Odd Lots - How to Succeed at Multi-Strategy Hedge Funds

Episode Date: May 20, 2024

Multi-strategy hedge funds are all the rage right now. But there's also a lot of confusion about what exactly they do, and how the the so-called "pod shops" differ from more traditional hedge funds. In this episode of the podcast, we speak with Giuseppe 'Gappy' Paleologo, a long-time veteran of the space. In addition to writing books about quantitative finance, Gappy was director of risk and quantitative analysis at Citadel and head of enterprise risk at Millennium, among many other jobs. He walks us through what multi-strat traders actually do all day, what makes for a good multi-strat candidate, and how to win in the pod shop game.See omnystudio.com/listener for privacy information.

Bloomberg Audio Studios. Podcasts, Radio News. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthall. Joe, I know we did one episode on Podshops. Yeah. On multi-strategy hedge funds.

But it was primarily focused on their impact on the market. And I have to say, I still came away from that conversation, sort of wondering if I worked at a pod shop, What is it exactly that I would be doing all day? I would love to know the exact same thing. I mean, like, I guess I have this like very vague sense of sort of they have a bunch of people all focused on their specific areas and the sort of average out and they net out a bunch of stuff and it's capital efficient and, you know, it's like market neutral in theory and et cetera. But beyond that, like I still don't really like understand.

The only thing I know is like they've done really well. and many people are launching more of them. Yes. They seem to be all the rage. They seem to be where everyone kind of wants to go in the quantitative finance space, at least. Everyone's sort of aiming for these big names, places like Citadel, Millennium, maybe. Yeah. But my question is like why?

Is it just that they're minting money? They're expected to continue minting money in the future. Or is there something that's like fundamentally intriguing and attractive about working? in that space that means lots of people want to get in. I mean, I think that could be two ways of saying the same thing. If they're minting money, then that probably is fundamentally attractive to people in that space. But I do think, like, backing up the question, I'm like, what we know is that many funds,

including apparently even like B tier or C tier funds have done like very well. So I'm just like curious like how and why. And then yeah, to the question of like, what does it take to succeed in them or who is the type of person who can succeed in this environment. All right. Well, I'm glad you put it that way, because today we're going to be speaking with someone who has done exactly that succeeded in this particular environment. We have the perfect guest. We're going to be speaking with Giuseppe Palliolio, aka Gapie. He describes himself as a constant gardener, someone who's on gardening leave quite a lot. He is also the author of Advanced Portfolio Management, a Quants Guide for Fundamental Investors.

And I have to say it is one of the funniest books that I've read in Quant Finance. I can't say it's the funniest because I did read my life as a Quant from Emmanuel Dermin, but it's definitely up there. And Joe, I know I know you enjoyed it too. I did. You know, I like skipped over all the numbers and equations and Greek. You just looked at the jokes. In Greek letters, but it's very breezily written for what it is. And I did actually, I think maybe I learned a little bit even in my sort of basic reading of it, extremely well written. I'm extremely excited about this conversation. You know, you mentioned that our guest is the King of Gardening Leave. If you look in as LinkedIn, it really is many different roles. Well, I also have to say he is the only person I know who has both an alpha and a beta tattoo on his shoulder. Oh, wow.

You know, some people do get the alpha symbol, but he has both. So, you know, a well-balanced portfolio of tattoos all around. The Yunnan Yang. Yeah. So Gapie, thank you so much for coming on all thoughts. Hi, Tracy. Hi, Joe. So maybe to begin with, I'm going to let you explain your previous job history, because there is quite a lot. What is it that you've been doing in this industry?

Yeah, I'm not sure. I'm not sure. Okay, good question. Well, I got into this industry almost accidentally. I was for a few years a researcher in the math department at IBM Research. And then I got a little bit bored. So the only place that you can, the only industry you can work in New York other than, you know, IBM or tech is finance. So I got into finance almost accidentally. And then again, there is no major plan to, you know, to my career choices. When I was getting bored for some reason, somebody called me and offered me a more interesting job. And so I have been working mostly on the so-called by side of the industry. So the part of the industry that invests, actively. invests and takes risks. So I worked for Citadel twice for a small hedge fund as a portfolio manager and then Millennium and Hudson River Trading. And I've kind of taken turns between doing quantitative research and risk management. So most recently I was at Hudson River Trading until the beginning of November. I think when people think about like multi-strategy hedge fund or pot shop or whatever, maybe sort of Millennium is the first one that would come to mind for

