Odd Lots The Math That Explains How Multi-Strategy Hedge Funds Make Money
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Oct 7, 2024 
Dan Morillo, co-founder of Freestone Grove Partners and former partner at Citadel, dives into the fascinating world of multi-strategy hedge funds. He clarifies the differences among fund business models and discusses the importance of selecting the right portfolio managers. The conversation touches on managing crowding risk with a poker analogy and the intricacies of compensation structures affecting trader performance. Morillo also highlights the balance between quantitative analysis and intuition, emphasizing the value of team dynamics in optimizing returns.
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The Math of Diversification
- Diversification increases Sharpe ratios, but correlation imposes a maximum limit, regardless of the number of portfolio managers.
- Adding more people beyond a certain point provides diminishing returns due to correlation.
Value of Uncorrelated Returns
- Uncorrelated returns are desirable because they allow for cleaner allocation and boost returns beyond standard market risks.
- Allocators seek uncorrelated returns to avoid paying high fees for easily accessible market beta.
Hedge Fund Allocation
- Focus on demonstrably extracting alpha, not just riding existing betas.
- If a hedge fund charges high fees but relies heavily on market beta, allocators should be wary.