Thursday, January 27, 2011

Rich Economists: "Paul Samuelson's Secret"

We've looked at Keynes in "Keynes The Money Manager" and "John Maynard Keynes: Money Manager (Couldn't Trade Lard to Save His Life)".

We saw David Ricardo's Golden Rules of investing in "Investing Tips from the World's Richest Economist" and "HOW THE RICHEST ECONOMIST IN HISTORY GOT THAT WAY"

Today we'll look at Nobel Laureate Paul Samuelson. From
The last two volumes of Paul Samuelson’s collected papers appeared this month, edited by Janice Murray, his assistant for twenty years. As far as I can tell, the only mention of Commodities Corp. to be found anywhere in the seven volumes appears in the final one, in the last serious piece he ever wrote, which appeared originally in Volume 1 of Annual Review of Financial Economics, two years ago, at a time when PAS knew full well he was slipping out the door.  (He died in December 2009.)

“I skip here my long years as activist charter investor and Board of Directors member for Commodities Corporation of Princeton,” he writes in “An Enjoyable Life Puzzling over Modern Finance Theory.”  “Space does not allow me to go into that intricate story.”

Somewhere, in the letters, perhaps, or in interviews with various colleagues that were taped and tucked away, further details of a great case study may be waiting for a scholar. Then again, maybe not.  Samuelson left his share of loose ends. Reflections on his  role in Commodities Corp. may be among them.

A good thing, therefore, that in the meantime we have “Paul Samuelson’s Secret,” chapter three in More Money Than God: Hedge Funds and the Making of a New Elite, Sebastian Mallaby’s very interesting book about the origins and recent history of the hedge fund industry.

It turns out that the great MIT economist was influential in the creation of one of the earliest and most influential hedge funds. Launched in 1970, Commodities Corp. blazed a trail of extremely high returns throughout the 1970s and early ’80s, before disappearing in various pieces into Bermuda mailboxes and Goldman Sachs.  Many of its star traders – Bruce Kovner of Caxton and Paul Tudor Jones, chief among them—formed successful hedge funds of their own. Samuelson thus had a ringside seat at the birth of an influential industry that is still only poorly understood.

About the same time, he invested a substantial amount in shares of Warren Buffet’s Berkshire Hathaway Inc. It was in 1970, too, that he won the Nobel prize in economics, the second to be awarded. Long famous for the fortune that his pioneering textbook earned him after 1948, it turns out that Samuelson may have made more money as an investor than as an author. He was both smarter and richer than is generally understood: as an investor, a bigger winner, perhaps, than the more volatile John Maynard Keynes.
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In 1965, Samuelson published a version of the efficient-markets hypothesis — a world in which all reliably predictable events are priced right, and only surprises would remain; there would be no easy pickings on Wall Street. About the same time, Eugene Fama published his own formulation, and the idea that stock prices were properly described as  a “random walk” – that  it was all but impossible to outperform the market — was on its way to becoming firmly established.

Not that Samuelson himself took the finding literally. He later explained, “Experience makes me think that a few folk do have an intuitive flair for making money by sensing patterns of momentum.” Others, he said, are good at “figuring out which fundamentals are fundamental and which new data are worth paying high costs to get.”
But the services of such wizards, when they could be found, would not come cheap, he warned. And even the hottest hand would sometime turns cold.  Someone proposed an experiment to Samuelson – Mallaby doesn’t say who – and the idea of Commodities Corp. was born. As one of two original venture investors, Samuelson put up $125,000 – real money back then.

The key figure was F. Helmut Weymar, whose prize-winning thesis on predicting cocoa prices Samuelson had supervised a couple of years before, along with MIT finance professor Paul Cootner. “I thought random walk was bullshit,” Weymar told Mallaby for More Money Than God.  “The whole idea that an individual can’t make serious money with a competitive edge over the rest of the market is wacko.”

Weymar had gone to work for Nabisco, buying its cocoa beans. After some signal successes, he and Frank Vannerson, a Princeton PhD who specialized in predicting wheat prices for Nabisco, decided to go into business on their own. After talking to Samuelson, they raised $2.5 million, including the economist’s five percent, and, opened for business in a bucolic Princeton farmhouse with seven professionals (including Cootner) and six support staff....MORE
For those so inclined, MIT has put Mr. Weymar's dissertatation "The dynamics of the world cocoa market" online. It is a big 'ol PDF and, I must say, much drier than Warren Buffett's story of the cocoa bean/common stock arbitrage:

...For several weeks I busily bought shares, sold beans, and
made periodic stops at Schroeder Trust to exchange stock
certificates for warehouse receipts. The profits were good
and my only expense was subway tokens....

From our post "Living La Vida Cocoa: Warren Buffett, Berkshire Hathaway and the Chocolate Wars (BRK.A; BRK.B; CBY; KFT; HSY)".