How the Hottest Hedge Funds on Wall Street Really Manage Risk

Tracy Alloway (0:02)

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Joe Weisenthal (0:18)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

Tracy Alloway (0:23)

And I'm Tracy Alloway.

Joe Weisenthal (0:24)

Tracy, I still want to learn more about how multi-strategy hedge funds work.

Tracy Alloway (0:30)

I thought you were gonna say, I still don't know anything about multi-strategy hedge funds.

Joe Weisenthal (0:33)

Well, that too, well, that too.

Tracy Alloway (0:34)

I feel like we're slowly getting there, and hopefully our listeners don't mind coming along with us for the ride. I feel like every time we have an episode on multi-strategy hedge funds or on the podshops, as they are sometimes called, we are deepening our understanding and we're sort of getting into more and more detail. And I feel confident that one day, after we've done like 50 episodes on this topic, we will get there.

Joe Weisenthal (1:00)

I do think it would take about 50 I think that's like an accurate number of what it would actually take to get there. But of course, most recently, we had that episode with Giuseppe Palaiologo, Gappy, talking about some of the big ideas and sort of from a high level of how some of these funds actually work. They're very popular. They've done some of the big ones that people know, like the Millenniums, like the Citadels, have just had incredible runs, really seems to be displacing a lot of the old style quant, disrupting the sort of fund-to-funds idea that was popular. I have some sense, you have all these managers and you give them very specific mandates and they have to really focus on that. And then if they're not too correlated with each other, you can get above market returns in theory and apparently in practice.

But like how that actually works, I still really don't know.

Tracy Alloway (1:53)

Well, okay, so two things. Number one, everyone should definitely go and check out Gappy's book, if you haven't already, Advanced Portfolio Management. A lot of the references that I'm about to throw out on this episode, anything that I say that might sound even remotely impressive or like I know what I'm talking about has come from Gappy's book. And also I will say, I read that book going to and from work on the subway. It's pretty short, so I think I did it in like a week.

And I have never gotten so many people like talking to me on the subway as when they saw me pull out Advanced Portfolio Management and they're like, what is that?

Joe Weisenthal (2:30)

It's very New York, isn't it?

Tracy Alloway (2:32)

And then secondly, the other thing I will say is we've been talking about multi-strategy hedge funds. We wanna learn more about them because they're this new thing on Wall Street that everyone seems very excited and interested in.

But beyond that, there are recent events that make this an even more pressing topic. So we've seen some of the big winners in the market in recent months start to come down. So the big tech names, things like Nvidia, we've seen small caps shoot up. A lot of people are talking about whether or not this is a factor rotation and we'll get into what factors actually are. But I think the discussion that we're seeing right now, and I should caveat this with, it is July 18th, so we've seen those big moves in the market very recently.

The discussion that's happening now is how much does the, I guess, growth in factor investing feed into some of these moves? And also how does the risk models that go alongside this actually impact investor behavior and then also feed into these market moves? So is it the case that everyone's getting out of big tech because their risk models are telling them to?

Joe Weisenthal (3:40)

Totally, and this is like a really important element for sort of understanding both how these investment vehicles work and the impact that they have on the market, which is one of the things we know, is that the various portfolio managers within these funds have very tight remits. It's like your team is responsible for trading ship stocks and your team is responsible for trading the short end of the Brazilian yield curve and your team is responsible for international oil plays.

And then we know that like, and then you're not allowed to take any sector beta and you're not allowed to take any market beta and all these things. And so, you know-

Tracy Alloway (4:16)

Factor neutral.

Joe Weisenthal (4:17)

Factor neutral and then, you know, tight risk limits. So if something starts to go down, you don't want to lose your job and you like get out of positions and that can create interesting moves for the market.