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D.E. Shaw and how computer geeks and English majors transformed Wall St. (2018)
- drtillberg 6y agoPaperclip maximizing AI. It's so interesting that the long-form narrative of a trading house omits to dive into the detail of a single actual trade!
- andrepd 6y agoAn excellent analogy for the financial markets which largely control our economic lives.
- an_opabinia 6y agoBecause all the computer hocus pocus is obscuring how they make money: they launder arbitrage banks are not allowed to do to their own clients in exchange for a large fee.
- Ntrails 6y agoI am going to need a pretty good citation on that
- cma 6y agoPaying for "dumb money" order flow, it's how everyone was able to go commission free, by selling access to it.
- sesuximo 6y agoThis isn’t true for every firm, but a lot of them do it. I think it’s bad (it’s weird/unfair), but on the other hand I am happy not paying commission/getting orders filled at prices often a bit better than advertised on my broker’s app, so maybe it’s ok? Idk.
- sp527 6y agoI’d argue it’s not bad at all. It very cleanly aligns incentives in a way that benefits both sides. Another way to look at it is that there’s an “implied commission”, paid in the form of a perhaps slightly inflated purchase price, that largely doesn’t affect retail investors. And this all works out for quant firms because they make money off this at volume, at near zero marginal cost. In fact, it’s odd that commission free trading didn’t happen a lot sooner. Etrade, Schwab, etc were rent seekers.
- badfrog 6y ago> I think it’s bad (it’s weird/unfair) How is it bad or unfair? Everybody wins: you get a better price, the market maker does a trade they're happy with, and your broker gets a little bit of money.
- sesuximo 6y agoI think it’s a little unfair compared to letting people put their orders on exchanges directly
- badfrog 6y agoYou are guaranteed a price that is equal or better than what you'd get on the exchange. Why would you want to bypass that?
- sesuximo 6y agoWell “the price” might be totally different if there were no off-exchange orders. But I’m sort of being a devil’s advocate... I agree with your argument in practice since I don’t expect to see such open exchanges anytime soon
- badfrog 6y ago> Well “the price” might be totally different if there were no off-exchange orders. I'm not sure what that means, but there's no scenario in which you'd get a worse price. That would be illegal under the Reg NMS order protection rule. https://www.investopedia.com/terms/o/order-protection-rule.asp https://www.investopedia.com/terms/o/order-protection-rule.a...
- fractionalhare 6y agoOrder flow has been sold for much longer than the more recent commission-free trading trend, which was primarily driven by Robinhood. Robinhood just decided they'd sell order flow without also taking commission. More to the point: the primary consumer of order flow is market making HFTs, which DE Shaw is not. Stat arb/quant trading firms don't rely on market making rebates for trading profits.
- Ntrails 6y agoThe suggestion above is that GP simply doesn't believe stat arb is a thing. Which I know to be untrue, or the level of cover up is quite impressive
- smabie 6y agoQuant fund are not involved in latency arbitrage. HFT is a completely different space, and most HFT firms are prop shops, not funds. Most quant strategies aren't really dependent on insanely fast execution. They may hold a position for weeks or months at a time.
- nojito 6y agoMost if not all the highly successful and most secretive quant funds execute hundreds of thousands trades per day...while not considered to be "HFT"...the idea of trading hundreds or thousands positions per second is quite a high frequency.
- hchz 6y agoThis is algo trading, or execution optimization. They aren't measuring the market / order book and then reacting at high frequency. They are reacting at low frequency and then the execution is optimized to minimize losses caused by market feedback. This is a very important distinction if you hold the view that HFT risks destabilizing markets.
- smabie 6y agoMost quant shops are not turning over thousands of positions everyday, the trading costs alone would be ridiculous. But regardless, HFT usually means latency arb, not just trading a lot. There's a misperception that quant funds are making money on slight mispricings, but while I can't speak for all funds of course, this isn't generally true. Quant funds are much closer to buy and hold long term investors than they are to HFT firms.
