But those were worries for another day. PDT’s performance was so incredible, it matched and at times even outpaced Renaissance’s Medallion fund. In 1997, however, Medallion’s returns leapt to a new dimension. The gains were unbelievable. Jim Simons had left everyone behind, and no one knew how he’d done it. Eventually, Renaissance stopped trading through Morgan, concerned that Muller’s operation was eyeballing its strategies. True to the spymaster culture they’d come from, the quants on Long Island were becoming increasingly paranoid, worried that rivals such as Muller would steal their special sauce. Likewise, Muller grew increasingly nervous about spies inside Morgan Stanley. PDT’s own traders were kept in silos, familiar only with their own positions and in the dark about the rest of PDT’s growing strategies.
Even as he reveled in PDT’s success, Muller was wary of over-confidence. “Keep your emotions in check,” Muller said to his traders over and over again. He knew from experience. After he and Elsesser first started trading in the early 1990s, they made several snap decisions to bypass the computer models. An unexpected economic report or surprise move by the Fed would send the market into chaos. Better to override the models, they thought, or simply shut everything down.
But they quickly concluded that the computers were more reliable than people. Every time they tried to outsmart the computer, it turned out to be a bad move. “Always trust the machine” was the mantra.
One day in 1994, Muller came across some old records from a quantitative trading group at Morgan Stanley that had briefly shot the moon in the 1980s. He’d heard stories about the group, trading-floor legends about a wild Italian quant named Nunzio Tartaglia, the astrophysicist and onetime Jesuit seminarian. Much of the history of the group had been lost. The rising young quants at PDT had little idea that the group was the originator of stat arb. While Muller and his team had developed the strategy on their own and had added their own unique bells and whistles to it, the earlier Morgan group was the first to discover it. By the 1990s, the strategy was spreading rapidly, and quants such as Muller and Farmer were trying to crack its code.
Knowing about stat arb and actually applying it were two different propositions, however. PDT had pulled it off.
The records from APT also taught Muller a valuable lesson. APT had piled up huge returns for a few years. Then, suddenly, the music stopped. It meant he could never let his guard down; he had to always keep moving, improving, fine-tuning the system.
In 1995, a young quant named Jaipal Tuttle arrived at PDT. Tuttle, who sported a Ph.D. in physics from the University of California at Santa Cruz, had been trading Japanese warrants in Morgan’s London offices for the previous few years. But Japan’s stock market and economy collapsed in the early 1990s, and so did the Japanese warrant business.
Tuttle’s physics background gave him the tools to understand many of the complex trades PDT executed. But since he didn’t have any computer programming skills, it limited his ability to design and implement models. Instead, he became PDT’s “human trader.” At the time, there were still certain markets, such as stock index futures, that weren’t fully automatic. Trades spat out by PDT’s models had to be called in over the telephone to other desks at Morgan. That was Tuttle’s job.
The automated trading system didn’t always go smoothly. Once PDT mistakenly sold roughly $80 million worth of stock in about fifteen minutes due to a bug in the system. Another time Reed, who was running the Japanese stock system at the time, asked another trader to cover for him. “Just hit Y every time it signals a trade,” he said. He failed to mention the need to also hit enter. None of the trades went through properly.
PDT often hired outside consultants to work for the group temporarily, typically academics out to make an extra buck in between teaching gigs. One day a consultant named Matt was implementing an arbitrage strategy on S&P 500 index options. The trade involved selling an option tied to the S&P 500 for one month, such as May, and buying an option for another month, such as June, to capitalize on an inefficiency between the two options. Tuttle had to process the trades over the phone. The consultant was in another room in PDT’s office, methodically reading trade orders to Tuttle. It was a large order, in the tens of millions of dollars.
Tuttle suddenly heard a faint scream somewhere in the office. He looked up and saw the consultant racing down the hall, flailing his arms in the air and screeching, “Stop! Stoooppp! Don’t buy, sell, seeelll!”
The consultant had crossed his orders: what he’d meant to sell, he’d bought, and what he’d meant to buy, he’d sold. Tuttle unwound the trade, but it was a lesson learned: humans are flawed; it’s best to let the computer run the show.
