The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds (8 page)

Going After What You Want

Dalio doesn’t think people should seek out what successful investors do and follow it. Dalio tells a story about an architect that illustrates how he feels about innovation and marching to the beat of your own drum.

“I told the architect what I wanted in the house and how it should work. He said, ‘Yeah, yeah, I get it. I really want to build a house that way.’ So I asked, ‘Well, can you show me houses that you’ve done that way?’ He said, ‘No, because customers don’t want to build the houses that way so I’ve had to build these other houses.’ And I said, ‘But how do we know that we’re talking about the same thing?’ And he brings out this book of another architect’s work. And he said, ‘This is what we’re talking about.’ So then I said to myself, ‘Well, let me call this architect instead.’ So the other architect and I did the house together. The interesting thing about the second architect was, when I said, ‘this other guy has always wanted to build the house this way, but he really felt he didn’t have the opportunity,’ he said, ‘well that was true for me, too. So I built doghouses to begin. But I really wanted to build this kind of stuff.’ And so it’s the same for me. I’ve got clients now for 20 years who allowed me to innovate on a small scale before going big.”

Dalio stresses the importance of being true to yourself, especially with investing. “We all understand that [independent thinking] is a necessity,” says Dalio. “We understand it better than other people because value-added alpha is zero-sum. So if you think about almost any career and any job, you can add value and it’s not zero-sum. If you’re a doctor and somebody breaks their leg, you can fix their leg, you can add that value. In our business we’ve learned that it’s not so easy to have an opinion and be confident that opinion is right. I learned this at a very early age. So you take me at 12, I went after what I wanted to go after, not following instructions. And I also know it’s not so easy to have an opinion that you’re confident in. Be careful of the opinion that you’re overconfident in.”

Dalio thinks the path to greatness is challenging, and that it ought to be, but he also believes it is attainable. “I met a number of great people and learned that none of them were born great,” he writes in the
Principles
. “They all made lots of mistakes and had lots of weaknesses—and that great people become great by looking at their mistakes and weaknesses and figuring out how to get around them. So I learned that the people who make the most of the process of encountering reality, especially the painful obstacles, learn the most and get what they want faster than people who do not. I learned that they are the great ones—the ones I wanted to have around me.”

Chapter 2

Man versus Machine

Pierre Lagrange and Tim Wong

Man Group/AHL

I love what I do. I love finding investments that people have missed. I love the whole discussion and arguing cases with bright people, or reviewing an obscure company, or discovering the best way to play that macro thematic on demand in that country. And I just hate to take no for an answer.

—Pierre Lagrange, Founding Partner of GLG, May 6, 2011, interview

Observing the peerless dance duo Fred Astaire and Ginger Rogers glide across the screen, the actress Katherine Hepburn reportedly decoded the duo’s brilliant chemistry, saying, “He gives her class and she gives him sex appeal.”

Those may not be the precise adjectives that come to mind when thinking about the Man Group’s 2010 blockbuster acquisition of GLG Partners, but they’re not far off; in creating one of the world’s largest hedge fund organization, with $69 billion in assets, each partner brought unique characteristics. In the Man Group, a company so old school it’s where the old school went to school, shareholders get the hardnosed quants who note every price fluctuation in every trend in order to patiently profit from the long-term trends. In GLG Partners, they get a star culture of investment gurus whose collective reputation for success attracted $30 billion in assets. Not class and sex appeal exactly; more like grit and glamour, patience and spark.

Opened as a sugar brokerage by barrel maker James Man in 1783, the company’s first break came a year later when Man won the contract to provide rum to the Royal Navy (the service’s tradition, by which each sailor received a tot of rum daily, was observed until 1970, with Man holding the contract for the entire time). Over the years, the company evolved into the commodities trading firm ED&F Man (which continues in business as a separate entity), and then, through astute acquisition of managed-futures traders and fund-of-funds operations, celebrated its bicentennial with its first acquisition of a hedge fund, New York’s Mint Investment Management Co. By the end of the decade, the company had a billion dollars in assets.

The flagship of Man’s operation, with $23.6 billion in assets, is AHL. This unit was founded by Michael Adam, David Harding, and Martin Lueck, three analysts who studied physics at Oxford and Cambridge Universities, who eventually sold the firm to Man in 1994. Rigorous in its study of long-term trends, AHL has achieved an annualized return of 16.7 percent from its inception in March 1996 through September 2010. But as Man Group CEO Peter Clarke told
Institutional Investor
in 2011, “clients, especially those in Asia, wanted exposure to a discretionary single manager.”

Enter GLG, which has single managers by the score. Established in September 1995 by Noam Gottesman, Pierre Lagrange, and Jonathan Green, a trio of erstwhile Goldman Sachs private-client executives, GLG quickly became home to nearly 200 elite fund managers, each of whom is free to pursue his or her own strategy. Though enormously successful—along with substantial growth and profits, the firm has won numerous accolades and awards—a system so dependent on star power has proven to be unstable; the departure of the highly successful trader Greg Coffey a couple of years ago triggered an outflow of several billion dollars.

With their needs and assets so obviously complementing one another, Man and GLG began exploring a merger in 2008. Those talks were abandoned amid the turbulence of the financial crisis, and were resumed with a new urgency in the aftermath. AHL was up in 2008 but was down 17 percent in 2009, and in 2010 was still 3.7 percent below its high-water mark. Man’s fees suffered accordingly; in March 2010, fees amounted to $97 million, down from $358 million the year before. In addition, RMF, Man’s fund-of-funds business, lost $360 million in the collapse of Bernard Madoff’s Ponzi scheme, and others strategies suffered significant losses as well.

