Re-run: Gappy Paleologo

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Speaker 4 Happy Thanksgiving.

Speaker 5 Hope you're having a great holiday. We are obviously not recording on this Thursday, so.

Speaker 4 We're going to rerun a favorite old episode.

Speaker 5 It's going to be great. You're going to enjoy it even more the second time.

Speaker 4 Bye.

Speaker 4 Wait, Cappy,

Speaker 4 Palaeologo or Palaeologo. Paleologo.

Speaker 5 I'm so excited for you to tackle that and not me.

Speaker 4 Good luck.

Speaker 5 I thought I had it down, but then I heard you say it.

Speaker 4 I feel like when I first met you, I think I asked you if you go by Gappy

Speaker 4 because of your

Speaker 4 famous track record of taking gardening leave and like having gaps in your career.

Speaker 6 Oh, okay. I didn't remember that.

Speaker 6 Yeah, that's a great excuse for a nickname.

Speaker 4 Is it just, I mean...

Speaker 6 No, but the reason is when I came to the States for grad school, and this was a long time ago in 95, so the first thing that you did was set up an email account.

Speaker 6 You still had the freedom to choose an email account. Now they just give you your initials with the number.
And so my initials are G-A-P, GAP, Giuseppe Andrea Palaologo. And of course, it was taken.

Speaker 6 So I said, okay, well, Gapi. And then everybody in grad school and then my wife was Italian, everybody started to call me Gappi and that stuck.

Speaker 6 And now at work, they just have dispensed with my real name. Like on all systems, I'm just Gappi Palaeologo.

Speaker 6 So I expect that that will be, you know, prosecuted for tax evasion because on my tax forms there is Gappi Palaeologo or something like that.

Speaker 4 Well

Speaker 4 hello and welcome to the What East Podcast. I'm Matt Levian.

Speaker 5 And I'm Katie Greifeld.

Speaker 4 And we have a guest today, Giuseppe Gappi Palaeologo, who is now at Palaeasny and has been at most of the other PayCatch ones and Hudson River Trading.

Speaker 4 I do want to start by talking about gardening leave. Okay.

Speaker 5 Natural place.

Speaker 4 I think that we

Speaker 4 counted from your link. Your LinkedIn is like famous for

Speaker 4 discussing your gardening leave in some detail. And I think we counted three years of gardening leave.
No, I think it's a bit okay.

Speaker 4 It's not precise.

Speaker 6 15 months from Citadel, one year Hudson River trading, and four months from Millennium.

Speaker 4 Okay, so pretty close. Not terrible, though.

Speaker 6 Yeah. A bit less than two years.

Speaker 4 From my perspective, it seems very fun. Did you enjoy your three years of gardening?

Speaker 6 I do. So I try to keep myself busy.
So I teach typically at some university.

Speaker 6 So the first time during my Citadel to Millennium Gardening Leave, I was teaching at Cornell and in the HRT to BAM Guardian Leave I was at NYU.

Speaker 6 And I love teaching. And then what I do is it helps me focus on

Speaker 6 stuff.

Speaker 6 Usually what I do in, you know, whenever I read a book or read a paper that I like, I take notes, I take notes in LaTeX,

Speaker 6 and then I rederive or think about things. And so that typically is the basis for my course material.
And then it becomes the basis for my books. I've written a couple of books during my non-competes.

Speaker 5 Interesting, because thinking about gardening leave, Matt and I talk about it all the time because it's very alluring to me. Gardening leave doesn't really exist in journalism.

Speaker 5 I love to imagine what I would do. But one of the questions I had for you was, you know, do you have ever have anxiety about losing your edge or falling behind?

Speaker 5 But it sounds like teaching is one of the ways that you can get it.

Speaker 6 Yeah, I'm not particularly worried with that. I think that there is only a very specific subset of quantitative researchers who are afraid of losing their edges.
And yeah, that's not been my case.

Speaker 6 I keep reading. I try to stay up to date.

Speaker 4 Do the books

Speaker 4 feedback into the work? Like, do you get good ideas or deepen your understanding of techniques by teaching and writing the books? Or are they just sort of like

Speaker 4 extracurricular?

Speaker 6 No, no, no. It's definitely, I learn a lot from writing the books.

Speaker 4 And then do you like go to your next job and

Speaker 4 generate more profits by?

Speaker 4 Of course, plenty more profits.

Speaker 6 Sell that to my employers. No, but I definitely learn a lot from writing from the first drafts and then I rewrite and rewrite and I learn a lot from discarding material too.

Speaker 6 It's very useful to discard material. It makes you really focus on what matters and what doesn't.
So I try to give a narrative. like a logical connection between various topics.

Speaker 6 And that is something that is possible only when you write a book. I really do not like writing.
Nobody I think likes writing, maybe except for you.

Speaker 4 I do. I do like writing.
I do like writing. I understand that it's weird even among writers, but I do.

Speaker 6 It is very, I find it very painful. I find painful letting go of material, yes.
But I also like it. You know, it's some kind of

Speaker 6 strange delayed gratification, I guess.

Speaker 4 One theory that I have written is that hedge fund and quantitative research gardening leave is like

Speaker 4 a source of like human flourishing because you have all these like highly trained people who have an enforced year off.

Speaker 4 And I've written that all the hedge fund researchers should go work at LLM companies or like

Speaker 4 analytics departments of sports teams.

Speaker 4 And I'm like partially kidding and partially not. How true is it for you, like how much of like your

Speaker 4 quantitative skills at this point

Speaker 4 really just for investing and how much of it is like if you spent three months you know consulting for a soccer team you'd be able to tell them how to find better players

Speaker 4 um

Speaker 6 i'm not sure so i'll say this right i was thinking a few days ago if there was a kind of a common thread in my professional life because it seems kind of random

Speaker 6 And actually, I think that there is, because I think that I was about 14 when when I realized that I had an aptitude for applied math.

Speaker 6 I discovered physics and I liked math and I also liked literature very much. So I loved reading.

