Day 138 in MIT Sloan Fellows Class 2023, Financial Market Dynamics and Human Behavior 5 - "Hedge fund"
Hedge fund
Hedge fund is the unique and interesting player to help you understand the physics of Adaptive Market Theory.
Hedge fund:
- Pools capital from investors.
- Uses diverse strategies for high returns.
- Charges performance and management fees.
- Key role in the financial industry
- During normal times, "tip of the spear"
- During hard times, canary in the coalmine
- As unregulated entities, hedge funds innovate rapidly
- Due to leverage, hedge funds have disproportionate impact on markets
Hedge fund vs. Venture Capital (VC):
Hedge fund: invests in diverse assets, including public markets.
VC: invests in early-stage, high-growth startups.
Hedge fund vs. Private Equity (PE):
Hedge fund: short-term trading, complex strategies, higher liquidity.
PE: long-term investments, operational improvements, leveraged buyouts.
Hedge fund vs. Bank:
Hedge fund: investment focus, risk-seeking, caters to high net worth clients.
Bank: provides loans, deposits, payment services, caters to diverse clients.
Hedge fund vs. Broker:
Hedge fund: actively manages investments, takes risks for higher returns.
Broker: facilitates transactions, earns commissions, does not manage investments.
Galapagos Island of Finance
Why does evolution occur so rapidly among hedge funds?
- Relatively low barriers to entry and exit
- High levels of compensation(stakes are high)
- Competition and adaptation are extreme
- New "species" are coming and going constantly
- Strategies wax and wane over time:
- credit strategies are waxising
- Dedicated short bias is waning
- Empirical evidence for adaptive markets hypothesis
Legendary hedge funds
George Soros:
George Soros, the "Man Who Broke the Bank of England," founded Soros Fund Management in 1970. Born in Hungary, Soros survived the Nazi occupation before emigrating to England, where he studied at the London School of Economics. A brilliant investor, Soros has a unique ability to identify macroeconomic trends and profit from them. His most famous anecdote is the 1992 Black Wednesday event when he bet against the British pound, forcing the UK to withdraw from the European Exchange Rate Mechanism. Soros made over $1 billion in profit within a day, solidifying his reputation as a legendary investor. His investment philosophy, combining macroeconomic analysis with market trends, has helped him navigate complex market conditions and consistently generate high returns.
James H. Simons:
James Simons, a gifted mathematician and former codebreaker for the US government, founded Renaissance Technologies in 1982. With a background in academia, including a professorship at MIT, Simons had a unique perspective on finance. He pioneered quantitative trading, using complex mathematical models and algorithms to make investment decisions. The Medallion Fund, the firm's flagship, has become one of the most successful hedge funds in history, with annualized returns of over 66% before fees since 1988. An interesting anecdote from Simons' career is his decision to hire scientists, mathematicians, and even astronomers, rather than traditional finance professionals, to build and refine his quantitative models. This unusual approach and the secretive nature of Renaissance Technologies have contributed to the firm's outstanding performance and legendary status in the finance world. His fund never become the size over $5B because he knows the maximum capacity to keep his investment performance and prioritize performance over the size.
Day 137 in MIT Sloan Fellows Class 2023, Choice point 7 "CASABLANCA"
Story
Casablanca is a 1942 American romantic drama film directed by Michael Curtiz and starring Humphrey Bogart, Ingrid Bergman, and Paul Henreid. Set during World War II, the story revolves around the complex relationships between the characters and the political atmosphere in Casablanca, Morocco.
Rick Blaine (Humphrey Bogart) is an American expatriate who owns a popular nightclub and gambling den called "Rick's Café Américain" in Casablanca. Rick is a cynical, mysterious figure who maintains a neutral stance towards the political conflicts surrounding him. However, his life takes a turn when his former lover, Ilsa Lund (Ingrid Bergman), arrives in Casablanca with her husband, Victor Laszlo (Paul Henreid), a Czech resistance leader.
