Do you need to be a market genius to start a hedge fund?

So do you really need to be a Bill Ackman, Ken Griffin, George Soros... in order to have a successful hedge fund? Do you know/or are you someone that started a hedge fund that does very good?

Comments (55)

Funniest
Jan 4, 2020

i have never started, nor worked in, a hedge fund, but since i have an account on this website i think that makes me qualified to answer your question.

in short: maybe?

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  • Intern in IB - Gen
Jan 6, 2020

Best comment of 2020 on this site.

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  • Research Associate in HF - Event
Jan 4, 2020

Do you need to be a shoveling genius to be a coal miner?

Jan 4, 2020

Well it depends what you're trading and niche is. Someone who trades currency will need to have a more global macro point of view as opposed to someone who trades natural gas. if it's natural gas, you should understand what effects gas market, the pipelines, weather, the effects of increased role of LNG to American natural gas and it's possibly of making natural gas trade more like a macro product like oil... will this increase volume in the basis markets to send excess gas to LNG exports? Maybe there is a way to make money off this? You have to keep thinking. Every day you have to find ways even if you're wrong. You need to keep an open mind. now the financial products like swaps, futures and options. How it's traded? What are my risk? Worst case scenario? Delivery risk? Curve risk? How is it traded year after year due to seasonality? Obviously someone who runs a gas hedge fund or an oil hedge fund is not going to trade like a vol hedge fund. It all depends on where you niche is. If you're a hot shot oil trader and you were making half a billion a year and you start a new fund entirely focused on rates and you have no idea how the rates market work... I ain't giving you my money.

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Jan 4, 2020

I agree with you but for the nat gas argument it is a bit sugarcoat. The manager would be advised by meteorologists, producers, scientific revues etc. So I should say that it is more an accurate view of how the entire supply chain works and what are the variables touching this market.

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Jan 4, 2020

Yeah but I'm just giving an example. Concept still applies.

Lol and why am I gonna get monkey shit thrown? He ask if you have to be market genius and I clearly specified, no. Depends on what you trade and your niche. I love it.

Jan 5, 2020

Thank you for clearing it up

Jan 4, 2020

A lot of the more famous managers aren't necessarily smarter than less publicly-known managers, they just like to be more public because of their strategy and/or ego (barring a few true rarities). Running large AUM is often just as much who you know when it comes to raising sticky capital as it is being a good investor.

That said, anyone who runs any decently sized fund consistently is very astute. It definitely takes a very personal almost neurotic drive to manage any fund, especially in the way that a Dan Loeb or Bill Ackman would. Again though, those two aren't necessarily smarter than the guy who runs a strong performing but less-known $1Bbn fund.

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Jan 5, 2020

Bill Ackman is a market genius?

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Jan 6, 2020

Hahahaha, the guy is bold, I'll give him that

  • Associate 2 in CorpDev
Jan 5, 2020

OP to answer your question: well, only if you want to make money

Jan 5, 2020

If you know why you make money and stick to it, without taking too much risk, you can outperform. The way you make money can be due to your infrastructure, ability to inventory certain types of risk, or being in a niche market. These are all not intelligence.

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  • Analyst 3+ in HF - Event
Jan 5, 2020

When I think about a successful hedge fund I think first of someone successfully creating and scaling a business before market genius.

Jan 5, 2020

100%. Izzy englander, Ken Griffin, Dalio.. the list goes on.

Jan 5, 2020

What do you think about Quants? Jim Simons etc? Where do the smartest people work within the finance industry?

Most Helpful
Jan 5, 2020
igorpavkovic:

So do you really need to be a Bill Ackman, Ken Griffin, George Soros... in order to have a successful hedge fund? Do you know/or are you someone that started a hedge fund that does very good?

As someone who has managed a book at a successful HF and knows/has met plenty of people who have done very well in the business for a long time here are some of my thoughts...

No. One does not have to be a genius to have a successful hedge fund. You need some edge though (or convince people you have some edge, and then hopefully you get lucky for a few years). And that edge could be as simple as a sticky family money that starts you off, or technology, or dealing in microcaps, or insider trading, or whatever. It could just be size and history.

But if you look at one of the main things these guys (and plenty of others) have in common is that they started a long time ago when HFs were new and hot products. Investors were literally throwing money at them, markets were less competitive. In other words, the space was relatively new. Plenty of them were not necessarily super experienced investors or traders and/or came from modest backgrounds and certainly did not have the risk limits that are the norm today. They could lever to the hilt, take significant draw downs (with the promises to investors of outsized potential returns) and operate much more freely in less competitive, less transparent markets. This means that a number of strategies, especially when levered could make you a lot of money.

