The Alpha Hedge Fund Hall of Fame
Fourteen men whose power and influence have helped to create a $2 trillion industry
When it comes to sheer financial power and influence, the hedge fund industry has few rivals. Since 1990, hedge funds have grown from a $40 billion cottage business into a nearly $2 trillion global industry. Rarely does a day pass without a hedge fund manager or two making headlines for their latest exploits.
To honor the people behind this phenomenon, we have created the Alpha Hedge Fund Hall of Fame. The first 14 inductees have all had an outsize impact on the hedge fund industry, enjoyed spectacular long-term success and displayed tremendous originality, starting with Alfred Winslow Jones , the inventor of the modern hedge fund. James Simons is on a 20-year roll of 40 percent returns. Bruce Kovner made commodities trading a hot pursuit. George Soros ’ larger-than-life adventures put hedge funds on the map, and Kenneth Griffin intends to ensure they stay there. Michael Steinhardt and Steven Cohen brought credibility to short-term trading. Paul Tudor Jones II is the macro trader writ large, Seth Klarman is the premier value sleuth, Leon Levy and Jack Nash pioneered the modern multistrategy fund, and Louis Bacon is the risk manager’s risk manager. Where they blazed trails, others followed — not least the “cubs” sent skittering into the investment world by Tiger Management Corp.’s Julian Robertson Jr . Some of the most influential figures aren’t managers at all, like Yale University’s David Swensen , who made the road less traveled acceptable.
Alpha magazine has published exclusive interviews with each of the Hall of Fame inductees -- and interviews with family members and former colleagues of the two honored posthumously, Leon Levy and Alfred Winslow Jones. Click on any of the names below for those articles, grouped according to the sequence published online.
Bruce Kovner , James Simons
Julian Robertson , George Soros , Michael Steinhardt
Kenneth Griffin , Seth Klarman , David Swensen
Steven Cohen , Leon Levy , Jack Nash
Louis Bacon , Alfred Winslow Jones , Paul Tudor Jones
“The crowded nature of the hedge fund community has changed the character of trading, so that you can see waves of risk-taking and derisking.”
How did you wind up as a trader?
I was looking around, and this work seemed very interesting because the structure of the world financial markets was changing, which meant opportunities would arise. So I started trading for my own account.
What changes have you seen?
First, the collapse of the Bretton Woods agreement, which freed up currencies to move. Second, ending the prohibition on gold sales. But probably the single most important factor was the development of the futures markets in currencies and interest rates. I remember one of my first trades involved calculating implicit yields in Ginnie Mae spreads. I was just an unemployed ex-professor doing fairly rudimentary work. But a number of us felt these were going to be very important new markets.
Were many hedge funds doing this?
Not many. The term “hedge fund” didn’t start being used until the late ’80s or early ’90s. I was a commodities trader for a very long time, even though it was not literally what I did most. I was registered as a CTA, a commodities trading advisor, and I remember the totally blank looks I would get on the faces of people when I would explain what I did. I’d explain it for five minutes and you could see them drifting off. And then they’d say, “So you’re like a stockbroker, right?” And I’d say, “Yeah, sure, like a stockbroker.”
Did you ever work in the futures pits?
For a short period of time, I went down to the floor of Comex. I got a seat on all the exchanges — I had a wonderful little gold badge that let me trade on all of the New York commodities exchanges. I wanted to understand what happened on the floor. I thought it was an essential factor in understanding the behavior of markets — the daily behavior, the way risk works and how stops were placed. I was totally unsuited for it. I wasn’t aggressive enough to push my way into the front of the pit. You know, it’s a bit like being under the hoop in basketball. You don’t get to stay there very long. People push you out. It’s quite a physical thing.
Did you get the understanding you sought?
In all things you get only partial understanding. But did I get some? Sure. And it was fun. I think part of it was just the pleasure of exploring a new world. But my skill set had more to do with analytics — what we call upstairs trading.
What market lessons have you learned over the years?
Some markets have very long, quiet periods. Some markets and some instruments become obsolete. Some markets become arbitraged out. The excess return in them goes away. One of the most important skills you need is to constantly reinvent where you put resources. Commodities markets were quiet for years. Now they’re very strong.
Does this mean that you must constantly make a macro judgment?
The view I started with and embodied in Caxton’s fund was that business cycles were very important and that they occurred all over the world, and it was useful to observe them and to take advantage of the opportunities across four different asset classes.
Which four asset classes?
Equities, fixed income, commodities and currencies. The raison d’être of the company is to observe the nature of the macro cycle across multiple economic and political zones and to take advantage of the character of each business cycle so that we would have multiple business cycles to trade. We trade Asia differently than we trade Europe or the U.S. And we could be long or short across multiple asset classes and regions. Until the late ’90s, this was not widely done.
Does the tremendous amount of money in hedge funds now make it more difficult than ever to exploit inefficiencies?
Yes. The crowded nature of the hedge fund community has changed the character of trading so that you can see waves of risk-taking and derisking coming from the hedge funds themselves. When there were ten or 15 very active hedge funds, it didn’t matter what they did. When there are 10,000 hedge funds, it does matter. They move the markets. In addition, market opportunities get arbitraged out somewhat. Fifteen years ago, I might have traded some things that we don’t trade at all now.
I don’t try to outguess the employment statistics on the first Friday of every month, because everyone is watching the numbers coming out. So now you must seek out undiscovered information somewhere else.
Outside the U.S.?
We’ve always looked outside the U.S., but in the past decade non-U.S. markets have become so much more liquid. There are many more opportunities in emerging markets. But we also find plenty of opportunities in U.S. and developed markets. U.S. markets are still more liquid than almost any other market, and that opens up opportunities.
What role have hedge funds played in the rapid run-up in oil prices?
Hedge fund participation in the oil price rise has been somewhat smaller than I would have expected. The price of oil is elevated for reasons that have much more to do with fundamental demand out of China and India and other places. The weak dollar has added to it.
Are hedge funds beaten up on too much?
I think so. Hedge funds are part of the demonization of financial markets. I think it’s a tradition in American politics to blame the banking community. This tendency goes all the way back to the famous William Jennings Bryan speech that ended “you shall not crucify mankind upon a cross of gold.” This was essentially an anti-inflation policy that was thought to benefit bankers against the interest of the average man — the gold standard policy. And now in the present period of extreme tension on financial matters, it’s hardly a surprise that people blame the participants in the financial markets. Hedge fund managers often get blamed because their profits are seen to be large. It’s easy to confuse public policy problems such as a collapse in the credit markets with ad hominem complaints about hedge fund managers who have made correct market bets. But in reality, the hedge fund manager didn’t cause the problem.
Politicians are looking closely at the taxes that hedge fund managers pay — or don’t pay.
I think it’s an absolutely legitimate public policy question: What’s the right tax policy? It’s a good thing to have a public debate on that. No single policy will make everyone happy. I can’t say I like writing large checks to the IRS, but I am very happy that good trading has put me in a position to do that. The best policy would probably be to have an extremely simple tax rate for all income. But our tax code is tens of thousands of pages long, and it creates a lot of problems.
— Interview by Stephen Taub
“The great thing about science is, your bad ideas don’t count against you. Trading is a little bit different. Your bad ideas can lose you money.”
Have you always been interested in trading?
Not really. When I got married for the first time, I was at graduate school at Berkeley, and we had some money from wedding gifts, and I thought I’d invest it. So I picked a couple of stocks, and they lay there like lumps. I complained to my account executive at Merrill Lynch, and he said, “Well, if you want action, you might invest in soybeans.” Of course, he was talking about investing in soybean futures. I bought two contracts and proceeded to make a lot of money over the next couple of days, only to lose it over the couple of days after that. I started going in earlier in the morning, when the markets opened in Chicago, for a couple of weeks and quickly realized that I was going to either write a thesis or trade soybeans, because I couldn’t do both. I elected the thesis and closed out the soybean contracts with, as it turned out, a small profit, but it was obviously 100 percent luck.
