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Hello and welcome to another episode of the Authoughts podcast. I'm Tracy Alloway.
And I'm Joe Wisenthal.
Joe, did you, at some point last month when markets were being very, very dramatic, did you maybe hear that a pod was blowing up? Maybe just maybe.
I probably saw some tweets, probably tongue in cheek. I may have sent some dms to people saying jokingly, have you heard of any pods blowing up? But no, it's become such a meme. Anytime like the market moves half a percent, I imagine some pods did blow up. But it is a funny joke, good intro.
It's definitely become a thing. But I think it kind of highlights something something very real, which is there is this mystique around pod shops, the multi strategy hedge funds, and whenever something weird is happening in markets now, they tend to get blamed or people start joking about them. And also part of the mystique is there's just a lot of interest in why they seem to be so hot right now blowing up in a very different way.
And what exactly is the attraction for big allocators of capital, because I always think it's not like big investors can't create their own diversified portfolios or invest in a fund of funds or traditional two and twenty or whatever. So what exactly is it about the pod shops that makes them so attractive.
We've done a lot of episodes on the multistreads at this point, the pod shops so various flavors.
There are still a lot of things I don't understand.
First of all, my understanding is that they sort of continue to prove their metal. I mean, it seems like they didn't lose a lot of money in April during some of that volatility, So they have this promise uncorrelated returns. We'll get into how they deliver that. So far, it seems like they continue to more or less do what's advertised.
I have a lot of questions about how and what is the actual source of alpha and how long can this go on, and whether there are a lot of copycats and whether that will cause alpha decay and all this stuff.
I have questions about comp the most important thing.
Well, this is really important, and actually, you know, we did that episode with the founder of Freestone, Grove dan Morello, just a lot of the conversation was about comp And I'm interested in comp because I'm interested in the topic of making a lot of money, But also I get the impression that comp and incentive alignment more broadly is actually one of the key problems that people are trying to solve for all the time.
I think that's right. Okay, So I am very pleased to say we do, in fact have the perfect guest. We're going to be speaking with Ronan Cosgrave. He is a partner at Alburn Partners. So Ronan, thank you so much for coming on all thoughts.
Thank you very much. I'm really honored to be here.
First question, what exactly is Alborn Partners because it's not a pod shop itself.
No, No, we're so.
I co lead multi strategy heads fund coverage at Alborn. We are an advisory only independently owned consultant. We help institutional investors invest in hedge funds, private equity, real estate, all across the alternate that spectrum. We have about three undred and fifty clients worldwide and we advise on greater than seven hundred and fifty billion dollars in assets.
Okay, give us a little bit more of your background. You're the perfect guests to talk about multi strategy hedge funds and why allocators like allocating to them. Talk to us about like how you built up your familiarity with the space and how you've built up your like understanding of their inner mechanics.
That's a long answer. I've been over twenty years in the hedge front industry.
Okay.
I worked at a fund of funds called Pamco for fifteen years or the partner there did a whole lot of stuff there, covered pretty much kind of the constituent strategies of many of the multi strats, right, so you're talking about longstrared equity, long shot credit, convert arab ballarb. As it got more difficult, I got more involved, you know.
Since then, I've worked with Albourne. I joined Albourne for four and a bit years ago, and you know, with my colleague Martina, we cover the multi strategy universe globally. So part of our job really is to kind of dig in deep into the multistrats, not just learn about the people, but the process, the inner mechanisms of what differentiates one particular multi strat from another. And the really cool thing is that they're all actually really different, you know.
And one of the fun things listening to you guys is when you talk about pod shops and so on and so forth, or multi strats in general, I mean, there's huge differences in how they're run internally, you know. And the other thing I distinguish in the multi strategy space is the pod shops, which are the classic ones that are you know, you know, with the three layer of the fees versus the more traditional multi strategy hedge funds, which are two and twenty.
Oh.
That is an important difference, isn't it. Before we get into that, I want to ask, when you're doing due diligence on possible hedge fund investments, how do you go about doing that? Actually, because you just said you dig into you know, the culture, the people, risk management. How much access do you have and how do you do that?
That's another big question.
So the thing is with the multi strategy hedge fund space is you start really with the single strategy stuff, and it's not really fair to ask anybody to cover multi strategies if they haven't worked hard at understanding the individual contributions of all the different trades and trade types that make up a multi strategy. But the critical thing, and you alluded to this, is that multi strategy hedge funds are another level of abstraction away from the markets.
