Ex-Tudor Quant PM: “There Hasn't Been a New Idea in Trading for 15 Years”

Everybody in quantitative finance is a genius. That doesn't make it special. It makes you just like everybody else. One of the things I love most about the hedge fund industry is how unfailingly honest it is. In order to succeed, you're going to go to the same 2,000 institutional clients that buy into hedge funds. They know exactly what you're doing. They know how you're doing it. They can deconstruct your portfolio without knowing anything except the results. If you show me what your results are, I can deconstruct absolutely everything you do. Even the best strategies lose money. 40% of the time you can lose money in operational ways. As long as you're honest about it, generally speaking, people will forgive you. But lie about your returns. Not always should I not invest with you. I better call my friends who are allocators and make sure they don't either. Reidea you've come up with as a second year analyst, third year analyst, fifth year analyst has been thought of a hundred times by somebody else. I haven't seen a real new idea in trading in at least 15 years. I have a good friend as an investment banker. And he says that if he had it to do all over again, he would do something completely different. The money is great, but there's a lot of easier ways to get the money. Comparing what a retail trader does to what a quantitative hedge fund does is like comparing driving a bus on the New Jersey Terrent Pike with winning a Formula One race. If you want to get into trading for the excitement, don't do it for a living. Tom, thank you so much for coming on the pod. Ethan, my very great pleasure. I've been looking forward to this. What is the number one goal of a hedge fund manager? So the number one goal of a hedge fund manager is to be successful. In order to be successful, there's a number of things that you need to do that most hedge fund managers don't do. The very first priority in my mind has always been to establish credit enough credibility so that when you go to the typical hedge fund investor, which is going to be an institutional financial manager, that you can provide a story that they are the first of all that they believe that's truthful, that can be backed up with data. But the goal is to establish enough credibility so that when you say things, they believe it and they will then invest in your fund, which is apart from turning a profit, garnering investment is by far the hardest thing a hedge fund manager does. So how do the early stage managers get to the point of credibility? It sounds like you don't have a talent. Well, it's hard to garner the talent. It's hard to get the capital as well given that you need to raise from the allocators. How does that work? Well, there are some metrics. Everybody starts with friends and family money pretty much. Unless you've come from a big bank and you're being sponsored by someone internally or one of your big customers or something, you're starting out with a large pool of capital. But if you're starting on your own, if you're coming up from nothing, then you're probably going to start with friends and family money. To put some context to this, people talk about the hedge fund industry and the hedge fund, that's too broad. In my mind, when I say the hedge fund industry, I'm talking about hedge fund returns are Pareto distributed. So it's like a chart of wealth, right? Elon's up there at the top and then a bunch of other billionaires. And it gets flat pretty quickly. In the hedge fund industry, that Pareto distribution right around the 40% mark, 60% profitable, the bottom 40% of hedge funds lose money every year. So, and 25% the bottom 25% will go out of business and be replaced by another 25% pretty much every year. So, that 40% of the bottom, there's nothing we can do to help them, frankly, because they're asking the wrong questions. AI is not going to help them, machine learning is not going to. There's no tools that they can learn. They misunderstand the markets in a fundamental way and they can't really be saved. What the rest of the industry thinks about is what I focused on. And trying to explain that to the bottom 40% or at least maybe some of the guys in the middle that are thinking about what markets really are and can see their way to finding more money. What are some of the things that the 40% the bottom 40% would do they miss that the other 60% get? That's a big list. First and foremost, I think they have a fundamental misunderstanding of what a market is. A market is a barometer. So, it is a tool for processing information in the wider world. Something happens in the straight of four moves. You learn about that. You figure out its impact on various equities and those assets all get reprised to include that information. Because in the bottom don't really think about that. They don't think about alpha as being the thing that's left over after you hedge away everything else. They don't think about capital preservation at all. In fact, most of them don't even think about risk management. They think there's a good time to be high risk and a good time to be low risk and that's market timing. That doesn't work for anybody. So, what they're trying to do is treat the markets like a casino. They want to buy a lottery ticket or they want to find some trick that is right all the time like selling options premium, which looks like it's right all the time until it isn't and then you lose money overall. And they don't really think about the larger structure of the market. In the top tier, that's all anybody thinks about. The watchware, the unified field theory of finance for the top portion is all the finances and probability of discounting cash for those. You print that on a t-shirt. But that's it. That's how you come up with fair value for absolutely any asset. There's a future cash flow or there's a probability of a future cash flow discounted to today. That's what the value is right now. We can disagree about when the cash flow is occur or what the probability is or what the amount is. There's all sorts of differing models for determining that. But once you do that, you calculate fair value and if current prices above it, you sell it and if current prices below it, you buy it and that's it. That's all they do in that top 20%. They do it over different time horizons and with various efficiencies. So there's a breadth of performance. But that's the story. And that I think is the thing that the bottom 40% miss. If you look at crypto is a great example because there's so many geniuses in the field but nobody knows anything about finance. So you've got to get a kid from Caltech who knows he's a much better mathematician than me. And he builds a high frequency system. But he doesn't know that a high frequency market-making system has a short volatility bias. It's basically a mean reversion system. That's betting that everything goes back to normal. So in volatility spikes, he takes a loss. That happened to roughly 50% of the market makers in crypto on 10/10 this last year. So they're just not thinking about it in the right way. It's not that they're not smart enough to do it. Of course they are. In fact, everybody in quantitative finance is a genius. That doesn't make you special. That makes you just like everybody else. But what they know in finance is the kind of thing that I've been learning for the last 35 years. It's that it is not a random number generator. It's a deterministic system where everybody is trying to outsmart everybody else. And you need to appreciate that. Every inefficiency in the market is directly related to somebody else thinking they're going to do better than you by doing it. That's it. That's the real not to crack. That's what quantitative finance is really about. It's understanding their incentives, estimating them, modeling them, and producing a profit because you're able to successfully predict the behavior. That's the real trick. The rest is just, you know, math's going to math. When people think about markets in the correct way, what are the ways in which that manifests itself? How does that present itself and say