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Comment by osrec | Hacker News Reader

This does not surprise me.

My personal experience with hedge fund managers is that they are good salesmen that peddle their financial expertise to clients, convincing them of their financial rock-star status (usually gained through a lucky investment or two). Paulson is a classic example. Wealthy individuals buy into it, especially those that are less educated (e.g. those that have inherited money), and happily allocate away their money to these guys. Once the funds grow to a certain size, then they might consider pitching their investments to pension funds, and their money pot grows, as does the nominal value of their fees. By the time they have pension funds on board, their investments get less and less risky, eventually looking more and more like a basket of standard commodities or a standard equity index! Thus, the value they add also becomes smaller and smaller.

In my opinion, the hedge fund industry is a bit of a farce, but there are a small number of firms that do have a secret sauce that works sometimes (rarely forever though). In my experience, the firms that tend to make consistent money are the market makers, rather than the speculators.

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Nothing works forever but there are funds like Renaissance Technologies' Medallion which may just be getting heads for a long time but rather seem to have some secret sauce that works for a long time. Usually though they're not very large and don't seek out investments.

I think that's an important point. The problem good funds have is not finding more capital but being able to manage it without cannibalizing their own returns. Anybody trying to sell you a hedge fund is probably not selling a very good one.

Yes, Renaissance is an exception. I would argue that their nature of their strategies almost puts them into a pseudo market maker category (I've personally never worked with/for them, but I hear much of their strategy is statistical arbitrage, made possible by favourable transaction fee set ups and fast, colocated execution infrastructure).

Plus apparently some dodgy "creative" tax code interpretations around short-term/long-term gains.

Is it dodgy? You buy a share in a fund, that fund buys and sells, should you pay capital gains on every sale that fund makes? I don't think that has any precedent. You pay tax when you sell your share.

The type of strategy they employed isn't something small time investors could. It was a complex option scheme essentially buying options on their own short term trading.

While what you're saying is true, in fairness there are two caveats:

1. Virtually all profitable strategies run by hedge funds are inaccessible to small time investors nearly by definition, because they have more capital and lower capacity constraints,

2. The partnership you're talking about with Deutsche Bank doesn't account for most of their returns, and was only in effect in the last decade, not decades before.

Any info on the colo'd infrastructure?

Unfortunately not, I'm afraid. I would guess they have much of their execution infrastructure in the same data centre as the exchanges they execute on.

There's a considerable early period (1980s, 1990s) when Renaissance was turning up amazing profits when electronic trading largely didn't exist. That would suggest other methods.

Perhaps they were just market making back then as well? See this link: https://www.wallstreetoasis.com/forums/is-renaissance-techno...

Renaissance is an exception at levels that makes me wonder if it isn't a cover for other methods or operations.

Howw many sigmas divergent is it?

It's a highly profitable market maker more than a long term investment fund.

I'd really like to see deets. I've looked, somewhat, and what I've found (including Jim Simon's very few talks) have been ... pretty uninformative.

You're not going to see details. No one who works there (or at similar firms) has any incentive to give away that information. If you come across people who work at one of these firms, you'll find they are extremely cautious about saying much of anything about their work.

The comments you see on forums like this one are just best guesses - educated guesses, but generally underinformed and relatively out of date. I personally consider it a fluke that RenTec is as famous as it is - other comparable firms like TGS have far less notoriety (and are probably better off for it).

There are several options that have noting to do with competence that allow for such returns. The most obvious is feeding the fund using another fund. Luck is another as the best returns from the largest outlier taking high risks looks great especially if you ignore large initial losses.

Look at their past performance, luck is just too unlikely for their string of successes.

Supose they had a 10% chance the fund is worth nothing in a given year. Over 20 years there is only ~12% chance a given fund makes it but taking such risks significantly boosts returns. Further, assume many such funds and you are only looking at the lucky ones.

This is why you need to make predictions of performance ahead of time instead of analyzing past performance.

PS: A standard trick is to start 20 funds and the 'best' one has high returns. Create another 20 funds to have a new 'best' when the old one reverts to the mean. Thus you need to analyze total returns weighted by funds size of a company not just individual funds.

This doesn't reflect how the industry actually works among funds that have alpha.

Clearly funds try and avoid going broke. However, many funds also have losses much greater than the market including the one we are talking about.

