Where has all the Talent Gone ?

I started in the hedge fund industry in the early 90's, I was, and still am a supporter of the industry, so what I am about to write is not something that puts a smile on my face. However investors need to know the reality in order for the industry to survive.  We have a quality problem in the next generation of hedge fund managers. Why this is, and how it happened I will explain. Starting my career as a hedge fund manager in the early 90s we were a fringe industry, controlling enough AUM (assets under management) that could make you wealthy by performance but not by earning a management fee. This meant that only the most dedicated of individuals would work in the industry. Our backgrounds were extremely varied, some from investment banks, some from prop trading companies, some from trading their own monies. We enjoyed running portfolios were we had freedom to execute strategies not governed by the long only asset management industry. We were secretly wealthy, never quoted in the press, never mentioned on the the front page of a newspaper. The markets were dominated by large tradition asset management firms that were governed by benchmarks. Investment banks conducted prop trading but due to their capital rules they were not a dominate force in the markets, mostly concentrated on market-making. However life changed as institutional investors started allocating funds to hedge funds, regulators relaxed rules on investment banks. Suddenly the traditional managers with their long-term investment styles became ordinary clients, hedge funds volumes exploded, investment banks became warehouses of risk. This led to a change in the hedge fund model. Management fee became the biggest driver of hedge funds income. At an average of 2% management fee of assets many of us were now becoming insanely rich just by surviving, suddenly performance fee was no longer the driver of our income. Institutional investors had a twofold effect: not only did their money mean due to our larger status we had to change our style but they were less demanding of absolute performance, more interested in returns compared to volatility. We as passionate managers of the 80s and 90s, were smart enough at first to balance the increased assets with still above average performance. We became even richer, our size of position meant now market commentary included our actions.  This extra publicity was not confined to market commentary as we started to find ourselves on Rich Lists, society pages and being investment minded individuals we even managed to gain publicity as we started to invest in other alternative assets like art. Suddenly everyone wanted to work for us. First we employed the senior traders from investment banks. What this meant was the relatively inexperienced traders left were promoted. Suddenly investment banks had lost their intellectual property and experience in proprietary trading. They did not care as other  business areas expanded in importance like product development, sales trading, market making, prime brokerage that directly benefitted from hedge fund volumes. This was the main factor in the demise of the schooling of traders at investment banks. They were no wise heads left to direct the young, raw arrogant talent. This was never really appreciated in a bull market as even the youngsters could produce profit.  However from 2007 -2012 it has became blatantly transparent, and explains why the investment banks are more than happy to quickly close down their prop trading in all asset classes.  So if the investment banks were not cultivating the trading talent then you think surely the hedge funds were but this was not the case. The main hedge fund managers now owning their own firms were talented traders and investors.  We had started working as hedge fund managers because we were passionate about trading. This passion translated to dedication to our work which did not make us the best teachers. This dedication to be the best was also lacking in our new employees. They really wanted to work for us just for the money.  They are smart, academically brillant but lacked the market savvy to deal with a changing market environment. This can clearly be seen when you look at hedge fund returns at the end of 2012. Firms where the experienced hedge fund managers who dominates risk taking at heir firms have outperformed. Take Dan Loeb at Third Point. Here is a manager that is a perfect example to show the passion of the old school hedge fund manager. Even though many criticize his style, he is a hands on leader, so when you invest in Third Point, you pay your management fee for one of the best researchers and portfolio managers around. However be aware not all old school managers are like that. Some firms really show the weaknesses where the founder has stepped aside to let others run their business. Izzy Englander's Millennium are a prime example of this. Izzy set up Millennium to be a quasi fund of hedge funds. Thankfully he does not charge a management fee but makes money from volume rebates and performance. Izzy was great at spotting trading talent and then putting a sensible risk structure around this talent. However Izzy is not hands on any more and his senior staff who run business lack the talent, knowledge and hubris to spot talent. If fact if ever there was example of how arrogance hides incompetency, the Millennium senior staff are that. This is an international problem: both New York and London have the same attributes (in fact in my analysis I think the London office is worse, where the head of finding new trading talent is so inept I think the only place he could survive is Millennium which thankfully still has a common sense risk management infrastructure that Izzy originally developed).  However if a Millennium, whose business is spotting new talent, cannot even staff itself with quality at a senior level, then this obviously reflects on the talent in the whole industry. Another key factor in finding the next generation of hedge fund manager is background. Unfortunately there seems to be belief that Physics or Mathematics from a top university means that an individual will be a great trader because of new technology of electronic execution. In fact the investment banks are partially to blame, but maybe this was there only choice given the lack of senior trading experience. While these individuals are extremely smart they unfortunately tend to have similar academic foundations. This is why the Flash Crash of 2010 and the quant problem driven by Goldman's hedge fund products of August 2007 exist, basically the models trade the same. One of my most successful trading hires in the last few years was a gentleman that was educated at the best university, did not get the highest mark, but the was someone through university traded his own account to make some money. He was passionate about the markets and became a great employee and trader. However as he often said to me, he would have never been considered as a trader in an investment bank or as trader with another hedge fund. If he ever has a desire to set up his own hedge fund I would back him. Of course I have not told him that but he does have that passion for trading, he is not just trading to earn lots of money, he enjoys it and he is dedicated. So there is hope. Unfortunately though finding him is like finding a needle in a haystack.

