Submitted by Ben Hunt of Salient Partners
Well, it’s funny that people, when they say that this is evidence of the Almighty, always quote beautiful things. They always quote orchids and hummingbirds and butterflies and roses. But I always have to think, too, of a little boy sitting on the banks of a river in West Africa who has a worm boring through his eyeball, turning him blind before he’s five years old. And I reply and say, “Well, presumably the God you speak about created the worm as well,” and now, I find that baffling to credit a merciful God with that action. And therefore it seems to me safer to show things that I know to be truth, truthful and factual, and allow people to make up their own minds about the moralities of this thing, or indeed the theology of this thing.
– David Attenborough
Ash: You still don’t understand what you’re dealing with, do you? Perfect organism. Its structural perfection is matched only by its hostility.
Lambert: You admire it.
Ash: I admire its purity. A survivor… unclouded by conscience, remorse, or delusions of morality.
Parker: Look, I am… I’ve heard enough of this, and I’m asking you to pull the plug. [Ripley goes to disconnect Ash, who interrupts]
Ash: Last word.
Ripley: What?
Ash: I can’t lie to you about your chances, but… you have my sympathies.
Parasite Rex
From an evolutionary perspective, the parasite is a beautiful
creature. Instead of possessing a set of adaptations that make it
suitable for thriving within a “natural” habitat – an ocean, a forest, a
tundra, a jungle, etc. – the parasite typically finds its habitat
within an organism itself. Parasites twist the core evolutionary process
of adaptive radiation in a new direction, finding opportunities for new
niches and species differentiation within host species that emerge over
time in new geographies, not the new geographies themselves. To a
parasite, the world IS an oyster. Given the amazing diversity of life on
Earth, using life-forms as habitats presents a phenomenal opportunity
for parasitic adaptive radiation and thus, evolutionary success. Almost
every multi-cellular life-form on the planet serves as a host for one or
more parasites, and as a result parasites account for more biodiversity
and sheer numbers than non-parasitic life. In many respects, the
parasite is an evolutionary apex.
Why do parasites get such bad
press? Most of them are not what zookeepers would call “charismatic
vertebrates”, but instead tend to be viruses or squishy worms with nasty
looking (from a human perspective) and voraciously-presented mouths.
That’s a problem for any public relations campaign. More importantly,
parasites do not behave according to what game theorists call a “nice”
or cooperative strategy. These are not win-win relationships, where
there’s some sort of symbiotic benefit shared between the two organisms,
some sort of reciprocal value provided by the tapeworm to whatever
warm-blooded intestinal tract it happens to inhabit. No, the very
definition of a parasite is that it is harmful to its host, with a
one-way transfer of resources. Parasites are squatters, not tenants.
They are thieves, not buyers.
But they don’t steal a lot. Not
usually, anyway, as examples of Alien-esque life-forms that kill their
hosts in some burst of gore are few and far between. Almost all
parasites are better off keeping their hosts alive for as long as
possible, so it would seem natural for any individual parasite to take
just enough from its individual host to live well without killing off
the host. And this is, in fact, the case – few parasites kill their
hosts – but it’s the why behind this fact, the evolutionary dynamic
behind this fact, that I want to examine.
An individually successful
hookworm is not thinking “Gee, I better slow down a little bit here.
Wouldn’t want to damage my host too much.” That hookworm acts exactly as
it is programmed to act … to eat and reproduce as much as it is
hookworm-ly possible to eat and reproduce. An evolutionary perspective
requires us to look at the population of hookworms in relationship to
its habitat – the population of host animals – to figure out the
evolutionarily stable strategy (or ESS as it’s known) for hookworms. We
will never figure out the ESS by looking at an individual hookworm and
an individual host, because you can’t just extrapolate from what’s good
or bad for that individual relationship, no matter how much of a
long-term view you take for that individual hookworm and its
descendants.
From a population perspective, a parasite species is
trying to balance growth with robustness in the context of its life-form
habitat in exactly the same way that a non-parasite species is trying
to balance growth and robustness in the context of its geographical
habitat. Both grow by consuming resources. If growth outstrips resource
supply, that’s a problem, because the offspring population is going to
starve and die off. This is the population dynamic that is most closely
associated with the work of Thomas Malthus, who despaired of any animal
(including the human animal) escaping this deterministic pattern of
population growth outpacing resource availability, punctuated by
enormous population die-offs in order to restore the balance between
resource supply and demand. In the human context, innovation in our
tools and our mental constructs has allowed us to increase our species
population essentially unchecked by Malthusian logic since the 14th
century and the Black Death, with only a small hiccup from pandemic and
global war in the early 20th century. In the non-human context, any
respite from resource-depletion die-offs must come from the glacially
slow process of natural selection and the evolution of adaptations that
push a species into a more robust, less volatile relationship with its
environment. This is an ESS.
What’s interesting (to me, anyway) is
that a parasite species tends to have more options in the development of
its ESS than a non-parasite species. A parasite is not geographically
“grounded” like a non-parasite. Because its habitat is another
population of life-forms, the population of parasites can more easily
“choose” how to allocate its resource consumption. Maybe the parasite
species is better off if it concentrates on a few individuals within the
host population and really loads up on those unlucky targets, depleting
all of their resources and killing them in the process, but leaving a
critical mass of healthy hosts unharmed so that they can reproduce and
provide juicy targets in the future. Maybe the parasite species is
better off by getting smaller and less noticeable or impactful on the
host species. Maybe the parasite species is better off if it moves from
host species to host species within its lifecycle, so that no single
host species is damaged too severely even if the individual parasites
run rampant during their stay. These are strategic options at the
population level that are much more difficult to develop or evolve
within species that have a specific geography for a habitat. Not
impossible … maybe you can rotate from one resource-rich patch of your
geography to another and then back again (migration) … but more
difficult. A resource habitat created by life-form populations is just
more fungible than a resource habitat created by a singular geography,
and that’s a really big deal for an ESS.
