Will England - A Primer on Multi-Strategy Hedge Funds - [Invest Like the Best, EP.342]

22:38The difference between 55 and 57 % of the time is huge. It's just really hard to do that. And you want to take essentially as many small bets and add them up as many times as possible to squeeze out that alpha over time. And I view it as, we'll probably get into quantitative versus fundamental stock picking. What is the place? It's very much a place for both. And it'll always be the case. Human's ability to synthesize information, even in a world of AI on a multi-month timescale, I think that is timeless. I'm definitely plagiarizing one of the leaders in our industry who said that recently, but I think it's a great statement, but it's really hard and you need to be very dedicated to doing that using tools available to you.

23:16Let's talk about what happens above the individual manager level. So a simple way to think about this would be, let's take a bigger number, a hundred managers, all of whom are doing something a little bit different, different sectors, different strategies, different asset classes, and they're all trying to earn that 2 % to 3%. Naively, you could say, okay, great. We've got 100 of those. We're just going to allocate capital to them. We get the average of those. They all just get to run their own books and we just get what we get on top of that, maybe with some leverage. But I think there's more going on at that second layer, whatever you want to call that, the center book or the core strategy or something.

23:50So I have more questions about the individual manager level for sure. But just at a high level first. What is happening when you start to roll all those things together? What literally is happening at the firm and in the portfolio above the individual level? So this is really going behind the curtain, which is fun. Definitely, there's a lot going behind the curtain. The basis for your question was saying, okay, let's think of a simple hypothetical problem in which you've got 100 uncorrelated time series. Well, the optimal solution to that would just be to give each one the same amount of risk.

24:18In practice, they're not uncorrelated and the correlations move around a lot, which is what makes this really hard. And so earlier statements around this being a giant risk management exercise, very true. And so there's a couple of questions to react there. What is going on as far as the center book or the back book or the alpha cash portfolio, the magnifying portfolio that's different than just the true risk management exercise of what is the risk team doing every day? What is my head of risk doing? What is a head of risk doing at Citadel Millennium? Again, technique is the same, style might be different at different firms.

24:48So number one, of course, every individual strategies has their lane. And that's a machine is looking, are you staying in your lane pretty much in real time? And if you go outside of your lane, the machine is going to flag that and it might get mad at you. And there's all sorts of nuances of how is it going to get mad at you, but practically speaking, you're staying in your lane and that's you put on a position that you shouldn't have, or you lose more money than you're effectively allowed to lose. Yeah, absolutely. There's a little automation to that. But then there's another sense is this is where machines can do a lot of it, but human intuition, human thought, human's ability to essentially architect the risk management system is really important.

25:23That's a living, breathing exercise of, okay, we have different strategies that we didn't think were going to be correlated. All of a sudden, they're becoming correlated. Why is that? Is there something in our baseline risk model that we didn't see before? When I talked about this concept of idiosyncratic returns or alpha, something that's not in the model, that's literally saying that just because something looks like an idiosyncratic return, it could be that there's a factor that's not actually in your factor model. So actually trying to think through that and dynamically adjust for that. And that is constant.

25:52And that is definitely going on at our firm. I know what's going on at all these different firms and being like, okay, is there something underlying that could be sort of resonant frequency, which could impact multiple different types of strategies and screw up this perfect analytical concept of having actually uncorrelated return streams. And it can appear in weird ways. You can have a biotech manager all of a sudden become correlated to someone trading European in consumer stocks. Why is that? That could be something in the markets and it could be flows driven. What fundamental stock picking is, and again, multi-managers do a lot more in fundamental stock picking.

26:25That's a huge part of it. It's obviously fundamentals. This is a big element. The other part is game theory. What are all the super smart people that effectively all went to the same schools or trained in the same banks and think the same way? What are they doing? You're all fighting with each other. This notion of positioning and crowding, and it is really game theory, is hugely important. That's another thing that the risk teams are crowds are trying to think about a lot is what is my crowding factor, which is this boogeyman of what's co-holding's risk, what are positioning dynamics? It's all basically saying the same thing of if everyone is positioned the same way and they all move their feet at the same time, it's like you run from one side of the boat to the other.

27:01Well, everyone's screwed. The whole thing might capsize. And so thinking around that, constantly monitoring that, it's just very amorphous. It's really, really important. So it's all of that is the risk management exercise. The other part of your question is, what is this boogeyman center book that gets talked about? And PMs really hate that at a lot of firms. And the reason for that is not because they disagree with it intellectually. The core concept of center book, again, just using equity long-term managers, is to say, once you get to a critical mass, again, earlier, an economy of scale, another argument, you've got 30, 40 individual stock pickers, they're all sector focused.

27:36Well, a machine can essentially take an automated eye, look across what positions that PMs are having, the trades that they're making, and say, you know what, that's actually a pretty interesting signal. When you put on that position or the fact that you have this position, I can do this across a large number of managers. And I can take that information and I can either throw it into one giant machine to holistically say, I'm going to call it the best picks, which is hard to do. But again, there's an approach to that. Or a simplistic approach to just be like, you know what, I'm just going to copy what everyone else is doing.

28:10And the reason why PMs don't like the latter, which is quite prevalent, is because oftentimes they're copied and then the PMs are not actually compensated for that. So there's this notion of, well, you're stealing my IP. and it makes sense for the firm to do that. And this is where there can be tensions because it's just more efficient, particularly from that cost standpoint. Obviously, if you're running X hundreds of millions of dollars in a given sector and half of that is the PM and they're getting carry on that and half of that is run by the center team and there's no carry on that before it goes to the fund, then obviously that's more efficient for the fund, but it can also create tension.

28:44So years ago, when we were starting our center book program, that is not the path that we chose. And not all firms do it that way. Some firms do. But it's not the path that we chose because we wanted to be transparent to the PMs and have them participate in the economics, which I think is important. But that's the core concept of saying you have a critical mass of people doing all sorts of different things. And a machine can take all the information simultaneously and do some interesting things with it and then do that at a huge scale. Again, 30, 40, 50 % of exposure in an equity long-term program and multi-manager model can be in these center books, it does make a ton of sense for first principles.