What role does luck play in investing?
People underestimate its importance except when things go badly. Then they’re very happy to ascribe it to bad luck, which it may be, of course. One has to recognize that luck plays a meaningful role in everyone’s lives. You get born to decent parents in a good part of the world, and you’re way ahead of the game. And that certainly doesn’t have much to do with skill or hard work. In my case, I was lucky to collaborate with some very good people when I was doing mathematics. I was also lucky in my choice of partners at Renaissance.
How has luck figured into the success of Medallion?
We started off in the ’70s trading fundamentally — we’d read the newspapers, tickers, news wires, and come to conclusions. And we were pretty good at it. The markets were particularly easy. The dollar was going down like a stone, and the long-term interest rates were going up to the moon. So if you would short the dollar and short the bonds, you’d do pretty well; we made a fair amount of money that way. But I began to look at the data and conclude that maybe one could model this. I brought in a friend of mine, Lenny Baum, who was the best code cracker in the world when we worked for the NSA. I asked if he’d like to work with us for a while and try to make some models. I think I was pretty lucky to know that guy, and indeed, we made some models. Now, it turned out that Lenny didn’t really want to use these models because he was doing so well just guessing which direction the markets would go. But the die was cast. By the late ’80s we were committed to models.
We made quite a lot of money trading fundamentally. But I didn’t know how to build a business based on traders. I didn’t know how to judge them. If a guy was extremely good, it would take a while to prove that, and by the time he’d prove it, he would probably be too rich for me to hire. But I did know how to hire scientists and mathematicians. And so we decided to build a business along those lines.
What makes a good scientist?
Creativity is the most important thing. You need to be pretty smart in the conventional way, but science and research are about being creative. It’s about discovering something new, something that wasn’t known before. And you don’t find that out by reading books or looking in the library. You need creativity, and you need ideas.
Lenny, the famous Lenny, would say to me: “Bad ideas is good. Good ideas is better. No ideas is terrible.” And that’s the way, in a sense, that science and research work. You have to generate a lot of bad ideas for every good one. And the great thing about science is, your bad ideas don’t count against you. Trading is a little bit different. Your bad ideas can end up losing you money.
Don’t you test your ideas first?
Everything’s tested in historical markets. The past is a pretty good predictor of the future. It’s not perfect. But human beings drive markets, and human beings don’t change their stripes overnight. So to the extent that one can understand the past, there’s a good likelihood you’ll have some insight into the future. It’s worked for us.
Do you ever override your models?
There are no human overrides built into the models. But every year or two, if there’s some event that looks to us like it indicates more volatility in the markets than the computer could have guessed, we’ll override the system.
During the second week of August last year, many quant shops, including Renaissance, experienced huge, unanticipated losses as a mass wave of selling hit the equity markets. Was that a time to override the models?
We did lighten up for those few days. Volatility was huge and, I might say, in the wrong direction. So volatility, plus the fact that we were losing money at a rate that we had never seen before, inspired us to lighten up, which we did for a couple of days. And then it seemed to be over. We stopped lightening up and started making money again.
What lessons should investors learn from last August?
The positions that collapsed those few days in August all came back, and came back rather quickly, almost certainly being taken on by a different set of players. This told me two things: first, that there’s more overlap among quant investors than I might have guessed. So we may think — and we have some reason to think — that we’re the best at what we do, but that doesn’t mean that everything we do is completely different from what everybody else is doing. Second, that our positions were perfectly sound and that this particular incident was brought about by a rush for liquidity on the part of some participants, not by the frantic desire to dump positions which no one else would want.
Renaissance seems to borrow a lot from academia.
The best science is done in an open exchange of ideas. So when a new researcher comes in here, we want him to learn everything about the system. Learn about every predictor that works, every way that we do things. And learn about things that have failed. Once he’s up to speed, he’ll get his own ideas. What you don’t want inside the walls is secrecy. If people don’t talk to each other, it’s just that much less likely that good ideas will have their day.
Does that mean that everybody within Renaissance knows exactly how you make money?
Well, no. Not because we refuse to tell them, but because they’re either not particularly interested or not able to think about it.
What would you consider to be your greatest legacy?
Renaissance. I was the founder, and it’s achieved a good success. I’m also proud of some of the mathematics that I did. And now that I’m involved with philanthropy, particularly in autism research, I’m proud of the progress that we’re making. I’m also pushing hard for Math for America.
Is the U.S. really that far behind when it comes to math?
We have this curious problem in the United States. Generally speaking, teachers of math and science don’t know math and science, particularly at the high school level. Obviously, some teachers do, but it’s fewer and fewer. To correct the problem, we have to pay teachers more and make their jobs more attractive. If we don’t, the U.S. is not likely to maintain any kind of economic leadership in the next 20 or 30 years. Praying is not going to work.
— Interview by Michael Peltz
Julian Robertson Jr.
"I have a pretty good feel of risk versus reward. That's the basic ingredient for successful investing."
What skills have served you best?
I have a pretty good feel of risk versus reward. That’s the basic ingredient for successful investing. When I first started out, I was a cheapskate looking for dirt-cheap stocks. When I got so many talented analysts, I realized it was better to go for more expensive growth stocks because the analysts could project earnings well into the future. If you have high assured growth, the price-to-earnings multiple really has to be out of sight for you to be taking much risk.
Not many managers change their investment style.
I don’t think I did. I think I wised up a bit and realized it wasn’t just price that created value. If you can buy a stock at 25 times earnings that you are sure will grow at 20 percent for a long period of time, it is a better value than a stock trading at seven times earnings that is going to grow at 3 to 5 percent. The investor makes money on both the multiple and the growth in earnings.
What’s the future of the hedge fund industry?
Hedge funds won’t have the same kind of returns because there are an increasing number of funds. Success begets success, and more people in the business means the tools of the trade become more expensive to use. When I started out, we got a nice payment on our short balances. Now, many times, you pay a fortune to borrow a stock.
What has been your biggest influence on the cubs?
The thing I’m most proud of is the Tiger Foundation. We tried to make philanthropists out of talented money managers, and it has succeeded beyond our wildest dreams. For one of the few times in my life, I did not micromanage. I stayed out of it, and it worked fabulously.
What did you teach the Tiger cubs to make them excel?
I’d rather you ask them.
Stephen Mandel Jr., founder of Lone Pine Capital and former Tiger retail analyst (1990–’97): “Julian, above all else, impressed upon me the importance of understanding people — the abilities, track records, ethics and character of management, particularly the CEO — not only forming our own impressions, but checking out management through our network and former colleagues and others in the same industry.”
Chris Shumway, founder of Shumway Capital Partners and former Tiger managing director (1992–’99): “I learned many things from Julian, but two things resonate: First, the process of identifying, mentoring and developing talented young people. When hiring, focus on someone who is competitive, team focused and has the courage of his convictions. Second, Julian instilled in us the importance of philanthropy, giving back to the community and encouraging others to do so as well.”
Paul Touradji, founder of Touradji Capital Management and former commodities manager at Tiger (1996–2000): “Julian taught us three key things. One, dig, dig and dig deeper. You quickly learned that what you thought was 100 percent of the work was [only] 20 percent of what was needed. Two, the value of a world-class information network. Julian had an unbelievable Rolodex. The third thing was the importance of management. Bad management with good assets can fritter away value.”
— Interviews by Stephen Taub
"I'm more interested in whether I have some ideas that can survive me than in preserving my wealth beyond my lifetime."
You’ve been very critical of recent American leadership.