Because yes, we do look at trades, at traders and pms and stuff like that, but almost as important as you're evaluating them as business models, you're evaluating them as risk models and investment models, and you know, they're all
super interlinked. And one of the things that we look at and look for is kind of consistency between all the strands, because if you have things that are in conflict internally, you end up with a suboptimal outcome, right, I mean, we've all lived that in our own personal
and professional lives. But if things aren't in a line, and you mentioned compensation, competition is a huge part of that, and I'm you know, one of the things I'd argue is that comp affects far, far, far more dimensions of a multi strategy hedge fund than almost any aspect.
Yeah.
No, this seems very interesting to me because often it feels as though, okay, you have some investment strategy and then make a lot of money and then okay, some of it goes to the manager and some of it goes to the outside investor. That's how I conceive of things. But it really does seem like comp structure is actually
core to the business model. But before we get to that, why don't you actually go back for listeners, and for my sake, when you distinguish between the sort of traditional two and twenty multistrats with the so called podshops, In my mind, I associate with the millenniums of the world but talk to us about the differences in these business models when you use these terms.
Yeah, so I refer to two and twenty simple it's a straight management fee of two, but it could be any fixed number, and a performance fee of twenty percent on the overall portfolio.
So the only fees paid.
By the investor are the management fee, which is idignated in advance, plus a cut of the gross performance of the portfolio as the whole. And that's a really critical distinction between between them and the platforms or pod shops. Right, so a pod shop has all that right now. First off, the first thing that happens is that the management fee may or may not be fixed. It can be what's known as a pass through fee, where it's kind of a blank check in many ways. For the most part,
they do take good care of that. But the third layer of fees that's really important is that there's fees payable at the level of the PM, not at the overall fund. And when you get to that level, there's a lot of things that people take for granted and
investing just simply breakdown, you know. And to go on to that, like the one thing that I keep getting told, you know, in my own personal investing life and everybody's personal investing life, is that diversification is the only fee launch R. When you are paying performance fees on a on individual components of a portfolio. Diversification is not a free launch. It costs you money, real money.
Wait, can you explain how do clients? How do investors actually pay individual pms? Like, how does that work?
Yeah?
So in a pod shop, what you have you think about it is you have you know a number of pms, anything between five to three hundred and something. They each basically have their own individual P and L. Right, so they the manager, the overall fund manager track tracks each PM and their p and L. They'll charge back all
the appropriate stuff that would be charged to that. They will normally be charged Bloomberg for example, all other trading costs, the analysts costs perhaps, and then if that number is above zero, the PM gets a payment from the manager out of the fund and that's their performance fees. So the investors themselves don't actually pay them, paid.
For them by the manager.
Now, you said that there can be the instances in when diversification is not a free launch, and so I take that to mean that you can have situations in which at the fund level you don't have a good year and you're not making any money. But some pod managers had a great year and they still have to get paid. And so you talk to us a little bit about these conditions under which that diversification can be costly.
Yeah, let's use a simple, simple model. So you have a pod shop, but you want to got two pods, and at the end of the year, one pod is up ten dollars and one pod is down ten dollars. Because it's pod shop, you're paying on the panel of each individual PM. So let's say it's twenty percent. Right, So on a gross before fees basis your flat. However, you're paying the guy who was up ten dollars two dollars, right. So after this is added together, now your portfolio is
down two dollars. And that is netting risk. And the interesting thing about netting risk is because to bring it out further, is that netting risk you could argue, well, that's you and be an issue for the ones that pay at the top level.
Well, the issue is.
That because they exist in a competitive landscape for pms, pod shops can go to a PM who didn't get paid.
Right, So, if you think.
About it, if that was a traditional two and twenty multi strat ten dollars up, ten dollars down, flash, nobody gets paid. The fact is you've got a very very unhappy PM who's up ten dollars, he's made ten dollars, who's like sitting there in the corner really angry because they worked really hard, they made a lot of money and they get nothing.
And the pod shop can ring them up.
And says we'll take you, yeah you know, and will guarantee if you make money you will get paid it. The other thing to remember as regards netting risk is it's actually we've modeled it at Albourne. We've worked it out and using various simulations, it averages for a just a regular set of managers and pms around one percent a year.
Right.
When you think about a two and twenty hedge fund, yeah you might, you kind of expectationally, should expect to pay one percent of that two percent management fee to people who've made money when everybody halse has lost money. And it can be way more than that, and that's a real business risk.
So one thing I wanted to ask is I get the impression that podshops are very, very competitive, and you know, the talent is competitive, but the pod shop itself is supposed to kind of work together, right and the positions are supposed to diversify and even each other out and all of that. So I guess my question is how cutthroat is it actually working at a pod shop?
It varies.
