Hedge fund singularity

More evidence that, in today's gilded age, all roads lead to hedge funds. Ray Kurzweil, inventor and AI optimist, is now running a fund called FatKat! Kurzweil is one of the advocates of an impending singularity caused by accelerating machine intelligence. His recent book is titled The Singularity is Near.

This reminds of the old adage that it's time to sell when your shoeshine boy starts giving you stock tips. When running money starts to suck in a sizeable fraction of all brainpower (as internet startups seemed ready to, in the last bubble), it probably means we've reached a peak. Either that, or it's a secular revolution with the financial machine taking over the whole world :-) In that case, it will only be a matter of time before predicting short term market movements has surpassed the sexiness of any of the Clay Prize problems in mathematics, or quantizing gravity in physics...


Via DealBook: this publishing event is another sure sign of a market top. Tell your shoeshine boy!

NYTimes: Ray Kurzweil, an inventor and new hedge fund manager, is describing the future of stock-picking, and it isn’t human.

“Artificial intelligence is becoming so deeply integrated into our economic ecostructure that some day computers will exceed human intelligence,” Mr. Kurzweil tells a room of investors who oversee enormous pools of capital. “Machines can observe billions of market transactions to see patterns we could never see.”

The listeners, attendees of a conference sponsored earlier this month by the Capital Group Companies, are slightly skeptical. Some have heard that Mr. Kurzweil, 58, who takes more than 150 vitamins and supplements a day, believes people will eventually live forever. Others know he has said that in 2045, man and machine will achieve “singularity,” and humans will hold their breath for hours thanks to nanomachines in our bloodstreams.

But some are aware that a former Microsoft executive and chairman of the Nasdaq stock market, Michael W. Brown, is an investor in Mr. Kurzweil’s new hedge fund, FatKat, and that Bill Gates once described him as “the best person I know at predicting the future of artificial intelligence.”

More important, many of them have seen Mr. Kurzweil’s ideas used by stock speculators. So, they want to learn more about his brave, new world.

“These ideas are the future,” said David Atkinson, a private investor who attended another lecture later that day by Mr. Kurzweil. “I’m not really sure I understand them, but they’re making some folks rich.”

Complicated stock picking methods are nothing new. For decades, Wall Street firms and hedge funds like D. E. Shaw have snapped up math and engineering Ph.D.s and assigned them to find hidden market patterns. When these analysts discover subtle relationships, like similarities in the price movements of Microsoft and I.B.M., investors seek profits by buying one stock and selling the other when their prices diverge, betting historical patterns will eventually push them back into synchronicity.

Today, such methods have achieved a widespread use unimaginable just five years ago. The Internet has put almost every data source within easy reach. New software programs, like the Apama Algorithmic Trading Platform, have made it possible for day traders to build complicated trading algorithms almost as easily as they drag an icon across a digital desktop.

“Five years ago it would have taken $500,000 and 12 people to do what today takes a few computers and co-workers,” said Louis Morgan, managing director of HG Trading, a three-person hedge fund in Wisconsin. “I’m executing 1,500 to 2,000 trades a day and monitoring 1,500 pairs of stocks. My software can automatically execute a trade within 20 milliseconds — five times faster than it would take for my finger to hit the buy button.”

Studies estimate that a third of all stock trades in the United States were driven by automatic algorithms last year, contributing to an explosion in stock market activity. Between 1995 and 2005, the average daily volume of shares traded on the New York Stock Exchange increased to 1.6 billion from 346 million.

But in recent years, as algorithms and traditional quantitative techniques have multiplied, their successes have slowed.

“Now it’s an arms race,” said Andrew Lo, director of the Massachusetts Institute of Technology’s Laboratory for Financial Engineering. “Everyone is building more sophisticated algorithms, and the more competition exists, the smaller the profits.”

A New Class War

The Haves against the Have Mores. Pity the poor doctors, lawyers and management consultants. Even the I-bankers, now that hedge fund management has become the ne plus ultra of capitalism. The only guys that the hedgies envy are the super-lucky entrepreneurs who can make their centi-million all in one pop!

As far as doctors and lawyers, I once asked a friend of mine in finance, who lives in a 3000+ sq ft apartment on the upper east side, who else lived in his building. After counting all the money guys, he let slip -- "Oh, I guess there are some doctors and lawyers as well. I don't know how they can afford it." You're so money, and you don't even know it! I like how Lemann hints at the social discomfort from occasional interactions between the rich and super-rich. Taking the whole family first class is justifiable, but a private jet is over the top ;-)

Note, I'd be a bit careful about the average numbers used below for top 1% and .1%. Averages are very misleading here and are dominated by the far tail. Numerically the bulk of each group are at the threshold rather than average value for each tranche, which is substantially lower. IIRC, the threshold income for top 1% is about $275k, much lower than the average of almost $1M for that group. What's a little innumeracy, this is America after all!

Note added: This topic is hitting the zeitgeist bigtime! The Times has a sequel to the first article, this time situated in Silicon Valley, here. See also this earlier article about all the "working class millionaires" in the valley.

NYTimes: ...Let’s define the terms first, or at least make some attempt to. The merely rich are those whose income puts them in the top 1 percent of the population. According to a recent study by the Center on Budget and Policy Priorities in Washington, the average real income for the top 1 percent of American taxpaying households was $940,000 in 2004 — a difficult group to feel pity for. But to stand for a moment on its shores (let’s pretend) and look toward the rapidly growing ranks of the superrich is to stare across a vast chasm indeed.

The superrich might be the top tenth of 1 percent (average real household income for 2004: $4.5 million) or the top hundredth (the $20-million-a-year households). Income inequality is growing fastest the higher we go up the chart. While the percentage change in average real household income between 1990 and 2004 was an increase of 2 percent for the bottom 90 percent of American households, it was 57 percent for the top 1 percent; and shot up to 85 percent for the top 0.1 percent; and up to 112 percent for the top .01 percent. That is, the richest are getting richer almost twice as fast as the rich.

Class warfare has been hypothesized by various publications, including the online magazine Slate, New York magazine and Matt Miller in Fortune last month. Mr. Miller calls the bigger and poorer group, which consists largely of professionals — doctors, lawyers, management consultants, the vast majority of Wall Street soldiers — the “lower-uppers.” The targets of their resentment, he says, are by and large hedge fund managers and certain astronomically paid C.E.O.’s.

“The problem is that there’s all this wealth at this new strata that feels unrelated to merit or achievement,” Mr. Miller says. “When a C.E.O. whose leadership has caused a company’s stock price to fall gets a $100 million golden parachute, or when a guy’s running so much money that his commission — even if his picks are only getting an 8 or 10 percent return on his client’s money — is $100 million, that’s crazy.” He says that such compensation “goes against the notion of a meritocracy.”

Or maybe not. “A meritocracy increases inequality — by its very nature, it has to,” says Nicholas Lemann, whose book “The Big Test” explored the history of the SAT and the American meritocracy. “The goal was equality of opportunity, not equality of result.”

Part of the problem may lie with the fact that the members of both classes went into their respective lines of work with the goal of making a lot of money, and one just happens to make several times more of it.

Take the lawyers. “Lawyers are an odd group,” says the novelist Louis Begley, whose day job for several decades has been practicing law with the white-shoe firm Debevoise & Plimpton. “Lawyers at the great law firms earn a lot of money. But for a good many of them, it’s impossible to do so without accepting anything but cases involving huge corporate deals that generate a great many hours they can charge for. But these deals are repetitive. And the lawyers in these transactions often play second fiddle to the bankers.”

The money paid to investment bankers, who were once the stronghold of the financial elite, typically pales next to hedge-fund money. “I recently hosted a panel with Carl Icahn at the Core Club where the whole point was that if you’re an investment banker nowadays, you’re kind of a schlepper,” says Michael Wolff, a Vanity Fair writer who has often written about the moneyed classes. “Investment banking is for the C+ students now. Where you want to be is not somebody who’s advising people with money — whose currency is intellectual capital — but somebody whose currency is money itself.”

This, too, may be what irks the professional classes. Managing a hedge fund is the purest abstraction of making money out of money — there is no other product to show for it.

The resentment may be intensified in New York, a city whose physical layout has always engendered a lot of class-mixing. The middle class might have been largely squeezed out of Manhattan over the past decade, but the merely rich and the superrich still live in the same neighborhoods (if not necessarily the same buildings), buy houses in the same Hamptons (just houses of very different scales), and send their children to the same schools.

Mr. Lemann said that the rich versus richer envy factor “assumes that the relatively poor group is bumping into the most upper income.”

He added, “You might only see it at, say, functions that parents go to at certain rarefied private schools — Fieldston, say, or Harvard-Westlake in Los Angeles.”

Even Mr. Begley, who has earned enough to raise a large family in a grand apartment on Park Avenue, said he was astonished by the sheer number of billionaires he has met in recent years.

“I must say, I’ve begun to feel in New York as if I were driving a Volkswagen on the highway when a Greyhound bus happens to go by,” he said. “At which point, I feel a whoosh of air blasting me off the road. These people belong to another species.”

