WSO Book Club MMTG Part 1

As promised, here is the first content thread for "More Money Than God: Hedge Funds and the Making of a New Elite" by Sebastian Mallaby. The discussion threads will be subdivided as follows:

Week 1 (01/08): Chapter I - IV (A.W. Jones, Michael Steinhardt, Paul Samuelson, Quantum Fund) YOU ARE HERE

Week 2 (01/15): Chapter V - VIII (Tiger, Paul Tudor Jones, Stanley Druckenmiller, 1994 bond crisis)

Week 3 (01/22): Chapter IX - XII (1998 Russian crisis, LTCM, Dot-Com Bubble, Tom Steyer)

Week 4 (01/29): Chapter XIII - XVI (RenTech, Amaranth, John Paulson, and the subprime crisis)

(PREFACE: Throughout this book title in particular, we will be discussing people who have had very particular opinions on the way the world should be run politically. These people have used lobbying, think tanks, and in some cases actually running for political office in order to advance their views. None of that is relevant for discussing this book, which is about the history of hedge funds and their strategies. Discussing the political ideas of these people in isolation of their hedge fund ideas is highly frowned upon, and will not be treated favorably. Don't make me regret picking this book.)

Without further ado, let's get into it!

Chapter I: Alfred Winslow Jones had some early flirtations with left-wing and anti-Nazi politics within Europe before settling on starting the first "hedged fund," an investment structure that he argued strictly outperformed the market for this reason: 

Example: Imagine that you have two stock-pickers, A & B, each with equal skills and $100K in capital. A, the unhedged investor puts $80K into his stock picks and keeps $20K in cash. The second, hedged investor B borrows $100K, then puts $130K into long stocks and puts 70K in short positions, yielding a net market position of ($130K - $70K = $60K). This means that investor B is less exposed to the equities markets. The book then elaborates on the notion that Investor B outperforms Investor A in bull and bear markets despite taking on less equities risk.

The other innovation of Alfred Winslow Jones is being the father of the multi-manager structure at a time when bank trust departments were extremely conservative about stockpicking. Jones would allocate a certain amount of capital to different stock pickers, reward the good ones with more capital, and punish the bad ones with less money, a very common model to this day. He also had this system adjusted for market volatility, a concept he discovered decades before Markowitz, as a means of risk control, but the go-go conglomerate years of the 1960s weakened this part of the system. As a result, his multi-managers took on too much market risk and were less hedged than they needed to be, resulting in significant losses, but not before Jones had already made many fortunes for himself.

Chapter II: Michael Steinhardt was on the other side of the go-go era: he shorted instead. This positioned his firm very well throughout the 1970s. Their strategy was to do deep-dive data analyses on individual companies and find situations where their opinion was highly contrary to what the broader market believed, a strategy that served them well.

The second successful innovation was that of block trading. The efficient market hypothesis (EMH) presumes that there is perfect liquidity in the market, an assumption that is violated when a pension fund or other larger stockholder wants to sell a large chunk of stock all at once. To take advantage of this, Michael Steinhardt became the go-to person for major S&T desks who were representing the sellers of these blocks of stock. He would buy at a substantial discount and successfully position it on the market for more, making a spread on the difference. In extreme instances, one of Steinhardt's tactics was to buy a block at a discount, then resell it on the market for a price even higher than the going price, converting a bearish sale into a bullish indicator and making more profit for himself. At times, he worked off of insider information, which made some of his business practices dubious, but he did well for himself nonetheless. 

Chapter III: Commodities Corporation, now a subsidiary of Goldman Sachs, was founded by Helmut Weymar, a PhD who had seen great success in predicting the price of cocoa for Nabisco, allowing them to buy low and sell high and secure their commodities at more favorable terms than other consumer brands. He had a very complicated, data driven model that even looked at weather conditions in Africa to attempt to prognosticate the price of cocoa.

For the first few years of Commodities Corporation's history, the firm used similarly complicated data models to project the price of every commodity they could get their hands on, but after poring over a new dataset, the firm realized that a momentum strategy was easier to implement and superior to their complex data models. They would buy what was going up and short was going down, trying to follow trends from their infancy to their grave. They enjoyed great success in doing this, although the latter years of Commodities Corporation that are covered in the book were characterized by mass departures, leading to the creation of other entities like Caxton Corporation and ultimately Paul Tudor Jones' fund (although he was less of an employee). 

Chapter IV: After fleeing Nazism, George Soros came into contact with Karl Popper's philosophies around falsification and how humans can never be entirely certain of anything. Soros used these philosophies to develop an idea that he called "reflexivity." Because reality is too complex for humans to understand, investors rely on guesses that only approximate reality. But these guesses then go on to influence the actual market (e.g. when people view a publicly traded firm favorably, the company can raise more equity on good terms, allowing them to fund innovation and ultimately perform well-- a self fulfilling prophecy). Because of this, investors are doubly uncertain; they are uncertain of the proper inputs of action and they are uncertain of the final outcomes of the inputs.

Soros' Quantum Fund made an investment in defense stocks because of a belief that Western governments would soon spend more money fighting the Soviet Union after lackluster performance against the Soviets in Egypt. He was correct, and quickly made money on that bet. He also believed that speculators had reflexively pumped up the value of the US dollar in a self-reinforcing loop, and that at some point this loop would reverse and crash. So he bet against the US dollar and won that as well. The chapter ends with Black Monday of 1987, and how the Quantum Fund was caught flat-footed and lost substantial amounts of money.

