Hedge Fund Market Wizards E-Book

Jack D. Schwager

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch
• Veröffentlichungsjahr: 2012

Seitenzahl: 894

Beschreibung

Fascinating insights into the hedge fund traders who consistently outperform the markets, in their own words From bestselling author, investment expert, and Wall Street theoretician Jack Schwager comes a behind-the-scenes look at the world of hedge funds, from fifteen traders who've consistently beaten the markets. Exploring what makes a great trader a great trader, Hedge Fund Market Wizards breaks new ground, giving readers rare insight into the trading philosophy and successful methods employed by some of the most profitable individuals in the hedge fund business. * Presents exclusive interviews with fifteen of the most successful hedge fund traders and what they've learned over the course of their careers * Includes interviews with Jamie Mai, Joel Greenblatt, Michael Platt, Ray Dalio, Colm O'Shea, Ed Thorp, and many more * Explains forty key lessons for traders * Joins Stock Market Wizards, New Market Wizards, and Market Wizards as the fourth installment of investment guru Jack Schwager's acclaimed bestselling series of interviews with stock market experts A candid assessment of each trader's successes and failures, in their own words, the book shows readers what they can learn from each, and also outlines forty essential lessons--from finding a trading method that fits an investor's personality to learning to appreciate the value of diversification--that investment professionals everywhere can apply in their own careers. Bringing together the wisdom of the true masters of the markets, Hedge Fund Market Wizards is a collection of timeless insights into what it takes to trade in the hedge fund world.

Leseprobe

Contents

Foreword

Preface

Acknowledgments

Part One: Macro Men

Chapter 1: Colm O’Shea

Addendum: Ray Dalio’s Big Picture View

Chapter 2: Ray Dalio

Chapter 3: Larry Benedict

Chapter 4: Scott Ramsey

Chapter 5: Jaffray Woodriff

Part Two: Multistrategy Players

Chapter 6: Edward Thorp

Chapter 7: Jamie Mai

Chapter 8: Michael Platt

Part Three: Equity Traders

Chapter 9: Steve Clark

Chapter 10: Martin Taylor

Chapter 11: Tom Claugus

Chapter 12: Joe Vidich

Chapter 13: Kevin Daly

Chapter 14: Jimmy Balodimas

Chapter 15: Joel Greenblatt

Conclusion

Epilogue

Appendix A

Appendix B

About the Author

Index

Other Books by Jack D. Schwager

A Complete Guide to the Futures Markets: Fundamental Analysis, Technical Analysis, Trading, Spreads, and Options

Getting Started in Technical Analysis

Market Wizards: Interviews with Top Traders

The New Market Wizards: Conversations with America’s Top Traders

Stock Market Wizards: Interviews with America’s Top Stock Traders

Schwager on Futures: Fundamental Analysis

Schwager on Futures: Managed Trading Myths & Truths

Schwager on Futures: Technical Analysis

Study Guide to Accompany Fundamental Analysis (with Steven C. Turner)

Study Guide to Accompany Technical Analysis (with Thomas A. Bierovic and Steven C. Turner)

Copyright © 2012 by Jack D. Schwager. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data

Schwager, Jack D., 1948–

Hedge fund market wizards : how winning traders win / Jack D. Schwager.

p. cm.

Includes index.

ISBN 978-1-118-27304-3 (hardback)

1. Floor traders (Finance). 2. Hedge funds. I. Title.

HG4621.H27 2012

332.64’524—dc23

2012004861

With love to my wife, Jo Ann, the best thing that ever happened to me (I know because she tells me so, and she has never been wrong)

Lara Logan: Do you feel the adrenaline at all?

Alex Honnold: There is no adrenaline rush. . . . If I get a rush, it means that something has gone horribly wrong. . . . The whole thing should be pretty slow and controlled. . . .

—Excerpt of 60 Minutes interview (October 10, 2011) with Alex Honnold, acknowledged to be the best free-soloing climber in the world, whose extraordinary feats include the first free-solo climb up the northwest face of Half Dome, a 2,000-foot wall in Yosemite National Park

To do my vacuum cleaner, I built 5,127 prototypes. That means I had 5,126 failures. But as I went through those failures, I made discoveries.

—James Dyson

Foreword

Once upon a time, a drought comes over the land and the wheat crop fails. Naturally, the price of wheat goes up. Some people cut back and bake less bread while others speculate and buy as much wheat as they can get and hoard it in hopes of higher prices to come.

The king hears about all the speculation and high prices and promptly sends his soldiers from town to town to proclaim that speculation is now a crime against the state—and that severe punishment is to befall speculators.

The new law, like oh so many laws against the free market, only compounds the problem. Soon, some towns have no wheat at all—while rumor has it that others still have ample, even excess, supplies.

