“From the point of ignition to the final drive, the point of the journey is not to arrive.” – Neil Peart
New clues are emerging on the nature and pace of change…
Here’s the setup: Unlikely and unexpected virtuosity often serves as the catalyst for a dynastic run of success. Moreover, legend has it, that it’s usually the will over and above the skill that fuels the initiation and duration of that run. While skills eventually decay, it’s the will to keep finding a way to win – to distinguish oneself or team relative to the competition – that’s the defining factor. Of course, whether it be a football field or a market landscape, like a moving sidewalk, everything happens as the ground is constantly shifting below our feet.
What happens to Tom Brady next, I’m not here to predict. He is merely a reliable hook to drag your attention to this point in the story because the debate about whether his game has changed to favor running, mobile or pocket quarterbacks (at any age) is relevant to a parallel debate we are having here on the Feed about the state of markets and whether certain strategies are still able to perform to expectations in an environment increasingly dominated by those who wield technology.
Our opening metaphor is germane because it seems that another category of dynastic success is coming to an end. In November 2019, Louis Bacon – the legendary founder of global macro hedge fund powerhouse, Moore Capital Management; built from an era and mold featuring the likes of Paul Tudor Jones (Tudor Investments) or George Soros (Soros Management) – announced that, after a stellar 30-year run of double digit performance, he would be taking his ball and heading home by returning all outside money. It’s unclear as of the writing of this Feed post whether this is a deflated ball or not. 😉
For those who have been watching closely, this is just the latest in a lengthening string of high-profile exits from the trading, hedge fund and asset management world. Of course, at the youthful age of 63, no one would fault Bacon for struggling to continue to muster the will – and assemble the skills – necessary to carry on in this environment.
Now, as we has been swinging, somewhat serendipitously, from vine to vine through the messy jungle of market-oriented data for the past few years – adding direct and contextual evidence to our platform as we go, Alphacution’s exploratory modeling exercise has yielded a series of consequential and framework-reinforcing discoveries that illustrate the da Vinci-esque prophecy that everything is somehow connected to everything else.
Alphacution first detailed its view of the source of such hedge fund and other exits back in October 2018 with “The Privatization of Alpha” where we posed that the “winner-take-all” nature of markets under threat of increasing technical adoption was causing a bifurcation of the landscape between alpha players and beta players. We later built upon this analysis in a much more detailed piece, “BlackRock, Bridgewater, Citadel: The Decline of Speculation at Scale,” which portrays the market ecosystem as a massive information reception, transmission and consumption mechanism that favors increasingly automated “information asymmetry harvesting” strategies and places largely discretionary strategies at an increasing disadvantage. Hence, we now see firms like Moore Capital and others apparently behind the curve and situated in their tenure such that the founder and/or culture is left without the skill or the will to fight the tape…
All of these types of developments continue to support Alphacution’s hypothesis that the capacity of alpha is finite (yet, elastic) and the leading tech-savvy firms are extracting a proportion of that alpha capacity that used to be more widely distributed among the likes of Moore Capital, thus causing increasing levels of concentration among the leading players (along with more exits, AUM declines and fewer new entrants).
And, though we remain challenged to visualize our discoveries in a more easily consumable format (given new insights into the layers and elasticity of interdependent factors), the overwhelming sense of complexity that you may find below should be temporary. Here’s what I mean:
This “map,” now interpreted to symbolize the theoretical capacity (i.e. – size) of alpha, is elastic. The “size” of the map is determined, at any point in time, by at least four factors: inventory, liquidity, volatility and information asymmetry – where the ability to harvest the value of unharvested information asymmetries is often known as “edge.” (We first proposed this factor list last week in the Feed post, “Implications: 2019 Payments for Order Flow Flat vs. 2018.” It may not yet be complete.) So, for instance, when the value of these factors is low or in decline (especially, volatility), the map should be interpreted to shrink – as we are attempting to illustrate in the exhibit above where the bottom panel is smaller than the top panel.
Meanwhile, the winner-take-all impacts of increasingly sophisticated workflow automation causes leading players to be more dominant, regardless of the capacity of alpha at any point in time but especially when that capacity is in decline. Thus, we depict them as being larger in the lower panel of the prior exhibit. In short, we are attempting to illustrate several factors in simultaneous motion. Chances are that we will need to revisit this interpretation a few more times so that it glides more smoothly to a point of greater understanding.
Note: Showcasing Citadel (Securities) as the leading “alpha player”and BlackRock as the leading “beta player” is not to suggest that they are the only leading players in their respective zones. We will expand on that soon. And, admittedly, we may want to rethink using Bridgewater as the quintessential leader example in the active management zone as they are more of a quant global macro player while many of the other leading players – like Renaissance, D. E. Shaw, Millennium, Two Sigma and others – line up more in a stat arb / mean reversion strategy category. Stay tuned for more updated thinking on that topic, as well.
One more thing on the prior chart before we move on to bring this one to a close: The boundaries of our three zones – structural alpha, active management and passive management – are also elastic. Certainly, given our insights about a subset of leading players executing what we are calling a “nested alpha strategy architecture” (NASA?) – and, as a result of that, extracting more structural and asymmetric forms of alpha from a single, unified multi-strategy platform – the active management zone (where all hedge funds and their relative-value strategies reside) is being squeezed from the structural alpha zone side. These are some of the most profound and impactful game changers on the field today. Alphacution believes that their playbook is a primary driver for the unique challenges faced by so many hedge fund managers…
Now, these are not the only game changers to keep an eye on. Alphacution’s ongoing research efforts have unearthed something new worth bringing into this perspective: Our foundational case study, “The Context Machine,” established a relationship between tech spending, headcount and trading (or investment) strategy. At the risk of a bit of oversimplification, that analysis established a reliable range of technology spending for the hyperactive strategy end of the spectrum (in the structural alpha zone). Intuitively, this means that it requires about the same number of employees to operate similar technology installations for similar strategies which are then scaled roughly by the number of liquidity venues targeted for that strategy.
Except, maybe not anymore. Alphacution has discovered that there is a team out there who appears to be expanding the definition of operational efficiency by redefining the relationship between the cost of the required technical installation and the headcount necessary to support that installation:
Now, we have decided to keep this last exhibit quite cryptic, as you can see. Rest assured, this will eventually be made far less cryptic as we further build out the analysis.
As for Jim Cramer, is anyone watching anymore? More on this later, as well.
Until next time…