organizational structure? What are the results of thinking about the market in as a deterministic system where participants are trying to outsmart one another? Okay. So one way you can think about what a successful hedge fund does versus an unsuccessful one. Is that a successful hedge fund makes money when other people make mistakes? So that's basically what they're looking for. They're looking for the antelope with a limb. They're trying to find the person who's doing something that's obviously incorrect. Say that last buyer at the top of a trend. You know, a trend's going to go, you know, it's also going to stop. That last guy, if you can figure out when he's in, if he has some method other than just looking at the trend, that's going to be an opportunity to car in a profit because you're not actually looking at, you know, a number of standard deviations or whatever, or maybe that's a part of your calculation. But what you're actually looking at is a specific decision making that's occurring in the head of that person. And one of the things I've always thought was that AI, you know, even if they do come up with an AI, it's never going to do materially better in the markets than the cumulative results of the hedge fund industry right now. And that's because we're already capturing all the alpha that's readily captureable. The thing we would need to do better than that is we'd need to be able to know what people are actually deciding and when, how new information changes people's minds. If we could find a way to obtain that information in a timely fashion, we could predict every blip of the market. And maybe that's part of the trick too, is you need to appreciate that the people you think are manipulating the market are not manipulating the market. They're trying to turn a profit, right? Now, sometimes they will be aggressive on the buy side or the sell side when you wouldn't be, but that doesn't mean they're manipulating the market. That means that's the side they think they should be on to optimize their P&L. And in the bottom 40%, they just don't think of it in those terms. They think there's one right side, it's time to buy in video, they buy it. There's no reason anybody would sell it because this is the right moment to buy. They think I'm correct, everyone else is incorrect. Because they're incorrect and doing things that are opposed to my interests, they must be lying, manipulating or cheating. That's not how it works. There's way too much competition in the traditional capital markets for any of that sort of thing to occur. I want to leave room there for, there's televents, there's always televents. Somebody will be busted for insider trading or one of the market making firms will pay a fine for front running. There's always a small amount of mayhem at the edges, but it's very, very unusual given how potentially profitable it would be. Generally speaking, one of the things I love most about the hedge fund industry is how unfailingly honest it is, which is sort of the opposite impression the media gives you, right? But in order to succeed, you're going to go to the same 500 or 2000 institutional clients that buy into hedge funds. They know exactly what you're doing, they know how you're doing it. These markets are known, I can figure out what the variance was for IBM yesterday or three months ago or 30 years ago in a blink of an eye. So if you show me what your results are and tell me just generally speaking, what you're doing and what your general holding period is, I can deconstruct absolutely everything you do. Which means that every story I tell to a potential investor needs to be the truth. That is the critical success point. If you're viewed as being dishonest in any way, you're never going to succeed in the hedge fund industry. Tell those investors the truth. You can make mistakes. People make mistakes. Even the best strategies lose money, you know, 60% of the time, or excuse me, 40% of the time, maybe 45% of the time potentially. That's not the kind of thing that's a problem. Everybody expects you to lose money sometimes. If you don't lose money sometimes it's indicative of a problem. You can even make a mistake. Big operational mistake, a problem with a bank, something. You can lose money in operational ways. So as you're honest about it, generally speaking, people will forgive you. Say that you produce your returns without being short gamma while producing a return distribution that looks short gamma. Either you don't know what you're talking about, which means I shouldn't invest with you. Or you're being dishonest about it, which means not only should I not invest with you. I better call my friends or allocators to make sure they don't either. Because I know they'll thank me for doing so. So it's extremely honestly my opinion, the most honest end of the financial industry. Marked to market accounting is what does that do us? Let's say I'm a hedge fund manager starting out and I'm pitching to call it a systematic strategy to an allocator. What if they steal my alpha? You know, I'm thinking there, you know, these guys, you know, maybe they want to recreate what I'm doing. My secret sauce. How am I going to let that happen? I love that question. So I, at one point I was head of equity trading in about a billion dollar quant fund. So I was the allocator. I interviewed prospective portfolio managers, you know, 10 times a week, something like that for a couple of years. And the advice I wrote a book about this a couple years ago, which I know you read. The advice I give in the book is don't ever ask that question. I've seen circumstances where people have tried to steal another person's strategy, but it was never from the top down. It was always the bottom up. Think about it from my perspective. Okay, I'm head of equity trading. I have half a billion dollars to allocate. I've got to give it to somebody. If I'm going to give it to anybody to run a particularly trading strategy, I might as well give it to the guy who built the strategy. Taking his idea is not going to get me that much. Ideas aren't worth anything. A proven, reliable strategy producing results. Even a back test is fiction. But if you're producing positive results, that has real value. That's what an allocator will buy. Right? So there's nothing but downside in me trying to steal your alpha and steal your idea. Your ideas and that on you isn't that unique. For 20 years more, some of the smartest people in the world have been plurying over quantitative finance. They've been using the resources of about a 300 billion dollar a year industry. And they've been promised vast wealth if they succeed in not smarting everybody else. Believe me, every idea you come up with as a second year analyst, third year analyst, fifth year analyst has been thought of a hundred times by somebody else. They're way ahead of you. The only way you're going to get out in front of all of that is to be taking completely unique spin on something that has been seen before. But one thing that's been kind of interesting in the last 10 years or so is high frequency trading has been a much higher focus. It's been come much more profitable. And I think that's because the technology put that into place where it couldn't have been 30 years ago. You just couldn't get that much of a speed advantage. Now it's a different story. Though I think we're coming to the end there too. I think we're at the point where all of that alpha or at least the vast majority of it has been teased out. The next set of strategies, the next set of alpha-producing structures will be smaller and shorter lived than some of the things in the past. Where do you think the future of alpha will come from? That has a very good question. I like emerging markets are always less efficient, which means they're smaller in size but larger in spread. As they increase in size, they increase in efficiency spreads decline, but the size increases. So instead of getting 10% of 100 million, you're getting 1% of 10 billion. So it nets out. Basically what you're doing when you're building a profitable trading strategy is you're trying to find a way to introduce market