Ilsa and Rick had a passionate love affair in Paris, but Ilsa abandoned Rick without explanation on the day the Nazis invaded the city. The two lovers are unexpectedly reunited in Casablanca, and their old feelings for each other resurface. Ilsa and Victor are in Casablanca to obtain exit visas to escape to America, where Victor can continue his work against the Nazis. They need Rick's help to obtain the visas, but the situation becomes complicated due to Rick's unresolved feelings for Ilsa.
As the story unfolds, Rick must confront his past and make difficult choices that will determine the fate of the people he cares for, including Ilsa and Victor. The film is renowned for its memorable lines, emotional performances, and its exploration of themes such as love, sacrifice, and the struggle between personal desires and the greater good.
Casablanca has become a classic of American cinema, and its iconic final scene at the airport, along with the famous line, "Here's looking at you, kid," has left a lasting impact on popular culture.
Rick's growth
Decisions and responsibility
The nature of choice and responsibility: The movie drives home Joan Didion's point that the things worth having in life come at a cost. They require us to put ourselves out there and risk something of ourselves. They require us to weigh our immediate personal interests and comforts against our deeper, more intangible values and commitments.
Rick couldn't ignore the reality that to maintain his "isolationist" policy—to stay on the sidelines and not help Victor to safety—would be to help the side of the Nazis. The film helps us see that choosing not to get involved in some situations can be a choice with profound consequences, whether we like it or not. Self-respect, as Didion tells us comes from being honest with ourselves about the agency we have and the likely consequences of our decisions. Reflect one's emotions and be authentic against this, you can make a decision without regret.
Power of love
Our love and respect for other human beings—for their safety, their health, their basic freedom—can, if we allow it, be a powerful guidepost in life’s key choice points. The film suggests that without a capacity and openness for human attachment, we have no foundation for a political and moral consciousness. When Rick isolated and shielded himself from personal attachments at the start of the movie, his political, moral consciousness was also suppressed.
As we followed Rick's journey through this story, however, we saw that what brought him back into the political fight was his willingness to open himself back up to love, to see his life and fate as connected to that of others. He was moved by the love the Bulgarian woman had for her husband, by the love he saw Victor had for Ilsa, and by the love Rick himself felt for Ilsa and the love he knew Ilsa felt for both him and Victor. In short, the process of opening himself back up to human attachments and personal connections seemed to be a necessary foundation for his moral, political reawakening.
Day 136 MIT Sloan Fellows Class 2023, M&A and PE 10 "Technical M&A by PE"
How we should evaluate technical capability in M&A from PE perspective? Is there enough room to improve? How was the price? Over-pricing or underestimated?
We reviewed three acquistion targets, Seagate-Hard drive manufacturers, McAfee, and Twitter. From those cases, we will find out the characteristics of LBO in the hardware, software and social media industries.
Analysis
- Pros: Stable cash flow, suitable for servicing debt. Low EV/EBITDA multiple, potentially undervalued.
- Cons: Low growth, low margin business, limiting value creation potential. High R&D, depreciation, and CapEx, reducing free cash flow. High competition, posing risks to market share and profitability. Existing 40-50% debt level, limiting additional leverage capacity.
- Pros: Growing cash flow and predictable revenue from the subscription model. Low debt level (10-20%), allowing for additional leverage. Top brand in the security industry.
- Cons: High EV/EBITDA multiple, making it expensive to acquire. High R&D cost. Risk to lose significant share if it loses relationship as OEM.
- Pros:Strong user base and network effect. Exponential growth potential.
- Cons: Extremely high EV/EBITDA multiple and high market value, making it expensive to acquire. Uncertainty from privacy regulation. Fluctuating revenue, posing challenges to debt servicing. Lower monetization power compared to Facebook. Struggles with average revenue per user (ARPU).
Industry characteristics and recommendation
Hardware
- Pros: Stable cash flows and potentially undervalued firms.
- Cons: Low growth, high competition, high capital expenditure, and existing debt levels. Also reliance on supply chain network.