The year Tuttle arrived, PDT moved to Morgan’s new headquarters at 1585 Broadway, a hulking skyscraper just north of Times Square. They set up shop in better digs in a corner of the sixth floor of the building, one floor above Morgan’s main trading floor. As their track record improved, so did their space.
They started expanding the quant approach into more and more markets. “I want lots of systems,” demanded Vikram Pandit, who oversaw the group. (Pandit went on to become CEO of Citigroup in late 2007.) The group started trading Eurodollar futures, a relatively young market based on the price of dollars in overseas bank accounts. Soon, PDT was expanding into energy futures, bonds, options—whatever they could model, they would trade.
The group started getting rich as Midas grew and grew, especially Muller. He bought a beachfront cottage in Westport, Connecticut, and an expansive apartment in Tribeca, a chic Manhattan neighborhood known for its celebrity denizens such as Robert De Niro, Gwyneth Paltrow, and Meryl Streep. He took well to a life of luxury and started picking up quirky habits. He told his housecleaner to iron his sheets as soon as they emerged from the dryer because he didn’t like wrinkles. He’d arrange for an assistant to buy groceries in Manhattan and drive them to his Westport cottage, rather than go to the local grocery store down the street. “He was in a kind of different zone in terms of what was rational,” said one person who knew Muller at the time. As one of his many, ever-mushrooming sideline avocations, Muller wrote crossword puzzles, and several were published in the New York Times.
The group started taking trips to exotic locales around the world: Jamaica, Grenada, the Turks and Caicos. They’d go on ski trips in Vermont and rafting jaunts in Maine, with paintball games on the weekends they stayed in town. They’d eat lunch together at a table in the office’s common area, sharing their crunchy salmon rolls from the local sushi shop. It was a long stretch from the onion-burger-pounding orgies of Salomon’s mortgage bond traders in the 1980s.
There was something New Agey about it all to the few Morgan traders who knew about the group, something so San Francisco, flower children on the trading floor—the horror! the horror!—but it was all designed to bond the group, and it worked for the most part. Over the years, very few of the original PDT team had left, an extremely unusual record in an industry known for high turnover and stress-shortened careers.
Elsesser was one of the first to hit the road, moving on to study gender issues in the workplace at UCLA. She’d grown sick of Morgan’s Big Swinging Dick, macho culture, even though she was relatively isolated from the worst behavior under PDT’s protective bubble. Traders often treated her as if she were Muller’s secretary. One time soon after they’d launched PDT, Elsesser was trading futures contracts electronically. A man walked into PDT’s office, stared at Elsesser, looked around, left. He came again, looked, and left. The next time he came, looking around in confusion, scratching his crotch, Elsesser finally asked, “Can I help you?”
“They keep telling me some quant trader is in here trading futures and I keep telling them there’s nobody back here.”
After a furious pause, Elsesser said, “That’s me.”
The guy stood staring at her slack-jawed, then left again without saying a word.
A number of oddballs passed through PDT’s offices over the years. One trader grew frantic abo
ut the glare off his computer screen. He duct-taped a ruler to the top of his monitor, then attached a slab of cardboard to the ruler to block the light. Visitors walking by peering into the trading room through the glass partition would see a hunched quant typing beneath a jagged cardboard canopy. A Morgan bigwig with an office across the hall was outraged. “You can’t have this contraption!” he said one day, barging into the office. “I meet with highprofile CEOs. It’s embarrassing!”
Another quant liked to work in the dark, late at night. The trading room’s lighting system was equipped with motion sensors that would go off with the slightest twitch. He taped slices of paper across the sensors so he could type away happily in his dark room.
Interview sessions could be harrowing, at times bizarre. Muller liked to ask job applicants to guess, within a range, how much money he had in his wallet with a 95 percent confidence level.
“I don’t know. Between ten and one hundred dollars.”
Muller would pull out a $100 bill and put it on his desk.
“Between one and two hundred.”
Muller would pull out $200.
“Five?”
