A Fund vs. Your Own Money

[Epic]

Quote from sle:

Yes, that's the positives - the negatives are obviously free rider problem, risk control and smart split. Even with a single partner who is my close friend, i am struggling with various forms of these problems. If you could structure it such as to resolve these issues, this is a dream come true for either emerging managers or independent large traders.


You could think of this as a multi-strategy hedge fund where every PM is a partner.

Well, personally, I don't know that I could find enough talent that I would want to do business with. Unfortunately the trading world is full of posers and degenerates. I know a guy who has been trying to create something similar to this. He tried to recruit me a couple years ago. He's literally met with several hundred traders and emerging managers to no avail. There were 3-4 shining stars who all flamed out within months of allocating capital.

Also, there still has to be one person sort of managing the show, and we all tend to be alphas in this space.

 

[macintash]

Let me enter some idea here, something like a swap between 2 (or more) funds. 20% of fund 1 returns after fees go to fund 2 investors, while 20% of fund 2 returns after fees goes to fund 1 investors. So if you perform bad 1 month your fee will suffer, while the client’s money would hold more stable. It’s just another level of diversification, and would make the curve smoother.
Off course you need to be very comfortable with the other manager’s strategy, and the strategies should not be correlated (or inverse even better). Any thoughts?

 

[Smoker]

Hi Everyone,

Quote from sle:

No, rates options initially, now equity vol.

Ok I was originally before going to the Merc floor for CRT an interbank FX options guy out of one of the Canadian chartered banks which is where I first heard “yard” as slang for a billion.

Quote from sle:

I don't know. You going to have to ask Paulson and a few other funds that pretty much built it as a part of their business model.

Ok, that was a good one; you got me on Paulson and I can’t really explain how that guy is still in business. It is also a mystery to me. All I can think of and it is only my bias opinion is he was ok before but then made the call of a lifetime and backed it up with the position of a life time and when it landed on red in front of the world he started to believe what the press said about him.

I also suspect that a lot of the money that flowed to him after the big 2008 payoff was from people that are newbie’s to the industry; maybe mostly long only equity guys out of pension funds and such like rather than professional hedge fund/CTA allocators.

He did approach the guys out here but couldn’t pass due diligence which I am assuming was due to there not being any confidence he could replicate a one off great call going forward.

Just my two dirhams.

Quote from sle:

I mean what I mean - individual level data is more or less crap. Unless you are dealing with a higher frequency strategy where the number of trades reaches high numbers fairly quickly, the statistical significance of the data on an individual trader/PM is very low. Take a single long/short PM with 10 years of performance history. The statistical significance of 120 data points is pretty low, unless your fund has invested heavily into proprietary bootstrapping models. A basketball player probably makes 120 basket shots or passes during a single game.

Don’t agree with or understand the logic here. Usually unless the guy is a long term trend follower in a few markets there are large amounts of data points available for evaluation. Also most of the smaller guys are shorter term so there is more stuff to go on even with on average shorter track records. When I was evaluated I had dozens and dozens of scalping and swing trades for the hedge fund principle to run his performance and risk analytics on so lack of data in my experience is rarely an issue.

Equity is not my area but most of the successful long short guys I know have hundreds of pairs and outright positions on and are running their models over thousands of different stocks in equity markets all over the world. The sample sizes are huge.

Quote from sle:

If you want to doubt the quality of hedge fund allocators, just think of Madoff (obviosuly, an extreme example).

I addressed Madoff in an earlier post and explained that the professional asset allocators avoided him like the plague. He couldn’t pass even the most rudimentary due diligence.

If you look at his customer list it is more what I would call retail than professional asset allocators. You see naïve HNW individuals like rich actors, sports people and retirees in Florida, charities and family foundations etc funneled into Madoff by sleezy and also naïve financial planners, brokers etc.

I think I remember several smaller hedge fund/money management guys based in the USA that sent annual letters to the SEC for years telling them he was a crook.

Madoff is a retail based crook and I am referring to the professional asset allocators.

Quote from sle:

Everyone in the industry knows the extent of the principal-agent problem in the hedge fund allocation process,

I am not sure who you are referring to here? I assume you mean the brokerage guys that recommend to their clients some trader that has had a hot year or two that is also generating a lot of commissions putting their trades through them.

Again I view that as retail and not the professional asset allocators who do not have a vested interest in funneling money for commission revenue but are evaluated entirely on performance.