The fact is that a podshop is an entity that can make certain decisions to create either competition or cooperation. Any multistract can do this in a pure eat what you kill and vironment. Obviously there's no incentive to do cooperation, but people do recognize this, right, And what I would say for that is that it's all about what do you want as what does the manager want to produce? And one of the things what I would say is there's a real choice that you have to make between
kind of talent and structure. And what do I mean by that? What I mean by that is to use the sports context. There's kind of two ways assemble professional sports teams. The first is to get a big pilot cash and go hire the best players in this position and put them on the field and hope for the best. Right,
that's a focus on talent. The other way is to hire a really really good coach with a really good system and to have him or her go with their team kind of a moneyball system where you put together people who fit in the structure. And what that means is the first one is like the emphasis on the individual, and the second one of the emphasises on it on the whole. And when you talk about competition, one of the main ways you enforce competition.
Is probably obviously compensation.
If you have a situation where it's purely what you kill and you get a presentive of your own P and L and that's it, it's very very hard to enforce that level of That's where you get those cutthroat stories, right. But there are many others out there who have other ways of doing this who recognize that. You know, if you just have everybody in it for themselves, you produce a portfolio that's actually suboptimal at the top level.
This is what I was going to ask. Have you noticed a difference in performance between the sort of cutthroat competitive firms versus the more cooperative ones.
That's a really good question, and the short answer is it's really hard to distinguish between them. On the outside The interesting thing really is more around what happens when things are going badly for both that you're more likely to have people kind of like quickly leave the more competitive and cut throat one. Ah then you would have then maybe they're more cooperative, you know. I mean the cool thing about the pod shop and the platform space
is there's literally no right way to do this. There's a real series of trade offs, right, and there's choices you make have cost many different different dimensions. Because, for example, if you choose to do cooperation right and you incentivize everybody, you typically would do it in a kind of a traditional multi strategy context, right. What that means is that you're not going to have the eat what you kill mentality.
You may have certain bits around that, but if you use that thing, you have a very good place to work, but you.
End up with a situation.
Where As we talked about earlier, netting risk is a real cost. So what that often means is that compensation choice drives you to be a bit more correlated within your own portfolio and be a bit bit less, bit less, little lower sharp ratio. Why is that Because if netting risk or the cost of netting is a real business risk.
You choose to minimize it, and the way easily to minimize it has had everybody kind of make money at the same time everybody kind of lose money at the same time, and then you won't be picked off by the pod Shopsimilarly, if you have competition, right, competition is an incredibly powerful human thing, but it gets out of control and you end up with a situation where people just burn out and just leave you. People are unhappy.
You know, you have to kind of keep feeding people into it, and you know that that's totally fine because there are many other industries out there besides finance that does this, you know. But at the same time, you know, you end up with a whole lot of scenarios that are kind of you end up with a kind of a team of rivals, you know, and then that's it's a dynamic, but it is the one that you have to really control zooming out.
Obviously, the performance of a lot of the well known names has done really well. You're talking to institutional allocators other than I guess the fact that the top line performance is good and everyone likes making money, what is the general pitch? And we've seen this trend obviously from allocation to single fund managers. You know your traditional guys who would like go on TV and they unveil their
long or whatever. As a digression. I always think it's funny when you see these pod managers on TV and they get asked about their thoughts about the market, because it's clearly that's not really even what their focus is on in terms of business structure design. So I'm always sort of raise an eyebrow when I see these conversations. Talk to us about what it is about these entities in general that holds so much an appeal for an institutional allocator.
They hold appeal for a variety of different reasons, and obviously it will depend on the individual mandate of the allocator, but there's a couple of fundamental things that really hold true across all multi threats. The first one is that it's interesting that we talk about pods like there's something new, But if you actually if all three of us decided to go out and invest into twenty individual hedge funds, we'd have the same issue. A. They would be paid
on what they eat, what they kill. Yeah, B we would have to hire and fire people. By the way, hiring and firing people. Hiring is fun, Firing sucks.
Yeah, But the point, but the.
Overall thing is that each individual pe in that set of single strategy hedge funds is allocating according to what two things, what they think in their set of investors want and be what they're willing to bear because it's their only job and their name on the above the door. And so what you end up is is your set of allocations that when you're roll them up together, are individually way under risked, right, and you're not making as much money as you should given the talent that you're
paying for and the amount of fees you're paying. So when you hire a multistrats, and part of the thesis of multi strats, which which is true, is that because they're a unitary portfolio with somebody atop in charge of it driving the risk of the individual pms, not the individual pms themselves, you can and you really should end up with a better return stream because you've coalested all together under a single unitary authority and they can put them to you know, they put leverage to work, risk
to work, so that the individual PM might be more risky than they really really want to be or maybe it's probably obscured from them usually, but at the end of the day, that rolls up into an appropriately risk portfolio return. Right, And you know, having somebody who worked in fund of funds, one of the issues of fund of funds is just that you had fantastic sharp ratios, but the returns were low.