The U.S. is still the most important country in the world, so obviously the way the U.S. is run has a tremendous impact. It’s ironic that right now the Chinese have a lot more discretion in deciding what’s going to happen economically than we do. It’s the outgrowth of running up our current-account deficit. That we got into that situation is largely because of the way we have managed our affairs.
What’s your position on hedge fund regulation?
It’s the role of regulators to prevent financial crises — and they haven’t done that. I’m as opposed to excessive regulation as I am to excessive freedom for leaving it all to the market. I advocate better regulation: You’ve got to regulate the availability of credit and of money. The instruments exist, but they aren’t used. We have margin requirements and minimum reserve requirements, but they’re meaningless because we’ve got so many synthetic instruments that allow investors to escape them.
How exactly would you limit hedge fund leverage?
I don’t think that I would apply leverage limits directly to the hedge funds. I would apply it through the banks. The banks would have to have more minimum reserve requirements if they are lending to a Long-Term Capital Management because it’s got more leverage than a Quantum Fund.
In your book — published in April — you present a bleak view of market conditions. Where do you stand today?
The dollar has found a temporary bottom, so I wouldn’t necessarily short it. I still think the right thing is to be short stocks, U.S. and European. The market believes that the worst is behind us and that it’s the time to put money in, and I disagree with that. It’s a bear market rally, and I’m surprised actually at how extended it is. I think that the double jeopardy of looming recession and inflation is a killer.
What is it that separates the good hedge fund managers from the great ones?
The most unlikely people are the most successful. The real test is whether the hedge fund manager is good for all seasons. Some are, and some aren’t.
The Soros way has been described as “unfathomable and unknowable,” and your own son once said you make investment decisions based on whether your back is hurting. Is there some mysticism in what you do?
I don’t think there’s any mysticism, but you are dealing with the unknowable. My philosophy — or my theory about markets — emphasizes that the prevailing paradigm underestimates or disregards the element of uncertainty. I consider myself an insecurity analyst, not a security analyst.
What can you possibly gain from publicizing your investment philosophy?
I’m at the end of my career, so I have an excessive commitment to the pursuit of truth. I’ve been pursuing the truth in my investments. Being a hedge fund manager is particularly suitable for the pursuit of truth.
Do you enjoy investing as much as you used to?
No, because my knowledge is outdated; it’s like an old man — your range of movement is constrained. The young man, he can jump and hit and skip; as an old man you can only plod along. I can use only blunt instruments, and I have only a very general understanding of what goes on. I used to have much more detailed and in-depth knowledge.
Was your shorting of the British pound and nearly breaking the Bank of England your most memorable trade?
That’s obviously the one that’s best known. On the negative side, my purchase of Svyazinvest (the regional Russian telephone company operator) is the other sort of outstanding event. I lost probably a billion dollars or something.
Back in the ’60s, when you were working with the investment firm Arnhold and S. Bleichroeder Advisers, you started one of the first hedge funds. How did you do it?
In 1969 I set up a model account with $100,000 of Arnhold and S. Bleichroeder’s money, and it was matched by an Italian banking family from Milan. I divided it into 16 slots. I invested one or two slots in any one stock, and then I wrote a memo explaining why I bought that stock. I wrote sort of a monthly report as a service to institutional investors. Eventually, I separated from Arnhold and S. Bleichroeder.
Can the industry continue its exponential growth?
There may be a weeding-out process, but a hedge fund is a superior way of running money — or it has been. But as the industry gets bigger and bigger and takes up a larger and larger segment of the market, it renders it more difficult to outperform and to justify the fees.
Where do you stand on hedge fund taxation and pay?
Treating the incentive fee as earned income makes sense. I’m not advocating it — I’m not going that far — but I’m not opposing it either. Compensation is a much bigger issue now in the U.K. than it is in the U.S. I’m struck by how prominent it is there. The big discussion is regulating compensation, not only for hedge funds but also for investment banks. It’s a public opinion thing. Look, obviously the sums that can be earned by hedge fund managers are egregious, and that is a factor in why I’m giving away most of my money.
Of course you recognize the growing tendency among institutional investors to lower their risk exposure.
They’re looking for lower volatility, and they are paying a very heavy price for lower volatility: They’re losing performance.
What do you hope your legacy will be?
My ambition is as a philosopher, and I’m more interested in whether I have some ideas that can survive me than in preserving my wealth beyond my lifetime.
Explain “reflexivity,” as you call it, especially as it relates to your effort to spread democracy.
They are intimately connected. Fallibility, reflexivity and an open society are the three key terms for my conceptual framework. Think of it this way: There’s a fundamental difference between natural phenomena and human phenomena because natural phenomena occur without human thinking entering into the causal chain. Human thinking seeks only to understand that chain, and since it doesn’t enter into it, the events, the facts, are an independent criterion by which you can actually tell whether your understanding is true or false. That’s the success of natural science.
But when it comes to human affairs, thinking has a dual function — cognitive and manipulative. Those two functions work in opposite directions, and they can interfere with each other. That’s reflexivity. So reflexivity and fallibility go together. And because you cannot attain the ultimate truth of what’s right and wrong — we don’t have the ability to actually nail it down — you need institutions that allow pursuit of the truth, critical thinking, people with different views to live together and still make decisions. That’s open society.
But that just complicates things.
Of course. That’s the problem, you see — that reality is too complicated. It’s more complicated than your understanding, and the more progress you make and the more power you have to influence reality, the more complicated the problem gets. It’s much harder to make decisions knowing that you may be wrong than acting on the belief that you’ve got the ultimate truth.
— Interview by Karl Cates
"Today managers are more interested in relative performance. When I was investing, I measured it one way — raw performance."
What was your greatest investment accomplishment?
The performance I achieved and the fact I was able to manage in all sorts of markets. I was able to function as a macro investor, an individual stock picker, and was able to adapt to a range of investment climates very early.
How did you pull that off?
My philosophy is not restrictive. It is a philosophy that says, “I am going to look at everything. If I see value anywhere, I’ll be sufficiently comfortable and knowledgeable and intellectually advantaged wherever I invest.”
What else distinguished your investment style?
I was very sensitive throughout my career to the idea that the bigger you are, the bigger your risk is. That was true of some of the people in the ’60s and ’70s and maybe the ’80s. It was not true of the major hedge fund managers of the ’90s and today. They go for size and are less interested in absolute performance. They are more interested in relative performance. You don’t hear people going for 30 percent, 40 percent returns so much. I wanted to be the best money manager. When I was investing, I measured it one way — which was raw performance.
Why did you retire when you did?
I was thinking about it for a long time. I grew up in a lower-middle-class family in Brooklyn where everyone was liberal. It was against the grain to live one’s entire life to make money. I made so much money early on, I didn’t know what to do with it.
Did you retire too soon?
Financially, I probably did. The amounts of money that have been made since are breathtaking. I would have given away more money.
What drives your philanthropy?
I don’t want on my tombstone, “Michael Steinhardt was one of the world’s greatest money managers.” I had said to myself, when I stop managing other peoples’ money, that I wanted to be ennobling and virtuous, something that really helped some part of the world that was important to me. What was important to me was improving the Jewish future.
Do you still invest?
I still trade a little for my own account. But I’m not in the office enough to do rapid trading. Almost every year I have done very well, but last year I lost money. When I have not invested well, it was because of investments I made in individual stocks. I have always done well with the macro stuff.
How have you positioned your investments?
I am short the S&P, but not in an intense way. I am also long the dollar, short American interest rates and short German interest rates. The thinking is, we are going to have inflation in all places and it will be a problem.
— Interview by Stephen Taub
"Citadel really is at the center of the world's markets. On a busy day we'll trade over half a billion shares of stock."
How does it feel to be the only Hall of Famer who has basically had just one job his entire career?