people. If someone asks you, how does Millennium make money? And they seem to have made a lot of money over the years. What's the answer? Okay. I hope without, you know, saying anything that is proprietary. Sure. But I think that... Or like the business model of Millennium. Yeah. I think that what Millennium has excelled at has been the ability to to scale up, so to adapt its existing platform to accommodate new new strategies and new portfolio managers. And so, So sometimes actually in some of their marketing material, they called it something like an investment operating system. So it's a system that is a firm that is willing to absorb some relatively new strategy and create an environment for that strategy to succeed. And so because of that, I think they might be having right now the highest number of individual pods, maybe close to 300.

and hovering around $60 billion of AUM of assets under management. But I would say what is their superpower is really their ability to scale in a number of pods. So you mentioned creating an environment for success there. What does that look like at an organization like that? What are the sort of like conduits that allow trades in that particular organization to be successful? So I would give a sort of idiosyncratic, maybe a story around the rationale for success of platforms. So I see platforms a little bit like managing an arbitrage or some kind of gap between the single platform, the single manager or the small hedge funds and the fund of funds.

So if you are a fund of funds, you do have the scale, but you do not have the ability to observe from a close-distance. the performance of your vehicles for investment. And let's say that they don't perform well. You have to wait a year in order to take your money back. In the case of a hedge fund platform, you could actually not only observe the performance of PM's, portfolio managers, their skill from a very close distance, but you can also help them perform better.

So you can centralize some of the functions that make them better, you know, capital access, corporate access, access, risk management. If they perform well to give them more capital, if they don't perform well to take capital away from them or let them go. And at the same time, you also solve for two other problems. So one is there is a risk transfer happening because a platform, almost by design, otherwise it's not really a platform, has a pass-through fee structure. That's fundamental for the existence of a platform. That makes really a platform what it is. instead of a just multi-manager hedge fund like D. Show.

So this means that a portfolio manager is not paid with the incentive fee that the hedge fund as a whole receives from the limited partners, but instead the portfolio managers are paid a percentage of their P&L. This payment is passed through directly to the limited partners, to the investors. And this basically transfers the risk directly, basically from the PNL, into the limited partner. And so this makes the system more robust in a sense, right? And combine this with the diversification across investment styles and the number of PMs,

and now you start having a moat around a platform that makes it successful. If an entity has 300 pods and everyone's doing their own thing, et cetera, why doesn't the return just become the market return? Like it seems like, because there is it right, like one intuition, could be that this model wouldn't scale, I mean, I know it does, but one intuition could be that this model wouldn't scale, that the more you add, you over-diversify, and then you just end up with like whatever, like, you know, like by the VTI-ETF or something like that. Why doesn't it work out that way? A simplest explanation for this is actually just to look at what a retail investor, right,

would hold in their portfolio. So let's say that they are, you know, long Apple and IBM. Okay, they have a little bit of an imperfect version of the market, right? But what makes their skill is how different are the weights of their Apple and IBM holdings compared to the market. Okay, so you can decompose your performance in your personal account into the sum of, let's say, the market and your idiosyncratic bets into these stocks. Now, what the hedge funds do is they do the same, but they completely eliminate as much as they can, their exposure or their investment in the market. So they run purely market neutral

and factor neutral portfolios. So there is diversification, but these idiosyncratic bets don't get diversified away into a big market, but they actually become essentially a bunch of independent bets that by the law of large numbers, they tend to have better and better risk-adjusted profiles. So I still see some platform heads describe like the overall. tilt as market neutral. So what do they mean by that exactly? I mean they typically run a wide range of strategies. So let's focus, because it's more relatable, let's focus on discretionary longshore equities and systematic equities because everybody knows what it's done. I love that you think systematic equities is relatable. Yeah. I mean, relatively to, I don't know, treasury bases or

selling vaults. So they mean that typically they do have a so-called factor model and a factor model is a little bit like having a market model on steroids. So you have a market term. So you can see your portfolio as having exposure to the market. So behaving a little bit like a market. And then it's also behaving a little bit like a portfolio that has momentum. Okay. And then it also has maybe a tilt in terms of value.