Except, he said, that it’s “these young Wall Street types” buying up the apartments in his building. “There are maybe four or five of us who bought our apartments at some understandable price 30 years ago,” he said. “And then these new people — I must say, with the money seems to come a rather large physical size. Some of them are polite, but the men do fill the elevator cage. And the women always seem to have a bottle of water attached to their mouths.”

He added that he did not feel any need to engage in class warfare against his neighbors. “If I did, they might crush me against the elevator wall,” he said. “The only thing to do is get adopted by them.”

Mouth bets

Brad Setser and Nouriel Roubini made a call that Bretton Woods 2 - an international monetary system based on central bank financing of the US deficit - would collapse sooner rather than later. I was of a similar view, and still think something bad will happen to the dollar - it's just a question of when. But nothing has happened yet, and Brad is starting to take some abuse on his blog:

You guys are smart, but you're also consistently wrong.

The two of you remind of a couple of trekkies that speak Klingon. This blog is wonderful for showing off how clever you are, but it's not useful at all. Self-conscious mental masterbation.

I mean, one of your bloggers commentators is so pretentious that he writes in haiku. It's perfect for your site.

I'm glad you're 'fessing up to how wrong you guys can be. That seems an impossible task for Nouriel. He responds by writing more and more blogs in his defense.

Written by truthHurtz on 2006-11-16 17:53:09


I agree that you've been wrong, Brad. There's a reason why you guys write papers, give advice, and argue with other "smart guys" - all safely from within the comfort of the fantasy world that theory and academia provides, never having to make money in the big bad real world by betting along the lines of your assertions.

Written by Anonymous on 2006-11-16 19:30:49

Brad responds admirably (look down the page at the comments), and lobs some fair questions back to his interlocutors. While I find the comments pretty nasty, they do get to an important point about academics in general. Traders sometimes use the term "mouth bet" for taking a position without putting any skin in the game :-)

Fault lines in Russia's Far East

The WSJ covers the demographic and economic forces at work in Russia's Far East, where a dynamic and populous China threatens to overwhelm sparsely populated and decrepit Russian territories. Things may go back to the way they were before Russia's eastern expansion of recent centuries.

WSJ: Russia is finding it hard to cope with the emergence of a new global power right on its doorstep, and many Russians fear being overwhelmed by their dynamic and more-populous neighbor. But on the ground, especially in Russia's sparsely populated countryside, Chinese labor is helping to stave off economic ruin.

To the outside world, Russia and China appear to be cozying up like never before. In October 2004, Moscow ceded territory to its southern neighbor to resolve a longstanding border conflict that had sparked a war in the late 1960s. The following year the two carried out their first-ever joint military exercise. China buys about $1 billion worth of Russian weapons every year, making it the Russian arms industry's biggest customer. Altogether, the two countries' trade was valued at $29 billion last year, an increase of 37% over 2004.

Meanwhile, as China scours the world for energy to power its booming economy, it's increasingly looking to Russia's bountiful reserves of oil and gas. Last week, the Kremlin's oil company, state-controlled OAO Rosneft, pledged to nearly double crude exports to China and said it was teaming up with China National Petroleum Corp. to build an oil refinery and operate gas stations in China.

But China's efforts to strengthen its economic ties with Russia have run into repeated roadblocks. Only one of Beijing's state energy companies has so far succeeded in gaining a stake in a Russian oil field, and only when it agreed to relinquish a controlling stake to Rosneft. Despite years of trying, Beijing has so far failed to secure access to a planned pipeline carrying Siberian crude to the Pacific. Russia, concerned about becoming too dependent on one customer, has refused to commit to building a spur that would link the pipeline to northern China, instead hinting that it will rely on rail shipments -- which are much costlier and less reliable.

Even when the Chinese try to invest in less-sensitive sectors than energy, the relationship can be fractious. In St. Petersburg, Russia's second-largest city, local politicians have campaigned to block a $1.3 billion real-estate development by a conglomerate of five Chinese state-owned companies. The concern: that the 553.5-acre project, which would include housing, schools, hospitals, recreation and retail, would become a "Chinatown"-style enclave for illegal immigrants.

...Behind the ambivalence is a fear that once the floodgates are opened, Russia could be swamped by Chinese immigrants. The surrounding tensions over linguistic, cultural and economic differences echo those along the U.S.-Mexico border, where states have to deal with a constant flow of legal and illegal immigrants seeking opportunity. In Russia the concern is heightened by the stark contrast between China's enormous population and Russia's steep demographic decline.

The differences are most palpable in Russia's Far East, a vast region bordering on China that has more than a third of Russia's territory but just 5% of its population -- seven million people. Across the border are China's three northeastern provinces -- Heilongjian, Jilin and Liaoning -- with a combined population of more than 100 million.

Inevitably, tens of thousands of Chinese migrants are already crossing over to fill the void, some of them settling down and acquiring Russian citizenship. According to the official count, there are about 250,000 Chinese living in Russia. Some Russian academics say they could become the predominant ethnic group in the Far East and eastern Siberia by the year 2025.

Visiting Blagoveshchensk in 2000, President Vladimir Putin warned that if the authorities failed to develop the region, "even the indigenous Russian population will mainly be speaking Japanese, Korean and Chinese in a few decades."

Yet in the countryside and Russia's provincial capitals, the Chinese are often seen quite differently -- as a potential lifeline for an economy desperately in need of extra hands.

1991 Honda Civic, 50k miles

Last week I hosted our colloquium speaker -- a condensed matter theorist who is currently chairman of the Yale physics department. Upon seeing my 1991 Honda Civic, which I've had since grad school, he exclaimed "Steve, you've got to get a better car!"

To me, it's a point of pride that I've only put 50k miles on my car in 15 years, traveling from Berkeley to Cambridge MA to New Haven and back to Eugene. It shows who the real environmentalist is among all the poseurs :-) Ever notice how many "environmentalists" love to haul their 1 ton metal vehicle 100 miles over the weekend to enjoy some rock climbing? Can anyone calculate the atmospheric CO2 produced per hour of climbing?

According to this Times article about a top Goldman trader, I'm in good company with my crappy car!

NYTimes: Managers of billion-dollar hedge funds do not usually drive Hondas — except at Goldman Sachs, that is.

Traders at Wall Street investment banks are now priming themselves for another big bonus haul this year. And Raanan A. Agus, the manager of one of Goldman’s largest internal hedge funds, and the owner of a Honda minivan, will be in line for one of the richer paydays.

More than any other investment bank, Goldman Sachs relies on trading gains to drive its profits. Mr. Agus had a very good year in 2005 — he is estimated to have made $10 million to $20 million — and he will surely get a raise in 2006. His year is further evidence that on Wall Street, the real money is being made not by investment bankers cutting high-profile deals, but by anonymous traders making risky, profitable bets with their firm’s capital.

That Mr. Agus appears to be content to drive a Honda is a reminder that the relatively ascetic sensibility that marked his predecessors, like Robert E. Rubin, the former Treasury secretary, remains in place at Goldman, even in today’s gilded era. ...

The ugly truth

Daniel Golden reports on discrimination against Asian-Americans in admissions to elite universities. I discussed his recent book here, and the Princeton study which concluded that Asian applicants faced discrimination equivalent to (on average) 50 points on the SAT here. Another article worth reading (thanks to Dave S. for the link) from Inside Higher Ed covers a panel called “Too Asian?” at the annual meeting of the National Association for College Admission Counseling. Particularly telling are the comments of a former Stanford admissions officer about an internal study which found evidence of higher admission rates for white applicants over Asians of similar academic and leadership qualifications (all applicants in the study were "unhooked" - meaning not in any favored categories such as legacies or athletes). Ugly, ugly, ugly.

The mechanism by which this discrimination operates is not overt. Admissions officers at elite universities are generally progressive and pro-diversity. They seek an ideal entering class with just the right balance of ethnic groups, and sprinklings of athletes, violinists, chess champions, junior entrepreneurs, etc. But this goal (especially the ethnic diversity part) conflicts with trying to get the intellectually strongest kids on campus, regardless of race. Of elite schools, only Caltech places the intellectual strength of the applicant above all else. Like it or not, admissions officers at elite schools are awarding preference to candidates based on their diversity goals. Too many high scoring Asians means not enough students from other groups, leading to a higher bar for Asian applicants.

Are individual admissions staffers aware of this consequence? Perhaps some are, but probably others prefer not to think about it. Those that do understand the consequences must be willing to sacrifice the lifelong goals and aspirations of Asian students like immigrant Jian Li, profiled in the article, on the altar of their diversity agenda.

If, for whatever reason, the distribution of bright, well-prepared students is very different in different ethnic groups, only discrimination against certain groups (Jews in the past, and Asians today) can keep their representation on campuses down. Cheers to immigrant kid Jian Li for challenging the discriminatory status quo, and cheers to Dan Golden for reporting diligently on this issue. See here for an Exeter senior's take on the college admissions process today.

WSJ: Though Asian-Americans constitute only about 4.5% of the U.S. population, they typically account for anywhere from 10% to 30% of students at many of the nation's elite colleges.

