In this guest blog posted on AllAboutAlpha.com on March 19, Konstantin Danilov, CAIA, highlights some of Machiavelli's ideas from 1513 that are relevant to today's hedge fund industry. 

Looking at several excerpts from chapter 25 of Machiavelli's letter to Lorenzo de' Medici written in 1513, it is interesting to note that a large portion of this particular chapter is particularly relevant to the hedge fund industry. It seems that ideas that were once known and respected have since been forgotten or largely ignored; modern day investors would be wise to revisit Machiavelli's prescient observations on the topic of luck and randomness and the implications for hedge fund investing.  (As you will see, you might even say that best-selling author Nassim Nicholas Taleb is somewhat of a latter-day Niccolo Machiavelli.)

Chapter 25 begins with the idea one must understand the overwhelming effect of luck on life events, and by extension, the financial markets:

"Nevertheless, since our free will must not be denied, I estimate that even if fortune is the arbiter of half our actions, she still allows us to control the other half, or thereabouts. I compare fortune to one of those torrential rivers which, when enraged, inundates the lowlands, tears down trees and buildings, and washes out the land on one bank to deposit it on the other. Everyone flees before it; everyone yields to its assaults without being able to offer any resistance."

Machiavelli's observations are even more relevant today, as the complex world of finance is highly influenced by randomness, yet few people realize the impact of luck on hedge fund performance. Because of the overwhelmingly large sample size (number of fund managers or investors), it is inevitable, based on randomness alone, that during our lifetime we will encounter a fund manager like Michael Steinhardt. With that in mind, it is easy to see that, as Nassim Taleb points out in Fooled By Randomness:

"...the number of managers with great track records in a given market depends far more on the number of people who started in the investment business (in place of going to dental school), rather than on their ability to produce profits".

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