29:20But managing some of those human elements, the dynamics, the interaction with the PMs obviously is very important. I'd love to get into the nitty gritty of the people. I'll call them the managers in the multi-manager sense that live at these firms and apply their trade at these firms. It's so interesting to think about what you've built, which is effectively a company for whom the finished product is money. Let's stick with that 15 % a year just because it's convenient and maybe in the right ballpark. and the raw materials that go into this factory and then produce the finished product of money for the outside investors, for the LPs, are these people and these teams that are, in many cases, and I know a lot of these people, incredibly talented investors.

30:00To earn 3 % of return is shockingly hard. And you're up against the market. And that means someone else has to lose, which I want to come back to, as to whether or not all the talent in the world gets sucked into these multi-manager platforms. But there's got to be so much interesting nuance going on around who these people are, how you recruit them, the incentive packages that you have to give them where your competition might be them starting their own firm or something like that because they're so talented. So talk me through the universe of the people. How many people out there do you think could earn that 3 % return?

30:35Is it thousands? Is it hundreds? Is it tens, dozens, and what is important to them? And maybe we're starting to get into the style versus the technique here, but the people are, without them, there's nothing here. It's just a house of cards. So tell me everything you can about what you've learned in this part of the business. There's not an infinite supply. And actually this is getting to an important point of just where we are because the multi-stranger models generated this amazing alpha in the recent years. It's not as if you can just plant a flag and say, the model generates so much alpha in and of itself that even if you've never done this, you're an analyst, you've never been a portfolio manager, or you're at a bank, you're at the sell side, and you've really never done this before, but voila, we can plug you in and imagine that you can be there.

31:18I don't believe that is true. So there is a finite pool of talent. That pool of talent in terms of how big it is, is I don't know the exact number. It's probably more hundreds than thousands at some level. And when I say that, that's less about the technical aspects of the job. You can learn how to model companies. You can learn how to be a quant wizard. You can do all those pieces. But the job of being a PM, whether you're quantitative or fundamental, is psychologically extremely taxing because you're going to be wrong basically just as much as you're going to be right. You're going to get kicked in the face a lot.

31:49And you're going to be someone who's the smartest person that they've known their entire life. And then they're just going to get beat up all the time. And that's what the job is. And that takes a certain psychological profile. And that requires training. and I just don't think many humans are wired that way. So I don't know the exact number, but it'd be inaccurate to say that you couldn't just take anyone with a resume and assume that they're going to do well on the model. And if anything, probably the multi-manager space, in my opinion, is a bit too crowded at the moment, which is natural in finance because something works when we know more people get drawn into it.

32:18And in some ways we're seeing that right now. The other thing that I found really interesting, because we did not start off as a multi-manager, we ended up here really by accident. And when we concluded for first principles that the multi-manager model is a great business and makes a ton of sense and iterated there over a number of years. Once we really reached a certain scale in a very intellectually honest way, where we could start hiring people, we had to think, what is it that someone is actually looking for? This is a very high quality person that you're dealing with. And frankly, this is where I think the big four maybe are a little bit vulnerable.

32:51These are humans. And especially if they're humans, whether they're a part of their career, or it's not just about the incremental guaranteed dollar, they care about the firm that they work for. This actually does matter, just like in other businesses. And I'm not talking about in a fake way of, oh, let's give someone a fucking ping pong table and they're going to be great, or some of these gimmicky things. Really, if you're a high caliber person and maybe you're at a point, the PMs that we're talking about in many cases, they might need to work, they might not need to work, but they've done very well for themselves.

33:21So they're trying to think, what is my experience going to be? after the assumption that all what I need to do to just do my job is there, do I actually want to work for this firm? Do I respect the people that are running it as humans? Do I respect where they're going? And there is this notion of these PMs, even though it is an eat what you kill model, what we've found in growing our firm, and I can say this because we wouldn't have been able to grow and produce if this wasn't the case, there's a group of PMs out there for where for them, that's really important. They don't want to be motivated by fear or they've already been burned out, maybe doing that elsewhere.

34:01That doesn't mean that they want to sacrifice performance-based environment because you need to be hyper-focused on performance in all aspects. But those other elements that in a cliche way can sometimes be wrapped up into culture, that really does matter. And I think that increasingly as the multi-manager space evolves, it's not just about providing capital. It's not just providing great technology tools. It's not just providing flexibility. In the same way that VC investing years ago, because the supply, demand, and balance of capital was about providing capital. Nowadays, if you're a VC firm and you're not actually adding value to a company in some way that's authentic to who you are, you're not going to be as successful.

34:39And they're seeing that now in the multi-manager space is because the capital is there to go after a finite supply of people, you really need to be thinking about what is your value add? And not in a fake, we're all going to be super polyanalyzed and claim that we're going to hug each other all day. But no, really, are you treating people with respect? Do they respect you? And do you have a track record of doing that for an extended period of time? So there's many data points where they can point to that way. I think that is increasingly going to really differentiate firms. Can you tell the walleye backstory and from this existing in Minnesota, probably even just the fact of where you're living and spending your time is quite a bit different.

35:17Almost all of these firms are in a couple of places. So tell the story, why Minnesota? Minnesota's state of mind in this case, I think, to some degree at the firm culturally. Talk about the history and the culture. So this is a very true story. Years ago, when we first started raising capital, because we were a prop firm, my partner and I were in New York. We'd have multiple meetings with people and say, we're Walleye. And they're like, the Disney movie, like WALL-E? And I'm like, no, it's not a fucking robot. It's the state fish of Minnesota. How the hell do you not know that? But it just, it tells the story of, yeah, Minnesota is different.

35:50And I can say that as an East Coast person married to someone from Minnesota, as I mentioned - I'm from Minnesota, so I can corroborate. Having the douchiest East Coast background imaginable, I can straddle both worlds. It would be irrational to assume that a firm, we were starting in 2005 as a proprietary options market-making business. So a Chicago-style trading firm, effectively building an engineering technology machine to quote single name options prices, very, very complex problem, but much more of an engineering problem than an investment problem. And especially around the financial crisis earlier on, I had some great success doing that, but literally based in a warehouse in Minnesota, didn't even have a website, no one had even heard of us.

36:30It'd be totally logical to assume that we evolve in terms of where we are today. And even at the start of 2017, the history of a firm. Effectively, we started as, I mentioned, the single strategy prop trading firm, breaking our history down to a couple of chapters. That was about the first five or six years. I had very good success for a capital base up until around 2011, 2012, never losing money, but markets became much more challenging for various different reasons, some structural changes. And today, Citadel Securities, which is different than Citadel Hedge Fund, but Citadel Securities and Susquehanna really are the only pure options market makers left.