Quote from rwk:

@Smoker (or anybody else):
Could you comment on the "bounday case", not the next James H. Simons? At what point might an aspiring manager have a shot at of being discovered? Would he/she need to be registered? Audited record? Where is the tipping point below which the trader simply lacks sufficient potential?

If you put up anything in the same ball park as the numbers posted earlier by Epic:

Quote from Epic:
at least 3 year live history
2.5 Sharpe
20-40% CAGR
<10% max drawdown
>$3MM AUM (around $500K internal capital)

…And you did not look like a one hit wonder like Paulson which would fall out of the performance/risk algorithm run on your track record I am sure you would get looked at and if it appeared like you could pass due diligence you would be contacted.

I keep saying it and here it comes again: With today’s technology and ability to monitor and flag the desired variables it is more or less impossible for a trading savant to spend a career invisible.

Quote from Epic:

Why is that always the go-to assumption?

Because any successful and experienced asset allocator handling serious wedge will tell you the assumption is not just an assumption but also true.

Quote from Epic:

EVERY strategy has a scaling cap.

And the robust ones that indicate the Beatles and not a one his wonder can all be scaled up into serious wedge.

If not the flag goes up and the smart and size money walks away. You keep throwing mud at these guys but I have never met one handling serious money that is stupid. They are all pretty darn smart just like everyone in the NBA can play pretty good basketball.

If they didn’t pick you or someone else for the team it is most likely because they had in their experience what they considered a good reason rather than they are just stupid.

Quote from Epic:

The best ones (e.g. Jim Simons) cap off their fund and trade it internally

I don’t like to comment on specifics or individuals (even though I have done it with Madoff and Paulson) but Renaissance is bit of a special case where the media and press have got the story wrong.

Renaissance is a very successful market making business rather than a proprietary trading shop that lifts offers and hits bids to express directional opinion etc.

They are not in the prediction business but the market making business. The Medallion fund is the cash flows of a brilliantly run market marking business rather than a proprietary trading business based on high tech prediction models.

From time to time Renaissance tries to start/run a true proprietary fund like the Renaissance Institutional Futures fund anyway you have seen the results compared to the cash flows the market marking business kicks off so you understand now why one is open and the other is closed.

An asset allocator once described the market marking of the Medallion fund to me as brokerage with flexible commissions.

I am incredibly jealous of them, brilliant business model and they are the best at what they do but they are doing something different from everyone on this thread.

I do wish I was doing that instead slugging it out prop trading every day.

And that is the last time I will be making any direct comments on Renaissance.

Cheers Smoker

 

[Ash1972]

Thanks for the insight, Smoker. It's interesting that pretty much all the big investment banks have been in the market making business for decades, yet never publish their return on capital figure as if it were the annual return of a fund. I wonder what we'd learn if they did.

 

[rallymode]

heech, Epic, if you are going to have mid 7 digits of your own money invested i am just curious how much capacity can your strategies handle?

 

[sf631]

Back on the cooperation idea...

I think the free-rider problem would make the pooling of performance (or AUM) fees unworkable. However, wouldn't there be value in making it very easy for an investor to allocate capital *across* the portfolio of funds within a fund family?

Each PM would own their individual track record, and would be responsible for their individual fund.

Management company would solicit investors for any of the funds in the umbrella, much like a mutual fund company markets their entire family of funds in one ad/brochure.

Investors could choose to allocate their investment across one or multiple of the funds, just one might allocate a 401k investment across the various funds in the sponsor's plan offering. Quarterly (or monthly or yearly) investors could rebalance based on performance, or based on correlation coefficients. They could meet the minimum requirement at the FoF level, and if they wanted to break their 1M into five smaller investments, so be it.

PMs could also be eligible to allocate some limited percentage of their personal assets (not LP assets) into other managers' funds for diversification of their own investment. This would need to be limited so they still had skin in their own fund.

Benefits to this, other than the shared administrative costs, would be that an investor could shift between funds easily and in smaller amounts. They would be able to make multi-strategy investments and benefit from diversificaiton.

Poor portfolios would atrophy and die - no free rider problem. Good ones would get lots of eyeballs and lots of capital. PMs could personally benefit from diversification of their assets.

Are there shops doing something like this?