I am probably unique on your list in not having worked on Wall Street, which is a bit different than this having been my only job. When I was in college I co-managed the portfolios of two small partnerships engaged in convertible bond arbitrage. After graduation from Harvard I was hired by Frank Meyer [founder of fund-of-funds firm Glenwood Partners] here in Chicago to manage a separate account. In my early days I continued to focus on convertible bond arbitrage, relative value and other trading strategies.
How would you quantify Meyer’s impact on your career?
I owe a big part of my success to Frank’s willingness to take a risk in hiring me out of college, entrusting me with his investors’ capital and then being my partner back in 1990 when we launched Citadel. Frank was a wonderful mentor, adviser and partner who encouraged me to build a platform. In other words, rather than focus on just one strategy, he encouraged me to assemble a team of professionals who could successfully deploy capital through a number of investment strategies. Balancing both the short-term need to drive profits and the long-term focus on building a platform has been instrumental in our success over the years.
Citadel has also been very opportunistic.
It’s very much part of our DNA. This is an organization that thrives on the challenge of entering new markets and putting together teams and competitive advantages that put us in a leadership position over time.
Such as the decision to get into energy trading?
When Enron went into disarray a few years ago, it was a great entry point for us to get into the energy trading business. And we’ve put together a team over the past couple of years that I think is one of the best in the world, a team that [in October 2006] was able to, in partnership with JPMorgan, acquire Amaranth’s enormous portfolio in just a couple dozen hours and stop, dead in its tracks, one of the most significant financial crises that had ever hit the energy markets.
And also make some money for your investors.
We priced the trade correctly, and fortunately we were very aggressive in the disposition of the portfolio. We were able to exit a fair number of positions that would have had losses down the road. I’m very pleased with how my team handled the situation. To go from being a nonpresence in a market, which is where we were when Enron collapsed, to just a few years later being the firm the world turns to to solve one of the biggest crises in the energy markets speaks volumes.
Was Sowood a similar story? [Last summer, Citadel stepped in to purchase Sowood’s entire portfolio, which had plummeted in value in the wake of the credit crisis.]
The swift resolution of Sowood’s liquidity crisis was important to the functioning of the world’s credit markets. It was obviously also of incredible importance to that firm’s investors. We were in contact with Sowood around noon on a Sunday. We quickly put together a 35-to-40-person team to go through the portfolio and had six or seven people on the ground in Boston by Sunday night. We bought the portfolio before the opening of business on Monday morning. It was a sight to behold. The teamwork here on our side — and to the credit of the principals of Sowood, the focus on their side to pull this together — was quite impressive.
How do investments like Sowood and Amaranth fit into what Citadel does?
A lot of these headline stories reflect what we do every day. Almost 20 years after being founded, Citadel really is at the center of the world’s capital markets. On a busy day we’ll trade well over half a billion shares of stock. Some 20 to 25 percent of all the options contracts in America will come through our four walls. And what that scale speaks to is — whether it’s 100 shares of Google or a $35 billion eclectic portfolio of assets — we can price it immediately.
If you look at the reputation of Citadel, let’s talk, just for a moment, about the so-called negatives. People say, “It’s a tough place to work. It’s demanding. It’s unrelenting.” I look at these traits as strengths. Market leaders are unrelenting. They are always trying to move the standard higher. I’m very proud that we have a sterling reputation when it comes to doing what we say we’re going to do. And that’s why, when Amaranth needs a partner or Sowood needs a solution or E*Trade needs a capital infusion or the investment banks have a large risk-transference trade to do, they come to Citadel.
Are you still involved in day-to-day trading?
Well, my trading activity, or lack thereof, seems to be a constant source of curiosity for the press. I’m involved. Before we spoke today, I went through our risk reports from last week, thinking about the various positions we have on the page, talking with one of my portfolio managers about one of the large positions. I’m not out there buying and selling assets on a day-to-day basis. The guys who work for me are much better at doing that. But I’m certainly involved in asking, Where is the portfolio today? Where do we want to take the portfolio? What are the key risks we are taking? Are we being well compensated for those risks?
How involved were you with Amaranth and Sowood?
With Amaranth, I think I slept less than an hour or two in the first 60 hours. But none of my colleagues slept. That was just what it took to get the job done.
How important is technology to Citadel?
Extremely. Our chief information officer, Tom Miglis, has a team of about 500 people who support our technology needs day in and day out. And I do believe that our technology gives us a substantial competitive advantage in the marketplace. How many firms can handle a million transactions a day? We do it every day.
You’ve been outspoken about the financial industry’s role in the credit crisis.
I think Wall Street dropped the ball. The losses that we’ve seen over the past nine months have been intolerable, in my opinion. It signifies a lack of discipline on the capital commitment and risk management side of these institutions.
What do you see as your biggest contribution to the hedge fund industry?
The story of Citadel has been a huge inspiration for hundreds and hundreds of managers. Look at my background. Never went to business school. Never worked on Wall Street. And my partners and I have created one of the most powerful and successful financial services firms in the U.S. — in the world. We have redefined what a hedge fund is and can be. And for many would-be entrepreneurs who face that decision — Do I go for it or not? — I hope they look at our success story and say, You know what? It’s worth taking a shot.
What does the future hold for Citadel?
I’m 39 years old. The first 20 years have been great. During the next 20 years, I need to make sure that I position this firm to be a going concern well past my last day here. And we’ll take steps as a team to create an enterprise that unquestionably has capitalizable value in the capital markets. I owe it to my partners. I owe it to my employees. I owe it to everyone who trusts me to make sure that when I am no longer part of this institution, this institution will be here.
Would it help ensure that future for Citadel to go public?
Being public is certainly an opportunity for us to increase the strength of this organization. It is not an imperative. It’s not something that we need to do tomorrow. It’s something we have thought about and reflected on over the years. And we’d be foolish not to understand both the pros and cons of being a public company. I think that Citadel is well positioned to be one.
Given the poor stock performance of hedge fund firms that have gone public, maybe you’ve been wise to wait.
Yes, this is one situation where we didn’t have to be first.
— Interview by Michael Peltz
"We're not the stereotypical hedge fund in terms of an idea a minute. We come in with a view that a security is trading for less than it’s worth, and we buy it."
How did you decide value investing was for you?
I was fortunate enough when I was a junior in college — and then when I graduated from college — to work for Max Heine and Michael Price at Mutual Shares [a mutual fund founded in 1949]. Their value philosophy is very similar to the value philosophy we follow at Baupost. So I learned the business from two of the best, which was better than anything you could ever get from a textbook or a classroom. Warren Buffett once wrote that the concept of value investing is like an inoculation- — it either takes or it doesn’t — and when you explain to somebody what it is and how it works and why it works and show them the returns, either they get it or they don’t. Ultimately, it needs to fit your character. If you have a need for action, if you want to be involved in the new and exciting technological breakthroughs of our time, that’s great, but you’re not a value investor and you shouldn’t be one. If you are predisposed to be patient and disciplined, and you psychologically like the idea of buying bargains, then you’re likely to be good at it.
What traits in Heine and Price influenced you?
Max Heine was great at not looking at what something was called, what its label was. He looked at what it actually was. For example, back in the late ’70s, Mutual Shares was buying the bonds of bankrupt railroads, and I think a lot of people would have said, “They’re bankrupt,” and “Who needs railroads?” Max and one of his partners knew how many miles of track the railroad had, what the scrap steel on the track could have been sold for and which railroads might have wanted pieces of those networks. They also knew what the real estate rights above the terminals were worth.
Michael Price was fabulous at pulling threads. He would notice something, and then he would get curious and ask questions. And one thing would lead to another thing, and that would lead to another thing. I remember a chart that Michael made of interlocking ownership of mining companies that was an extension of a thought where one good idea led to another and had the potential to lead to many more if the threads kept being pulled. That was a great lesson — to never be satisfied. Always be curious.