That's a really important point. One other thing I wanted to ask just on the why allocators are interested in multi strats. Point One thing you sometimes hear is that, well, multistrats or pod shops they can dip in and out of positions really really fast, and they can react to the market very very quickly. How true is that?
So let's go back to two and twenty funds versus pod shops, because it's differently.
True for both of them.
Let's talk about pod shops first, right in the kind of the stylized pod shop, you get to set up, you get money, you ale, you invested as a PM, and you get paid on that. If you get cut, if your capital you get cut substantially. Even with the best will in the world and the promises from above saying it'll come back to you, your pay has been cut. And I mean we're all professionals here. If your pay is cut by fifty percent, your updated your CV and
you're checking the job market. Okay, So in the context of responding to opportunities in the market, it's hard to move too much too quickly in the context of a pod shop, why because of that reason, and be because that person may not be there to do when it's an opportunity there. So it's kind of hard. They do do it, They absolutely do do it. They will lever up into opportunity. But when you think about what people's kind of perception in their heads of what it is,
it's completely more static than you'd imagine. In the context of a traditional fee structure, the two and twenty, it's different, right, everybody is incentivized to get the top line to be the highest number it can be. And so if I'm a convert manager and your merger art manager, I'm cool with being my capital be given away. I assume I get it back eventually. But if it makes the overall proibly larger, I can benefit in the long run too.
So the ability and then quite frankly, the willingness to move capital in size around it is really that's where camp comes in. Camp has now led us to the situation where it's hard to move capital right, and you think about, like we talked about it, kind of the theme of this for me is comp kind of drives everything. How you structure your camp is one of the principal underlying features or a and how multi strategies work.
I think this is such an important point because again I think, like comp structure.
You hear about it like people love.
Reading stories about bonuses, et cetera. And people love reading stories about people getting paid a lot of money, or maybe they hate read these stories about people love getting mayde but this idea that no, this is the business you know people. I think when people hear bonuses, they're like, oh, you get some extra money. But the business is design. I mean, to hear you describe it. The business is the design of the bonus. The business is the design of the comp.
It kind of is you know, it drives so much if you just think about, like we talked about, how a capital allocation is basically held back or you know, you're the way you can do it is changed by how you compensate people, you know, or constrained is the better world. There's other things like I mean you think about in the context I going back to like the story about the single strategy hedge funds, you also have
the similar problems. Were given too much leeway in an e EQ what you kill environment, pms will start to set risk to suit themselves than they do for the overall portfolio, because after all, why should they care, you know,
why should they care about the overall portfolio performance? If if I can you know, if I've made money for the first nine months of the year, you know, the temptation is a lockdown risk and have Christmas, you know, enjoy Christmas rather than take more risks where at the portfolio at the top level may not want that, you know, So you have all these other things that drive others, drive these decisions of people, you know, across so many
different dimensions. It's one of the most fascinating things because you know, at Albourn we've done a huge amount of work trying to understand this.
But I learned Python to do this. God help me. Yeah, it's just one of those things.
How does the what.
You kill environment solve for the problem of the PM who's made money for nine months of the year and then want to lock it down? What types of risk controls or I guess controls for under risk because in a way, the thing that they don't want is someone taking some risk or you know, getting too conservative. What are the approaches that they have to align those incentives so that you have to keep going for those final three months of the year, even if it means risking your great year.
I mean, sometimes it's very simple minimum amounts of capital deployment requiring. You know, it's kind of hard, right because at the end of the day, if you've got successful PM on the year, yeah, and you want to keep them or her, it's not an easy question to answer. And like there are more hybrid approaches to these what you kill right for example, partnership so you know, many funds offer partnership to the pms where they do participate
in the overall fund fund profits. You know, there's other kind of you know, fancier trade ways to make you know, increase say the payoffs to the PM depending on the fund's performance.
It fun's overall performance.
But yeah, it's a really hard problem because it's a camp. It's a personal relations problem, you know. I mean sometimes you just got to accept it. You got a guy who's up coming to the end of the year and they're just going to de risking. Look, the thing beyond camp is really culture, right, and you can say comp drives culture.
But it's not quite that simple.
You couldn't just hire the sort of individual who won't do that, you know, and a lot of funds will talk about we talked about the war for talent. I often call it the war on talent. But people go to places they want to work with, people who they want to work for, and you do try to just hire professionals, regular people like us who work through the holidays, you know, and stuff like that, you know, just to finish off top for the year. You know, you've got to hire the right people.