Even so, based on their outstanding grades and test scores, Asian-Americans increasingly say their enrollment should be much higher -- a contention backed by a growing body of evidence.

Whether elite colleges give Asian-American students a fair shake is becoming a big concern in college-admissions offices. Federal civil-rights officials are investigating charges by a top Chinese-American student that he was rejected by Princeton University last spring because of his race and national origin.

Meanwhile, voter attacks on admissions preferences for other minority groups -- as well as research indicating colleges give less weight to high test scores of Asian-American applicants -- may push schools to boost Asian enrollment. Tuesday, Michigan voters approved a ballot measure striking down admissions preferences for African-Americans and Hispanics. The move is expected to benefit Asian applicants to state universities there -- as similar initiatives have done in California and Washington.

If the same measure is passed in coming years in Illinois, Missouri and Oregon -- where opponents of such preferences say they plan to introduce it -- Asian-American enrollment likely would climb at selective public universities in those states as well.

During the Michigan campaign, a group that opposes affirmative action released a study bolstering claims that Asian students are held to a higher standard. The study, by the Center for Equal Opportunity, in Virginia, found that Asian applicants admitted to the University of Michigan in 2005 had a median SAT score of 1400 on the 400-1600 scale then in use. That was 50 points higher than the median score of white students who were accepted, 140 points higher than that of Hispanics and 240 points higher than that of blacks.

Roger Clegg, president and general counsel of the Center for Equal Opportunity, said universities are "legally vulnerable" to challenges from rejected Asian-American applicants.

Princeton, where Asian-Americans constitute about 13% of the student body, faces such a challenge. A spokesman for the Department of Education's Office for Civil Rights said it is investigating a complaint filed by Jian Li, now a 17-year-old freshman at Yale University. Despite racking up the maximum 2400 score on the SAT and 2390 -- 10 points below the ceiling -- on SAT2 subject tests in physics, chemistry and calculus, Mr. Li was spurned by three Ivy League universities, Stanford University and Massachusetts Institute of Technology.

The Office for Civil Rights initially rejected Mr. Li's complaint due to "insufficient" evidence. Mr. Li appealed, citing a white high-school classmate admitted to Princeton despite lower test scores and grades. The office notified him late last month that it would look into the case.

His complaint seeks to suspend federal financial assistance to Princeton until the university "discontinues discrimination against Asian-Americans in all forms by eliminating race preferences, legacy preferences, and athlete preferences." Legacy preference is the edge most elite colleges, including Princeton, give to alumni children. The Office for Civil Rights has the power to terminate such financial aid but usually works with colleges to resolve cases rather than taking enforcement action.

Mr. Li, who emigrated to the U.S. from China as a 4-year-old and graduated from a public high school in Livingston, N.J., said he hopes his action will set a precedent for other Asian-American students. He wants to "send a message to the admissions committee to be more cognizant of possible bias, and that the way they're conducting admissions is not really equitable," he said.

Princeton spokeswoman Cass Cliatt said the university is aware of the complaint and will provide the Office for Civil Rights with information it has requested. Princeton has said in the past that it considers applicants as individuals and doesn't discriminate against Asian-Americans.

When elite colleges began practicing affirmative action in the late 1960s and 1970s, they gave an admissions boost to Asian-American applicants as well as blacks and Hispanics. As the percentage of Asian-Americans in elite schools quickly overtook their slice of the U.S. population, many colleges stopped giving them preference -- and in some cases may have leaned the other way.

In 1990, a federal investigation concluded that Harvard University admitted Asian-American applicants at a lower rate than white students despite the Asians' slightly stronger test scores and grades. Federal investigators also found that Harvard admissions staff had stereotyped Asian-American candidates as quiet, shy and oriented toward math and science. The government didn't bring charges because it concluded it was Harvard's preferences for athletes and alumni children -- few of whom were Asian -- that accounted for the admissions gap.

The University of California came under similar scrutiny at about the same time. In 1989, as the federal government was investigating alleged Asian-American quotas at UC's Berkeley campus, Berkeley's chancellor apologized for a drop in Asian enrollment. The next year, federal investigators found that the mathematics department at UCLA had discriminated against Asian-American graduate school applicants. In 1992, Berkeley's law school agreed under federal pressure to drop a policy that limited Asian enrollment by comparing Asian applicants against each other rather than the entire applicant pool.

Asian-American enrollment at Berkeley has increased since California voters banned affirmative action in college admissions. Berkeley accepted 4,122 Asian-American applicants for this fall's freshman class -- nearly 42% of the total admitted. That is up from 2,925 in 1997, or 34.6%, the last year before the ban took effect. Similarly, Asian-American undergraduate enrollment at the University of Washington rose to 25.4% in 2004 from 22.1% in 1998, when voters in that state prohibited affirmative action in college admissions.

The University of Michigan may be poised for a similar leap in Asian-American enrollment, now that voters in that state have banned affirmative action. The Center for Equal Opportunity study found that, among applicants with a 1240 SAT score and 3.2 grade point average in 2005, the university admitted 10% of Asian-Americans, 14% of whites, 88% of Hispanics and 92% of blacks. Asian applicants to the university's medical school also faced a higher admissions bar than any other group.

Julie Peterson, spokeswoman for the University of Michigan, said the study was flawed because many applicants take the ACT test instead of the SAT, and standardized test scores are only one of various tools used to evaluate candidates. "I utterly reject the conclusion" that the university discriminates against Asian-Americans, she said. Asian-Americans constitute 12.6% of the university's undergraduates.

Jonathan Reider, director of college counseling at San Francisco University High School, said most elite colleges' handling of Asian applicants has become fairer in recent years. Mr. Reider, a former Stanford admissions official, said Stanford staffers were dismayed 20 years ago when an internal study showed they were less likely to admit Asian applicants than comparable whites. As a result, he said, Stanford strived to eliminate unconscious bias and repeated the study every year until Asians no longer faced a disadvantage.

Last month, Mr. Reider participated in a panel discussion at a college-admissions conference. It was titled, "Too Asian?" and explored whether colleges treat Asian applicants differently.

Precise figures of Asian-American representation at the nation's top schools are hard to come by. Don Joe, an attorney and activist who runs Asian-American Politics, an Internet site that tracks enrollment, puts the average proportion of Asian-Americans at 25 top colleges at 15.9% in 2005, up from 10% in 1992.

Still, he said, he is hearing more complaints "from Asian-American parents about how their children have excellent grades and scores but are being rejected by the most selective colleges. It appears to be an open secret."

Mr. Li, who said he was in the top 1% of his high-school class and took five advanced placement courses in his senior year, left blank the questions on college applications about his ethnicity and place of birth. "It seemed very irrelevant to me, if not offensive," he said. Mr. Li, who has permanent resident status in the U.S., did note that his citizenship, first language and language spoken at home were Chinese.

Along with Yale, he won admission to the California Institute of Technology, Rutgers University and the Cooper Union for the Advancement of Science and Art. He said four schools -- Princeton, Harvard, Stanford and the University of Pennsylvania -- placed him on their waiting lists before rejecting him. "I was very close to being accepted at these schools," he said. "I was thinking, had my ethnicity been different, it would have put me over the top. Even if race had just a marginal effect, it may have disadvantaged me."

He ultimately focused his complaint against Princeton after reading a 2004 study by three Princeton researchers concluding that an Asian-American applicant needed to score 50 points higher on the SAT than other applicants to have the same change of admission to an elite university.

"As an Asian-American and a native of China, my chances of admission were drastically reduced," Mr. Li claims in his complaint.

No way out

China's trillion dollars in FX reserves is just too big to diversify out of without moving markets. At the moment, "diversification" means leaving it in dollar-denominated assets, but moving away from Treasuries into CMOs or corporates. For now, helping to depress the yield curve on the long end. One popular theory is no big moves before the Beijing Olympics in 2008 (stability is everything). Shout out to Brad Setser :-)

Economist: ...So long as China runs a large external surplus (the natural result of its high saving rate) and refuses to set its currency free, its stash of foreign currency will probably continue to mount.

How that money is invested has big implications for the world economy, not just for China. Brad Setser, head of global research at Roubini Global Economics, estimates that about 70% of it is invested in dollars, mainly Treasury securities. This has propped up the dollar and reduced American bond yields—by up to 1.5 percentage points according to some estimates. A big shift out of dollars could therefore push up bond yields and hence mortgage rates, damaging America's already crumbling housing market.

China's central bank is thought to be switching from Treasury bonds to American mortgage-backed securities and corporate bonds in an attempt to earn higher yields. Chinese officials have also discussed in private the need to diversify reserves out of dollars in order to reduce exposure to a big drop in the greenback. The bank may be putting a bigger slice of any increase in reserves into euros and emerging Asian currencies, but so far there is little sign of a shift out of its existing stock of dollars. One problem is that China's investments are so big that they move markets. Shifting money into euros would push down the dollar. China would then not only suffer a capital loss on its remaining dollar reserves, but it could also be forced to buy yet more reserves to hold its currency down against a weaker dollar.