The platforms tend to run portfolios that have no market exposure whatsoever. And then they also tend to have controlled. exposure in these more exotic factors. How do they know that? I mean, so there's someone up there at the center, there's all that 300 pods, the data gets probably aggregated and sliced in various ways, but what is the job or how do they actually ensure that on net their portfolio managers don't have that market beta exposure? They typically have, at the very minimum, they will buy some commercial factor model,

which is a model of the market, like of your investment universe, how a stock behaves, how can you decompose the performance of the stock in these various systematic, or let's call them pervasive market-wide factors and instead idiosyncratic. So you buy them off the shelves. I mean, they're really expensive. And they do a job. And so once you have bought them, you create some kind of user-friendly interface so that a portfolio manager can always see how.

the portfolio looks like at any point in time. It's a little bit like having an x-ray of your body in real time. You can see, oh, well, my portfolio is a little bit short. The market is a little bit long momentum. Maybe there is some crowding exposure, whatever. And so this is in the hands of the portfolio manager. And then there is another layer on top of that, which is very important, risk management, which ensures that PMs are behaving well, that they're not going out of scope.

you know, they're not buying micro stocks or, you know, investing in crazy stuff. Just going or just going along in video. Or long invidia, yeah. If their idea is going along invidia, probably that's not an ideal portfolio manager. Yeah. So the other thing I've been wondering is how much visibility are there between the different pods within one shop? Yeah. And I mean that.

Like, I assume there's a centralized risk management system. of some sort that is netting out positions and trying to make use of capital most efficient. And that's where a lot of the edge comes from. But also, if you're just a trader pursuing your own strategy, do you know what the guy next to you is doing? Do you have that kind of visibility? Or is the idea to keep everyone sort of intellectually separated so that they're not influenced by each other? Right. That's a good question. So there is no really black and white answer to this, historically, there was a time when platforms had more visibility and more collaboration among pods, or at least pods in the same sector, for example.

But I would say that the historical trend has been more and more to give them the tools to succeed, but not give them the ability to see into each other's portfolios, for example. And the rationale for this is you probably prefer having independent bets to having maybe correlated bets that could be like maybe a little bit more informed. So that's the trade-off. If we talk, maybe we can come up with slightly better ideas. Sure. But yeah, I think that the trend is more and more toward, you are not seeing what I am having, what I'm holding. Talk to us more about the risk management component. And again, I don't know very much. I understand that, you know, stop losses are very tight and you don't get a long leash to lose money. And if you're

not doing well, your capital is reduced. If you're doing well, I guess you get more and if you do more, you get more, et cetera. But how would you describe the sort of the essence of risk management at the hedge fund level? So there are maybe two or three core functions that can be described in a qualitative way, but I think pretty comprehensively. And then there is something that is a little bit more esoteric or like domain specific. So let's talk about the general principles. Okay, so you mentioned stop losses.

So this is very important. you know, there are always stop losses, the ones that you know you have and the ones you don't know you have. But everybody has stop losses in life. Okay. So those are very important because you could imagine that a PM is a little bit like somebody who's holding a call option. And you, you know, the PM who's losing money has kind of an incentive to go for broke maybe sometimes. But a stop loss is effectively a sort of a primitive tail insurance, tail risk management. tool on the left tail of a PM. So that's very important. The second principle is sort of self-enforcing

is true diversification. So this is where you want to have some kind of risk model that tells you what are the hidden bets that kind of overlap and maybe compound at the aggregate level so that if everybody takes a little bit of factor exposure in the same direction and then you sum this across 300 PMs, it becomes a big factor exposure. So a risk management organization, needs to get that right. The third thing is making sure that people stay in scope. Okay, so seems trivial, but actually that requires a lot of domain expertise. So understanding the trades, what can go wrong from an operational standpoint, microstructure standpoint. Is this factor drift risk as well? I would say that scope is more like factor drift or in general strategy drift,

not only factor, but whereas being in scope is more of a pure strategy to drift or just taking risks that a portfolio manager would be possibly aware of, but that maybe the head of the hedge fund, because it's not an expert in that area, is not so aware of. So the risk manager has to know very well what's going on and an alert, talk to the PM, talk to the business head. can you give us concrete examples from your experience of the kind of things that would set off alarm bells so is there like I guess you don't have to give us specific examples but you know the kind of thing the types of examples yeah the types of examples that would catch your eye in a risk management position so we covered a little bit the easy stuff right so the easy stuff is people taking