Muller, smiling and shaking his head, would pull out $500. It was a trick question. Muller might have a wallet full of cash for a late-night poker game. Or he might not have anything. The applicant obviously had no idea. A guess with a 95 percent confidence level should encompass a very wide range, between zero and a few thousand. More often than not, the question simply made the interviewee angry: Who is this freaking guy?
Muller also liked to interview top professional poker players, to the exasperation of his colleagues. Sure, these guys are good at poker, but can they trade? Can they program a computer? Do they know anything about factor modeling? None of the poker players panned out. One guy, it turned out, had a rap sheet for sports betting.
Headhunters caught the whiff of money and were continually pushing new candidates at Muller. Office secretaries fielded frantic phone calls from headhunters desperate to get a client a shot at the hot new Morgan hedge fund. “Get Muller on the phone right now!” they’d scream. “If you don’t put him on the phone right now, I’m going to lose millions!”
Everyone suddenly wanted a piece of Peter Muller. The success led to even more unconventional behavior. Muller started skipping the firm’s early-morning meetings and would drop by the office around 11:00 A.M. or later—if he showed up at all. Tuttle wore torn Clash T-shirts and flashy earrings, a bizarre sight at buttoned-down Morgan Stanley. The group would celebrate days when they’d earned $10 million with rounds of wine in plastic cups. As time went on, there were more and more plastic-cup wine days.
On one occasion, Muller decided he needed the calming burble of trickling water in his office. He purchased a giant stone waterfall called Niagara. It was shipped into PDT’s office in a massive crate. The building’s office personnel went ballistic—the waterfall was so heavy it could collapse into the floor below, Morgan Stanley’s main trading floor. Not good. The box sat in the office for weeks. One wag scratched out the N in the waterfall’s name and replaced it with a V, suggesting that Muller had taken delivery of a massive box full of erectile dysfunction medication.
Another time, Muller told Elsesser he wanted to install a revolving door between their offices to make it easier to go back and forth and exchange ideas. Muller meant it as a joke. Elsesser, spooked by the idea of Muller rotating in and out of her office all day, didn’t think it was so funny.
The top brass at Morgan couldn’t care less about the bizarre behavior of their secretive sixth-floor quants. The money they were kicking out was a miracle. Morgan Stanley won’t reveal precisely how much money PDT made over the years, but former employees commonly characterize its profitability as off the charts. For the ten years through 2006, PDT churned out an estimated $4 billion in profits, after shaving 20 percent off the top, which the company paid to members of PDT. That means the small group of traders during that time took home roughly $1 billion. The salaries of the top brains at PDT such as Muller, Nickerson, and Ahmed in some years vastly exceeded the take-home pay of top executives in the firm, including the CEO. In certain years—especially during the late 1990s and early 2000s—PDT accounted for one-quarter of Morgan Stanley’s net income.
“I would describe it as a superhumanly large amount, a staggeringly large amount. It was beyond belief how large it was. It was an exceptionally well-functioning machine,” said Tuttle, who left the firm in 2001 to follow his dream of competitive windsurfing.
“PDT keeps the lights running at Morgan Stanley,” Vikram Pandit liked to say.
In 1999, Muller bought Nickerson an expensive bottle of singlemalt scotch to reward him for his work on Midas. In the five years since it had been up and running, Midas had delivered $1 billion in net income to Morgan, in the process making everyone at PDT rich beyond their wildest dreams. In the coming years, it would only get better, making everyone even richer. Especially Peter Muller.
ASNESS
When Cliff Asness took a full-time job at Goldman in late 1994, he wasn’t sure what his job was supposed to be. He was given the task of building quantitative models to forecast returns on multiple asset classes, a broad mandate. Essentially, Goldman was taking a gamble on the young phenom from Chicago, trying to see if his ivory tower schooling would pay off in the real world. Goldman had made one of its first wagers on book smarts with Fischer Black in the 1980s. By the early 1990s, it was the go-to bank for bright mathletes from universities around the country.
