More Money Than God_Hedge Funds and the Making of a New Elite

by Sebastian Mallaby

  40. John Lattanzio joined Steinhardt in 1979. John Lattanzio, interview with the author, October 4, 2007.

  41. Cary Reich, “Will Weinstein, Former Head Trader, Oppenheimer & Co.,” Institutional Investor, Vol. 21, no. 6, June 1987, pp. 38–42. Weinstein as much as admits in the interview that he colluded with the chief traders at Salomon Brothers and Goldman Sachs. Conversations with Steinhardt confirm that, as the biggest block trader on the buy side, he was part of the same circle.

  42. “If he [the broker] had something coming, if he knew he had a huge seller, he would say to me, ‘You know, it wouldn’t be a bad thing for you to get short on blah blah blah.’ Why would he want me to get short on blah blah? Because he had a huge seller and he knew, at some point, he was going to trade that stock down. And if he had me as a buyer covering my short, it would be good for him; it would be, almost certainly, good for me because I would be buying it lower.” Steinhardt interview, October 4, 2007.

  43. Ibid.

  44. Ibid.

  45. This calculation assumes that the odds of making a positive return in any given year are one in two. For a normal mutual fund, this assumption would be false: The stock market moves up in more years than it falls, so the odds of making a positive return are higher than that. But for a hedge fund that was both long and short, and that invested heavily in bonds, the assumption of one in two seems roughly fair.

  46. “Steinhardt Fine Firm Agrees to Court Order in Seaboard Case,” Wall Street Journal, April 23, 1976, p. 3.

  47. To be sure, none of these reforms succeeded in eliminating the insider advantage. “It’s impossible to disseminate information exactly homogeneously,” Steinhardt says of the regulators’ efforts. Steinhardt interview, September 10, 2007.

  48. Anise C. Wallace, “Pullback at Block Trading Desks,” New York Times, December 24, 1987, p. D1.

  49. Dan Dorfman, “Sabbatical for a Superstar,” Esquire, August 29, 1978, p. 12.

  CHAPTER THREE: PAUL SAMUELSON’S SECRET

  1. Justin Fox, The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street, (New York: HarperCollins, 2009), p. 124.

  2. Peter L. Bernstein, Capital Ideas Evolving (Hoboken, NJ: John Wiley & Sons, 2007), p. 113.

  3. Samuelson explains, “Fama’s theory of the random walk and mine are not the same. Mine is that there are no easy pickings…. If you read the numerous papers I have written on the efficient-market hypothesis, you will realize it is not a dogma. If you can get information early, before it is widespread, you can’t help but get very rich.” Paul Samuelson, interview with the author, February 5, 2008.

  4. Bernstein, Capital Ideas Evolving, p. 143.

  5. Explaining his investment with Buffett, Samuelson wrote, “Experience has persuaded me that there are a few Warren Buffetts out there with high rent-earning ability because they are good at figuring out which fundamentals are fundamental and which new data are worth paying high costs to get. Such super-stars don’t come cheap: by the time you spot them their fee has been bid sky high!” See Paul A. Samuelson, foreword to Marshall E. Blume and Jeremy J. Siegel, “The Theory of Security Pricing and Market Structure,” Journal of Financial Markets, Institutions and Instruments 1, no. 3 (1992): 1–2. For more on Samuelson’s investment with Buffett, see Roger Lowenstein, Buffett: The Making of an American Capitalist (New York: Broadway Books, 2001), pp. 308–11.

  6. The other outstanding example of an early quantitative firm is Princeton-Newport, created in 1969. For an entertaining account of Princeton-Newport, see William Poundstone, Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street (New York: Hill and Wang, 2005).

  7. My thanks to Jan Kunz, who worked for Commodities Corporation from its start and who provided me with a copy of the launch prospectus.

  8. In 1964 Cootner published an influential book titled The Random Character of Stock Market Prices, which was a compilation of all the efficient-market papers published up until then.

  9. The Apollo graduate was Morris Markovitz.

  10. Many hedge funds that are marketed to investors that don’t pay U.S. tax are legally structured as offshore corporations. Commodities Corporation was unusual in being an onshore corporation.

