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Hello and welcome to another episode of the Odd Lots podcast.
I'm Joe Wisenthal and I'm Tracy Alloway.
Tracy, have you noticed there were some crazy moves in the market lately.
I know, it's kind of funny if you look at I guess traditional measures of overall volatility in the market. So obviously things like the vis it was relatively low up until recently, and that was despite all these big surges in a bunch of stocks. So the megacap tech companies kind of stand out there. So I guess overall
benchmark moves were kind of low. But if you look within that, if you look at specific single stock performance, things like dispersion, it's been kind of crazy, sort of under the surf, there's been a lot going on.
We are recording this February fifteenth, twenty twenty four shares of super Micro. I don't know what they do. I know they do something with AI. They're currently at nine to fifty one, up sixty nine dollars a share on the day. On January eighteenth, they were at three hundred and eleven, so it's a triple in a month. There was some armholdings recently, which is like now in one hundred and fifty billion. I mean, these are like serious high market cap companies I do.
They're call these upcrashes.
Up crashes, that's the word that I use. So it's something like, here's just a company that's been around for a while, mature people understand it. It was a sixty five billion dollar company a couple of weeks ago, it's currently one hundred and twenty eight billion dollar company. Just these big fat, chunky moves in both directions that we're saying.
Yeah, And on the one hand, obviously you can describe it all to investors are getting really excited about things like AI and again a lot of the movement we've seen happen in tech stocks. But on the other hand, it feels like there might be something else going on here. And every once in a while I hear people talking about multi strategy funds and the impact that those might be having on these overall market moves.
Totally like these sort of moves that just keep going in one direction over and over again. Speaking of multi strategy hedge funds, which we're going to get into and understand how they work and maybe if they are sort of like changing the complexion of house docks trade these days. I think there's been a lot of launches of them, so we know that some of them have done really well, and of course we've regaled with the incredible returns a Citadel.
But I think we're starting to see a lot of people who were at those shops launch their own multi strategy shops. So there was a good article too on Bloomberg just this week talk about like, not only are they proliferating, but for years they talked about how the
two and twenty model was fading. Like you and I have probably heard that our whole career, it's going away because they're making they're taking in more than that, and I think they're like keeping like half the profits that they make, so like twenty percent to sort of old hat like, so these are huge money making machines.
Now is this is this pod Lots?
I think it's pod Lots.
This is the original pod Lot.
So there's only three things I really know about multi strategy shops, which is like one, they're very hot right now, and as you say, we have seen a lot of launches recently. Two, I think they trade a lot, like just in terms of absolute volume. I think they're very active and becoming increasingly active in a bigger portion of
the market. And then three, I hear a lot of talk about measuring performance scientifically and like the things they do differently to maybe a traditional long short fund, but I don't actually know what it means in detail. And then also, as you were saying, I don't actually understand completely the market impact. I think there are a lot of different theories at the moment of how they might be impacting the market. So I'm very excited about this conversation.
Yeah, tons of questions on a big and growing topic that we should talk about more. So I'm excited. We have the perfect guests. We're going to be speaking with Krishna Kumar. He is the founder of goose Hollow Capital. He previously ran pod capital at the Multi Strat Hedge Fund MKP. He was also previously at Omega, and he is going to talk about how these places work and the sort of impact they have on house dogs trade. So, Krishna, thank you so much for coming on Oudlacks.
Hey excited to be here, A big fan of the show.
What does a pod shop? Let's just start there, because I have some idea of like this big fund. This is what I think in my head. You have a big fund with a bunch of money, a bunch of teams. Maybe you have like a handful of people on each all working for themselves. The better the teams do, presumably they get more money, more resources, more capital to trade. If they do badly, they're on a short leash. They can be fired quickly, and somehow they make a lot
of money with that. But that is probably like the extent of what I actually understand about how they work. What are they So.
If you think about most hedge funds that people talk about, most of them are now multi strategy funds, and that are made of a bunch of pots underneath. So if you go back in time to the first hedge fund that ever started, A W. Jones, I mean that was in some sense a manager with all these underlying analysts who are then picking up looking at radious sectors and running strategies right. And the evolution to that today is this monster called the multi strategy fund, and it's sort
of a platform. So if you think about our economy, we're very good at creating platforms out of things. So if you take Apple as a company, Apple is a platform company. They don't actually produce anything. They come up with ideas. They come up with this vision pro and then they get a bunch of people overseas to make them,
and then they market it. So the similar kind of concept in hedge fund space is this idea of multi strategy platforms and parts of the units that are working within that platform.