Value is your mantra.
We don’t even think of ourselves as a hedge fund. We see ourselves as basically long-only investors. Unlike hedge funds, we don’t leverage the portfolio — never a nickel of portfolio leverage. We have a minimal amount of shorts, currently less than 1 percent of the total assets. We’re not the stereotypical hedge fund in terms of an idea a minute. We’re very bottom up, not top down. We don’t come into the office with a view that interest rates, the dollar or the economy are going to do this or that. We come in with a view that this particular asset or security is trading for less than it’s worth and we want to buy it. We have a different approach than a lot of, quote, “hedge funds.”
What were some of your best value investments?
Distressed-debt investments where we owned the senior debt. That is a favorable place for a value investor. You have a margin of safety since, as things go bad, people who are junior to you are the ones who lose value before you do. Second, the bankruptcy process itself is a catalyst. A cheap stock can stay cheap forever, but if you own a bankrupt bond, the process of emerging from bankruptcy and distributing new securities offers a practical catalyst to realize the value. Back in 2001, 2002, we successfully invested in the debt of funeral home companies like Service Corp. International and Stewart Enterprises. We were investors in Xerox Credit Corp. debt.
There are too many examples that we could say, “Ah, that was right in our sweet spot, and we should have had it.” All investors need to learn how to be at peace with their decisions. We as a firm are always going to buy too soon and sell too soon. And I’m very at peace with that. If we wait for the absolute bottom, we won’t buy very much. And when everybody’s selling, there tends to be tremendous dislocation in the markets.
What’s the secret to success?
Every manager should be able to answer the question, “What’s your edge?” This isn’t the 1950s, when all you had to do was buy a corner lot and build a small drugstore and it gradually became incredibly valuable land or you owned a skyscraper or you built a small shopping center and it became the big regional mall. The market’s very competitive; there are a lot of smart, talented people, a lot of money chasing opportunity. If you don’t have an edge and can’t articulate it, you probably aren’t going to outperform.
Why do some hedge fund managers fail?
Their clients are pressuring them for short-term results, or they think their clients want short-term results. That’s probably the biggest problem for professional money managers. It makes it very, very hard for an investor to hold a stock that’s going down, to take a contrary viewpoint. I also think leverage is a great risk. If you look at hedge fund failures, virtually all of them were on the back of excess leverage.
Are you worried about the hedge fund industry becoming too crowded?
If you took some of the people in your [Hall of Fame] group and compare what they do with what we do, there would be no overlap of positions. Probably ever. So are there too many? No. It’s not competition for us, but yes, more and more money has gone into the kinds of strategies many hedge funds follow. On the other hand, there are also some bad hedge funds — overleveraged hedge funds — and those are the causes of tremendous selling opportunities. When they get in trouble, they may be forced to sell at bargain prices.
Is it getting more difficult to find value?
Sure, but I can’t worry too much about things I can’t control. If suddenly tomorrow I got the conviction that all securities were efficiently priced, that nothing was dropping to levels where I cared about it, I would be happy to close up shop. But human nature makes it hard for the markets to be efficient. As recently as earlier this year, there were days when it felt to a lot of people like the world was ending, that we were staring into some kind of abyss of financial distress, and a lot of buyers weren’t buying. Those were interesting days. We were looking for bargains, and the Fed massively intervened, and people decided it was safe to invest again, and the markets worked out. So the question is not, Are people smart, are people sophisticated, do they have clever ways of looking at things, are they looking in the right areas? The question is, Are there periods when none of that matters because their human natures get the best of them?
What’s your opinion on hedge funds going public?
It’s a terrible mistake. One of the worst days for the hedge fund industry was the day the first one became public. As an investor, you do best when you think about what’s in your client’s interest, which is managing a reasonable amount of money that will earn a good return with limited risk. When you go public, you change that risk-return equation and start thinking about how much money you can make. It becomes a business where the client relationships don’t have to be longer than the next quarter and the talent can leave and the clients can leave.
Name one of the most pressing issues the world faces today.
It would be great if we got a long-term energy policy in this country, because if we could put a floor under the price of oil, we could enable alternatives to spring up. We can’t risk oil going back to $40, and we’re just so shortsighted and stupid about that. We could have a global war over energy if we’re not careful.
What’s your philosophy when it comes to philanthropy?
I’m not a big fan of giving to endowments, because people in endowment situations tend to give away the minimum. I believe problems are compounding faster than the money, so spending more money sooner rather than later is more likely
to address a problem. I’m interested in situations where you get a sizable bang for the buck, where it’s proven that intervention is effective and where even a relatively small amount of money or a relatively targeted amount of money can change the game.
— Interview by Stephen Taub
"The most important shift in vetting hedge fund managers has been an increasing focus on the character and quality of people."
“I’ve always had a willingness to take a position that is fundamentally different from the rest of the world and maintain it. I don’t mean that in the sense of investing in a single security; it’s the ability to pursue an intellectual strategy and stick with it. For example, when I arrived at Yale, I increased the equity orientation and diversification of the portfolio. The equity orientation obviously drove the results, but the diversification put us in a position where we were able to generate positive returns year in and year out.
We did have one negative year, in the fiscal year that included October 1987, but you could put an asterisk by that because we were only two years into moving toward an equity-oriented, diversified model, and the negative return was less than 1 percent.
In the late 1980s we hired a number of managers who were indifferent to the markets in the sense that they were trying to make money regardless of the direction of the S&P 500 index. One of my investment committee members, Parker Gilbert, who used to run Morgan Stanley, said, ‘You have a lot of assets classified as domestic equities that don’t look anything like the S&P.’ It was true.
If you had things classified as domestic equities that weren’t going to behave like the domestic equity market, then they were misclassified, because the idea of an asset class is that the constituent parts should respond similarly to important drivers of returns. If you have managers pursuing strategies designed to be fundamentally uncorrelated with a particular asset class, they should be classified elsewhere. Not having any other sensible home for these non-S&P-like strategies, we decided that we would create an asset class and call it ‘absolute return.’ Several years after we started using the term at Yale, I remember some financial institution sent us a pitch book titled ‘Absolute Return: What Is It, and How Does It Work?’ I thought, Hey, somebody is using our term! I had no idea it would become such a phenomenon.
Nowadays a lot of market participants are seduced by the returns reported for the hedge fund industry by consultants, but the image is a lot more attractive than the reality. The consultants’ numbers are substantially inflated by survivorship bias. When managers exit for bad performance, their records disappear. Prospective investors tend to look at historical performance for the industry and assume that they can get low-double-digit rates of return and substantial diversification, but when they invest, they discover that they can get only low- to mid-single-digit rates of return with some diversification, which is not nearly as attractive.
At Yale the most important shift in vetting hedge fund managers over the past 15 or 20 years has been an increasing focus on the character and quality of the investment principals.
Years ago, I would have talked about this investment characteristic or that objective factor. Now we focus overwhelmingly on assessing the managers running the business. The fundamental question is, Are these people you want to be partners with? I think it really comes down to individual characteristics.”
— Interview by Loch Adamson
"I don't think any of us got into this business thinking we would make the money we've ended up making. But that's the American way."
Was it easier to make money in the ’90s than it is today?
Absolutely. I always tell my guys, “You would have loved the ’90s.” It was different, and everyone was smaller. Plus the markets worked a lot better. When I started, the S&P 500 was up 20 percent a year for seven years. And there was the technology boom besides. So you had a lot of tailwinds. It was a good time to be in the markets. And we were managing a lot less money, so you could move it around a lot more easily.
How has SAC evolved during the past 16 years?
We started out as traders. Frankly, we didn’t do a lot of fundamental work. And then, in the mid- to late ’90s, we started transitioning from being a trading firm to a fundamentally driven firm. That continued over the years. As our assets grew, to effectively manage that type of capital, we had to do real fundamental work and analysis. Today we have probably 150 analysts and 85 portfolio managers covering Asia, Europe and the United States.
