Just a general added comment on Bill Gates and Eisenhower being poker players; Nixon was also a very good poker player, and used his winnings to help fund his first political campaign. I'm an old guy. I voted for Nixon in '72 and remind eminently proud of the fact.

Mr. Hedgefundguy:

Construct an augment of why you would hire an Alfalfa framer (AF) from New Mexico to your firm. Given any reasonable qualifications you think an AF may have to bolster your argument(s). And if you would never hire an AF, please state why.

Is the structure of your firm and business model different from most other firms so that it gives you an advantage in this extremely competitive market, and if so, how is that construction (including hiring practices) achieved. This may have been asked before but I'm not going to parse through the entire thread. So apology in advance if so.

It is my firm conviction that Putin would make an excellent Hedge Fund Manager. You may comment on this as you see fit, or not.

Thank You

Well this is probably one of the 3 best threads on 2p2 right now, and if someone knows of better threads than this, please link me!

For OP, thanks for doing this, my questions:

-3 books on trading/finance that had the biggest impact on you

-The 2-3 biggest changes you personally made that had the biggest impact on your ability to pick winners

-Of the plunging commodities right now, what are the 1-2 you guys are starting to load up on the most? Likewise which are the 1-2 you think have a long way to fall still. I understand if this one is also unanswerable, just thought I'd ask

shouldn't the manager be payed to correctly predict when to load more beta if beta SR is higher then strategy alpha SR and vice verse? (assuming we want to max SR)

people have a relative utility function and so lagging behind beta even when getting alpha is an undesirable outcome

Hey hedgefundguy, thanks for doing this thread. As someone who played hsnl/hsplo for most of my 20s and quit to try and get into investment mgmt I'm especially enjoying the insights here given ur background etc.

Hope this isnt too noob a question, but as you've been happy to educate on Sharpe ratios and how hf performance should be measured (I now see the stupidity of measuring vs SP500 as is commonly done in newspapers/articles) I was wondering:

In poker my bb/100 might be 5 while stdev might be 150 so I should have a paltry sharpe ratio of 0.033? But poker lets you play a ton of hands so that your probability of having a losing year is virtually zero. How do you 'scale up' sharpe from 100 hands to however many hands you play in a year, in order to get some comparable estimate of poker returns vs hf returns? I guess that expectation goes up linearly with hands played whereas stdev goes up less than linearly somehow? What would be the sharpe of a 5bb/100 ev, 150bb/100 stdev player over 200k hands for example? (i'm sure many people can answer this one)

Finally, have to ask, tips on getting good at picking stocks/doing analysis/finding alpha/good investment performance in general? Especially interested in nonstandard things that you don't hear everywhere else

^^this is precisely true

Since you increase sample size by a factor of 2000 (200k / 100), std dev would increase by a factor of sqrt(2000).

So your expected win at 5bb/100 over 200k hands is 10,000bb, or 100 buy ins. Your std dev would be 150 * sqrt(2000) = 6708bb/200k hands. So your "Sharpe ratio", if we can even call it that, would be 10,000 / 6708 = 1.49.

Note, if you put in more volume, this gets better drastically. With 400k hands, your expected win is 20,000bb, with std dev of 150*sqrt(4000) = 9487bb/400k hands --> 2.11 "Sharpe ratio"

For 600k hands, it goes up to 2.58.

^brilliant, thanks. interesting the numbers are v similar for good poker players to the best performing hfs. the staking galfond analogy is even closer than i thought then

Indeed...and well done Two SHAE

Thanks for the response!

Just like what Rikers said, isn't accurately predicting when to load on more beta and reduce beta just as important as finding alpha at times??

If a hedge fund manager had a portfolio of 85% low beta securities in Q2 2008 and converted that to 85% high beta securities in Q2 2009, it would have been immensely valuable to their clients!

That being said, in your opinion, what is the most fair way(a formula, if you can think of one) an hedge fund can charge their fees, where they get compensated for how good of a job they do:

a. Delivering true alpha
b. Accurately adjusting the right amount of beta given market conditions
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Given how obsessed Hedge fund managers are at delivering alpha, adjusting beta, generating strong sharpe ratios, I still don't understand why:

a. Hedge funds constantly benchmark their performance to the S&P

b. Structure their fees based on simple scam metrics, where any regular Joe can manipulate a portfolio(add a ton of beta) to get rewarded handsomely for doing nothing.

Sign me up for 2/20, 0/20, 25% of profits above a 6% hurdle, etc and a $10 billion fund. There's a 25% chance that my pet monkey throwing darts will make me a billionaire as long as I add enough beta.
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IMO the pricing structure is the biggest thing that needs to change in the industry.

I think that once this does, people may start respecting the industry more.

The Taleb books, books on behavioral finance (Predictably Irrational, Winners Curse), books on value investing (Margin of Safety, Buffett's letters)

Picking winners--surround yourself with smart but self critical people (who have diverse views), learning to accept that you are going to get some trades wrong no matter how hard you think or work on them.

Commodities--not my true specialty, but a bit of a long term bear (really long term) as more value gets created in cyberspace. For the same reason, I am bullish education (and countries who get education right). Not easy to turn these views into quick alpha, as they play out over decades, not weeks or months.