Fear of a capital loss, and dissatisfaction with unrewarding yields, have triggered a flurry of ideas on how to put the money to better use. One popular idea is to use some of China's reserves to buy oil and other commodities. The snag is that stockpiling oil would push up prices, yet absorb only a tiny proportion of the sums at China's disposal. Buying the equivalent of six-months' oil consumption, as has been suggested, would take only 8% of total reserves at current prices, but the extra oil bought would amount to three times the growth in global oil demand this year. Buying gold would have similar results: if China invested just 5% of its reserves in gold, it could buy the world's entire annual mine production.

Hedge fund clones

The Economist discusses some proposals for cheap replication of hedge fund strategies. The first paper mentioned below is by Andy Lo of MIT. Recent innovations like ETFs and other narrowly focused instruments allow cheaper exposure to well defined types of risk -- the cost of placing a bet on a particular strategy is lower than ever before. However, this begs the question of how one decides which bet to make, and when. I don't think the difficult part of generating alpha is the mechanics of making an investment (at least, not anymore), but rather the decision making.

Economist: ...But financial scholars are beginning to demystify hedge funds. They think they can replicate their performance using garden-variety financial products. The result could be a cheap competitor for the hedge-fund titans, akin to the index-tracking funds that have eaten into the market shares of active fund managers.

Replication is possible because hedge-fund managers are not as distinctive as they claim. They say their returns are based on skill, or “alpha”, but in fact their performance is largely derived from market movements. A recent paper* by two academics at the Massachusetts Institute of Technology breaks down the returns of 1,610 funds from 1986 to 2005. It finds that six common factors, such as the change in the S&P 500 index and the return on corporate bonds, explained a significant part of hedge-fund returns.

Investors can gain exposure to these factors through widely available liquid instruments. Thus it should be possible to build “clone” portfolios that resemble hedge funds. Such portfolios would not only avoid hedge-fund fees, but would also escape the risk of backing a mismanaged fund, such as Amaranth, which lost 65% of its value in September.

The authors suggest cloning a fund by dissecting its performance over the past year or two. One could sift and sort the factors behind its success, and allocate the clone's money accordingly. A back-tested clone portfolio returned an average of 12.8% a year over nearly 20 years compared with 14.2% for the typical hedge fund. And the copycat portfolio offered investors many of the same benefits of diversification as the fund it mimicked.

Not every academic is impressed by this approach, however. Harry Kat, at the Cass Business School, says that such “multi-factor” models fail to explain a large proportion of hedge-fund returns. But Mr Kat proposes his own cheap alternative†. It may be impossible to know the particular plays hedge-fund managers make. But, he says, you can devise a formulaic trading strategy in the futures markets that would duplicate the overall shape of their returns. His strategies would give investors two of the three things they look for from a hedge: a low correlation with their existing portfolio, at a level of volatility they can tolerate. The return would be out of their hands, but tests suggest profits can be decent: 10% a year in one example.

Neanderthal-human interbreeding

Bruce Lahn is at it again. Earlier work from his lab showed that the microcephalin gene (MCPH1), which plays a role in brain development, has undergone strong selection in the last 40k years, with a new variant allele reaching a frequency of 70 percent in Eurasian populations. Shockingly to our politically correct thought police, the frequency in some other populations is much lower. Recent results (HHMI press release) imply that the origin of the advantageous variant allele dates back 1.1 million years, suggesting it may have entered the gene pool of modern humans via interbreeding with Neanderthals, already present in Eurasia when modern humans left Africa 40k years ago.

How do we know how old the advantageous allele is? I suppose you look at its detailed structure, and that of the other alleles. By using the roughly known mutation rate (base pair changes per unit time), you can estimate the time at which different versions diverged.

This was briefly covered in the Times today, but the article is lacking in detail. See here for more discussion.

Earlier studies by Lahn's group yielded evidence that the microcephalin gene has two distinct classes of alleles. One class, called the D alleles, is comprised of a group of alleles with rather similar DNA sequences. The other class is called the non-D alleles. Lahn and colleagues previously showed that all modern copies of the D alleles arose from a single progenitor copy about 37,000 years ago, which then increased in frequency rapidly and are now present in about 70 percent of the world's population. This rapid rise in frequency indicates that the D alleles underwent positive selection in the recent history of humans. This means that these alleles conferred a fitness advantage on those who possessed one of them such that these people had slightly higher reproductive success than people who didn't possess the alleles, said Lahn.

The estimate that all modern copies of the D alleles descended from a single progenitor copy about 37,000 years ago is based on the measurement of sequence difference between different copies of the D alleles. As a copy of a gene is passed from one generation to the next, mutations are introduced at a steady rate, such that a certain number of generations later, the descendent copies of the gene would on average vary from one another in DNA sequence by a certain amount. The greater the number of the generations, the more DNA sequence difference there would be between two descendent copies, said Lahn. The amount of sequence difference between different copies of a gene can therefore be used to estimate the amount of evolutionary time that has elapsed since the two copies descended from their common progenitor.

In the new studies reported in PNAS, the researchers performed detailed sequence comparisons between the D alleles and the non-D alleles of microcephalin. The scientists determined that these two classes of alleles have likely evolved in two separate lineages for about 1.1 million years — with the non-D alleles having evolved in the Homo sapiens lineage and the D alleles having evolved in an archaic, and now extinct, Homo lineage. Then, about 37,000 years ago, a copy of the D allele crossed from the archaic Homo lineage into humans, possibly by interbreeding between members of the two populations. This copy subsequently spread in humans from a single copy when it first crossed into humans to an allele that is now present in an estimated 70 percent of the population worldwide today.

The estimate of 1.1 million years that separates the two lineages is based on the amount of sequence difference between the D and the non-D alleles. Although the identity of this archaic Homo lineage is yet to be determined, the researchers argue that a likely candidate is the Neanderthals. The 1.1 million year separation between humans and this archaic Homo species is roughly consistent with previous estimates of the amount of evolutionary time separating the Homo sapiens lineage and the Neanderthal lineage, said Lahn. Furthermore, the time of introgression of the D allele into humans — about 37,000 years ago — is when humans and Neanderthals coexisted in many parts of the world.

Lahn said the group's data suggest that the interbreeding was unlikely to be a thorough genetic mixing, but rather a rare - and perhaps even a single — event that introduced the ancestral D allele previously present in this other Homo species into the human line.

“By no means do these findings constitute definitive proof that a Neanderthal was the source of the original copy of the D allele,” said Lahn. “However, our evidence shows that it is one of the best candidates. The timeline - including the introgression of the allele into humans 37,000 years ago and its origin in a lineage that separated with the human line 1.1 million years ago — agrees with the contact between, and the evolutionary history of, Neanderthals and humans.

Chat with Lisa Randall

Someone at Discover Magazine invited me to chat with Lisa Randall tomorrow -- Thursday 11/9 -- at 2 PM EST. Lisa is a leading particle theorist and author of the book Warped Passages. Her work with Raman Sundrum on warped extra dimensions is one of the most highly cited papers of the last decade.

I'm announcing the chat here since at least some of the readers of this blog might be interested. I'm not sure whether I'll participate yet, but perhaps I'll see you there.

Taxes and inequality

I don't have a link for the following data, it came in an investment advisory called the Gartman Letter. You can read this data in two ways: as an indication of the extreme concentration of wealth and income in the US, or (if you like Ayn Rand) as an indication of how a small fraction of the population produces most of the value for society :-)

The newest data released by the Joint Economic Committee of Congress is really quite enlightening. Firstly, the top 1% of the nation's wage earners paid in 34.3% of the total taxes paid. The top 5% paid in 54.4%; the top 10% paid in 65.8%; the top 25% paid in 83.9% and the top 50% of the nation's wage-earners paid in 96.5% of the total taxes. The bottom 50%, however, paid in only 3.5%. To have made the grade and be counted amongst the nation's top 1% of wage earners, one had to have an adjusted gross income of $295,495 [Ed. Note: We need to make clear that these figures are all from taxable 2003, and that is in fact that most recent year for which the data is fully available.]. To have made the top 10%, one's adjusted gross income had to be $94,891. The cut off to make the top half was $29,019.

In '01, the top 50% paid in 96.0% of the total taxes. In '02, they paid in 96.5%, and the 96.5% again last year as noted just above. The bottom 50% paid in 3.97% of the total taxes in '01; 3.5% in '02 and the same 3.5% (rounded to the nearest 0.1%) in '03. We note that '99, according this time to the Tax Foundation, the top 1% of the nation's wage earners paid in an even greater portion of the total taxes: 36.2%. The top half of the nation's wage-earners then paid in 96% of the total tax revenues earned by the government, while the bottom half paid in 4%. So since '99, the top 1% are paying a bit less, but so too is the bottom 50%; the remaining 49% are paying more. Oh, and to have made the top 1% of all wage earners in '99 one had to have an adjusted gross income of "only" $293,415. The bottom 50% had an AGI of $26, 415.