So you actually work in a multi strategy fund. At one point, I believe I'm curious how that platform idea drives the culture. But then also like, what exactly is the competitive edge that a multi strategy fund or a pod shop is offering here? Is it just we're able to select the best managers of individual strategies and put them together in one place, like what makes a successful multi strategy fund?
So yeah, so this is again is a sort of part of the evolution. So if you go back in time, we used to have this construct of single manager hedge funds, which in the nineties were fairly big, and then people said they wanted to get the average hedge fund performance.
Just like people like to buy the index, they wanted to buy the index of hedge funds, and there wasn't once, so they created something called the fund funds, which just added fees on fees, so essentially you had underlying Hetch funds, and then there was a fund manager that selected these hedge funds, and they did extremely well from two thousand to two thousand and seven, and then in eight also
so bad things happened. But what we found out was fund of funds, the earlier iteration of the multi strategy fund had all the downside and less of the upside, because what we had in eight was a lot of the underlying managers did poorly and people just wanted to get out of Hetch funds as a whole, and the hedge funds started to get all these investors, and then the fund of funds, which were one level removed from them, also gated the underlying investors, right, So that created this
whole thing where fund of funds as a concept became not a great idea. And so the next version of that now is this multi strategy fund. Essentially, you want to get in of different managers returns, and you don't have the ability to do that yourself, so you go to a multi strategy platform and you end up getting a whole bunch of managers as a composite Oh see, So.
It's not necessarily outperformance, although there are a lot of multi strategy funds out there that seem to be outperforming, but more the diversification benefits.
Yeah, I think it is. I mean, if you think about the average multi strategy fund, they have lots of uncorrelated strategies, right, So they have, you know, a typical multi strategy fund. The core of it, it's some sort of quant strategy like a stat art strategy. Pretty much every large multi strategy fund is built around that. And then you have fixed income RV, credit RV, macro RV, and then macro directional which is what I do, and all of that is put together into a composite performance profile.
So given that all these strategies are sort of orthogonal, over time, you tend to benefit from the lack of correlation. And that's one of the biggest benefits that investors see when they allocate to multi strategy funds.
So someone sets up the pod shop. Someone is the you know, runs the whole platform so to speak, and brings in fund managers and fires fund managers who are doing these different strategies. What does that person have to be good at for the platform to work.
Yeah, so if you think about platforms, so if you think about Apple as a platform, Apple is good at coming up with cool ideas and marketing it. So if you take a multi strategy fund, the platform owners have to be good at raising capital obviously because that's one of the biggest things you need, and then you have to be good at risk management and the operational infrastructure.
So what they're providing in a sense is providing all the stuff that's not investment related to the underlying pods, so the pots can go about doing their investing and then the platform provides all the other services.
So talk to us about what multi strategy funds are actually doing here, because I think about a traditional hedge fund, maybe something like Pershing under Bill Ackman. There's a charismatic guy, to put it one way, and he's making all these big bets. He's going long or short certain companies. Multi strategy funds. Obviously, the clue is in the name. They have a bunch of different strategies, but typically what are they doing on a daily basis?
So I think there's a couple of reasons why they are in prominence, right, So the first and foremost one is that of course, like you have, the regulatory burden of a single manager hedge fund has gone up dramatically, So if you are a single person and you want to start a hedge fund, it's much more complicated now than it was twenty years ago.
This is like the key man risk aspect of it.
Well, a key mand risk, but also the operational infrastructure you need and the support and all the other regulatory burdens that come with it is tremendous. So that's one aspect of the thing multi strategy fund is solving. But the other thing is the multi strategy fund is technically looking for good managers and providing them a platform so
that they can actually run their business. And the multi strategy fund, the fund holding company, then provides all the other infrastructure needs like risk management, reporting, all of that fun stuff. But if you think about why they have done so well in the recent past, I mean, part of it is just that, you know, we have this
like demand for leverage right in the system. So if you think about like what we did in the global financial crisis, obviously in my view, the fiscal response was very timid, right, Like we spent about three percent of GDP compared to COVID basically spent you know, ten percent of GDP or more. So that meant that our recovery
was very, very timid. And there was this whole thing with austerity, not just here but elsewhere too, which meant that yields, real yields collapsed and the overall return you could get on capital collapsed. So the only way for you now to generate any sort of return was to take a lot of leverage, and so hedge funds as
a whole are doing that. Like they provide you some form of leverage in terms of access, but the multi strategy funds take it to the next level where one of the biggest problems with a single manager fund is often that you may not have that many good ideas. Right. So if I'm a macro guy, I'm probably lucky if I find four good ideas in a year. Right. The rest of the time, I don't know what to do.