37:02So we had an existential crisis really a little over 10 years ago of saying we've had really great profitability, but now the magic money machine is going away. We've got a lot of capabilities, just like an industry, we need to transform ourselves or shit, we're going to die. And many firms that did look like Walleye years ago just died. And the reason why I run the firm now is I was a driving force, or not the only force, but a driving force of saying we are going to transition effectively into a multi-manager model while being a prop firm. We didn't do this to raise capital. We didn't do this because it was faddish.

37:35We did just to fucking survive. And as a prop firm, again, prop meeting is all the partner's own money, conveys intellectual honesty, where if you're not making a really high gross return on capital, you're dead very quickly. And the only way to do that is that very high share ratio is very consistent. So we spent all five years transforming ourselves from a single strategy firm into a multi-manager and in a scrappy way. I mean, we were a$60 million prop firm all over 10 years ago, and it worked. And it didn't work because there was this one thing where it was this lead bullet and we just, we threw it all in there.

38:09It worked because there's a lot of trial and error. There's a lot of throwing things against the wall. Even when we were starting to build our fundamental equities business, originally we'd do that with managed account relationships with external firms because we were too small to even hire people. So that was a process. And we got to the start of 2017, we had retooled the business. Again, that was our chapter two. Chapter three starts at about that time. We said, okay, we're a$100 million prop firm. We have multiple different businesses now. We think we have some scale. We'd seen what some of the larger multi-managers had done.

38:38And there was another prop firm that had evolved from being a prop firm to starting taking external capital. We think we can do that. It makes a lot of sense. And it's an intellectually honest proposition for us to do that, to grow a bit. It's better for our investors, better for our employees, better for the partners, just to get a little bit more scale. But scale, I'm talking in that time of going from a$100 million firm to a$200 million firm. And I remember in 2017, and we were able to double the size of the firm pretty quickly, largely through people that knew us. And even though we were a prop firm, we structured the capital in a hedge fund format, so it could point to a true track record.

39:09And we thought that was big. And when I say track record, again, to give a sense of the numbers, at that time, we effectively hit a$100 million firm with$30 million of expenses, another$20 to$40 million of variable expenses. So effectively, if we weren't making at least a 50 % gross return on capital every single year, actually the investors, the partners were losing money. Crazy. Yeah. It really conveys, as I said, intellectual honesty. And so chapter three, basically the past six years, it's definitely not like everything has worked. Got a lot of scars over the years, but we've just incrementally grown and grown and grown.

39:43And so when people hear our story, you asked about being in Minnesota, we've obviously expanded to other geographies. At this point, New York is our largest presence. It's at about 300 people now. We still have our warehouse in Minnesota, but it will look from the outside. Oh, okay. This is one of the real multi-managers, but the core DNA of having been through that experience of fighting for survival, maybe a little bit too strong, but there was the element of we got to figure this shit out, or we got to find something else to do is really helpful. And there's a youth element to that as well, because I personally was given a lot of responsibility at a young age.

40:16I'm only 38 now, so back then in my early 30s, and my partner who's 30 years older than me gave a lot of responsibility. I was very much an entrepreneur himself, was saying, okay, go and figure this out. So when we recruit, when we talk to PMs, it's not like I go out and say, we're the best in every single dimension. I think we're great in some areas, we're good in other areas, and we still suck in certain areas, and that's fine. We want to accept where we are. And I'll tell people that, but definitely when someone interacts with me, the other members of the senior team, and be like, that's an intellectually honest person.

40:43That's someone who's not bullshitting me. There's a realism to that. And because there is so much bullshit in finance, if you're a really high caliber individual and you're selecting, because there is a little bit of supply, demand, and balance, you're selecting across a number of firms, they want to work with the intellectually honest person, but they don't want to sacrifice competency. You need to have both. You can't just tell a great story about we're great people. We got this great culture. We treat each other really well. You need to be really fucking good. If you're not, it doesn't work.

41:09But if you can do both, that's really powerful. And because the biggest firms in our industry who are amazing institutions, I have so much respect for all of them, especially Citadel. And I think Ken Griffin is truly brilliant. It's like if Michael Jordan was still playing basketball, that's the analogy to think of, or is the Elon Musk of money making, like really. And that's such a gift to people like me to say, okay, there's someone up there who is still pushing it, who is still going to the limits, who is not satisfied. That is amazing. But I think the one thing where those firms and partly could just be size or a little bit vulnerable, is this notion of thinking about the individual PM experience and what are they looking for?

41:46What is the attachment that they want to look for? Because they still want to be part of something, I believe, or a certain group of people that want to be part of something. They don't just want to be a mercenary sitting in some random ass office in Dubai or Spain or you name it, and you see all these places poking up. They still want to have a connection to their firm. And we can tell a story of our Minnesota roots, of our prop shooting roots, of realism in all the partners. How does that feel different live? If I'm one of these hundreds, this incredibly valuable resource, these individuals that can go do this, and let's say I'm the best and I'm a free agent and I have my choice, every platform's after me.

42:20What would be the felt experience difference of being at Walleye versus being somewhere else? Sure. I'll give an example of that of someone that we just hired who was definitely of that profile. And we still try to get the entire firm together. And we're 300 people, so we can still do that. But we're all over the world, so that's harder. But we brought the entire firm out to Minnesota in early August. Minnesota is an absolutely amazing place to visit six months a year. The other six months a year, absolutely do not go there. Unless you like ice fishing. Yeah. Ice fishing is not a joke. I literally live in a lake.

42:51People ice fish. There are pickup trucks that will drive a mile offshore. That's not exaggeration. So come there in August. But we brought the entire firm out there, had a party on the lake, and I had my office door open the entire time, people coming in and asking questions like, how do you think about this? How do you think about that? What is the firm doing in these dimensions? So there's a notion of accessibility and just, again, it's not complicated. It's not overly complicated, but doing it the right way, not putting on errors, it'd be totally inaccurate to say that this is a family. It's not a family, it's a business, it's a professional sports team, but professional sports teams can still operate with respect, respect for everyone across the organization.

43:25So that's one element. The other element, which does, I think, come from our firm a bit more and the particular people that are running the business, myself and my other partners. And very fortunate because we have effectively our chairman, who's very successful, who's almost 70. And then there's a group of us young guys that are running the business. And there's a great balance there. The young guys, we're really, really hands-on. And I think that also really resonates with PMs. If we bring someone into our firm. And let's say that it's a little bit of a new category for us. We haven't necessarily done this type of strategy before, or we're not perfect in some dimension, which can happen.

