As a teenager growing up in Bronxville, New York, in the 1950s, Black loved to play the role of devil’s advocate, extolling communism to his conservative father and expressing admiration for Greenwich Village’s bohemians to his religious mother. He started a neighborhood group called the American Society of Creators, Apostles, and Prophets, which would gather to discuss topics such as Aldous Huxley’s experimentation with mind-altering drugs. He attended Harvard, grew fascinated with computers, and eventually gravitated toward finance after working for a management-consulting firm near Boston called Arthur D. Little.
In the fall of 1968, he met Myron Scholes, a young MIT economist from Canada. Scholes had recently started thinking about a tough problem: how to price stock warrants. Black had been mulling over the same puzzle. The pair teamed up with Robert Merton and several years later published their groundbreaking research, with a little help from Thorp, on how to price stock options.
In the early 1970s, Black took a job teaching finance at the University of Chicago. His third-floor office in Rosenwald Hall was sandwiched between the offices of Myron Scholes and Eugene Fama. He then took a job teaching at MIT for the following nine years.
But he was getting restless, stymied by the slow pace of academia. Robert Merton, meanwhile, had been working as a consultant for Goldman Sachs. He’d once suggested to Robert Rubin, then head of the firm’s equities division and future Treasury secretary under Bill Clinton, that Goldman should consider creating a high-level position for a financial academic.
One day Merton asked Black if he knew anyone who fit the bill.
“Bob, I’d be interested in that job,” Black replied. In December he took a trip to New York to discuss the job with Rubin. In early Black was hired as head of Goldman’s Quantitative Strategies Group.
One story—perhaps apocryphal—goes that soon after taking the job, Black was getting the grand tour of Goldman’s trading floor in downtown Manhattan. The noise on the floor was deafening. Traders shouted buy and sell orders at the top of their voices. Harried men ran to and fro. It was a bizarre scene to the middle-aged Black, more used to the cloistered halls of universities where he had spent most of his career.
Black was eventually brought to the firm’s options desk to meet the head of trading. “So you’re Fischer Black,” the trader said, reaching out a hand to greet the legend. “Nice to meet you. Let me tell you something: you don’t know shit about options.”
Welcome to Wall Street, Mr. Black.
Black’s office was on the twenty-ninth floor of Goldman’s main building at 85 Broad Street, a few blocks from the New York Stock Exchange. Hanging on the wall of his office, situated next to the firm’s trading floor, was a poster of a man jogging along a dirt road that read: “The race is not always to the swift but to those who keep running.” He could often be seen typing away on his Compaq Deskpro 386 computer, obsessively entering notes into a program called Think Tank as he swigged bottle after bottle of water kept in an office credenza.
His job was simple: figure out how to turn his quantitative theories into cold hard cash for Goldman. There was something of a problem, however. Black hewed to the Chicago School notion that markets are efficient and impossible to beat. In one of his first attempts to trade, he lost half a million for the firm. But he soon realized, watching Goldman’s traders make millions of dollars from an endless cycle of inefficiencies, that the market might not be quite the perfect humming machine he’d thought back in his ivory towers in Cambridge and Chicago.
Slowly but surely, Black was turning into one of Fama’s piranhas. Always attuned to the power of the microprocessor, he became an innovator in transforming trading into a highly automated man-machine symbiosis. Goldman’s edge, he foresaw, would be the powerful mix of financial theory and computer technology.
It was only the beginning of a dramatic change on Wall Street, the creation of the Money Grid, made up of satellites, fiber-optic cables, and computer chips, all of it tamed and fed by complex financial theories and streams of electricity. Like a spider in its web, Black was at the center of it all in his dark office at Goldman Sachs, pecking away at his computer and torturing subordinates such as Cliff Asness with his deafening silences and oracular comments about the market.
Quants make their living juggling odds, searching for certainty, shimmering probabilities always receding into the edge of randomness. Yet for Cliff Asness, there seems to be one single factor in his success that he almost obsessively returns to: luck.