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- an_opabinia 6y agoThere isn't going to be documentation out there, in some pithy Bloomberg article, "Banks have prized relationships with arbitrageurs that help them monetize opportunities that plainly violate fiduciary duty." Information about how hedge funds work - like information about say how ad tech firms work - is incommensurable with HN's Reddit/Wiki-style way of disseminating knowledge. I hope that information without citations could be tolerated more, I have no dog in this race, I just like sharing knowledge. Shaw and many hedge funds that have been around for decades acquire smaller arbitrage firms that can be thought of as having "licenses" to perform arbitrage. This portfolio of arb is how they scale to their AUM. There is nothing actually secret or protectable about what an individual arb firm does to execute the trade. For example a particular HFT trading algorithm. Such firms that rely on actual secrets do not last long and so in a Darwinian way do not wind up in the portfolios of huge funds like DE Shaw. The arb shops that last a while have permission, from a bank, that depends on a relationship with a real human being, that is exclusive to the firm granted, to launder a particular form of arb the bank would like to do but could not. For example you're allowed to take a spread as a bond trading desk, but wouldn't you like to sell the bank's bonds instead of its competitors bonds? That's plainly against fiduciary so it "doesn't happen." Instead you go to an anonymous arb firm, for $1m in bonds, and you say, "okay we're going to sell you the bond that is actually ours, you will sell it back to us, here is your fee, now we can sell this bond back to the client and wash the fact that it is ours." Nobody says that! But that is the economics of the trade, why the arb firm can make money for so long, why banks work with them despite seeming to be "parasites," etc. The computers are just part of the hocus pocus of laundering that arb. Shaw doesn't actually come up with this arb or necessarily source the relationship. Instead it finds the little anonymous arb firm and buys it, and carefully scales the relationship for $1m of bonds with 1 bank to $1b in bonds with 10 banks. The risks in Shaw's business are that you lose the license to arb. The upside is from investors persistently underpricing the ability for Shaw to scale this arb from $1m to $1b. No, they basically pull a rabbit out of a hat every year and continue to scale a particular arb further than people thought was possible. Also, nobody is going to want to just give Shaw, a bunch of rich people, a bunch of free money. But you can't fight their ability to acquire little arb firms. This is the way.
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- stainforth 6y agoCan your rephrase that last part or explain what that means?
- throwlogon 6y agoWhat does "launder arbitrage" mean?
- rosstaylor90 6y agoEd Thorp’s Princeton/Newport Partners was the first great quant hedge fund.
- smabie 6y agoYeah, came hear to post this. Recently read his autobiography "A Man For All Markets." Simply an incredible and creative man. From beating blackjack to roulette, to discovering Black Scholes before Black and Sholes. PNP changed the game like no other. Really sad Giuliani and his thugs took him down. Thorpe is epitome of the best of humanity: creative, fearless, and tenacious. His life story was really inspiring to me. The book comes highly recommended.
- rmrfstar 6y ago> Thorpe is epitome of the best of humanity: creative, fearless, and tenacious. I guess we see what we want to see. There are a lot of little red flags littered throughout the book. One thing that rankled me was his assertion that he independently discovered Black-Scholes before Merton/Black/Scholes and offered as evidence a chart that post-dated the original paper. There's a lot of stuff like that in the book. Don't get me wrong, this is a person with many admirable characteristics. Just don't drink the Kool-Aid.
- bitxbit 6y agoHighly recommend Poundstone’s Fortune’s Formula. Claude Shannon and Ed Thorp. This is the book (along with A Non-Random Walk Down Wall Street by Lo and MacKinlay) that got me interested in finance.
- admin_account 6y agoJim Simons/Renaissance were the first great quant hedge fund. For the last 30 years their annualized returns, after fees, is 39%.
- hchz 6y agoThe medallion fund began at Axcom under Elwyn Berlekamp and RenTech bought it. https://en.wikipedia.org/wiki/Elwyn_Berlekamp https://en.wikipedia.org/wiki/Elwyn_Berlekamp https://en.wikipedia.org/w/index.php?title=Axcom_Trading_Advisors&redirect=no https://en.wikipedia.org/w/index.php?title=Axcom_Trading_Adv...
- viburnum 6y agoThere was another famous hedge fund noted for mathematical excellence but it turned out to be a different story entirely ...
- selectodude 6y agoRenaissance?
- smabie 6y agoNo, probably Madoff. Renaissance is incredible.
- fractionalhare 6y agoMadoff was not known for "mathematical excellence", though he did fool a lot of people. This commenter is almost certainly talking about LTCM.
- w1ntermute 6y agohttps://en.wikipedia.org/wiki/When_Genius_Failed https://en.wikipedia.org/wiki/When_Genius_Failed
- cvrjk 6y agoAmazing book. Truly astounding sequence of events. Greatest irony of all, they named their firm "Long-term Capital Management", while taking hugely leveraged short-term positions ($1 trillion dollars worth of derivatives backed by about $100 billion or so assets) that were beyond the understanding of anyone else. Didn't last 4 years before they blew. They did show 40% annual returns when they started and I guess that's what kept them going without much regulation. But man, did they crash hard. Investors who were returned their money after a year or 2, and those who were turned down from even investing must have thanked their Gods for saving them from absolute destruction. There is another book by Michael Lewis (who also wrote "The Big Short") called "The Liar's Poker", where he talks about his time at Salomon Brothers and how they collapsed in a very similar fashion. Highly levered derivatives with a magic formula that has worked well (so far..). It's fascinating how they were allowed to do what they did. Open gambling with client's money, and no repercussions on loosing it all. "Blowing up a customer" was apparently common and chalked up to a rookie's mistake. "Baptism by fire". How did the rookies even get access to millions of dollars of money to bet on crazy derivatives!! I feel that every time a major upset in the financial markets lands on us, it is because some group of really talented people managed to convince everyone that they discovered something that no one else has and have "cracked the market" by showing consistently high returns for a period of time, and gain access to huge pools of capital. Only, after a few years the market turns around, showing a side of things that they did not take into account and the whole thing goes belly up, market crashes, loads of people loose money, mostly its everyone else but that group (leverage, borrowing, access to someone else's capital etc). And because everyone who was supposed to keep them in check did not do it because despite it being their job not to, they did take them for their word, they try to cover it all up by paying the very people who caused all the trouble and who were supposed to watch out for all this. Banking world seems to have a lot of conflict of interest all around. It is much better now, with lots more rules and regulations, but it is still there.