It's cold here

Sorry for lack of posts. I gave a colloquium at University of Illinois at Chicago yesterday, and today I'm headed to Montreal to do the same at McGill University (physics/computer science talk on entanglement entropy and black holes, computer science colloquium on technology startups). They videotaped my talk yesterday, which was on dark energy. If the video appears on the web as promised I'll post a link to it. (Note, links above are to slides. The first two are PDFs and the third a big .ppt file. If you look at the three talks you might understand why my head is about to explode :-)

Tom Imbo, the colloquium organizer who introduced me yesterday, was my officemate at Harvard many years ago. As an old friend he knows a little too much about my past. In his intro he mentioned my not so stellar athletic career as a linebacker on the Caltech football team (Caltech dropped football in 1993; I was also on the swim and water polo teams, which seem to have survived) and ultimate fighter. No, I never stepped in the ring for an ultimate fight, but did spend years training in Brazilian Jiujitsu, including some time with professional fighters in Tokyo one summer. I've trained less and less in recent years, and in my last training session a few months ago was schooled by one of our new graduate students***, a wrestler and judoka who competed at Pacific University. I guess I consider myself retired from the mat for now :-/

*** Perhaps I shouldn't feel too bad -- it looks like the guy who crushed me scored a major decision (12-4) over a 197 pounder on the Pacific team in their alumni vs team tournament just recently.

Bricks and broadband

OK, I have to admit I've been suffering from gizmo envy for some time now. How is it that a connected guy like me has no mobile device with always-on internet and email capability? How is it that even stodgy UO administrators sport fancy BlackBerry's while a wannabe hipster tech entrepreneur has no way of checking his email at SFO without paying T Mobile for wifi access?

Well, the situation is now remedied with Sprint's EV-DO data plan. For only $15 a month I get all I can eat broadband (up to 1 mbps or so) through my new gizmo, the admittedly brick-like PPC 6700 smartphone.

So far I'm pretty happy with the phone, despite the large form factor. It has a retractable qwerty keyboard (see link above) and is very functional -- I can ssh into my server, run emacs and use gmail. I can even use Bluetooth to get my laptop online, using the phone as a modem. Urbanites in Asia probably find my giant phone very amusing, but, hey, I live in the semi-rural United States, with its patchy broadband and 3G coverage.

I admit, it does make for behavioral problems when you can check your email at all times. I'd hate to know how many times a day I do it.

It's crazy: there's no close second or third

Michael Steinhardt, one of the most successful hedge fund managers ever, is from the old school. In this WSJ interview, he has a few things to say about how things are today.

Mr. Steinhardt founded Steinhardt Fine Berkowitz in 1967 when he was 26 years old. In the next three decades his fund, later renamed Steinhardt Partners, boasted average annual returns of nearly 25%...

Now, hedge funds that make [4%] over T-bill rates are doing great. It's crazy. That's why the field of money management is today the most highly compensated field in the world times three. There's no close second. There's no close third. And I think the expectations inherent in that sort of compensation are absurdly unrealistic.

...I do think there are a lot of inexperienced mangers running hedge funds today. There are a lot of people who do not have a history of superior performance over a long period. While certainly a long period of successful performance is no guarantee for the future, it gives a reasonable amount of comfort. But the fact that you've got a lot of young people running hedge funds whom I wouldn't be comfortable with, that makes one a little bit wary.

Compare to Charlie Munger, another billionaire and Warren Buffet's longtime partner:

I regard the amount of brainpower going into money management as a national scandal.

We have armies of people with advanced degrees in physics and math in various hedge funds and private-equity funds trying to outsmart the market. A lot of you older people in the room can remember when none of these people existed.

and Carl Fox (Martin Sheen, playing Charlie Sheen's father in Oliver Stone's Wall Street):

Carl Fox: Stop going for the easy buck and start producing something with your life. Create, instead of living off the buying and selling of others.

Does string theory predict an open universe?

New paper! See here for related discussion.

The first two pragraphs:

If, as suggested by recent results [1], string theory exhibits a landscape of over 10^500 distinct, metastable vacua, its status as a conventional scientific theory is in jeopardy. Scientific theories must make predictions which are falsifiable by experiment. Such a large diversity of vacua means that essentially any low-energy physics might be realizable from string theory. Even ultra high-energy physics experiments may not yield additional information, since scattering at trans-Planckian energies leads to black holes [2] of ever increasing size, whose subsequent behavior (evaporation) is controlled by the low-energy physics of the ambient vacuum state. If recent results are any guide, string theory will be extremely difficult to falsify.

It is therefore important to carefully consider any robust implications of the string landscape. One of these, recently elaborated in [3], is the testable prediction that our universe must be open, with negative curvature. A recent analysis combining WMAP and Sloan Digital Sky Survey data gives Omega =1.003 +- 0.010 [4], but improved future observations could yield a statistically significant central value larger than unity, implying positive curvature. Would this rule out string theory?


hep-th/0610231
Authors: R. Buniy, S. Hsu, A. Zee

It has been claimed that the string landscape predicts an open universe, with negative curvature. The prediction is a consequence of a large number of metastable string vacua, and the properties of the Coleman--De Luccia instanton which describes vacuum tunneling. We examine the robustness of this claim, which is of particular importance since it seems to be string theory's sole claim to falsifiability. We find that, due to subleading tunneling processes, the prediction is sensitive to unknown properties of the landscape. Under plausible assumptions, universes like ours are as likely to be closed as open.

Proximity, ecosystems and Silicon Valley

If you're a young tech entrepreneur, move to Silicon Valley. The Times article I've excerpted from below is not exaggerating in any way. You not only have better access to venture capital in the valley, you have access to a whole ecosystem of other startups, entrepreneurs, technologists, attorneys experienced in startup issues, and big tech companies that are your potential acquirers. Note that both Google and YouTube are Sequoia companies. The article is also correct in pointing out that, beyond proximity and the ecosystem, the entire attitude toward risk is different in the valley. There's a startup culture. People have seen startups succeed, have seen their friends get rich, and expect to be able to do it themselves. That positive attitude can make all the difference. If, instead, you're cranking away in Minneapolis or Pittsburgh or even Boston or LA, dreaming of a sweet exit, it's just that much harder to believe that it's actually going to happen.

Lucky for me Eugene is only an hour flight from the bay area. But even that hour (and having to book a flight in advance) sometimes makes scheduling meetings a nightmare compared to driving from our Oakland offices down to Palo Alto.

FIBER networks cross the world. Data bits move at light speed. The globe has been flattened, and national boundaries obliterated. Yet in Silicon Valley, the one place that is responsible more than any other for creating the network technology that supposedly renders geography irrelevant, physical distance is very much on the minds of the investors who provide venture capital.

Meet the “20-minute rule” that guides fateful decisions in Silicon Valley. Craig Johnson, managing director of Concept2Company Ventures, a venture capital firm in Palo Alto, Calif., who has 30 years of experience in early-stage financings, said he knew many venture capitalists who adhered to this doctrine: if a start-up company seeking venture capital is not within a 20-minute drive of the venture firm’s offices, it will not be funded.

Mr. Johnson explained that close proximity permits the investor to provide in-person guidance; initially, that may entail many meetings each week before investor and entrepreneur come to know each other well enough to rely mostly on the phone for updates. Those initial interactions are fateful. “Starting a company is like launching a rocket,” Mr. Johnson said. “If you’re a tenth of a degree off at launch, you may be 1,000 miles off downrange.”

Capital and attention are lavished on entrepreneurs in the Valley as in no other place. Ten years ago, when Dow Jones VentureOne began a quarterly survey of where venture investments landed, one-third of all deals in the country went to the San Francisco Bay Area. Since then, the same share of deals has gone to the same place, almost without variation. Most recently, in the first six months of this year, Silicon Valley still pulled in 32 percent; the region with the second-largest total, New England, was far behind, at 10 percent.

...It’s convenient for venture capitalists to have entrepreneurs close by, but the reverse is true, too, said Allen Morgan, a managing director of the Mayfield Fund, which manages $2.3 billion in venture capital and is also on Sand Hill Road. Mr. Morgan made the case by pointing out that a prospective entrepreneur would, on average, need to have three to eight meetings with a venture fund before he or she was successful, but would have to go through a similar process with 5 to 10 firms before finding the one that approved the funding request.

Even if the process goes smoothly and requires only 15 meetings — the fewest possible, given the lowest range of possibilities — and even if most of those meetings are set up in advance, the time consumed in getting to Sand Hill Road, even using local highways, can be significant. The problem is that much worse when, as often happens, a meeting is called with just an hour or two of notice. “If you live in Santa Clara, it’s doable,” Mr. Morgan said. “If you live in Dubuque, it’s not.”

Entrepreneurs who live in Silicon Valley also find the technical talent they need faster than they can in any other place; they pay more for that talent, but speed is the sine qua non for success. Seth J. Sternberg, the chief executive of Meebo, an instant-messaging company in Palo Alto that is backed by Sequoia, described Silicon Valley with the fervent appreciation of a recent transplant from New York, where he had suffered three separate bad experiences with start-ups, none of which had attracted venture funding.