So listening to talk on pass throughs versus traditional fees the two and twenty, I'm kind of wondering why would you ever invest in a pass through because when you describe the downsides, it's like you don't have as much cooperation. Maybe it's harder to move capital around. It seems like the traditional fee structure might be the better choice here. But tell me why I'm wrong.
Well, we've been taking I mean that this is partially my training, taking the side of the alligator here and you're right, like superficially at the top level, a pass through it seems like a bad idea for the allocator, but there's kind of three people, three entities getting commed. Here is the alligator, they're the manager and they're the PM. And the thing is one of the one of the standout features phychologically of most pms is they all think
they're really good. That's how you become a PM. You become ambitious, you press yourself to test yourself against the market. A pass through manager will give you the max compensation if you're a good PM, right, And at the end of the day, what we're describing is an industry that relies on pms to do good work and who are really smart. And if you have a situation where they're going to get paid in a particular entity more than
another sort, they will gravitate towards that. So the answer to your question is, if alligators had their way, they probably wouldn't.
Want to invest in pass throughs.
But the fact is that they don't have a choice, and pass throughs are you know. The other thing to remember is past throughs are good for pms. But the interesting thing and people do forget about. This is in a past through situation in a pod shop, the PM is getting paid from their own P and L. The manager themselves is fully aligned with the investor, with the allocator because they're only getting paid off the netted of all the pass throughs. They're paying off the same P
and L at the top line as the investor. So there is somebody and I mean people do talk about how much has been paid, how much they make and whatever. It's a an like I've heard it described as the worst best job in the world, but it's an incredible thing of coordination and getting people together. But they're actually incentivized and in aligned within allocator and to give them
their due. They do their best to do that because they are conscious of keeping costs under control because that's their profit margin that's eating into I mean the other I mean, the other thing is which is kind of scary for allocators is the extra layer of.
Fees, right, and it does cost money.
And fundamentally speaking, the other thing that camp is driving in that case is risk. Right, they're driving leverage. We've done simulations and a pass through manager has to be around one third more leverage than then the two layer of fees two and twenty manager. I mean they have to be because they have to make more money to pay that extra cache out and it costs.
Real money to do that.
And you know, you know, in one sense, price is what you pay, values what you get. Returns have been really good because of the pass through manager has been a really effective business model investing side. Yeah, but yeah, I mean alecators do complain about the cost.
It's something I'm curious about with the very traditional hedge fund model, which you described very a good articulation. If I'm an institutional allocator, I'm diversified. Therefore, I want my allocations to take max risk. The individual hedge fund manager might not want to take mask max risk because it's
their whole career and name on the line. What is actually the expectation in the sort of traditional hedge fund model for like, how much of the manager's net worth is in the fund and how do you establish that? And by the way, if I were a hedge fund manager had done really well, I would buy a lot of mansions and yachts and stuff so that if my fund ever went to zero, I still have a lot of wealth.
You've thought this through, jah, Yeah, mentions where in particular.
Miami, Aspen, the Golf States, New York City and anyway. But like, how do they like, how do you how do they actually establish that the man is fully aligned with the performance of their fund.
So that is a really really good question because opinions really vary there, right, And the standard answer to that question is the majority of the manager's liquid net worth and you can define that whichever way you want.
Is their way to audit there. I mean, I say, hey, look, I have it all on my fund.
You can, you can have to admin.
The manager can authorize the administrator of the fund to disclod their investment in the fund to you if you ask them nicely.
They don't know that I have.
They wouldn't know if I had a billion dollars in bitcoin on a private wallet.
That's not any any key.
I'm just saying I would when I hear this, I saw this in your notes. When I hear this, my first mind goes to how can I pocket net worth and places that aren't easily visible, and so I'm not fully exposed to my own fund.
Sorry, look, I mean they actually big They's a bigger question.
There, okay, In which you mentioned at the starter your question before you went on about the nice mansion an aspect which is kind of distracting me right now. But to be clear, the fact is that if you have all your money in a fund, yeah, you're kind of going to mind it differently, yeah right.
Yeah. And if I'm an investor who's got a hundred of funds like that, I don't want.
Yeah, yeah, you're going to be You're going to under risk it relative what I want as an investor, and so it's a real dance.
Right.
Again, it goes back to the character the person you're hiring, which we talked about earlier on about the pad shot
with the similar scenario. It really depends on how you want to risk manage your investments as an alligator, right because at the end of the day, when you're asking a manager to put their own capital in the fund, you're signing them a certain role as a risk manager because and you have to assess honestly, my answer is, it really depends on the person who I'm dealing with and the sort of person who I think we're dealing with.
Right.
If I think it's somebody who is just really professional and good, I'm not so sure. That having all their money in the fund is necessary, you know, if I think it's somebody where.