  11. In a lecture delivered at Princeton University in May 1999, Weymar recalled, “I was particularly taken by the theme and role of the hero in the western canon. If one is contemplating heroism, it helps to be driven by existential angst, and mine was palpable during my 20’s and 30’s.” F. Helmut Weymar, “Orange Juice, Cocoa, Speculation and Entrepreneurship” (Beckwith lecture at Princeton University, May 1999). I am grateful to Helmut Weymar for providing me with the text of the lecture. A former Commodities Corporation employee says bluntly: “Helmut wanted to be king of the world, basically. He got interested in art and then he stopped doing it because he thought, ‘I’ll never really make a splash in the art world.’ So he did it because he needs and wants to be superior to others and be seen as superior to others.”

  12. F. Helmut Weymar, interview with the author, April 19, 2007.

  13. Weymar interview; Weymar, “Orange Juice, Cocoa, Speculation and Entrepreneurship.”

  14. Weymar, “Orange Juice, Cocoa, Speculation and Entrepreneurship.”

  15. These descriptions of Weymar and Vannerson come from Jan Kunz, one of the start-up employees at Commodities Corporation (Jan Kunz, e-mail to the author, February 5, 2008), and from Irwin Rosenblum, the author of the autobiographical account Up, Down, Up, Down, Up: My Career at Commodities Corporation (Bloomington: Xlibris, 2003). I am grateful to Irwin Rosenblum and his book for this vignette and several other points in this chapter.

  16. Weymar interview.

  17. Commodities Corporation survived because Nabisco was keen to keep it in business in order to retain access to Weymar’s cocoa forecasts and Vannerson’s wheat forecasts. Nabisco was able to overrule the other shareholders, which wanted to close the firm, because it held a senior claim on the remaining assets. In case of liquidation, Nabisco would have reclaimed its $500,000, leaving the other investors with only $400,000 of their original $2 million. Having been virtually wiped out, the other shareholders decided that there was little to be lost by allowing Commodities Corporation to continue trading. Weymar interview.

  18. Ibid.

  19. This quip is attributed to Frank Vannerson. Morris Markovitz, interview with the author, November 1, 2007.

  20. Weymar recalls: “Valuable as market analysis and data generation may be, money management discipline is even more important to successful speculation…. Most successful speculative derivatives traders generate more losing trades than profitable trades. They are successful only because their gains on positive trades are substantially larger than their tightly controlled losses on negative trades.” Weymar, “Orange Juice, Cocoa, Speculation and Entrepreneurship.”

  21. For example, Paul Tudor Jones began his hedge fund, Tudor, with the help of seed capital from Commodities Corporation. An official at Tudor recalls: “When we incubated young traders, when they came close to kickouts he [Paul Jones] would bring them into the office and say, ‘You’ve got to write an analysis on why this happened and how it’s not going to happen again.’ He took that away from Commodities Corporation.”

  22. Weymar interview; Irwin Rosenblum, interview with the author, April 19, 2007. Rosenblum was responsible for implementing the new risk controls and describes them in his autobiography. See also Tully, “Princeton’s Rich Commodity Scholars.”

  23. Elaine Crocker, who rose to become a senior manager at Commodities Corporation and later president of Moore Capital, recalls, “The kickout forced you to liquidate your positions and get out of the market for thirty days. During this period you would plot the history of your trades in the period leading up to your losses and see whether you had violated your own trading philosophy. Most of the time, the answer would be yes. The whole system allowed traders to develop an approach to mark
ets that would work for them, but at the same time held them accountable for sticking to it.” Elaine Crocker, interview with the author, July 30, 2008.

  24. In the mid-1980s MIT information theorist Robert Fano wrote a paper questioning the random walk in stock prices. Colleagues warned him that submitting the article for publication in a peer-reviewed journal would get him branded a crackpot. See Poundstone, Fortune’s Formula, pp. 127–28. Similarly, Scott Irwin, who published one of the first articles to affirm the existence of trends, vividly recalls the difficulty of getting such views published. Scott Irwin, interview with the author, February 14, 2008.

  25. As Weymar put it, “Happily blessed by an inquiring and open mind, Frank overcame the bias of his Princeton economics training.” Weymar, “Orange Juice, Cocoa, Speculation and Entrepreneurship.” Vannerson himself notes, “The academics were slow to come around. I think currencies did it, where trends were so obvious a child could see them.” Frank Vannerson, e-mail communication with the author, February 11, 2008.

