Say it Ain't So, Stevie?

Saturday's WSJ article about the highly-secretive Steven A. Cohen was, well, quite shocking. It was an extremely well-written and informative piece that really humanized the man that has been the subject of so much mystery, admiration and scorn over the past decade. One quote in the story completely blew me away, however, as it seemed so out-of-character for the larger-than-life SAC himself:

That quick-trading game is now over, says Mr. Cohen. With about 7,000 hedge funds competing for investment ideas, good stock investments are getting more scarce. "It's hard to find ideas that aren't picked over, and harder to get real returns and differentiate yourself," he says. "We're entering a new environment. The days of big returns are gone."

To make matters worse, the stock market, he says, is no longer as forgiving for investors. The tailwind of low interest rates, low inflation and strong corporate profits, he says, has been lost. There are no more easy pickings, he says.

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"The hedge-fund run is not over," he said. "I think the game is changing, and if it is, I have to react. We won't go off the ledge with everyone else."

This does not sound like a multi-billionaire running an eleven figure sum for some of the most powerful investors in the world. Where's the hubris? What has changed? Is he right that the easy money has been made and it will be tougher sledding from this point forward?

I'm not buying any of this. SAC and its team is way, way too smart to be pigeon-holed by a single strategy. If there is too much money chasing too few ideas, invariably there is a lot of dumb money out there that can be exploited by someone smarter and more experienced. I mean, come on, he is up 18% YTD on a big, big number. That is pretty good based upon the stats I've seen.

Further, what of globalization? I'm not sure that the big money will be made trading conventional strategies in the U.S.; it may be made in Asia and other rapidly-growing parts of the world. As these markets become more liquid, firms like SAC can increasingly deploy larger amounts of capital which is what is often required to get these mega-firms to play. It may also mean that instead of 225 names he will have to follow 500 or even 1000 names to manage the liqudity risks while reaching for alpha. He has great people working with him that can build this seamless global platform, so I am 100% confident that this will be one of the ways that SAC will change with the times.

Then what of technology? As written about previously (most recently in my Lonelygirl15 post), tools now exist to extract, filter, analyze and display information from the Internet in a manner previously unimaginable. Given the trend towards more and better data and information being put out there on the Internet, it will be those with the vision, the brains and the tools to take advantage of this alternative data set that will establish a true edge on the competition. Again, SAC is a very forward-looking organization with the resources and trading acumen necessary to exploit the massive opportunity for discovery that is the Internet, so I am also certain that they will lever their expertise into this area as well.

So, from my vantage point things don't seem so bad for Stevie. Maybe he is showing his soft side so we'll all get complacent and he'll clean our clocks! That seems far more likely than the defeatist attitude on display in the WSJ article.

Comments

[Roger]

Greg, good points. I hear you. I think it's all on the table now. We'll just have to wait and see. Thanks for your intelligent and passionate comments.

[Greg Battle]

Roger, I would agree with you that there is a cyclical nature across any SINGULAR strategy/investment mandate - every strategy will eat itself in time as competition chases returns. As you've said previously, this is simple microeconomics via the rotation of capital among strategies. But we're not talking about any one strategy here, we are talking about an asset class (a misnomer that I despise) encompassing EVERY feasible strategy (or rather, every strategy in use).

Are you suggesting that the hedge fund space, which includes the leveraged investing/trading of every single type of global security, commodity, currency and collectible is in a "cyclical" downturn (as evidenced by the data)? If that's the case, what is the catalyst to rotate money away from hedge funds to open up the returns again? Globalization, technology and consolidation (all important industry forces) aren't the catalyst to bouy returns through another *on average* double digit return decade. Thanks to capitalism and the transparent meritocracy of the industry, innovation is nothing new. However, is the level of innovation accelerating with the increasing level of competition? For both our sakes, let's hope so, but this is a separate discussion.

Stating that there will always be a long-tail of funds (SAC or otherwise) who knock it out of the park relatively isn't saying much. Heck, probability states that as the number of funds increases, the chances of a fund(s?) having triple digit returns for a decade increases. Still, not really pertinent. Steve, however, was talking about how this new environment has compressed the average returns across the "asset class" [cringe] of hedge funds.

The good thing is, we're agreeing on the big points enough to end the thread, but it's still a good thread.

[Yaser Anwar]

"what of globalization? I'm not sure that the big money will be made trading conventional strategies in the U.S"What of globalization? I'm not sure that the big money will be made trading conventional strategies in the U.S." Big money might not be made in the US but SAC & other hedge funds know too well that the risks are also higher when it comes to investing outside the US. Especially when these HFs utilize a great deal of leverage. Just look at what happened to the international markets earlier this year, especially emerging markets. When the HFs decide to cut and run, they came falling down.

The opportunities have come down a lot since the emergence of twice as many HFs each year, plus SAC had close to 70%+ performance results in 99-00 era. Those types of opportunities are not available anymore. That's why we have seen such a drastic correction in commodities such as Gold, Silver. Gold used to be the least of the volatile commodities based on its history, however with so many HFs trading commodities due to their run up, Gold has become a somewhat poster child of risky commodities.

The interesting thing about the article is the evolution of Mr. Cohen. I believe that just being a trader is only a portion of the overall necessary faculties it takes to make it. As Mr. Cohen holds stocks for longer he will realize that it may not be as 'cool' as day/swing trading them but most fortunes have been made that way. (ex: Warren Buffet, Eddie Lampart)

I also think Mr. Cohen was showing a soft side not because he wants to increase the AUM or any of that, but with recent allegations made by Biovail, Overstock etc, SAC has got a bad name, so he had to come out & demystify the S. Cohen-SAC myth (A PR job of sorts).