- Recommendation: PE should be cautious when targeting hardware companies, focusing on those with strong competitive advantages and operational improvement opportunities.
Software
- Pros: Growing cash flows, predictable revenues, and low capital expenditure.
- Cons: High valuations, potentially limiting LBO returns. Reliance on OEM network.
- Recommendation: PE should target software companies with strong subscription models and value creation potential, while being mindful of high valuations.
Social network
- Pros: Strong user bases, network effects, and growth potential.
- Cons: High valuations, fluctuating revenues, and monetization challenges. Privacy concerns.
- Recommendation: PE should be cautious when targeting social network companies, considering the high valuations and risks associated with fluctuating revenues. Firms with strong monetization strategies and growth potential may present opportunities.
Day 135 MIT Sloan Fellows Class 2023, The art of leading 2 "Kegan: stages of development"
Constructive Developmental Theory
Today, we learned about how to relate with people and demonstrated some exercise to equip us with some frameworks in practice.
Kegan's developmental theory is a framework that describes how individuals develop their sense of self and cognitive abilities throughout their lives. It outlines four mindsets or stages of development that individuals can progress through.
Four different stages and pros/cons
- Instrumental Mindset: In this mindset, individuals see the world as a set of external objects to be used for their own purposes. They tend to focus on their own needs and desires, and have a limited ability to understand the perspectives of others. "It's all about me"
- Pros: Individuals in this mindset can be very task-oriented and efficient at achieving their goals.
- Cons: This mindset can lead to a lack of empathy and an inability to understand the impact of their actions on others.
- Useful situation: This mindset can be useful in situations where a task or project requires a high level of efficiency and focus on achieving specific outcomes, such as in a manufacturing or production setting.
- Socialized Mindset: In this mindset, individuals begin to see themselves as part of a larger social system, and understand that their actions have an impact on others. They prioritize the needs and expectations of the group over their own desires, and conform to the social norms and expectations of their community. "I am my relationships" mindset.
- Pros: Individuals in this mindset are good at collaborating with others and working towards shared goals.
- Cons: This mindset can lead to conformity and a lack of independent thinking, as individuals may not challenge social norms or question the status quo.
- Useful situation: This mindset can be useful in situations where teamwork and collaboration are essential, such as in healthcare settings or community organizations. Team sports are typical
- Self-authoring Mindset: In this mindset, individuals begin to develop a more independent sense of self and take responsibility for their own values and beliefs. They can evaluate their own thoughts and actions and make decisions based on their personal principles, rather than conforming to external expectations. "I am the auther of my story" mindset
- Pros: Individuals in this mindset are able to think independently and take ownership of their actions and decisions.
- Cons: This mindset can lead to a sense of isolation or detachment from the larger social context, as individuals may prioritize their own needs and values over the needs of the group.
- Useful situation: This mindset can be useful in situations where individuals need to take initiative and make decisions based on their own values and beliefs, such as in entrepreneurship or artistic endeavors.
- Self-transforming Mindset: In this mindset, individuals are able to view their own beliefs and values as subject to change and transformation over time. They can hold multiple perspectives and integrate different ways of thinking into their worldview.
- Pros: Individuals in this mindset are able to adapt and change their thinking as they encounter new experiences and ideas.
- Cons: This mindset can lead to a lack of certainty or stability in one's beliefs and values, as individuals may be constantly revising and adapting their worldview.
- Useful situation: This mindset can be useful in situations where individuals need to be adaptable and open to new ideas and perspectives, such as in research or academic settings.
Exercises
We did four exercises to experience the four mindsets. First, we played a game where we walked towards our destination in a circle while passing by others. We focused on ourselves for two minutes. Then, we played a game where we mimicked the actions of the person in front of us without looking back. As the circle rotated, leadership changed hands. Next, we formed a circle and took turns mimicking each other's gestures. Unlike the second game, everyone had an equal turn, and the person making the gesture could observe the reaction of others. Finally, we practiced the self-transforming mindset by playing a game where we made forest sounds quietly for two minutes and gradually increased the volume before decreasing it back to silence.