You know, I have to keep busy. Now, if you're an investor paying two and twenty in fees, you want all the capital to be deployed at all times and to be invested in all sorts of things. So one of the problems the multi strategy fund solves is to make sure that capital is always deployed, and they do
that by applying a lot of leverage. Right, So a typical multi strategy fund, you know, you give them a dollar, they have four or five dollars of exposure, and they have multiple pods that are then essentially deploying a capital.
My impression post financial crisis was this idea that leverage was supposed to get more expensive, and it definitely did, I guess for regulated banks, and we saw, for instance, the regulations on things like prop trading. I guess liquidity, coverage, ratio is just everything that makes it more difficult for banks to actually trade on behalf of their clients or for their own books. So how are multi strategy firms get the edge here on leverage?
So leverage is always expensive, I mean it was much cheaper ten years ago when interest rates were close to zero everywhere, so you could borrow infinite amounts of money. And so if you think about the performance of these strategies, they've been phenomenal in that period. We need two things for a typical hedge fund or any sort of levered strategy to work, right, The assets you buy have to
yield more than the cost of your funding. So if you go back in time, we had a positive upward sloping yield curve, which meant that you could borrow money at one percent and buy assets to three percent, and so you could level that up. And then even when we had you know, two year notes here at half a percent, you could borrow money and buy two year jgbs FX, hedge it back and generated two percent kind of quasi risk free return. And so there were many
similar sort of traits that you could do. Historically that was what I think fuel the of these strategies right and now if you come to today, leverage is expensive. Most multi strategy funds are probably funding themselves at SOFA plus some spread, so maybe a six percent, and the coupons you can buy they're all much lower because we have an inwarded yokurve where you know, sofur is much higher than where any any sort of coupon you can buy.
So a lot of the strategies that are carry type strategies don't work as well, But then you have all these other sort of quasi RV type thing where you're long and short different things, and those sort of strategies tend to do better in this environment.
So in addition to of course all the infrastructure and all that, the importance of a strong risk management at the top. And I want to talk about that further because I can think of a couple of ways in which risk management might be expressed. One is, obviously, people get fired somewhat quickly for poor returns. If a manager's strategy or approach isn't working, they're not going to be
held around for long. I imagine another element too is style drift and making sure that pods are actually investing in the way in which they're sort of mandated, because if you want that diversification benefit, you don't want, you know, some random let's say, or some quant strategy or whatever to be like quietly really just going along super micro and in video or finding a way to make just do a buy AI strategy, because that's what's out right
now to juice return. So talk to us a little bit more about the risk management component in terms of like allocating capital internally and making sure that the managers are actually not all crowded into the same traits.
So this is a super interesting topic, Joe, and I think you know this is I think the most important topic of the moment. So if you think about it, there's a conservation of risk, and it's just like conservation of energy, right, So you know you can't just get rid of risk. It just gets transformed and it gets passed around from one person to the other person, right, because it's a complex system, you know, that's what happens.
So if you think about what the multi strategies are doing, in a sense, is what the banks were doing ten fifteen years ago, before the vocal rule and before the dot frank came about. Right. So if you had some off the run treasuries and you know somebody had to sell it, you took it down and you put it
on your balance sheet. You know, when I started at Citybank twenty plus years ago, we had twenty people on the spot trading desk and we had an auto trader machine which worked some of the time, but then when something happened, some sort of event happened, the machine would not be able to do it and it would get
passed to the humans that were on the desk. Now, you go to Citybank, you'd be hard pressed to find maybe three spot traders, and the machines basically taken over, right, So all of those people that were there, they've all moved to the multi strategy funds. Right. So the typical multi strategy fund has specific pods that are focused on trading one particular asset. So in many cases, you know, you'd have a trader he would only trade five year notes and that's all he's doing, you know, that's all
his mandate will allow him to do. And so what this does from a systemic point of view is we've shifted all the risks that was on the bank's balance sheet onto these funds. Right, So which is which is great? I mean, which is not a bad thing. But if you think about how the capitalist now managed, right. So, we always we're very good at coming up with complex formulas to calculate risk and do all that. And we
saw that with the VR issues in the past. We had a Black Monday episode with the CPI constant proportion portfolio insurance. It turned out be a bad idea. And then we also start with the CEO crisis where we had you know this you know, single correlation parameter. We were using the models and wasn't capturing the real dynamics in the underlying portfolio, right, so we've always had this issue with you know, creating these mouse traps to manage risk,
and often they create other problems. So I think one of the issues now with the growth in the multistrat universe and the fact that they are fairly large, is if you have a stat ar book and you're running, you know, at fifty by fifty start our book, and something happens or you decide like you want to de risk, it's fairly easy. You could probably get out of the
whole book in no time. But let's say you are a forty billion dollar fund that now has levered that capital up four or five times, and now something happens and you need to de risk. There is no other side for that trade. There's no balance sheet on the other side. And we saw that in March of twenty twenty.