efficiency. Make the market more responsive to outside information, either faster or more accurately or whatever. But we've seen a bit of a stasis. Most of the innovation on the large hedge fund side has become a question of legal structure. Millennium builds their internal structure differently. So how much they pay people versus whether or not they have an internal team trading against them. Those are the kinds of innovations we've seen in more recent years. Prior to that, there was strictly find a guy who looks like he's producing P&L that is uncorrelated to what you've got now. Slot them down in the chair and give him some money and see what happens. On the topic of the organizational structures, something that is often spoken about is the genius in the structure of the pod shops and in everything they do in that they are very much well oiled machines. Risk management is done exceptionally well at all of them. I feel like maybe I'm wrong on this, but that is another thing that hedge fund managers starting out may not think extremely deeply about is the sophistication of these participants and how honestly how well run the businesses are. What can maybe not just emerging hedge fund managers, but what can investors in general learn from the processes and the seriousness from which these guys run their businesses, strategies, teams, funds, etc. So one thing I think is very useful here is to think about the industries as a set of filters. When I was coming up, I got my first job on the hedge fund side because I come from the big bank side. I started on the Swap's desk at J.P. Morgan. I moved to Deutsche Bank where I did some modeling for strategies and I went to work in more capital. I got that job because they had already filtered me as having a decade on the cell side. So they knew was an institutional guy. I understood the basics of risk management, given my experience or whatever. And I was well suited to the role. They can't go out and hire a guy at a college to do that job because it just doesn't have the basis of knowledge, right? So these pod shops, you're at, they are exceptionally well run. And the reason they're so well run is because filters have been applied to them too. I don't know if you've spoken easy, Englander, I think that would be a great conversation for you to have. But the man's brilliant. Stephen Cohen is a brilliant man. Paul Tudor Jones is a brilliant man. Louis Bacon, in my opinion, the best macroeconomic market strategy just alive. And they've been filtered as well, right? Not only are they the guys who could turn a profit trading, but they were the guys that had hired people to turn a profit trading, risk managed this overall structure, put the business practices in place. This guy gets paid that much and when he does this, he gets that. And those sorts of innovations all come from, it's just a few guys. How many pod shops, when we say that, are we talking about 50, maybe globally? And they've all been filtered over time, right? To have access to capital, they know how to solve those problems in a way that the customer wants solved. So yeah, I would argue that one of the effects of that is all of those filters before you get into a large pod shop. Means that you need to decide that that's what you want to do much earlier, right? Like, when I went to work at J.P. Morgan, I thought I wanted to work on Wall Street, but I didn't have it in my head while I want to be a quant. I want to work on the exotic swaps desk for a couple of years and then work for some other guy building two factor models or whatever. I hadn't planned all that out very carefully. Now, I think you need to, because there's so much competition for it, it's a very high status job. And you're going to get filtered like crazy before you get there. Millennium is not going to offer a kid at a college, some huge job as a PM. He's not even going to offer you an analyst job because the hedge funds don't typically train. Now, it's a little bit different in the high frequency shops. They do do some of that, right? They realize that they need a different skill set that's more math intensive. So that still works, but that's become even more competitive because everybody with a math degree on the whole planet wants to go to work at Chain Street or Hudson River Trading or whatever, right? So I don't know. To say those businesses are well-run, tightly run, is an understatement. If you're going to work there, you're going to have extremely careful risk-manager and structures built around you that are fairly standardized in the industry for reasons that are well known. You're going to have careful supervision. You're not going to be trading equities today and equities and currencies tomorrow. And hey, I think I'm going to add in a little crypto. Those kinds of decisions you don't make anymore. When you go to work at one of those shops, they don't hire you. They hire you as a set of cash flows. And that cash flow, the source of those cash flows, they need to know in advance. So maybe once you're there, people realize how smart you are, how good you are at this, you come up with new ideas. Maybe you can build a little credibility internally. But going in the door, the only thing you're going to be interested in is the things you can prove. I don't, forgive me. I don't even know that answering your question. It's just the place where my brain went when you brought it up. Not at all. But in what you've said there, there's something that I've been thinking about a lot recently that I just need to ask you. It seems like the way jobs become high status is because people see other people in the past, go through the same path, and then they back test. They look at what happened to these guys, right? And they go, okay, that is going to be what will happen to me. So I see a guy, he worked at, say, Susquejana, right after graduating, he spent 20 years there. And now he's fabulously wealthy. He has so much opportunity. Everyone hails him as an amazing trader and pick the best career one could go into. And then people try to say, okay, that's exactly going, that is going to be my situation. If I enter the industry at this time. And obviously, that is a foolish way to think because there are so many tailwinds these guys are riding. The circumstances back then were different to today. And so this is more a question about the industry as a whole. If you were to aggregate HFT, PodShrop, Quant, or trying to be a PM, it's still edge in choosing to go down that path in 2026. - Well, it's a perfectly legitimate question. Markets are not universally efficient. - They never will be. Because the cost of information from various parties differs in blah, blah, blah. You wanna have a conversation about the economics. We can go into all that. Joe Stiglitz and Yadda Yada. But you have successfully identified an issue. And that is that there's a moment, right? I think I'm I old bosses. Pulitzer Jones and Louis Bacon became millionaires because they were in some respects. They were in the right place at the right time. Were they brilliant? Were they excellent at what they did? Did they do all the right things in that moment? Beyond a doubt. That's beyond dispute. But that's not what, because lots of people have done that and not gotten anywhere near that level of success. I'm in some respects, I'm kind of a good example of this. I've been in finance for 35 years I've been managing money for 20 of them. I've never had a down year. You've never heard of me. No one's ever heard of me. And that's partly because, you know, I come from the Louis Bacon School of no press is good press. But with that said, I'm nobody really in the industry. I'm a PM and I was head of equity trading, but I'm not a big deal. I'm not a billionaire. I'm not even close to, even my ex-wife is an a billionaire and she's plenty rich now. I, so yeah, there is a moment, right? They were in the right place at the right time for that moment to be the guy that said, "Yeah, I'm gonna be, you know, the Global MacroHedge Fund Manager." Right? I was in the right place for the right time for a guy who, you know, had the economics background that I did, that knew enough