Trading Wisdom for Aspiring Hedge Fund Managers

[chipmunk]

Darkhorse:

On your web site and in your PDF you talk about smaller funds having to have "excellent" gains or R.O.I. to attract inst money. I agree. A smaller funder of say less than $50M should be able to make better ROI that a $500M AUM fund.

But what is your defintion of "excellent returns"?

The best I can ever do is around 40% in great market conditions and less than -12%. Without taking on too higher risk. Or averaging out 20-25% per annum over the years. Unless i toook on higher risk I can't see how I can improve on this at all.

(long term end of day investing)

 

[darkhorse]

Trading Wisdom 21: Constantly Exceeding One's Level

"Bruce [Lee] had me up to three miles a day, really at a good pace. We'd run the three miles in twenty-one or twenty-two minutes. Just under eight minutes a mile [Note: when running on his own in 1968, Lee would get his time down to six-and-a-half minutes per mile]. So this morning he said to me "We're going to go five." I said, "Bruce, I can't go five. I'm a helluva lot older than you are, and I can't do five."

"He said, "When we get to three, we'll shift gears and it's only two more and you'll do it." I said "Okay, hell, I'll go for it." So we get to three, we go into the fourth mile and I'm okay for three or four minutes, and then I really begin to give out. I'm tired, my heart's pounding, I can't go any more and so I say to him, "Bruce, if I run any more," - and we're still running - "if I run any more I'm liable to have a heart attack and die." He said, "Then die."

"It made me so mad that I went the full five miles. Afterward I went to the shower and then I wanted to talk to him about it. I said, you know, "Why did you say that?" He said, "Because you might as well be dead. Seriously, if you always put limits on what you can do, physical or anything else, it'll spread over into the rest of your life. It'll spread into your work, into your morality, into your entire being. There are no limits. There are plateaus, but you must not stay there, you must go beyond them. If it kills you, it kills you. A man must constantly exceed his level."

- John Little, The Art of Expressing the Human Body



JS Comment:

What actions do you take to constantly exceed your level?

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[darkhorse]

Quote from chipmunk:


The best I can ever do is around 40% in great market conditions and less than -12%. Without taking on too higher risk. Or averaging out 20-25% per annum over the years. Unless i toook on higher risk I can't see how I can improve on this at all.

(long term end of day investing)

I'm not sure what "end of day investing" means, but if you can do that consistently and at scale, such would definitely qualify as excellent.

It is less about percentage return than consistency and expected multiple of reward to risk, as an investor can always lever up returns on their own (by investing with borrowed money, allocating a larger portion to the strategy etc), or alternatively decrease exposure by investing a smaller notional amount and matching it with t-bills, cash equivalents etc. What they cannot dial up or down is the historical performance ratio of unit of reward per unit of risk - that is what the skilled trader creates.

For instance, with a profile of 40% returns and 12% drawdowns, you could cut the leverage in half, go for 20% returns and 6% drawdowns, and attract significant amounts of capital.

 

[maler]

You do realize that even the mighty PTJ has 25% returns with
a max drawdown of 17%. The Medallion was down around 40%
during the Aug 2007 quant meltdown and if you look at the
published CTA track records you can hardly
find one with a sharpe above 1 that has been in business more than
five years. High sharpes and MARs can be sustained for short periods with small capital
and are common in HFT, market making, day and short term trading and for the plethora of shady
operators on the edge of insider trading, frauds (a la Madoff),
or those using creative accounting with private and illiquid securities marked to model and not to market.

Quote from darkhorse:
For instance, with a profile of 40% returns and 12% drawdowns, you could cut the leverage in half, go for 20% returns and 6% drawdowns, and attract significant amounts of capital. [/B]

 

[OddTrader]

My guess is, when trading size without leverage, a ratio for Return:MaxDD greater than 1.5 (close to 25%:17% as mentioned below) would be quite extraordinary! Just 2 cents.