44:00You don't have certain product types enabled, or you need a new technology piece. Even at this day, I'll get really involved because years ago, that's what I was doing. And I have the knowledge to be able to do that. Same with the other partners. There's this notion of no one's above that. No one's a figurehead. And that can be really, really in the details at times. It doesn't mean that I'm micromanaging or getting lost in the weeds. But there's definitely a place to be like, yeah, be hands-on, get after it, show people that it's important. And I've had so many new PMs that have come here and be like, I can't believe that you actually took the time to look into that personally.

44:34Or when you said that it's going to get taken care of, just even something as simple, I need some new futures options enabled in the system. Can we actually go through and do that? Okay, fine. I'm not saying we're the only firm that operates that way, but definitely from my experience, the best firms. You still have very hands-on senior people that are also, frankly, very confident and able to do that. And you're showing PMs really that they're important and they care. It's not just about hiring PMs, but you're really building teams of investors. You have a PM, they can have sub-PMs, they can have analysts.

45:03And sometimes there can be competition for those analysts as well. So PMs will come to me and say, hey, I really like this person. They're in process in a number of places. Can you speak to them? Absolutely. And people feel that in all various different ways, as I mentioned, whether that's getting the weeds in a technical problem, whether that's helping with recruiting. And that doesn't mean one of the things I haven't mentioned, it's not like we're saying we're soft on anything goes and you can lose a ton of money and there's no problem to that. That's not the attitude. I think we're very fair in that respect, which is a third piece is that when you talk about all these risk parameters in the corridors, sometimes from the outside people like, oh, well, this group they run with such tight limits and here you basically can't operate.

45:42Generally speaking, I don't think that's true. Maybe with the exception of one firm. Overall, the risk corridors are fair, but what PMs want to feel is just that, that they are actually fair. And if they have a question or they want to actually have a discussion with a reasonable person, let's say someone's going through a drawdown and they get close to the point at which there's this drawdown limit, which every firm has, including us. And that's really a way to say from a fiscal standpoint, let's automate the offboarding process. Obviously the hardest piece in risk allocation, whether that's allocating individual positions or allocate individual managers is one to actually call a quiz because there's this human psychological bias to say, oh, okay, if I fire someone or if I change my idea, then I failed in some way.

46:24So drawdown limits are very helpful to just automate that and take the human emotion out of it. But the PMs want to feel like, well, shit, there actually could be situations. They're rare, but there are situations where the path matters and that could be not the right decision to do. So what we tell people, look, that is rare. This is definitely not a, oh, if you've got a great story. You can just keep going indefinitely. But we're willing to have that conversation that we are investors ourselves and have a lot of experience of what it's like to be in that situation. And that is what PMs really respect.

46:52Again, going back to reasonable, competent people that are doing the obvious things well. Yeah, if you're in a tough spot, you want to have a fair conversation about it as opposed to just essentially being fired by some 23-year-old because in a spreadsheet, the sell goes from green to red. That's again what these high-help people want. Do you identify personally more as an investor or as an entrepreneur or systems builder? Me personally? Yeah. Definitely the latter. Definitely the latter. Earlier in my career, I went to grad school for math, started off at a big quant firm in London. I was able to, in a random experience, spend some time at now one of the great growth equity firms in Chicago.

47:30So for people that have my seat, I've had just a wider range of experiences. and even when I first came to wall, I was running my own quant strategies that I wrote personally as writing code all day. And then it was evolving into hiring teams of people in quant strategies and then more broadly across effectively over time, everything that can be done in our world. And in terms of differences between being a PM, it's essential for someone in my position to have been a PM. That's for the psychology aspect of it. And to be successful in doing that, you need to prove your bona fides and you also need to be able to say, I understand psychologically how hard that could be, no matter who you are.

48:04But in terms of where we are now, my role is I'm designing processes. And increasingly, as we get bigger, I'm interfacing with people and putting in place people that I really trust that are experts in their domain. My official title is CEO and CIO is Achievement Investment Officer. But the investments that I'm making are investments in strategies. I'm not making a call on individual stocks. I'm not making macro calls. and effectively the individual strategies are, to use a normal company analogy, they're like individual products. And I'm saying, how much do we want to invest over here in our equity longshore business as a whole?

48:38And then maybe in particular areas, and how do we get the right coverage across the map? Do we want to start bulking up our quant business, just like, again, another division of the firm? And for me, having a quantitative background and the ability to abstractly architect that has been very helpful. What I personally really enjoy is because it is such a human business. And I really think that has overlooked the multi-strip model. This business, its risk and people on the people side is so important, being given the opportunity to lead groups of people that effectively are coming together. Look, this is finance.

49:08This is the money-making business. We're taking money from rich institutions and we're trying to make it into more money. So as humans, you need to find purpose in doing that. And yes, there's all sorts of stories you can tell about who those institutions actually are and their core purpose, which is true. But for the people that are in there day to day, this notion of how you do anything is how you do everything. And let's be excellent for the sake of being excellent. That doesn't mean that we are excellent in every way, but at least that's the goal. And my role now is leading that across our investment and our non-investment functions.

49:42And the non-investment functions are so critically important in our business. That is what I personally enjoy the most. I have to ask, since we share this background, coming up as a quant, a couple of quant questions. What can you say about the half-life of successful quantitative strategies? So if you think simply as a quantitative strategy, it's just a predetermined, pre-baked set of rules for making investment decisions based on some model. I'm talking about the models themselves. How long do you think the average model can or does quote unquote work for? It's related to Sharpe ratio. You can't just group quant into one bucket.

50:18And there are quant strategies that are double digit sharp ratios. And if anything, the half-life of those is a lot shorter. And that's because if you just think about it from an analytical framework, the higher the sharp ratio, the closer it is to a pure arbitrage. And at some point, capital is going to flow in and close that arbitrage. And there are real 10 sharp ratio strategies out there. I've seen them that can run for years. So it's not like anything that the higher the sharp ratio, the faster it dies. But generally speaking, something could be great for six months because of some strange anomaly and then go away.