- dcaisen 6y agoIs David Shaw brilliant? Absolutely. Has the quant/technology revolution been a positive development for financial markets? No doubt. But secondary trading is still a zero-sum game. Firms like D.E. Shaw are profit maximizing and extract a huge amount of value from society. Probably less than the old boys club they replaced, but probably much more than necessary. There is a great deal of competition among quant trading firms overall, and their rise has coincided with electronification of markets, tighter spreads, lower commissions - all good things. But if the forces of capitalism are truly working, you have to wonder why so many firms like these continue to print money year after year (although there have been some new developments-- for example, stock exchanges have gotten much more effective at monetizing their access and data feeds, which has really put the squeeze HFT market makers; still, zero-sum game though). There's no good reason we can't have it all: efficiently-priced modern-technology financial markets without these huge rents being pulled out. And I shouldn't pick on quant firms specifically - every layer of the system extracts its share, and I'd argue brokers and exchanges are much worse since they're fiduciaries and semi-regulatory entities, respectively, and riddled with conflicts of interest. Disclaimer: former co-founder/head quant at IEX (Flash Boys), current CEO of Proof Trading (YC S19)
- nradov 6y agoThe standard justification is that these firms provide market liquidity which lowers the cost of capital for all businesses, thus boosting economic growth. But I've never seen a rigorous quantitative analysis. How much growth do they actually cause in the real economy relative to the value they extract?
- cma 6y agoBeing one microsecond faster is worth all the profit, but did the market gain as much with one microsecond less latency as with 1 second or one minute less latency? No. But the payoff for achieving it is just as high, winner takes all to whomever is fastest, so the market will put as much money into shaving off an additional microsecond as a minute, if it makes the difference on being first.
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- hogFeast 6y agoThey have a huge non-quant business. I believe they are actually mainly a non-quant firm now.
- edna314 6y agoWondering what D.E. Shaw did after getting rich? He used his money for building a specialized super computer (https://en.wikipedia.org/wiki/Anton_(computer) https://en.wikipedia.org/wiki/Anton_(computer)) which runs molecular dynamics simulations for drug development. His 2008 computer still runs molecular dynamics simulations about an order of magnitude faster than general purpose super computers in 2020.
- bxji 6y agoSo that's where Gilfoyle got the name Anton from...
- adamnemecek 6y agoI thought it was an Anton LaVey reference https://en.wikipedia.org/wiki/Anton_LaVey https://en.wikipedia.org/wiki/Anton_LaVey
- arthurcolle 6y agoNo, Gilgoyle's name is a reference to Anton LaVey, the head of the Church of Satan and general weirdo
- flobosg 6y agoThey have made available some SARS-CoV-2 related simulations: https://www.deshawrd.com/downloads/download_trajectory_sarscov2.cgi/ https://www.deshawrd.com/downloads/download_trajectory_sarsc...
- schoolornot 6y agoOther “philanthropy”: https://en.wikipedia.org/wiki/David_E._Shaw#Political_and_philanthropic_donations https://en.wikipedia.org/wiki/David_E._Shaw#Political_and_ph...
- holidayacct 6y agoI hate to rain on everyone's parade but no one transformed Wall Street. If you saw how most of the banks are run and who is in charge of these places up close there would be a run on the banks. Everyone would be withdrawing their cash and storing it under their mattress.
