Citadel/MLP are 10:1 but with the level of vol/correlation (very low) and low concentration (even a $3b book is $300m of aum or less than 1%), even blow ups don’t really hurt returns or create business risk.
I recall the banks were levered 30-40x pre GFC. Why can’t the MMs get to 15-20x which is still meaningfully below peak?
| +14 | Average single manager slope | 5 | 1d |
| +13 | Fastest Way to MMHF? | 7 | 8h |
| +6 | Bad PM | 4 | 15h |
| +5 | X | 6 | 10h |
| +2 | Walleye SA 2027 | 4 | 1d |
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It is a matter of P&L capacity while maintaining the same sharpe ratio.
If you just leverage more all the fund's trading books by a factor of 2, assuming that the strategies don't become unprofitable, you would be multiplying sharpe ratios by a factor of about 1/√2 ~ 0.7 x (using textbook models of market impact), which is a significant 30% decrease (in the ideal case, because in practice it is probably going to be worse) and it will significantly impact the fund's consistency.
Now, the only way to scale without a significant impact in sharpe ratio, consistency and to use more leverage is by adding more uncorrelated strategies to the system and the problem here is that it is just very hard to find new significantly profitable strategies when you are already making more than 10 billion dollars in annual gross trading P&L (like C and M).
Because the alternative is raising more money (or giving less of it back), for a product where there is virtually unlimited demand, as you can see in M's last raise (or C who force redeems every year).
A larger asset base means more management fees (where applicable) and a lower expense ratio (so if performance turns & people pull, there is a larger buffer against expense ratio growing in a self-reinforcing way). The incentive is to get away with the lowest % vol you possibly can, which lets you maximize asset base relative to capacity.
However, the lower bound is when LP's redeem because the expected vol is too low to generate a reasonable return - otherwise management would try to get away with 5x!
The largest and best-known platforms dont charge a management fee, but rather pass through all expenses in a way where they make zero margin. The only "margin" they make is through the performance fee. So the incentives you suggest, I don't think are there.
As yuuyuu explained above, MMs dont want to turbocharge volatility in their earnings stream because it would kill their entire value proposition/differentiation. Many/most of their LPs are looking for annuity-like low double-digit annual returns, with low volatility. If you are fulfilling your clients' needs and getting paid nicely for it, why would you change the winning formula?
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