50:48At the other end of the spectrum, you think of something like trend following strategies. I started my career after grad school. I was at the time the world's largest trend following manager. And trend followers are very simply, I'm going to look at momentum, typically measured by a moving average crossover, and that's going to determine how long I am or how short I am. It's still a huge part, particularly of futures markets. And it does even impact equities markets because of the positioning that history. Trend followers have been around since the seventies and generated decent uncorrelated returns for quite a while.

51:21And last year was one of the best trend follower years in quite some time. Now the Sharper ratio of those strategies is less than one. If you're a good trend follower, you're like a 0.8 Chirp. And I can say this because I wrote a trend following strategy over a decade ago that still runs. So I actually know everything that's in there and the nuances are different, but it doesn't necessarily mean it goes away. So that's how I think about it a bit more. In quant land and multi-managers, most of what quant is, is equity stat arb. And that's analogous to what I was mentioning before is that you're long$100, you're short$100, you're looking for idiosyncratic returns.

51:57So what people are fighting over now is there's a signal aspect. Is there some new bit of data that could help improve my signals. But at the same time, ARKWays started our business running at scale for almost eight years. A lot of the data that they're using has been available really since the 70s. You go back, Compustat's been around for a long time. And when you read about Princeton-Newport, what they were doing in the 80s, they're talking about fucking value and momentum. Yeah, that book about it was great, but the core concepts have been there for a while. What does change, it is still very competitive.

52:30I'm not trying to say it's not competitive, is that even in quant, there's still artists. And this is what we find in evaluating. There's definitely quantitative artists that are saying, okay, quant, especially that style of equity that are quant investing is less about finding the thing that no one else has. And I think that's totally ridiculous to think that you really are going to find something that no one else has found, especially when you realize that at least since 1990, people that go to the elite universities of the world have been pouring into quantitative finance and everyone's really fucking smart.

53:00You have the same technical abilities are there. And I can say that with personal knowledge. So what differentiates people is how you're putting together everything in the soup as one. That's a bunch of small decisions that are much more akin to artists making painting on a canvas than necessarily following a terministic standpoint. And that can be how you're combining balance sheet data with technical price data, which type of machine learning model you're using. And then that feeding into the portfolio construction piece of how much you're trying to optimize for sharp ratio versus how much you're trying to optimize for drawdown and all these different elements.

53:36How much of your exposure is going to be in the US? How much is going to be outside? How are you going to shift that around? There's all these tiny, tiny decisions, even in building an equities.arb strategy. If you had, let's just normalize it to 100 managers or 100 points or whatever. If you had to break down both for walleye and generally, how you think those are allocated to the different styles, whether that's traditional equity long short, quantitative equity, quantitative other macro, et cetera. What are the major buckets and what are the percentage roughly of managers in each bucket? We started as a volatility specialist, mostly in single name options.

54:08We still are very active trading options. It's a different style than what we started with, but still very active. There are a lot of single name equities trading, but more so asset class of the volatility. Across our entire business, that number is still at this point, 25 % or so, 25 to 30 % is related to volatility trading. We do a lot in long short equity. So that would be another 40 % or so. And then the balance is split up between capital market strategies and fixed income macro strategies of various different formats. And I'm not to say that's the ideal fashion. As I said, the history for us, we started as a volatility specialist and we started pushing these other areas.

54:45Sorry, I forgot quant in that as well. That would be in that last bucket. Quant is a decently large part of what we do, about 20%. Fixed income macro is a small piece. That was the point I was trying to make. And And that's not because we don't believe that there are good things to do in that category. It's just, it's not our background. It's not in our DNA. And that's a thing as well, when you're building a multi-manager platform, you think about playing to your strengths. You can't do everything all at once. And at scale, if you're millennia, if you're Citadel, you've been around for 30 years that you've had time to build these different businesses and build them in high quality fashion.

55:15And that's where there can be attention because there's definitely benefits of diversification. But if you expand too quickly, then you just lose money in diversified sideways. How many is it? How many managers is it total? In our case, it's about 100. Oh, so it is about 100. It is about 100, but millennium is, I think, about 300. So the scale is large. And that's where it's a very complex management exercise. But what's crazy to me is to think about there's plenty of investment firms, I'm sure that the investors listening will have encountered, that's a leader, a small team,$500 million, a billion dollars, whatever.

55:45And just to think that there's a hundred of those under one roof, let alone 300 of those under one roof. Again, we're relatively small. It's crazy. And that the scale is dramatic. And that's what I was saying before is the model makes a lot of sense. It's very easy to articulate. Oh, you just earned 2%, 3 % on gross market value. I can do that. But no, no, you have to do that at scale, not just from an AUM perspective, from a strategy standpoint perspective. It's very difficult to execute. It's very much an execution challenge. Well, let's talk about leverage. So I'm also curious about how you you control the portfolio, why you push down the limitations to the individual manager level versus just take whatever they give you and manage everything above them.

56:25But leverage is probably important that we haven't talked a ton about other than just saying there's lots of it. So what determines how much leverage you use and how much does it range? What does it mean to be great at applying leverage versus just good? This seems pretty damn critical. 3 % is uninteresting, 30 % is really interesting. The difference there is leverage. So explain it to us. So ultimately, you're targeting a return profile for your investor base. It's much easier to target a volatility profile than a return profile. So you're really backing into, okay, if I'm trying to make 15 % return to investors and I want to do that very consistently, really, really good net returns would be about a three sharp ratio.

57:05So just again, do simple math. The sharp ratio for the best platforms has been at that level the past couple of years, but three sharp ratio is realistic, but nonetheless, let's say it's 5 % annualized vol at the fund level. So the leverage that you're taking is that, okay, I need to be in this category and returns day-to-day, you can't necessarily measure, but you can get a pretty good sense of your volatility profile just by looking at the distribution of your P &L. And there is an element of we're backing into with the range of possibilities that can happen of I'm generally speaking going to be 5 % to 7 % annualized vol.

57:38And I don't want to trivialize that problem because it is not simple, but it's also not that complicated to say if you go bit by bit and block by block, and that piece is really important. I think it's insane to try to start one of these businesses from scratch. There's a few weeks that have tried. The results of that have not been great. But if you're going bit by bit and saying, okay, I'm a hundred million dollar firm and my standard deviation is plus or minus$500 ,000 a day. So he analyzes a million. Okay. I'm in range there. Then I get a little bit bigger and a little bit bigger and you keep it at that same level.

