Review: Drobney’s “The Invisible Hands”

I haven’t quite gotten used to reading on the iPad just yet, preferring the feel of a book in my hand despite spending at least an hour on the iPad scanning Flipboard and the like each day. With that backdrop, I finally finished the first book I loaded onto the iPad about 18 months ago – which is Steven Drobny’s 2010 book: The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money

If you are a pension fund or endowment investment manager, this is a must-read. The key concept of the book is the concept of “real money,” which Drobny explains as the money institutional firms like pensions and endowments access to do real things with (like pay out benefits and build classrooms and pay the electric bill).  They invest that real money in stocks, bonds, and more recently hedge funds – and therein lies a problem which Drobny explores. His view is that those in charge of investments for such “real money” shouldn’t just be looking for the best performance regardless of risk and ignorant of liquidity and correlation with the general market and economic cycles (hardly a novel idea, but one which was surprisingly ignored up to the 2008 crisis).

The investment should be tailored to what the real money needs are, not the other way around with the performance of the investment dictating what can be done with the real money.

He explains the issue well in a TradingMarkets.com interview

“… What got me interested was that, post-2008, when these funds lost a staggering amount of money, and it started to effect the underlying entities they were set up to support.”

“So for example university endowments lost so much money that the actual university had to fire people, turn down the thermostats, cut financial aid, etc. In Boston, Harvard had to stop construction projects.”

“And then in the pension world, you saw forced selling of privates, you saw the contributions provided by states and municipal entities increase, which caused them to cut teachers, cut police, cut firefighters. So all of a sudden you had the tail wagging the dog, just because of investment performance.”

Drobny goes on to highlight (anonymously) some global macro managers who did well during the 2008 crisis, and without explicitly doing so makes a good case for managed futures with their liquidity and crisis period performance, by criticizing the move of the real money crowd into illiquid, stock market mimicking private equity funds.

As an aside – I was actually chatting up the President of my wife’s college about it a few weeks ago. I was telling her about the book and the lesson to avoid the liquidity trap –  which infamously befell endowments during the 2008 crisis because they were all heavily invested in private equity and hedge funds (which proved to be a lot more correlated to stock prices than they had previously appeared to be).

She had an interesting insight – that liquidity for a college endowment isn’t as simple a concept as it may seem, because much of the money given to such endowments comes with strings attached. Rich Aunt Jenny may give a few million which is to only be used to fund scholarships for budding botanists, for example. Or perhaps Grandpa Joe may donate his millions specifying they only be used to build a new philosophy wing in his name.  The point is, a lot of the money in an endowment is earmarked in one way or another – making it difficult to simply move money around to where it is needed. This little inside info on the inner workings of endowments just makes the point that much stronger – that endowments are real money funds, which need access to that money on a regular basis; meaning loading up on illiquid investments might not match your plans.