 

[heech]

sf631: ... that was more like my initial thought, just sort of a loose affiliation for sharing investor leads + operational efficiencies. But I agree with Epic that that approach isn't super compelling... not a lot of need there.

rallymode: ... I've been telling people max capacity of $200 million or so, but with the warning I don't really know since I trade pretty heavily intraday + higher frequencies. But yes, since my primary goal is to trade my own money, I might very well stop accepting outside money completely once I get to around $50-75 mm in total AUM.

 

[hilojack]

Quote from sf631:

Back on the cooperation idea...

I think the free-rider problem would make the pooling of performance (or AUM) fees unworkable. However, wouldn't there be value in making it very easy for an investor to allocate capital *across* the portfolio of funds within a fund family?

Each PM would own their individual track record, and would be responsible for their individual fund.

Management company would solicit investors for any of the funds in the umbrella, much like a mutual fund company markets their entire family of funds in one ad/brochure.

Investors could choose to allocate their investment across one or multiple of the funds, just one might allocate a 401k investment across the various funds in the sponsor's plan offering. Quarterly (or monthly or yearly) investors could rebalance based on performance, or based on correlation coefficients. They could meet the minimum requirement at the FoF level, and if they wanted to break their 1M into five smaller investments, so be it.

PMs could also be eligible to allocate some limited percentage of their personal assets (not LP assets) into other managers' funds for diversification of their own investment. This would need to be limited so they still had skin in their own fund.

Benefits to this, other than the shared administrative costs, would be that an investor could shift between funds easily and in smaller amounts. They would be able to make multi-strategy investments and benefit from diversificaiton.

Poor portfolios would atrophy and die - no free rider problem. Good ones would get lots of eyeballs and lots of capital. PMs could personally benefit from diversification of their assets.

Are there shops doing something like this?

Short answer, yes. There are many shops that operate in a myriad of ways. I've seen some decent ideas here in the last few pages, but I will share how the concern I am affiliated with operates. The reason I'm sharing, is because I am actually thinking of stepping out and trying to run something similar, but with improvements to how I think it should operate.

My primary backer is an offshore fund of fund type set up that charges a 1/30% fee structure to the investors of the fund. The fund in turn "invests" in managers, at whatever percentage the manager can negotiate. So the fund receives x% of manager 1, y% of manager 2, etc. in this regard, there are individual PMs earning more than the 30% the overall funds charges investors.

The individual PMs are responsible for their own costs, (though the FoF will pay them upfront and take reimbursement from PM). Thus the decision is left to the PM whether to run lean and mean, or hire chicks with huge boobs to take dictation LOL.

However, fees and payouts to each PM are based on the gross and not net revenue figure. As a PM, you have the ability to use the FoF vendors and deals, or go out on your own. Economies of scale make using auditors and data providers more cost effective IMO.

So every PM in the portfolio eats what he kills, with the exception of the "coop" portion where the sharing occurs. In the coop portion, every PM must allocate 15% of their individual net profit to the pool, which then gets divided up equally among all PMs. You have to have positive numbers to participate. You contribute monthly, payout occurs annually. If you leave prior to that, sayonara to that money.

I found that this has been a good deal for the following reasons: it promotes a more congenial and helpful environment in that you want te other PMs to do well to increase the overall size of the pool. The 15% figure is not large enough for a total free ride to occur, yet it is big enough to keep everyone's skin in the game. I think of it similar to investing back into the fund, though you're money isn't locked up.

Does free riding occur? Yep, but not for the reasons you think. There are actually strategies in the portfolio which act as pure hedges and thus have low and/or negative returns. It helps smooth out the equity curve, keeps us hedged (hopefully), and thus keeps investors happy and the gravy train rolling.

These strategies are treated as separate for performance figures and are announced in advance.

That's really it. The FoF really is just an asset allocator/risk manager/cap raiser/ leverage provider. The rest of the place operation is self-policing, collaborative, and overall a great model to be involved with.

As I said, I think there are ways that the operation can be improved, but overall I think the model is as good as there is for individual PMs.

 

[Epic]

Quote from rallymode:

heech, Epic, if you are going to have mid 7 digits of your own money invested i am just curious how much capacity can your strategies handle?

I estimate mine currently at about $200-400MM with potential for decent return. Higher than that would require expansion into other markets and asset classes.

 

[chipmunk]

It's a hell of a lot more lucrative running a fund than investing in one! For sure.