How has your role changed?
When we were smaller, the firm needed my P&L to survive. Today I still trade, but because the firm is now so diversified, the impact of my trading on the firm’s P&L is not what it was. I actually take more pride now in the building of this firm than I do in whether I make money in my own trading. I take more pride in the fact that this firm is now a real business.
How much time do you spend trading?
Between 9:00 a.m. and 4:00 p.m., I’m usually on the trading floor. I think there’s a dimension in having me out there that provides value for the firm. I’m in the bunker with the troops. Occasionally, I’ll take meetings during the day, but most of the time I’m on the floor. And then, after 4:00, I conduct business meetings.
Has your trading style changed?
In the early days it was a little bit more like trading the tape. The New York Stock Exchange had quotes of blocks of 500,000 to a million shares that were trading, and you could see the price action as it developed. Now, because everything is traded electronically a few hundred shares at a time, you don’t see large blocks trading. So the way I used to do it is really gone. But I could see that happening ten years ago, which is why I reinvented the firm.
Can investors create alpha by trading around positions, buying or selling to take advantage of price moves?
There’s no question that the whole point is to create alpha, and there are lots of ways to do it. And the reality is, if you have a great idea, you may want to trade around the position a little bit. But I wouldn’t do it a lot, because ultimately, how many great ideas does anybody really have? You’ve got to make a high-conviction bet when you feel like you have a great idea. That’s really the only way to outperform today.
A decade ago you brought in a psychiatrist, Ari Kiev, to coach SAC traders. Has his role become less important as you’ve moved to more-fundamental investing?
Ari is still an important part of the firm. It was somewhat innovative at the time to bring in someone like him. Investing and trading is a mental game. There’s always something people can work on to improve what they do. Ari’s job is to try to help them identify that and get them thinking about how to do things better. Part of being successful in the markets is being in control of your emotions and making decisions for the right reasons, not the wrong reasons. And the more you can stay in touch with that and what’s going on in your head, then I think the more successful you can be.
Can traders and investors get better over time?
Yes, I think so. But the real question is, Are they wired to adapt? The ones who can adapt are probably the ones who are going to end up being successful, because markets change. I think one of the reasons SAC has been successful over the years is because I’ve been very flexible.
Will SAC continue to evolve?
I assume that the game is always changing, and we’ve got to keep adapting to what the markets allow. The world has changed a lot in the past five years. So if you had asked me five, six years ago, “Would you have an office in Hong Kong?” the answer would have been, “I doubt it.” And now I do have one there.
Have you been to China?
I was there about three years ago, and I was just blown away by it. I could start to understand why certain industries and certain stocks have been acting the way they are. Of course, you can read about the growth that’s happening in China, but when you see it, it forces you to think about things differently. China is very far away from Connecticut. And you need to see it to understand it.
How much does SAC invest outside the U.S.?
Probably 15 to 20 percent of our activity is outside the U.S. There’s a lot of opportunity for growth in both Europe and Asia. The game is changing. Stock markets are starting to develop all over the world, and that creates opportunity.
Is the lack of information in new markets a problem?
Those markets are more inefficient. And consequently, you can probably do better over there in the sense that if you do good analysis, you probably create a better edge there than you can here. In a perfect world you would want to transplant some of your own people so that the culture sort of happens over there like it happens here. We try to do that. We’re pretty careful about putting people in places that we’re not sure about. We’re going to grow these businesses slowly and develop a good foundation.
How would you describe the SAC culture?
Entrepreneurial, collegial and independent-minded. We want people who are self-starters and people who know what they want to do and how to execute on their strategy. I tend to be a guy who gives people a lot of autonomy. I tend to believe in human nature. I also believe that if you give people enough rope and enough room, they’re going to create something that’s unique to them. I’ve learned as much from my people or more than they’ve learned from me. These young guys, they’re smart, they’re inquisitive, and they teach me stuff.
How do you keep employees happy?
Pay them well. I also think it helps that I give people a lot of autonomy. The vast majority of people who have come to this firm have had a really good experience. We usually don’t lose people to other firms. We tend to lose them if they start their own firms. So you’re going to have some turnover. That’s inevitable. I started my own firm, so I understand that. And that’s why I try to keep this firm well diversified, so when and if people leave, the firm just keeps going, which I think is the mark of an institution as opposed to just a one-hit wonder.
Do you think the huge sums made by hedge fund managers are justified?
I don’t think any of us got into this business thinking we would make the money we’ve ended up making. But that’s the American way. These are small businesses, and with the amount of hours that people put in to be successful, they ought to be applauded, not criticized. I’m not forcing anybody to invest with me. And the reality is, I have a lot of my own capital at risk in the firm. So if I make good investments, I ought to make a lot of money. And when I lose money, I’m losing my own money too.
How does collecting art fit into your life?
On a Saturday, rather than play golf, I’ll go to a gallery and look at art. Art collecting brings in some of my skills as an investor — my ability to assess risk and figure out what something is worth. I’ve also learned a lot and gotten to know many people who I would never have met in the normal course of doing business.
— Interview by Michael Peltz
"Leon had a reputation for being out of planetary, always thinking in very big concepts. But he was as hard-nosed as anyone."
Larry Feinberg , a former Odyssey executive and the founder of Oracle Partners: “Leon would get so engrossed in economics, charts and books that his secretary had to have a fire extinguisher ready because he would dump his pipe ashes and start a fire every day. He was a brilliant economist and idea guy. He would ask, ‘What is the trend? How do we get there before anyone else?’ He was great at being early. He and Nash hired people like me. They didn’t know if I could make money. Their ability to judge people was spectacular. Within ten minutes they had their minds made up about you and had you well pegged.”
Stephen Berger , chairman of Odyssey Investment Partners, a successor firm to Odyssey Partners: “Leon had a reputation of being out of planetary, always thinking in very big concepts. But he was as hard-nosed as anyone. He was also brutally honest and a clear thinker. He had a long time horizon but was also very clear about the present. He could be wrong on timing, but seldom on the trends. He was also attuned to the whole psychology of what was happening in the world, to people and to patterns. He was always asking about patterns. Leon also never forgot a company he had looked at.”
Shelby White , Levy’s widow: “I most admired his brain and his ability to focus and think abstractly and long term. Leon and Jack always went for the smartest people. They were more about ideas than strategies. Leon’s decisions were always based on his view of the economy. He had an ability to wait patiently. He saw Chapter 11 railroad bonds as a real estate play well before others started to think about them that way.” -
Jeffrey Gendell , founder of Tontine Partners and a former Odyssey portfolio manager: “Leon was always trying to find the next big idea before anyone else. He would say, ‘We need to find an idea that can make us half a billion dollars. There’s got to be some new ways, new technology.’ He was always negative on the economy, always thought things were worse than they were. But he still figured someone had to be doing something right. There was always something out there.”
J. Ezra Merkin , longtime friend and managing partner of Gabriel Capital Group: “In remembering our times together, I have to remind myself that he was almost 30 years my senior, because Leon treated me as a complete equal. This was, perhaps, the most unusual quality of his capacity for friendship: his ability to treat as an equal partner someone younger, less experienced and much less wise — as someone to be consulted, informed, questioned, depended on, disagreed with, berated, scolded and praised without any ulterior motive. This capacity emanated, I think, from Leon’s innate honesty. He simply took people as they were, and if it made sense to treat a generation-younger junior as an equal, that is precisely what he would do.”
— Interviews by Stephen Taub
"Interviewing prospective hires, I'd ask, 'Who are your heroes? Where do you see yourself 20 years from now?'"
