From Inside a Hedge Fund: Revelations From Insiders

Hedge funds are the most off-limits financial institutions doing their best to keep the ways of making money off the competitors' radar. Generally, what happens within a fund, stays there. Former and current fund managers, traders, and analysts protect their portfolios and prevent data leaks.

Some bits and pieces of insider information about the inner workings of hedge funds can usually be found on imageboards, as well as deep within Reddit and Quora. Here we have collected some interesting facts about what is happening in hedge funds based on open sources.

“Gods and Slaves”: Ordinary Fund Employees Have 100% Risk, 5% Profit

Traders and analysts working for funds should often make risky, non-obvious, and sometimes seemingly absurd decisions that defy explanation, especially when trying to justify them to clients.

This was noted by Reddit user dascarescu, who provided moderators proofs of working in a hedge fund management company.

...You need to invest a lot in hand holding and explaining to people you know what you're doing - especially when you take on a contrarian trade (like the Greek REITS we are buying) that everyone thinks is insane...

And especially if it drops after you buy it, since it's very hard to time the bottom on these things - you need to make sure you are right, and have the stamina to hold the position until it goes to a good sales price.

There are no guarantees for small fund employees whose income directly depends on the performance of the entire fund. A good year can easily be followed by a loss-making one slashing incomes of even successful employees who have fulfilled their plans.

According to Laurent Bernut, Former Analyst at Fidelity and Ward Ferry Management:

...HF eat what they kill. There is no guarantee there, no safety net.

...In small hedge funds, there are only 2 types of employees: gods, the partners and slaves the rest. Regular employees have 100% of the risk and 5% of the upside. In the 2nd HF, after the 800K bonus, we had a down year. I had a spectacular one but got paid a pittance. The principal kept his 2% of the 2–20 for himself.

Retired Investors are Unable to Make Profit, While Managers Suffer from Burnout Caused by Broken Promises

Working for a hedge fund is definitely not suitable for professionals who evaluate their work in terms of ethics, public duty, and morality. Phil Lord, Managing Partner at Vezno Capital, says that most investors bring their retirement savings bringing in another stress factor for decision-makers:

Most accredited investors aren’t jetsetting billionaires. They’re regular people who need the 1–2M they saved up to retire. They worked their whole lives for that money, sacrificed time with their kids and friends. Lose the money, and you ruin their lives.

It is no secret that the hedge fund performance has decreased significantly after the crisis of 2008, and the income of investors has fallen as well. According to Tom Groves, who has marked his Quora account as a “hedge fund partner,” it is easy to start hating what you do due to the inability to achieve the desired return for an investor:

I actually retired because I hated it. I hated the feeling of not being able to give investors the returns they wanted…
...I hated most of all the fact that I felt like I could do "smart"
things and guarantee failure, or take "dumb" risks that were bad for virtually everyone else (my partners, my investors, society in general).

Tom also notes that working in a hedge fund is often accompanied by a toxic atmosphere and aggressive colleagues. This is why many get disappointed and quit. Tom notes that after leaving the hedge fund, he took up blogging and painting.

Funds Cut Traders in Favor of Quantum Tools

Fund managers can lay off traders if robots prove their worth in choosing stocks. As noted by an anonymous Reddit user, despite the fact that some fund partners do not fully trust quantum methods and question algorithmic trading, their fund may become 100% quantum in the future:

I think quant is going to continue to dominate and if you have the desire and ability would encourage you to pursue a PhD in a math, science or comp sci field.

Cameron E. Wild, former Vice President of Millennium Management with 17 years of trading experience, sums up career difficulties faced by traders leaving a hedge fund.

After 8 years in the industry and 6 years as a hedge fund trader I couldn’t get another job. Though I didn’t try that hard since I was sick of it all (burnout). Technology is a massive destroyer of trading jobs.

Cameron also confirmed that some funds set a goal to rid the trading process of the human factor within five years.

Ready-made Software is Gradually Replacing Custom Applications and Excel

Hedge funds still use custom applications (for example, the ones developed in C++) created for specific tasks. According to Scott Gosnell, Excel functionality remains ubiquitous.

I have yet to see a firm that doesn’t take Excel out for a spin every day for basic modeling… Sometimes, the fancy prop models run on whatever software it is that the most junior analysts know how to run.

Nevertheless, fund managers are currently opting for the market of ready-made software solutions allowing them to combine the experience of a development team with their own resources. For example, MetaTrader 5 for hedge funds works in conjunction with the powerful MQL5 algorithmic trading community and MQL5 Cloud Network resources allowing users to speed up testing strategies from a few days to 15 minutes.

Richard Matthews, Ph.D. Computer Science and Engineering, notes that buying ready-made software enables fast and flexible fund structure deployment, as well as reduces the budget for creating an IT team:

…Buying software from various quantitative trading software firms (like Backstop, Dynamo, ect) has the advantages of being fast to deploy because it's a ready made package and doesn't require extensive in house testing. Building software takes more time, more effort, and frequently the hiring of a team of quant developers.