The truth is risk is hard to measure accurately and most Alpha is simply risk hidden from their investors.

Which is why a statistically significant Alpha takes more than a single funds past performance. And how someone just lost a 1 Million dollar bet on this crap.

Not so unlikely if you consider survivorship bias.

Actually yes, it's still quite unlikely. If you formalize your thesis here and actually do the calculation, you'll see that the chance of a fund achieving a consistently annual average 70%+ return over 20+ years is overwhelmingly unlikely to emerge with the number of funds that existed in the same time period.

"Survivorship bias" is a meme that is commonly thrown out, but to date no one I've challenged on it has empirically demonstrated that this accounts for the emergence of ultra-successful funds. Model this out a bit - what is your single unit of trading to judge and what is your time interval? How many other participants are there in the same interval, and how is each unit judged? You can't just judge on an annual basis - no firm has an actual 50% chance of beating the market each year. Funds like Renaissance make hundreds to thousands of trades each day. Moreover, different firms have different chances of beating the market each year.

Basically, I want you to rigorously formalize how a firm like Renaissance maps to monkeys throwing darts at the wall, because as much as people like to use these analogies (coin flipping, etc), they're never empirical. How do you account for a firm that beats the market by an overwhelming margin for 2 - 3 decades and never having a return poorer than the market (and in fact only rarely being down per quarter or month).

EDIT: Elsewhere: https://news.ycombinator.com/item?id=13797635

They don't consistently average 70% returns.

Feel free to list the years they had over 70% returns vs less than 70% returns.

That was a misnomer, you're right. But that doesn't meaningfully impact my point. An average annual 70% return, some years greater (notably, 2008) and some years lesser, but only a very small number of down quarters or months in the same time frame.

Don't forget to include the preceding 30% drop which reduces both the total returns directly and rate of return as the fund operated over a longer period.

Further, they stopped publishing returns suggesting an even lower long term average.

So, you are looking at a biased subset of a funds returns not total returns which greatly shifts the probability's.

The trick is that any non-illegal investing strategy has finite potential, because it is exploiting some sort of mispricing by the market. Eventually either your buying and selling will correct the mispricing, or other investors will catch on and start doing the same thing, spreading the profits thinner among a larger crowd.

This means that if you want to continually beat the market, using any strategy beyond an impressive gut, you need to be continually developing new tricks and strategies, finding new market mispricings to exploit as your old ones dry up. It's like juggling: someone who is skilled or lucky can keep the balls in the air for quite a bit of time, but eventually you're going to run out of tricks, and the best you can hope for when that happens is returning to average returns.

> This does not surprise me.

It shouldn't. That anyone would take a basket of hedge funds and think it would win vs the market is madness. Active investment is negative sum due to fees - it's essentially implausible for hedge funds on average to generate alpha.

There are plenty which do. There are lots which actually simply provide alternative Betas, or smart betas, or whatever. Some of them have genuinely reasonable fee structures! Finding those funds and even getting access to give them your money is really problematic (and often results in another layer of fees to "access providers").

> it's essentially implausible for hedge funds on average to generate alpha.

Only if they're playing fair. But, wink wink, you should really wink wink invest in my uncle's fund, he knows a wink good strategy, but if you enjoy plausible deniability you'll just fork over the dough without asking too many questions.

But it turns out that uncle, a former NASDAQ chair, was running a pyramid scheme the entire time...

I expect that you are right about a significant number of funds (I would say most long-only funds). But a decent chunk of the industry exists because investors want higher-sharpe investments than the market even if they don't beat a bull market and/or investments that will remain uncorrelated with the market.

This is a reason why a lot of money is flowing into quant funds despite the overall outflow, because most quant strategies do great in volatile markets (but mediocre otherwise) where other funds are the market+fees.

Yes, my reply was focusing on equities as the s&p was referenced in the post. There are other kinds of funds that do reasonably well; distressed credit shops seem to have done okay in the past few years, although that's starting to tail off now as there are more players in the market.

Money is flowing in because they think they can pick the funds with true alpha, but they can't.

I've only dabbled a little in cryptocurrency exchanges, so the terms seem to refer to the same thing to me, but maybe it's contextual? Forgive my ignorance, but can you explain the difference between market makers and speculators?

