I am going to need a pretty good citation on that
Information about how hedge funds work - like information about say how ad tech firms work - is incommensurable with HN's Reddit/Wiki-style way of disseminating knowledge. I hope that information without citations could be tolerated more, I have no dog in this race, I just like sharing knowledge.
Shaw and many hedge funds that have been around for decades acquire smaller arbitrage firms that can be thought of as having "licenses" to perform arbitrage. This portfolio of arb is how they scale to their AUM.
There is nothing actually secret or protectable about what an individual arb firm does to execute the trade. For example a particular HFT trading algorithm. Such firms that rely on actual secrets do not last long and so in a Darwinian way do not wind up in the portfolios of huge funds like DE Shaw.
The arb shops that last a while have permission, from a bank, that depends on a relationship with a real human being, that is exclusive to the firm granted, to launder a particular form of arb the bank would like to do but could not.
For example you're allowed to take a spread as a bond trading desk, but wouldn't you like to sell the bank's bonds instead of its competitors bonds? That's plainly against fiduciary so it "doesn't happen." Instead you go to an anonymous arb firm, for $1m in bonds, and you say, "okay we're going to sell you the bond that is actually ours, you will sell it back to us, here is your fee, now we can sell this bond back to the client and wash the fact that it is ours." Nobody says that! But that is the economics of the trade, why the arb firm can make money for so long, why banks work with them despite seeming to be "parasites," etc. The computers are just part of the hocus pocus of laundering that arb.
Shaw doesn't actually come up with this arb or necessarily source the relationship. Instead it finds the little anonymous arb firm and buys it, and carefully scales the relationship for $1m of bonds with 1 bank to $1b in bonds with 10 banks. The risks in Shaw's business are that you lose the license to arb. The upside is from investors persistently underpricing the ability for Shaw to scale this arb from $1m to $1b. No, they basically pull a rabbit out of a hat every year and continue to scale a particular arb further than people thought was possible.
Also, nobody is going to want to just give Shaw, a bunch of rich people, a bunch of free money. But you can't fight their ability to acquire little arb firms. This is the way.
If this was actually how the world's biggest hedge funds work, somebody would have written a whistleblower article by now.
> As soon as most applicants arrived at their first interview, they signed nondisclosure agreements. If hired, they signed more, which may be why former employees spoke with us anonymously
We don't know what we don't know. That having been said, I also believe that if what DES were doing were truly and obviously illegal, someone would have burst it by now. [0] https://www.propublica.org/article/hedge-fund-billionaires-d...
> This secrecy and vigilance extended to the company’s extreme caution on legal and compliance issues. One of Shaw’s common sayings, repeated at an annual training session by a compliance officer, was that it was important to avoid risks and legal trouble because Shaw wanted to make sure that his kids could go to college.
How does the bank make money doing this? Routing the sale of this bond through the "anonymous arb firm" doesn't do anything to the price. If the bank's competitor is selling their bond at 1.00, the bank could directly offer their bond at 0.99 without getting "anonymous arb firm" involved. If the bank routes the trade through the "anonymous arb firm"... what difference does that make? If it shows up on the market at 1.01, the bank still has to give the client the 1.00 bond first, and if it shows up on the market at 0.99, the bank could have just done that itself.
I think it’s bad (it’s weird/unfair), but on the other hand I am happy not paying commission/getting orders filled at prices often a bit better than advertised on my broker’s app, so maybe it’s ok? Idk.
Another way to look at it is that there’s an “implied commission”, paid in the form of a perhaps slightly inflated purchase price, that largely doesn’t affect retail investors. And this all works out for quant firms because they make money off this at volume, at near zero marginal cost.
In fact, it’s odd that commission free trading didn’t happen a lot sooner. Etrade, Schwab, etc were rent seekers.
How is it bad or unfair? Everybody wins: you get a better price, the market maker does a trade they're happy with, and your broker gets a little bit of money.
I'm not sure what that means, but there's no scenario in which you'd get a worse price. That would be illegal under the Reg NMS order protection rule.
https://www.investopedia.com/terms/o/order-protection-rule.a...
More to the point: the primary consumer of order flow is market making HFTs, which DE Shaw is not. Stat arb/quant trading firms don't rely on market making rebates for trading profits.
Most quant strategies aren't really dependent on insanely fast execution. They may hold a position for weeks or months at a time.
They aren't measuring the market / order book and then reacting at high frequency. They are reacting at low frequency and then the execution is optimized to minimize losses caused by market feedback.
This is a very important distinction if you hold the view that HFT risks destabilizing markets.
But regardless, HFT usually means latency arb, not just trading a lot. There's a misperception that quant funds are making money on slight mispricings, but while I can't speak for all funds of course, this isn't generally true. Quant funds are much closer to buy and hold long term investors than they are to HFT firms.