58:10The leverage overall at the firm stays relatively constant. For us, it's been five to 600 % over the years and that's reasonably stable. But no one is specifically saying, I need to apply this leverage concept. You're really backing into, I need to deliver interesting returns for my investors in order to do that with a variable I can forecast, which is much more around volatility and also the potential for loss as well. Because realistically, if you're trying to make call low to mid double digit returns a year, having a 10 % drawdown, and 15 % drawdown is not particularly good. So that's a huge piece of it as well as saying within that distribution of outcomes, what leverage level am I comfortable with?

58:45Another thing that is pretty critical, you ask the question of how much does it vary, especially at the larger platforms, being able to, and this is true for us too, being able to say, okay, I'm confident that I actually can have a view on the potential range of outcomes. So I don't need to be like, oh, my risk management strategy is just to take down gross. That's stupid. And there's a lot of investors and very famous ones that have made a mistake over the years of, oh, when it gets a little dicey, I'm just going to pull back from that. You kind of need to prepare for that storm ahead of the fact, which is where vector analysis does come into play.

59:17So it's cliche, but you can play position of strength when everyone else is a little bit weaker. So that's another maybe misunderstood, but certainly important point to make is that the risk management policies, I think this is a technique thing. They're built to withstand and crazy things that can happen in markets. And that's not to say that there's this eyes closed, we'll be fine no matter what, very much paying attention, but definitely being able to hold your ground when you're going through it is really important. What is typically going on when there is a storm for this investment strategy in business?

59:47I'm curious about, is there a red button somewhere in the firm that can be pressed in the times that have been toughest? What is usually going on? I'll use the GameStop week of January of 21, maybe as a more isolated example to just our industry. So if you remember then, it was really a four-day period, started on a Friday and there were some rumors that Melbourne was really having some trouble with her GameStop position. And then Monday, Tuesday, and Wednesday for a very brief period of time, people in our industry just absolutely freaked the fuck out. And there was this idea of - Technical term.

1:00:19Yeah. Sorry, this is how I talk. I love it. but it was like, wow, you could never short a stock again. So holy shit, we have to take down our entire books. And so what's happening in those periods, again, as mentioned, and I believe that everyone in my seat at the top firms is very much in the weeds and we can see a lot of what's going on in our portfolios. That's where having the systems in place to be able to watch that in real time, very helpful. And even in that case, it'd be like, okay, we didn't really think about what the fuck is going on in Reddit could actually impact this world, but we need to pipe that into our system real fast and pouring Twitter's feed into our system, building tools on top of that to identify.

1:01:01It's like, oh, this is the next one that's there. Do we have high short interest stocks? Could something become targeted? That's very much a whack-a-mole exercise. So when you asked about what is it about, what's actually going on, just to give some examples of that, I remember hearing a rumor during that week, Citadel's taking down, telling their books to cut in half. And I was like, there's no fucking way they're doing that. But nonetheless, those are the rumors that are coming in. And the human piece, and this is really, it's these low frequency moments where you really can distinguish yourself as a firm is you need to be able to manage that personally.

1:01:32And I can even say managing that personally, because I've been through a number of these periods now, and I'm not saying I'm perfect by any means, but absolutely. Was I better prepared in January 21 than in March of 2020? Having been through March of 2020? Yes. And so what came out of that is you're watching what's going on. You're thinking about whether you're exposed to these factors that are now obviously coming up as the mean factor or the game soft factor, whatever craziness you want to call it. And if the answer is no, and you see that you have some strategies of losing money because very clearly there's people across the street that are freaking out, then the best thing to do is to say, we're not in a position where we're impaired.

1:02:07We understand what's going on. You need to have situational intelligence about it. you need to triangulate information and need to be able to weather that storm. That was absolutely the right call because it rebounded very quickly. How did you know that Citadel wasn't taking down gross like that during that period? People in industry definitely have channels of communication. I did not speak to anyone there personally, to be clear. There is an element, and you read about this in entrepreneurs of all types, but there's an element of just being disagreeable and backing your own intellectual intuition.

1:02:37And I remember thinking when I heard that, I was like, that's just not true. That just wouldn't make any sense to me. So I'm going to ignore the jobs that are freaking out and saying that there was certainly a piece because it just wouldn't make any sense. Why not? Why wouldn't it make sense? Well, in that first in particular, that is a core mandate of basically don't take down your exposure. So it'd be a huge departure from effectively stated operating principles. Also, the potential market impact of that would be enormous. And it's almost like, okay. Literally hundreds of billions of exposure.

1:03:10And that's like someone saying you have a bloody nose. Well, let's just cut off your fucking nose. That doesn't make any sense. So there's a skepticism about how well that actually valid it. And underpinning that assumption is that you have extremely smart, sophisticated, competent people that are running those businesses that would make sound decisions. We're in a game of relative, not absolute talent, which is, I think, a really important thing that people often forget. When you are selecting people to play that game on your team, aside from strategy, actually abstracting away from strategy, are there things that you are always looking for when you're interviewing a PM that feel like just necessary conditions of someone that you would hire, the key traits of a PM in this relative game?

1:03:54Yeah, there's a few things. And some of these are going to sound cliche, but they really matter and you feel them. So intellectual honesty is the biggest one. You meet a lot of people. They need to really understand why they made money in the past, because we're not underwriting the past, we're underwriting the go forward basis, which is an obvious statement, but very few people really understand that. Did you just make money because of the market call? Or did you make money because you followed a process which has a probability of repeating itself in the future? Are you doing things in the right way?

1:04:20Are you putting yourself in a position to be successful? And can you evaluate and analyze that. And experience matters, but it would be inaccurate to just say you're just hiring based on experience. If anything passes a certain point, there's a U-curve where you have almost two experienced people that were trained in a different world back in the 80s or 90s or even early 2000s picking stocks or before Reg FD. They're not equipped with a modern tool sometimes to be able to be successful. As I said, it's kind of interface a little bit more in a gray box style for fundamental stock picking as the most salient case.

1:04:50A core tenant of our firm, when it was started, my partner, who as I said, is almost a mall of 70s, been in the business since the 1970s, amazing career. When he started Walleye, one of the things that he said is, I don't care how much money someone can make us. We're not going to hire high maintenance people. Believe me, there's a lot of high maintenance people inviting us. And sometimes it can be tempting to say, you know what, let's hire that person. Even if they're a pain in the ass and they're going to drive us crazy, they're going to make us so much money that it doesn't matter. Well, you know what, that's never the case.