[Arroz con Pollo] economicswatcher punk [Pierogi Equities] IBWriterMachine [Ben Matan Biran] wsomaster [K-Peezy] user6969420 [Sinner G] ChunkeyMonkey WestCoastMonkeyMan [guamiousprime] marketMergerMaddie StonksAlwaysGoUp shls22w21fdada liquidiot TheBankr notaballer 112343321 early_morning112 ke18sb [Intern Monkey57] [The Dandern] chimpnotsimp ProbablyEngAnyway iridescent007 [Troy McClure] [Bobby Axelrodd] TrackPoint greengoblin8897 Jack211999 TMD777 [Cousin Greg] fincosmos wubbster0408 DariusAp

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Comments (31)

Jan 2, 2022 - 10:19pm
Undercover meme, what's your opinion? Comment below:

Very helpful - thanks!

"one for the money two for the better green 3 4-methylenedioxymethamphetamine" - M.F. Doom

  • 1
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Jan 2, 2022 - 11:14pm
Arroz con Pollo, what's your opinion? Comment below:

Awesome. I got to working on my spreadsheet but no books are business or finance related. Do think it makes sense for the books we cover here to lean towards those subjects but if we ever want to expand I have several books I can bring up

Jan 3, 2022 - 2:29am
Frybird101, what's your opinion? Comment below:

Read the book over the past year and liked it a lot. Thanks for starting this- will be a great way to recap what I read.

Jan 3, 2022 - 4:14am
112343321, what's your opinion? Comment below:

Thanks for following through and putting this together, look forward to the discussion thread.

Jan 4, 2022 - 3:08pm
LATAMpapi, what's your opinion? Comment below:

It's one of the best books I've ever read. The later chapters on Tiger funds are quite interesting.

My Brother. My Captain. My King.
  • 1
Jan 5, 2022 - 1:35pm
neink, what's your opinion? Comment below:

Following

Never discuss with idiots, first they drag you at their level, then they beat you with experience.

  • 1
Jan 8, 2022 - 11:54am
kellycriterion, what's your opinion? Comment below:

Bumped to include the first set of content. Enjoy

[Arroz con Pollo] economicswatcher punk [Pierogi Equities] IBWriterMachine [Ben Matan Biran] wsomaster [K-Peezy] user6969420 [Sinner G] ChunkeyMonkey WestCoastMonkeyMan guamiousprime marketMergerMaddie StonksAlwaysGoUp shls22w21fdada liquidiot TheBankr notaballer 112343321 early_morning112 ke18sb [Intern Monkey57] [The Dandern] chimpnotsimp ProbablyEngAnyway iridescent007 [Troy McClure] [Bobby Axelrodd] TrackPoint greengoblin8897 Jack211999 TMD777 [Cousin Greg] fincosmos wubbster0408 DariusAp

Jan 8, 2022 - 2:39pm
Pierogi Equities, what's your opinion? Comment below:

hi kellycriterion, I'm getting the book from the library tomorrow so I'll have to sit this week out, I'm good for next week's chapters

Quant (ˈkwänt) n: An expert, someone who knows more and more about less and less until they know everything about nothing.

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Jan 8, 2022 - 2:41pm
kellycriterion, what's your opinion? Comment below:

Sounds great. If you want to sail the seven seas, someone also dropped the link above.

In any case, I'm going to try to give people more lead time for the next title. Cheers

  • 1
Jan 13, 2022 - 12:28am
Efficiently Inefficient, what's your opinion? Comment below:

Firstly I just want to extend a massive thanks for putting this together. Has been good to push my own reading as well as reinforcing what I had read over the prior week. 

Couple of my key takeaways below (just off the top of my head, so nothing spectacular) 

  • Interesting to see how different the people's temperament, background and investment philosophy is. I mean the book starts with an ex-Marxist that turns hardcore capitalist. Pretty different from your standard IB / PE / HSW kid which is thought provoking.
  • Brought to light how important the "edge" is, particularly as markets have become more sophisticated. Obviously having an edge now is slightly more challenging, but in order to outperform the market and attract more capital, I believe you really need to be doing something "innovative" (used loosely given relatively limited innovation in finance compared to say tech). Whether it be the invention of a "hedged fund", becoming the go to guy for block trading or trading the commodity trends, you need to bring something different in order to be rewarded.
  • Following on from the above two points, it made me question whether the standard pre-HF careers prepare us for a successful career in the game. All of our colleagues think (broadly) the same. Running the 20th iteration of some bullshit LBO that a Sponsor will never be interested in isn't teaching me to think like a HF investor. A lot of us have very narrow educations (for me I don't know a lot about psychology, block trades and other products run by a S&T desk, etc.). Reinforced my belief that if you really want to go for HFs you need to have a well rounded education and work bloody hard outside of office hours to get ahead.  
  • There are so many asset classes and ways to trade within those asset classes. The first 4 chapters touched on broadly very different strategies and how each made money. Made me reflect on crypto (not that I'm invested or know enough about it to say anything with any legitimacy) and a piece Matt Levine wrote on Citadel the other day. Have linked it here for anyone interested - https://www.bloomberg.com/opinion/articles/2022-01-11/who-can-resist-the-crypto-boom
  • Maybe controversial, but George Soros is a fucking badass. Fled Nazism, came from absolutely nothing, had a really independent way of thinking and was honest enough to reflect on his investment decisions by journaling them (side note - the Alchemy of Finance could be another good read). I have nothing but respect for people who have grinded their way to the top from nothing and changed an industry forever.

Haven't had time to proof read the above (doing that bullshit LBO), but I again wanted to express my thanks for doing this. It is hugely beneficial for me and I hope that you can also get something out of my perspectives.

Array
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Feb 14, 2022 - 2:32pm
CarsnWatches, what's your opinion? Comment below:

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Feb 15, 2022 - 12:14am
IncomingIBDreject, what's your opinion? Comment below:

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Array

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