math to work as a quant. I had a skill set that was easily adaptable to what finance needed at that moment. Now, my entire job at JP Morgan, you can have done for you by turning on a Bloomberg terminal. It's all done. It's all uncoated. It's all standard. It's all. So, for the last 20 years, it's been a different set of priorities. The last 10, it's been a high frequency, but that road is gonna come to an end fairly quickly too, I think. So the really question is, what's the next thing gonna be? It's entirely possible it'll be something that neither of us can see. When everything goes up on crypto rails, you'll have markets connected to one another in a much more efficient way. There'll be an element of high frequency there or arbitrashing between, you know, the Dubai real estate market in Dubai and Dubai tokens for real estate in Chicago or whatever. There's always going to be something. Predicting it is beyond my kin tragically. But yes, I will say that if you're a kid in college right now, I don't think you should look at what my career did. I don't think you should look at Paul Tudor Jones' career. I don't think you should look at even your friends who went to Jane Street and were making real money in a couple of years. I think that channel is gonna be really crowded. I think you'd be better off, you know, trying to find some other route is my opinion. I agree. And I think it's a shame that so many people try to play the status games and then map on other people's paths to them and then take the load just, it'll just be, there's just certainty that in 20 years they'll end up somewhere to someone else. I have a good friend who's an investment banker. He and I were involved in some projects early on in our careers and we just stayed in touch for 20 years. And he says that if he had it to do all over again, he would do something completely different because he has a friend who has an ambulance supply company. It's 10 employees and he supplies most of the, you know, local governments in the US with their ambulance surprise at stratospheric markups. The guy's 10 employees, he works six hours a day and he's worth $150 million. And in the meantime, my buddy is, you know, doing those 20 hour days in investment banking, banging his head against the wall. wall trying to get a couple of million bucks. I think it's the same thing in the hedge fund space. There are things about it I love. Staticism, the thing that should draw you to it. Because frankly, I think it makes you one of the least popular people in the world to say, "What do you do? Well, I work at a hedge fund." Nine times out of ten, the person I say that to is going to look down at me because of it. They're going to think I'm a bad person because of what I do. I completely disagree, but that's what they're going to think. So the money is great, but there's a lot of easier ways to get the money. My opinion. You work for Paul Tudor Jones, a tutor, and on this topic of game selection, do you think he, when starting out, saw the industry, saw what was happening, and said, "Oh, money management's going to be huge." Or did he just fall into it, little by little? I'm asking that question because he's so exceptional, because he's Paul Tudor Jones. Did he think about it? Did he have this foresight and this vision of what the industry would become? I'm speculating about it. So I worked for Paul Tudor Jones. I don't know him particularly well. We've had a few conversations, but it's a big shop when I was there. They've was intervening management layers between Paul and I. So Lewis Bacon, who is a friend of Paul's, he's just much less known in the media. I know much better. I worked directly with him for a long time. But to get to the punchline, if you just don't want me to speculate on it, I would say that neither of them saw it coming. I think they were both good traders. I think trading is what they like. I think they've been smart enough to hook up with good managers because, frankly, you don't want to run the business if you're a hedge fund manager. You've got to have a good, you know, a CFO or an operations guy. Somebody to actually pay everybody salary and make sure the account and get it done right. That's a lot of work. More than you imagine. So you need somebody to do all that for you. They both got very lucky in that regard where they got great operational people. They had the right kind of perspective on risk management, which is essential in the industry. And that's the thing more than anything else that I think gave them credibility with the largest hedge fund investors. So you think about it, right? You know, I run a fund. I only get 20% of the P&L. My firm will get 20% of the P&L. From that, I've got to pay everybody salaries. My partners get a piece of it. My firm may go and make $10 million, but it doesn't mean I make $10 million, nothing close. And it's the same as true for Paul Tudor Jones. The same is true for Louis Baker for is the England or whoever, right? So the only way you're going to get really paid in the hedge fund industry if you grow to a very large size when you're managing $10 billion, you know, and you're delivering a 15% return, taking 20% of that was quite a bit left after you pay everybody salary, right? But running a small fund is just not going to be that much for you. Be better off just trading your own money probably. Yeah, I was talking to a friend about this and he's, you know, friend from my school and very, very driven guy. And he was talking about one day he wants to start a fund. And he's very intelligent. So I've no doubt that he could perhaps do something of this sort. And he asked me how viable I thought it was. And I told him, you know, if you really run the math on it, for most people, it is really not viable. As in, I remember we were talking and the example I gave and we were talking about was raising $100 million, which number one is extremely hard to do, especially like starting out, that is extremely hard to do. You can't even get to 120 on that today, right? Especially starting out. And then you have all your staffing, your like, when you, like, you know, started going through it, plus you're in an expensive place like New York, really the amount that enters your pocket and then from there, really truly grows your net worth is not what it seems on the surface. You know, I think everyone thinks of this guy running billion dollar hedge fund as just bawling in cash, right? He, he's a key, a hundred dollar bills, just throwing them everywhere on the street. When the, when the reality is a different story, right? Can you talk a little bit about that and what people outside the industry kind of get wrong? Sure. So right now, there are, I would figure in the air, there's probably eight or 10 million super smart engineering students out there thinking they're going to write a program trading system. The right piece of code, they get themselves a Robin Hood account that connected to the API and poof a Lambo appears in their driveway. This is not real life, okay? When someone's starting out, they make the same set of mistakes that every other smart guy in the industry makes because they're learning the same things about it. So, you know, they will all have it in their head while I can't really do market timing, right? Because that doesn't work. Because I can't figure out when things are going to go up and when they're going to go down. But I can figure out mean reversion, so I'll build a mean reversion strategy. They do that and it doesn't work. Why? Because every mean reversion strategy that works has already been running for a decade, more, 40 years. Okay? I will do, you know, SP 500 arbitrage. So, you build this whole matrix and guess what? Everybody's doing that too and they're co-located so they're getting the trade and you're not. Okay, that won't work. I'll do momentum trading. I'll figure out a momentum factor with this and that and they do that and that doesn't work. And then depending on how much math they have, they'll do principal component analysis or they'll do some sort of factored deconstruction and then they go off into other directions, opening and closing