The king keeps raising the penalty for speculation, while the price of wheat, if you can find any, keeps going higher and higher.

One day, the court jester approaches the king and, in an entertaining sort of way, tells the king of a plan to end the famine—and to emerge as a wise and gracious ruler.

The next day, the soldiers again ride from town to town, this time to proclaim the end of all laws against speculation—and to suggest that each town prominently post the local price for wheat at its central marketplace.

The towns take the suggestion and post the prices. At first, the prices are surprisingly high in some towns and surprisingly low in others. During the next few days, the roads between the towns become virtual rivers of wheat as speculators rush to discount the spreads. By the end of the week, the price of wheat is mostly the same everywhere and everyone has enough to eat.

The court jester, having a keen sense for his own survival, makes sure all the credit goes directly to the king.

I like this story.

The loose end, of course, is how the court jester happens to know so much about how markets work—and how he happens to know how to express what he knows in an effective way.

While we may never know the answer for sure, my personal hunch is that the court jester makes frequent visits to the royal library and reads Reminiscences of a Stock Operator by Edwin Lefèvre, The Crowd by Gustav LeBon, Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, and the entire Market Wizards series by Jack Schwager.

Trading, it turns out, is the solution to most economic problems; free markets, sanctity of trading, and healthy economy are all ways to say the same thing. In this sense, our traders are champions and the men and women in Jack Schwager’s books are our heroes.

Schwager’s books define trading by vividly portraying traders. He finds the best examples, he makes them human and accessible, and he allows them to express, in their own ways, what they do and how they do it. He gives us a gut feel for the struggles, challenges, joys, and sorrows all of them face over their entire careers. We wind up knowing each of his subjects intimately—and also as a uniquely complete expression of repeating themes, such as: be humble; go with the flow; manage risk; do it your own way.

Schwager’s books are essential reading for anyone who trades, wants to trade, or wants to pick a trader.

I go back a ways with Jack. I recall meeting him while we were both starting out as traders, long on enthusiasm and short on experience. Over the years, I watched him grow, mature, and develop his talent, evolving to become our Chronicler-General.

Schwager’s contribution to the industry is enormous. His original Market Wizards inspired a whole new generation of traders, many of whom subsequently appeared in The New Market Wizards, and then, in turn, in Stock Market Wizards. Jack’s Wizards series becomes the torch that traders pass from one generation to the next. Now Hedge Fund Market Wizards extends, enhances, and perfects the tradition. Traders regularly use passages and chapters from Schwager’s books as a reference for their own methods and to guide their own trading. His work is an inseparable part of the consciousness and language of trading itself.

Some 30 years ago, Jack reads Reminiscences of a Stock Operator and notices its meaningfulness and relevance, even 60 years after its publication. He adopts that standard for his own writing.

I notice that books that actually meet that standard tend to wind up in the libraries of traders and court jesters alike, on the same shelf with Reminiscences, The Crowd, and Extraordinary Popular Delusions and the Madness of Crowds.

That’s exactly where you find Jack’s books in my library.

Ed Seykota

Bastrop, Texas

February 25, 2012

Preface

This volume is part of my continuing effort to meet with exceptional traders to better understand the elements underlying their success and what differentiates them from the multitude of pedestrian market participants. The traders interviewed range from the founder of the largest hedge fund in the world, managing $120 billion in assets with 1,400 employees, to a manager running a solo operation with only $50 million in assets. Some of the managers trade from a long-term perspective, holding positions for many months and even years, while others focus on trading horizons as short as a single day. Some managers utilize only fundamental data, others only technical input, and still others combine both. Some of the managers have very high average returns with substantial volatility, while other managers have far more moderate returns, but with much lower volatility.

The one characteristic that all the managers share is that they have demonstrated an ability to generate superior return/risk performance. Because so much of what passes for high returns merely reflects a willingness to take more risk rather than being an indication of skill, I believe that return/risk is a far more meaningful measure than return alone. In fact, the fixation of investors on return without the appropriate consideration of risk is one of the great investment mistakes—but that is a story for another book. One return/risk measure that I have found particularly useful is the Gain to Pain ratio—a statistic that is explained in Appendix A.

There were three key criteria for selecting interviews to be included in this book:

1. The managers had superior return/risk track records for significant length periods—usually (but not always) 10 or more years and often much longer.

2. The managers were open enough to provide valuable advice about trading.

3. The interviews provided sufficient color to allow for a readable chapter.

A half dozen of the interviews I did for this volume were not used because they fell short in one or more of these categories.