Speaker 4 I read a lot.

Speaker 6 I was not a very social animal. And then basically since then, I've been doing the same thing in various forms, right? I did physics.
I did applied math. I didn't do applied math in finance.

Speaker 6 I did applied math in weird things like optimization and logistics. So I have been doing kind of the same thing over and over, which has been writing and applying math to something.

Speaker 6 So I think that I could do it. I would like to do it.
But I also think that

Speaker 6 it's not that simple

Speaker 6 to go to a new field and say, oh, after three months, I know soccer. No, there is a lot of specificity.

Speaker 6 And And the beauty of, I think, being a good applied mathematician is that they start with the problems and with the domain first and that they're sufficiently mature from a mathematical standpoint that they are not making too much of an effort in using math.

Speaker 6 So I think the good art of being an applied mathematician is to study persistently the application.

Speaker 6 So, no, I don't think that after three months it would be good enough, but after a year you know, about a year of being fully immersed in an application, then you start getting a little bit better.

Speaker 6 And then the math is not the problem. And then you start doing some good work.

Speaker 4 You have a famous essay on like advice for quant careers.

Speaker 4 And you say that like the things that matter the most are creativity and

Speaker 4 genuine interest in the problems

Speaker 4 more than

Speaker 4 math horsepower. Yeah.

Speaker 4 This is a dumb question, but how does one develop, how does one identify, you know, creativity and interest in financial topics? And is the obvious answer, those are where the money is? Or like,

Speaker 4 why, why did you fall in love with finance as a topic? And is the answer? Because that's where the money is.

Speaker 6 So first of all, I think that creativity is a personality trait. It doesn't belong to fi.
You're not creative in finance.

Speaker 6 You know, you're creative in cooking. You're creative in whatever.
And it's a mix, I guess, of extroversion, openness to experience.

Speaker 6 And I don't know what else. I'm not a psychologist, but I do believe that people are genuinely creative.
And in fact, you see it, right?

Speaker 6 Sometimes

Speaker 6 you ask someone and you find out that, yes, they like writing, they play some instrument if badly, and

Speaker 6 they paint and they do whatever. And so I would say if you go to finance, because that's where the money is, there's nothing wrong with that.
And in a way, that's my story.

Speaker 6 I was a researcher, I wanted to have more money and whatnot. But eventually, you stay in finance, or at least in my little domain, because you're genuinely curious about finding out stuff, right? So

Speaker 4 why are the problems like

Speaker 4 why do they arouse curiosity? Like, why do the problems of finance intrigue you after

Speaker 4 years of doing it, right? Like, what's interesting about those problems as opposed to other domains?

Speaker 6 It's really hard for me to say. Like, I think that I read once that a young songwriter asked Bob Dylan how to become a good songwriter.
And Bob Dylan just answered, Well, what's going on?

Speaker 6 I say, what do you mean, what's going on? Yeah, what's going on? What's going on in your life? Just, you know, look around. So sometimes I get these questions from investors.

Speaker 6 Oh, but you know, how do you keep yourself interested? How do you find problems? It's not a problem. Like, the problems jump at you.

Speaker 6 Like, there are too many problems. There are too many interesting problems.
So if anything, the skill is in sorting the problems in the right order, right?

Speaker 6 That is where maybe having some maturity in doing doing research kicks in. But there are lots of problems, infinite problems, weird problems.

Speaker 4 What's your favorite problem right now?

Speaker 6 I don't know, like right now, what are we working on? I mean, we are trying to understand how earnings are monetized, right? How do you make money in earnings?

Speaker 6 It's such a basic thing in fundamental equities.

Speaker 4 You mean if you're correct about predicting earnings? Yes,

Speaker 6 what are, I mean, without getting too much into details, but

Speaker 6 what are the relevant variables? Imagine that you had an oracle who told you what the variables are. What would you do with that? What would you do if you had all the information in the world? Right.

Speaker 6 And everything in your world, in your existence, would be like an approximation problem.

Speaker 4 There's an incredible stylized story of the guys hacked into, I think, like one of the Newswire services and got...

Speaker 4 earnings releases early like for hundreds of companies and they traded on this and they had like a 70% success rate which is great great, but also like it means they had a 30%.

Speaker 4 Like, they traded the wrong way, knowing earnings perfectly in advance. It's like a good yeah, yes, so they had the Oracle and you know, it's still hard, yes, it's still very hard.

Speaker 6 Actually, shout out to Victor Hagani, who wrote the paper about 10 years ago on this.

Speaker 6 He made a organized simple controlled experiment where he gave basically a biased coin where you, I think, had a success rate of 60%, 40% failure, and you had some capital and you could invest it over time on these informed predictions.

Speaker 6 And a lot of subjects went bankrupt.

Speaker 6 Okay, now I think we are better than that. But still, there are lots of problems related to trading around an event, for example.

Speaker 5 Before we get too far away,

Speaker 5 you mentioned Bob Dylan. It actually reminded me of another Bob Dylan quote, which I'm going to paraphrase poorly.

Speaker 5 But he basically said, when asked about writing songs, do you think that you could write whatever the work that was being referenced now? And he said, I don't think so.

Speaker 5 It's like the words were in the air, and I just plucked them out. They were just sort of hanging in the air and they came to me.

Speaker 5 And it kind of also rang true with what you were saying about you didn't go looking for problems, they're just there necessarily.

Speaker 5 I actually want to go back to applied math if it doesn't interrupt the course of conversation too much.

Speaker 5 You tweeted on June 24th that there's no child prodigies when it comes to poetry, when it comes to applied mathematics.

Speaker 5 And I'm not saying that you said that you were a prodigy, but you were a child at 14. I mean,

Speaker 5 how at 14 do you realize that you have an aptitude for something like applied mathematics?

Speaker 6 Okay, I don't want to flex about this stuff.

Speaker 5 No, you should.

Speaker 6 I think I'm honestly a little weird. I'm just a little weird, I think, honestly.

