Doing due diligence on Galleon

By Felix Salmon
November 7, 2009
Sam Jones's article about investors who did due diligence on Galleon and decided to stay away, but I think it raises a number of silly ideas which ought to be put to rest.

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I’m late to Sam Jones’s article about investors who did due diligence on Galleon and decided to stay away, but I think it raises a number of silly ideas which ought to be put to rest.

First, it’s worth noting that, ex post, this kind of exercise can be done on any hedge fund. The vast majority of hedge-fund investors, and all big ones, do some kind of due diligence before investing in a fund. There’s no such thing as a fund which receives investments from everybody who does due diligence on it. Therefore, for any fund which fails, there is going to be a certain number of investors who did due diligence on it and who didn’t invest. The same is equally true, of course, for any fund which succeeds.

What’s more, the reasons given for not investing in Galleon are so weak and vague as to be all but substance-free:

“Crudely, there are three ways to make money as a hedge fund manager,” said one large multi-billion dollar asset manager.

“You can take advantage of trading technology, but few do. You can be more intelligent than others, but few are.

“Or you can have some specialised source of sustainable information. Unless that information is from fundamental analysis – and in Galleon’s case it did not all seem to be – then that’s a red flag for us.” …

“People mistake wealth for intelligence,” according to one investor.

“No one pretended Raj [Rajaratnam] was a brilliant stock analyst – he was just extremely well connected.

“And he always made that known.”

Both investors accept unquestioningly that there’s some kind of a correlation between intelligence and alpha — despite a long history of extremely smart guys blowing up, and despite the fact that no one has come close to empirically demonstrating any such correlation. On top of this dubious correlation, they then layer the assertion that Raj Rajaratnam wasn’t actually all that smart. How would they know?

What’s more, if being extremely well connected is grounds for suspicion when choosing money managers, that would probably disqualify pretty much every single Silicon Valley venture capitalist.

It’s not even clear that investors who steered clear of Galleon were smart in hindsight, for all this self-congratulatory slapping of their own backs:

Investors that did put their money in Galleon, however, can take comfort from the fact that, by and large, the companies funds’ are highly liquid and are unlikely to suffer losses as a result of unwinds.

The good thing about investing in a fund which makes large short-term bets on individual stocks is that such bets are unlikely to be crowded trades which suffer enormous losses when everybody tries to exit at once. Anybody who invested in Galleon received healthy returns over the length of their investment, and got out unbloodied at the end. The principals won’t be as lucky, of course, but the investors have nothing to regret.

(HT: Manham)

One comment

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Felix – you are as bad as them!
You can’t give smart guys blowing up as evidence that there is no correlation between intelligence and alpha; even worse when you link to just one example.

Plenty of funds blow up, the question is whether a disproportionate number of smart funds blow up relative to dumb funds.

More interesting would be the Nobel prize you would win for achieving a useful definition of “intelligent”.

Posted by Tiny Tim | Report as abusive