People had all these basis traits because if you think about it, when you don't have carry, when you don't have an upward sloping eel curve, a lot of the traits tend to be this sort of fixed income RV type stuff where we are doing these spaces stuff, and many of those bases started to blow up in March of twenty twenty, and then the FED literally had into So we have this sort of thing where the size
of the overall funds is so big. We have about four hundred billion at the moment, and they're growing at ten to fifteen percent a year, and you take that and you multiply by three to get the actual dollars invested. So they're about a trillion two dollars in these sort of platforms and they're all risk managed the same way. And I think that is the problem we could.
Have outside though of the big event, whether it's like a black Bonday day or whether it's outside you know, March twenty twenty, with the relative value in treasury, it's like in normal times, just how would you describe like the sort of day to day blocking and tackling of good risk management of evaluating POTT.
Just to add to that, I'm really curious so multi strategy funds, it's a collection of different strategies obviously, so how are risk managers getting a sort of holistic view of that business? And then also I'm super curious if they're all using the same software. Like I remember writing about Black Rocks Aladdin and the portfolio management tool there like almost a decade ago now, But I'm curious, is everyone using the same sort of system to do this?
Well, I don't know about all of them, but you know, I can say that, you know, the risk thinking is kind of similar in a lot of these firms in the sense that imagine you had a dollar and you levered it up to four dollars. Now you want to make sure, let's say you've promised your LPs that you're
not going to lose more than ten percent. You know, you want to manage each of the underlying strategies that you've deployed capital into to not lose more than three percent, right, because then, by definition, if all of them lose at the same time, you've now blown through your ten percent limit.
So that means that they all end up with some sort of risk management that is not necessarily bad when you look at the platform as a whole, but from the perspective of what it does on a system stomic basis, it's not great. So I know, Joe mentioned this thing about the basis blowing up in March or twenty twenty, but you have this episode every other month where you could have some random event which has nothing of any real significance, could cause like a little unwind of positions, right.
So what I mean by that is, so let's say you're going into the Polish elections last year in September, you look at Polish rates and europoland the currency all kind of started to move in the wrong direction, meaning Polish rates blew up and Europoland started a rally. And part of the issue there is that when you have a whole bunch of strategies that are all kind of risk managed the same way, it's no longer about the fundamentals, right.
If the P and L starts to move in a certain direction, you now have to de risk your book, and that causes these events.
Well, this is what I really want to get it because I want to talk about you know, you could see the chart of RPL and it shoots up and then a month later it's back to where it was. What is that day to day risk management process that
causes trades to all go in one direction like that? Again, like outside of like the crazy times where it's like a pandemic hit like day to day, if I'm a manager at a pod shop and I have like the platform over me evaluating my risk, like talk to us about that process and how that informs the risks I'm willing to take.
Yes, the risk management is almost algorithmic, right, So it's not even because I don't think it. It'd be very hard for the risk manager at some massive pot to know every individual position, so they don't really kind of they kind of understand the whole thing, but they don't necessarily know that you know X or wise you know what it is. So so essentially what happens is your P and L kind of drives risk management. Right, So if you draw down capital, you know you're getting delevered, right,
and not only are you getting delevered. Let's take Poland is a good example, and we have a position in Poland, so we kind of followed closely. So imagine now you're at a POD and now you have a Europoland position. Now you have to take it off because you know it's gone against you, and you you know if you lose more than three percent, you're going to get capital is going to get cut in half, and you lose five six percent, you're probably getting stopped out, right, So
that's typically how the pot capital gets allocated. So now you are now de risking that Europoland position. Which then causes everybody else to also de risk as well. So
it's not even like a risk management thing. It's just the structure where everybody is allocating capital in the same way, which means that like an innoquous thing, like you know, somebody literally coughing at some place causes something to move and then next thing, you know, a whole bunch of people have to unwind the positions.