Over longer-term intervals (e.g., 10 years, 15 years), hedge funds consistently outperform equity indexes and mutual funds.1 The typical pattern is that hedge funds, as a group, will have modestly higher returns, but far lower volatility and equity drawdowns. It is ironic that in terms of any type of risk measure, hedge funds, which are widely viewed as highly speculative, are actually much more conservative than traditional investments, such as mutual funds. It is primarily as a consequence of lower risk that hedge funds tend to exhibit much better return/risk performance than mutual funds or equity indexes. Moreover, with rare exception, the best managers are invariably found within the hedge fund world. This fact is not surprising because one would expect the incentive fee structure of hedge funds to draw the best talent.

When I conducted the interviews for my first two Market Wizard books (1988–1991), hedge funds were still a minor player in the world investment scene.2 Based on estimates by Van Hedge Fund Advisors, total industry assets under management during that period were in the approximate $50 billion to $100 billion range. Since that time, however, hedge fund growth has exploded, expanding more than twentyfold, with the industry currently managing in excess of $2 trillion. The impact of hedge fund trading activity far exceeds its nominal size because hedge fund managers trade far more actively than traditional fund managers. The enhanced role of hedge funds has itself influenced market behavior.

With hedge funds accounting for a much larger percentage of trading activity, trading has become more difficult. In some strategies, the effect can clearly be seen. For example, systematic trend-followers did enormously well in the 1970s and 1980s when they accounted for a minority of futures trading activity, but their return/risk performance declined dramatically in subsequent decades, as they became a larger and larger part of the pool. Too many big fish make it more difficult for other big fish to thrive.

Even if one does not accept the argument that the greater role of hedge funds has made the game more difficult, at the very least, it has made the game different. Markets change and good traders adapt. As hedge fund manager Colm O’Shea states in his interview, “Traders who are successful over the long run adapt. If they do use rules, and you meet them 10 years later, they will have broken those rules. Why? Because the world changed.” Part of that change has been brought about by the increasing prominence of hedge funds themselves.

Not surprisingly, virtually all of the traders interviewed in this volume are hedge fund managers (or ex–hedge fund managers). The one exception, Jimmy Balodimas, a highly successful proprietary trader with First New York Securities, had to adapt to the presence of hedge funds. In his interview, he describes how hedge fund activity changed the nature of equity price movements and how he had to adjust his own approach accordingly.

Markets have changed in the generation since I wrote the first Market Wizards book, but in another sense, they have not. A bit of perspective is useful. When I asked Ed Seykota in Market Wizards whether the increasing role of professionals had changed the markets (a shift that the intervening years have demonstrated was then only in its infancy), he replied, “No. The markets are the same now as they were 5 to 10 years ago because they keep changing—just like they did then.”

In many of the interviews, traders made reference to one or more of my earlier books. I did not include all such references, but I included more than I was comfortable doing. I am quite cognizant how self-serving this may appear to be. My guideline whether to include such references was to ask myself the following question: Would I include this comment if the reference were to another book, rather than my own? If the answer was yes, I included it.

Readers who are looking for some secret formula that will provide them with an easy way to beat the markets are looking in the wrong place. Readers who are seeking to improve their own trading abilities, however, should find much that is useful in the following interviews. I believe the trading lessons and insights shared by the traders are timeless. I believe that although markets are always changing, because of constancies in human nature, in some sense, they are also always the same. I remember, when first reading Reminiscences of a Stock Operator by Edwin Lefèvre nearly 30 years ago, being struck by how relevant the book remained more than 60 years after it was written. I do not mean or intend to draw any comparisons between this volume and Reminiscences, but merely to define the goal I had in mind in writing this book—that it still be meaningful and useful to readers trading the market 60 years from now.

1All the performance statements made in reference to hedge funds as an investment category implicitly assume hedge fund of funds data. Indexes based on fund of funds returns largely avoid the significant statistical biases inherent in hedge fund indexes that are based on individual manager returns.

2Market Wizards, New York Institute of Finance, 1989. New Market Wizards, New York, HarperBusiness, 1991.

Acknowledgments

First and foremost, I would like to thank my son Zachary for being my sounding board for this book. He had three essential qualifications for fulfilling this role: He understands the subject matter; he can write; and most importantly, he can be brutally honest in his opinions. His comments about one chapter: “Sorry, Dad, but I think you should pull it.” Although reluctant to see two weeks of work go to waste, on reflection, I realized he was right, and I did. Zachary provided many useful suggestions (besides “ax it”), most of which were incorporated. Whatever defects remain, I can assure the reader they would have been worse without Zachary’s assistance.

Four of the interviews in this book were suggested and arranged through the help of others. In this regard, I am deeply grateful to the following, each of whom was the catalyst responsible for one of the interviews in this volume: John Apperson, Jayraj Chokshi, Esther Healer, and Zachary Schwager. I also want to acknowledge that Michael Lewis’s terrific book, The Big Short, was the source for one of the interview ideas for this book. I would also like to thank Jeff Feig for his efforts.