They see other funds too, you know, big fund managers see they do.
Yeah, I mean I used to see that at my former job, you know, and it was a real issue because you did have people who, you know, they had made decent money. But like, what we really wanted to see at the time that PAMCO was people putting their money into the business, you know, paying for Bloomberg, paying for office space, you know, all that over over putting
money in the fund, because that was commitment to the business. Interesting, right, I mean that's something that we're you know, we were comfortable more as comfortable with them putting working capital into a functioning business.
Interesting.
We then maybe putting more an extra five hundred thousand, a million, two million million dollars into a fund.
Very interesting.
So much of what you're describing it sounds very very granular, like the idea of looking at individual talent to see how they operate, looking at something like culture, which tends to be difficult to define. If I'm an allocator, how much transparency or how much information am I actually getting from one of these funds? And I realized allocators will hire your company Albourne to actually do a lot of
this due diligence for them. But if Albourne was out of the picture, what would I be seeing if I'm a potential allocator.
So that's a a long there's a long answer to that question, and it really does depend on a if you're a certain size of an alligator.
There's there's kind of the fast lane.
Ah so if I'm PIMCO or something, if.
You're in you get in the executive lounge, you know, you'll get treated more, you know, get more access. You know that, and there's nothing wrong with that because simply these people have limited time, you know, and somebody who's going to be a larger client will get more in almost any line of business, you know, in terms of access, it does vary, I think, you know if I you know,
speaking of an allocator's shoes. You know, basic stuff is regular meetings, good substantial risk reports, helping me understand where and how risk is our plays, you know, updates when necessary, and then you know, just it's really it is granular.
It's multi strategies are a combination of both zooming out and taking the big But we talked about what camp means in the global scale and how it's all that, but it's also super super granular, so understanding you really want to understand, like where their real competency is as the multi strated, because many places start off with a particular kind of thing.
They're good at.
Equities, Yeah, right, you know, at the end of the day, most multi strategies make most of their money from kind of I would call it equity alpha for lack of a better word, which can include traditional long short equity, quant equities index rebaal. We've heard about that a couple of times. You know, all this sort of stuff that's kind of equity alpha. Then you have other ones who have more focused on kind of fixed income and credit, you know, and you've got to understand what you're getting.
And I mean, then you've got to think about, given what I think that my heuristic or my mental map of what these guys are, does each incremental change what they do. Does that makes sense because you know, I mean one of the things I like to think about is making sure that the stories are aligned.
Very simple stuff.
Right, Let's say I'm a pod shot manager, you're an allocator in here, and.
I go on you know to ask a constructure, Well, my pms.
You know, we put them in a room, give them Bloomberg, We give them all the facility they need.
We charge them for that, and they just get paid on their own P and L. Yeah.
Oh okay, you say, I find good And then you say, okay, well talk to me about you know what sort of culture you have? Oh yeah, well, actually you know what we also, you know, we have a real cooperative culture
becomes loved here. You know, they all get back massages and we all work together as across the team as well, you know, and you're kind of going answer one and answer to don't make sense together, right, And you see this in all sorts of sort of ways, you know, And the thing is that what happened is that people have you know, the successful funds are the ones who's answered made answer one and answer to come I line up together, you know, in whichever way it needs to be.
They've worked on ways.
That makes sense that they're kind of I hate to say about like a narrative alignment and how they do things. They know what they're good at, you know, like what for example, you don't have somebody who's really really got an equities background to suddenly decide to hire some you know, rockstar and allocate forty percent into commodities. You know, that would be kind of a weird thing.
Well, so I know you're not going to like name any specific names. I will name some names, but you don't have to talk about them directly, you know, like I mentioned someone like Ken Griffin or in Izy England or at Millennium. When you look at the managers who have done really well in this space, what are they good at?
They are good at what I said, kind of bringing alignment to finding that align, finding that solvement for align, you know, solving for kind of the business issues, the risk issues, the investment issues, and the personnel issues, and making sure that they all work together.
You know, they're really successful.
People are just not that they are in it for the money, but now they're in it for the competition to improve because like I said, it's the best worst job in the world.
You know, I would like.
To try it out at least for a little bit see how good it is.
I have a question.
Part of the appeal of any multi strategy hedge fund is the internal diversification. Obviously, whether we're talking about the two and twenty or whether we're talking about the pure pod model. You have these periods where one trade more or less works out very well for a long time. In the twenty tens, it was the disinflationary trade, which represented in rates, and it was the tech trade or various flavors of that. What do you see when you do due diligence on a fund? What do you look for?
Because I would just.
Think, yeah, here's a bunch of people, but all you all want to make money, so y'all put on the same trade in different clothing, right, and there's different ways to play the same trade. How do the good funds actually establish diversification?