Sorry - we are greedy but we are stupid...

I apologize. I apologize on behalf of all top hedge fund managers and private equity managers. Even if most would probably would not want me to apologize for them or even feel they owe anyone an apology. Personally I do not care. When the latest fiscal cliff deal was signed, once again my industry ended up paying less tax than teachers, doctors, nurses firemen. For those who are knowledgeable on tax law, I am referring to the carried interest tax rule that both Democrats or Republicans guard with the same passion and intensity. This rule is not only anti-social, it is actually offensive given how much tax-payers money has been spent on bailing out the financial industry. The fact is that even some of the most intelligent investment professionals, leaders of their industry, blessed with a great ability to see into the future,  can be absolutely blind and stupid when they have to confront their own emotion of greed. You see these great men can not see that their happiness is not just created by accumulating wealth for themselves and their families but also involves the happiness of the environment they live in, beyond their front door and street. The wealth gap between the middle class and ultra rich has widened to an enormous level over the last 10 years. What is even more worrying is that this rate has increased since the financial crisis. Basically as the world had to did deep in their  pockets, the elite few made sure they were not digging as deep. Prima facie you might think this to be smart. But it is not true. They can not see they are building a level of resentment amongst the masses. This resentment is justified. It is not driven by pure envy, it driven by anger. And this anger is well founded, the super-rich in the financial industry are not paying their fair share, especially after benefitting so much in the good times. The resentment if not addressed will escalate and ultimately it will be the super-riches next generation that suffer. The problem is power and greed are dangerous drugs, highly addictive and as a hedge fund manager for over 20 years one that I confront on a daily basis. But the reality is true wealth is not having isolated power, its enjoying life amongst others who are also enjoying life, so they don't even notice you. The financial industry owes it to everyone including themselves to readdress this issue now. All we have to do is pay our fair amount. It does not mean that the tax rate needs to be so stringent that it strangles growth and investment, but we should contribute to the general welfare state to ensure the foundations of the next growth period (which there will be one) are built as quick as possible. I ask all hedge fund managers, private equity managers to contact me and maybe as a combined force we can beat this greed. However I doubt I will receive one contact. The problem is it just to easy. the elite control. The present system of party donations means there is no end to this selfishness. All I can do is apologize to the rest of you..

SAC - The Real Issue

Apologies its been too long but these markets have been tricky and I had to prioritize my investors. Thankfully this paid off and I pleased to have delivered nearly a 20% return for them in these markets. Ok lets talk insider trading and hedge funds. Of course as SAC and Steve Cohen come under scrutiny its worth thinking about exactly what the hedge fund industry has become. I started as a hedge fund manager at a similar time to Steve Cohen. He was one of the most gifted equity traders there was. He could have a positive view on a company and yet on a daily basis be short that company make money  and then go back to being long. But SAC today is a billion dollar hedge fund and Steve's style cannot run that size money. So he had to bring in other managers and traders. as SAC success grew so did their asset base and Steve became a smaller percentage of the capital. He made a conscious decision to build SAC into a large asset management firm and by doing this he made the decision to focus on management fee and not performance fee. I took a different route, always running a small amount of money for a select group of investors but my income is driven my income performance. Is Steve more wealthy than me? In pure money terms yes. We occasionally cross paths in the art world and he has more buying power than myself for sure ( I believe he is in the top 3 art buyers in the world. An unregulated market where insider trading, and cornering a market is legal!). But wealth is not just measured by money. I provide a service where my investors are my friends (this probably has a lot to do with the fact I make them money rather than my personality). I do not employ anyone else and have no operational headaches focussing on investing. Steve has to run his firm, which involves a lot personnel issues and ultimately has led him to getting the negative press he is receiving. Do I think Steve is an insider trader..No. He was always looked after by the street (Wall Street), was one of the first calls on breaking news but this is all legal and he had the knack to take advantage of it.  However this skill is only privy to a few and the vast majority of Steve's employees are no where near as good as him. This then leads them to the temptation to cheat. Unfortunately SAC only crime may well be that they did not have the infrastructure operationally to identify and prevent this. It basically comes down to a simple fact: hedge funds should not be that big. I often think how I would create a large hedge fund and I have come up with one solution. Get together a small group of experienced and talented managers and create a super hedge fund. I thought of calling up Bruce Kovener, Louis Bacon, Paul Tudor Jones and Steve Cohen and suggesting it to them. But I would imagine that ego might be a preventive factor and in truth we all are in control of own lives so why? I would do it as a showcase, to show there is still trading talent in the hedge fund world. However this talent sits with a few. I feel sorry for all those institutional investors: pension funds, insurance companies etc who believe large hedge funds provide them alpha. Let me tell you they don't, they can not, they are far to big not to be Beta. Anyway I guess that is human nature..Alfred Winslow Jones created a great vehicle, for approximately 50 years it delivered excessive returns but now greed has destroyed this product. I hope Steve Cohen does not suffer too much from this, he is someone to respect. He probably needs a good succession plan at SAC but that a discussion for another time....

