Inside hedge funds' never-ending hunt for an edge

By

Bradley Saacks

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Hedge funds have never stood still, but the constant search for an incremental edge — over the market, over their peers, over the machines — is getting more harried.

The world's biggest managers, with the deepest pockets, have always sought information no one else has. The hunt has spawned entire industries, such as expert networks and alternative data vendors, that promise to give funds' portfolio managers a leg up on the competition. In recent years, the ongoing talent war has been driven by funds looking to hoard the best traders.

Now, firms are increasingly turning to ideas from outside their walls.

Funds are embracing alpha capture programs — which gobble up ideas from traders, market data, or sell-side research for a fee — to give their investing engines another source of fuel. It's the latest evolution for an increasingly institutionalized industry where markets move too quickly for investing edges to last, and AI is eroding competitive advantages.

The massive multi-manager platforms that have come to dominate the industry — firms like Millennium, Citadel, Point72, Balyasny, Marshall Wace, and more — want a monopoly on the best investment ideas. The investing machines they've built rely on a constant stream of market-beating concepts that have historically come from their own teams of talented traders.

Talent war response?

Thanks to a near-unlimited recruiting budget, restrictive non-compete clauses that artificially shrink the pool of job seekers, and a surge in assets under management, the cost of recruiting new investors has risen to the point that funds are seeking out the raw resource.

"The large multi-managers are exploring buy-side alpha capture for a simple reason: they need to deploy more capital than their core pod model allows. External alpha capture lets them expand supply at a lower cost than building teams internally," said Cameron Hight, the CEO of Alpha Theory, a research platform that helps smaller funds size and position their portfolios.

Citadel's quant unit and Point72 are building out buy-side alpha capture programs that will partner with external funds to provide them with signals — data that informs whether a fund should buy, sell, or hold an asset — in exchange for a fee. Rivals Millennium and Balyasny are considering it.

Rokos is creating a program focused on compiling sell-side equity research and sifting it for trading opportunities, a structure pioneered by Marshall Wace's long-running TOPS strategy.

Both Marshall Wace and Rokos also run their own macro-flavored alpha-capture programs, two people familiar with the matter say, that compile and crunch interest-rate projections from sell-side research desks.

Alpha capture — internal and external — is far from new. As Business Insider previously reported, funds such as Man Group and Squarepoint have added to their teams in recent years. Internal programs, known as center books, have been a core part of the biggest managers for decades.

The "dirty little secret" of large multistrategy firms' equity divisions, one allocator said, is that the center book is, on average, one of the most profitable parts of the stockpicking operation. Expanding the cost-effective structure to find more ideas is only natural.

For instance, a new portfolio manager might cost millions to bring in-house. Partnering with an external manager can be a fraction of the cost.

AI leveling the playing field

AI's advances have pushed firms to search even harder for new ideas. The edge that used to come from sources like alternative data — such as credit-card receipts and satellite images — has gone away.

It's made the data that only a few can access or possess that much more valuable.

Some firms are building investing strategies around that premise. Aethon Fund, a new firm from George Kailas, the founder of Prospero, a market research platform for retail investors, will invest using signals generated from retail traders who have used the platform over the years.

"For decades, quant funds competed on their data budgets, outspending everyone else to find alpha others couldn't," a press release for the new $50 million fund reads.

"Aethon is built on the argument that AI ended that race, and it's structured around the key differentiator for the new reality: proprietary data inputs stress-tested before institutional use."

It's not just quants who have decided to tap into the knowledge of the masses. David Stemerman founded long-short fund Conatus Capital and picked stocks for Steven Mandel's Lone Pine, but now runs CenterBook Partners, which invests its capital based on ideas from dozens of partner managers.

Even though external alpha capture is primarily a systematic business, there is an art to the science, Stemerman said.

"Managers will only participate if they believe it serves themselves and their investors, and that comes down to trust around sharing data with another hedge fund that will trade on it," he said.

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Bradley Saacks

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Bradley Saacks covers hedge funds and other asset managers for Business Insider from New York. He first wrote about the multi-trillion-dollar industry for Business Insider from New York in late 2018, after spending two years covering mutual funds for the Financial Times' trade publication, Ignites.He left Business Insider for a little over a year, starting in mid-2022, and worked as a business reporter for Semafor, a media startup. He rejoined Business Insider in 2023, this time in the publication's London office, and has since relocated back to New York. A graduate of the University of North Carolina at Chapel Hill's School of Media and Journalism, he was the recipient of the O.J. Skipper Coffin Award, which is given to the top graduating senior in the reporting track.During his time at Business Insider, he has broken news on the biggest names in hedge funds, including Paul Singer's Elliott Management, Ken Griffin's Citadel, Seth Klarman's Baupost Group, and more. He is interested in telling stories about the people behind the scenes who are driving big changes at the biggest firms. He can be reached on WhatsApp and Signal at +1 919 816 5537.Notable stories include:

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