the timer eyes on it, all sorts of things. And yeah, that's that's the big mistake. They assume that because they have a new idea for them, that it's a new idea for everyone. And that's absolutely not the case. I've been in the financial, I've been in institutional finance for 35 years. In that whole time, I think I've had one original idea and in truth, I kind of stole it from Joe Stiglitz. Right? It was an extension of what he had already come up with. You did get the Nobel Prize for it so it's not nothing. But that's one idea. Everything else I've ever done was an extension of or adding onto or whatever, right? Taking this massive knowledge and trying to extend it one more rational step in order to find some opportunity for alpha. Well, that's it. That's that's it. The strategies, you know, the strategies I've employed, I've only ever done three things. They've bought, they've sold and they've waited. That's all anybody else is doing either, right? So you need to approach it. If you're going to start out in the industry and you say, okay, I want to be a great trader. I want to find a way to get great profits. You can't do that. It's a lottery ticket because luck will not hold out. You can't say, I'm going to go all in on this high conviction bet. And when it goes my way, I'm going to make a bunch of money. No, sooner or later, you're going to lose that way. What you need to think about is how you can get a systemic information advantage over somebody in some small way and reproduce that a great many times. And even then, even if you can do that, even if you could figure out a way to out smart, everybody else in the market, you're not going to be able to do it with much money. Unless, of course, you're multi-millionaire, in which case, what are you bothering with trading for? Anyway, you can do without the stress. So yeah, by far, the biggest mistake anybody makes is they underestimate the competition. They think, if I come up with an idea, any idea, it'll work and then that'll be the great source of wealth for me. And it's the exact opposite. It's by far the most efficient market in the world. Meaning the competition is better at this than it is in any other discipline. You'll be better off trying to build a social media platform against Facebook and Twitter and whatever. There's more room for competition in that market than there is in trading. My opinion. I haven't heard a real new idea in some time. I mean, high frequency guys do math in a different way. They they look at this angle or that angle or for a nis perspective or that perspective. They change things around. The technology is advanced so people will have faster chips to do things on. But I haven't seen a real new idea in trading in at least 15 years. Wow, that's no real new idea in 50 years is that's ridiculous. Just better people being better at doing the things that we already know how to do, you know. Even crypto. Crypto is sort of a bunch of Sue, Prasupas, Prasupas, smart guys, cost playing at finance, right? Crypto was built for the retail industry. It wasn't built for institutions. And that's the easiest money in finance is taking money from retail, right? Because it's where you have the biggest information advantage. They don't really know what's going on. If you know even a little about what's really going on, it's easy to find somebody who's wrong. And that's most of the crypto space. Now there's a lot of really great and innovative ideas in the crypto space. And a lot of that will inevitably produce great efficiency, but it's not going to be in trading. There are no new trading ideas in there. None that will end up with somebody in prison, I should. The other thing that I feel is not talked about and what people trying to get into the industry specifically, some variation of quantitative trading. What I think a lot of people trying to get into the industry get wrong is especially having say not done an internship, they don't actually understand what the nature of the work is when the reality is what you said of just advancing this little thing a little bit than advancing it's some more than advancing it's some more. I feel like people have this vision where they're sitting on the trading floor. They're, you know, the wind is blowing and they have 16 monitors and they're calling the shots like, Oh, I'll go number five is a is down. We got a cut, cut, cut, right? Or they're like just in a in a flow state where they're just programming the entire day. When I feel like the reality and this is the reality of all work is that most of it is boring, right? Can you speak to that as well the day to day? What it actually feels like and the misconceptions people have? Yeah. I had I for my book, I came up with what I thought was a really great analogy. So comparing a retail trader, what a retail trader does to what a quantitative hedge fund does is like comparing driving a bus on the New Jersey turnpike with winning a Formula One race. Totally different things. One has absolutely nothing to do with the other. And yeah, a successful quantitative hedge fund is a great deal of maintainability though AI is going to change that. In my current fund, we use AI is basically research assistance. They do all the data cleaning, they do all the mundane, you know, data structures and making sure this set of data is associated with that set of data. And a lot of the really low level grunt stuff we've handed off to AI with that said, yeah, it is not the day on day. In fact, it isn't even a goal to make it exciting. The goal is to make it as unexciting as possible. What you want to do, like Goldman Sachs, Goldman Sachs trading floor collectively makes money 365 days a year. A stunning statistic when you think that through, right? They almost never lose money on a full day. Almost never. And the reason is that they built this decision-making structure that is always one step ahead of the competition in some small way. And they manage the risks between them well enough so that the net result is a profit on virtually every day. That one down day every third year or something. And Goldman is not a particularly quantitative shop. There's still highly discretionary in quantitative work. It's even more disciplined. You know, the kind of thing that leads to a profit is, here's a good example. So in 2003, I built my first successful quantitative trading system. This was a system which used natural language parsing to read the news and trade the result. Now, I had, this is where that Joe Stiglitz idea comes in, right? I had a different vision of how you apply that information to markets. So I was working through that from sort of a different direction. And it turned out to be wildly successful. That was the big idea. So I wrote a system which read the news. This was so early in the equation by the way that there was nobody I could buy a news database from at that time. Nobody was storing it. It was just produced on the wire and then thrown away. So I had first off, that's 2003 to think of that. Kudos. Because I feel like people are trying to think about that today when starting out there like, whoa, you know, please continue. So 2003, I built this thing. The very first thing I had to build was a tool to read the news wire and store all the data in the database. So I could use it for back testing. It took me to I started coding in 2001, but I needed two years of data to test. So that was the only way I could get it. 2003, I actually built the system. So it used natural language parsing it parsed all this information and it traded the result. Had a holding period between three days and about 12 days, something like that. So not a super long hold period, but being sized. I built that system. I went through the drama of getting them being allowed to turn it on. I got it turned on. We got some risk thrown into it. Start doing spectacularly well. After about a year, sharp ratio started to decline. Returns started to level off a little bit. Things started to decay. So what was the work I needed to do then? Well, I needed to look at the results I'd produced and find better hedges. So instead of using like the S&P for a hedge, I had to