Speaker 6 But I'm like prodigy weird, or I did have my share of adults telling me that I was good at this or that, or, you know, but yeah, I mean, what can I say? I'm just a little bit atypical.

Speaker 6 Also, when I talk to investors, I think investors enjoy my presence because

Speaker 6 I think I'm incredibly unfiltered for somebody who's talking to them.

Speaker 6 So it's like fun for them. And I was very unfiltered when I talked to my professors in in school.
Sometimes I corrected them.

Speaker 6 Stuff like this.

Speaker 4 Yeah, I don't know. Honestly, I I I don't know.
When you talk to like fundamental equity portfolio managers, like

Speaker 4 how much like matrix algebra is there in your conversations? Like how quanti are the fundamental PMs or whatever?

Speaker 6 I don't think they're quanti, but I think that they're very analytical. So I don't think that they would make

Speaker 6 great mathematicians, but I think they would make very, very decent applied mathematicians, actually. They tend to be very analytical.
They tend to be very process-oriented.

Speaker 6 And they have also additional qualities that actually mentioned in that essay. Like they have very little disposition effect.

Speaker 6 So that's part of being analytical. They have no sunk cost fallacy in them.
So even though they don't do a lot of math, but they do some math, okay.

Speaker 6 So first of all, they're fluent in a sense in basic literacy. But I think it's more their process that is closer to, if not a mathematical one, but more of a scientific one.

Speaker 5 And when it comes to being a quant, does it basically boil down to being good at math and being interested in math or things such as statistics and physics? I mean, do you need to have any

Speaker 5 finance or economics background at all?

Speaker 6 So I think that having an economics background is not necessarily a benefit, might even be a disadvantage,

Speaker 4 actually.

Speaker 6 But just based on very few samples that I have, a lot of very good, outstanding quantitative researchers actually come from physics and specifically from astrophysics.

Speaker 6 That's the experience that I've had in a couple of places.

Speaker 5 In broad brushstrokes, could you talk about why economics, in the small sample size you have, how could that possibly be a detriment?

Speaker 4 And why is astrophysics good?

Speaker 6 So I can answer the second question more easily. I think that astrophysicists deal with large amounts of data and they deal with the observational data, so they don't get to do a lot of experiments.

Speaker 6 And that's good for finance, right?

Speaker 6 You deal with a lot of data, you need to know how to have good hygiene for observational data, and you need to have very good theory, like you need to have very good instruments without being falling in love with those instruments.

Speaker 6 Whereas I think economists, okay, first of all, my statement is purely empirical, okay, so I'm just really guessing on economists and I'm going to be hated by all economists or economists in finance.

Speaker 6 But I do have my issues with their methods, right? So first of all, I think that there is an original thing in economics, which is

Speaker 6 I think a lot of economics is informed by a desire to be as rigorous as mathematics, right? And so a lot of theoreticians in economics are very deductive in their approach.

Speaker 6 If you think of the unrealistic assumptions behind the welfare theorems or Arrow's impossibility theorem or whatnot or just pick up Samuelson textbooks.

Speaker 6 And I think this this is sort of axiomatic rather than very axiomatic, very deductive. Whereas physicists are very happy to think in terms of small idealized models that apply to a specific domain.

Speaker 6 And if the model doesn't work out, they will discard and make another one.

Speaker 6 The grand theory behind physical theories exists, like there are people who do this for a living, but many, many good theoretical economists, physicists, start in the small and then they expand the domain of their models.

Speaker 6 So economists tend to maybe in a sense fall in love with methods too much, with techniques too much.

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Speaker 4 We had Cliff Aslas on the podcast a little while ago, and my father, not a finance person, listened to the episode and said, I still don't know what a quant is. I just

Speaker 4 read, skimmed your new book, which is called The Elements of Quantitative Investing and

Speaker 4 lays out the elements. What is a quant? Like, what are the elements? Like, what's the thing that makes someone a quant investor or that like

Speaker 4 someone reading a slim book about the elements of quant investing needs to learn?

Speaker 6 Well, if I am being consistent with my book, investing is really about problems and not about specific techniques or anything like this, right?

Speaker 6 So it's basically a way to go through the whole investment process from, let's say, preparing the ingredients to cooking to eating that is very process driven.

Speaker 6 Ultimately, you would imagine that one thing that quantum investing has in common across multiple domains, if you do futures, stocks, event-based and whatnot, is

Speaker 6 I think the number of bets tends to be high in systematic investing, right?

Speaker 6 So you can be a very successful macroeconomic investor, portfolio manager, and you, you know, according to even several statements by Buffett, you know, he made like 10, 12 very good bets.

Speaker 6 Okay, so that's great. And that's not quant investing.

Speaker 6 You know, you could put enough PMs making, you know, 20 bets in their lives and you will get a few that have, let's say, 12, 13 right and they will be rich.

Speaker 6 We do not have that luxury, like we have to make millions of bets. You know, we trade a portfolio with 3,000 stocks, sometimes in waves of half an hour.
You can't make a judgment on all of these bets.

Speaker 6 So you need a method that reduces the dimension of your problem to something that can be treated in a systematic manner.

Speaker 6 I don't know if that answers for you, you know,

Speaker 6 but you know, basically, basically the idea is think about if you make a lot of bets, you cannot bet individually. You have to have some kind of heuristic or some kind of method around that.

Speaker 4 Right. And like to me, like the book sort of, you know, the standard method, I guess, in quantum investing is you build a factor model of what drives your universe of investments.

Speaker 4 You're shaking your head. Yeah, I yes and no.

Speaker 6 I think yes, because the book, you know, has maybe 150 pages on factor models, but also no, because

Speaker 6 maybe in a hundred years from now, I I suspect there will be still something left, but you know, we might have better techniques and not necessary factor models any longer.

Speaker 4 I don't know. Wait, I wanna go two directions with that.
One is like, are the better techniques something more

Speaker 4 neural, netty, unstructured?

Speaker 6 Who knows? Yeah, something like that. I mean, there is a revolution every five years.

