Why do HFs “risk off” when trades move against them?
Why do HFs (especially MM platforms) take risk off / gross down when losing money?
Shouldn’t you be doubling down if the fundamentals are in tact?
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Everyone has wrong thesis’s. The way you blow up is thinking your so smart and continue to avg down. Impossible to be right 100% of the time - let winners run and cut losers.
I think Ken Griffin said that markets are fairly smart and when they move against you chances are you might be missing something.
i think the big MM’s are fairly momentum driven like that.
I think there’s another quote from Einhorn where he said some HF managers just want to own a stock when it’s going up…
I thought the big MMs are fully hedged against factors such as momentum.? But maybe not
That would make sense but I have no clue how it actually works. My sense from what I know about them is that they are not making multi-year investment bets as a general rule. The pressure is probably to produce returns within a 12 month period or even shorter if possible would be my guess
ask gabe plotkin
These funds have tight stop-loss limits on PMs, where they get fired if they lose a pretty small % of capital. Much easier to talk about doubling down and being a hero from an armchair than when you're actually managing $ and can feel the axe above your head.
Is there a rule of thumb limit to how much loss PMs are willing to take on a single position basis before admitting defeat and pulling the ripcord? Say for L/S equity. I understand the firm imposed drawdown limits are on the portfolio level, so curious how this is actually applied by the PM on individual positions.
Depends on the specific PM. Some guys operate with position-level stop-loss. Others stick to "fundamentals haven't changed, so I'm staying on or even adding to my position".
Also appropriate to refer to Mike Tyson's words of wisdom: "Everyone has a plan, until they get punched in the mouth".
“Let’s wait for a pull back before we add”
*pullback happens*
”errrrrr…”
There are a few reasons:
1. If you're leveraged, when you lose money your leverage ratios (or VAR or choose your risk metrics) get worse. Let's say you're 4-to-1 leveraged, and you lose 10% of your gross book. Now you're at 8-to-1 leverage. If you want to keep your leverage constant, you have to reduce risk to adjust for the fact that your equity has been reduced.
2. If PMs at a platform lose money, the optionality of their payoffs increases, incenting them to take more risk. For a (very) simplified example, let's assume that if you, the PM, lose money over a Jan-Dec calendar year at a multi-manager, you get fired, but if you make money, you keep a % of the PnL. If you're highly profitable year-to-date, you're going to be cautious about losing money as it comes out of your bonus; your risk/return incentives are going to be balanced, and mostly aligned with those of the platform. But let's assume instead that you're losing a lot of money year-to-date. It doesn't matter how much you lose by year-end; the outcome is the same, you get fired. Thus, you have a massive incentive to take on a ton of risk (for instance, betting heavily on a theme) to attempt to get back to positive returns. You're no longer aligned with the platform, as the risk of further downside is meaningless to you. Thus, the platform needs to keep an extra close eye on you and reduces your risk allocation to offset your incentive to take on more risk.
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