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"A wise American hedge fund manager once said..." | quant trading clips

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AI's margin fork:
Balyasny's founder Dmitry Balyasny

"At the moment, while AI is making us much more productive and efficient, we haven't let go of one person because AI has automated their job. We're just hiring more AI people."

"But if you look out five years from now, is that still going to be the case? Probably not. Some jobs are going to get automated."

"If you think of a typical company where there's a lot of folks doing very bureaucratic type of things, a lot of pretty mundane tasks, all that stuff is gonna be automated. I don't know if it's in a year or in five years, but somewhere in that timeframe."

"If you're a company that can really harness that and you could produce your products, your services at a much lower price point, and you figure that out ahead of the competition, your margins might explode to the upside."

"On the other hand, if everybody in your space is doing that, maybe your margins are actually gonna collapse, because everybody's gonna drive down pricing."

"Everyone is focused very much on the next quarter. But if you think out two, three, four years, how's this space going to look?"

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@brad_D6 No crying in the casino.

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When a position goes against you:
Point72's founder Steve Cohen

"I mean, listen, you gotta keep processing information."

"You gotta remember the way we do things, one stock is part of a bigger portfolio."

"Let's say you own a stock and it's going down, you may have shorts against it, protecting you. We run long, short, we don't necessarily just run long."

"You gotta recheck your work and, you know, make sure that you're not missing something. I mean, you can't know everything."

"And you may want to add if you've done all the work and decide, hey, this is a great opportunity."

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No tracking error, no outperformance:
AQR's Managing Director Peter Hecht

"Tracking error is the volatility, but it's the volatility of the relative return, your return versus a benchmark."

"A tracking error of 3% means, if you think it's a normal distribution, you're going to have a return that's going to be either 3% ahead of the S&P 500 or 3% behind the S&P 500 with roughly a 66% probability."

"If you want to beat the benchmark, if you want to try to add value, you have to take tracking error."

"You can take bad tracking error, right? That's with a manager that does not have a good process for determining what's an attractive security or an unattractive security."

"The more tracking error you take gives you more possibility for beating the benchmark, but it also means you might actually lag the benchmark by more when your manager experiences bad luck."

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@spliffymagoo No crying in the casino.

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AI as an amplifier of human intuition:
Citadel Securities' Technology COO Jeff Maurone

"It's very easy to dismiss them as efficiency gains or operational gains. It's 99% cheaper to produce software."

"When the mindset shift goes from purely automation to starting with a spark of human intuition around what moves markets and amplifying that, magical things are happening."

"Maybe historically, as an analyst covering several hedge funds, you read a few 13F filings to see how holdings changed."

"But now, you might have an agent reading every single 13F filing the moment it comes out, compares with every historical filing in history, builds essentially every portfolio in the market, shocks every portfolio daily and maps the risk across the entire market."

"That amplification of human intuition about the way markets work is the source of alpha here."

"Human intuition is the spark that starts it, and AI and agents amplify it."

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@HedgeFundClips No crying in the casino.

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@internpierre No crying in the casino.

[Ethan Kho @ethanrkho]

Hedge Fund Manager David Orr (@orrdavid) on why he backed a game show winner with no credentials:

"I think that people aren't actually focused on just the simple answer of, like, what's this guy's edge. They're not willing to look outside and pick unusual people."

"In our case, one of our guys won a TV game show."

"He doesn't have any credential at all. He didn't work in any of the big shops or banks or anything."

"I'm fine hiring him because his personal account Sharpe for a few years is two point something, so we'll give him a shot."

"You could be a delivery guy, but if you're killing the market, I'll give you a shot. It could be anybody."

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Quitting trend following at the worst time:
AQR's Managing Director Peter Hecht

"In 08 it actually did well. So that's actually why everyone got in after 08."

"If trend following is based on underreaction to news, if there isn't much news, there is very little to underreact to."

"A lot of people got out of trend following after holding it for 10 years and it was sort of mediocre, and they got out in 2021, and in 2022 the industry was up, let's call it 30% or 40%."

"Sometimes holding it with equity beta is a way to force discipline."

"If you're just holding managed futures standalone and it's just having two, 3% returns, you're sort of like, ah, is that a good use of my capital?"

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Slugging vs. hit rate:
Balyasny's founder Dmitry Balyasny

"If you contrast it with high frequency trading, which is a hit rate type of business, you're going to have 99% of your trades going to be profitable or a tiny loss. You've got to do tiny, tiny, tiny, and repeat, repeat, repeat."

"We have 170 investing teams at the moment. When you hire an investing team, chances are, depending on their track record, maybe 75% of them will wind up working out."

"If you can control the risk, you might lose 10 million, 20 million, 30 million on somebody who doesn't work out, but the ones that do work out, they'll hopefully be with you for 10, 20 plus years, and you might make hundreds and hundreds of millions off of them."

"In order to enable the slugging, you have to have very well-defined risk boxes within which people will operate, to enable them to bet on the things that they're really good at betting on and try to exclude as much of the other stuff as possible."

"For every strategy, we'll have stops, vol targets, vol limits, stress limits, liquidity limits, et cetera."

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Answer every question before it's asked:
Citadel Securities' Technology COO Jeff Maurone

"For 50 years, the process of sequencing amino acids into folded proteins was a bottleneck on biology research."

"Researchers would spend quarters, sometimes years, folding just a single protein until Demis Hassabis and the team at DeepMind fundamentally changed this."