So diversification in investing is generally good and people like it. And one way you can diversify is over time. So it's like in theory, you know, it's like people buy the SMP every two weeks in there four one k or something like that. But it sounds likely your example is that the pod manager does not have the ability to diversify with time, that as soon as the move goes against them, they don't really have the luxury to say, yeah, well it's just a brief thing and it'll be back
to normal like that. Mechanically, they can't let it. They can't let the position lose for very long.
Yeah, I think so. And also the other aspect of that which you touched upon is the fact that you're not maximizing long term returns you're maximizing returns per unit of time, right. So, so what it means is, let's say, you know, let's take a different example. Let's say you have a stock. So any given stock on any random day is just some beta to the S and P. Right, It's just it's going to move along with the rest
of the market. Unless there's some stock specific news. It's just going to keep up with that, except that when you get into an event, like you have have an earnings release or Apple's vision pros getting released at that time, Now there is actually an event, and now you have to take a view on whether it's going to go
up or down at that point in time. Right. So what happens with this sort of pot capital and that being a bigger part of the market, is that you now have to basically take a view on this event,
which is an earnings release. Now, if it turns out that all the parts think that the earnings are going to be good, and if the earnings actually is not good, now we know that the stock is going to have a massive reaction because you know, everybody will try to get out at the first possible time, right, So you create these sort of mini crashes in equities and in other markets because of the way risk is managed, right, I imagine if I were to sort of look at
my position every day and say, on every little blip, I'm going to take all my risks down, and not only take my risk down, but take other positions I might have also down. That's going to cause these sort of systemic events, which I think is actually an opportunity. If you're not playing that game and you're playing a slightly longer term game, then it's a slightly it's a great opportunity.
So just to hammer this point home, in addition to the sort of short termism that you just described, there's a sort of reflexivity that's happening here too, where if a position starts to trade against you and everyone gets out at the same time, that makes it worse. But also if a position is going in your favor, then everyone crowds in and that gives it momentum and it sort of exacerbates the up crashes. As Joe would say.
Yeah, I think to some extent that is probably the case. But I would say we probably have the ETFs to blame for that, just because of the way the ETF market is, and you know, a lot of what is happening now is money flowing into ETFs, which then end up buying you know, whatever is the underlying index of stocks, and then you end up with these stocks that don't have a lot of free flow, right, so you have large inflows. I mean this is not just a US phenomena.
Like you look at what happened in Europe here to day, right, the top five six stocks in market gap are up like fifteen percent, right, and the same thing in Korea, same thing now, So everywhere in the world, as more money flows into these passive vehicles, I think it generates this effect where people are just buying it, you know,
without actually looking at the valuation. So taken VideA, as long as we have new money coming into the S and P five hundred and video stocks going to go up and until something happens, as earnings comes out or some something else changes, this thing sort of drives the momentum effect. The pods, I think have a little bit to do with it, But I would imagine the typical long short equity pod. You know, it's sector neutral and
market neutral and all kinds of neutrals. So basically they try to neutralize every possible factor that they could lose money against, right, And so that's what they do. I actually think that they might be a new factor that we might have to have, which is the multi factor multi strategy pod factor, right, because this is a factor like if you have a stock in which a lot of multi strategy pods have a position, you know, that might make that stock behave differently.
By the way, super Micro, I think it was up about six what did I say? It was like up about sixty dollars on the day when we started the episode. It's up eighty anyone now. So when we see these crazy moves on the upside, it's like, okay, there isn't much free float. There's this sort of uninformed demand from the ETF flows. And then when we see like the crazy moves on the down it's a lot of pod all with the same risk profiles. How quickly do they
get fired? Like in my mind like, oh they have a bad few weeks or a bead quarter a bit. What is the reality of like longevity And how quickly do they just say you're not cutting.
It, you know, my guess And this is not you know, by any way scientific you know sort of thing is probably, you know, it's not very long, but you'd be surprised that a lot of these fairly large platforms have managers that have been around forever, right, and they all have
something in common. One of the things is if you have a very high sharp ratio strategy, so a strategy where you know you're boltild these small relative to your returns, then you're more likely to survive in this sort of pod environment, right because if you have you know your drawdowns are limited, and then every once in a while you might have a big blow up, but then you know that's just part of the high sharp ratio game. Right.