Then, we reflect what we thought and how we behave in each activity. We discuss pros and cons of each mindset and deeply understand which situation we should demonstrate each leadership style.
Day 134 MIT Sloan Fellows Class 2023, M&A and PE 9 "LBO modeling"
LBO modeling
Leveraged Buyout (LBO) modeling is a key tool used by private equity (PE) firms to evaluate the potential acquisition of a company using a significant amount of debt. The goal is to achieve high returns by using leverage, improving the target company's operations, and eventually exiting the investment through a sale or public offering. Here's a step-by-step guide to the LBO modeling process:
- Sourcing the target company:
The first step is to identify a suitable target company with strong cash flows, manageable debt levels, and potential for operational improvement. Criteria may also include industry trends, competitive positioning, and growth potential. - Developing the transaction assumptions:
Private equity firms need to make key assumptions about the deal, including the purchase price, transaction structure (debt and equity mix), and financing sources (senior debt, subordinated debt, mezzanine financing, or equity). These assumptions will influence the model's output and must be based on market conditions, target company fundamentals, and investor preferences. - Building the historical financial statements:
Construct the target company's historical financial statements, including the income statement, balance sheet, and cash flow statement. This will provide a foundation for forecasting the company's future performance and help identify trends and areas for operational improvement. - Forecasting future financial performance:
Using the historical financial statements as a starting point, forecast the target company's financial performance for a period of 5-7 years. Key assumptions will include revenue growth, margin improvements, working capital requirements, capital expenditures, and taxes. - Determining the appropriate capital structure:
Based on the transaction assumptions, determine the target company's new capital structure, which will include the debt and equity mix used to finance the acquisition. Consider factors such as debt serviceability, interest coverage, and credit ratings when deciding on the debt levels. - Modeling the debt repayment schedule:
Develop a debt repayment schedule based on the terms and conditions of the debt facilities, including interest rates, amortization, and maturity. This will affect the target company's cash flows and the private equity firm's return on investment. - Calculating the free cash flow to equity (FCFE):
Calculate the free cash flow to equity, which is the cash flow available to equity investors after accounting for all operational expenses, taxes, capital expenditures, and debt service. This is a crucial metric to assess the target company's ability to service its debt and generate returns for equity investors. - Estimating the exit value:
To determine the potential return on investment, private equity firms need to estimate the target company's exit value at the end of the investment horizon. This can be done using valuation multiples (such as EV/EBITDA) or the discounted cash flow (DCF) method. - Calculating the internal rate of return (IRR) and cash-on-cash multiple:
Using the FCFE, exit value, and initial investment, calculate the internal rate of return (IRR) and cash-on-cash multiple. These metrics are used to evaluate the attractiveness of the investment and compare it to other potential opportunities. - Sensitivity analysis:
Perform sensitivity analysis on key assumptions to understand the impact of changes in variables such as purchase price, growth rates, and exit multiples on the investment's IRR and cash-on-cash multiple. This helps identify potential risks and opportunities in the investment.
Operating Projection example
Important points
- What is the improvement opporunities? growth? margin?
Sources and Uses of funds
Simple LBO projection
After paying down debt, what is the debt and EV at exit date?
- Paydown
- EV/EBITDA multiples
- Net value for PE funds
The only two variables you need to use.
- Ending Net debt at exit date
- EBITDA at exit date
Exit Value Information
Day 133 in MIT Sloan Fellows Class 2023, Financial Market Dynamics and Human Behavior 4 - "Evolution, the origin of behaviour"
Adaptive behaviour
Modern sharks appeared 100m years ago. In all the races, the great white charks are number one.
The great white shark (Carcharodon carcharias) is an incredible testament to the power and adaptability of nature's apex predators. As the largest predatory fish on the planet, great white sharks can reach lengths of up to 20 feet and weigh over 2.5 tons, with their sheer size and strength allowing them to dominate the ocean's vast ecosystems.