  26. Vannerson believes he was the first to create an automated trend-following system: “I am pretty sure I was the first to put the whole thing together.” A similar system was developed a little later by Ed Seykota, a legendary trader at the brokerage Hayden Stone whom Vannerson remembers as a “friendly rival.” (Frank Vannerson, e-mail communication with the author, October 28, 2007.) But the truth may be that Vannerson created the second automated system. Dennis Dunn of Dunn & Hargitt recalls creating such a system in the late 1960s. (Dennis Dunn, e-mail communication with the author, February 25, 2008.) It’s worth noting that Fortune’s excellent profile of Commodities Corporation, cited above, wrongly reported that TCS was invented after 1971.

  27. Because of Weymar’s mixed feelings, the company’s launch prospectus mentioned the firm’s research into price trends only in passing. Commodities Corporation aimed to market its superior knowledge of fundamentals, not its computerized trend following.

  28. Recalling his status as the first non-PhD trader, Marcus says: “It created a certain amount of controversy. The whole idea was that this would be the best and brightest. I wouldn’t have been hired if it wasn’t for Amos pushing. Once I was hired, I wouldn’t say that I faced considerable opposition. Some of their PhDs hadn’t done as well as they had hoped.” Michael Marcus, interview with the author, November 21, 2007.

  29. Markovitz recalls, “Mike got a private jet. He wanted to have his wedding in Hawaii so [he] flew everyone out and put them up. He was a businessman, he would be cautious, he wouldn’t waste it, but when it was for his own pleasure, his own enjoyment, life is short, you’ve got the money, spend it. It was pocket change to him, he might as well.” Markovitz interview, February 5, 2008; Jack D. Schwager, Market Wizards: Interviews with Top Traders (New York: New York Institute of Finance, 1989), pp. 10 and 36.

  30. Helmut Weymar, who commented on a draft of this chapter, objects that Marcus paid great attention to fundamentals, so that the shift away from Commodities Corporation’s initial faith in fundamental analysis was less stark than I suggest here. (Helmut Weymar, personal communication with the author, August 1, 2008.) But there seems little doubt that in Weymar’s initial trading the fundamentals dominated the chart following while in Marcus’s trading the opposite was true. Marcus recalls: “The trend followers used to say that the fundamentals were embedded in the trend and that you could make more money if you waited until the fundamentals were being acted upon and causing a trend in one direction.” (Marcus interview.) Note also Kovner’s remark, later in this chapter, that the most profitable opportunities exist when there is no fundamental information. The contrast with the firm’s founding prospectus, which emphasized econometric modeling and made no mention of trends, is fairly conclusive.

  31. “You had advantages on the floor. Your advantage was that you knew a lot about the technical insides of one market. You could see who was buying, who was selling, how the orders were getting filled, where the stops were. The drawback was that you were pinned down to that market. If you were trading cotton, and soybeans were having a fabulous move, you would miss out. I later decided that you were better off giving up that technical advantage and having the opportunity to pick and choose among a number of markets.” Marcus interview.

  32. Ibid.

  33. There were several libertarians at Commodities Corporation. Markovitz recalls: “There was a lot of the antiauthoritarian, libertarian sentiment. I think a lot of people in the business who weren’t that way when they started became that way. I think it accelerates your awareness when you study the markets, analyze them, you see when the government interferes with the markets, ninety-nine times out of a hundred there is no benefit and it just creates problems.” Markovitz interview, February 5, 2008.

  34. Schwager, Market Wizards, pp. 19–20. On price controls and lumber, see also Barry Bosworth, “The Inflation Problem during Phase III,” American Economic Review 64, no. 2, Papers and Proceedings of the Eighty-sixth Annual Meeting of the American Economic Association (May 1974): pp. 93–99; and William Poole, “Wage-Price Controls: Where Do We Go from Here?” Brookings Papers on Economic Activity 1973, no. 1 (1973), p. 292.

  35. Jeffry A. Frieden, Global Capitalism: Its Fall and Rise in the Twentieth Century (New York: W. W. Norton & Co., 2006), p. 364.

  36. Xue-Zhong He and Frank H. Westerhoff, “Commodity Markets, Price Limiters, and Speculative Price Dynamics,” Journal of Economic Dynamics & Control, 29(9) (September 2005): 1,578.

  37. Meanwhile, investors sought safety in gold, driving the price above $300 an ounce in the summer of 1979 and above $800 in the winter—a far cry from the $35 mandated by the Bretton Woods system.