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- scottlocklin 6y agoWhat a marketing submarine! [0] Let me count the vastly more transformational and earlier quantitative funds just off the top of my head: Princeton Newport, Commodities Corporation, Tudor, RenTech, Chicago Research; hell even Soros and the Tigers were more influential and just as quantitative. DE Shaw was an early mover for certain kinds of automated trading, but if he had never met Nunzio Tartaglia (and basically stole his secret sauce -hey at least they mentioned Morgan Stanley), he'd still be writing shitty papers on parallel computing models at Columbia. He got lucky, and was able to take advantage of his luck, but he is also a garbage human being who has made the world worse[1][2]. His company once offered me a job: I told them to go fuck themselves, and the only better "no" decision I made was saying no to Bear Stearns in 2006. [0] http://paulgraham.com/submarine.html http://paulgraham.com/submarine.html [1]https://nymag.com/intelligencer/2019/09/david-e-shaw-college-donations.html https://nymag.com/intelligencer/2019/09/david-e-shaw-college... [2]https://www.propublica.org/article/hedge-fund-billionaires-donations-college-admissions-elite-universities https://www.propublica.org/article/hedge-fund-billionaires-d...
- harryh 6y agore [1][2]: It's not clear to me how donating 10s of millions of dollars to prestigious universities in order to secure a grand total of 2 spots for his kids has made the world worse.
- scottlocklin 6y agoYou know, if you're going to make a comment on links, you should really read the damn things. Do you think faking achievement in your (apparently useless) crotch fruit offspring is acceptable behavior? Do you think forcing your underlings to use hand signals to communicate with you in case you're on the phone with the Dalai Lama is reasonable behavior for a member of the human race? Did you read about how he treats the help? "Those who didn’t measure up suffered the consequences. Meriwether, who joined Shaw staff as a 22-year-old Yale graduate, was fired after forgetting to put snacks — bottled water and Asian pears sliced a quarter of an inch thick — into the car that picked the children up from school, according to two people familiar with the incident." Shaw is human refuse. No amount of accumulated money or bribery will ever change that.
- mlthoughts2018 6y agoI passed a series of phone interviews with DE Shaw and they flew me to NY to interview on-site many years ago. It was for a statistician / machine learning role. Once I arrived on site they asked me to write a program to rotate a matrix on the whiteboard. The catch was, it had to be in syntactically correct Tcl, a language I had never heard of, which was not on the job listing, not discussed in any of the phone interviews, and not on my resume. I clarified that I had never heard of that language and no one gave me any information that I had to prepare to answer questions about it and the two interviewers in the room said it was required for the job. I offered to code it in Python but they said it had to be Tcl. I was freaking out at this point, sweating, wondering if I was mixed up with a different candidate. I said the role I was interviewing for and asked if it was possibly a mistake, they replied it was not and they expected me to write Tcl for that solution. I thought maybe it was some kind of finance bluster sort of thing, like to test if I would stick up for myself or offer an outside the box idea. I sat down from the whiteboard and said if they could explain to me the syntax of Tcl I would give it a try. The interviewers both thanked me for my time and said the next interviewer would be in shortly (I had a printed sheet of a 9-5 full day of scheduled interviewers). I sat and waited in that room for over 45 minutes, no one came to get me, nothing. Eventually I walked back to the main reception desk area and explained what happened, and the attendant person looked me up on a computer and said all my interviews were done for the day, I was free to go, and they would be in touch. The point of contact was someone named Isaac Torres. I went back to the hotel they put me in which was right across the street, feeling incredibly depressed, and just ordered food and stayed in. My flight was the next evening, but around 11 am before I even left the hotel, Isaac called me to say they were going to pass on me. It was a weird thing. I wasn’t even mad because it was so absurd, like getting struck by lightning or something. It was like surrealism, irrational. But I sure did walk away feeling like DE Shaw the company is absolutely fucked internally, and I would never in a million years consider working for them and would try to warn anyone I can away.
- fractionalhare 6y agoI'm sorry that was your experience. If that's true it reflects really poorly on the firm. I have considered applying to DE Shaw in the past and I've heard a few stories like this, which have mostly made me stay away.
- Brett_S 6y agoI am confused. This article is very positive about DE Shaw. Nonetheless, it says DE Shaw is a "$47 billion firm [assets underlying management (AUM)], earning its investors more than $25 billion". That is a return of 53% which sounds good until you consider the firm was started 32 years ago - at which point the compound interest rate is less than 1% a year. I realise the AUM has likely grown over time, but this rate of return is less than inflation at a time when the market has grown considerably. This is a negative return while, per the article, many employees have become millionaires and Shaw himself a multi billionaire. From the article it appears that DE Shaw is good at is attracting assets underlying management and paying themselves well without providing value to their customers. What have I missed?
- throwaway1777 6y agoYou missed that the fund started out a lot smaller.
- innagadadavida 6y ago50% per year - that’s what you missed.
- smabie 6y agoUmm... you're missing that the firm has not always been $47 billion? You think DE Shaw was started 32 years ago with 47 billion dollars?
- known 6y agoWhen you find a loophole in market you'll inform the authorities to correct it you'll make money out of this anomaly DESCO chose the 2nd option; The devil is in details.