I’ve always been confused by the existence of most hedge funds. And I’m not alone. In 2014, John Cassidy of the New Yorker wrote an article entitled, “The Great Hedge Fund Mystery: Why Do They Make So Much?” He puzzled over the high fees charged by many hedge funds (often 2% of the investment plus 20% of any profits), which were often completely incommensurate with their performance relative to the overall market:
Years ago, defenders of hedge funds argued that they earned their money by delivering above-market returns on a consistent basis, but this argument is much harder to make these days. For five years in a row, hedge-fund returns have trailed the stock market. Last year was a real doozy for the industry. The S. & P. 500 had a great year and generated a thirty-two-per-cent return. According to Bloomberg, the typical hedge-fund return (net after fees) was 7.4 per cent. That’s a differential of almost twenty-five percentage points.
None of this is terribly surprising. The financial markets are exceedingly competitive. Millions of people have access to the same data and are trying equally hard to extract insights from it. As a consequence, generating above-market returns over long periods of time should be essentially impossible without some real “edge”. What does this edge look like? For some hedge funds, like Renaissance Technologies, it entails assembling a “Manhattan Project”-level of mathematical talent to construct a model so fantastically sophisticated, opaque, and secretive that Bloomberg called it “the blackest box in all of finance”.
Yet for others, like SAC Capital Advisors, the edge was not so clear. S.A.C. are the initials of Steven A. Cohen, venerated as one of the greatest traders on Wall Street. Cohen’s system appeared remarkably unsophisticated, though. As the New Yorker described it, “Cohen has suggested that his decisions about stocks are governed largely by “gut.” He is said to have an uncanny ability to watch the numbers on a stock ticker and intuit where they will go.” Cohen attracted traders with similarly talented “guts” by showering them with money – if they were successful:
Careers at S.A.C. followed a starkly binary narrative. Portfolio managers were given a pot of money. If their investments were consistently profitable, they became very rich very quickly. If their investments lost money, they were out of a job. Contracts at S.A.C. contained a “down and out” clause, so it was prosper or die.
Unsurprisingly, SAC attracted a certain kind of trader: one that was willing to do anything to generate an edge.
And this was the secret of SAC: their edge was of the “black”, illegal kind. Insider trading – trading on material, non-public information – was rampant there, as detailed by Sheelah Kolhatkar in “Black Edge”, her fabulous account of the rise and (partial) fall of SAC. For me, the most interesting character in the book was Mathew Martoma, the SAC employee responsible for the most infamous trade in its history. He was the son of Indian immigrants, who, like many Indian parents, would accept nothing less than excellence from their children.
When Martoma’s father first came to America, he was admitted to M.I.T., but he could not afford to attend. He retained a fascination with Cambridge, however, and prayed daily that his oldest son would go to Harvard. Martoma graduated from high school as co-valedictorian, but he ended up going to Duke. Shortly after Mathew’s eighteenth birthday, Bobby presented him with a plaque inscribed with the words “Son Who Shattered His Father’s Dream.”
As Kolhatkar writes, this was a “stunning act of paternal cruelty.” Arguably, though, the experience provided an excellent preview of the world of finance. It prepared Martoma to inflict such cruelty onto others.
Martoma was entrusted with a healthcare portfolio at SAC, and he sought an edge by befriending a doctor who was intimately involved in supervising a trial for a promising new drug to treat Alzheimer’s disease. The results of the trial would make (or break) the fortunes of the pharmaceutical companies (Wyeth and Elan) funding the research. Martoma worked his way into the good graces of the doctor, Sid Gilman, through flattery and sheer persistence. Gilman was a lonely, divorced man who had no life outside of research, and Martoma was a bright young man taking interest in his life’s passion. Unsurprisingly, Gilman came to view Martoma with increasing fondness, and eventually thought of him as “an adopted son”. And, as family members are wont to do with one another, Gilman let secrets slip. (Martoma’s incessant poking and prodding didn’t hurt either.) Gilman revealed to Martoma the disappointing results of the drug trial in advance of their public release, and Martoma passed along this information to Cohen, who immediately unloaded SAC’s massive position in Wyeth and Elan and even reversed it, eventually making hundreds of millions of dollars off the trade (and saving losses even larger in magnitude). After he had used Gilman to make his own 10 million dollar bonus, Martoma dissolved his “friendship”:
Several months later, at the end of September, 2008, Gilman sent Martoma an e-mail with the subject heading “How are you?”
Hi Mat. I haven’t heard from you in awhile and hope that all is well with you and your family. I hope that you have not been too terribly set back by the great turmoil in the markets plus the disappointing drop in Elan stock. . . . Anyway, no need to call, I have nothing new; I just wonder how you are faring.
Martoma never responded.