Happy Holidays!

As the leaders of countries go on holiday, I wonder just how they will be feeling. Mr Sarkozy will probably go and have a great time, forgetting the troubles both Europe and France face in 2012. No doubt his tremendous self belief, that sometimes crosses the line into blinded arrogance, will allow him to forget the following: France and other major European countries need to refinance and a large amount of debt in 2012, banks need also need to refinance a large amount of debt especially as they start preparing for new regulatory capital rules. French banks in particular hold a large percentage of Greek, Italian, Spanish and Portuguese debt. The rating agencies have France on their negative watch-list for a potential downgrade. Europe need to implement their new treaty quickly to at least give the markets some positive action to be come optimistic to a solution to the European debt problem.  He has elections in April and he basing his campaign on his handling of the economy. No matter of the severity of these problems, Mr Sarkozy will no doubt feel he has handled the situation to date perfectly, even though he has managed to cause friction with the UK, who the rest of Europe need to be amicable in order to quickly implement many of their new measures by using existing European Union infrastructure. Regardless Mr Sakozy will look into the mirror and still remain firmly in love in what he sees. Mrs Merkel will not quite have such a joyous christmas. Her biggest concern is how to convince domestic politicians and the German public that a greater federal Europe is the best for Germany. While economically her arguments are strong and clear, sociologically there are many issues. The greatest is Germany once being perceived as wanting to be the masters of Europe. If austerity leads to a protracted European recession Germany will become once again resented by the rest of Europe. This is something the German public want to avoid at all costs. Mr Cameroon christmas will be a subdued affair with element of exhaustion. While he knows deep down the stand he made regarding Europe was the correct one, he also knows the reaction to this action needs to be managed. Mostly he knows he must keep a coalition government united which has mixed and vastly different views on UK's participation in Europe. He also must balance UK's interest while still appreciating how dependent the UK is on the free trade benefits of being a part of a European union. He might feel a little proud of how he handled himself on the international stage especially compared to the juvenile French leader.  But this warm feeling may dissipate quickly as he remembers the present stress of the global banking industry, which is the main driver of the UK economy. Mr Obama will have a philosophical holiday break. He will be bemused at the process behind the US political system. He will question whether the systems allows for personal gain to prevent consensus cross party politics, which is necessary in times of crisis. He will be preoccupied by the Iranian situation. Somehow he must appease Israel enough not to take military action, and work out how best to diplomatically handle a irrationally Iranian leader. And for the Chinese premier it will be just another day, in a week, in a month, of a long term -cycle that will see China's influence in the world increasing. Happy holidays. 2012 looks set be just as challenging yet full of immense potential as 2011.

Making Money with the Swiss Franc

Most traders, hedge fund managers and portfolio managers I speak to have lost money trying to trade the Swiss Franc this year. I initially find this surprising as trading the Swiss Franc this year has been a very profitable currency for myself. I decided to conduct some research into why this is so. The conclusion to this research may also have some bearing on why I have been profitable in 2011 and to my surprise others have not. The key in 2011 to making money in the Swiss Franc (also I believe this will continue in 2012) is to understand Hildebrand the Head of the Swiss National Bank.  Unlike other Central Bank chiefs he has true market experience in trading. This means when he decides to intervene or use political messages to depreciate the Swiss Franc, this can be, to a certain degree, preempted. It takes a simple trading analysis of what you would do as a trader if you were in his shoes. This study of market psychology is sadly not conducted by the majority of macro and FX dedicated traders. Most short-term traders in FX are purely systematic. I should point that this style of trading, I believe, does have true validity but can go through periods of losing, as 2011 shows. Pure systematic traders therefore ignore the market psychology aspect that I believe is the key to Swiss Franc trading at the moment.