This is not to take anything away from these individuals. Some of them are or were very talented traders/PMs/business people.

Today is a different story. Starting a HF isn't so hard, but keeping it running and finding reliable investors is. Investors are also generally not willing to put up with significant draw downs which means it's tough to buy when things in the market don't look so hot (unless you have sticky/nice investors or are a distress/ss fund).

  1. The asset class as a whole has not performed over the last decade (for reasons that have been mentioned to death). Seriously, why pay 2/20 (or more like 1/20 or 1/15 or whatever) when Vanguard or whatever index tracker is nearly free and has crushed HFs for the last decade? Institutions are starting to ask themselves that question or asking if they can do certain strategies internally (I'm not sure that's the answer)... yes, I understand "risk adjusted returns" and "sharpe/sortino ratios" but as a number of folks in the business have told me "you can't feed your family on sharpe alone." Investors are asking themselve, essentially, why buy a Ferrari when a Corolla has outrun it?
  2. It is just so competitive. Investors have choices and they know it. What differentiates one HF to another? You need to be able to show it, or hoodwink investors, or convince a big reputable (not necessarily smart) investor to give you money, do ok/well performance-wise and others will come in.
  3. Costs are much higher. A number of these guys didn't have things like post-Madoff compliance, and regulations to deal with. That means they could literally be like 3 dudes with a Bloomberg in a garage trading stuff and dealing with assymetric advantages or in less competitive markets. Things like compliance and legal costs, especially post-Madoff have skyrocketed and investors demand much more compliance. That means systems need to be put in place and a fair few non-revenue generating staff need to be hired. All of that is expensive, which raises start up costs. Which gives big/established players a huge edge because they can not only pitch their long established track record, multiple share classes, celebrity (plenty of investors would be thrilled to have Griffin/Ackman et all personally visit them if they will cut a check), and of course ability to COMPLY with all kinds of policies. These funds can also hire armies of IR staff to scour the world for capital. Smaller funds simply can't do that. Smaller funds will also pay more for margin/leverage, which means higher cost of capital, as well as have to pay more trading commissions. Since they are smaller, they are not as big volume customers, right, which means they can't negotiate the same low low trading costs. All of this adds up.

In other words, it can be done, but it's hard to stay in the game.

This is not that comprehensive but hopefully it is a helpful start for you, OP. I shall let others chime in to add to things that I may have missed, or some nuance.

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Jan 6, 2020

Extremely helpful, thank you very much for taking time to write this

Jan 6, 2020

This sounds very right to me. Hedge funds have underperformed because the investor base changed and limits what hedge funds can do.

Witness that one London macro fund that had terrible performance. He then returned the outside money and just ran his billion and change. Since he kicked out pension funds and there rules he's been putting up 50%+ yearly returns.

Array
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Jan 7, 2020

That's an interesting story. Is there more information about this anywhere?

Jan 6, 2020

I agree with much of this post but have a few comments. If you have alpha, you don't have to be a genius. If the OP is asking about starting a small hedge fund and growing it, I would add the following, as someone who has started and run a small hedge fund. It is not as hopeless as you think.

1) You can't dismiss risk adjusted returns so easily. They are a primary feature of many hedge funds, and some are worth the fees. Instead of your comparison of ferrari vs corolla, I would ask would you rather a car that can be slower that has seat belts, or one with no seatbelts and doors because it has gone faster?
2) Recent performance is all that matters. So if you don't have alpha don't bother. Absent real performance, I agree you'll have to sell yourself, but without having run real money, no one will give you any.
3) Costs are not as high starting out as you might think. A reputable administrator and auditor are very affordable ( a few hundred a month for administrator, ~30K for audit ). Compliance can easily be outsourced cheaply. I don't think this is a significant hurdle to starting a fund.

In short if you have alpha, I don't think any of these points should dissuade you from trying to start a fund. The tough part is getting that first investor to build a track record on. Oh yeah and finding alpha.

Array

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Jan 7, 2020

What exactly do you mean by "having an alpha"? You mean like an edge or something else?

Jan 17, 2020

i believe i have an edge...10 years ago i made 20mm prop trading at a BB, but i've been out of the market for a number of years...and am just returning...trading in my PA...its only 50k to start ...but i'll be trading with 6-10x leverage (futures)....so i think i can hit some decent numbers. lets assume i can make 10-15% per month (net on avg) with max 3-5% drawdowns and a sharpe ratio around 2. How long would i need to maintain that before i could goto a MM platform and try to get a seat as a PM?

ideally i would just compound my PA returns and grow it to millions....but i need to withdraw profits for living expenses...hence the desire to goto a platform.