“Odyssey was a real partnership. We built long-standing relationships with investors — who did very well — many of whom were with us from the beginning. Importantly, everyone had a very profitable experience with us. The firm was a very good training ground for young people coming into the business. They learned about balancing risk and reward. We gave them the ability to make decisions and allowed people to make mistakes and to think differently. We didn’t second-guess people.
We had a very rigorous process for deciding who we would hire. It included psychological testing, which looked for flexibility, open-mindedness and decisiveness among the characteristics we wanted. When interviewing prospective hires, we tried to understand the person’s character. I’d ask, ‘Who are your heroes? Where do you see yourself 20 years from now?’ The idea was to really understand the character of who it was we might be asking to join our team.
We wanted people who would act well under pressure — in both good times and bad. How they handled the good times was perhaps even more indicative of their character than how they handled the bad.
We carefully evaluated the risk-reward ratio in our major investments. We wanted to be sure that the upside opportunity far outweighed our analysis of the downside risk. I think that our willingness to be open, to change direction if necessary and to make decisions differentiated us. That included cutting losses when the time came.
It was very helpful to have such a valuable partner as Leon Levy, who clearly had the greatest influence on my career. We were really co-equal, and that was important. We complemented each other very well. We had different strengths, weaknesses, areas of interest, personalities and perspective. But together we made a powerful combination. He was more optimistic and creative.
Overall, I think the wisest investment decision was our call on the bond market in the early 1980s. We began aggressively taking long positions in bonds at a time when the country had just gone through the inflation of the 1970s. It was a contrarian point of view at the time, but one that worked out extremely well for us and our investors.
We saw firms that grew too fast. They took in money just because it was available but didn’t have the resources to properly manage or administer it. We were very careful to avoid that.
Many hedge fund managers don’t understand leverage today. It’s very sweet on the way up. But not on the way down. It has got to be used carefully and strategically.”
— Interview by Stephen Taub
"I started my career in futures, and the rallying cry was always free markets for free men, so I've tried to create a open architecture."
Who has had the biggest influence on your career?
My friend Paul Tudor Jones. We were both Southerners in the big city of New York. Paul got me my first job, with E.F. Hutton as a runner on the floor of the cotton exchange. That was many moons ago, but I would say that his real mentorship came when I started trading commodities and launched a CTA fund. I didn’t know that it would turn into a hedge fund, but when I started to raise money for a hedge fund, he was a big supporter with his investors.
His approach to research and trading had a real impact too. He wasn’t worried about small stuff. He taught me to think in points, not dollars, and he always used to say, “It’s just points, it is not money.” He gave me an ongoing tutorial in disassociating oneself from the result of the trade, yet still having passion about it.
Why do you live in London?
Living here gives me broader perspective on a number of different countries. I find it ideal to be based in this time zone, and I use the time advantage to set up early for the U.S. markets.
How do you decide where to invest?
We tend to make top-down, interest-rate-driven investments. We’ve been pretty U.S.- and European-centric throughout most of Moore’s history, and we have been pretty closely focused on what happens with the interest rate cycle and the reactions that it drives around the world. But our focus is shifting now because micromarkets — and those can be anything from individual equities to commodities and emerging markets — are becoming more and more dominant.
What accounts for Moore’s success?
Hard work, patience, knowing when to hold ’em, fold ’em or go all in. We have a rigorous risk framework, and although I do not micromanage every position, my portfolio managers understand the risk format prior to joining the firm.
Does the label “global macro” reflect your style?
We kind of had the moniker “global macro” thrust upon us. We didn’t sign up for it. But I look at it as kind of the 007 license to do whatever we want, and we’re in a period now where globally there is no lack of opportunity: in fixed income and currencies and the distressed and credit markets. We don’t have to try and decide to make our money in any one instrument or strategy — we can invest in private equity, individual equities or arbitrage. We feel that we are versatile enough that we can move into a number of different strategies, and if doing that means that we’re global macro, then we’re not going to argue with the label.
Are there historical precedents to the current turbulence?
You can find similarities, but this situation is shaping up to be a long-term bear market — and it is corresponding with a secular decline in American financial power. You have to hark back to the ’70s to get an equivalent sense of loss of U.S. control. At that point in time, though, the U.S. had no natural economic rivals. Now there are a number of emerging markets, like the BRICs — Brazil, Russia, India and China — that are vying for power and showing economic leadership. They may, in time, rival U.S. global dominance.
How worried are you? Especially about inflation.
The U.S. has gotten out of a number of really difficult economic situations where inflation was a pressing issue, so there is an expectation that we’re going to get out of this crisis, too. But I’m very concerned, given the negative savings dynamic in the U.S. and the inability of our politicians and people to acknowledge that we have the financial structure of a third-world economy dependent on leverage and dissaving, coupled with an addiction to foreign goods and oil. Other competing economies are much more disciplined.
What was your best trade?
I’m lucky enough to have more than one. The first was a complete market malfunction. In the crash of ’87, I happened to be short Nikkei contracts, and as we were finishing up and closing the books late on that Monday night, the Nikkei futures opened at 4,000 — it had closed the night before at 28,000! I bought shares to close the short position between 8,000 and 18,000. It was incredible buying the second-largest stock market down by almost two thirds.
Had I not been in the office during those 15 minutes after the market opened, I would have missed it. The lesson was that a good part of success is predicated on showing up and putting in time.
The second great trade, or a great exit, was in the last week of the Nasdaq rally in March 2000. We were really worried about what the Fed was going to say, so we sold close to $2 billion of Nasdaq futures just before the bottom fell out. Now that sounds great, but I had told my head trader earlier in the week to get rid of all of our technology longs we had been riding for months. But he didn’t sell anything that week, so we ended up with a lot of dot-com equity on our balance sheet. Not executing the entire trade cost us dearly, however beneficial selling at the peak of the market. The lesson was, Don’t rely on others when you are really sure.
The last one, last year, was probably where we made the most absolute money, and that was in subprime. We traded around the position very poorly and yet made a ton of money. The lesson was that picking the right investment will trump any lousy trading around it.
I have probably blanked them out of my mind — not enough memory for them.
What’s it like to work for you?
We run a laissez-faire, entrepreneurial shop. I started my career in futures, and the rallying cry was always free markets for free men, so I’ve tried to create an open architecture here for traders to test their ideas and thrive. I think that we have a good understanding of risk, but we take a different approach to it. We prefer to see what our traders want to have as their individual risk profiles, and then we fit our assets around those to modify our net exposure.
Should hedge fund managers give back?
They should, and they do, probably more so than other pockets of wealth, perhaps because after mastering the markets on their wits, they believe their wealth is replicable. In 1992 we founded the Moore Charitable Foundation, which aims to conserve and protect our natural resources. Conservation remains underfunded relative to other charitable causes, and the organizations we support are working to slow the loss of Earth’s resources.
What’s the most pressing issue facing the world?
A Malthusian population explosion intersecting with globalization. We have encouraged all 7 billion of the world’s inhabitants to live like Westerners, and now that they have taken the bait, we are realizing it is impossible on this small Earth. The first big hit has been to the environment; the next, which we are witnessing, is to energy prices, and it is leading to food shortages and eventually more famines.
Governments are only starting to address the problem, and the planet’s most inventive and powerful economy, America’s, is leading only from the rear, if at all, given our present administration.
— Interview by Loch Adamson
Alfred Winslow Jones
"There are many illusions about short-selling. One is that the practice is immoral or antisocial. Another is that it's dangerous."
“Hedging constitutes the most important of the unique features of our investment method in that we make use of short sales for the control of stock market risk and for actual capital appreciation of our fund in a declining stock market. Hedging, that is, the taking of both long and short positions, makes our fund more stable and conservative than the ordinary forms of common stock investment; and the borrowing of additional money, protected by hedging, permits the most efficient use of our capital, without additional market risk. . . . In this early emphasis on hedging, we risk obscuring our chief aim, which is long-term capital appreciation through the buying and holding of good common stocks.
