From inception to execution, assuming it's not fully automated. I guess I have always found it a funny idea to imagine that somewhere at a renowned hedge fund is still some guy in front of a computer pushing BUY and SELL, except they're operating with far more capital and have to iceberg their orders while a team of people backseat drive his execution and everybody fights over the charts.
OP - would you like to copy them, or trade against them? not to be facetious here, but perhaps a more to-the-point question is...what is the best way to fade the non-retail entities...because by all accounts the average/median hedge fund is returning like 2-3% per annum currently, so whatever they are doing is not very good - ie. instead of copying them, it may be more advantageous to focus on the inefficiencies they have created in supply/demand sure, there are the top percentile entities like rentech, etc, but for a $3 trillion pool of capital just in the hedge fund industry alone (and then you also have the additional capital in mutual funds, pensions, etc), on an asset-weighted basis, the returns are sub-par even compared to long-only market indices, not to mention the '20-40% per annum' level that first set the justification for hedge fund performance fees a generation ago. so if the perceived 'smart money' is actually the 'dumb money' in reality, then the true 'smart money' must be out there on the opposite side of those trades...just saying
The question is as mechanical as it gets; I'm not asking any strategy-related questions. I'm sure it differs from firm to firm, but literally, for a given hedge fund, is it one guy calling a shot, a team of analysts chattering about it, and one guy pushing a button? What are some notable firms that rely on one central decision-maker? What about some that are a team of analysts? And those that have a team of analysts with proprietary algorithms helping them? Pretty much was interested in if anybody had interesting anecdotes about what the trading firms of real hedge funds actually operated like. Structurally, logistically, what are interesting anecdotes about what happens before some grunt plugs in the numbers and hits BUY/SELL?
Lets take a simple LS fund. There is a PM (he's doing "the philosophy" and the final say), there are analysts (they actually do the analysis) and there is a trader (he presses the button). The investment flow would go like PM to analyst: what do you think of buying some shares of DB? analyst to PM: let me do some numbers...blah, blah, balace sheet, revenue, book value PM: ok, sounds like a great investment PM to trader: I want to be long 100mm equivalent of DB shares! trader to PM: let me see what the best way to get that exposure would be
It would be interesting to know the thought process of the trader...his or her plan of executing a large purchase of this magnitude. Might have some importance for the little guy, since we have to deal with institutional order flow whether we know it or not.
I have never sat in an HF execution seat but I have been on the other side of phone for their EQD flow, so my version might be a bit distorted. It really depends on a variety of factors. If it's just a question of getting some shares, he'd probably look at either executing electronically (anything from simple vwap to a complex execution process via multiple venues) or getting a block offer (for a fee). If PMs mandate includes derivatives, they might look at options or equity swaps etc. If we are talking something BSD (e.g. Pershing Square style activist investing), it's a complex process that involves legal analysis, derivatives and a lot of moving parts - usually, they end up paying a fair bit for the execution process.
Most hedge funds centralise their execution regardless of how many decision makers there are. Would be crazy if one desk was selling whilst another was buying. There are some other efficiencies involved as well. Same at banks - when I was working on interest rate options desk we had to do our cash trades with the cash desk, swap hedges with the swaps desk etc. Sometimes we did our own futures trading as that was on screens (I'm old enough that swaps weren't on the screen yet), for large trades we sent it to the futures desk. Each desk then pools the net risk from internal trading and goes out to hedge it. The exception are multistrat 'umbrella' funds with lots of people running their own book with p&l cut, particularly with quicker strategies where you don't want to wait for an internal team to do the trade for you, more like a prop shop than a hedge fund. Execution is often a mixture of 'grunt', prop algos and outsourcing to banks ('do this trade today your benchmark is VWAP'). And the banks in turn of course will use a mixture of 'grunt's and algos (assuming they don't just match the orders on their desk internally or in their private dark pool). I'd say in equities that around 90% of trades go to algos, one way or the other (directly or via banks). In futures 75%. These are % by # of trades, by volume the human share will be higher - humans still tend to do the larger trades especially in futures. More complex trading is also more likely to be done by 'grunts'. Clearly smaller funds are more likely to outsource their trades or use 'grunts' rather than build their own algos. Sometimes it's hard to tell the difference between humans and algos. A 'grunt' trader might be given a large order, say 500 US 10 year futures contracts. They probably aren't going to do that entirely manually. They're more likely to use a simple iceberg algo if the market is holding steady, gradually feeding in clips of 50 lots to the algo which in turn is probably only showing 1 or 2 lots in the market. Then if the market starts to run away from them they might switch to just dumping it manually. Is that a human, or an algo, executing that order? Bank algos and internal algos have different incentives. Internal algos are always built to provide best execution, outright. Bank algos are there to provide best execution against a benchmark, like VWAP. These aren't always the same. Hope this helps. GAT
The descriptions above are mostly accurate. However, keep in mind that methodologies and setups can vary a lot. Dedicated execution desks/traders occasionally make sense, but not always.