use sector ETFs or something, right? And then once I did that, performance approved, I got another couple of years out of it. Now it's declining again. Now what do I do? Well, okay, I get rid of the sector ETFs as hedges and I start treating beta and gamma hedging separately. So I'm maybe going to do a little bit of options, hedging or whatever. I'm going to fine tune the results. So I'm getting more idiosyncratic risk than, you know, than market risk than beta. So the big idea in 2001 or 2003 was this really great big thing. This new thing, right? But in 2005 and in 2007 and 2009 and 2010, that was simple financial engineering. That was the same sort of boring stuff that I've been doing as a research analyst 10 years before, right? Finding a better way to hedge this structure and improve the performance. So, you know, one big idea. It turned into quite a bit of money. It was a very, very profitable strategy over the nine years I ran it. But for eight years of it, it was just elbows up to, you know, in the mud up to your elbows, wrestling with making sure that it squeezed as much off out of the markets as it could. It was, frankly, dull work. Kind of the work that, you know, I appreciate because I don't, I think excitement is wildly overbid in finance. Nothing I like better than making a nice steady profit every single day. Don't tell me we lost a bunch of money. I don't want to know what's put steps in place to make sure we don't, you know. Excitement is overbid in finance. Oh, yeah. Yeah. If you're, if you want to get into trading for the excitement, don't do for a living. That's, you're in the wrong game. And if that attitude alone will keep you from advancing in my opinion. And would you argue that the type of person that wants to get in for the excitement? That's already an indicator that it's not for you. Yeah, exactly. If, if you think, wow, that would be a really great exciting job. That's the, that's the wrong choice. Go to work in Silicon Valley, find an exciting job in venture capital. Don't do it in trading because there's an excess of excitement. You know, and one of my little favorite little statistics that I don't know that this really applies, but maybe we can just think about it a little bit outside the box. One of the things that an early analyst will do is he'll look at a price chart and he'll say, well, some days it moves up a little or down a little, but some days it really moves up a lot. And like, there's three of those days a year. So if I could just predict those, I'll make a huge amount of money and they invest this huge amount of effort in trying to predict those days. And what they don't realize is that the reason those days are so big is because no one was able to predict them. That's what a market does when something happens that no one else expected. The no one had already put a position on or hedged for whatever. That's what a market does. It shows you a great big move up or down. So they've just spent, you know, who knows how much energy and effort trying to predict, the thing that is least predictable, all because they're drawn to it for excitement's sake. It's one of those weird psychological ways that that sort of attitude makes you waste time. How do top hedge funds think about pricing the unexpected or do they even try to price the unexpected? Well, you know, you think about it as a distribution, right? I tend to think of everything these days as a distribution, you know. It's not what it'll be like one time, you know, it's like what is it the propensity of times that I do it? So what you're really asking about is tail risk. And there's been a spectacular amount of intellectual energy thrown into trying to manage tail risk. In fact, I would argue that the difference between physics and trading, financial, you know, financial return statistics is that in physics, they're dealing with truly random phenomenon. And in trading, they're taking deterministic phenomenon and pretending to random because it's the only tools they've got. So there, you know, we look at tail risk and we try and find some quantitative way to measure and grapple with it. And I find it's very easy to get a hold of as soon as you realize that most of that tail risk is just a product of somebody outsmarting you. They knew you didn't. So if you look not at the result, but look at the cause, it's going to be a little bit easier to get to. But what do large funds do to anticipate tail risk? A lot of variety of things, it really depends the level at which the decision is made, right? What's a good example? So I'm not going to name the firm. I was working at, but the firm had a basis trader, which was his trade was US treasuries against US treasury futures cheapest to deliver that sort of thing, right? So very, very stable structure, very stable return series, huge leverage, massive leverage. He would trade these two assets and he made a lot of money on it. And eventually the risk manager figured out that the reason he was making so much money on it was that he was buying his treasuries at one in the afternoon and he was hedging them at $259.59 right before the market closed. So he looked like he was market neutral. But in reality, all day long he'd been carrying this huge beta. That's his tail risk, right? That was the tail risk that was showing up in his returns that nobody could figure out. Eventually the risk manager of the CRO figured it out and forbid him from doing it anymore. And there was a lot of drama about that. So that's one way to handle tail risk is figure out the actual source and either buy into it or don't buy into it. More often than not, you're in a not buy into it. That big move is not something that's reliable. What you want is reliable, something you can predict, right? All the finances of probability of discounting cash flows in my experience, probability is where most of the room is, right? Not that hard to figure out what the range of future dividends will be from Nvidia or what their revenue is going to look like or whatever. You can predict that within a certain range. But the probabilities are what's important. That story I think is so interesting because the incentives that are at play when you're at a big fund are ones where how do I take as much risk as possible? Right, beta somewhat so that I can get my 20% cut. And so I have a question, I guess in two parts about that. Today at various sophisticated shops, are there ways in which people can actually game the system? And then you don't have to tell me if you think there are ways you don't have to say which ones those are. And then number two, how do those guys, I guess, prevent their traders PMs from doing that sort of thing? I had the benefit of working with some exceptionally smart chief risk officers, the chief risk officer at more capital, the chief risk officer at Caxton. I was very close to both of them. They were transcendently brilliant individuals. Nobody was going to put anything over on them. I don't know who the CRO is at millennium. I'd be shocked if it isn't someone equally intelligent. Is there a way you can game the system? You know, a bigger problem is that you're going to thank your gaming system and you're really not. One problem I've seen, even experienced traders, one trap I've seen them fall into, is the gamma trap. Gamahedging is much more difficult than it looks like. It's not simple. You can go out there and sell options for the premium and make money 99 days out of 100. And for 98 of those 99 days, you're sure you're brilliant. You've come up with something totally new. It's going to make you rich. You don't make much money every day, but you make it every day. So all you need to do is multiply your size by 10,000 or whatever and you're going to get rich because it makes money every day. You think you've cracked the code. You haven't cracked the code. What you've done is you've compressed your risk. You've traded a 1% gain or a half a percent or a tenth of a percent gain every day for a 150% loss on the 99th day. So when you average that over years, you're going to be a loser. But on the way up, you get paid. So you know, hedge fund, you're portfolio manager