You have market makers where you don't have an exchange, or where there is very little liquidity. Usually a bank but not always. They are there to "make a market", i.e. to offer liquidity to clients. Speculators take a directional position. Market makers make money on the bid/offer.

The exchange is not a counterparty. You have market makers there as well. Even in very liquid markets, it may be common to trade against market makers, just at a tighter bid-ask spread.

Think of a market maker as a used car dealer. Alice has a car that she wants to sell today and Bob wants to buy a car, but he won't be ready to until next week. The dealer will buy Alice's car today and hold it until Bob wants to buy next week (for a profit of course). Thus the dealer is making a market for Alicia to sell her car, and for Bob to buy one, without the two having to having to meet in time or space.

Market makers perform a similar function on illiquid stocks, where there may be more sellers than buyers at one moment but more buyers Jan sellers the next.

Speculators are simpler. They're the guy who buys Telsa roadsters because he thinks they will be a collectible soon.

A market maker takes both sides of the market, and makes money on the spread.

IE, a market maker would have a standing order to buy 1000 shares of microsoft stock for 29.99$ and then have a second standing order to sell it for 30.00$ at the same time. If the market is on average buying and selling randomly, the market maker makes .01$ for every pair of buy and sell trade.

A speculator is someone who takes only 1 side of the market. IE, they buy 1000 microsoft shares, hoping that the price will increase, or sells 1000 shares hoping that the price will decrease.

See John C. Bogel (https://en.wikipedia.org/wiki/John_C._Bogle).

I understand a lot of the top performing hedge funds operate via insider information.

This is sometimes true, and in my opinion, happens more at the smaller, unregulated hedge funds where the volumes can go undetected.

Is your understanding that they operate via illegal insider information, or access to information that is very difficult to achieve?

To be clear: I have mined and sold data to hedge funds before, including well known ones, and from that work I derived two conclusions:

1. It is fundamentally possible to beat the market consistently and legally by exploiting information asymmetry, and

2. Most hedge funds, especially the most successful ones, do not operate via illegal insider information (and will, in fact, fly into a compliance department initiated lock down on a security if, say, an overzealous data vendor compromises confidentiality).

Basically, I'm asking for clarification because as stated, I disagree with your assertion here. There are legal grey areas and some people are outright criminal, but overall I wouldn't characterize the top performing funds as being wholly or even close to partially dependent upon insider information, let alone at a systemic organizational level.

> I have mined and sold data to hedge funds

Are you able to tell more about what types of data this was? I'd be interested in hearing more. I love the story of hedge funds using satellite imagery of parking lots to predict retail store strength

> Are you able to tell more about what types of data this was?

I mined data in the real estate, QSR, automotive and airline sectors (and a few peripherally related ones). We would identify a source of data that was a demonstrably strong proxy for a specific company's revenue (that is to say, if we broke out a naive timeseries of the data it would map nearly 1:1 to earnings results each quarter). Then we would collect this data en masse, writing software over a custom crawler and infrastructure, bespoke to each case. During ingestion we'd process and normalize the data and dump it in a database. Once we had a significant amount of data we'd build a forecasting model, which could be very straightforward ("how many products have they sold this quarter", for simpler companies) to very complex ("can we reverse engineer the amount of business which is now online" or "can we determine the undisclosed amount of business being done in this specific region"). This analysis (and not the data itself) constituted the product - we never even provided the data directly to the hedge funds.

Once the crawling and analysis was mature, we'd incubate it for a few quarters while building interest; then, after showing a very strong mapping over several quarters, offer it as a data product. It was not uncommon to achieve <5% or even <1% margin of error for forecasting earnings announcements on a quarterly basis.

The data was always public and legal, though challenging to identify and difficult to effectively crawl. It was typically derived from very uncommon sources, and would range in complexity from the extremely simple ("we can crawl sequentially incremented integers from this third party that appear to map to products sold by this company") to the very sophisticated and complex (e.g. "we've collected a zero sum distribution of ad partners and their spend on the network, are more partners churning off, and is this a better or worse outcome for the company?"). I've spoken about this in comments here before.

This is still very doable, and I still do this sort of work for personal research (and profit). However, the work I do is now much more quantitative - I'm currently taking a similar approach for baskets of equities with the goal of forecasting macroeconomic trends (e.g. subprime auto loans) instead of the earnings results of individual equities. To give a very specific throwaway example (because it doesn't violate an NDA and it no longer works): it used to be possible to pretty accurately forecast large tech retailers' product sales each quarter (like Apple) by reverse engineering FedEx and UPS tracking numbers.

