied a lot on my own, and worked as a research assistant, in psychology, while working on my graduate physics degree.  I am a student of the behavior of living things, and I realize the importance of psychology, in markets.  Thus, my next career on Wall Street was as a merger arbitrageur.

Merger arbitrage involves business and market psychology, valuation, legal understanding of securities and contracts laws.  There is much information to collect and many types of analyses to perform.  There are also many rumors, flying about, in this very secretive and proprietary investment business.  Moreover, because buying and selling move market prices, you do not want your private information to be distributed to the general community or he public.  So, in addition to testing sources for accuracy, one must also test those with whom one trades proprietary.  The testing is for fidelity or to induce their networks by observing where your information pops up at other sources.

Finance was born from warfare, having arisen in response to the need for funding wars among Italian city-states, in the 13^th century.  It was beneficial for business men to buy war bonds to help fund the side that would do best by their interests.  Having grown up together, finance has taken many of its strategies and tactics from warfare, including from the espionage and   counterespionage parts of that business.   After all, finance and investing must be secretive businesses by their nature.   Especially where money is concerned, I have found, in my three decades, in the business that you can only surround yourself with those who you can completely trust and rely on.  A useful lesson from counterespionage is the additional importance of not only misinformation but also disinformation.  You might consider using untrustworthy contacts for disseminating that. 

In deciding, a priori, which fits into which category, you can test the source, the information, and the network by disseminating information or misinformation, one bit at a time.  After you dole out the information, you can observe where trading activity or return of the information , subsequently, occurs.   If you give out information with the caveat that it cannot be redistributed, and you see results of the knowledge, elsewhere, you know how far you can trust that particular contact.  It is truly something that is done by proprietary traders on Wall Street.

Thus, we can surmise that there is, in use, the strategy of compartmentalization of information from espionage, in the business of investment.  We form investment spy rings, and we also are aware and participate in making the information spread among some of the ring.  Furthermore, we set up a network of misinformation, including trading accounts at a number of discreet brokers, so that even our trading will make tiny tracks, not those of an elephant.

Indeed, most of the time one can only compile a fraction of even specific information.  For example, I might take a survey of business at selected Holiday Inns to try to predict profitability of the whole company.  I would never have the time, and it would not be worth the resources employed to survey all of their branches in the world.  However, I might have several associates who also take similar surveys from different branches, and it would be very useful to share our information for comparison.  It might even help us build a more accurate prediction (model) of the future.

A more elaborate part of merger arbitrage was that we hired lawyers to sit at courts waiting for any filings, to immediately forward papers and analyze.  Those types of services cost several hundred thousand dollar per year, and both their cost and understanding the legal arguments and issues are out of the reach of the ordinary person.  It is an example of both economies of scale on investment funds and barriers to entry based on expert knowledge.  Even so, we all had different lawyers, so there might still be usefulness in comparing note.

In the end, professional investing is very hard and technical work, involving elements of psychology, warfare, and espionage.  It is neither possible nor economically feasible to collect and properly process all of the information.  Thus, admitting that no man or woman is an island, we begin to develop contacts and networks for the collecting, testing, synthesizing, and disguising relevant and irrelevant information.  Testing sources and information networks is necessary to develop the amount of precision, in this business where large losses are lurking, awaiting the more careless.  It is the reason that I advise my students in finance at the universities where I teach and my assistants at Red Hill Capital to, first, read both Machiavelli’s The Prince and Sun Tsu’s Art of War.  After that, I also advise them to read both physics and psychology books, on their own: physics, not because investment is about math, but, instead, to develop good general analytical skills.  Moreover, in psychology, I would especially encourage them to study concepts in psycholinguistics and behavioral finance.  Then, the comparative tools that they have learned can be combined and compared with others.  After all, the fundamental basis of investing is comparison, whether it is interest rates, PE’s, or imagination, ability, and technical skills of artists.  Comparison needs points of comparison in sets of information.  Indeed, the latest craze in investment modeling is neural networks, which, I assume, is just a precise abstract version of the points that we have been discussing.

You can read more of the things that we have written about in this and our other blogs and on the In Country Analysis page of our website.

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