Asness called his fledgling operation Quantitative Research Group. To beef up QRG’s brainpower, he recruited several of the smartest people he’d come across at the University of Chicago, including Ross Stevens, Robert Krail, Brian Hurst, and John Liew. Krail and Liew had spent time working at Trout Trading, the money management firm started by trading legend Monroe Trout Jr. Liew, the son of an economics professor at Oklahoma University, had planned to follow in his father’s footsteps and pursue a career in academia. But his time at Trout, where he worked building quantitative trading models, changed his mind. One day he was talking to Krail about their work at Trout Trading. “This actually isn’t that bad; this is kind of fun,” he said. Liew had always expected to hate work. He was surprised to find that he was actually enjoying himself.
“Don’t think of this as a job,” Krail said. And it paid well, too.
At first Asness’s group didn’t directly manage money. Its initial task was to act as a sort of quant prosthesis for a group of fundamental stock pickers who’d run into trouble trying to pick stocks outside the United States. Was there a way to use quantitative techniques to guide investment decisions on a country-by-country level? This was not a problem Asness or anyone on his team had previously considered. It had never come up in the classroom or in the stacks of textbooks they’d memorized.
Asness’s reply: “Of course!”
They put their heads together. Was there any similarity between the strategies they’d learned at Chicago and the task of assessing the health of an entire country? The surprising answer, they discovered, was yes. The value and momentum anomalies in stocks they’d studied in academia could actually work for entire countries.
It was a monumental leap. They would measure a country’s stock market, divide that by the sum of the book value of each company in that market, and get a price-to-book value for the entire country. If Japan had a price-to-book value of 1.0 and France had a price-to-book of 2.0, that meant Japan was cheap relative to France. The investing process from there was fairly easy: long Japan, short France.
The applications of this insight were virtually endless. Just as it didn’t matter whether a company made widgets or tanks, or whether its leaders were visionaries or buffoons, the specifics of a country’s politics, leadership, or natural resources had only a tangential bearing on the view from a quant trader’s desk. A quantitative approach could be applied not only to a country’s stocks and bonds but also to its currencies, comm
odities, derivatives, whatever. In short order, Asness’s team designed models that looked for cheap-versus-expensive opportunities around the globe. Momentum strategies quickly followed. Goldman’s higher-ups were impressed with their bright young quants. In 1995, they agreed to seed a small internal hedge fund with $10 million.
It would be called Global Alpha, a group that would go on to become one of the elite trading operations on all of Wall Street. Global Alpha would also become a primary catalyst for the quant meltdown of August 2007.
During his first few years at Goldman, Asness frequently came in contact with one of the chief architects of the Money Grid, Fischer Black.
Along with Thorp, Black was one of the most crucial links between post–World War II advances in academia and innovations on Wall Street that led to the quantitative revolution. Unlike the practical-minded Thorp, Black was much more of a theorist and even something of a philosopher. Among his many quirks, Black was known for his conversational sinkholes, extended periods of awkward silence that left his companions off-guard and confused. Asness had his fill of these experiences at Goldman. He would step into Black’s office, just off Goldman’s trading floor, to answer a question from the great man about some market phenomenon. Asness would quickly spit out his thoughts, only to be met by Black’s blank stare. Black would swivel his chair around, facing his blinking computer screen, and sit thinking, sometimes minutes at a time. Then, after a crushingly long silence, he would swivel back and say something along the lines of “You may be right.”
“It was like the air coming out of the Hindenburg,” Asness recalled.
Black believed in rationality above all else. But he was also a man awash in contradictions. A central figure in quantitative finance, he never took a course in finance or economics. He was a trained mathematician and astrophysicist, as risk-averse as a NASA launch director, with a childlike wonder about the inner workings of stars and planets. He soaked his cereal in orange juice instead of milk, and in his later years confined his lunch to broiled fish and a butterless baked potato. Worried about a family history of cancer, the disease that eventually took his life, Black scanned his workplaces with a radiation meter and bought long cords for his computer keyboard to distance himself from the monitor. But he also had a rebellious streak. He dabbled in psychedelic drugs as a young man and trolled through pages of classified ads seeking companionship, suggesting to his estranged wife at the time that she do the same.
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