So there's a very nice paper by Jean Philippe Buschat that shows that most of these high sharp ratio strategies often tend to have a negative sq to P an
L profile, which kind of makes sense. Like, if you're going to sell s and P options every day, that's going to be a very high sharp ratio strategy until something happens and then you lose three four years with a P and L. Right, So I think the longevity of a typical part is not that high, but you'd be surprised how many of these managers have done extremely well over time because they have this sort of high sharp ratio strategies that they can then survive.
Some of this reminds me of the original discussion I guess it would have been more than ten years ago now, but around algorithmic or machine learning trading, where like the big discussion point was, Okay, you get a news release that comes out, maybe it's something company specific, maybe it's something macro, like the latest jobs release, and all the machines react to it. Sometimes they actually are read or at least back then, they would pull back from the
market and just wait a little bit. But the idea is that you kind of get this gap where if you're not a machine or an algorithm, maybe there's an opportunity there in the market. Maybe you can be smarter I guess than the machines that are sort of like going on on wrote code.
Yeah. I think, if you think about it, the biggest opportunities for slightly longer term investors. So if you are let's say your time horizon is not a month or three months now, this gives you a greater opportunity because you obviously get these big drawdowns every few months. Right.
So so in my personal view, I think, you know, we have some active ETFs and and that we think of that as longer term capital, and we're looking at creating some sort of a drawdown structure where we actually wait for these big drawdowns that are caused by the pods and then use that to actually participate in these in these moves. And then that in case, could be a very interesting way to take advantage of this stuff.
But anytime you have in al garden that decides how capital gets allocated and it's sort of rule space, you kind of know that it's going to create a problem the end, because the market is sort of a complex machine. So anytime you think you've found like some risk mousetrap, you know it's probably going to create other issues elsewhere.
This might be a simplistic question, but how do you measure drawdowns? How do you know that those are happening and impacting a particular stock or factor.
So you can kind of look at that on a kind of a micro scale by certain specific assets that are in focus. So for instance, like let's say you're going into an earnings release and you sort of see that the stock missed earnings and then has a massive reaction and it's a several sigma move, and you'd sort of say, like, Okay, the company did miss earnings dis quarter, but otherwise everything else seems to be fine. It shouldn't
be as big reaction. And you can kind of look at these reactions from the past when they've missed earnings and you'd find that, you know, the reactions are much larger now, and part of that has to do with the fact that a lot of the capital that is deployed, apart from the ETFs, which are passive holders of this stuff, the active management part of it is a lot of these pots and multi strategy fonts, and that creates this sort of behavior, not just inequities, but in other assets
as well. Like you'd get a really massive reaction in treasuries for like some random thing, and you'd be like, what has changed, Like economy hasn't really changed that much, but because like everybody was one way now they all have to kind of get out of the way, and that creates like, like, take this CPI reaction. I mean, you know, we had a big repricing the front end, which kind of made sense, but you look at the treasury move and you say, like, ah, does it really
make a big difference. In the grand scheme of things, the one year forward ten years yields and the five year yields are about the same. They are about four percent, and so that hasn't really changed. But people's positions had to be unbound, and that creates these sort of large reactions.
So one thing I was wondering, just going back to why these types of investment firms seem to have proliferated in recent years. I mean, to some extent, this was the desired outcome of post two thousand and eight regulation. Again, you make it more expensive to get leverage if you're a bank. If you're a bank, you also can't trade for your own account anymore, and so it all shifts into I kind of hate this term nowadays, but the
shadow banking system, and it gets done there. So I guess my question is how worried should we be about this activity on a systemic basis? And then secondly, could multi strategy pod shops be hit if we were to see leverage get more expensive. So, for instance, there's a lot of talk right now about the basis trade in treasuries and maybe regulators are going to start cracking down on that or making it more expensive to use treasury futures, which are basically a source of leverage in that market.
Is that a risk here?
Think? I think on the second question, there's definitely a
risk that the cost of leverage goes up. From a systemic point of view, if banks are financing these trades, and if that financing business gets charged more in risk capital, then you would imagine that you know, the traction of some of the pots become less attractive because if imagine I have to fund my book at ten percent when risk rere rates are five percent, then I'm less likely to find any GOO opportunities, right, I mean, I'm still going to find something, but not as much of these
R type stuff. But the other aspect of it is like what they're really so I think, which is like one of the positives of the multistrat funds is that like unlike a fund of funds where you couldn't net risks together, here you're able to net all this exposure. Right, So imagine you have one person long of Tesla and the other person short of Tesla. Now you as the end investor, doesn't have to have these two positions and
two different hedge funds. They're all getting netted and you're only getting charged for the net exposure cross margining, cross margining, which has been a big challenge. So if you're a single manager fund and let's say you're invested in like ten different single manager funds, you know what if like five of them along of Tesla and the other five were short, Now your problem is you're on a net basis kind of flat.