There are many illusions about short-selling. One is that the practice is immoral or antisocial. Actually, the successful short-seller is performing a useful market function in that he arrests an unjustified rise in a stock by selling it and then later cushions its fall by buying it back, thus moderating its fluctuations. Another illusion is that short-selling is somehow more dangerous than buying a stock for a rise in price. A stock can theoretically go up to infinity and down only to zero . . . and in both cases there is no danger that cannot be provided for by adequate diversification.”
— Alfred Winslow Jones, “A Basic Report to the Partners,” May 31, 1961
Robert Burch III , president of A.W. Jones & Co.: “The first thing Alfred would say about hedge fund managers today is that they are not hedged. The word is being abominated. Anybody leveraged 30 to one is not hedged — they’re just using the word to get the 20 percent performance fee. It’s false advertising. That’s the first thing he’d say. Then he’d go to his socialistic bent and ask, ‘What are they doing with all that money?’ He’d be pleased that foundations and endowments are up to their elbows in hedge funds.
He had two powerful ideas. One was that you didn’t need the traditional allocation of bonds and cash and all that — you can go 99 percent stocks, you’ll get a bigger return. Two was that you stay in there, you hang in there because you’re hedged. Those were his two things: always being in the market and having a big percentage of assets in stock.
Alfred always said just pick the best guys, but he wanted talent to prove itself. He’d give them a paper portfolio, see how they did and in the process get good ideas himself. If you wanted to work for Alfred, he’d say, ‘Fine, do a million-dollar portfolio and let’s see how you do — and make sure you’ve got plenty on the short side.’ Because the ability to short was where you separated the wheat from the chaff. The years 1949 to 1970 were huge for Alfred. The Dow was 160 in the summer of ’49! It rose to over 1,000 by 1970, and he was participating in it the whole time.”
— Interview by Karl Cates
Paul Tudor Jones II
"In this business there will always be that top 10 or 20 percent of managers who will outperform everyone else."
What’s so special about macro hedge fund managers?
I love trading macro. If trading is like chess, then macro is like three-dimensional chess. It is just hard to find a great macro trader. When trading macro, you never have a complete information set or information edge the way analysts can have when trading individual securities. It’s a hell of a lot easier to get an information edge on one stock than it is on the S&P 500. When it comes to trading macro, you cannot rely solely on fundamentals; you have to be a tape reader, which is something of a lost art form. The inability to read a tape and spot trends is also why so many in the relative-value space who rely solely on fundamentals have been annihilated in the past decade. Markets have consistently experienced “100-year events” every five years. While I spend a significant amount of my time on analytics and collecting fundamental information, at the end of the day, I am a slave to the tape and proud of it.
Is it possible to teach someone to be a tape reader — what some might call a trend follower or technical analyst?
Certain people have a greater proclivity for it because they don’t have the need to feel intellectually superior to the crowd. It’s a personality thing. But a lot of it is environmental. Many of the successful macro guys today, they’re all kind of in my age range. They came from that period of crazy volatility of the late ’70s and early ’80s, when the amount of fundamental information available on assets was so limited and the volatility so extreme that one had to be a technician. It’s very hard to find a pure fundamentalist who’s also a very successful macro trader because it is so hard to have a hit rate north of 50 percent. The exceptions are in trading the very front end of interest rate curves or in specializing in just a few commodities or assets.
What’s your take on the next generation of managers?
I see the younger generation hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over. When I got into the business, there was so little information on fundamentals, and what little information one could get was largely imperfect. We learned just to go with the chart. Why work when Mr. Market can do it for you? These days, there are many more deep intellectuals in the business, and that, coupled with the explosion of information on the Internet, creates the illusion that there is an explanation for everything and that the primary task is simply to find that explanation. As a result, technical analysis is at the bottom of the study list for many of the younger generation, particularly since the skill often requires them to close their eyes and trust the price action. The pain of gain is just too overwhelming for all of us to bear!
You’re not necessarily a fan of hiring people straight out of business school.
Today there are young men and women graduating from college who have a tremendous work ethic, but they get lost trying to understand the logic behind a whole variety of market moves. While I’m a staunch advocate of higher education, there is no training — classroom or otherwise — that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it — a sort of baptism by fire. One has to experience both the elation and fear as markets move five and six standard deviations from conventional definitions of value.
How will macro investing fare over the next five years?
The macro space will be great. I think we’re going into one of those slow or zero-growth periods in the U.S., which will give us a lot of volatility.
Will hedge funds do as well as they have done in the past?
Average returns will drop. The amount of money that was made by hedge funds in the past two decades was so outsize relative to anything in civilization in the past couple of centuries that it naturally attracted the best intellectual capital in the world. As a result, the inefficiencies that existed in the ’70s and ’80s and even the ’90s are not as readily seen. But in this business there will also always be that upper tier — that top 10 or 20 percent of managers who will outperform everyone else.
What experience had the biggest impact on your career?
Trading commodity markets back in the late ’70s — when they were still extraordinarily volatile — allowed me to experience repeated bull and bear markets across a variety of different instruments. Remember, in agricultural markets the cycle can be just 12 months. I lost my stakes a couple of times, which taught me risk control and risk management. Losing those stakes in my early 20s gave me a healthy dose of fear and respect for Mr. Market and hardwired me for some great money management tools. Oh, incidentally and by necessity, I became a pretty good fundraiser, which has helped me in the not-for-profit world.
Who’s had the biggest influence on your career?
My first boss and mentor, Eli Tullis, of New Orleans. He was the largest cotton speculator in the world when I went to work for him, and he was a magnificent trader. In my early 20s, I got to watch his financial ups and downs and how he dealt with them. His fortitude and temperament in the face of great adversity were great examples of how to remain cool under fire. I’ll never forget the day the New Orleans Junior League board came to visit him during lunch. He was getting absolutely massacred in the cotton market that day, but he charmed those little old ladies like he was a movie star. It put everything in perspective for me.
What was your single best trade or investment?
Probably buying March put options on the Japanese stock market in early February of 1990. The volatility was an absurd 5 percent, owing to the newness of the options market, with which many Japanese had little experience. Much like the U.S. stock market just before the 1929 crash, the Japanese stock market in early 1990 was following the same price pattern with remarkably similar fundamentals and valuations that provided enormous profit opportunities in a truncated period of time. I actually felt sorry for the people who were on the other side of that trade when I was buying those puts.
Your biggest missed chance?
I missed the subprime opportunity of 2007, and it rankles me every time I hear the term. We have studiously avoided mortgages at Tudor specifically because it is a big-carry game that does not adequately compensate for the inherent tail risk. That unfamiliarity, though, came with a huge opportunity cost.
Is the price of oil high for fundamental reasons, or are hedge fund managers and Wall Street driving it up?
It’s a very bullish supply-and-demand situation, and the peak oil theory is probably correct. But the run-up in prices is now bringing in an enormous amount of speculative, nontraditional capital such as pension funds and university endowments — principally through index products. Commodities have been the worst-performing asset class behind stocks, bonds and real estate for the past 200 years, but Wall Street doesn’t highlight that long history when selling commodity index instruments today. Instead, it shows a chart of the bull market of the past 12 years to rationalize why some pensioner should be long cattle futures in the derivatives markets as part of a basket. I am sure they were using similar logic about tulips three centuries ago. Oil is a huge mania, and it’s going to end badly. We’ve seen it play out hundreds of times over the centuries, and this is no different. It’s just the nature of a rip-roaring bull market. Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic.
Should hedge funds be more closely regulated?
I selfishly do not want to be regulated, but I understand the necessity of it.
— Interview by Stephen Taub