So there's actually April is a really good example of the versification at work and what it means for how funds work. And I'm going to loosely describe April very loosely, and I'm sure somebody in your audience will go completely wrong, but loosely, April was mostly in equity story, right, And what we had, what we saw was equity only focused managers had a much tougher time of it than the diversified managers. Okay, so diverse fight I being cross commodities rates converts other stuff.
And why is that important?
Because last year one of the biggest trades that worked with equities, right, And so the way you stay and so the way you stay diversified is really disciplined, right. And you know, in the context of what you're trying to do. One of the interesting things about running simulations around multistrats, right is you actually don't need to have such great pms or great trades to have a really
good multi strat if you risk manage it right. Okay, if you actually have a set of people who are very lowly correlated with each other and you put them together, you lever them up, you can have a very good business. So to your question is, like, the answer is, you got to be disciplined, You got to have like you put the right amount of risk into your twenty ten different inflationary trade, put the right amount of risk into
fundamental fundamental equity market neutral last year. But you make sure that you're not over the limit, right, and you stay disciplined so.
That our equity market neutral.
I would still find a way to make it long tech and disguise there.
Well, people totally do. Yeah.
I mean, look, we haven't even got into factor factor controls and stuff like that, and so on and so forth. Look, the fact is that and there's multiple answers to that question across how multi strates have implemented this in terms of what they're willing to take in terms of factor risk or sector risk and stuff like that and when. But when you get down to it, look, the job of an investor, any investor is to take risk in the way they're supposed to. And multi strategy funds they
take risk. You know, there's no getting around that. Key is is how you take it, how disciplined you stay with it, the quality of the people, the quality of the structure around that, and just you know, sometimes some look as well.
Just on the risk management side, it sounds like a lot depends on historical core correlations when it comes to diversification, and what we've seen in recent years and in April is some of those historic correlations breaking down, So for instance, bonds not being a good hedge for equities, or more recently the dollars selling off at the same time that
bonds were selling off. How are people managing or judging that correlation risk because that seems to be a potential area of weakness for multi strats.
It's a weakness for everybody, potential area weakness for everybody. I think, look, management of correlation is super fundamental to management of risk. In the context of any multi strategy hedge fund. There's tremendous benefits to keeping your correlation low between your strategies, in terms of risk management, in terms of how much you can lever, in terms of everything.
When I look at managers, when I test managers, when they you know, when I simulate managers, I look at kind of two regimes, low and high correlation, and everything that works in low is punishes you in high correlation. Right. For example, when you're creating diversified portfolio of really cool trades that have nothing to do with each other, is great. When it works in a high correlation environment is a nightmare because it's things you've never heard of blowing up.
Because I mean, there's a limited amount of things that any any one person can know, right, So every choice you make at a low correlation environment will come back to bite you in a high correlation environment. Correlations between
asset classes is a fundamental part of that. But the critical thing around that is the and this is one of my managers said to this, it's like, when you're sufficiently diversified, each individual line it him you ad makes no difference to the portfolio risk or innd like that, except what you're actually looking to allocate when you're at that diversified is how much of a loss you can make in that high correlational environment, how much of a loss you're willing to bear, And so if that individual
component is something that's additive to that loss or makes it worse, that's where you judge it. Right, when you're sufficiently diversified, so you try to insulate yourself from breakdown and correlation by having a budget for that breakdown and correlation and making sure that you're individ you a components. You know what each individual component for portfolio is going to do for that and if you do that, then you're kind of that's how you kind of figure that one out.
Look.
You can buy hedges as well, and people do explicitly do tail hedging to provide kind of return and cash in those sorts of scenarios. But allocating that tail risk, especially in a pod shot because they're more diversified, is probably the most important job that these guys have.
One of the things that I'm interested in is you know, there's still new multistrats being launched. A lot of them continue to make a lot of money, but there has to be some limit to the alpha generated capacity of these vehicles. I would think, and I'm trying to wrap around my head about what happened. Does more and more funds launch and what is the capacity? And based on this conversation, if I had to.
Guess about what degrades alpha over.
Time, it would be something to do with compensation, where just like all the money accruise at the PM level because there's such competition with more talk to us about like how you would articulate the source of alpha and how much can realistically be captured as more and more people and more and more money flows into this space.
Okay, so articulating a source of alpha, that's probably the biggest question there is.
An investing for hedge funds. Can I cope with a metric?