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Jan 8, 2020

A balanced, measured and accurate comment. Thanks

Jan 6, 2020

The bottom line is you need an edge that people will believe is a real edge.

Anyone can launch a few funds simultaneously, pick a few stocks in each fund, and have at least one of those funds outperform over a couple years. That will happen by random chance. You can then close the losing funds and go to LPs with the winning fund and say "hey look, the track record on this fund is great."

LPs (or their consultants) are generally smart enough to realize it could've been just luck, so they'll want you to explain what your edge is, why your background gives you that edge, why it will persist over time, etc.

That edge could be very narrow. I know a guy that's an expert on electricity pricing who runs a fund; something about different utilities trading based on certain details in electrical transfer pricing that only few people understand.

Or it could be broad. If I recall, Ackman's edge that he pitched to investors was just that he felt he is a superior critical thinker who does good old Graham style value investing better than the thousands of Graham disciples who follow the same philosophy. That is a very hard thing to pitch. If your pitch is that broad, you need to be ready to start with a very small amount and count on your track record to get you to the promised land.

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  • Intern in PropTrad
Jan 6, 2020

agree - plus Ackman is also a phenomenal communicator just like the way Bill Clinton was. He can charm anyone and that quality counts in any industry. You can see proof of it in the Netflix doc 'Betting on Zero'

Jan 6, 2020

Basic probability: let's say 1 billion imbecilles are in the market. By betting random, a handful of them will be billionaires.

Not saying that Ackman or Soros were just lucky, but you can't underestimate the randomness of life.

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  • Intern in IB - Gen
Jan 6, 2020
Jan 30, 2020

I need a lot more info before expressing an opinion.

Jan 7, 2020

uh, bill ackman had lost money for 3 years before making some money in 2019.

So, ya. I think even a non-target could run a hedge fund.

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Jan 16, 2020

which of the followings are more successful? a 300mn fund with a 5yr CAGR of 30%, or a 3bn fund with a 5yr CAGR of 15%? I guess most people will pick the later one right?

The key for a fund to be considered "successful" is definitely securing your AuM. Only with a stable AuM base can a fund grow, and then investment performance can help further. Even if you are a market genius, if you failed to secure funding, say pissing investors off, mismanaging investor expectation, not having good contractual clause to lock up funding, having bad investor base who always try to BS and teach you trading instead of letting you to manage their money, even if you outperform you won't be able to build a successful HF.

One last thing, don't forget 60% of the HF die because of operational failure, such as funding for leverage, compliance, legal issue, etc.

So I'll say even market genius may fail to build a successful HF.

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Jan 16, 2020

Whats the source of your 60%? I dont buy it. The large majority of HFs shut down because investors tired of bad performance.

Jan 16, 2020

There was academic papers writing about that, and yes, no one can be sure whether this 60% is precise, all I can say is several paper suggested a range of around 40-60%, depending on how you define "operational risk"

Yet what I'm trying to point out is performance itself is not the sole determining factor for a HF to fail, there are HF over borrowed and caught by volatility, HF committing fraud by working with auditors to manipulate performance, auditing, investor redemptions not because of performance, such as divorce (am not joking, know 2 of the funds closing down because of this), politics, family arguments, etc resulting in liquidity crunch.

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Jan 17, 2020

Someone asked Buffett if you need to be smart, and he said investing isn't a game where a guy with a 160 IQ beats a guy with a 130 IQ.

People have since taken the quote as evidence that being smart isn't so important. But consider his choice of IQs for the example. 130 was his low number.

So even Buffett, aka Mr. McDonalds, aka Mr Cherry Coke, the man who sells his humble Average Joe image harder than anyone in history . . is implicitly admitting you should be pretty smart.

I suspect being very bright is almost necessary and at least a big advantage. The big differentiator is whether a very smart person can still be humble enough to attack their own thesis and do the work.

I've been in meetings with a few of the guys behind LTCM, and they are all brilliant but even today they are not humble. They speak with great certainty about how markets work, and any decent critical thinker can ask questions that cause them to stumble because they are so sure of X that they didn't even consider Y. They have a very rigid set of beliefs and their brain shuts down when forced to think differently. That kind of genius is great for incremental engineering (ie making a plane engine 5% better), but it's not good for something creative like beating other smart humans in a trading game rife with information asymmetry and biases and strategic iterations and so forth. You need to be a lot more humble and patient to win a game like that.

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Jan 30, 2020
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Jan 30, 2020