Finally, I would like to thank the traders who agreed to participate in the interviews and share their insights, and without whom there would be no book.

Part One

MACRO MEN

Chapter 1

Colm O’Shea

Knowing When It’s Raining

When I asked Colm O’Shea to recall mistakes that were learning experiences, he struggled to come up with an example. At last, the best he was able to do was describe a trade that was a missed profit opportunity. It is not that O’Shea doesn’t make mistakes. He makes lots of them. As he freely acknowledges, he is wrong on at least 50 percent of his trades. However, he never lets a mistake get remotely close to the point where it would provide a good story. Large trading losses are simply incompatible with his methodology.

O’Shea is a global macro trader—a strategy style that seeks to profit from correctly anticipating directional trends in global currency, interest rate, equity and commodity markets. At surface consideration, a strategy that requires participating in directional moves in major global markets may not sound like it would be well suited to maintaining tightly constrained losses, but the way O’Shea trades, it is. O’Shea views his trading ideas as hypotheses. A market move counter to the expected direction is proof that his hypothesis for that trade is wrong, and O’Shea then has no reluctance in liquidating the position. O’Shea defines the price point that would invalidate his hypothesis before he places a trade. He sizes his position so that the loss from a move to that price level is limited to a small percentage of assets. Hence, the lack of any good war stories of trades gone awry.

O’Shea’s interest in politics came first, economics second, and markets third. His early teen years coincided with the advent of Thatcherism and the national debate over reducing the government’s role in the economy—a conflict that sparked O’Shea’s interest in politics and soon after economics. O’Shea educated himself so well in economics that he was able to land a job as an economist for a consulting firm before he began university. The firm had an abrupt opening for an economist position because of the unexpected departure of an employee. At one point in his interview for the position, he was asked to explain the seeming paradox of the Keynesian multiplier. The interviewer asked, “How does taking money from people by selling bonds and giving that same amount of money back to people through fiscal spending create stimulus?” O’Shea replied, “That is a really good question. I never thought about it.” Apparently, the firm liked that he was willing to admit what he did not know rather than trying to bluff his way through, and he was hired.

O’Shea had picked up a good working knowledge of econometrics through independent reading, so the firm made him the economist for the Belgian economy. He was sufficiently well prepared to be able to use the firm’s econometric models to derive forecasts. O’Shea, however, was kept behind closed doors. He was not allowed to speak to any clients. The firm couldn’t exactly acknowledge that a 19-year-old was generating the forecasts and writing the reports. But they were happy to let O’Shea do the whole task with just enough supervision to make sure he didn’t mess up.

At the time, the general consensus among economists was that the outlook for Belgium was negative. But after he had gone through the data and done his own modeling, O’Shea came to the conclusion that the growth outlook for Belgium was actually pretty good. He wanted to come up with a forecast that was at least 2 percent higher than the forecast of any other economist. “You can’t do that,” he was told. “This is not how things work. We will allow you to have one of the highest forecasts, and if growth is really strong as you expect, we will still be right by having a forecast near the high end of the range. There is nothing to be gained by having a forecast outside the range, in which case if you are wrong, we would look ridiculous.” As it turned out, O’Shea’s forecast turned out to be right, but no one cared.

His one-year stint as an economist before he attended university taught O’Shea one important lesson: He did not want to be an economic consultant. “As an economic consultant,” he says, “how you package your work is more important than what you have actually done. There is massive herding in economic forecasting. By staying near the benchmark or the prevailing range, you get all the upside of being right without the downside. Once I understood the rules of the game, I became quite cynical about it.”

After graduating from Cambridge in 1992, O’Shea landed a job as a trader for Citigroup. He was profitable every year, and his trading line and responsibilities steadily increased. By the time O’Shea left Citigroup in 2003 to become a portfolio manager for Soros’s Quantum Fund, he was trading an exposure level equivalent to a multibillion-dollar hedge fund. After two successful years at Soros, O’Shea left to become a global macro strategy manager for the multimanager fund at Balyasny, a portfolio that was to be the precursor for his own hedge fund, COMAC, formed two years later.

O’Shea has never had a losing year. The majority of his track record, spanning his years at Citigroup and Soros, is not available for public disclosure, so no precise statements about performance can be made. The only portion of this track record that is available is for the period at Balyasny, which began in December 2004, and his current hedge fund portfolio, which launched in June 2006. For the combined period, as of end of 2011, the average annual compounded net return was 11.3 percent with an annualized volatility of 8.1 percent and a worst monthly loss of 3.7 percent. If your first thought as you read this is “only 11.3 percent,” a digression into performance evaluation is necessary.