Asness readily admits that luck is not the only factor in success or failure. Being prepared and working hard puts a person in position to capitalize on that lucky chance when it comes around the corner. But luck is without question a major force in Asness’s world.
After flipping the switch on Global Alpha in 1995 in Goldman’s office at One New York Plaza, the fund promptly proceeded to lose money for eight straight days. Then its luck changed. Massively. After the initial downtrend, Global Alpha didn’t lose money for a very long time. It gained a whopping 93 percent in its first year, 35 percent in its second. A very auspicious, and lucky, start.
To show their appreciation for all the money Asness’s group started bringing in, Goldman’s bigwigs arranged a meeting with one of the biggest wigs of them all, the firm’s chief operating officer, Henry Paulson (who went on to become CEO of Goldman and then Treasury secretary in the second term of the George W. Bush administration).
Asness could have thought of better ways for Goldman’s brass to express their appreciation, but he didn’t object. He slapped together a PowerPoint presentation to explain to Paulson exactly what he was doing.
The big day came. As Asness went to meet the firm’s notoriously prickly and long-jawed COO, he thought back to the day he’d gone to tell Fama about his research on momentum. Asness respected Fama far more than Paulson, whom he barely knew. So why was he so nervous?
The presentation involved, among other things, the various markets Global Alpha traded in. Asness rattled off a string of regions and countries: North America, Southeast Asia, Brazil, Japan.
“We trade in all of the countries in the EAFE index,” Asness added.
Paulson had been silent throughout the presentation. So he shocked Asness when he suddenly blurted out, “Hold it.”
Asness froze.
“How many countries are in that index?”
“Well,” Asness said, “it comprises Europe, Australasia, the Far East—”
“That’s not what I asked,” Paulson said curtly. “How many countries?”
“I believe twenty-one,” Asness said.
“Name ’em.”
Asness looked at Paulson in shock. Name them? Is this guy screwing with me?
Paulson wasn’t laughing. Asness swallowed hard and started to tick off the names. France, Germany, Denmark, Australia, Japan, Singapore … He listed every country in the EAFE index. His broad forehead had sprouted a dew of sweat. Paulson sat there coolly watching Asness with his steely eyes, clenching his massive mandible. There was an awkward silence.
“That’s eighteen,” Paulsen said.
He’d been counting the names. And Asness had come up short—or so Paulson was implying. There was little Asness could say. He fumbled through the rest of the presentation and left in confusion.
Great way to show your appreciation for my hard work, he thought.
As Global Alpha continued to churn out awe-inspiring returns, Goldman poured in billions. By late 1997, the Quantitative Research Group was managing $5 billion in a long-only portfolio and nearly $1 billion in Global Alpha (which could also take short positions). Barely a month went by in which they didn’t put up eye-popping gains. Asness kept pulling in new talent, hiring Ray Iwanowski and Mark Carhart, alums of Chicago’s Ph.D. program in finance.
He also started teaching classes from time to time as a guest lecturer at New York University’s Courant Institute, a rising quant factory. Universities throughout the country were adding financial engine
ering courses. Carnegie Mellon, Columbia University, and Berkeley, as well as the stalwarts at MIT and the University of Chicago, were hatching a whole new generation of quants. The Courant Institute, a short hop from Wall Street in Greenwich Village, was gaining a reputation as a top quant farm. It was at Courant in the late 1990s that Asness met a young quant from Morgan Stanley named Peter Muller, as well as Neil Chriss. Several years later, he became a regular at the quant poker game.