1:05:22So that's actually really been a core tenor for her. It does come from her, my partner, and we do think about that a lot. How do you screen for that? Reputation? Reputation. You can get a sense in meeting with someone. Interviews are easy to fake, but it's a small world where someone's been before. It usually follows them around. So there's obviously limits to how much you can screen for that. One of the things that I've definitely learned is that's not germane to our particular model is you can get a sense pretty quickly when you're actually working with someone and the romance has gone away of where they really follow that tenets.

1:05:52And so I do think that we put a bit more emphasis on the human side of it and less just trying to hire pure mercenaries and looking at people on numbers on the screen and not to say we're perfect. We benefit a lot from those that have gone before us. And your question was about relative talent game. Absolutely. That is true. Our sweet spot is people that are typically in their mid-career where they've spent time at large institutions and for various different reasons, They want to pursue a different path from being there. Some of that is structural. Some of that can just be environment. I'd love to talk a bit about performance.

1:06:23I don't mean investing performance. I mean, cultural, individual philosophy, almost of performance. At lunch, we were talking about the all blacks. And I know you're working with the author of that book on the company's culture. I'm dying to hear about that. But even at the personal level, you won't say, but I will. I think you deadlift like 700 pounds or something absurd. It seems like your philosophy of performance is that you said earlier, how you do anything is how you do everything. Just say more about the philosophy behind all this and then how the notion of culture and performance blend into aspects of your life.

1:06:52One of the reasons why I love our particular model is that notion of, yeah, be excellent is celebrated. Actually, in many parts of life, people that want to be excellent are somewhat pushed to the side. And what I mean by that is personally, probably still can deadlifts are under pounds, but I was an athlete in college and afterwards it was in rowing, which is a totally ridiculous sport because you essentially sit down next to someone else and then say, who's going to pass out first? But if you can be successful in that and you really understand, okay, inputs and output and rowing is just this amazing sport because you can get pretty darn good on very little talent and just being incredibly pigheaded.

1:07:30So that has definitely defined me. But the things that I've done personally in my life for the years, whether at first that was academically and then athletically, and then as I've gone on in my career and I've definitely had my own faults in my personal career. The thing that comes from that is when I'm personally the most happy is when you pursue something that is hard and it's a struggle, but you persevere and you do that. And you're doing that with other people that are in it for the same reasons. And the people that are really attracted to or from that I've enjoyed working with, we've got people that can not to overhype it, but spend time in the SEALS program, people that have played athletics at very high levels.

1:08:05There's this core notion. There's certain types of people that are wired in a way of they just want to be great at what they're doing. And over the past couple of years, as I've been in a leadership position, I've been bracing that a bit more and be like, you know what, that's okay. And if other people find that inspiring and want to come along with that, that's great. But that is what gives me meaning is what gives a lot of the senior folks at our firm meeting. The final piece of that is to be able to demonstrate to people, you know what, you can do that while also being an excellent human, excellent individual in your personal life, how you take care of yourself physically.

1:08:34Definitely that's hugely important to me. And I believe oftentimes people don't stress enough the connection, not to get too crunchy about it, but actually between your mind and body and how you're physically primed to the machine and how it's going to impact your ability to just have energy to perform all that really matters. So all those things together, personally, I think that's why I've been able to have some success and also to be able to drive a firm forward of saying, we're going to do this thing. We're going to do this thing that's irrational because if we do it, it's going to be great and we're going to feel great about it.

1:09:02And then we're one to the next thing and the next thing, the next thing. What have you learned that's valuable about the All Blacks? Maybe say what the All Blacks is just for those that don't know. So this book, it's called Legacy by another name, James Kerr. James embedded himself within the All Blacks. The New Zealand rugby team, arguably one of the most successful sports franchises. Teams ever? Yeah. Just amazing degree of success. And when he came away from that, in a nutshell, he was saying, you have these individuals who are incredibly high performing, but in the book, he has this line of sweep the sheds mantra.

1:09:31And that's a New Zealand terms. It means like, pick up the fucking locker room. Even if you're the God, the rugby God, and you physically look like a gigantic human, do the little things well. And that's not just talking about all blacks. You find that in all areas. I love that line, how you do anything is how you do everything. And the notion of humility, the notion of supporting your teammates. Another key takeaway from that book is don't be a dickhead. So it's similar to what I was mentioning before about not hiring hire maintenance people, just some really great values and that you can have this organization that has those pieces where you have this collection of team strength, a team of support that's also really high performing.

1:10:09And so the reason why we're working with James is that he had worked with a firm where I had spent time years and years ago that I have tons of respect for helping them to articulate and institutionalize elements of their own culture at scale. And then we were at the next Guinea pig up to do that. And as far as what that means, There's artifacts to that, of course. There's words. He's an author, so he's an amazing writer. But it's more, what are the rituals involved? Even things like getting the whole firm together. What is the right communication cadence? And in talking with James about it, these are things that all firms face as they go from, there was this core group of people that was seeing each other every day.

1:10:44And there was a lot of nonverbal communication to once you get above 150 people, this magical barrier in human cognition, you lose the ability to keep track more than 150 faces. you have to really focus on institutionalizing that. And there are organizations that can do that at scale. Typically, they're outside finance, but certainly the military, they're the case, the obvious special forces teams. Some sports teams do this better than others. And so we're spending time on that. What aspects of the ingredients that go into the recipe that is the firm, maybe even like the most insider-ish type things, have we not talked about that you think a lot about?

1:11:19How big to get and how fast. So the past couple of years, because the returns of platforms have been strong and there's this general intellectual acceptance that there's a better mousetrap. There's been money that's just been thrown at institutions like ours that have a credible shot. The biggest firms have effectively doubled in the past few years to just scale that boggles my mind and many others minds. There's effectively blank check SPAC type multi-managers that are being started by very smart people, but very different coming from a massive institution to starting one on yourself. So this base is crowded.

1:12:00There's a lot of money that's come into this base, investors of all sizes. And we've grown, but on a percentage basis, we've definitely grown. We've also turned down a lot of capital. But the conversations that we have internally are, how do you get that pace right? And I'm sure that startups that are in a bit of a bubble have had similar types of conversations. It absolutely happens in our industry. And finding that right balance is really important. So that's certainly something that happens behind the curtain as talked about. I guess the other one that is worth mentioning, and just to come out and say it, because people, have good manners in our industry, or maybe I don't always at the time, but at least I was brought up to have good manners so I can fake it.