too much risk first of all it's simple but you know we think in terms of dollar volatility. Dollar volatility is a little bit like how much you can make or lose in one year. So like value at risk, those kind of calculation. Yes. I mean, most people think in terms of all value at risk too. Okay, I mean, choose your risk metric. You want to stay within that. Then factor exposures. Okay, that's also easy. Concentration. So if you take a megabet in invidia, it has to surface. Okay. So these are relatively simple. There are things that are a little bit more complicated. Like, for example, you take some true arbitrage positions where you think that something is running cheap versus rich

in, say, bond versus futures, or you do some kind of funding arbitrage trade, where different agents in the investing world have different funding rates for their assets. And those can break, like in a dislocation, they can break. And so the way that typically you manage these things. It's a little bit like in merger ARB. You give it a max size and you want to make sure that this is correct, that this size is correct and it's monitored. So this is stuff that can go wrong. Do managers, like, how much do they, I mean, I'm sure there's sort of, I don't know if it's accidental style drift or, you know, drift is sort of a neutral term. How much does the risk manager have to watch out for, I guess, intentional drift or this isn't working. I know this is not

quite my mandate. This is not quite what I was made to trade, but I could sort of justify it this way, or I just see all these lines up over here going up. I need to. How much of a risk management concern is that? Okay. I think that in general, the principle should be trust, but verify. I would say that the vast majority of portfolio managers are very responsible, and because they are in that role, they have been educated to control their risks, to understand them, with occasional screw-ups. And so that's why you need to verify. Got it. Okay.

On the opposite side of screw-ups, I'm curious how capital gets kind of doled out. And if I'm running a massively profitable, successful training strategy, do I automatically start being given more money to, you know, play around with? Or is there some amount of discipline here where you don't want people to be bumping up against, you know, sizing positions or additional trading costs and things like that. Imagine I am the most popular trader. The most successful. I don't think popularity should matter.

Also popular. But successful. I'm both the most popular trader and most successful trader at Citadel. What is the process for Tracy getting more money to trade? How do I get more popular and successful? Probably not popular. Okay. Assume that you are popular and successful.

Yeah. Okay. So do you get more capital? You do get more capital up to a point. So there are a couple of factors. The first one is there is like a natural limit where somebody can be too successful. And without giving examples, but there are large hedge funds whose daily P&L sometimes at points are driven, is driven by a single strategy. Okay.

And maybe that's justified, right? But there is a point where the risk could be just too much because the concentration across strategies are, think of pods as stocks, right? you don't want to have 90% of your savings in Nvidia. So, okay, so that's number one. So there is some kind of basic heuristics. Then there is just a natural limit to growth for strategies. Like there is a trade-off because your market impact is very high. And so, or there is just a hard size for your strategy.

So you cannot scale high frequency. You cannot scale to infinity, even index rebalancing. or if you are a consumer PM, your costs increase faster than the size of your portfolio. So your P&L in the absence of costs goes more or less linearly, but your costs grow faster than linearly. So there is a point where you just don't want to grow. All right. On the flip side, let's say Tracy comes in and she is a PM and she has her pod. How long is she likely to last?

And what would cause her, what would be the threshold at which she gets fired? I don't have the statistics on the average tenure of a PM. If I had them, probably I shouldn't say, well, and also depend a lot on the place. Okay. So how long? I would say that it's like everything in life, right? So like 90% of everything is of poor quality. I'm sorry to say, but the same applies to P.M.'s.

But this is another beautiful aspect of platforms, by the way. So let me take a quick detail about this. Because like a beautiful and underappreciated aspect of platforms is that they act like sieves. So you go through basically every possible PM on the market and there is a turnover, let's say, of 20%. So 20% of PMs more or less are let go or leave every year. But you keep the good ones, right? And so eventually you have a sufficient number. of PMS who really can carry, make the business sustainable.

And a platform is an instrument for exploration. Okay, so I'm not saying how long they last or whatever, right? But okay, how good need do you need to be? I think that if you have a market neutral sharp ratio, which for those who are not used to this number, basically is a risk-adjusted measure of profits. So you take your P&L and you divide by some measure of risk and you get the sharp ratio,