Meanwhile, the success of Global Alpha was making Asness and his Chicago all-star team wealthy. In retrospect, Asness would realize he and his cohorts had been especially lucky to start investing during a period that was very good for both value and momentum strategies. At the time, however, luck didn’t seem to have much to do with Global Alpha’s success. Asness got cocky and restless. When he’d come to Goldman in 1994, he’d hoped to combine the brainy environment of academia with the moneymaking prospects of Wall Street, a kind of intellectual’s nirvana where he’d get richly rewarded for cooking up new ideas. Trouble was, he didn’t have time to do as much research as he would have liked. Goldman was constantly shuttling him around the world to meet new clients in Europe or Japan or to counsel employees. Then there were all the office politics, plus nuts like Paulson. He started thinking the unthinkable: leave the mother ship.
It wasn’t an easy decision. Goldman had given Asness his start, shown faith in his abilities, and provided him the freedom to implement his ideas and hire his own people. It seemed like a betrayal. The more Asness thought about it, the more it seemed like a bad idea. Then he met a man with the ideal set of skills to help launch a hedge fund: David Kabiller.
David Kabiller had been something of a wanderer among Goldman’s ranks since he’d joined the bank in a summer training program in 1986. He’d worked in fixed income, equities, and pension services. He first met Asness as a liaison between institutional investors and GSAM, which managed money for outside clients in addition to running proprietary funds for Goldman itself.
Kabiller, who’s something of a mix between a Wall Street financier and car salesman, was quick to notice that Global Alpha was raking in money. Global Alpha had a live, second-by-second computerized tabulation of its profit and loss. One day Kabiller was watching the ticking numbers fly across the screen. It was increasing, he saw with a gasp, by millions of dollars every second.
Something very special was going on with these nerdy quants from Chicago, he realized. They weren’t like the other people at Goldman. Not only were they smart, they were intellectually honest. They were on a quest—a quest for the Truth. He didn’t quite understand all the mumbo jumbo, but he did know that he wanted to be part of it.
Asness and a select group from Global Alpha, as well as Kabiller, started meeting at Rungsit, a Thai restaurant on the East Side of Manhattan. Over steaming bowls of tom yum soup and satay chicken they weighed the pluses and minuses of striking out on their own. Goldman paid well and offered long-term security. Asness had recently been made a partner. There were rumors of an IPO on the horizon, and all the money that would mean. But it still wouldn’t be their company.
At the end of the day, it seemed the choice was clear. Much of the conversation centered on what to call the new firm: Greek god? Mythical beast? True to their nerd roots, they settled on a name more blandly descriptive than colorful: Applied Quantitative Research Capital Management, AQR for short.
For a brief period Asness got cold feet. Goldman’s bigwigs were pressing him to stay. Goldman was his home. Kabiller was crushed, but there was nothing he could do to change Asness’s mind.
Then, one night in late 1997, Kabiller got a phone call.
“It’s Cliff.”
Kabiller knew something was up. Asness never made personal phone calls.
“How you doing?” Kabiller asked. He was smiling so hard his face hurt. There was a long pause. Kabiller could hear Asness breathing on the other end of the line. “You ready to do this now?”
“Yeah,” Asness said.
And that was it. In December 1997, just a few days after the bank handed out its bonuses, Cliff Asness, Robert Krail, David Kabiller, and John Liew turned in their resignations to Goldman’s management. Asness listened to the soundtrack from the Broadway play Les Misérables to psych himself up for the task. He didn’t want to change his mind again.
Less than a year later, on August 3, 1998, AQR was up and running with $1 billion in start-up capital—one of the largest hedge fund launches on record at that point, and three times as much as they’d originally projected they could raise. Indeed, Asness and company turned down more than $1 billion in extra cash because they weren’t sure their strategies could handle so much capital. Investors were desperate to get in. The charismatic French fund of funds manager Arpad “Arki” Busson, future beau of the supermodel Elle Macpherson and the actress Uma Thurman, offered the use of his Swiss chalet in exchange for capacity. AQR turned him down flat.
Indeed, AQR had the ideal hedge fund pedigree: University of Chicago quant geniuses, a plethora of pension fund and endowment clients through Kabiller, sterling Goldman Sachs credentials, mind-boggling returns …
“It was a total labor of love,” recalled Kabiller. “We knew our shit, we were prepared. We had the right blend of skills, we were the real deal.”