at hedge fund, you're going to get paid every year. You get a check. Maybe they hold back some pay and stock later, whatever. But you're going to get paid every year. So if you make money being short gamma, year one, you get paid, year two, you get paid, year three, you lose more than you made in the last two. So you're a net loser overall, but you still got paid. Maybe you get fired. You go to another shop and do the same thing over again. That's a common error I've seen in many, many times. Now I would imagine that the millennium guys and the bridge water guys and all of everybody is smart enough to see that coming now. So yeah, I would not bet on being able to let you kind of have to invert all of this, all of this thinking, right? The reason they're that big is because they know how to do this. Number four, your ability to do it is not going to work. Don't try and gain the system. Try and be honest. Being a smart guy maybe is a requirement for quantitative finance as opposed to something that makes you special. But there is a value in it. I mean, it's not like it's nothing. And with all the critical things I've said and how difficult it is and all of that, people come into the industry cold, build successful strategies and make vast amounts of money every single year. Something new comes along every single year. It's usually a small improvement on something that exists already, but that's not the point if you're the guy who's doing it, right? So I don't want to be too discouraging. There is a path for this. It's just there's a whole lot of people in line to get on that path a lot more than they're used to be. You know, when I went to more capital, it really wasn't that crowded. Now people would knife you in your sleep to get into more capital. And it's a family fund now. To get into millennium to get into 0.72 or 2 sigma, you know, the shops that are doing that sort of thing, people will, you know, there's a whole lot of people want to be there. And there's very few roles available for them to take. So on the topic of people gaming the system, you know, having this return stream where they've compressed their risk, make money for two years, blow up, move to new fund, try to do the same thing. When fund managers blow up, can they bounce back? Can they, you know, I imagine, and I'm just thinking about, say, you're at a pod shop and maybe you don't own your track record and you got fired, but you say you left. Yeah, how does that work? So I can only tell you about my experience. I'm a peasant. I went to a state university. I, you know, my father was of modest means. We grew up when most people were called poor. I did not go to Eaton. I did not go to Oxbridge. Most of the people I worked with at Cheapy Morgan and through the rest of my career were those people. Just as a brief anecdote, I was the smartest kid in all of my grammar schools. We moved around a lot. I was the smartest kid in my high school classes. I was the smartest kid in most of my college classes. I'd be surprised if it wasn't all of them. I'm trying to be open minded. I'd say I was smarter than most of my professors as well. When I got to J.P. Morgan, I was nobody. I was in the bottom 25% at best. They had drawn in the best, most accomplished, most advanced, hardest working, most self-discipline, the top of the top. Take the hardest schools in the world, the most difficult program. Take the top 2% of the people who graduated from that program and filter them by personality. And that's who walked into the door to J.P. Morgan in 1990. I was so outclassed, I had no idea that these people existed. In most of the hedge fund industries, people like that too. Maybe their father is the house of Lords. Their great grandfather was Treasury Secretary to Warren Harding. There's some stuff like that. They've got family connections, school connections, and other connections that embed them in the industry in a way that I never really had. The only thing I had was a sharp-minded and unhealthy work ethic. It worked too hard. So I never blew up. I've had periods where I had single-digit returns, but I've never blown up. Never had it down year in managing money. So I can't really speak to what would happen if you do that, having never done it. I imagine, based on all my other experience in the industry, that if it happened to me, I'd just be out. That they don't have room for second chances for guys from the trailer park. You know what I mean? If you went to Eaton and you played Polo with the Prince, they'll find room for you somewhere else. But I think that's how it goes. And if that means the world's unfair, then guess what? The world's unfair. Don't like it. Don't have to, but that's how the world is. That's another thing about the hedge fund industry is you don't get anything for pretending the world is any different than it really is. You know, one example. I promised you some controversial stuff that will give people money. There are very, very, very few women in institutional trading. Very few. Why? I don't know. None of my business. Let them think of that out. I will tell you this, though. One effect of that is that when you meet a woman in institutional trading, they are unbelievably competent. I think the smartest person I ever met was someone, a woman I worked with, a tutor who is now CIO of UBS, who's not only a very, very nice person, but she's, I think the smartest human I've ever met. She's just off the charts brilliant. I've been lucky enough to work with a bunch of women in the industry. And all of them were absolutely the best and the best and the best and the best. Better than 99% of the men. And that's because there aren't that many of them. They don't, it's not a priority. You don't get anything just for being female in trading. It's results, which isn't to say there isn't politics. I just mentioned there are some politics in the industry. It's impossible to avoid. You can't have three people in the same room without there for being politics, but very, very little as little as is possible. The overwhelming thing that you're judged on, even more than your personality and your charisma and your good looks or whatever is your performance. If I'm, you know, delivering 20% return in a three and a half sharp and you're delivering 10% return in a one and a half sharp, you would damn well better be related to somebody or I'm getting your capital. The thing they care about is making money. So it's all about performance. That's something that's often spoken about. It is the most meritocratic industry that's said very often. But then you've also said you went to state school, you didn't go to eat in, you didn't go to these elite institutions or have that network of guys who went to these elite institutions. And so this is a more, I guess, broad question about how truly meritocratic it is when these guys have gotten all the right inputs. So maybe it appears meritocratic when they're there, but you think about the ecosystem that they're embedded in and the mindset, say dad was a hedge fund manager, coached him. Okay, this is how you think about things, even in sports. There are ideas that they've just internalized that are much more difficult for someone from a different background to grass. You know, how do you think about that? Well, I think you've hit on something important and the thing that ties us back to the broader conversation we've been having. There's a set of filters and the goal is credibility. A degree from Oxford, Oxford Bridge or from MIT or from Harvard buys you a great deal of credibility that going to Rutgers doesn't and not without good reason, right? But with that said, if you can demonstrate, if you can provide real evidence, well, that's more firmly relied upon than someone's breeding or their network or their reputation. You want to make money on your network and your reputation and your family's connections. You should go to venture capital where a network is everything, right? If you want to make money, if you're like me and you're a peasant, if you come from a lower socioeconomic background, where you're not given any real education and how Wall Street works, trainings about as good