1:12:43But the fact is it's a relative talent game and there's only a small number of firms. It's extremely competitive. And that's not to say that firms hate each other, but absolutely probably a big part of what drove Millennium and Citadel to be so excellent is a huge rivalry there. Then maybe you could extend that to other firms as well. And we have our rivalries too. And I grew up in a sport is literally, you're going to sit down and erg or line up and yeah, who's going to pass out first? And the level of intensity and competition around that behind closed doors. Yeah. People care a lot about that.

1:13:20And if you're going to play in this arena, you have to embrace that and be like, you know what? I want to compete day in, day out. Because if you're not, you're going to get passed by. We talked about some of the robber barons early on in the conversation. Is there anyone else that you find yourself returning to, whether that's reading about them, studying, thinking about the way that they lived that has been most impactful on your thinking or way of living? I didn't mean to compare you to a robber baron either. No, I don't think of a robber baron for sure. It's less about one individual because I don't think anyone's perfect.

1:13:53And I think it's quite dangerous to be like, this is the one person that I think is ideal. If there was one person that I'd be like, you know what, if I could have that guy's life holistically in every element, not just business success, personal success, it probably would be Ed Torp, who's one of the pioneers of quantum investing. He's been successful across many areas. He's like 90 years old, but he looks like he's 60 and has a good family. Okay, that's successful. But it's not like I studied that guy intensely. What I do find myself studying, and it's why I love the Founders Podcast, it's not just a shameless plug.

1:14:23It's really true because learning about successful people of the past, whether they be in finance, going back to the robber baron age, Vanderbilt was a fucking psychopath, but he's still extremely admirable in many ways in certain parts of his life. Same thing with J. Gould, James J. Hill. You go down the list. You can't be serious without studying Rockefeller. You name it. And human nature doesn't change. And so what I find myself doing constantly, just because I'm so curious, is reading books about these people. How did they think when they were my age? What was their life? How old were their kids?

1:14:54What were the problems they're facing? What were the stresses that they're facing? How did they interact with their partners? How did they interact with their employees? Because all that stuff doesn't change at all. And then ultimately, not trying to copy anyone, but you take bits and pieces from what other people have done before. And that's true of those really outside our industry, as well as even within our own industry. And you ultimately come up with your own mosaic of saying, I'm learning from others because because you'd be crazy not to, but blindly copying is also equally crazy. You want to come up with your own recipe.

1:15:25So I'd study, I'd say the personality type as opposed to one individual personality. This has been such an interesting dive into a model, which has become one of the largest gravitational forces in markets. And I think because it's fairly complicated, maybe other than my conversation with Dimitri Baleazny, there hasn't been a good summation of what is going on? What are the component parts of this? So I've really loved how much detail we've gotten into. I think you know my traditional closing question. What's the kindest thing that anyone's ever done for you? So I'm going to tell a story involving one of the previous members of your podcast, which as I've gone on and gotten a little bit older and have a little bit less hair, I think about more and more now.

1:16:03So I used to work in a firm called Valor Equity Partners run by Antonio Gracias. And the way I got there, and two people know this story. After grad school, I was at Oxford doing math and I was a hardcore math nerd and a big time rower, I thought I was awesome. And then I started working in a quant firm in London. I was doing really well. And back in 2009, effectively my best friend is 20 years older than me. He's my son's godfather now. He's like, well, you're a smart guy in your 20s, but you know jack shit about the world and investing. And I think you should come work. I just joined this firm with this guy, Antonio.

1:16:37He's really great. They're doing really cool things. It's a private equity firm in Chicago. And I was like, that sounds crazy. But you know what? I wanted to come back to the US. I'm a very curious person. I met those guys. I love those guys. Okay, great idea. So moved to Chicago in 2010. And I was terrible, really. I didn't know how to model. I didn't even know what a fucking LLC was the first day. I was a hardcore math guy. And I thought that was the ultimate intellectual achievement, but I just got my ass kicked and it was super helpful in hindsight. But the specific story that I want to tell to answer your question was, I remember distinctly this one day, it was about when I was two months in and I was really not doing a good job.

1:17:12I just was not trained properly. I was not mature enough for the role. And I thought I might get fired. I was like, oh my God, it's the first time I've ever failed in anything in my life. And Antonio sat me down and he said, you know what? You're fucking up. Yeah, I know. But we're going to help you. We're going to give you the tools to support you. We're going to send you to company modeling school, which everyone does in an investment bank when I'd ever done because I was a math guy. And so we're going to give you the tools to do that. You still got to carry your own backpack. This is a culture of excellence.

1:17:38You need to perform, but we're going to support you and give you the option to put yourself in a position to do that. And at the time, I didn't think, oh, wow, this is really kind. But as I've gone, and particularly now in running a larger firm, I realized how kind that actually was. When you have someone that is just not performing, it'd be so much easier to be like, you know what, this is not a fit to move on. But seeing something in me and the intensity within me and be like, you know what, this is a person where I'm going to actually go, not really out on a limb, that would be way too strong, but to be like, I'm going to be supportive here.

1:18:07That was extremely kind. And that's been kind to me because if I had not had the experiences of being in that firm, which were in hindsight, truly crazy, about three months after that, they were leading an investment in this rocket company called SpaceX that I never heard of. I didn't know where the fuck Elon was. And then I was crawling on rockets, literally. Had I not had just those literal experiences of being there, developed relationships with some of these individuals, seeing what's possible, that firm has gone on to be extremely, extremely successful. It would not have set me up for the next thing and the next thing.

1:18:37And I think about this notion a lot when we talk about combining excellence in a performance-based culture, but also being supportive and thinking about the human a lot. It's been extremely, extremely helpful to me. So I'm very grateful for that. One of the great little sayings I picked up from the Special Forces community is deeds over glory. And one of the funny things about Antonio, who I think the interview we did with him is like the only way you can hear him say anything, is he'll always show up in these pictures. It'll be Elon in a room fixing some problem and he'll be off on the corner helping solve problems.

1:19:10Such a fascinating guy and a really neat story to hear that would not have been my expectation that Antonio would pop up in this story, but a great closing answer. Thanks so much for your time. Thank you. If you enjoyed this episode, check out joincolossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.