In the face of these losses, Man’s CEO Peter Clarke began the search for new assets. GLG was the first place he turned, and he found receptive listeners. Between the market turmoil of 2008 and Coffey’s departure, GLG’s stock price tanked, and the amount of assets under management fell to $17.3 billion, reportedly threatening to put GLG in breach of a covenant on a $570 million loan from Citigroup. Although the company rebounded rapidly, Clarke’s call came when the smell of disaster was still fresh in the air. Suddenly, each side saw itself looking at a partner who not only addressed its problems but promised attractive synergies. The allure of becoming among the first $100 billion hedge funds on the planet was too attractive to pass up, and the acquisition was announced.

Still, no marriage is without its bumpy patches, and, in this case, the partners are not without the sort of habits, traits, and idiosyncrasies that often prove quite bothersome. We have the Man Group (from 1783, a buttoned-down, corporate, systems-driven, black-box operation based in a venerable Sugar Quay building in the city of London) and GLG (from 1995, an individualistic, personality-driven, entrepreneurial, blue jeans–wearing, star system–driven operation based in fashionable Mayfair). No wonder
Institutional Investor
called them the “Odd Couple.”

But no Felix and Oscar combo has ever enjoyed such expectations. Observers fully expect the new Man Group, with the quants designing new products for the gurus, to become not only one of the first hedge funds to surpass $100 billion in assets, but suggest that—if hedge fund growth continues as analysts predict and if big successful funds continue to take advantage of their scale to keep attracting new assets—the Man Group could reach the $200 billion mark in the not too distant future.

Two of the Man Group’s key executives, Tim Wong, the CEO of AHL, and Pierre Lagrange, one of the three founding partners of GLG, each had very different paths they took to the Man Group, but now work hand in hand to run one of Europe’s biggest, and most complex, hedge funds.

Tim Wong: The Engineer

Looking back, Tim Wong realizes that while his upbringing in Hong Kong was not steeped in the disciplines of finance, a great many of the people that he knew in his family and his neighborhood were involved in playing odds one way or the other. “My father probably had more success with horse-racing than trading in the stock market,” he laughs. Either way, such concepts as trends, odds, risk, winning, and losing were introduced at an early age, and must have taken hold. When the intellectually gifted Wong left Hong Kong to study engineering at Oxford University, he had not decided to which branch he would devote his skills, but, as an undergraduate, he became increasingly interested in finance.

As he neared graduation, he saw an advertisement in the newspaper. “It was probably about an inch and a half by an inch and a half, something like that, very small,” he says, “and it didn’t say which company it was from. But it said something like ‘If you want to join a dynamic business and if you have some science background and like market value, please apply.’ I guess there must have been other ads out there, but that was the one that actually caught my eye. So I applied, and it turned out to be from AHL. And once I started interviewing with them, I never looked back.”

Wong, who became the company’s CEO in 2001, says he was not daunted by the fact that he had no background or education in the stock market. “AHL was all about using systems, which is what I had studied and what I knew. I knew how to write programs and how to analyze data and how to build models. The rest I could learn. So, it was a good way, actually, to enter into financial sector.” Today, Wong says he is very grateful that he studied engineering. “They don’t actually teach you how to build anything in school,” he says with a chuckle. “But they teach you how to think.”

Wong’s experiences during his first few years at AHL were hands-on, writing programs that would deliver data and trading signals to markets more quickly (every few minutes, which used to be fast). Wong says he learned two lessons from these early experiences, which he continues to emphasize.

The first is teamwork. “We were a very tight-knit group that shared ideas and tried to help each other. It wasn’t a big group—the research team was probably 10 people, and the whole company had fewer than 30. But we were extremely helpful to one another, and that culture is still here today. People are always ready to help.”

The second lesson, says Wong, “is that, for some reason, and I don’t know why—we had no fear. We all somehow just believed that we could do whatever needed to be done. Deadlines? No problem. We were super optimistic. And as a result, we didn’t care if we failed. You would try and fail, and try and fail, and try and fail again. But everyone was so optimistic, and believed that it just was a matter of time until you discover something.” And it was okay, Wong says, if after three years, the only thing you had discovered was that the thing you were trying to do just couldn’t be done; you still learned something. “It was extremely good to have done that because that really drew into your head what was possible and what was not. I was very lucky to have started out in a place where we could be unbelievably optimistic about our own ability.” He admits that it is not so easy to have that kind of attitude in a company like AHL today.

Although he is CEO of a trading company, Wong says he still sees himself as an engineer. “I’m very practical,” he says. “If we’re looking at a model, I’m not interested in the underlying theories behind why this model is so successful. I’m interested in the outcome, and I’m interested in how to bring the outcome to life. The purely intellectual pursuit of alpha? It’s absolutely not what I do. And I know I drive the people who come from a pure math background crazy. There have been times when we’ve had to put a risk factor in an equation, and the math people have been going back and forth over whether to make it 2.3 or 2.4. And I say, come on, just make it three. I just want something that works.”

Wong says that the one thing most people don’t understand about systematic trading is the trade-off between profit potential in the long term and the potential for short-term fluctuation and losses. “We are all about the long run,” he says. “It’s why I say, over and over, the trend is your friend.”

“If you’re a macro trader and you basically have 20 positions, you better make sure that no more than two or three are wrong. But we base our positions on statistical models, and we take hundreds of positions. At any given time, a lot of them are going to be wrong, and we have to accept that. But in the long run, we’ll be more right than wrong.” Evidently—since 1990, AHL’s total returns have exceeded 1,000 percent.