At first I scoffed, then I thought you were joking, and now I actually think it's not the worst idea I've ever heard. There's some good talent here.

Now that would be a fun contest and HFG could actually buy real securities with it. We each buy exactly 10 stocks and every 6 months we get to re-balance or change the 10. Every 6 months we get new recruits. The one year are the finals but the contest rolls on every 6 months. You are only allowed 2 stocks in a sector. What the winner gets is up to HFG (the winner might get a Cadillac and the runner-up a set of steak knives). Limit contest to only those with 100 posts. Maybe limit to marketcaps > 100 MM. Maybe one option.
How about that HFG?

I was thinking more along the lines of making a few billion rather than a Cadillac or some steak knives.

I don't think a format that only allows long stock investments with trading limited to one day every 6 months is particularly conducive to fostering uncorrelated trading strategies.

Continuing...altered the numbers above up by a factor of 10 for ease of calculations.

Now, let's assume that one of the 10 traders has an enhanced edge for a certain period of time (let's say this happens to all traders 10% of the time, so you expect 1 on average). That trader now has a 55 percent chance of winning per bet. (If this were blackjack, this trader has a big plus count...if poker, a "live player" or two has entered that trader's table)

This trader alone has a information ratio of near 2 (I will leave it to you to confirm). Moving 100% of the capital to this trader would be a worse risk/reward than before, but certainly it should be increased. Now you may want to let this trader bet $7 per hand during this period, and to keep standard deviation (risk) neutral, decrease the other traders bets to $2 per hand. Now your expected win is (10*7)+(4*2*9) = $142 for approx the same SD...information ratio up to 2.84

When the fund has only one trader, that trader had a 0.8 info ratio 90% of the time and a 2.0 10% of the time. Because that trader is the only strategy and investors don't want to pay fees to sit out, the firm is taking a similar amount of risk at all times and the info ratio is a little over 0.9 including these enhanced return periods.

Adding 9 equally talented traders takes the firm's info ratio from 0.9 to 2.8 from diversification (largely) and increased ability to alter bet sizing when you have an increased edge.

How can this be applied outside of theory? How does a hedge fund manager take a proactive role in monitoring and finding these traders with enhanced edges? Is there ideas or markets traders should be focusing on within a firm, that is currently not explored by other traders, in order to potentially hit this "sweet spot" while remaining uncorrelated to others, and is this optimal for a trader to focus on when thinking about trading as a team player for the fund?

It makes sense for people with track records to go to a place like Millenium to get a larger % of the pnl, as opposed to their existing role where they maybe get a small % or a discretionary bonus. So Millenium (or similar) doesn't need to be that proactive... traders come to them naturally. I don't think they particularly care if a new trader brings in a strategy being traded by another group. If the new trader is profitable, Millenium (or similar) would rather see that pnl go to them, instead of somewhere else. As long as the two silos are operating independently and arriving at the same conclusion, is probably a good thing.

I wasn't referring to a trader currently at one firm, looking at leaving externally to another one for higher pay. My question was specifically for a hedge fund manager analyzing his own team of traders, using the quoted theory mentioned to improve the fund's overall performance. Subsequently I wanted to know what he thought a trader was best served spending his time on, again within the firm, knowing that this enhanced trading EV is not only better for the fund, but likely desirable for any competitive person looking to work harder to be better and more useful.

I think your asking how we know when a certain trader has gone from 0.8 info ratio to a 2.0 info ratio zone, right?

By analogy, in blackjack it would be a good count. In poker, live players arrived.

In markets, if there are forces or headlines that are forcing certain actors to make trades for less than rational reasons (being stopped out, etc.) Those markets where those events are happening are likely candidates for enhanced returns.

How much consideration is given to the middle/back office when managing a fund? What type of goals do you have in this area?

Awesome thread btw.

I have the sincere intention (though I continue to delay actually doing it) to write a post about the "Hedge Fund Meta-Game" which will discuss everything it takes (all the subgames) to be a great hedge fund. Having a talented and successful middle/back office is critical (especially in a multi-strategy fund).

Someday, more on this...

Two people on the first page asked about book recommendations, you may have missed it. What books have helped you in investing the most (doesn't have to be investing books, could be econ, psych, etc)?

Looking forward to that meta-game post btw.

Expected Returns by Ilmannen (a bit dry, but super smart)
Game Theory and Other Topics by Malmuth
the Taleb books
When Genius Failed
Nate Silver
Winners Curse

a good start...more later

whats your firm's opinion on fund of funds and consultants

I met a person this summer who works for a hedge fund in Chicago that's sole purpose is to generate alpha via investing in other hedge funds. He said they move in and out of various funds, following the required redemption periods, and generate better returns with less risk than the firms themselves. How viable do you think firms like these are, and how can any of them build a more superior fund given the fees that need to be paid?

Empirically, I think many of the top FOFs have track records that give evidence that they have added value.

Given my stated views that some hedge funds are better than others and this is at least somewhat predictable, it should be no surprise I feel that effort in selecting funds could be valuable.

but wouldnt all the firms traders be in this same position at the same time? Im assuming you are talking about putting different traders in different markets completely, so each market faces pressures at uncorrelated times. But havent most markets, even across asset classes, become more correlated over the past few years? How many asset classes are we talking about?

I guess im approaching this from a buy and hold investor perspective so my approach would be to fund the best ideas in different proportions since not everyone generated amazing ideas at all times. but this doesnt help the info ratio, just the alpha. guess thats the different between some hedge funds and real multiasset class hedge funds

different asset classes...different geographies. Should be largely uncorrelated (and have for the most part proved to be so)

Any thoughts by you or the industry in general on setting up a fee structure of X% of profit/loss only with no asset charge? You get X% of profit and you pay to investor X% of loss.

I'm highly skeptical of hedge funds and fee based financial advisors but I'd get on board something like this.

I would certainly be game for it (on at least a portion of our capital), but if we did it for all AUM we could have issues staying in business if we had a bad year or two (or even a few flat return years) and that would be an added risk that investors would not want us to have (ironically in some sense I suppose)

Fwiw I know a fund that runs 0/20 and does very well, but very small stakes (<100mm).

obviously strategy dependent but are you guys really trying to manage scale? As in, if your fund was half the size, would that influence what trades or opportunities you look for or effect your results?

OP, thanks for doing this...

i'm grunching but what type of investments do you do? i.e. hedge fund category.

i'm always skeptical about return to risk ratios for anyone who invests in anything but highly liquid assets. my wording might not be right. maybe heavily traded assets as liquid makes me think of money market or short term bonds

-how much does financials factor into your ultimate decision?
-what are the top 3 factors you look at when deciding to invest?
-can you walk through your process when you receive an investment pitch?
-would you be so kind to take a look at some of our stock pitches here in BFI? we can send it to an anonymous email account you set up.

I've mostly followed value investors over the years so I don't really know much about multi-strategy, so I apologize for the newbie questions

Hi Hedgefundguy:

I think if you walk into a major card room, a good estimate would be 70 percent winning players (and over 90 percent in high stakes games). The reason why this number may seem high is there is a difference between those who play many hours and those who play just a few. Another example of a non-self weighting effect.

Best wishes,
Mason