This may be a naive question as I’m just a PE guy but I’ve always heard that Citadel et al aim to grind out low single digit returns juiced up to ~15-20% by levering at like 8x. With rates where they are today though, doesn’t this become prohibitively expensive? I guess I don’t really understand what the right reference rate is so maybe I’m just not thinking about it the right way. Just curious how the model works - thanks!
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Also on the pod level, I.e what matters to me, we target gross returns and get paid on GMV. No one is actively aiming for LSD payouts lol
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Alpha is always in excess of the risk free rate. So if you generate pure alpha (so expected returns are alpha + risk free rate) and lever it up, you are fine no matter how high the nominal risk free rate is. I am sure there might be practical considerations but at a high level this is it.
Bro obviously…
Bro I am obviously answering OP’s question
Yes but if they are truly market neutral they will only be generating alpha and not collecting the risk free or cost of equity. So their alpha would then still have to be higher than the risk-free correct?
It feels like this is just a semantic point but no the way you frame it they would also collect the risk free (so expected returns are alpha plus risk free rate). Sometimes people just abstract the fact that "true" alpha is netted out of risk free rate implicitly in discussions.
This was discussed here a while ago. They run dollar neutral, so the costs are unchanged because they pay the long rate and earn the short rate, and both increase by the same amount when the fed rate rises. You can do this on an IB account yourself.
This is the right answer. As simple as it is, amazing how many people are clueless about it in the prior answers and try to obscure it with mumbo-jumbo.
These funds also trade things other than equities - there is ample free leverage in derivatives
Prime brokers charge you a spread. On your longs you pay SOFR plus a spread. On your GC (general collateral) shorts you receive SOFR minus a spread. The spread you are charged depends upon how attractive of a client you are for your PB. As an example on interactive brokers you are charged +0.50/-0.25 which means that for a long you pay SOFR plus 50 bps and for a GC short you receive SOFR minus 25 bps. A good client for a PB would get better rates than that. So for a market neutral fund your cost of leverage would be bps.
20-25bps per turn of leverage, for a market neutral book with generally easy to borrow names. so 8x for example would cost roughly 2% per year
cost has little to do with risk-free rates because the book is self-funding (borrowing a stock and selling it raises cash, which funds the purchase on the long side). the 20-25bps cost comes from paying the broker to take on a small amount of risk in case you go under before they can liquidate you.
Costs more than that. The big market neutral funds pay 37.5 BPs a year for their leverage, smaller funds pay more.
you are likely quoting differently
for $100m long / $100m short I am saying ~20bps on the $200M GMV (~$400k), you are quoting as ~40bps on the $100m
Do the big platforms charge for that financing cost in equities? I'm only familiar with the macro world and margin consumption where generally we do not get charged
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