You're paying for everyone's leverage.
You're paid for everyone's leverage, and so that is like a big advantage I think of having this sort of thing. But on the flip side, right, if you think about it, if imagine you have five pods, there are long of Tesla and five pods that are short of Tesla, just to take a simple example, and Tesla goes up. Now, typical multi strategy investor takes all the netting risks. So historically in edge fund, if you invested in edge fund and the edge fund didn't make money, you didn't pay
any fees to the manager. But now with the pod structure and the multi strategy platform, the people who made the money are getting their payouts and then the ones that lost money, now you're actually taking the losses. So if you have too much dispersion, that's not necessarily good from a overall perspective.
And what about the systemic aspects of all of this? So, yes, Okay, there are some weird moves in the market, and maybe there's more short termism and we're getting bigger reactions to one off events or announcements. But is it an issue that we should be worried about? Should regulators be thinking about this?
Well, I think the issue is less to do with the day to day stuff. It's more to do with these events, right, So I think the risk becomes more material when you go into any sort of event that we're not thinking about, Like, for instance, let's say EMP strike happens and all the great costs. Obviously we would be thinking about other things at that point, But just to make an example of something that we're not thinking about, if that would happen, we could have big systemic unwinds
of positions just because of the way risk is managed. Right, And this is just natural, Like if you have a system where there's a lot of leverage and it's being tightly risk managed, you know you're going to create these unwinds over time.
I'm curious about the non systemic risks to the model, and by that I mean like there have been a lot of new hedge fund launches over the last several months. I keep seeing headlines on the Bloomberg, many of them with the multi strap model. I imagine many people at multi strategy hedge funds want to be the guy on top rather than the pod with the you know, always having to worry about is their capital being pulled, so they leave and start something new. The returns for several
of the existing ones are pretty extraordinary. Last year, I think Citadel's the Wellington Fund, it was up over fifteen percent, like really pretty solid year. Sitting aside systemic events is the risk that's just like the strategy is no longer as good the more people into it, because typically that's how it is. You just think about with investing, various quant strategies eventually don't work when everyone figures out the
abnormality or whatever. What do you think about, like the long term prospects of good returns in this space as more people try to do the same thing.
I think it's a great question. So I think that smaller you are, the better your advantages, because you know, if you go back to what I was saying before, if you have a one hundred bie hundred long short equity book, you could get out of it immediately. Right, if you have a fairly large book, it's nearly impossible to get out. There's no exit liquidity for the traits. Right, So the size is a major factor in terms of
how they would perfer over time. Now, what does happen is the larger funds tend to have better financing terms because they've been around the longer, and so they've locked up all the funding and you know, so there is a definite benefit for the size. But from a forwardlooking return basis, you're going to be much better served in smaller multi strategy funds because the multi strategy as a concept is not a bad idea, it's just that the
sizes become so big. And also, think about like how these managers are moving around, Right, So imagine somebody had a great alpha source some secret sauce, and they worked at a fund and now their junior person moved to the fund across the street and starts to do the same thing. Now, essentially that's what's happening is most of these strategies are the alpha is kind of decaying, right,
because you have all the migration of people. So you might say you have fifty or forty multi strategy funds, but they might all be doing something very similar, right, And so that's I think is going to mean that overall returns might not be as attractive as they have been in the past. I mean, and some of the multi strategy funds I mean spectacular, right, Like look at Citadel that you mentioned, they've been phenomenal.
Millennium had year last year.
They've been great. I mean, so in the past they've been phenomenal. But on a going forward basis, as this thing gets bigger and bigger, you would imagine that the alpha kind of comes down. You don't have as many people. So if you take a typical multi strategy fund, the person who starts out starts out with two three hundred million to manage. So if you have a trillion two of capital, you're going to need forty thousand different parts. I mean, not every part is you know that size.
A lot of parts are much bigger. But you know, you can just think about a number of people that you're going to require and enough orthogonal strategies, and I just don't think there's that many you know, orthogonal strategies out there.