  38. Marcus interview, November 21, 2007.

  39. Marcus recalls, “I remember being in Bermuda and trying to curtail the growth of big government. That fitted in with my libertarianism.” (Marcus interview.) Markovitz also recalls clashing with Weymar at the Bermuda conference. The following years brought even more forceful efforts to get Weymar to curtail overhead. (Markovitz interviews.)

  40. For example, a company that contracted with school systems to provide lunches reckoned it had no need to insure itself against a spike in food prices until 1973, when it suddenly lost money as its input costs skyrocketed; from that time on, it insured itself by locking in its costs via the futures market. See Roger W. Gray, “Risk Management in Commodity and Financial Markets,” American Journal of Agricultural Economics 58, no. 2 (May 1976): pp. 280–85. The article also notes that after 1973, commodities markets experienced “unprecedented high hedging levels relative to speculation.”

  41. Commodities Corporation arranged this loophole with a grain wholesaler. Markovitz interview, November 1, 2007; Marcus interview.

  42. Commodities Corporation traders studied the “White Book,” a summary of the trading ideas of Amos Hostetter, a revered elder statesman at the company. Burton Rothberg, a trader who recalls the influence of the White Book, also emphasizes Vannerson’s influence. “Commodities Corporation really learned that trends always go further than you think. There was a lot of mathematical work on this by Frank Vannerson, and we found that over the short term trends tended to continue at every level. The theory was that unless you had a really good reason, you want to stay with the trend.” Burton Rothberg, interview with the author, February 5, 2008.

  43. Richard J. Sweeney, “Beating the Foreign Exchange Market,” Journal of Finance 41(1) (March 1986), pp. 163–82; Louis P. Lukac, B. Wade Brorsen, and Scott H. Irwin, “A Test of Futures Market Disequilibrium Using Twelve Different Technical Trading Systems,” Applied Economics 20, no. 5 (May 1988): pp. 623–39. These publications were followed by B. Wade Brorsen and Louis P. Lukac, “A Comprehensive Test of Futures Market Disequilibrium,” Financial Review 25 (4) (November 1990): 593–622. Belief in the existence of momentum effects became mainstream with the publication of Narasimhan Jegadeesh and Sheridan Titman, “Returns to Buying Winners and Selling Losers: Implications for
Stock Market Efficiency,” Journal of Finance, vol. 48, no. 1, March 1993, pp. 65–91.

  44. Irwin interview.

  45. Marcus interview.

  46. Philip Weiss, “George Soros’s Right-Wing Twin,” New York, July 24, 2005.

  47. Marcus recalls: “At the time I met Bruce, he was driving a taxi part-time and trading part-time. I was astounded by the depth and breadth of his knowledge. I would try to come up with something esoteric and arcane that would impress him, and he was right there and knew about it and could talk about it. Here was a guy working part-time and driving a taxi, but he was a colleague already.” Marcus interview.

  48. Rosenblum, Up, Down, Up, Down, Up, p. 98.

  49. Markovitz interviews.

  50. Rosenblum, Up, Down, Up, Down, Up, p. 98. Recalling Marcus’s prediction that Kovner would become the president of Commodities Corporation, Paul Samuelson says, “My comment was, ‘Bruce Kovner couldn’t afford to be president of Commodities Corporation.’” (Samuelson interview.) Rosenblum also remembers Kovner as follows: “He was extremely ambitious and had all the requisite skills needed to fulfill those ambitions. He was brilliant, verbal, and confident and possessed of a great deal of personal charm. Helmut was totally taken by him and like most people in the company, would go out of his way to please Bruce. Bruce became very close to Michael [Marcus] who took him under his wing and taught him a great deal about trading.” (Rosenblum, Up, Down, Up, Down, Up, p. 52.) Meanwhile, Kovner himself says of Samuelson, “He was always delightful. He was rather bemused by the fact that there are people who make money in these markets.” (Bruce Kovner, interview with the author, October 14, 2009.)

  51. Kovner emphasizes that he regarded Weymar’s original efforts to estimate the “efficient” price for a commodity as less fruitful than Marcus’s efforts to judge the market’s direction. Trying to come up with a point estimate for the right price of cocoa or anything else was difficult and potentially dangerous, since it could lead to obstinacy in trading. “As a trader of a leveraged fund you had to be centrally concerned with path rather than end points.” Kovner interview.