Speaker 4 My other question is like,

Speaker 4 I've never fully understood

Speaker 4 like a factor model is like, here are some factors that drive the returns of stocks. And then there's like some residual idiosyncratic return.

Speaker 4 There are clearly people whose business is to identify factors and then invest in factors.

Speaker 4 My impression is that at like the places that you work, the business is the opposite of that is to hedge out your factor risk as much as possible and to get as much idiosyncratic risk as possible.

Speaker 4 Is that right? And like, how do you discriminate between like a factor return and an idiosyncratic return? Like what makes a thing a factor as opposed to another?

Speaker 6 So that's a good question.

Speaker 6 So first, a lot of systematic investing is still about factors, just not the factors that get published in the literature, you know, not the factors that Cliff maybe was talking about.

Speaker 6 And yet, a lot of successful systematic investing is really factor-driven.

Speaker 4 In the sense that you have a model that has like twenty factors and like ten are like value, and you neutralize those, and you try the other ten kind of things.

Speaker 6 You do, and you do the rest. You have other terms that matter.
So that's one thing. But there are two other things.

Speaker 6 There are sometimes sources of returns that are factor-like, but not quite like factors.

Speaker 4 So

Speaker 6 you may have a theme, for example.

Speaker 6 You may identify a theme in the market that is not pervasive enough or is alive only for a few months, but is there and it's not only affecting, let's say, two stocks, right?

Speaker 6 So these broad themes can be invested on, but cannot really model in the traditional way as traditional factor model. Also, there is a lot of good modeling in factors as opposed to bad modeling.

Speaker 6 So it seems easy, but it's not that easy. So there is a little bit of craftsmanship in making these models.

Speaker 6 Okay, and then the third thing is that there are also returns that have nothing to do with factors or almost nothing to do with factors.

Speaker 6 So if you really know how a company works and you have a little bit of an edge in predicting its future performance, you can bet on it and you make enough bets and again, you will make some money if you repeat and recycle.

Speaker 6 So even discretionary investing in this sense has inherited a little bit of the spirit of systematic investing.

Speaker 4 I think of that as like at a pod shop, but like at Baleasny, like you have

Speaker 4 discretionary investors who know a lot about a company, make bets on the company, and then someone like you tells them, these are your factor exposures.

Speaker 4 You have to get those down to zero so that you're making pure bets on your idiosyncratic knowledge of the company. Is that like kind of right? Kind of right.

Speaker 6 Yeah.

Speaker 6 I think that at this point, it is very interesting how the mind of professional portfolio managers has been remolded in a factor-based world so that a modern portfolio manager, discretionary portfolio manager, thinks in factors.

Speaker 6 So I don't even need to tell them, hey, this is your exposure. They see their exposure, they have the tools to see it, and they control it in real time with minimal intervention from me.

Speaker 6 So what we do is we have a good team that models factors in a way that is suitable for the investment universe and style in which they operate. That's again, very, very sophisticated and difficult.

Speaker 6 And portfolio managers use that and they neutralize.

Speaker 6 It's become like second nature.

Speaker 4 And they've internalized that their goal is to create idiosyncratic alpha rather than factors.

Speaker 6 That's right.

Speaker 4 I feel like a criticism that people sometimes have of like the pod shop model is that like there's some universe of factors that exist in commercial models and that like are known in the literature and then portfolio managers have a set of exposures to factors that

Speaker 4 are sort of inchoate or unknown but like ultimately when you become really really smart you will know that like actually the bet they were making was some you know partic like knowing the company really well means like they had exposure to like some you know personality factor in the CEO or something that like eventually someone will be able to write that down and and it'll come out of like being idiosyncratic and become a factor and then I don't know what happens.

Speaker 6 I think that there is some truth to that.

Speaker 6 There is definitely some truth to that in the sense that sometimes portfolio managers, especially in specific sectors, will use some heuristics that you could call characteristics in a factor model, but they are not in a factor model.

Speaker 6 And then they trade that. However, it's also true that the decision that enters a particular investment is usually not that simple as taking a ratio in a spreadsheet.

Speaker 6 So it's a bit more complicated than that. You could still argue that there is a factor, right?

Speaker 6 And what's the factor is ultimately the set of theses that are highly correlated or relatively highly correlated across portfolio managers, across firms.

Speaker 6 Because if there is an expected return and if you have skill and you have sufficient skill to be close to the best possible portfolio, you have to be also relatively close to other people approximating that best possible portfolio, right?

Speaker 6 So then it becomes a truism, right? There is a factor and that's the factor of investor, of informed investors. So it's true.
Right.

Speaker 4 I think of it as like there's like a scientific process that everyone is pursuing and they hire the best people and they like do the best work to pursue that scientific process.

Speaker 4 And so like they'll eventually converge on something that is like truth, but that means buying all the same stocks.

Speaker 6 Yes, it's very difficult to get to that truth.

Speaker 4 Sure.

Speaker 4 It is a good sort of abstraction. But yeah.
It's not like, okay,

Speaker 6 let's hire up.

Speaker 4 But it would be weird if there weren't hurting among like the best.

Speaker 6 Yes, yes, but there is, there is. And by the way, and this brings to one of the limitations of factor models, right? Which is

Speaker 6 effectively a factor model is a form of glorified regression over time, right?

Speaker 6 And behind a regression, there is a bit of an assumption to some extent of independent observations over time and the market and hedge funds are not independent random variables they are super dependent random variables and they are in a sort of continuous indirect conversation through their portfolios and sometimes the conversation gets really nasty when one hedge fund is in state of distress and all of a sudden or not even a hedge fund it could be also an institutional investor and they decide to liquidate part of their portfolio and then it becomes a process where you have a lot of reflexivity and positive feedback, and everybody suffers.

Speaker 6 And in this case, factor models don't really, you can still identify

Speaker 6 if the system is running at temperature with some characteristics, but they're not factors in the traditional sense.