as going to get, in my opinion. And that's why you see like, so Jane Street will hire people that probably don't have, like they hired Sam Bankman Fried. The Sam Bankman Fried couldn't get a job at Tudor washing up. He wouldn't be allowed to sweep the floor there because his personality made him lose so much credibility. But at Jane Street, they weren't really worried so much about his personality and his whatever, right? What they were worried about was his came theory of mass skills and even then he lost a bunch of money. So, you know, maybe I should be questioning the wisdom of their decision. With that said, I don't think it's purely meritocratic. I do think it's as meritocratic as he gets. I know if someone came to me as a portfolio manager and had two years of rock solid history and was tapping a source of alpha that I didn't already have in my head. And, you know, it'd be very hard for me to say no to them. And I don't care if they'd, you know, a third eye in the middle of their forehead or, you know, I can't think of any individual characteristic that would discourage me if they represented true source of complimentary alpha because that means I'd make money on them. And, you know, that overrides every other instinct. You bring up an instant case with Sam Beckman-Fried end of credibility because obviously he's very nerdy. There's a, but I would also argue that he fits a certain archetype of a genius whiz kid that could build up credibility. You know, especially now you think of a quant, you know, that's seen in the big short where Jared Venet the banker, he points at his Asian quant who got first in a math competition in China. He looks at the camera and goes, "No, you figure fine." And I was like, "Well, math competition." Yeah. Well, that's true. So, Sam Beck, I don't understand the Jane Street decision making that brought him on board. It's the only conclusion I can come to. This is a guy who, when he finally went out and started FTX, he believed the dollar cost averaging was a sound risk management strategy for a hedge fund, which tells me that the guy should never have been vested without amount of money. But that image that you talk about, I think that's the start up slash founder image where if they're a little sociopathic, you kind of expect that, where charisma comes in a lot of different forms, and sometimes it's just being weird. They put an over-over emphasis on that. Let me tell you, he's not, he would have been laughed out of 0.72. Is he Englander would never hire someone like that? Because he didn't have the ideas to back up to his quantitative weirdness, right? So, he was a startup founder. He was not a trader. And as evidenced by the fact that, you know, the very first thing he did as a trader was half his people get out over their skis in terms of duration and blow up his portfolio. And even today, he still goes out on social media and says, "No, I was solving it all along." Which means he doesn't know what solvent means either. You know, in the traditional financial world, it is much more conservative, much more study, you need to convey the image that you're unflapable. That charismatic weirdo thing works in Silicon Valley. It does not work on Wall Street or Park Avenue now, right? Can you get a job at JP Morgan as a quant doing stuff like that? Well, maybe if you're really good, but they're going to keep you in your box, they're never going to let you out because you don't have the credibility to put in front of investors, you don't have the credibility to enhance the firm's image in the way they want it enhanced. Oddball weirdo from the Bay Area doesn't fly. It does, in venture capital, you want to start up? Yeah, great. Here's half a million dollars. Let's see what you can build. You know, are you going to get a $500 billion book on the Swap's desk? No, not a prayer. So we've gone full circle. All most credibility is the most important thing. We're back to credibility. Yeah, well in the traditional finance, the traditional hedge fund space, I believe it is. Yes. Credibility comes through a lot of channels, but it's always the same thing. Can I, is this guy telling me the truth? If he is, are the ideas he's talking about valid? Is he making sense? Are the ideas that he bring forth consistent with my overall view of the market as a machine? Knowing that everything is connected and I pretty much understand how everything works with everything else. I know, you know, what to expect of equities when bonds goes one way or the other or what happens when the currency goes this way, where do bonds go and what do equities probably do? And when they do it, why? Right? All of that stuff makes sense to me. So is the thing he saying something that fits into that program? Does he convey the seriousness? Is he responsible? Or is he going to show up, you know, high on Coke and Tuesday morning after being out all night Monday night and do something stupid that's going to cost us money? You know, you're being given a responsibility when you've got that decision making authority, right? You can do stupid things with it. Wouldn't be the first hedge fund in the world where somebody just took a trade and put it in the bottom drawer. Even worse, even if you do all that right, is he so arrogant that he believes he's smarter than everybody else? Look at your member Amarath, a hedge fund that blew up. The guy Brian was he was taking up the entire options structure of the natural gas markets times two or three, right? I mean he was way, way out over his keys because he believed he was smarter than everybody else. As soon as you believe that, you're going to be taught otherwise. So these are all part of the things people are thinking about, you know, when they are either investing in you by giving you a chair and their hedge fund, we're investing in you because you've started your own. You need to find a way to convince these very, very serious, very thoughtful people who know as much about the markets as you do, then you're providing an uncorrelated, positive cash flow. That's the goal. That's when a hedge fund is really designed to do is to be a hedge for PEMCO in a way that they don't have to pay for, they get paid for taking it on. Or you know, and I say PEMCO is an example of one of the large institutions that puts a portion of your assets in alternative managers. I want to extract one last bit of operation alpha from you. Okay. I'm an emerging manager. Let's say and I hear everything you're saying. Credibility is the most important thing. I need to build up credibility out of everything that I can do. What is the single most important thing that I need to do when talking to allocators that enforces this idea that I am credible? Evidence. Audited, externally audited. Multi-year returns. Once you can provide that, everything else is just color and personality really. If you've got two years, if I say two years because inequities, that's sort of the benchmark, right? If you can provide two years of returns that have been audited, that are confirmed by an auditor, then that's a reality. That's what you are. You are a business that produces that cash flow. So there's other things that you'll need to talk about and you'll need to talk about scaling. You'll need to talk about the how, where and why. But that's the thing that will do it in the end. If you've got two years of, you know, qualified returns and two years of standard, if you went to MIT, you can maybe get away with one year. There's there's trade-offs that everybody makes. If your idea is really unique, if you've defined something that no one else has figured out, but is still consistent with that general picture of how markets work and you went to a good school and you're, you know, this and that and the other, all of those things better. But yeah, in the end, you want to walk in their office, say things which they absolutely believe. What would make anyone believe you when you're talking about money? Proof? Proof more than anything else. So credibility comes from proof. It comes from evidence. I love that Tom. Thank you so much for coming on Auto Open. You know, my pleasure. It's great to talk to you.