If you don't have this kind of market exposure, as you call it, information ratio. If you have an information ratio of one and you are managing your left tail sufficiently wisely, you can survive. Okay. So, you know, start practicing. Okay. Okay. But on this note, the other thing I wanted to ask you was, you know, we tend to talk about these things, platforms, pod shops, multistrat as like this one big blob. basically doing a similar thing. But my impression is that the culture varies quite substantially across firms. And again, there aren't that many that are doing this, although as Joe said in the intro, the number is growing. But when we talk about that kind of cultural variation, what do we

mean exactly? To an amazing extent, I think that platforms are shaped by the personalities of their founders. So is Yanglander as a personality and a personal history? Ken Griffin has a different one. The founders of Hudson River trading, not a platform, you know, strict to censu, but to some extent multi-strategy. And so the cultures are very affected by this. So if you are a trader like Ken Griffin, it's more likely that the fund that you work in. It's more of a trading as opposed to to maybe a pure technology culture. Millennium is very decentralized. Citadel tends to run more like a centralized

and efficient organization. So in the words of a hedge fund manager, Citadel is like Singapore and Millennium is like the United States, right? Singapore, very efficient, efficiently run, technocratic to some extent, and the US is messy and inefficient, but it's very robust.

And in a sense, you know, Millennium has these features of robustness, it's like an organic creature. It does change a lot. So some firms are more collaborative. I think Ballyasni, for example, tends to be more collaborative than these other two firms. By the way, and your mileage may vary between different teams. Depending on where you work, you can be heaven or it can be hell. All right. Someone hears this podcast. Maybe they're in college studying finance or maybe something in tech or something, engineering or whatever. They're like, oh, this sounds really cool. want to work for one. What is sort of the basic path that one winds up, maybe first in a pod and then

running a pod? Okay. So first of all, I would like to dissuade everybody who's listening from starting a career in finance. Okay. Everyone's going to take that as a challenge, but keep going. Of course. And so I wrote a small document because I got a lot of questions like this from students. And the brutal answer is that is very difficult and there is some luck involved. So, So it does help to go to schools with a brand name, for sure. It definitely does help if you want to do quantitative stuff to be a very good programmer. And, you know, you need to have the ability to think quantitatively. So that's for sure.

There are coding tests that make the admission a little bit more democratic nowadays, but still, still, it's very selective. I am not particularly qualified to give advice on how to get foot in the industry. I think I have a better view of how to succeed in how to be happy, not succeed, how to be happy in the industry. So that's probably more important. Let's hear this. Yeah. Yeah. So, I mean, how to be happy in the industry.

I think that I ask a lot the question of what makes a good analyst or a good quantitative researcher to people. And I get very often the same answer, which is people who are curious do well and seem to be happy. So as usual, you need to have passion. You need to go, you know, to get into the weekend and not being able not to think about a problem. So I think obsession helps. Okay. So I think the world belongs to the obsessed for good or worse in the future. Like you can see this.

It's a heavy-tailed world. So if you want to have a more stable job and less absorbing, I think being a dentist is a better career path. but having some level of obsessions into this stuff is good. Otherwise, at some point, you know, you leave the industry. It's perfectly fine, by the way. So this actually reminds me of something else I wanted to ask you. So you said the world belongs to the obsessed, which is a very good line. But when I read books on quantitative finance, so much of it seems to be about Greek letters for a start.

But basically sizing and managing risk and how to look at your positions and all of that, how do you actually generate trade ideas? Like, where does the strategy come from? Am I just looking for mathematical dislocations in the market and arbitrage opportunities? Or am I thinking, like, I want to go big on something like AI or clean energy or whatever? So I think that there are two dimensions to your question. So the first one is how objectively do you create alpha? And so there are only a certain finite number of ways to go about alpha.

So there are structural imbalances that are not adaptively filled because the market is poorly designed because we don't live in a neoclassical world. So these imbalances persist. And how do you exploit this physical alpha is two ways. The first one is you're a freaking genius and you face a wall for two years, do research and you come up with an original idea. Okay, there are people like this, very few. The other is simpler. It's like a Renaissance style. You are an apprentice in a famous painter's shop and you learn the trade and then you strike it on your own and you make it a little bit better. And even making it a little bit

better can make a huge difference. So I would say imitation plays a big role. And then maybe there is another characteristic, which is you just have to have the right makeup in terms of, you know, drive tolerance, risk tolerance. So, you know, when you, I was actually having lunch with a former 0.72 p.m. now. And his biggest drawdown was $90 million, which is, by the way, not crazy, crazy high. If you're down half a billion dollars, you're literally losing your marbles. Okay. Your, you know, your face looks different. Have you seen that? Oh, sure.

