Opinion

Felix Salmon

When prop traders turn hedgie

By Felix Salmon
April 5, 2010

Jenny Strasburg finds a couple of former in-house prop traders with new funds of their own: Arvind Raghunathan, formerly of Deutsche Bank; and Mark Carhart, who was at Goldman’s Global Alpha fund when it blew up. Both are pushing a quant strategy, although Raghunathan layers on top some outsourced fundamental analysis, with more than 50 researchers in Chennai poring over public filings.

The main question which Strasburg anticipates from potential investors is basically “why should I invest in you when your strategy blew up in 2007″. But more fundamentally, I just don’t see the attraction of prop traders setting up their own shop with huge investments from their former employer. I’d love to see some numbers on that: how often do such funds have huge success, and how often do they fail?

Anecdotally, banks have enormous difficulty replicating the success of their sell-side traders when they move those traders over to a buy-side structure. The reasons for this aren’t obvious, but I suspect that it’s because Chinese walls are always more porous than banks think they are, and that when you’re sitting on a big trading floor, or even just part of that business, you get a feel for short-term capital flows which is very hard to replicate at a much lower-volume hedge fund. This isn’t (necessarily) about privileged insider information, but ask yourself this: what would happen if a hedge fund manager asked to lease a desk on the Deutsche or Goldman trading floor, using none of the bank’s own money, but simply trying to monetize the advantage of just being physically in that place? It’s pretty obvious that the bank would say no immediately, no matter how high the offered lease payments were.

So in general I’m suspicious of hedge funds being set up by sell-side superstars: once they go buy-side, their hot streak has a tendency to come to a screeching halt. No matter how clever they are, or how unique their strategy is.

Comments
3 comments so far | RSS Comments RSS

it seems Raghunathan attempts to provide more disclosure (less black-boxy) in an attempt to assuage investors.

I’m confused by one part of your post, though, Felix – these guys weren’t sell side traders. they were buy side traders at sell side shops. If the distinction isn’t clear, email me and I’ll explain. Raghunathan didn’t even sit in the same building as the DB broker dealer business – so I don’t think Chinese Walls have anything to do with it.

In fact, my former boss, while we were on the sell side, used to say “man, if we were on the buy side and had access to the entire Street’s research and views, this would be much easier.” of course, then we went to the buyside and realized that the grass wasn’t so much greener.

Posted by KidDynamite | Report as abusive
 

Yes, both these guys were at in-house hedge funds, which are more buy-sidey than sell-sidey, it’s true. But they almost certainly got there from being genuinely sell-side prop traders, who got given an in-house hedge fund to prevent them from leaving for an out-of-house hedge fund. Which they ended up doing anyway.

Posted by FelixSalmon | Report as abusive
 

Mark Carhart was an academic, never had a clue about prop trading.

Posted by alea | Report as abusive
 

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