The ecosystem in Silicon Valley, Mr. Sternberg said, includes “incredible techies, who live here because this is the epicenter, where they can find the most interesting projects to work on.” The ecosystem also includes real estate agents, accountants, head hunters and lawyers who understand an entrepreneur’s situation — that is, emptied bank accounts and maxed-out credit cards.

“In New York, it would be extremely difficult to find a law firm willing to defer the first $20,000 of your legal fees,” Mr. Sternberg said. “Here, we got that. It’s a pretty standard thing in Silicon Valley.”

...Predictions of the Valley’s demise have become a perennial, said Mr. Morgan, the Mayfield venture capitalist. “Every five years, Time or Newsweek runs a story: ‘Silicon Valley is Dead,’ ” he said. “But Silicon Valley is bigger and more vibrant and better at creating companies than it has ever been.”

Silicon Valley is not “bigger” in a literal sense. In fact, it remains geographically contained by the Santa Cruz Mountains on one side and San Francisco Bay on the other. The physical features of the place help explain the Valley’s vitality.

MR. JOHNSON, the venture capitalist in Palo Alto, noted that the greater Los Angeles area also has a pool of talented engineers (working at aerospace companies like Lockheed, Northrop and Hughes) and great universities (notably Caltech and U.C.L.A.) and plenty of money to invest. “But in Los Angeles,” he said, “people are scattered across a wide area; everything is more spread out.”

It’s harder for entrepreneurs to meet with one another and with investors, he added. And that means connections take longer, deals move slowly, fewer companies are formed. “Like a gas, entrepreneurship is hotter when compressed.” he said.

Income inequality by education

Here it is, broken down by level of education. Note that even the PhD income increase from 2000-2005 is only slightly positive in real terms. Also, it significantly lags the increase for professionals. See here for previous posts on income inequality.

WSJ: The wage gap between those with business, law, medical or other postgraduate degrees has widened a lot more than the gap between college and high-school graduates. Even excluding capital gains, tax-return data crunched by Emmanuel Saez of the University of California at Berkeley show that the top 1% in the U.S. got 16% of all income in 2004, compared with 9% in 1984.

Before nitpicking emails arrive: No single set of numbers gives a complete picture. The data in this chart cover only cash wages -- not health benefits or pensions. If they were included, most of those inflation-adjusted minuses would turn to pluses. But inequality wouldn't disappear. The best-paid 20% of workers on private payrolls are three times as likely to have health insurance as those in the bottom 20%, and this tally doesn't count stock options and the like -- and you know who gets the bulk of those.

The question isn't whether the gap between winners and losers in the labor market is widening; it's why. And it's no longer as simple as saying: The more education one gets, the more one earns. Something more complicated is driving up pay at the top.

Explanations come in three strains, all of which have some merit. One, it's more socially acceptable than it was a generation ago for the top-tier chief executive, hedge-fund manager or baseball players to make an enormous amount of money. Two, the world has changed in ways that make the No. 1 or No. 2 -- whether a trial lawyer or a rock star -- much more valuable than No. 19 and 20. As technology has helped create superstars, the gap between Oprah's paycheck and those of local talk-show hosts is larger than ever.

And, three, there's the influence on supply and demand of globalization and technology. At the high end, sharply rising wages suggest demand for the most-educated workers is growing faster than the supply. "The very top is doing very well," says Harvard University labor economist Lawrence Katz. "It's changes in demand, combined with the fact that it's very hard to replicate a lot of that talent... and we haven't expanded the ranks of those professions as fast as we could."

At the bottom, where the supply is influenced by the ranks of unskilled immigrants and laid-off workers falling out of the middle class, demand for hotel workers, nursing aides, security guards and the like may be helping to prop up wages even though the minimum wage hasn't kept up with inflation.

It is in the middle -- where many four-year college graduates work -- that imports, overseas outsourcing and technology seems to be reducing U.S. employer demand most significantly, and thus restraining wages.

That is the kind of shift in the tectonic plates of the economy that produces political earthquakes.

Implied probabilities

I was expecting a bigger negative correction in Korea indices from the recent nuclear test. The KOSPI index trades at a price/earnings discount of a factor of about 1.5 compared to US equities (current iShares MSCI S. Korea index has a P/E of 11.3), and not so long ago the discount was a factor of 2. I thought a big chunk of that was geopolitical risk due to N. Korea, but after the recent test there was only a small 3-4 percent correction. On the other hand, it seems to be almost business as usual on the Korean peninsula, so perhaps markets knew better than me what the consequences of the test would be.

Are extreme negative events in the probability distribution (war, natural disasters, crashes in general) priced accurately by the market? In the case of S&P options, deep out of the money puts (which are essentially crash insurance) have a big premium built into their price (see here for details). Contrary to some people's folk wisdom, the derivatives market does not underestimate the probability of rare negative events. On the other hand, the utility or payoff function for ordinary fund managers probably tells them to ignore rare negative events. Insuring against such events is a drag on their performance, as they are evaluated against a benchmark that typically includes no such insurance. In the event of a catastrophe, they'll be in good company and the damage sustained by their career will probably be less than the damage to their portfolio (i.e., the investor will suffer more than the manager).

Malware clusterbomb movie

At my startup RobotGenius, Inc., we've been building new technologies to fight malware, spyware and adware. Our "Spyberus" software installs at the driver layer between the Windows OS and the physical hard drive. It tracks all file modifications, and stores a history of all files on the system, allowing users to trace any infection back to its source (even to the web site or media it came from), and to reverse it with a few clicks.

We have an automated farm of PCs crawling the entire web, downloading, installing, and classifying all Windows executables based on their behavior. There are about a million executables on the internet, about .5% of which are malware. Soon we'll have data on every executable and a complete list of sites which distribute malware. You may see the data someday as security warnings in search results from your favorite search engine :-)

For now, you can enjoy the following movie, which shows a clusterbomb attack. The user downloads an innocuous seeming toolbar application, which initially only does a few nasty things, like modify the Windows hosts file, but after a pre-set delay starts jamming all sorts of downloaded malware code onto the machine. If Spyberus were not already installed on the machine, the user would probably have to wipe the hard drive completely and reinstall Windows. But as you can see, Spyberus allows for a quick and painless reversal of the infection.

The battle for brainpower

Another nice review in the Economist. I think it was Kleiner Perkins venture capitalist John Doerr who suggested that every PhD awarded in the US come with a green card attached.

IN A speech at Harvard University in 1943 Winston Churchill observed that “the empires of the future will be empires of the mind.” He might have added that the battles of the future will be battles for talent. To be sure, the old battles for natural resources are still with us. But they are being supplemented by new ones for talent—not just among companies (which are competing for “human resources”) but also among countries (which fret about the “balance of brains” as well as the “balance of power”).

The war for talent is at its fiercest in high-tech industries. The arrival of an aggressive new superpower—Google—has made it bloodier still. The company has assembled a formidable hiring machine to help it find the people it needs. It has also experimented with clever new recruiting tools, such as billboards featuring complicated mathematical problems. Other tech giants have responded by supercharging their own talent machines (Yahoo! has hired a constellation of academic stars) and suing people who suddenly leave.

...Alan Eustace, a vice-president of Google, told the Wall Street Journal that in his view one top-notch engineer is worth “300 times or more than the average”. Bill Gates says that “if it weren't for 20 key people, Microsoft wouldn't be the company it is today.”

Reversing the brain drain. 20m Indians living abroad generate income equivalent to 35% of India's GDP, making them almost 20 times more productive than their counterparts at home!

Half the Americans who won Nobel prizes in physics in the past seven years were born abroad. More than half the people with PhDs working in America are immigrants. A quarter of Silicon Valley companies were started by Indians and Chinese. Intel, Sun Microsystems and Google were all founded or co-founded by immigrants. But now India and China are sucking back their expats, and America's European competitors have woken up to the importance of retaining their talent.

...Some of the best prospects in the competition for talent are émigrés—people who have gone abroad to make their fortune but still feel the tug of their home country. Both China and India are now trying to emulate Ireland's success in wooing back the diaspora, but China is trying harder. In 1987 the Communist Party's general secretary, Zhao Ziyang, described China's brain drain as “storing brain power overseas”. Officials from every level of government have been raiding the store since, as part of a policy of “strengthening the country through human talent”.

They have introduced a mind-boggling range of enticements, from bigger apartments to access to the best schools, from chauffeur-driven cars to fancy titles. The Chinese Academy of Sciences has established a programme of generous fellowships for expats—the “hundred talents programme”. Beijing has an office in Silicon Valley, and Shanghai has established a “human talent market”. China is littered with shiny new edifices labelled “returning-student entrepreneurial building”.

All this coincides with a change in the flow of people. For decades returnees were rare. The numbers began to shoot up in 2000, when the bursting of the Silicon Valley bubble coincided with rapid growth in China. Despite doubts about the quality of some of these people, there is growing evidence that China is going in the same direction as South Korea and Taiwan—first tempting back the diaspora (see chart 4) and then beginning to compete for global talent.