I probably could in terms of just volatility and markets extract, you know, you know, alpha extraction from that, you know, I mean for me that they're kind of critical things in terms of understanding what alpha is. Is most of the time in most markets there's a large number of people with different mandates, different things going on their head, different things going on their institutions. As long as there's a sufficient ecosystem of time horizons, capital constraints, there's always
going to be the alpha. And the interesting thing about you know, certain markets, for example, is like alpha and this may sound a little bit of philosophical, alpha can be something other than money. For example, if you take a tap simple tail edging situation, buying puts on the S and P, right, they're notoriously expensive, right, But the alpha that the people who buy puts get is the kind of the alpha of a peace of mind for the rest of their portfolio.
Right.
So I mean, if you're a hard edged to hedge funds, you're monetizing the alpha by doing a dispersion trade. But like for people who are like feel can they can sleep at night by buying puts, that's fine. You know they're taking their alpha and kind of non manatory form.
Now that I said that's philosophical. In other cases, you know, the hedge fund space, they're the pushing the pull going on here, right, And so you talk about multi strategies hedge funds, but they're not the only sort of hedge funds the whole set of other hedge funds doing other things. And so you know, if you just what's been happening, and that's why we're talking about multi strategy hedge funds. Is broadly speaking, hedge fund investing is more or less
the same size for the past couple of years. But this share of multi strategies have gone up because, like as I said, they kind of offer a pretty good deal to a PM. You know, they take away all the business risks that they have to deal with. They don't talk to me, you know, they just get to INVESTI trade, thank you. But you know, they take away all that sort of risk, and so the pms they kind of have a different maybe better life, depending on
what their admissions are and stuff. And as I said, for investors, the underlying risk taking inside of a multi strat makes for a better kind of return and level at the top level. You know, I think this will reverse, you know, over time, but like for the moment, like multistrats, and you ask about how big individual multi strats can
get it as well, which is an interesting question. Empirically, kap is around fifty fifty to seventy billion dollars right now you know, whether that's liquidit in markets, whether that's share of Wall Street's bank's credit book, you know that's or where it's just organizational sites because you know they're hard to manage, you know, hundreds of pms right, physically and mathematically different to do that.
Is prime brokerage a factor as well, because I imagine, you know, if you have a multi strat that suddenly becomes as big as JP Morgan or something that's unrealistic, but just as an extreme example, I can't imagine the prime brokers.
Are going to be okay with that, with what exactly.
With the size and the risk of a giant multi of having a relationship with a giant multi strat.
They would not love it because you know it just put it's this famous story. If a few ten dollars to the bank, it's your problem. Yeah, billion dollars the bank, it's their problem. So you know, banks across the world avoid try to avoid having customers so large that they it becomes their problem.
So yes, the answer is yes.
Ronan Cosgrave, thank you so much for coming on all thoughts and explaining to us why comp is important.
That was fantastic come back on the podcast again for a further conversation.
But that's great, Thank.
You guys, Joe.
That was fun.
That was great. Yeah.
I like digging in to the business model of these things. One thing I hadn't come to appreciate is the idea of how difficult it might be to actually move around capital because no one wants to be firing pms that you fought like tooth and nail to actually hire in a competitive environment.
I mean, so this gets to something that actually I thought about after we did that recent episode with Scott back on boutique investment banks.
Which is the idea of where.
Does franchise value come in in a talent driven business? Yeah, in boutique investment banking, there's another area where it's like, Okay, you build this talent, but is there any franchise value external that? And so it was really interesting to hear Ronan talk about at any hedge fund, not just the degree to which the manager has actual money tied to the investments in this space, but to which they're invested in the business as a business, as opposed to just
the fund. I thought that was a super fantastic Yeah.
And also like the idea of looking at over head spending as like an indication how much people care about the business.
Yeah, I hadn't thought of that. You know, I would like to be in this space one day. That's never going to happen for obvious reasons. But it's very fun thinking about ways in which, depending on what seat we have, we're gaming the system.
You know.
So it's like, if I'm at the manager level, I'm thinking about how I can have personal wealth that is visible to me.
But is it not that your mind immediately goes to gaming the system.
It's not visible to the LPs. I think about how if I were at the PM level, I was like, yeah, of course I'm taking a market neutral long short book, but I'm really just finding a closet way to go long in video. During the AI bull market, it does feel though that like part of the entire game is here.
You have these parameters and risk constraints and so forth, and this cat and mouse game between those who want to essentially find a way out of the constraints and those who want to put them back in the box.
Yeah, that seems to be a fundamental tension, although I imagine it exists, you know, in some other funds as well.
And I just like the fact that all this bonus money is the business itself. I think that's a really important idea when you hear about bonuses, et cetera. This is not just like someone getting their Christmas bonus.
This is the business. This is the business.
Shall we leave it there?
Let's leave it there.
This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
And I'm Jill Wisenthal. You can follow me at the Stalwart.
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