Speaker 4 I do want to talk about,

Speaker 5 before we move too far away, I do want to talk a little bit about how and if factors can die, because we've talked a bit about identifying factors, but when do you decide that this doesn't work anymore necessarily, that the market has fundamentally changed, and this worked maybe 10 years ago, maybe 15 years ago, but maybe now it's devolved?

Speaker 4 Well,

Speaker 6 there is the good old reason, which is people make mistakes in the sense that we think that there is a factor and then we look back and there is no factor, right?

Speaker 6 So, there are so many factors that some of them have got to be a little bit redundant. So, that's one reason, right? So, just pure, in a sense, research revisions.

Speaker 6 And then there is also the fact that there are two other things that can happen. One is the moment that you tell

Speaker 6 people that there is a factor, the factor comes into being to some extent, right? So, it's never black and white that the factor did not exist. Maybe the factor did exist.

Speaker 6 And then the moment you identify it, it becomes more

Speaker 6 existent.

Speaker 5 You speak it into existence.

Speaker 6 Yeah, yeah. So ESG is one case where the focal point that it became makes into an investable theme.

Speaker 5 I thought that was just blackrock pumping, ESG.

Speaker 6 That's possible,

Speaker 6 but everybody had to incorporate it in some sense, right? So it became a major source of revenue for the vendors, right? So that's one thing.

Speaker 6 And then there is the adaptive nature of the market. So things that before generated a priced to return.

Speaker 6 So you run some risk, you made some money, and then it becomes table stakes, it becomes incorporated into factor models, it becomes

Speaker 6 a smart beta, it is a smart bid. And then it becomes so I think, you know, you could say, Daphne, that medium-term momentum worked much better.

Speaker 6 You could say that even, you know, short-term reversal worked better. There were years when short interest was great.
And there are factors or data sources that work well now.

Speaker 6 And then maybe in five years will become known and become part of the I mean, credit card data, right? For consumer.

Speaker 6 That was like there were people who were making a lot of money in 2011 through, I don't know, 16, 17. And then it's become then it's very hard to make money in that.

Speaker 4 You said the market is a conversation among hedge funds. One thing that I think might be true that I'm not entirely sure of is like to what extent the market is a conversation among

Speaker 4 four hedge funds now like to what extent is like the marginal pricer of every stock a portfolio manager at you know one of the places you've worked

Speaker 4 it's a very good question i don't i don't really have the answer to this i'm not sure it's it's like what is what is the intuition at places like that like is it like the market price is determined by like the collective thought of like the top people at the top hedge funds or is it like

Speaker 4 we are a little bump on the market and we're trading against the whole random universe?

Speaker 6 I mean, you'd like to think that the the prices are determined by the marginal informed investor, right? So by people like us at the time horizon where we predict, right?

Speaker 6 Which is not the same as at the time horizon of alpha day, right? That's a different player.

Speaker 4 What is your time horizon? Like, I think of it as...

Speaker 6 Well, it depends.

Speaker 6 Well, yes, it depends. Within a hedge fund, you have a variety of, even within long-short equities, you have portfolio managers who are very tactical.

Speaker 6 And so they think in terms of they have strong daily or intraday alpha even though they're fully discretionary up to PMs that think easily in terms of months also depends on the sector so you know financials typically probably monetizes a little bit less on earnings and tends to have a longer horizon you know banks are basically modeling giant balance sheets right

Speaker 6 and then in a hedge fund you also have systematic but even in systematic there are all sorts of time scales and this cacophony makes the prices i i really don't know like i said another question is basically,

Speaker 6 how inefficient is the market? How incorrect are the prices? Are within a factor of two, like Black used to say? I don't know.

Speaker 6 Like, I don't think that the market is becoming so super efficient, but it's getting, it seems to be more efficient.

Speaker 4 Like, I do feel like one of the big stories is the rise of like these big multi-strategy hedge funds. Like,

Speaker 4 you would hope.

Speaker 4 Maybe you wouldn't hope because it's sort of conflicts the economic interest, but like one might hope that like the rise of these big multi-strategy hedge funds and a lot of capital being allocated to them would

Speaker 4 observably make the market more efficient.

Speaker 6 Yeah, I don't know if observably holds.

Speaker 6 It's really hard to

Speaker 6 like,

Speaker 6 can you tell when a bubble is forming?

Speaker 5 A lot of people would say that they can.

Speaker 4 Yeah.

Speaker 6 I can point you to a few papers

Speaker 4 that

Speaker 6 made all the wrong calls.

Speaker 6 I don't want to shame academics in public.

Speaker 5 I do like the idea that the market is a conversation between four hedge funds because I live in the ETF world and the big thing is passive is just distorting the market and there's no price discovery anymore.

Speaker 5 And it sounds like that's on the opposite end of that spectrum.

Speaker 6 I didn't say, I think, exactly that it's a conversation between

Speaker 4 four hedge funds.

Speaker 6 It's a beautiful thing to say, though. It sounds really cool.

Speaker 4 It does sound good.

Speaker 6 It sounds good. I don't know.

Speaker 4 of podcasts. Yeah, yeah.

Speaker 4 That's great.

Speaker 6 Yeah, but

Speaker 6 I think your question is whether the rise of passive has made markets less efficient. It's more of a statement.

Speaker 5 I don't think I was a bad podcaster and didn't actually ask a question.

Speaker 4 But

Speaker 6 okay. How do you know?

Speaker 5 How do I know? Yeah. That passive is destroying the market.
Yeah. People on Twitter tell me so.

Speaker 4 Oh, okay.

Speaker 6 Don't trust people on Twitter.

Speaker 5 That's rule number one.

Speaker 4 Rule number one. No, I don't know.

Speaker 6 I mean, the rise of passive passive has made index rebalancing a weirder strategy, right? So, where the margins have compressed, but the size has become so big that you can still make money in it.

Speaker 6 And periodically, it's a very, you know, cyclical strategy. So,

Speaker 6 I don't know.