India has taken a different approach. The government has relied as much on the goodwill of prominent businesspeople as it has on the wisdom of bureaucrats; it has also cast its net wider, focusing not just on luring back expats but also on putting the wealth and wisdom of the diaspora to work on behalf of the mother country. There are an estimated 20m Indians living abroad, generating an annual income equal to 35% of India's gross domestic product. The Indian government is doing what it can, in its haphazard way, to let them participate in the Indian boom, making it easier for them to invest back home and streamlining visa procedures. There is a special visa for “people of Indian origin”.

All Things Considered

My collaborator A. Zee was interviewed about our paper Message in the Sky (see also here) on last Friday's broadcast of NPR's All Things Considered. Harris did a pretty good job of explaining the idea, but I think what most non-experts miss is that it is non-trivial to have a physical mechanism that can place an identical message so as to be readable by all advanced civilizations. Think of the causal structure of the Big Bang -- not all civilizations see the same patch of sky.

Note the pains taken to identify us as "serious" and "well-respected" physicists :^)


Scientists Propose Looking for Big Bang Messages

by Richard Harris

All Things Considered, October 7, 2006 · This year's Nobel Prize in physics went to two men who studied the afterglow of the Big Bang. Earlier this year, two very serious and well-respected physicists suggested that the afterglow should be probed even more carefully -- to see if it contains a message from a creator.

Recommended reading from The Economist

I have a little time to kill here at SFO, so I thought I'd make a quick post recommending three nice survey articles in recent issues of the Economist. Sorry if you can't get to some of these articles without a subscription.

Special report on virtual online worlds: Second Life, virtual economies; this is just the beginning.

Unlike other virtual worlds, which may allow players to combine artefacts found within them, Second Life provides its residents with the equivalent of atoms—small elements of virtual matter called “primitives”—so that they can build things from scratch. Cory Ondrejka, Linden Lab's product-development boss, gives the example of a piano. Using atomistic construction, a resident of Second Life might build one out of primitives, with all the colours and textures that he would like. He might add sound to the primitives representing the keys, so the piano could actually be played in Second Life. “Of course, since these are primitives, the piano could also fly or follow the resident around like a pet,” says Mr Ondrejka.

Because everything about Second Life is intended to make it an engine of creativity, Linden Lab early on decided that residents should own the intellectual property inherent in their creations. Second Life now allows creators to determine whether the stuff they conceive may be copied, modified or transferred. Thanks to these property rights, residents actively trade their creations. Of about 10m objects created, about 230,000 are bought and sold every month in the in-world currency, Linden dollars, which is exchangeable for hard currency. Linden Lab estimates that the total value (in “real” dollars) this year will be about $60m. Second Life already has about 7,000 profitable “businesses”, where avatars supplement or make their living from their in-world creativity. The top ten in-world entrepreneurs are making average profits of just over $200,000 a year.

Special report on credit markets: growth in private debt financing driven by hedge funds, credit derivatives; reduction in average vol, but systemic risk due to an untested system. Is it a classic story of risk diversification reducing vol and the cost of capital, or a gambling machine that might have a nonlinear meltdown?

Indeed, the market has changed so fast that regulators are not sure if it is spinning out of control. On one hand, innovations in the credit markets have helped to provide a remarkable period of stability in the world's financial system. In recent years, markets have lived through the end of the internet bubble, the collapse of Enron, the terror attacks of September 11th 2001, debt downgrades in the car industry and a stampede out of risky assets in May and June. Any one of these might once have triggered a financial crisis. But none did.

Cheap and liquid financing has enabled companies to make more efficient use of their balance sheets, potentially boosting returns to shareholders and allowing managers to concentrate on profits and cashflow. Despite the increased lending, banks have increased the cushions of capital that they rely on to be a safeguard.

On the other hand, as the debt and derivatives markets have grown out of all recognition, they have moved increasingly into the shadows. Regulators worry that some of the complex financial instruments conjured up around the lending and borrowing of money—worth trillions of dollars—may sow the seeds of the next financial crisis.

The credit markets are the motor for three of the big trends of the decade and some people find them unsettling. First, companies are raising more and more capital through privately issued loan instruments, as opposed to public equity—such as selling stocks or issuing bonds, which can be openly traded. Private deals are harder for regulators and ordinary investors to keep tabs on.

Second, the lending is increasingly being orchestrated from outside the regulated banking industry, by hedge funds and other credit investors that are often supervised only indirectly, if at all. These are especially big in the booming market for credit derivatives, which are also traded outside public exchanges.

Third, although some of this capital is available to public companies, such as Ferrovial, most of it is being gobbled up by leveraged buy-out firms, which use the money to buy public companies and remove them from the stockmarket.

Central bankers and supervisors increasingly worry about the risks to financial stability that may be lurking in the complex debt instruments dreamt up by the finance industry. One of their biggest concerns is how much danger there may be to regulated banks from the faceless institutions they now do much of their debt trading with: hedge funds.

Regulators are beginning to ask themselves whether hedge funds are adequately monitored through the supervision of the banking industry. Pressure is growing on the banks to deal sensibly with their trading counterparties. Equally, some question whether over-zealous supervision may have had the perverse consequence of driving business and finance away from the public eye.

Survey of world economy and emerging titans India and China. Very useful data and growth projections from Goldman. Note the difference between PPP and exchange rate comparisons of GDP; for these to converge in the next decades would require a big slide in the dollar vs. emergent currencies. Also note historic world GDP shares -- for 18 of the last 20 centuries world GDP was dominated by China and India, which accounted for (on average) 80% of the total.

LAST year the combined output of emerging economies reached an important milestone: it accounted for more than half of total world GDP (measured at purchasing-power parity). This means that the rich countries no longer dominate the global economy. The developing countries also have a far greater influence on the performance of the rich economies than is generally realised. Emerging economies are driving global growth and having a big impact on developed countries' inflation, interest rates, wages and profits. As these newcomers become more integrated into the global economy and their incomes catch up with the rich countries, they will provide the biggest boost to the world economy since the industrial revolution.

Indeed, it is likely to be the biggest stimulus in history, because the industrial revolution fully involved only one-third of the world's population. By contrast, this new revolution covers most of the globe, so the economic gains—as well as the adjustment pains—will be far bigger. As developing countries and the former Soviet block have embraced market-friendly economic reforms and opened their borders to trade and investment, more countries are industrialising and participating in the global economy than ever before. This survey will map out the many ways in which these economic newcomers are affecting the developed world. As it happens, their influence helps to explain a whole host of puzzling economic developments, such as the record share of profits in national income, sluggish growth in real wages, high oil prices alongside low inflation, low global interest rates and America's vast current-account deficit.

...Perhaps some of these countries should be called re-emerging economies, because they are regaining their former eminence. Until the late 19th century, China and India were the world's two biggest economies. Before the steam engine and the power loom gave Britain its industrial lead, today's emerging economies dominated world output. Estimates by Angus Maddison, an economic historian, suggest that in the 18 centuries up to 1820 these economies produced, on average, 80% of world GDP (see chart 2). But they were left behind by Europe's technological revolution and the first wave of globalisation. By 1950 their share had fallen to 40%.

Greetings from Pasadena

I'm at Caltech for a couple of days, giving a talk at the Institute of Quantum Information (slides are here). The weather is beautiful, and, judging by the screaming on campus last night, the tradition of frosh initiation is alive and well.

The Nobel prize in physics was awarded to Mather and Smoot for COBE (measurement of temperature fluctuations in the microwave background, confirming the big bang model of cosmology). When I was a grad student I had an office across the hall from Smoot's group at LBNL. They were moved at some point and some HET postdocs (including Raman Sundrum) inherited the nice view of the bay. Smoot used to drop by all the time to look out the windows and lament his loss. He told me that, contrary to rumor, he was not the Smoot used as a unit of length by MIT students to measure the Harvard bridge. (If you don't know what I'm talking about there is always Google.)

Finally, via Dave Bacon, a hilarious history of string theory by Peter Shor (of quantum factoring fame), which appeared as a review of Smolin's book on Amazon. Now string theorists can complain about how Shor is not smart enough to have an opinion on the subject, or understand what they are doing. (See further down the same page for Lubos' review.) Oh, and as pointed out elsewhere by Wolfgang, it was not Nature scamming the string theorists, but rather Mathematics masquerading as Nature ;-)

The string theorists were scammed!, September 25, 2006
Reviewer: Peter W. Shor (Wellesley, MA USA) - See all my reviews

The part of the book I found most interesting was the part which tells how the string theorists were scammed by Nature (or Mathematics). Of course, Smolin doesn't put it exactly like this, but imagine the following conversation.

String theorists: We've got the Standard Model, and it works great, but it doesn't include gravity, and it doesn't explain lots of other stuff, like why all the elementary particles have the masses they do. We need a new, broader theory.

Nature: Here's a great new theory I can sell you. It combines quantum field theory and gravity, and there's only one adjustable parameter in it, so all you have to do is find the right value of that parameter, and the Standard Model will pop right out.

String theorists: We'll take it.

String theorists (some time later): Wait a minute, Nature, our new theory won't fit into our driveway. String theory has ten dimensions, and our driveway only has four.