> it used to be possible to pretty accurately forecast large tech retailers' product sales each quarter (like Apple) by reverse engineering FedEx and UPS tracking numbers.

That's great. Were tracking numbers vendor-specific in some way? So you could, let's say, order an iPhone once a week and get an idea for how many iPhones (or total Apple products) were sold in that time period, just by using the tracking numbers? Was it dependent on geography in some way?

Yes, yes, no.

Reminds me of the British figuring out how many tanks the Germans made in WW2 by a sampling of the serial numbers.

That's genius! But then you have to buy a lot of iPhones, right? I suppose you can sell them on, and if you're getting ~$10k per quarter, it's OK. Or did you use a different approach?

What changed BTW? Did the format of tracking numbers change?

> But then you have to buy a lot of iPhones, right?

Just two per carrier would do: one at the start of the quarter, and one at the end. Earnings dates happen weeks after the quarter ends, so you'd have heaps of time to peddle your analysis around.

Would you be able to describe how your data was normally priced? I'm sure it is very context dependent, but I'm very interested. For example, let's say you have information that allows you to forecast the earnings of a publicly traded company to within 1% MoE; for how much could you sell this information (either one time, or periodically) to a financial company?

I once briefly chatted with a man who ran a company that used satellite imagery to predict crop yields. I found it amusing how rather than providing this information to farmers ("It looks like you're going to produce only 60% of what you did last year, time to cut some expenses!"), there was so much more money in providing this information to hedge funds and trading firms. Morality aside, the potential for technology like this is exciting.

It's kind of cool how the combination of big data, scraping, statistics, etc. allows this small niche of analytics to thrive. I have a decent background in most of these subjects, and this seems like a very freelance-able job, so I'd love to dabble in this area and learn how it works.

> I'm sure it is very context dependent, but I'm very interested. For example, let's say you have information that allows you to forecast the earnings of a publicly traded company to within 1% MoE; for how much could you sell this information (either one time, or periodically) to a financial company?

It is context dependent, but I can give a basic idea. In the example you've given, high four figures per customer per quarter, assuming you just give them a deliverable report once a month and the data is turnkey enough that many customers (30 - 40) can "subscribe" to it. For a fund that wants something more boutique, like exclusivity or a specific company, five figures becomes the floor.

The nature of the business is significant upfront work (setup of data collection and analysis model) followed by infrequent tweaks going forward. Lucrative data on a single hot company could be sold for mid - high six figures per year with very high profit margin for as long as the data is available and the analysis model is both functional and interesting (i.e. delivers an insight not already priced into the market).

How do you approach a customer once you have the data? I imagine you will build a relationship with your customers eventually, but when you're just getting started, do you just ask a potential customer via mail/email/phone if they want to meet and discuss your data of company X?

I'm also curious as to the level of "polish" that you are expected to provide. Let's say you know how many widgets Acme sold this last quarter. Is that by itself enough information, or would you need to calculate projected expenses / other stuff to actually be able to deliver an earnings estimate? What if you just had projected revenue?

Thank you!

I base my comments on stuff like this:

https://www.ft.com/content/efda2ca2-ec69-11e6-930f-061b01e23...

https://www.nytimes.com/2016/01/09/business/dealbook/sec-and...

I used to work on Wall St, and nearly every hedge fund was a client of our company. This is absolutely true.

There is no single Wall Street vendor who has nearly every hedge fund as a client, unless perhaps you are talking about a major exchange like NYSE. Even that is probably not a valid because of the huge number of firms doing smaller volumes via third parties (and having no direct relationship with the exchange).

Or perhaps you worked at Reuters or similar, in which case you would not have much visibility into the funds.

So are your two sentences related in any way?

He worked at Starbucks and would overhear traders bragging about their crimes in queue.

My understanding is that trading on non-public info isn't a crime unless both parties benefit. The behavior I'm referring to was sharing tips with the expectation of getting tips in return at a later date. As far as I know, it's not possible to prove that's illegal.