[Roger]

Greg, I think you are engaging in selective reading. Look at my comment beyond the "getting squeezed" part - SAC and the other smart and forward-looking funds out there are developing new tricks for alpha generation. Maybe you are too young to remember, but things in this business are CYCLICAL. Attractive areas for investment are identified, returns are high, capital flows in, returns moderate, then even more capital flows in, and then returns get crushed. Capital then flows out, returns stabilize, even more flows out, returns improve, and so on.

We've seen this story before. It's just that guys like Steve are highly motivated (both by money and ego, really one and the same) and highly adaptable, and just figure stuff out. So I don't buy that he necessarily will suffer in the same way that overall hedge fund returns will suffer. Will he rip the cover off the ball in perpetuity (like somehow Jim Simonds seems to do), who knows. But I am confident that he will still be a massive alpha generator and that the negative tone he set in the article will not come to fruition - for him.

I'm not drinking the Kool-Aid, man. I just think that really smart guys, be they investors, entrepreneurs, CEOs, whomever, figure it out. And he will figure it out.

[Greg Battle]

[Note: The facts I gave were more for your audience, as I know that you know the moving parts of SAC better than I do.]

So wait Roger. In your original post, you say "I don't buy any of this," with regards to Steve's statement that "the days of big returns are gone," but then, in response to my post, you admit that returns have been "squeezed." So, do you agree with Steve's statements or not?

The truth is, Steve's comments are evidenced by the numbers. From Bloomberg today:

"The average hedge fund gained 9.2% last year after fees, slightly ahead of 2004's 9% and well below the average annual return of 16% compiled during the 1990s, Hedge Fund Research Inc. reported"

I'm not saying Steve's conceding defeat (gobs of investment in human, technology, and global innovation say otherwise), or even his crown (arguably the most successful over the longest run), but merely admitting the obvious; the "environment" (as well as returns) has drastically changed. Any friends of his know these numbers as well, so I don't really agree with that argument.

Given the number of times you refer to the quality of Steve's team (which has never been in question), I'm wondering if you might be drinking too much SAC Kool-Aid to agree with Steve's statement of fact. [I'm kidding, of course]

FYI: I'm still laughing at the Picasso's line - so true.

As for Amaranth, you are 100% spot on. The veil of multi-strategy funds being a proxy for diversification has officially been lifted. The emperor has no clothes. The sky is falling ... slowly.

[Roger]

Greg, needless to say, I know the facts about SAC as you do. Your analysis, though cogent and logical, misses a few key points. And it's not about lying, it's about ego. In a hedge fund manager, it's questionable which is more important - ego or money - though it is probably fair to say that they are inextricably linked. SAC's performance over the past few years has been OK, clearly not in the parabolic realm of prior years. This can't feel good to our friend Steve. Forget about the wallet - he is still buying Picassos and whatever else he wants at a rapid clip. As the environment has become more challenging and more money is sloshing around, the rapid-trading/quasi market-making game has gotten squeezed. This is true. However, Steve has hired some pretty great guys to both go global and go high in technology, two areas where I believe he is well-positioned to extract alpha. I think his arguments are more reflective of someone managing expectations - his own expectations and those of other people whom he respects - than anything else.

I also don't buy that argument that concentrated AUM by top managers necessarily correlates with intellect and risk management, as the recent Amaranth debacle attests (based upon the losing traders' comments, he clearly hasn't read Taleb's Fooled by Randomness). My comments don't revolve around rational motive in the wake of his unique fee arrangement. He could care less from a financial standpoint if people redeemed, but I am sure his ego would take a beating. So at the end of the day if people were purely rational beings in the microeconomic sense, then I'd agree with you. But they're not, which is why people like Steve make gobs of money off less savvy market participants over long periods of time.

[Greg Battle]

Well Roger, I gotta disagree with you here, namely because SAC is a unique monster among beasts. I'm gonna give some backstory and then my argument.

As always, fund structure reflects the incentives. Given that SAC is a 0% mgmt fee and 50% performance fee fund, what is really going on? Well, what the fee structure tells us (and is bourne out in fact) is that Steve himself is the largest LP in the fund, by a HUGE amount. Given his money accounts for most the AUM, he's not going to pay himself a management fee, and any investor lucky enough to get into his closed fund pays handsomely to invest side-by-side with him.

What does all this mean? For all intents and purposes, SAC is a one LP (Steve Cohen) shop, hence, there's no management fee "income" since there is no management fee. Due to this fact alone, SAC is NOT aligned to be an asset aggregator (a mutual fund like vehicle generating returns from mgmt fees) mimicing a hedge fund. No other mega-fund dujour can make this pure-play claim. I'd venture to say that the only way Steve could get in this position is through the discipline of giving back returns to LPs and eventually their principal, leaving him with the lion's share over time. SAC is structured the same way you or I would do it - given we had a deep 10 figure wallet, a couple hundred people on our investment staff, and a few select friends along for the ride.

I went through that long-winded explanation to back up my reasoning why Steve is actually telling the truth, the whole truth and nothing but the truth. Simply put, he doesn't have a reason to lie! He's not raising assets (doesn't need to). He's not beholden to a group of alpha starved "fast money" LPs (there are none). He's not afraid of redemptions via a run for the exits in tough times since (miniscule impact). He's not afraid of losing key talent because with a 50% carry, he can pay them more than they'd make starting their own fund without the headache (great incentives).

I submit, there is no reason for him NOT to be telling the truth.

[note 1: though i will say, when he says "big returns", i think he's talking about 30+% or 40+% range.]

[note 2: of the 7-9K hedge funds in existence, only about 200-300 of them control over half the $1.2T in the asset class....that's a lot of concentrated smart money]