The Hedge Fund SAC Capital is a very successful hedge fund given the sheer size and performance, but still some people are scared to work in a multi-manager model. The stigma of short-term driven results are a function of the business model. SAC has equity, which they lever up and give to various portfolio managers.
With over 90 portfolio managers, portfolios are sort of treated like stocks – they ride the winners and cut the losers. Even if you were a winner for several years, as soon as you become a loser, the job won’t last long, Because they take a lot of leverage, there isn’t any room for losses, so you can get stopped out very quickly. This model works very well as long as you are successful cutting your losers. Because there is such a heavy emphasis on not losing money, “long-term trades” are tough under this model because stocks don’t go up in a straight line. If the goal is to make 30% a year, they view it to be much easier to make 5% 6x than 30% 1x. It’s all a numbers game.
Here are some of the statistics they judge you on:
- Average return per winner idea annualized: i.e. 30% — know as the “slugging rate”
- Average return per losing idea annualized: i.e. -15%
- Win/ Loss ration: 2 to 1
- % Winning: 55% — know at “hit rate”
So your average return = you are right 55% of the time, you make 30% on your winners and lose 15% on your losers, your return = (.55 x .30) + (.45 x -.15) = 9.75%
In general, a portfolio manager is allocated a certain amount of capital, which is effectively buying power. A portfolio manager cannot invest greater than his or her buying power. The buying power is 3x the amount of equity allocated to the portfolio manager. The portfolio manager will usually collect a “management fee” on the equity allocation which will be used to pay salary, health care, technology, and research expenses. While sustained losses are not tolerated, because the portfolio manager is using 3x leverage (remember buying power = 3x equity), small losses on buying power are actually large losses on equity. For example, a 10% loss on allocated is really a 30% loss on equity. So on an equity basis, it takes a decent size loss to get into hot water, but on an allocated basis, losses cannot be large. Portfolio managers at the firm understand this concept, so most do not deploy 100% of their buying power.