Yeah. Yeah. Yeah. I remember in a, fooled by randomness, Teleb talks about watching all of like the hormones of someone who just lost a lot of money, like pour out and how pale they look. Right. He had a specific comment about that.

If there are really so many geniuses, if there isn't an infinite supply of alpha, if the structural forces, the physical forces as you describe them, you know, there's only so many sort of these dislocations or reasons why reality is separate from the neoclassical world. Does it imply that as we see more of these launches and as these hedge funds get bigger, that the opportunity diminishes? Yes. Cool. Wait, why? Well, because everything has a finite capacity.

That's it. I mean, and, you know, as you say Joe, right, there is only that many opportunities. and each opportunity has a finite capacity. And so at some point, everybody is doing the same thing and you get to some kind of equilibrium, which is not necessary that everybody makes the minimum rate of return, right? You mentioned earlier that systematic equities are more relatable than other things like the treasury basis trade.

And my personal experience, I would beg to differ because I come from a sort of credit background. But it reminded me, a lot of these firms are becoming bigger presences in the bond market, bigger market-making roles and that sort of thing. Does the day-to-day of being in equities versus fixed income in this kind of world, is it very different? Or do similar principles apply?

I think it's very different, actually. And why first in fundamental equities, your edge is mostly informational. So you do have a model of the world that differs from consensus and you monetize that. It's really informational. In the case of a lot of fixed income is truly structural. You know, there are predictable flows, there are well-known imbalances, there are different demands for liquidity. So it's more of a strategy or a class of strategies that has skew, so you could lose a lot of money, but you collect pennies on a regular basis. So you need to manage risk for that. you need to have more capital for that and scenarios for that. So the risk management,

the way you think about investment is different, is more scenario-based. It's less diversified. Fundamentally, you have relatively correlated bets. Why isn't the world actually mapped to the neoclassical view of the world? Because there's so much money and there's so much investment and effort being put into spotting any price dislocation anywhere. So why is it that with all the money and all of the professionals and the geniuses and the supercomputers and the AI that are like essentially attacking the question of finding mispriced securities. Why are there still mispriced securities? In theory, everything should get arbed out. Yeah, but like instantly, right? But not in practice. Well, yeah, but that's why. Why not in practice? Why does it even with all the professionals and money

trying to do this, did there still persist in these anomalies or dislocations, whatever you want to call that? I don't, look, I'm not really qualified to answer. But I just see there is only a final number of professionals. Yeah. You know, and there is only a final number of professionals with a certain risk tolerance. So, and there are constraints all around. There are constraints on your balance sheet. There are constraints on how much money can you lose.

So there are all sorts of limits to arbitrage that go beyond the toy model of, you know, Schleifer and Vishni. But they go, so that's kind of a funding arbitrage. And the mechanism, by the way, it's wrong. that paper. I mean, it's not realistic, not wrong. It's like artificial. But wherever there is a constraint, independently of how many players you have, you have a potential inefficiency, period. And it's not going to go away. I have a practical question, and I always wanted to ask this of someone, and I think you are the perfect person to perhaps answer this. But if you are a risk manager at this kind of firm. And I don't know, you're, you come into the office and it's,

let's say it's like the day of a Fed meeting and Jerome Powell comes out and says something completely unexpected. Or let's say it's 2015 and China suddenly announces they're devaluing the UN. And you're looking at your computer screen and you're looking at the various risk metrics. How fast do those move and how much of it is calculated in real time, versus all the numbers having to be run at like the end of the day when you net out trading positions? If you have the right model, you should be able to either capture those risks directly. In a sense, imagine you have a sensitivity to the various points in the yield curve, either in your fixed income portfolio or in your equities portfolio.

If you capture those well, so it's a risk that you know you are taking and you can, hedge, you should see the factor moving, but not your portfolio moving. Okay. Okay. And by the way, you can also not have these factors, but you may have factors that are proxying this macroeconomic drivers, like say, for example, momentum is one, crowding is another. And so even if a portfolio manager doesn't think directly in terms of points on the yield curve, but they have other related ways of thinking, so they can still control for that.

And then there is, unfortunately, the case where, oh, well, we never. model this, we do not have a proxy for this, and then you're screwed, and yeah, you don't want to be in that situation. Typically, you know, you can see these effects. Like, I mean, there was a big surprise. When rates went up, a lot of equity portfolios moved and they really didn't know why, and there was no interest rate sensitivity in commercial factor models. So there you go. In theory, on a day of some sort of unexpected event, Tracy mentioned the China-U.N. devaluation. If everything is working perfectly and you truly do have like completely eliminated your market exposure. Does that show up at that level?