Also, it's not like actual illegal behavior is uncommon when it's hard to prove, and it's not like a lot of people aren't proud of it. Watch Jim Cramer's interview with Jon Stewart as an example and the reaction to Wolf of Wall Street as another.

In business school, a friend asked me to recommend firms where he could do some quiet insider trading by tipping off relatives who would trade on his behalf. He ended up at MF Global.

There aren't statistics on this kind of thing, but my experiences have all told me succeeding as a hedge fund requires breaking the same rules as everyone else, not unlike doping in pro sports.

>My understanding is that trading on non-public info isn't a crime unless both parties benefit.

Trading on non public information for a gain is going to land you in hot water with the SEC.

These two lines on the SEC site [1] define this.

>Corporate officers, directors, and employees who traded the corporation's securities after learning of significant, confidential corporate developments;

>Friends, business associates, family members, and other "tippees" of such officers, directors, and employees, who traded the securities after receiving such information

1. https://www.sec.gov/fast-answers/answersinsiderhtm.html

The SEC has established two precedents in this arena to satisfy the "personal benefit" or quid pro quo requirement:

1. Bribery, or a monetary reward,

2. Friendship and good relations.

In both cases there must be an unbroken chain of confidentiality compromise. If you legitimately come to know non-public material information about a company and you didn't acquire this information through your own or someone else's confidentiality agreement, you're fine to use it.

Information asymmetry couldn't be functionally and profitably exploited if it was literally illegal full stop. You just have to acquire it without breaking a confidentiality duty to your own company and without aiding and abetting someone else in breaking such a duty (e.g. they tell you and you trade).

It was a cheap, useful data vendor and research firm and lost most of its clients during the crash. I don't know if it regained its market share, as I left shortly after.

I'm surprised that anyone is surprised by my statement because it seems like an open secret. I don't think most of it is illegal, but sharing of non-public info is very, very common.

You cannot perform above average without an information asymmetry. This asymmetry may be either because you found "bug" in financial system or insider information or custom data collection. The test for "good" funds is essentially what information asymmetry they have. If their answer is "good fund managers", "years of experience", "past performance" etc then it's not concrete asymmetry and most likely won't work over longer term.

Buffett clearly disproves this theory. The reason is it's ignoring the overwhelming impact of bias and mal-incentives. Hundreds of thousands of investors have professional training in valuation techniques Buffett uses. But 99% don't make the same use of that skill as Buffett does, for reasons that include

1) they can't buy in to using valuation as their sole investment criteria. They want to be "smarter", thinking they can see things others can't using psychology or charts or other pseudo sciences. 2) They fall sway to Mr Market ( read the Ben graham parable). 3) They can't sell value to clients and only want a strategy clients will pay for. 4) Buffett spends a great deal of time trying to make decisions free of bias. A CFA program teaches you nothing about this, but it's critical to good valuation work. For example, WEB does not want to know the stock price of a company he's analyzing until he's made his valuation estimate. He doesn't want to be biased into giving a too high valuation to a company he loves just to ensure he can buy it.

Lastly, there is a meta level to value investing. A great valuation at a current price isn't enough if the company lacks a competitive moat, or management can't be trusted to treat shareholders well. First level cigar butt value investors never learn this.

Or perhaps Buffet has an information asymmetry. Don't you think when he is interested in buying a company that may not even be in the public market that the meetings, tours of facilities and financial due diligence represents a significant information asymmetry. This information is probably available to any who seek it but not practically to most.

That's the whole point of a mutual fund (of any kind). You're paying them to do things you couldn't possibly justify given the size of your portfolio. If all they're doing is sifting through quarterly reports they're not providing much value for your fees.

Well first, Buffett still buys lots of shares in public companies. His first few decades were almost entirely public companies. Second, any investor running an investment fund can make offers on private businesses, and get the same tours.

Its not an informational asymmetry, it's what you do with it. Walter Schloss is another great example. Beat the market by 5% a year for over 40 years, did it buying exclusively the doggiest public companies. He was the ultimate cigar butt hunter. His advantage wasn't information Wall Street didn't have, it was his willingness to use information Wall Street wouldn't, to invest in opportunities they would not.

Buffett does have one informational edge, his experience and judgement. He knows how value works, he has total confidence it works, and he never panics, even when down 50% in 2008. He never leverages himself in a dangerous manner, never gives someone else control over his decisions.

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