Norman Mains - Winning With Liquid Alternatives

Copyright 2014 by Norman E. Mains. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a data base or retrieval system, without the prior written permission of the publisher.

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To my wife, Ginna

W hen I was approached to submit an outline to McGraw-Hill for a book, Ill admit that I was a little intimidated. However, after giving the subject a little thought, I realized that my topic, the rise of Liquid, or Investment Company Act of 1940 (40 Act) Alternatives, had mostly occurred during my career in financial markets. Moreover, my various professional positions had given me a somewhat unique vantage point on their creation as one of the most important developments in contemporary financial history. So lets begin at the beginning.

After studying economics as an undergraduate at the University of Colorado in Boulder, I applied to the same school for a PhD program in economics. In hindsight, this was not a very good choice. I earned an MA degree after one year, maintaining nearly straight As in my classes. Unfortunately, I wasnt really learning very much. I was taking graduate-level courses taught by the same professors I had had as an undergraduate. Sure, the reading lists were longer, but the professors didnt have that much new material in their graduate classes. About midway through my second year, I got a lucky break. A visiting professor who liked my work was about to take an endowed chair at the University of Warwick in Warwickshire, England, and he offered to arrange a grant for me if I matriculated into the PhD program there.

Having never been to Europe, I saw this as a great opportunity. I returned to the United States a couple of years later with a good PhD thesis topic but very little actually done on writing the dissertation. Needing a job, I was put in touch with the Securities and Exchange Commissions (SECs) chief economist, who interviewed me for a position on the team assigned to the soon-to-be-underway Institutional Investor Study. Unfortunately, it was a civil service position, so it was going to take about six months to actually get me hired. I was broke, and I needed a job. The SECs chief economist was kind enough to call the chief economist at the mutual fund industrys trade association, the Investment Company Institute (ICI), because he knew that the ICI was looking for an associate economist.

The ICI was a perfect fit for me because my thesis topic was focused on whether mutual fund portfolio managers could augment their investment returns by shifting the riskiness of their portfolios to enhance their investment returns. It is now, by the way, an almost forgotten fact that virtually all the early work in risk measurement and performance management in financial markets was based on the investment results of mutual funds. Why? Because mutual funds published their net asset values on a daily basis, and researchers could build a databases that largely encompassed the industry. Academicians and other researchers could then test various hypotheses via statistical methods on the early computer systems. My thesis convinced me and my external readers at the Wharton School of Business that mutual fund portfolio managers were not very good at predicting overall market swings, but they were much better at identifying undervalued and overvalued equities.

Having completed my PhD thesis, I was then fortunate to be offered a job as a research economist at the Federal Reserve Board in Washington, DC. Rather than focusing on equities, however, the Feds director of research asked me to become the boards senior researcher on the corporate and municipal bond markets. When I protested to him that I really didnt know very much about fixed income, he simply responded, Dont worry, youll learn.

Almost seven years later, I was a senior economist in the Feds U.S. Treasury and agency market when I received an unsolicited telephone call from the individual who created the interest rate futures market at the Chicago Board of Trade (CBOT). He was in the process of organizing a new group at a firm he had just joined, Drexel Burnham Lambert (DBL), and he asked me if I would be interested in creating a research team for DBLs institutional financial futures and options group? It was a big jump to go from the cloistered halls of the Federal Reserve Board to the open-outcry futures markets in Chicago, but financial futures, and later options on futures, were still in their infancy. These financial instruments were not called derivatives in the 1980s but eventually would become one of the major financial markets, not just in the United States, but around the globe.