"Using models, they reduced that process from years to call it six or seven weeks."

"Even though they were using a model to accelerate the process, it still worked first in, first out."

"Instead of working that way, why not just fold every single protein we've ever seen?"

"More than 200 million proteins folded, became an incredible resource that changed biology forever."

"Using what is essentially an early form of agents, rather than answer questions when they arise, but to preemptively answer every possible question before it is asked, is one of the real emerging ways that we are seeing AI and agents being used to achieve incredible results."

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AI and the holding-horizon problem:
Balyasny's founder Dmitry Balyasny

"I don't think you can replace any for the foreseeable future, but I think it's a really good adjunct."

"Markets are quite different. And the longer your holding horizons, the more different they are."

"For that stuff, you can use AI to really automate your trading because the rules are quite clear, like what causes a stock to go up in the next 30 seconds? Well, it's more buyers and sellers."

"But over a longer period of time, is this employment number that comes in hot good or bad for equities? Well, that depends on the environment that you're in."

"When a company misses their earnings number, but the revenues are better, is that good or bad? Well, it depends."

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The 55% hit rate:
AQR's Managing Director Peter Hecht

"In stock selection, the way it ends up working on average is, let's say, if we're right about 55 percent of the time, we hit our target return."

"So that means 45 percent of the time we're wrong."

"Let's say one year we were 52 percent right and we hit our target return."

"Let's say we're having a bad year and you must be like, well, instead of 52%, you must be at 37%. No, we're at 49%."

"The difference between hitting your target return or having a good year versus a bad year, it's small, right? It's a small edge."

"It's not like we're right 80% of the time. It's more like low 50s, mid 50s for our stock."

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Small edge, high reps:
Balyasny's founder Dmitry Balyasny

"A simple way for folks to think about it is like a casino. The edge that a casino has is relatively small."

"When you have millions of people coming through the casino, their earnings are very consistent, because they have a little bit of an edge, and any one player might win, which keeps people coming back."

"You need high enough reps to put the statistics in your favor."

"How do you optimize your trading efficiency to lower the slippage, your cost of moving the stock when you're buying or selling, execution costs?"

"You still might only have a 55% chance of being right, but you're not gonna lose that much if you're wrong and you'll make a lot if you're right, because your view is sufficiently variant."

"If it does happen, it's a big surprise to the market and the security gets repriced."

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The out-of-sample gauntlet:
AQR's Managing Director Peter Hecht

"Start off with an economic thesis on why this signal should predict returns."

"Let's say you first test your hypothesis in U.S. large caps and it works. Then we're going to say, all right, but your theory also says it should work in U.S. small caps. Let's test it there."

"It should work in European markets. It should work in Japan. Let's go grab European markets and test it there and in Japan and Australia. It should work in emerging markets."

"Some of our signals, if they predict a single name stock, maybe they should also predict country level indices like the S&P 500 versus the FTSE versus the Nikkei."

"So we're always pushing the data with all of this out of sample verification, even though we're starting with sort of an economic foundation, to try to minimize the chance that we're just finding patterns in randomness."

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@Lihong062 How many family offices actually hedge their privates exposure using pre-ipo perps?

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The three traits that scale a PM:
Balyasny's founder Dmitry Balyasny

"The things I look for are how does the person respond to adversity. Because if they had an amazing track record before they got to you, you can be certain they'll have a drawdown once they're here."

"You need people who have the perseverance and mental fortitude to use the difficult periods to re-underwrite what they're doing, come up with some fresh ideas, improve their process, improve their team, as opposed to pack it in."

"A real learning, adaptive type of mindset, where they're constantly looking for better ways to do things and aren't overly wedded to a particular trade style approach."

"The folks that are really scaled over time are ones that have a business building DNA."

"They enjoy hiring people, they enjoy managing people, they enjoy running their own business within a business, and those kind of folks do a better job of scaling over time."

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The airline problem for GPUs:
Citadel's CEO Ken Griffin

"GPUs, like airlines, have a very low marginal cost to run. Like the incremental seat on an airline that's not full, if you can sell that ticket for $20, you're making money in that seat."

"That's one of the reasons that the airline industry is such a nightmare: the moment you have overcapacity, pricing goes into freefall."

"We saw this actually with the telecom build out back in 2000."

"We built more fiber than we had demand for, and the price of telecommunications just went straight down."

"If we reach a point where the provisioning of GPUs exceeds demand for GPUs, marginal pricing will actually go into free fall. And that really upends all the investment assumptions that people are working with today."

"Right here, right now, there's people that are earning extraordinary pricing on GPUs that are five or six years old. That probably doesn't persist for another five or six years."

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Prompts vs. embeddings:
AQR's Managing Director Peter Hecht

"You literally ask ChatGPT or Claude, is Apple cheap or expensive? Give me your analysis and give me the details why you think it's cheap or expensive. That's prompt, okay?"

"Then there's a way of using a large language model where you feed in documents, financial documents, broker reports, earnings reports, and you go under the hood of the large language model and you take what we call a word embedding, which is a numerical representation of the text."

"When we use large language models, we're doing the latter. We're not doing the prompt-based approach."

"All of the special sauce is not in the large language model. The fact that you can get a numerical representation of the data is sort of a commodity."

"The hardest part is can you find whether that numerical representation of the data can predict future returns."

"That is very difficult to do, requires a ton of skill and it's highly subjective. And that's why I don't think there will be convergence."