Like does it still show up somehow? It still can show up in weird ways, right? So for example, you can be market neutral. Yeah. The market has a big drawdown and you still lose money. Yeah. Why? Because the the market, the drawdown starts weird processes of the risking that affect your

portfolio. even if I'm market neutral, somebody is selling my stock to reduce their risk, and it's affecting me even though I'm perfectly market neutral. So weird things can happen, unfortunately. So there is no perfect model. That's a short answer, unfortunately. You mentioned crowding in multistrap and the idea that maybe, you know, eventually you would reach a limit for the efficacy of some of this type of trading. What's next for hedge funds? So we went from fund of funds to pod shops. They became the hot new thing.

What comes after pod shops? What's exciting? I'd love to know. It's for the next guest to answer. I don't know. This is where you reveal where your current gardening leave ends and where you're going to wind up next. Oh, yeah. My best job is always the next.

I don't know. So what's next? In terms of business model would be very interesting to know what's next. So there are some interesting ideas. So there is the idea of alpha capture, which is kind of a big umbrella. And alpha capture has an interesting story. So there was external cell side alpha capture that's historically like kind of a creation of Marshall Ways, an English hedge fund that in 2003 or four studied a program called Tops where they gathered ideas from the cell side. and that for a while was very profitable

and also has lots of other byproducts that are great. Now I think it's kind of arbitrage out. Now there is a similar concept of bi-side external alpha capture. So there are firms that are trying to get ideas from hedge funds, small hedge funds, they don't have scale.

They can aggregate them and then they make into a portfolio. That's a new business model. I don't know how scalable it is, how sustainable it is, but that's an idea. there is definitely an expansion into privates. I have like zero skill or zero visibility into this stuff,

so that's really another question for somebody else. And then there is always product innovation. Every strategy is continuously innovating, has to change. So just look at where fundamental equities was 100 years ago, right? The recommendation was invest in a railway, single stock and, you know, be happy. And now we have, you know, and now we spend hundreds of millions of dollars in alternative data and there are tools and stuff. So what is it in 10 years? I don't know, but it will be very different than it is today. I remember, you know, when I was over 20 years ago and I first got

interested in markets picking up the intelligent investor, because of course, you know, Buffett and Munger into it. And like reading is like, and so if you buy the Brooklyn Rail Bond yielding 8%, I was like, what is this? I just thought it seemed so disconnected from it. I mean, I'm sure there's a lot of deep wisdom and I probably should have like internalized it. But just in terms of like what they were talking about it. It seemed so funny because of how antique at all seemed. Totally. Yeah. And so now PMs are quantitative, fundamental PMs tend to be quantitatively quite literate. In the future, they will be even different. Maybe they will be prompt experts. I don't know. Can you be a fundamental PM by just being a domain expert in a certain area?

Say like you really understand biotech or say you really understand the semiconductor industry and you want to trade chip stocks versus and not really have that sort of quant background, but some other expertise. So being a domain expert is definitely a necessary condition. You absolutely need to be a domain expert. And since you make the example of healthcare, super domain expert. So a lot of good healthcare PMs have either worked in healthcare companies, they have never practiced, but they are domain expert. Is it sufficient to be just a domain expert? No. I think that you need to be able, also to monetize and to risk manage your portfolio, and that's very difficult. So that's not sufficient, but it's definitely necessary. How important are the data sets? Like, what if I'm just

really good at finding original and alternative data sets? Maybe it's someone's an analyst. Yeah. It varies a lot, so some PMs, well, okay, first of all, for systematic, it matters a lot, period unconditionally. For discretionary PMs, it varies a lot. So some PMs will use alternative data. Some will do deep research and think three months to a year ahead. And the reality is that there are not that many data that really help you think at that horizon. So we don't live in the world of really, really big data for fundamental thinking.

So I think that's interesting. I have just one more question, which is, What do you find most satisfying about your job? What gives you the most? Yeah, or jobs, yeah. What gives you the most pleasure on a day-to-day basis? Do you feel fantastic if China devalues the UN and you look at, you know, positioning across the firm and you're not going under?