Their remarkable strength is due in part to their powerful, streamlined bodies, equipped with a cartilaginous skeleton that makes them incredibly agile and flexible. This anatomical advantage, combined with their torpedo-shaped form, allows great white sharks to reach speeds of up to 15 miles per hour. These powerful swimmers are also known for their impressive leaps out of the water, known as breaching, which they use to ambush and capture their prey.
Great white sharks have evolved to become highly adaptable predators, able to thrive in a variety of marine environments. They can be found in coastal waters, open oceans, and even the frigid waters of the Arctic and Antarctic. Their ability to regulate their body temperature, through a process called regional endothermy, enables them to survive in a wide range of water temperatures, from the tropical seas to the colder waters of higher latitudes.
Great white sharks also boast an extraordinary sensory system, which helps them navigate and adapt to their environment. Equipped with keen eyesight and an exceptional sense of smell, they can detect even the slightest traces of blood in the water from miles away. Additionally, they possess electroreceptors called ampullae of Lorenzini, which allow them to sense the electrical signals emitted by the muscles and nerves of their prey.
Despite their remarkable adaptability and strength, great white sharks are vulnerable in certain environments, particularly in shallow waters near beaches. In these areas, they are at a higher risk of encountering humans, often leading to conflict and negative consequences for both parties. Human activities such as fishing, boating, and swimming can inadvertently result in shark encounters or entanglement in fishing gear, which can lead to injury or even death for the shark.
Furthermore, great white sharks are slow to mature and have a low reproductive rate, making their populations susceptible to decline due to human activities such as overfishing and habitat degradation. As a keystone species, the health of the great white shark population is crucial for maintaining balance in the marine ecosystem. Therefore, it is essential to promote conservation efforts and responsible human interactions with these magnificent creatures to ensure their continued survival in our world's oceans.
The environment matters
The environment is always stable? No. We know the most disruptive ones which replace the dictators at that era, dinosaurs, with mammals.
The Chicxulub impactor and volcanic activity during the late Cretaceous period were cataclysmic events that dramatically reshaped life on Earth, leading to the extinction of approximately 75% of all species, including the non-avian dinosaurs. These catastrophic phenomena disrupted the planet's ecosystems and altered the course of evolution, forever changing the face of our world.
The Chicxulub impactor was an asteroid or comet measuring approximately 6 to 9 miles in diameter, which collided with Earth around 66 million years ago. The impact released an immense amount of energy, equivalent to billions of atomic bombs, creating a colossal crater over 110 miles wide and 20 miles deep. This massive collision triggered fires, tsunamis, and earthquakes, annihilating countless lifeforms and habitats.
In addition to the immediate devastation, the Chicxulub impactor's aftermath created a global "nuclear winter" effect. The collision ejected massive amounts of debris, dust, and sulfur into the atmosphere, blocking sunlight and dramatically cooling the planet for an extended period. This sudden temperature drop had devastating consequences for the planet's flora and fauna, as it disrupted the delicate balance of ecosystems and led to a massive loss of plant life, which in turn caused a collapse in the food chain.
Around the same time, intense volcanic activity was taking place in present-day India, where the Deccan Traps were formed. These massive volcanic eruptions released enormous quantities of lava, covering thousands of square miles, along with vast amounts of greenhouse gases, ash, and aerosols. This volcanic activity further exacerbated the planet's environmental upheaval, contributing to climate change, acid rain, and prolonged darkness.
The combined effects of the Chicxulub impactor and volcanic activity created an inhospitable environment for many species, including the dinosaurs. Unable to adapt to the drastically altered climate and diminished food sources, the once-mighty dinosaurs, along with many other species, succumbed to extinction. This catastrophic chain of events cleared the way for the rise of mammals and, eventually, the emergence of human beings, forever transforming the trajectory of life on Earth.
Key things for adaptation is
- Diversity of traits
- Selection of traits
- Heredity of traits
Mutation introduces diversity and sexual reproduction speeds up evolution.