Quote from maler:

You do realize that even the mighty PTJ has 25% returns with
a max drawdown of 17%. The Medallion was down around 40%
during the Aug 2007 quant meltdown and if you look at the
published CTA track records you can hardly
find one with a sharpe above 1 that has been in business more than
five years. High sharpes and MARs can be sustained for short periods with small capital
and are common in HFT, market making, day and short term trading and for the plethora of shady
operators on the edge of insider trading, frauds (a la Madoff),
or those using creative accounting with private and illiquid securities marked to model and not to market.

 

[darkhorse]

Quote from maler:

You do realize that even the mighty PTJ has 25% returns with
a max drawdown of 17%. The Medallion was down around 40%
during the Aug 2007 quant meltdown and if you look at the
published CTA track records you can hardly
find one with a sharpe above 1 that has been in business more than
five years. High sharpes and MARs can be sustained for short periods with small capital
and are common in HFT, market making, day and short term trading and for the plethora of shady
operators on the edge of insider trading, frauds (a la Madoff),
or those using creative accounting with private and illiquid securities marked to model and not to market.

Yep, though as you note there is a major gap between trading millions (or even tens of millions) and hundreds of millions to billions, which PTJ has been doing since the 80s - in the original MW he made a point of stressing how much of a hurdle size had become for his trading (though the 200MM or so was only a fraction of what he evolved to). The size advantage can be significant for diverse directional strategies as well as the others you site (more playable vehicles within one's liquidity threshold, ability to turn on a dime etc, positively impacting one's ability to generate risk adjusted returns).

There is also potential value in distinguishing between the typical drawdown outlier (e.g. to 95% confidence level) and max drawdown worst case scenario extreme - the 5% or even 1% tail outlier - which is going to get bigger the more adverse events and abnormal landscapes one has traded through (if you trade long enough, your biggest drawdowns like your biggest upswings will always be ahead of you). But in general I agree with the spirit of your observation, achieving excellent returns relative to max DD is no cakewalk (though sharpe is not always the preferred measure as it penalizes asymmetric upside volatility).

 

[Specterx]

Quote from Martinghoul:

I am in agreement with cdc on this particular quote, I'm afraid to say. It really says nothing to me that I don't already know. The important bit that the author should have concentrated on, IMHO, is the understanding of what the flows exactly are and why they're occurring at any given time.

I think you'd be absolutely stunned at the proportion of traders who find it physically impossible to buy the 'grind up' type of moves we've seen in recent years. Advice doesn't have to be complicated to be useful: if the market is rising [in a way that produces a consistent and tradeable pattern], then buy it.

 

[Martinghoul]

Quote from Specterx:
I think you'd be absolutely stunned at the proportion of traders who find it physically impossible to buy the 'grind up' type of moves we've seen in recent years. Advice doesn't have to be complicated to be useful: if the market is rising [in a way that produces a consistent and tradeable pattern], then buy it.

I respectfully disagree... The mkt can be "grinding up", down or going any which way. Unless I have a decent understanding of what's going on and where "fair value" is, I am not gonna do anything about it just 'cause it's moving in some particular fashion. But that's just me...

 

[chipmunk]

Yeah and how large are these funds?

A big advantage i have is keeping it small and nimble. A fund of less than say $30M can easily outperform a huge billion $$ fund on the stocks it can invest in and the speed it can get in and out. I only invest in small cap stocks as these generally give me the biggest bang on the the $. A billion dollar fund can't even look at them or not with any significant capital.

Once a fund gets too big the returns are no better than index investing not because they are poor but because of size. Size kills returns eventually..

Would you rather invest in a nimble $30M fund or with a $2 billion mega fund? Where will the bigger % returns be made?

 

[chipmunk]

It does seem to me that whole Insitutional "play it ultra safe, red tape, etc stops most small funds even attempting to manage money? Thos costs involved make it very hard for small funds (<$30M AUM) to even survive yet this is where the biggest gains can be made.

I understand that inst money has to be very safe but has it gone too far?