Or do you feel great if you identify a particular strategy or something like that? No, the thing that gives me most pleasure when I work is when I do something that, that is useful and it works for others. So I just love the social aspect of working. Like, it's actually a job where you can be of some use to other people and I just enjoy that. So when things work out, like you come up with an idea after multiple failures and it works, you implement it

and somebody else uses it or finds a volume to this and everybody's happier and like we get drunk together, that's great. All right. Decepe Pala Loco, aka Gapie. Thank you so much for coming on odd lots. Really appreciate it. Thank you.

Thank you. That was fantastic. Joe, I feel like that's good life advice. If it all ends in people getting drunk, it's usually, no, wait, that doesn't make sense. Sometimes it's really bad. Yeah. Don't say that. Never mind.

But sometimes it's great. Sometimes it's good. I love that line. I feel like the world belongs to the obsessed. It's just like a really good line. That's sort of ominous to me because I don't really get obsessed with anything besides country music. then the rest of my time, I'm just like, I want to talk about hedge funds one day, and then the

next day I want to talk about like how energy works. Yeah, I was going to say, you do get obsessed. It's just you flip from obsession to obsession. Yeah, so it's not real obsession. It's kind of deletante. Wait, Tracy, have I told you about when I got a job offer at a prop trading shop? This vaguely rings a bell. So can I tell a quick story? Go for it. So I had traded stocks in college just because it was like the dogcom era. It was fun. It was very easy. Everything. was going up. I managed to sell for accidental reasons at a good time and I didn't lose all my money. Anyway, I was always, I got interested in markets. Then I graduated with my useless liberal arts degree and I had a job. I was making minimum wage working at a deli and I saw this help wanted

at a prop trading shop in Austin, Texas. And it didn't seem like they had many requirements. So I went. They asked me about my personal trading. I played ping pong against the CEO. I played this video game that involved me using two joysticks. One was to control the tilt of a triangle and the other one was to control the space and I kept it in the square. This seems weird. And I did this other thing where I like typed without like too many typos and stuff like that and there were like 200 people applied and I stuck around. I got one of the four spots that they offered. And for reasons that still allude me to this day, I didn't take the job. I was enjoying making minimum wage at the the deli. All my friends worked there is like the cool place to work in Austin. I didn't feel like giving

that up. And I didn't. And I just like, I always think about what if what does my life look like if I took that job? The strangest, most inexplicable career decision I could ever imagine not taking a trading job from a $5 minimum wage job or whatever it is at the time. Anyway, I'll never know. Okay. Well, I once got offered a specialty sales position in bank equities at a Swiss bank. And I never question what my future would have been had I taken that job. I'm very satisfied. But I actually have a question. Do you think you were put off by the weirdness of the interview process? Like, did you think that you were going to be playing ping pong and like moving joysticks as part of the job? That was fun. And I didn't even beat the CEO in ping pong. She beat me. But she still hired me.

I don't. No, I don't know why. The only thing I could explain is that in my post-college life, I had a cool job where I got to hang out with my friends in the back of this deli in a grocery store. I didn't really feel like giving it up just yet. All right. Well, I do feel like coming out of that conversation with Giuseppe, I feel like I have a much better conception of how multistrat actually works and what people are sort of doing on a day-to-day basis. And also just maybe a better understanding of some of the terminology around the industry. Totally. So now we'll probably do more episodes, but I feel like I'm now like roughly grounded in at least some core ideas here.

Yeah, and everyone should definitely check out Gapie's byside quant job advice. It's nine pages, and it actually goes into some detail on the structure of the industry itself of how quantitative hedge funds actually work and who are the big names and things like that. So anyone's interested in the space, definitely check it out. Shall we leave it there? Let's leave it there. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway.

you can follow me at Tracy Allaway. And I'm Jill Wisenthall. You can follow me at the stalwart. Follow our guest, Giuseppe Pallioloago, aka Gapie. He's double underscore polyoligo on Twitter. Follow our producers, Carmen Rodriguez, at Kermannerman, Dachel Bennett, dash bot, Kill Brooks, at Kill Brooks. Thank you to our producer, Moses Andam.

For more oddlots content, go to Bloomberg.com slash oddlots, where we have transcripts, a blog, and a newsletter, and check out the Discord where you can chat with fellow listeners 24-7, Discord.g.g. slash oddlots. And if you enjoy odd lots, if you like it when we talk to practitioners in a particular space, such as multistrat, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is connect your Bloomberg account with Apple Podcasts.

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