Speaker 4 So, if you're an index rebalancing PM, do you take like

Speaker 4 eight months of vacation a year and like just

Speaker 4 do it all day when there's not a rebalance?

Speaker 6 Not the ones I know who probably listen to this podcast. podcast.

Speaker 6 They work very hard. Sure.

Speaker 5 They want to name their names too. No.

Speaker 4 Indexes aren't being rebalanced all the time. They're planning on.

Speaker 5 They rebalance more than you would think.

Speaker 6 Index rebalancing is another poster child for a strategy that seems so simple that everybody can talk about it. And then it's full of nuances and it requires a lot of skill to trade effectively.

Speaker 4 I believe that just because

Speaker 4 I've thought a little bit about just like the sort of accounting of like

Speaker 4 you basically know how many index funds there are, you, let's say, can predict what will come in and out of the index, and like, what the so, like, there's like some mechanics around, like, you know, figuring out the market calves that'll come in and whatever.

Speaker 4 But then it feels like the unknown is like, who else is doing the rebalancing strategy? Is that right?

Speaker 6 I think you're mostly right.

Speaker 6 I don't want to say because, you know, out of respect for

Speaker 4 the industrial PMs that I know. Fair enough.

Speaker 4 So we had Cliff Asnas on a few weeks ago. And like, to me,

Speaker 4 Cliff Asnas is like a quantitative investor, like a systematic investor. But like what he's doing is sort of recognizably

Speaker 4 what a sort of traditional asset manager would do. He's like trying to find companies that are undervalued, right? Like you talked about, it's like being a Graham and Dot investor.

Speaker 4 You know, you want like valuation plus a catalyst. And he's like, well, we're, you know, trading, you know, value and momentum.
And like you look at what

Speaker 4 HRT is maybe a little different, but but there's like you know the high frequency trading firms like you can model those as like those are quantitative versions of like a voice market maker 50 years ago where they're like trying to keep inventory flat and like trying to you know make the bid ask spread

Speaker 4 so like those are like very traditional economic functions that have been quantified like turned into systematic

Speaker 4 What's the intuition for like what a Baleazny or a Citadel or a Millennium does? Like what business are you in, do you think? Like, as a philosophical matter?

Speaker 4 Like, one thing I think, like, I think about like,

Speaker 6 you're asking from a social

Speaker 4 standpoint or

Speaker 4 the index rebalancing, like, to me, feels like the sort of trade, and I think to some extent was the sort of trade that an investment bank would have done 20 years ago or 30 years ago.

Speaker 4 And, like, some of that function, I think, has moved to the big multi-manager head of funds.

Speaker 4 But, like, I wonder, like, from where you sit, like, how you see the role in the financial markets of those firms?

Speaker 6 So at a very high level, we don't do anything different than everybody else in the sense that what we provide is always this, right?

Speaker 6 We provide shifting time preferences, which means we provide liquidity. We house, you know, risk for people who don't want to hold it right now.

Speaker 6 And that's what you do when you do index rebalancing, right? That's what you do when you do merger arb and when you do the various subtypes of basis trades, right?

Speaker 6 So we do provide liquidity, which is very important. And then the second thing, we again, very high level, we provide price discovery, right?

Speaker 6 So we study the firms and we think, okay, this is at the margin, mispriced, and we're gonna short it, or we're gonna invest in it. And that's a beautiful thing.

Speaker 6 So we do it at a different time scale, right? So you always want to do things at the margin where you don't have a lot of other participants.

Speaker 6 And at the margin of the, let's say, month to three month investment horizon, there are not that many

Speaker 6 participants. So, in the words of another hedge fund manager, I cannot name, but he said once, you know, we don't invest in securities, we date them.

Speaker 6 And so, we are in the dating service. Not that many people are doing it, and so we do it.
But I would say also this, right? Not at the social level.

Speaker 6 I just want to answer at the like my personal level: what we do. We are a massive filter of talent, and the talent that we hire is a massive filter of information.
So, it's like information squared.

Speaker 4 Maybe this is like a bad question, but like, do you think that

Speaker 4 long-only asset managers are worse than they were 30 years ago because that filter has been so successful? In other words, like

Speaker 4 there were lots of jobs you could have gotten in finance in 1990, but like, yeah, there's like a clear hierarchy now.

Speaker 6 I think that the market and the set of investors has learned, right?

Speaker 6 And I think the distinction between beta and alpha has been useful for investors. And so

Speaker 6 active investors who are mostly long only, I think have suffered from this distinction because the vast majority of them underperform their benchmarks. And so there is no reason for them to exist.

Speaker 6 And then what we do is we provide really uncorrelated returns to the benchmarks, to most factors.

Speaker 6 And investors want that, right? So there is a future where active investors, long-only investors, asset managers will become even less influential, smaller.

Speaker 4 And also a like, I think of that as like a customer demand side, but also like a talent filter side, right? Yes.

Speaker 6 Yeah.

Speaker 6 And then the interesting thing is, and then there is also a process where the multi-manager platforms are able to make the business model of a single portfolio manager that is not sustainable in isolation working in this kind of federated system.

Speaker 6 So why would you or how could you survive as a single portfolio manager hedge fund nowadays it's really really difficult but you can do it in a multi-manager platform provided that you have you know sufficient talent sufficient edge that's also where you can blame the passive influence on twitter if you're a long-term manager that you know it's impossible to be the market now because you just have this money constantly pouring in yeah I don't disagree.

Speaker 6 Yeah.

Speaker 4 I have one more question on like social roles, which is like you've worked at most of the big pod jobs, but you also worked at HRT.

Speaker 4 Like, what's the difference in roles and in like what they do all day?

Speaker 4 Because HRT I think of as a classic like high-frequency dating firm where I don't know that they're exactly a market maker, but they're certainly on the higher frequency side.

Speaker 4 And then like the pod shops have a lower frequency and a, you know, they're not prop, they're running hedge funds. Like, what's the

Speaker 4 cultural and role and differences? Yeah, okay. So

Speaker 6 I briefly mentioned HRT in an interview with the Financial Times, and my manager told me that people at HRT were both annoyed and delighted by what I had said about HRT.

