Why do MM fundamental L/S equity pods shoot for that 3-5% range?
I know this is a dumb question but can someone please explain to me the reasoning/math as to why pods aim for returns in the 3-5% range? Im assuming it has something to do with the market neutral + tight risk framework that they are dealing with?
Because they run 5-10x leverage
Yea. This is what so many people in this forum don’t seem to understand. $100m in capital levered into $1b worth of bets earning 4% is $40m in profits, which is a 40% return on capital.
Leverage can actually be way higher in other strategies. Easily can be 25x levered or more.
I've also wondered about this. Pretty new to the space. Could someone elaborate more on the answer, besides the leverage point which frankly I dont understand?
Running market neutral is very hard and making more than 3/5% is very hard given most of the time stocks go up. That 3% is also in gross money value, which includes the leverage they use. If you lever up 4%, you're making 10-15% on your equity.
The 3-5% is before leverage, so assuming 5x leverage it becomes 15-25% at the larger portfolio level. The strategies are market neutral, so any long position is hedged by a corresponding short. This means the fund can’t benefit from big gains in the overall market and has to target tiny amounts of alpha in pair trades. This makes the returns uncorrelated to the market, which is very attractive to LPs.
Don't necessarily believe that MM returns are that uncorrelated anymore. The capital following that strategy has increased exponentially during the last few years and they all put on the same trades and chase momentum.
Super helpful - thanks a lot to both of you. Does running market neutral make it very difficult or even impossible to have massive returns like 30-40% a year given you almost always have a corresponding short? I remember Melvin Capital had such big years and it was market neutral.
Also, just because everyone is putting the same trades, can you not still be market neutral?
I mean you can buy Treasuries and get those returns. If that’s what they want why take the risk?
Some pods are targeting 8-12% nowadays, FYI.
Why not lever to 50x?
Please tell me a bank that will leverage you 50x on an equity?
Only do it if you plan to be long Paramount and Warner Bros
😂
God told me to lever up on those names
delet
No it has nothing really to do with leverage. It is because the percentage return is quoted on gross notional of the book. Why do MM shops do this? Likely because it strokes PMs egos to say they are running billion dollar books.
If you run a $500m notional book, $250m long $250m short, the actual capital you need to post to your PB as margin, which is all anyone really cares about, is likely no more than $30-40m. No PM wants to say they are running only $40m so alas the capital base inflation is born.
How does this number change for credit pods?
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