Its Better To Die On Your Feet Than Live On Your Knees

After the UK's decision to step out of the Euro crisis and risk political isolation, the immediate reaction of many market participants has been to consider this a negative move. I am not sure this is the correct perception. It must be not be forgotten that UK's GDP is driven predominately by services, most of which stem from finance. This fact means the greatest risk the UK face from all the proposals of Europe on the table is the financial transaction tax. In fact it was JFK's decision to have a tax regarding Eurobonds that original aided London to become the financial centre in Europe in modern times. It would have been a risk to trust that Germany and France would not have used the new proposed treaty changes to try to take some of this lucrative business away from London to Paris and Frankfurt. In fact the French's Napoleon-like president's reaction was all too clear in showing his disappointment in what might have been his saving political move to win himself another term. France under his leadership is definitely not to be trusted. As for Germany this is rather more of a complex analysis. I fortunately have worked closely with a German bank  and so maybe have a little bit more of an insight into their motives. However a quick review of recent history can be an interesting guide. When German reunification was first proposed, both UK represented by Thatcher and France by Mitterrand opposed the move as they believed this nation would become too powerful within Europe. At present their fears seem to have some validity. Germany now controls Italy and Greece via technocratic governments, as well as France. Germany seems to be making the fatal mistake of ignoring the public feeling of other nations in favor of austerity at all costs. Is this similar to their previous mistakes of dominating Europe? Unfortunately yes. But this is only true of German leaders and politicians. The average German on the street does not want to be in the spotlight. They fear accusations of similarity between them and Nazi Germany. They want their country to do well, be the great industrial power which they are, but not to invade Europe. Unfortunately this rational and sensible view is lost at the political and high ranking German level. Here you find characters who have the fatal cocktail of arrogance and resentment. I never thought Merkel fell in to this category but unfortunately I think I was wrong. For Sarkozy the analysis was straight forward. His ego is  his biggest hindrance combined with his inability to control his feelings. The French must be totally embarrassed at voting such an individual into power? Remember his first speech on US soil after his election win: he told the Americans to get their finances in order! The French have a chance to rectify this situation at the April elections. It will be interesting for me to see just what the French people decide and certainly for an onlooker the result will tell us a lot about the French public. They may also feel that they do not want to be Germany's puppet...will we see. So given this background, the UK's decision may not be perceived that negatively. What I find the most disturbing is that the European Union was set up to prevent war and a dictatorship in Europe by friendly nations sharing defense and trade. It was never about the loss of individual nation's sovereignty.   The UK demands last week were not that unreasonable. Germany and France response was worrying. For me as trader I think the probability of all outcomes, including the most negative for the UK, Cameron's decision was a good trade. I bet many Greeks and Italians must feel they wish their governments have made similar decisions. For surely it is better to die on your feet than live on your knees?

How to Profit from a key week in Euroland

As the markets prepare themselves for another European summit, canny investors will be prepared to take advantage of the weeks events. When they analyze how to implement strategies it is always worth assessing what they know and they do not. What they do know is there will be price movements surrounding the summit as politicians use the press to restore confidence in the European debt markets. Whether the final announcement will induce this confidence or be ignored is an unknown. Therefore a trading plan should incorporate both these outcomes. It is relatively clear how a positive outcome should be played: go long equities, short treasuries, short the dollar and long commodities.  However the key to success will be picking the right way to implement these macro themes. given the expected volatility, it is essential to avoid crowded trades. These crowded trades will have numerous stops placed by traders and therefore will experience excessive volatility on an intraday basis. This means there is a higher probability of a trade held being stopped out. The answer is simple search for uncrowded trade that has the same macro catalyst. Let me give you an example: instead of going long the Euro verses the dollar, an extremely crowded trade, an alternative is to go long Canadian dollar verse Swiss Franc. This latter trade is essentially long risk, just like the Euro position. It also has the characteristic that it may benefit from Euro specific very negative news due Swiss National Bank's policy of pegging to the Euro. This kind of alternative trade can be sort in all asset classes. The next piece of the puzzle is to decide on an entry level, profit target (if used) and stop loss level. Once these have been established the size of the trade in terms of risk can be defined. The same exercise can be done for a negative reaction to the summit. In this way an investor can be armed with definitive plans to quickly react once a direction is established.