In a company as mercenary as SAC Capital, how do we reconcile “business” with “ethics”? Aren’t the two inherently at odds? Everything at SAC Capital was done in service of a single goal: creating an edge. And if there is only one goal, then everything else is, by definition, dispensable. Cohen and his deputies dispensed with all of it: people were valuable to them only as long as they were making money, and were discarded as soon as they stopped doing so. And what Martoma did to Gilman, Cohen ended up doing to Martoma. After two years of poor performance after the Elan/Wyeth trades, Martoma was fired. It all reminds me of the line from Death of a Salesman, where Willy Loman cries out, “You can’t the orange and throw the peel away – a man is not a piece of fruit.”
There’s no better example of this mentality than Uber. Arguably their behavior is even more extreme than that of SAC Capital. Whereas at SAC every decision could plausibly be interpreted as maximizing profit, Uber appears to engage in non-profit-maximizing behavior purely for the joy they derive from being cruel. In one appalling incident,
Uber’s senior vice president Emil Michael suggested Uber hire a team of opposition researchers—equipped with a million-dollar budget—to dig into the personal lives of journalists who reported negatively about the company in order to dox, target and harass them and their families. One of his main targets was Pando founder and editor-in-chief Sarah Lacey, who had reported on the company’s sexist and misogynistic ways. Further proving her point, Mr. Michael said he thought Ms. Lacy should be held “personally responsible” if passengers who head Ms. Lacey’s advice and stop using Uber are sexually assaults by taxi drivers. Mr. Kalanick apologized on behalf of the company, but Mr. Michael didn’t lose his position.
Two blog posts, both by women who have been sexually harassed at Uber, underscore this point. They describe behavior that is not just shocking cruel but also moronic. Allowing “high-performers” to get away with treating their subordinates like shit is not an intelligent way to run a company. It means placing the individual above the team: decimating morale and cohesion all to satisfy the urge for domination that these losers feel. And the consequences shouldn’t be surprising to any one: Uber ended up hemorrhaging female engineering talent. Fowler writes
When I joined Uber, the organization I was part of was over 25% women. By the time I was trying to transfer to another eng organization, this number had dropped down to less than 6%. Women were transferring out of the organization, and those who couldn’t transfer were quitting or preparing to quit. There were two major reasons for this: there was the organizational chaos, and there was also the sexism within the organization.
When we elevate certain individuals above others, we ascribe virtue to their actions. Travis Kalanick elevated sexual harassers, the so-called “high-performers,” above the women who had been harassed. In doing so, he made harassment and domination into a virtue. Steven Cohen paid Martoma handsomely ($10 million) for his Wyeth and Elan insights; it was his reward for being a high-performer that year. In doing so, he made insider trading (or, really, sociopathy in pursuit of money) into a virtue.
And we have elevated Donald Trump above Hillary Clinton. What does that say about us? There’s one particularly telling incident from Donald Trump’s early life, involving a bitter dispute over the family inheritance.
As David Cay Johnston explains in his book The Making of Donald Trump, Fred Sr. had written a will after the death of his oldest son, Fred Jr., known as Freddy, in 1981. The will left the majority of Fred Sr.’s wealth to Donald and his surviving siblings. Freddy’s family was largely cut out.
When Fred Sr. died, Freddy’s children sued, claiming that the will “had been ‘procured by fraud and undue influence’ by Donald and the other surviving siblings,” according to Johnston.
Johnston writes that medical insurance had consistently been provided to the family through Fred Sr.’s company. This coverage was crucial for Freddy’s grandson (Donald’s grandnephew), who suffered from seizures and later developed cerebral palsy. So crucial, in fact, that a letter sent from a Trump lawyer to the insurer after the patriarch’s death in 1999 said that “all costs” for the sick child’s care should be covered, regardless of caps on the plan or medical necessity, according to Johnston. That didn’t last long.
A week after the lawsuit was filed in court, Freddy’s son (Donald’s nephew) received a letter informing him that the health insurance would be discontinued, meaning his ill son would be left without coverage. Donald openly admitted to the New York Daily News that he and his siblings took this action out of revenge.
“Why should we give him medical coverage?” Trump said, adding, “They sued my father, essentially. I’m not thrilled when someone sues my father.”
In other words, by elevating Donald Trump, we have made the pursuit of profits over people into a virtue. We have endorsed and entrenched our sick culture of letting people die for lack of money. Donald Trump’s plan is to take away healthcare from millions of people and to use the proceeds to enrich his fellow assholes, just as he took away healthcare from his own grand-nephew in order to enrich himself. Donald Trump’s heartlessness reflects our own.
Business and politics are increasingly run by sociopaths and sadists, people who enjoy being cruel either for reasons of self-interest and greed or for the pleasure of seeing others humiliated. As Martoma’s father did to his son, as his son did to Sid Gilman, as Travis Kalanick did to Susan Fowler and “Amy Vertino”, and as Donald Trump did to Freddy Trump, Trump now, as president, threatens to do to most of us. It’s like H.L. Mencken said, “Democracy is the theory that the common people know what they want, and deserve to get it good and hard.”