In its first month, AQR Capital, once described as a dream-team blend of Long-Term Capital Management and Julian Robertson’s Tiger Management, scored a small gain. From there, it fell off a cliff. It was a disaster. The reason for AQR’s downturn was in many ways more unlikely than the chain of events that destroyed LTCM. Luck, it seemed, had abandoned Cliff Asness.
WEINSTEIN
A pair of black limos raced out of Las Vegas into the desert night. It was the fall of 2003, and Boaz Weinstein’s credit traders were celebrating at an off-site bonding session. The plan was to discuss the changing landscape of the credit markets, but this was Vegas. Weinstein’s traders were itching to cut loose.
“It was a lot of betting, a lot of drinking, a lot of blackjack,” said a former Deutsche Bank trader who worked under Weinstein.
After hitting the blackjack tables, where Weinstein won over and over again using the card-counting techniques he’d learned from Beat the Dealer, and playing hand after hand of high-stakes poker and roulette, they piled into rented stretch limos, popped open bottles of chilled champagne, and told the drivers to step on it. Their destination: that classic quant pastime, paintball.
At the paintball facility outside the city, the teams squared off. “Prop” traders, the gunslingers who did nothing but trade all day to earn money for the bank (and themselves), faced the “flow” traders, who had the less glamorous job of acting as go-betweens for clients of Deutsche Bank, matching up buy and sell orders that “flowed” through the firm. Flow traders were allowed to make side bets, making their lives somewhat worth living, but they were never able to put the real money on the line, the colossal billion-dollar balls-to-the-walls positions that could make a year or break it.
Weinstein led the prop paintballers. One of his top lieutenants, Chip Stevens, led the flow squad. Clad in T-shirts that read “Credit Derivatives Offsite Las Vegas 2003,” the Deutsche Bank credit quants donned their goggles and fanned out across the paintball obstacle course.
Naturally, the gunslingers were victorious. But it was all in good fun. Everyone piled back into their limos, guzzled more champagne, and convened at Weinstein’s huge luxury suite at the Wynn Las Vegas, where the festivities—including a magician and mentalist recommended by Bear Stearns chairman Ace Greenberg—really began. If there was one thing Weinstein’s credit traders knew, it was that they understood how the game was played—and they played it better than anybody else. Blackjack was a joke. The real casino, the biggest in the world, was the booming global credit derivatives market. And they were playing it like a fiddle. The money was huge, the women were beautiful, and everyone was brilliant and inside the secret. Deutsche Bank had just been named Derivativ
es House of the Year by Risk magazine, topping the previous champ, J. P. Morgan, which started referring to Deutsche as “enemy number one.”
To Weinstein, ascending to the top wasn’t a surprise. They had developed an aggressive, no-holds-barred approach that the rest of the Street couldn’t match. And that was the real point of the Vegas trips, some of those attending thought. At Deutsche Bank, risk wasn’t fucking managed. Risk was bitch-slapped, risk was tamed and told what to do.
The traders lapped it up.
It was all happening. Weinstein’s dream of becoming an elite Wall Street trader, nurtured ever since he watched Louis Rukeyser on TV as a precocious chess prodigy on the Upper East Side, was coming true.
And it had been so very easy.
Just as AQR was starting to trade in 1998, Weinstein had set up shop at Deutsche Bank’s fledgling credit derivatives desk. A mere twenty-four years old, he seemed nervous and a bit frightened by the frantic action of a trading floor. But he absorbed knowledge like a sponge and was soon able to spit out information about all kinds of stocks and bonds at will from his steel-trap photographic memory.
Weinstein’s expertise at his previous job had been in trading floating rate notes, bonds that trade with variable interest rates. It wasn’t much of a leap from there to credit default swaps, which act much like bonds with interest rates that swing up and down.
The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It Page 16