I have actually not answered this excellent question yet in the post, despite having threatened to do so on a number of occasions.

Part of the reason, is that I am getting closer to actually committing to writing a book, and if I do this will be the core of it...and having second thoughts on whether to post here for a number of reasons...none of which is related to the quality of the questions or comments in the forum (which have been generally high).

Sorry to have been a bit of a tease on this question (and I have avoided a few others as well).

Beta loading (market timing) seems (at least for me) to be a lower Sharpe ratio strategy than the strategies we currently pursue. Also, the institutions and individuals I invest of behalf of often have their own views on market direction and they can express their beta views cheaply and easily without us.

On relative utility, I discussed a poker staking situation. If you staked a poker pro and that pro earned you a 20% return, would you be happy? Now, would you be displeased if the SP500 was up 50%? Would be even more happy if the SP500 was down 10%? It seems silly (to me anyway) to compare the poker player's results to the equity market as those results are uncorrelated to the SP500. The same argument would hold for a beta neutral, alpha seeking hedge fund.

The argument could be made that the S&P 500 would be the opportunity cost of investing in a hedge fund or alternative investment though, right?

Bump

Investors in hedge funds could invest in SP futures (at a reduced cash usage) and use some of the cash to invest in hedge funds. It is not really an opportunity cost.

The constraint is risk, not cash for these investors. And the question is for the same amount of risk, does adding *some* amount of hedge funds to your portfolio (given that they diversify you and that in and of themselves have good return per unit of risk) increase your expected return. I think yes.

Could you give us a life story?

It seems you have taken an unconditional path towards becoming high up in a hedge fund. I'm curious to what your route after high school looks like and how some of the different ventures you have gotten involved with )i.e. poker, travelling) have helped you in your hedge fund.

Thanks

Read the first 4 chapters of Predictably Irrational on my flight today upon this recommendation, and am enjoying it so far. I especially liked chapter 4 where he emphasizes we live in two different worlds: one ruled by markets, and by social norms.

So you think hedge funds are great. And after you filter out the many that go broke, of the remaining ones that choose to report, some of them report being successful some/most of the time. That's not ground breaking!

How are you planning to fill out an entire book that you don't expect to make any money on, though? Can you give us an idea of chapter titles, or more generally what kinds of topics you plan to cover in depth? Any myths you expect to bust?

Do you see your book as something that will be of general interest, or do you think it will wind up in the do-it-yourself finance / get rich quick / idiot's guide to investing type niche?

To make sure I understand your point fully: the individual investors will commonly pay the income tax rate on hedge fund gains instead of the capital gain rate that passive index investors might pay. So let's say 39.6% vs. 23.8%. In addition, the capital gain rates are only paid on realized gains, so the gains from compounding over the years are smaller.

Other big disadvantages that I can think of are: the risk of the hedge fund imploding (Madoff's, Amaranth, LTCM) likely being much higher than this risk for other standard investments, the lack of transparency making this risk impossible to evaluate for an individual investor, and the lack of liquidity (for example, yearly lockup period and quarterly withdrawals with a 60 day notice).

Based on a few simulations I ran, I believe that even with the taxation issue, adding a low-beta, high Sharpe-ratio fund to a standard stocks/bonds/real estate portfolio would result in a significantly lower volatility of the portfolio with the overall returns that are not worse. It is difficult to find any other ways to achieve this result. However, I can see how the additional negatives might tip the scales against hedge funds.

HFG here signing off. I have been busy for the last week or so, and have let the thread slip, so best to just tie things up here. Apologies for leaving some questions unanswered, but usually there was some reason (preserving anonymity mainly) for doing so.

I want to thank 2p2 and the forum members for their excellent and thought provoking questions. I think I have moved closer to getting this book launched and this was a useful way to process some of the ideas behind it.

Come back and link your book when its finished please. Youve piqued my interest at least.

Rats, just found this thread, too late. Had a couple questions I wanted to ask.

BTW, a friend of mine is a hedgie, and never went to college at all. He's just very talented (he's up 20%+ YTD ) and has an innate ability to analyze a situation, especially a bk and the relevant bonds.

Mine as well.

I also want to thank hedgefundguy for taking the time to participate in this thread. I certainly learned a few things and benefited from it!

Threads like this where I am very thankful to have stumbled upon twoplustwo one fine day a few years ago, almost like a second wife!

Thank you HFG and David!

Do reveal yourself one day and link us to your book once published.

I know you are not responding to this thread anymore. However I have an idea for the hedge fund industry. Suppose you have a stock you want to make changes at but do not have the votes. You can put out a stock like Dell-I. Where people can pledge their shares to vote alongside Icahn. Or they can pledge their vote to put members on the board that are shareholder friendly, ie like to lower wages, limit CEO pay, break unions, end stock options, start buybacks, increase dividends, end wasteful capital expenditures, growth, and marketcap campaigns. Campaign congress to allow you to change vote control without a capital gain reassessment.

Looking forward to the book.

Thanks for creating the thread hfg. One of the better threads in BFI for awhile now.