Human evolution
Human evolution was transformed by tool invention, symbolic thought, and language. These milestones allowed our ancestors to access new resources, communicate, and think abstractly. Today, human evolution progresses at the speed of thought due to our ability to think abstractly.
Tools opened new possibilities for early hominids, like Homo habilis. Later, Homo erectus made hand axes, and Neanderthals and Homo sapiens crafted refined tools. This paved the way for advanced technologies.
Symbolic thought emerged 40,000 to 50,000 years ago. Early humans created art and adornments, showcasing complex thought and communication. This facilitated social structures and cultural practices.
Language revolutionized human evolution. It enabled knowledge-sharing, collaboration, and collective wisdom. Intentionality, or understanding others' thoughts and actions, developed, vital for cooperation and social cohesion.
These developments led to a cognitive explosion. Rapid advancements in technology, culture, and society followed. Human evolution now moves at the speed of thought, driven by abstract thinking.
Evolutionary forces can explain many human behaviors, such as altruism, fairness, group selection, and social customs. These traits are deeply rooted in our evolutionary history and help shape modern human society.
And then, probability matching would be the best strategy from survival of races not from survival of individual perspective.
Day 132 MIT Sloan Fellows Class 2023, ChatGPT 1 "The Impending Training Data Shortage in the ChatGPT Era: Challenges and Consequences""
The ChatGPT era has revolutionized artificial intelligence and language processing, but with these advancements comes a new set of challenges. One of the most pressing concerns is the future shortage of training data. In this article, we'll explore the implications of this issue, examining the imbalanced dataset, the decreasing incentive to generate data, and the homogenization of decision-making. We will use the example of restaurant recommendations to illustrate these points.
Shortage of Training Data Will Happen in the Future
As the use of AI models like ChatGPT continues to grow, the need for diverse and accurate training data becomes more critical. However, several factors contribute to a future shortage of such data, including imbalanced datasets, reduced incentives to generate new data, and homogenized decision-making.
- Imbalanced Dataset: Shortfall of Tasting, Smelling, and Touching Data
AI models like ChatGPT face an imbalance in datasets, particularly in the areas of tasting, smelling, and touching. While there is a wealth of data related to sight and sound, information on the other three human senses is far less abundant. This deficiency impacts the model's ability to generate well-rounded recommendations based on all five human senses, limiting the user experience. - Less Incentive to Generate Data: No One Believes Influencers, but ChatGPT
In the ChatGPT era, there's a reduced incentive for individuals to generate and share their opinions. People increasingly rely on ChatGPT for advice and decision-making, placing less trust in influencers or experts. This reliance on AI not only decreases the amount of new data available for training but also narrows the range of opinions and experiences that can be used to improve the model. - Homogenous Choice in Decision Making: ChatGPT's Influence
As more people turn to ChatGPT for advice, they tend to make similar decisions based on the AI's suggestions, resulting in a homogenization of decision-making. This narrows the spectrum of experiences and data, as people are less likely to venture outside the model's recommendations.
Example: Restaurant Recommendations
The aforementioned challenges become apparent in the context of restaurant recommendations. An imbalanced dataset means that ChatGPT may not consider factors like ambiance, aroma, or tactile elements of a dining experience when suggesting a restaurant. Meanwhile, the diminishing influence of food critics and influencers leads to less diverse and less accurate recommendations. Lastly, the homogenization of decision-making results in diners flocking to the same establishments based on ChatGPT's suggestions, leaving less popular or undiscovered restaurants out of the equation.
Conclusion
The ChatGPT era has undeniably brought about significant advancements in the AI landscape. However, the potential shortage of training data, imbalanced datasets, and the shift towards homogenous decision-making have surfaced as notable challenges. To address these issues and ensure the continued growth and improvement of AI models like ChatGPT, it is essential to invest in diverse data collection, encourage user-generated content, and promote a culture of open-mindedness and curiosity. By doing so, we can work towards a future where AI is not only more powerful but more representative of the diverse human experiences it seeks to emulate.