Speaker 6 I think HRT is a really special place, even in the context of prop trading firms. So I'm a little bit hesitant to

Speaker 6 just be in them

Speaker 6 as a representative, right?

Speaker 4 Tell me why they're not representative.

Speaker 6 They're not representative because there is something in the culture of HRT that is special. Okay, it's collaborative, it's truly kind.

Speaker 6 Yeah, so I think it's a great place to work and it is fundamentally monolithic. So you have, you know, sharing of ideas and you can work at the intersection of these ideas.

Speaker 6 It's also a place that is very tech-oriented. So it's a bit of a technology firm operating in the financial space.

Speaker 6 And because of that, it also attracts, I think, the best technical talent that I've ever worked with.

Speaker 6 It's just a pleasure to work with great technologists, people who are very competent in that respect.

Speaker 4 So,

Speaker 6 nothing against the hedge funds. I love hedge funds for different reasons.
So, you know, I love BAM, which is also very collaborative and it's an investment company.

Speaker 6 But HRT has a technical side to it and also, again, a cultural side to it, that's great.

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Speaker 4 We didn't talk about AI. We don't have to talk about AI.

Speaker 4 AI.

Speaker 4 Of course. You have to talk about AI.

Speaker 4 So I have like three models of how investing works and systematic investment. Like, one is like, you have some economic intuition and you build a model of the stock market that predicts prices.

Speaker 4 And another way is a sort of like... neural nety AI-y way where like you throw a lot of data at a neural net and it builds its own model of how to predict stock prices.

Speaker 4 And then the third model is like you get really good at prompt engineering and you go to ChatGPT and you say what stocks will go up, but you ask it in the right way.

Speaker 4 And then ChatGPT tells me what stocks will go up.

Speaker 4 How good is it? How good is this one? Okay.

Speaker 4 I assume the third model no one uses, but like someone uses.

Speaker 3 I think a lot of people use that. All right.

Speaker 6 So first thing, like, okay.

Speaker 6 Nobody knows anything. And anybody saying the opposite, you know, should be heavily discounted.
Okay. So we agree on this.

Speaker 6 And

Speaker 4 so

Speaker 6 let's forget for a second all the technical details of AI just from a pure industrial organization standpoint, right? So what's going to happen,

Speaker 6 consider AI just like another technology, like internet and whatnot, right? So, you know, first of all, we are going to observe economies of scale.

Speaker 6 So there's going to be concentration and there was going to be some kind of monopolistic competition. I was thinking about Bloomberg specifically, which could be,

Speaker 6 I hope for you people, to be among the winners because you have a good starting point, right? You have lots of data, right? You have a customer base.

Speaker 6 And maybe in the future, we'll finally not see the good old Bloomberg terminal, which has been kind of unchanged since I remember it.

Speaker 6 And instead, people will just prompt Bloomberg to conduct very complex actions where it will act on a sequence of of keywords and connect them and give you like a much more valuable product for which Bloomberg will charge twice as much as they do already.

Speaker 6 So this is going to happen in one form or another. If it's not Bloomberg, somebody else will do it.

Speaker 4 Okay.

Speaker 6 But the same thing applies to other areas of finance. So maybe once upon a time, you know, a big, sufficiently big fund could build their own client for email, right?

Speaker 6 Of course, nobody builds a client for email anymore, right? So a a lot of this stuff gets outsourced.

Speaker 6 We will outsource at some point some of the functions that we conduct internally using AI to other AI agents. It's perfectly fine.
So, this will become a utility to some extent.

Speaker 4 These functions include like,

Speaker 6 well, not stock peaking.

Speaker 6 Not stockpeaking. I think that the functions that we will see available are essentially like another self, like another Matt Levine who can, uh, you know, be a good baseline for you.

Speaker 6 Okay, you could feed a post-train an AI system with all your gazillions of words, right? And that agent will reproduce your sense of humor, your investigative style, and everything.

Speaker 6 Okay, it's a good approximation, it's not going to be perfect, but why not, right? So, I would be very happy to have a replica of myself that can answer most simple questions.

Speaker 6 Now, I think that the decision to invest in a particular stock is a very demanding cognitive function, and I don't see that really being replicated very well.

Speaker 6 But I think that this will be baselined to some extent.

Speaker 4 Is it a demanding cognitive function because

Speaker 4 it exists in a competitive market? So like...

Speaker 6 The sort of like whatever the cognitive function is is going to get like the baseline is always going to get higher because like someone else will have a will have the same information as you do or the same well this is getting really in the highly speculative side of you know things I think that in order for an AI agent to be good at this, they have to be able to experience the world the same way that an investor experiences it.

Speaker 6 And our inputs are much more complex than just a string of text or YouTube videos, right?

Speaker 6 We have a model of the world which comes from visually experiencing the world, talking to humans, consuming the goods, right? Anything.

Speaker 6 It's vastly more complex than the way an AI system right now experiences the world and also influences the world.

Speaker 6 So an investor has a fundamentally different experience of a company than an LLM that has an experience that is mediated by multiple layers of processing.

Speaker 6 You know, they learn about a company through text that is written by somebody. So I don't think that that's in danger for the time being.

Speaker 6 But maybe, you know, again, in five years, maybe we will have our glasses feeding our experiences to AI agents. Who knows, right? But I don't think that it's that close.

Speaker 6 And I don't think AI is that smart, also. So I think that having a baseline system would be already pretty good.

Speaker 5 That's somewhat comforting that our experiences count for something, our physical experience of the world.

Speaker 4 It's interesting because I always think of the comparison as investing in self-driving cars.

Speaker 4 Investors do a lot of things. Like one thing they do a lot is sit at a desk and read computers and like look at numbers, right?