This flexibility (and hence
evolutionary speed) in creating an ESS is a big reason why parasites
dominate the world. Like humans, they’re pretty good at getting around
the gloomy future that Malthus predicted. Not by inventing the printing
press, fossil fuel energy sources, and liberal ideas of social
organization, but by quickly evolving a wide range of behavioral
adaptations that are extremely effective at balancing resources and
growth. Here’s what these parasite ESS’s have in common: they make the
parasite population invisible to the host population. The relationship
between individual parasite and individual host may also be invisible,
but it also might be a violent struggle to the death or somewhere in
between … evolution doesn’t care about individuals. Evolution has to be
understood at the group level, and the evolutionary beauty of the
parasite is its amazing suitability and fitness – at the group level –
for using life itself as a habitat.
Now why do I care so much about
parasites and their evolutionarily stable strategies? Because the most
effective alpha-generating investment strategies are parasites. An
alpha-generating strategy of the type I’m describing uses the market
itself as its habitat. It’s not an investment strategy based on the
fundamentals of this company or that company – the equivalent of a
geographic habitat – but on the behaviors of market participants who are
living their investment lives in that fundamentally-derived habitat. A
parasitic strategy isn’t the only way to generate alpha – you can also
be better suited for a particular investment environment (think
warm-blooded animal versus cold-blooded animal as you go into an Ice
Age) and generate alpha that way – but I believe that the investment
strategies with the largest and most consistent “edge” are, in a very
real sense, parasites.
What do these parasitic strategies look like?
Their number is legion. They exist in every nook and cranny of every
public market in the world, and they feed off the behaviors of
non-economic or differently-economic market participants. A giant
pension fund isn’t engaged in commodity markets because it has an
opinion on the contango curve of oil futures; it’s trying to find a
diversifying asset class for a massive portfolio that needs inflation
protection. If you’re an experienced trader in that market and you see
signs of the giant pension fund lumbering through the brush … well,
you’re in the wrong business if you can’t skin a few dimes here. This is
what good traders DO, and the really good ones have devised effective
processes and strategies that comprise a strategy, so that it’s not just
a one-off trade but an expression of a consistent informational edge.
These strategies are inherently niche-oriented, and they do not scale
very well, any more than any single parasite species can scale beyond
the size of its host species. But the informational edge is real, which
means that the alpha generation is real, and that’s a beautiful thing
even if the outward form is as ugly as a hookworm.
Why does a
parasitic strategy have a bigger informational edge than a non-parasitic
strategy? Because market participant behaviors are far more consistent
over time than the economic fundamentals of companies or countries. I
can predict with 100x more confidence what a giant pension fund is
trying to achieve with its market activities than what S&P 500
earnings will actually be next year. World events and market outcomes
are utterly unpredictable, especially in a global environment of
economic deleveraging, massive monetary policy experimentation, and
political fissures the size of the Grand Canyon within and between
countries. Human nature, though, is as constant as the northern star.
How
does a parasitic strategy with an informational edge persist? Why isn’t
it arbitraged (or regulated) away? First, remember that we’re talking
about the group level, not the individual. Certainly it’s possible to
have competition between individual parasitic strategies that split the
economic resources taken from the host. But at the group level, just
like their biological cousins, effective parasitic investment strategies
are largely invisible to their hosts. As Baudelaire said way before
Kevin Spacey did in The Usual Suspects, the greatest trick the devil
ever pulled was convincing the world he didn’t exist.
What’s the
pay-off for thinking about alpha-generation investment strategies
through this evolutionary perspective? Two big pay-offs, I think.
First,
one of the trickiest puzzles of effective allocation and risk
management for anyone who invests in actively managed funds is trying to
figure out the capacity limits of those strategies. This typically
isn’t something you worry about with a strategy that is focused on
capturing broad market returns or one that uses big liquid securities
like S&P e-mini’s to express its portfolio, but it’s a significant
concern with funds that claim to have some sort of informational or
process edge (alpha generation potential) and express that edge with
single-name securities or any sort of liquidity-challenged instrument.
There are very powerful formulas in the evolutionary biology toolkit for
figuring out both the optimal population size of a parasite species
relative to its host as well as the optimal amount of resources that the
parasite population should take from the host. This is at the heart of
figuring out what behaviors, including size, are evolutionarily stable
for the parasite, and it is directly applicable to alpha-oriented
investment strategies with parasitic qualities. Instead of taking a
manager’s word on investment capacity or making some rough guess based
on the AUM of other managers (which is basically the state of the art
today), these ESS tools should allow us to project investment capacity
directly for many alpha-generation strategies.
Second, it shows how
one might create an advanced multi-strat investment platform, one that
uses the Adaptive Investing perspective to identify the alpha-generation
strategies with the most effective ESS’s, as well as the optimal
capacity and allocation characteristics for the market “habitat” in
which these strategies operate. Unlike the individual strategies, which
inherently scale poorly, a multi-strat structure scales easily, limited
only by the number of individual strategies brought under the
operational umbrella. Would this sort of investment platform have
something of an image problem, intentionally seeking out and unafraid to
characterize certain investment strategies as parasites? Maybe. But
somehow I think there are plenty of others out there who, like me, can
see the evolutionary beauty of these strategies and are not afraid to
call them by their proper name. I hope you’ll join me in this
exploration.
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via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/uXKHH9hvudM/story01.htm Tyler Durden