>You can do 4 Sharpe at 5mio AUM after 6 years at a BB in anything that's not equities or delta 1.
Can you explain for a non-finance audience?
Can you explain for a non-finance audience?
Sharpe ratio = (Your return annually - Annual Risk Free rate) / ( Annualized Vol of your portfolio).
BB = Bulge Bracket, basically a Tier 1 Bank (Goldman, UBS, MS, Citi, google the list).
Equities = Stocks.
Delta 1 = If underlying moves by X $, your product/ derivative moves by X $. Basically swaps, etfs, futures, etc.
Now for some numbers: Say you are under a "vanilla" 2/20 structure (which is actually like 10 years out of date but is still listed on all finance websites) where your fund charges a 2% management fee (i.e if you manage 5 mio USD you charge 100k per year for fund cost) and 20% performance rate on your gross above benchmark ( so you take 20% of the return above your benchmark).
Annualized SP500 vol is let's say 18%, your cash return right now is 3.5%. Quick maths gets you to 4 Sharpe is about 75% yearly return. ((75-3.5)/18 is about 4).Under these assumptions, 4 Sharpe return on 5 mio is 3.750mio.
Your performance fee as a HF manager is gonna be 0.715(75%-3.5%) x 0.2 x 5mio = 715k. So 4 Sharpe on 5mio is basically you earning 900k-1mio USD (depends on the jurisdiction for your base, i took like 180k USD for base) as the HF manager.
Edit: For people who don't trade professionally, capacity (i.e how much money your strategy/you as a trader accept before becoming inefficient/losing money) is the big filter. There's a shitload of strats that work at 1 mio USD but completely stop at 2mio or 5mio.
"Arbs" on stuff that big desks don't touch because of capacity (small mergers for example, you lever up on 2-3 small merger arbs per year and you are almost there);
DEX to liquidity pool latency arbs for shitcoins if you want a crypto example;
Pure arbs (One of my friends who admittedly is not satisfied with 1mio USD comp did this trade: https://notion.moontowermeta.com/financial-hacking-etf-vs-ne... ).
Edit: The other option is that if you are a trader in "special" markets (the best example is biotech/medstocks) where domain knowledge really matters being 4 sharpe is basically 1 good trade a year, and at 5mio USD AUM you are always at capacity.
Think about it this way. You are trying to sell an apple. In one room, there are 100 people trying to sell an apples and 100 people trying to buy them. In the other room there is 1 person trying to buy apples and no one selling. In the first room you don't have much leverage. The buyers can go to the other 99 sellers if they don't like your price. In the second room you have a ton of leverage. If the person wants to buy an apple they are either going to have to buy it from you or wait for another seller to enter the room.
When it comes to non equity or delta 1 assets, there tends to be more complexity in understanding the assets, which acts as a barrier to entry. If you have been in investment banking for 6+ years, you likely understand these complexities and can find pricing inefficiencies.
Super super ELI5 is that people don't like volatility in returns, even if the returns are good (i.e. down 40% one year, up 200% the next year is 34% CAGR, but crazy volatility). T-bills for example have extremely low volatility but also very low return. The holy grail is very low volatility with a great return. A 4 sharpe fund is in that quadrant.