Is SM or MM pure stock picking ?
Might be a dumb question but what position in hfs is mostly pure stock picking alpha rather than running a market neutrsl hedged book like a pod , correct me if I’m wrong but in a pod you have 0 market risk and are just playing the risk between 2 stocks with no factor exposure , the way you make money is your longs going up and your shorts going down ,in most pods is your market exposure 0? Are you perfectly balanced between your longs and shorts or do some pods prefer net long ? I understand that pods pretty much make you deploy all your capital but what if you only have 2-3 good ideas and don’t want to weigh them that much? Then do you just allocate the capital to your 4th and 5th best idea anyway? In a SM it’s all up to the PM on whether you deploy all your capital but why do LPs prefer the pod model then? Is it just the consistent 6-8% with limited risk?
There's like a million questions in here.
Yes pods are market neutral. That inherently means near zero market risk, in theory. But it's not like you start as a PM.
Market neutral doesn't mean you have to have a short or a long, just means you need a pair trade where one should outperform the other. Neither necessarily has to go down.
Idk about the capital thing.
You're confusing how LPs think about pods with how you, as a prospective analyst, thinks about pods. You're thinking about one pod, the LP is thinking about the entire pod shop. Law of large numbers, theyre not worried about individual teams. LPs like MMs because they're low beta, "pure alpha". Hard to get this exposure in asset management in public markets.
Ok I see, so LPs aren’t looking for the home run play with pods , they’re just looking for the consistent hit, makes sense
Think about what the incentives and objectives of institutional LPs are. In general, they're not looking for home runs.
A stock has many sources of returns -- e(r) = risk free rate + beta(ERP) + beta(factor1)...+beta(factor_infinity) + idiosyncratic return (standard error)
Your "net exposure" refers to the contribution of non-idio sources of returns. A "high net" means you have a view (or want participation from) additional factors. A "low net" means you are trying to extract just the idio (+/- some tilting).
So, on a gradient, a low net strategy's return is more dependent upon stock picking skills, while a higher net is going to incorporate sector, thematic, and factor tilts in returns.
This doesn’t make any since to me , how can a stock return the risk free rate if the risk free rate is the 10y? If you wanted the risk free rate returns wouldn’t you just invest in government debt? I thought that’s why we have a equity risk premium
You're thinking about this backward.
An analyst picked a stock last year that returned 10%. Pretty good right? Well, let's see...
10% = 4.5% (10yr) + 21.5% (SPX return - 10yr) - 16% (alpha is negative here)
On a portfolio basis, the analyst went long that stock and went short a stock that returned -5%.
Portfolio return = 15%
If you are market neutral, then the betas cancel out. E.g. +4.5% +21.5% - 4.5% -21.5% = 0%
So alpha = 15%
That's pretty good!
The ratio of long and short exposure is measured in two primary ways: cash delta and beta delta.
Cash delta = stock price * units = cash delta
Beta delta = cash delta * beta
Market neutral investors try to have a beta delta of close to 0. That means the return they get are "pure alpha" -- purely from security selection.
Hope this helps.
Could you explain a low net and high net situation with a stock ? Like what view would fall in each basket
Bruh. In the end it’s all just vibes. The biggest $ made has probably been in stuff like long NVDA / META / LLY and riding that up. Whether you’re SM or MM: you’re doing the same shit. It’s just how you’re wrapping that. Can probably get away with an index hedge or running net long at the SMs. In the MMs, you’ll find some hedges that fits the construct and gives you the ok to be “market or factor neutral”. So you’re doing the same type of “stock picking” in both places. I think people glorify this idea of “pure alpha” a lot in MMs (long LLY / short Novo type of trade) but the reality is that’s not how pods are making $100m+. People are swinging with sector and factor tilts a lot.
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