So this might be getting ahead of ourselves a little bit, but we started out describing the evolution of hedge funds. So going from the two and twenty model to fund of funds and then multi strategy, what's next in the evolution if there is a risk of overcrowding and alpha decay as you just described, what's the next big thing on the radar?
So I think that this will evolve. You know, it'll take time obviously, because you know, you'll need a few years of underperformance before people say like, oh, this doesn't work. But in my mind, the two things I'm betting on is one is obviously anything that takes advantage of this sort of you know behavior right where you're being risk
managed and forced unwined positions. So if you can actually have slightly longer term capital, you can actually be the person going and buying the stuff when everybody has to sell, right,
So that's a bigger opportunity I think. And then the other one is any sort of long term capital structure like an ETF or any of that sort of stuff, because what happens there is that an ETF investor is not like looking at it every single I mean, although some might be, but most of them are investing for the long term, right, So if you could sort of manage that sort of money, then you get the ability to actually sit through all these things.
Christiana Kumar, Goose Hollow Capital, thank you so much for coming on of love.
That was so good.
Thank you, Thanks Gus.
Tracy. I really enjoyed that conversation. There was a lot in there that was interesting to me. I think where I would start was actually maybe with that last answer, where it sort of seems like, you know, the one thing that a POD seemingly cannot do is just that sort of like long by and whole philosophy, right, Like that's the one sort of bread and butter investment strategy that you probably can't do when you're being short term
managed like that. So in the end, like the sort of benefits may accrue to those who can just and it's like what every financial advisor says, like right by the index and like stocks go up, go about the rest of your life.
Yeah, absolutely, that really crystallized that point, the idea of like it's the time horizon. Yeah, that is different here. And also you know, the crowding behavior. I was sort of thinking back, do you remember flows before pros?
Yeah, that's your life.
Yeah, So the idea there was that, Okay, in an environment of low returns sort of post two thousand and eight, that it's hard to find you know, genuine like outperformance, and so the best thing to do is just follow the crowd, and that's how you kind of eke out alpha. And then I'm thinking about it in the context of the multi strategy firms, and I'm kind of thinking, like,
maybe pros create flows. Now, maybe that's what the multi strategy firms are doing, Like they're just going in and out on a daily basis.
Yeah, it's exactly that. Like I knew that there was a lot of trading volume that came from there, but I don't think I like totally understood why they had to trade. So yeah, like why not just you know, invest in some text docs and they probably go up. But if you think it was, like, no, you're really like not being paid to just like take a long term view or anything. Because the long term is for the end investors. The long term is for the LPs
and everyone else. Like your job is short term performance, and you sort of like diversify it that way, and it benefits the long term. There's just a lot of interesting things about there so much isolating aspects. There's also you know, like it makes so much sense about like the capital efficiency of pod shops versus the fund of funds, which no one enjoy tell like all these things like sort of make a lot of sense to me.
Now.
Yeah, the other thing I would call out is the leverage point. And again this has been going on for for sort of a long time. And again I would call back to the lack of returns in the post two thousand and eight environment. That's when we saw people start to use a whole host of intro well not start, but using a whole host of interesting derivatives and like CDX index options to bet on corporate credit because you had that general macro environment as well. Things are sort
of evolving now. But I take the point, Okay, leverage is expensive, particularly if you're a bank, and that's part of the reason we've seen it migrate in some respects to multi strategy funds. But I am interested to see if that kind of war, the regulatory war on leverage starts to pick up, because we have seen again going back to the basis trade and treasury futures. A lot of noises about that, and so yeah, definitely something to keep an eye on.
Yeah, there's a lot there also just that point about like, okay, you know it used to be that the sort of proprietary trader at the bank could take advantage of some weird dislocation when an investor needs to sell some off the run treasuries and there may be not be an obvious buyer for at the moment and you like pocket a little bit of money. Yeah, and how okay.
That that balance sheet that was available.
Yeah, for those types of trades, and how that creates opportunities for these funds and the specialists in these areas to identify the as any really interesting conversation.
So much and there shall we leave it there for now.
Let's leave it there.
Okay.
This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy.
Alloway and I'm Jill Wisenthal. You can follow me at the Stalwart. Follow our producers Kerman Rodriguez at Kerman Ermann, Dashel Bennett at Dashbod Kilbrooks at Keilbrooks and Thank you to our producer Moses On. For more Oddlots content, go to bloomberg dot com slash odd Lots. We have transcripts, a blog, and a newsletter and you can chat about all of these topics with fellow listeners in the discord twenty four to seven, one of my favorite places on
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