Speaker 4 and like those things seem like things that a computer can do well whereas like you know drivers like have physical reflexes and like have a you know complicated field of vision i always thought like investing should be easier than self-driving cars for a computer to master but you

Speaker 6 and i don't think you're alone in this think of like investing as like the great liberal art where it's like you incorporate all of human experience and so the ai can't really okay let's let's let's take the metaphor to you know extreme consequences imagine that you had a system that is the equivalent of a perfect self-driving car in investing.

Speaker 6 So now I'm giving you a machine, a box, that is telling you the long-term value, if not the returns, right?

Speaker 6 Because the moment that the value is known, you immediately equilibrate to that level, right? So imagine that you know the true value of everything because a box tells you so, and it's infallible.

Speaker 6 It's an oracle. Okay, would you think that finance stops existing?

Speaker 6 I wouldn't say so, right?

Speaker 6 So I I think that a lot of arbitrage trades, you know, would maybe change significantly, but every risk, right, every return would be correctly priced by the risk of the agents trading it.

Speaker 6 So there still would be trading because we still have different preferences. But basically, every risk would be priced.
There would be, you know, in a sense, less alpha, but finance will still exist.

Speaker 4 It's a lot of like service provision, like liquidity provision.

Speaker 6 Liquidity provision.

Speaker 6 So the liquidity provision would still exist. The informational services maybe will stop existing in the current form.

Speaker 4 But that's okay.

Speaker 6 I think that we'll all still be employed.

Speaker 4 It's an interesting way to think about it because I do think, like, we talked about like

Speaker 4 one thing that the big hedge funds do is things that have the flavor of liquidity provisions like basis trades and merger arb and whatever.

Speaker 4 Things that like I think of as like something that a bank would have done 30 years ago and that now a big hedge fund does.

Speaker 4 And then another thing they do has the flavor of information provision where it's getting prices right.

Speaker 4 Like to me, those things seem quite intellectually separate, but I guess they feed each other in the sense that

Speaker 4 the better you are at prices, the better you can be at liquidity provision. Is that sort of right?

Speaker 4 Like you wouldn't merge your arbitrators if you didn't know the value of this.

Speaker 6 Yeah, I mean at short at Short Horizon, liquidity provision and information tend to be very closely related. Like, you know, a limit, if you are good at

Speaker 6 crossing, if you're good at crossing, you should be pretty good at adding yeah okay adding liquidity so you know by this I mean like you could make you know a profit by posting a lot of limit orders and providing liquidity to the market or crossing the spread and making money with predicting the future prices if you're good at one you're good at the other most likely right at that time scale i think that this though might i'm not sure because i haven't thought about this very very carefully but i think this might decouple at a longer time scale so at you know you're when you're out.

Speaker 6 I'm not sure. And in any case, at that time scale, it's really difficult for an AI or for a human being, anyone.
Like, there are not that many hard data. Even the unstructured data are not that many.

Speaker 6 So it's a very difficult problem. It's decoupled.
It's complicated. So

Speaker 6 yeah. But I tend to believe at longer time scales, you have more or less liquidity provisioning and violations of law of one price on one side and predicting on the other side.

Speaker 4 But you combine both.

Speaker 6 But you can combine both, and it's a very potent mix, right?

Speaker 4 Is it normally different people? It is, right?

Speaker 6 Very different people, for sure.

Speaker 4 Different pods or different.

Speaker 6 Very different. Very different people, very different cultures.
Yeah.

Speaker 4 Can you summarize the difference in cultures between... Like, I have a guess, but.

Speaker 6 Well, as you said, people who typically trade in ARB trades, if not historically, but also historically, come from banks. Yeah.
Right.

Speaker 6 Whereas you still can see long-only portfolio managers being recycled and reformatted into long-short portfolio managers.

Speaker 6 You can have an excellent short specialist becoming a long-short portfolio manager, like it happened.

Speaker 4 I mean, my sense is that

Speaker 4 the people on the information provision, long-short side are

Speaker 4 more academic and research-oriented, and the people on the ARB side are more

Speaker 6 trading or

Speaker 4 self-side traders. Yeah.

Speaker 6 I think you can actually have very good long-short portfolio managers who were journalists in their past lives.

Speaker 4 I've heard of some of these. Yes.
Thought about this.

Speaker 4 No, just like idly. Big reveal.
No.

Speaker 5 Breaking news on your own podcast.

Speaker 4 I've noticed how much money jumped out of it.

Speaker 4 That's better than podcasting. Not thought about it in the sense that I'd be good at it, just in the sense that the money is good.

Speaker 5 You could be bad at it and paid really well for a short amount of time.

Speaker 4 I don't know that that's true, actually.

Speaker 4 They're an excellent talent filter, or so I hear.

Speaker 6 Yes, I think that you could interest a few

Speaker 6 hedge funds.

Speaker 5 They might be listening.

Speaker 4 They might be listening.

Speaker 4 I redo

Speaker 4 for an end on that.

Speaker 6 We're closing on a high note.

Speaker 4 Kathy, thanks for coming on the issue.

Speaker 6 It was a pleasure.

Speaker 6 Thanks for having me.

Speaker 4 And that was the Money Stuff Podcast. I'm Matt Levian.

Speaker 5 And I'm Katie Greifeld.

Speaker 4 You can find my work by subscribing to the Money Stuff newsletter on Bloomberg.com.

Speaker 5 And you can find me on Bloomberg TV every day on Open Interest between 9 to 11 a.m. Eastern.

Speaker 4 We'd love to hear from you. You can send an email to moneypod at bloomberg.net.
Ask us a question and we might answer it on air.

Speaker 5 You can also subscribe to our show wherever you're listening right now and leave us a review. It helps more people find the show.

Speaker 4 The Money Stuff Podcast is produced by Anna Mazarakis and Moses Andam.

Speaker 5 Our theme music was composed by Blake Maples.

Speaker 4 Brendan Francis Newnham is our executive producer.

Speaker 5 And Sage Fauntman is Bloomberg's head of podcasts.

Speaker 4 Thanks for listening to the Money Stuff Podcast. We'll be back next week with more stuff.

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