Nature: I can sell you a Calabi-Yau manifold. These are really neat gadgets, and they'll fold up string theory into four dimensions, no problem.

String theorists: We'll take one of those as well, please.

Nature: Happy to help.

String theorists (some time later): Wait a minute, Nature, there's too many different ways to fold our Calabi-Yao manifold up. And it keeps trying to come unfolded. And string theory is only compatible with a negative cosmological constant, and we own a positive one.

Nature: No problem. Just let me tie this Calabi-Yao manifold up with some strings and branes, and maybe a little duct tape, and you'll be all set.

String theorists: But our beautiful new theory is so ugly now!

Nature: Ah! But the Anthropic Principle says that all the best theories are ugly.

String theorists: It does?

Nature: It does. And once you make it the fashion to be ugly, you'll ensure that other theories will never beat you in beauty contests.

String theorists: Hooray! Hooray! Look at our beautiful new theory.

Okay, I've taken a few liberties here. But according to Smolin's book, string theory did start out looking like a very promising theory. And, like a scam, as it looks less and less promising, it's hard to resist the temptation to throw good money (or research) after bad in the hope of getting something back for your return. One of the questions Smolin addresses in the rest of the book is why the theoretical physics community has kept with string theory and largely abandoned all the other approaches to quantum gravity. The short answer is that it's hard to admit that you've been scammed. The long answer is much more complicated. Another thing Smolin addresses in the book is other approaches to quantum gravity. And as could be predicted, he gives lots of space to his own approach and too little space to others, especially Alain Connes' non-commutative geometry. But overall, I found it very worthwhile and entertaining, and a good explanation as to how theoretical physics came to be in the state it is today.

Strings in the New Yorker

I think the article, which discusses the new books by Woit and Smolin, is very fair, and it ends with a surprisingly mature recapitulation of the decoupling theorem and the irrelevance of quantum gravity to applied science. Every man, woman and child should read it and then ask their local particle theorist for more clarification.

I've read chunks of Smolin's book and it's quite good, although not without flaws. I have to go back and reread it -- I picked it up in a bookstore and couldn't put it down for at least an hour. I found his discussion of finiteness of string perturbation theory confusing -- he represents Mandelstam as saying one thing in the main text, but the email quoted in the footnotes doesn't seem to back it up. If the analytic continuation is the only problem then it's not on worse footing than many other results in theoretical physics. But, then, what have D'Hoker and Phong (and my grad school colleague Nathan Berkovits) been up to all this time? If I believed in string theory I'd have to spend some time sorting this all out.

...Today, more than a decade after the second revolution, the theory formerly known as strings remains a seductive conjecture rather than an actual set of equations, and the non-uniqueness problem has grown to ridiculous proportions. At the latest count, the number of string theories is estimated to be something like one followed by five hundred zeros. “Why not just take this situation as a reductio ad absurdum?” Smolin asks. But some string theorists are unabashed: each member of this vast ensemble of alternative theories, they observe, describes a different possible universe, one with its own “local weather” and history. What if all these possible universes actually exist? Perhaps every one of them bubbled into being just as our universe did. (Physicists who believe in such a “multiverse” sometimes picture it as a cosmic champagne glass frothing with universe-bubbles.) Most of these universes will not be biofriendly, but a few will have precisely the right conditions for the emergence of intelligent life-forms like us. The fact that our universe appears to be fine-tuned to engender life is not a matter of luck. Rather, it is a consequence of the “anthropic principle”: if our universe weren’t the way it is, we wouldn’t be here to observe it. Partisans of the anthropic principle say that it can be used to weed out all the versions of string theory that are incompatible with our existence, and so rescue string theory from the problem of non-uniqueness.

...Neither Smolin nor Woit calls for the forcible suppression of string theory. They simply ask for a little more diversity. “We are talking about perhaps two dozen theorists,” Smolin says. This is an exceedingly modest request, for theoretical physics is the cheapest of endeavors. Its practitioners require no expensive equipment. All they need is legal pads and pencils and blackboards and chalk to ply their trade, plus room and board and health insurance and a place to park their bikes. Intellectually daunting as the crisis in physics may be, its practical solution would seem to demand little more than the annual interest on the rounding error of a Google founder’s fortune.

“How strange it would be if the final theory were to be discovered in our own lifetimes!” Steven Weinberg wrote some years ago, adding that such a discovery would mark the sharpest discontinuity in intellectual history since the beginning of modern science, in the seventeenth century. Of course, it is possible that a final theory will never be found, that neither string theory nor any of the alternatives mentioned by Smolin and Woit will come to anything. Perhaps the most fundamental truth about nature is simply beyond the human intellect, the way that quantum mechanics is beyond the intellect of a dog. Or perhaps, as Karl Popper believed, there will prove to be no end to the succession of deeper and deeper theories. And, even if a final theory is found, it will leave the questions about nature that most concern us—how the brain gives rise to consciousness, how we are constituted by our genes—untouched. Theoretical physics will be finished, but the rest of science will hardly notice.

Managing expectations

Kindler, gentler hedge fund manager Barry Ritholz writes about the Amaranth blowup. He puts some of the blame on investors, for not understanding that Amaranth had to be taking huge risks to generate recent outsized returns. The way the game is structured, managers are incentivized to describe their strategy and expected returns as follows:

"We expect gains of 35-45%, with minimal risk or leverage. Our black box algorithms have been backtested, and generate better numbers than that, but we would rather under-promise and outperform."

Before you roll your eyes, hear me out on this. I have some very specific experience with this, as I have spent the past 18 months or so traveling around the United States, speaking with my limited partners (i.e., investors) and with potential investors for our hedge fund.

My experience with this is why I have been watching the unfolding debacle at Amaranth Advisors’ with some bemused detachment.

Now, without revealing any specifics, I will tell you we have had conversations with some very intelligent people who were a pleasure to meet with; Brilliant, fascinating, successful folk with interesting lives and of great accomplishment. However, once we sat down with their financial advisors - lawyers - accountants, things became, well, repetitious. In every meeting, there were some variations on the same conversations; Its like there is some hedge fund due diligence form that makes everybody ask nearly identical questions:

What's your track record? (Good)
How much skin do you have in the game? (alot)
How is Alpha generated (our models keep us on the right side of the major trend, and avoid big counter-trend moves)
What do you think will happen to the economy and the market?
(I don't know, but here's an underappreciated possibility . . .)
What is your Gamma ? Sharpe Ratio? (I neither know nor care; This isn't a B-school exam)

Then comes the exact same question, which I (foolishly) answer honestly:

"What sort of performance are you looking for?"

I usually start with: "It depends upon what the market offers us; If we remain range-bound, it will be difficult to put up great numbers without a lot of leverage or a lot of risk (or both), and we don't do that. We do particularly well, however, in major dislocations or strong rallies."

My initial answer is rarely accepted, and I am forced to go to a 2nd and 3rd option:

"Give us more details on what you want to do. What performance would you be happy with?"

Answer two: "What we want is irrelevant; Its what we can reasonably do while still managing risk, and not overleveraging. Our goal is to outperform the S&P500 with less risk, and in the event the SPX is negative, still have positive expectancy (i.e., be up when the indices are down)."

"So you are a relative (rather than absolute) performance fund?"

Answer 2b: "Well, most funds actually are, despite their claims of absolute performance regardless of market conditions. Consider the mediocre performance numbers from most funds recently when the market's been range-bound. Its been pretty weak, and that's no coincidence. There are only a handful of true absolute performance funds with great long term track records (and if you are talking to me, its because you cannot get into them)."

Now comes THE QUESTION. This is the one that gets people into trouble:

"We are looking for a number. What should we expect from you in the first 2 years?"

What they want to hear is "I am going to do 30-40% annually, fully hedged."

I don't say that, because it isn't true. (God bless Jim Simons, who actually can honestly say that). That's what too many investors are looking for; its nothing more than the greed factor at work. They don't say it explicitly, but its true: We want you to outperform the long term S&P500 benchmark by 300-400% annually (and we don't care about mean reversion). We really don't care how you do it. We want outsized profits. WE WANT THE LATE 1990S AGAIN.

Money raisers and some GPs have long ago figured this out. You have a few choices: you can answer the investors' questions honestly -- or to quote Ray Davies, you can give the people what they want (or think they want):

"We expect gains of 35-45%, with minimal risk or leverage. Our black box algorithms have been backtested, and generate better numbers than that, but we would rather under-promise and outperform."

Of course, that statement will be nonsense for 99.8% of the people who utter it. The vast majority of funds will not out-perform the indices dramatically year after year. We were fortunate -- we ended up with investors who understood this; Then again, we are a small fund, and not a $9B giant.

There are some funds that aim to fill this niche. They use lots and lots of leverage, play the highest beta moves, load up on derivatives, put up good numbers for a stretch. Eventually, they do one of two things: They take on some risk management -- lower their volatility plays, reduce leverage, aim for more sustainable gains.

Or they blow up.

Not all of them, but enough. Something like 25% of all hedge funds every couple of years dissolve, go away, reform, pop up elsewhere. That's not a coincidence, either.