A little over twenty years ago I moved from chemical engineering to finance. Interestingly, I still consider myself an engineer. I always figure I can solve any problem, which in the case of chemical engineers is through processes.
I was attracted to finance because it is a technically demanding and very interesting field. Unfortunately, it is also opaque and usually poorly understood. This is a shame because it is very important for everyone in this modern world for finance to operate effectively.
What does it mean for finance to be effective?
It means that capital and risk are allocated appropriately. History is very clear in showing that an economy that allocates risk and capital well grows much faster than an economy with poor allocation mechanisms.
In the public markets, the measure used for allocating risk and capital is the market price. We buy securities that we think are underpriced and sell securities that we think are overpriced. If we get this right, we make money. If we get this wrong we lose money and stop trading.
Benefits of active managers
I believe that active managers (including hedge funds) are the main agents for keeping this allocation mechanism effective. They are more incentivised to find and take advantage of mispriced securities than other industry participants such as banks and mutual funds.
Ready, willing and able
For active managers to be effective in this vital role, they need to be ready, willing and able. That is, they need to have the right infrastructure, the right incentives and the right capabilities. Herein lies both the challenge and the opportunity.
In the next post, I will elaborate on this, and talk about how we are trying to build a business that addresses each of these challenges.