Thursday, August 15, 2013

Whack Rant

I just started reading 'A Whack on the Side of the Head'. I had read that it was very good, so I borrowed it from a friend when I had the chance recently. But when I got to page 19, I became so disgusted with the author that I yelled "You Idiot!" at him and threw the book down in disgust.

What follows will be a rant. If it is like my previous rants, it will be heartfelt, entertaining, persuasive, compelling, and quite possibly wrong. You have been warned. But the rant was in my head, growing and taking form from the moment I threw the book down, and I have to let it out.

Here is the text that set me off, somewhat edited:

"To be more creative, all we need to do is "look at the same thing as everyone else", and then "think something different". Humans have been using their imaginations this way since the beginning.
The first person to look at bacterial mold and think "antibiotics" did this."

This is wrong. This is not how penicillin was discovered. One of the greatest public health miracles of the century did not happen because someone had a creative idea. What actually happened was that someone was running an experiment, noticed something strange about a plate of bacteria, and then started investigating further. Doing random things and observing the results, not premeditated creative thinking, was the real source of antibiotics.

His claim about antibiotics is wrong so thoroughly that it immediately and permanently discredited his entire thesis. He obviously does not know, or care to know, about the actual, real-life operation of a very important human invention. He has simply made up a narrative to fit his thesis. It is a breathtaking example of intellectual dishonesty. This is an unforgivable sin in someone trying to tell me how to change my thought process make good things happen.

I must assume that if he cares so little about truth and reason where I can catch him, he must be just as cavalier in the places I cannot catch him. I must assume that all of the rest of his examples and evidence are just as false, and therefore that any conclusions he has are false, wrong, and useless. It is clear that he has imagined a reality that fits his prejudice, rather than forming his ideas by observing reality.

Until I encountered this monstrous lie, I was prepared to accept the book's thesis. When I was kicked out of my acceptance, I immediately started thinking of other information that opposed the cult of 'creative thinking' Just like in the case of penicillin, progress does not come from thinking. It comes from tinkering, experimenting, observation, recording and sharing the results of random tests and observations.

The history of actual science, and our knowledge of how the human brain works, both tell us that thinking mainly exists to explain what has already happened. For most of human history, discoveries came first, and then the theories came later. People did things, got their hands dirty with the physical world, ran experiments and observed the results, tinkered and explored, and after all that was done, the creative thinkers spun theories to try to explain the results. Most of these theories were worthless, but some were right, and produced testable predictions, and then more experiments were used to figure out which theories were useful.

Thought is, to a first approximation, worthless. Humans have been thinking for thousands of years, producing vast volumes of philosophy and theology that are basically useless. Human life remained nasty, brutish, and short until we stumbled across the habit of running experiments and sharing the results.

If you want to accomplish something with your life, then the best advice is to stop thinking things and start doing new things. Try new activities, make new friends, and learn new skills. Humans spend way too much time just sitting around and thinking, and they accomplish almost nothing by doing so. Much 'thinking' is just a way to try to signal good qualities to people we want to impress.

Rich countries today are full of overeducated "creative thinkers" with no useful skills. If you talk about your creative thinking in a job interview, that is a strong signal that you have accomplished nothing in your life. People want results, and they want people who can deliver results, and results come from doing lots of different things and developing skills and good habits. Experience is far more important than thinking, and you will not get experience in anything useful by thinking about things.

I freely admit that I do not follow this advice. Overthinking things is a vice of mine. I even got lucky enough to land one of the few jobs where creative thinking is actually a useful skill. But I did not get the job because of my creativity. I got the job because I had produced a good job market paper; I had demonstrated that I had already accomplished something that was very similar to what they wanted me to do in the job.

The best businesses today do not rely on creativity. They rely on data and tests. They experiment with lots of things, observe the results, tweak things, and experiment again. Creativity is one small and almost unnecessary part of this process; it can tell what it might be interesting to test.

Creativity is mainly an asset in the bizarre, artificial, and manipulative world of the entertainment industry. Human do crave creativity in their entertainment. I argue that they crave it for exactly the same reason that they crave airbrushed images of sexually attractive people. It is something that we have evolved to see as a good signal. Creative people make good political allies because they can find persuasive ways of arguing that our side is right and their side is wrong, so the tribe should banish them and reward us.

Okay, the rant is winding down. I see no reason to try to keep it going or tidy it up. If this were a LessWrong group meeting, it would have started an interesting and creative discussion and I could start enjoying listening to and sharing the creative thoughts of potentially useful allies...

Thursday, August 8, 2013

Ideal Hedge Fund

A friend asked me an interesting question today:

"If you could design an ideal, i.e. optimally efficient and proficient hedgefund, how would you go about it?  What features would make it unique?"

As I was answering, I realized that it would make a good blog post. So:

Short answer to question 1: The optimal hedge fund is a venture capital firm that either operates in an industry served by no other venture capital firms, or uses validated testing methods to judge the people they invest in.

Short answer to question 2: Actually pay your traders for alpha, by correcting their returns for both average market returns and the beta of whatever they are doing. None of this '2 and 20' nonsense that just rewards people for sitting on a lot of risky assets in a bull market.

Long answer: Asking an economist to design an ideal hedge fund is like asking an engineer to design an ideal motor. The structure, size, and organization depend in the intended use and a lot of other design constraints. If you are actually looking for a way to hedge risk, then it matters what risk you are trying to hedge against.

If by 'hedge fund' you mean a way to make excess returns by taking advantage of market inefficiencies, which I assume, then the important thing to remember is that the only way to beat the market is to be smarter than the market. That means being not only smarter than every individual trading in the market, but smarter than their entire combined intelligence as coordinated by prices and institutional knowledge.

It is basically impossible to be smarter than a large, liquid, well-analyzed market (unless you have access to Strong AI and nobody else does). You have to look for markets that are underanalyzed and illiquid, where highly specialized knowledge is needed to operate or that trained finance people have neglected so far. For example, the Harvard endowment was known for investing in things like timber land.

Of course, finding such markets is also a hard problem, because you have to be smarter or have better connections than everyone else attempting the task. However, you may have success by hiring subject matter experts with esoteric knowledge, and then spending the time and money to teach them about finance and markets. These experts should probably be experienced industry insiders rather than academic experts, although you will need a few people with technical and quantitative skills for the serious number-crunching.

Then you have to give them the right incentives. You have to make sure that you are not rewarding churn, but also not rewarding just sitting on assets. Actually pay your traders for alpha, by correcting their returns for both average market returns and the beta of whatever they are doing. This would be the unique internal organization of my ideally managed hedge fund.

I'd guess that the biggest market inefficiency in our economy today is that small companies are starved for investment because banks are trying to recover their balance sheets. They are being crazy strict with their small business loans, but in their defense, knowing which small businesses are worth investing in is a hard problem. You need good industry experience, good finance knowledge, and probably most important, good skills at reading people and judging their competence and character.

If you can get away with it, maybe you could use tests of various kinds, from personality tests to practical tests related to important business skills, to judge the loan applicants. That would be unique, and almost certainly more effective than standard interviewing techniques. However, be warned that the character traits that make good employees, like IQ and conscientiousness, are not the most important for entrepreneurial success. That seems to be based on perseverance, networking skills, and other things that valid testing instruments do not exist for.

If you invested in researching and validating such tests, then perhaps it could be a source of competitive advantage. I understand tech forms like Google do similar things for choosing employees. But the fact that nobody uses applicant aptitude tests to make venture capital investment decisions may suggest that there are legal problems. If your tests were discriminatory, you might get in trouble. That would require legal analysis.