BijaAdvisors

Better Decisions, Better Results

Seeds of Thought
Cognitive Science Meets Investment Management

Issue 13-17
June 15, 2013

Kicking the Macro Tires

As a rule, I dont do reconnaissance research. In other words, I dont travel to a country in the hopes of
deriving some competitive analytical edge. Macro investing is different from individual equities or
credit. Regardless of which people I select to meet, city I opt to visit, restaurant I choose to patronize or
factory floor I elect to survey, the perspective I will gain from the visit is but a tiny, self-selected (or
worse) sliver of the true reality. All future research will then be tainted; requiring reconciliation with
what I saw with my own eyes.

Bizarro World
The universe is not hostile, nor yet is it friendly. It is simply indifferent. - J. H. Holmes
I think one of the things that makes the current environment so perplexing for macro traditionalists is the
fact that we are living a world where carry is king, but most are reticent to admit it. How else can you
explain equity markets that rally on poor economic data and weaken on strength? Perhaps it isnt that the
world doesnt make sense, but that we refuse to see the world as it really exists.

Barefoot Manager
No great improvements in the lot of mankind are possible, until a great change takes place in the
fundamental constitution of their modes of thought. - J.S. Mills
I love being on the mountain trails. Ive hiked, run, climbed, mountain biked, unicycled, even yarn
bombed and jumping stilted the trails, but my favorite way to go is barefoot. There is a very logical
reason for why I have chosen to buck convention. When you walk barefoot, you walk very differently.
You tend to keep weight off your heels. Your movement is more methodical, more deliberate. Your eyes
focus on the landscape directly in front of you. Your brain actively participates in the plotting of your
course, every step of the way. Your feet are extremely sensitive to touch due to a high concentration of
nerve endings. They are that way for a reason. They provide vital feedback to your brain which then
responds by sending important signals to other parts of your body to make necessary adjustments in
response. Our socks and shoes act like dense filters, dulling the feedback, thereby rendering the rest of
our body oblivious to the dangers of our action. No pain? Well, then we can drive harder into our heels,
inevitably leading to knee, hip and back problems. We dont have to worry about the minor hazards
ahead, which increases the odds that a tiny, unexpected rock can trigger an ankle sprain or ligament tear.
As it is with so much in life, people are willing to turn a blind eye to long-term risks in exchange for
short-term comfort. Studies have proven that the shock from driving all our body weight into our heels
will inevitably lead to back, hip and knee problems, but these shoes are so cushy. We know bacon
double-cheeseburgers increase our odds of heart disease and are responsible for our frustrations on the
scale, but boy doesnt it taste good? We know that putting our thoughts on paper, helps us reduce
cognitive mistakes, but oh what a hassle. We know that formal expectancy analysis leads to better
!
Copyright 2013 by Bija Advisors LLC.; BijaAdvisorsLLC.com
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
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Bija Advisors Seeds of Thought

Issue No. 13-17

decision making, but its so much to think about. We know that reading the unfiltered transcript of a
central bankers testimony is more informative, but its so much easier to let an analyst decide whats
important in the nanoseconds that follow its release. When Im asked what makes my investment
process unique, my answer is simple - discipline. I am willing to sacrifice short-term comfort for longterm gains.

When Size Matters

Since becoming a portfolio manager more than ten years ago, I have managed as little as $8 million and
as much as $910 million. What did I do differently at each extreme? Nothing. On average, I had the
same number of trades in the portfolio, structured the positions the same, analyzed the markets the same,
generated trade write-ups the same, and in proportion to the overall portfolio, I sized the positions the
same. Those are the relevant factors that investors should be asking about when it comes to AuM and
here is why. With a minimal1 amount in AuM, you are clearly not confronted with capacity constraints,
therefore you can be highly selective when choosing among opportunities, allowing for optimal portfolio
composition. While operating below your capacity constraint, the portfolio composition runs within a
fairly steady range. So how do you identify the limits of a PMs capacity?
Well there are two determinants of capacity. One is internal (mental) and the other is external (market).
For those trained as prop traders and PMs within large organizations, you are typically allocated risk
rather than capital, which means you think of gains and losses in notional terms. That makes for a
difficult adjustment to the world of proportional returns, and particularly shifts in AuM, thereby
prematurely capping either AuM growth, or the risk and returns on it. The external constraint is market
liquidity per trade or structure. So long as I can maintain the same proportional exposure to a given
position, I remain under my capacity limit. Once I have to increase the number of trades in order to
maintain the same overall proportional risk exposure, I have breached max capacity for my style. You
see, before you reach capacity, you are selecting only the best ideas and expressing them via the optimal
structures. You could do more, but you choose not to. When your overall risk budget gets to a point
where you cannot maintain the same overall exposure with the same number of trades, you must begin
adding less optimal structures and even ideas of lesser conviction. That is the true signal of having
breached your maximum capacity.

About the Author

For nearly three decades, Stephen Duneier has applied cognitive science to investment management, and
life itself. The result has been top tier returns with near zero correlation to any major index, the
development of a billion dollar hedge fund, a burgeoning career as an artist and a rapidly shrinking
bucket list.
Mr. Duneier teaches Decision Analysis in the College of Engineering at the University of California
Santa Barbara. Through Bija Advisors' publications and consulting practice, he helps portfolio managers
and business leaders improve performance by applying proven decision-making skills to their own
processes.
As a speaker, Stephen has delivered informative and inspirational talks on global macro economic
themes, how cognitive science can improve performance, and the keys to living a more deliberate life, to
audiences around the world for more than 20 years. Each is delivered via highly entertaining stories that
inevitably lead to further conversation, and ultimately, better results.

Copyright 2013 by Bija Advisors LLC.; BijaAdvisorsLLC.com

Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 13-17

Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America and
Managing Director of Emerging Markets at AIG International. His artwork is represented by the world
renowned gallery, Sullivan Goss. He received his master's degree in finance and economics from New
York University's Stern School of Business.

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Copyright 2013 by Bija Advisors LLC.; BijaAdvisorsLLC.com

Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document