[dcaisen]

Is David Shaw brilliant? Absolutely. Has the quant/technology revolution been a positive development for financial markets? No doubt.

But secondary trading is still a zero-sum game. Firms like D.E. Shaw are profit maximizing and extract a huge amount of value from society. Probably less than the old boys club they replaced, but probably much more than necessary. There is a great deal of competition among quant trading firms overall, and their rise has coincided with electronification of markets, tighter spreads, lower commissions - all good things. But if the forces of capitalism are truly working, you have to wonder why so many firms like these continue to print money year after year (although there have been some new developments-- for example, stock exchanges have gotten much more effective at monetizing their access and data feeds, which has really put the squeeze HFT market makers; still, zero-sum game though).

There's no good reason we can't have it all: efficiently-priced modern-technology financial markets without these huge rents being pulled out. And I shouldn't pick on quant firms specifically - every layer of the system extracts its share, and I'd argue brokers and exchanges are much worse since they're fiduciaries and semi-regulatory entities, respectively, and riddled with conflicts of interest.

Disclaimer: former co-founder/head quant at IEX (Flash Boys), current CEO of Proof Trading (YC S19)

[ghufran_syed]

“probably much more than necessary”

How exactly do you decide how much is necessary?. And is there any reason to think that they are extracting value from society rather than other market participants?

And is there any evidence that having one company make a billion dollars from other market participants is somehow worse for the system than having a million companies make a thousand dollars each?

The low spreads and liquidity are not some fact of nature - I’m pretty sure that a lot of it comes as a result of many people competing with each other to try and make money. I agree there are lot of people trying to screw their clients to make money in both the retail and the institutional markets (I used to work in sales for an I-bank). And I agree that those areas with conflict of interest are badly policed and do NOT help market structure or society as a whole. But my impression is that DE Shaw is a prop trading firm - where is the conflict of interest?

[rmrfstar]

It is hard to formulate a coherent opinion about the optimal level of activity $W without discussing the concrete details of activity $W.

There is a saying in the Beltway, "those who talk don't know and those who know don't talk." The same is probably true in this line of business.

It is hard to determine whether our financial markets do enough/too-much of whatever it is that tier-one liquid market buyside quants do. They probably do a lot more than you'd expect.

[carlineng]

GP is in agreement with you on the last point, and the highlighted conflicts of interest are not related to DE Shaw:

"brokers and exchanges are much worse [than DE Shaw] since they're fiduciaries and semi-regulatory entities, respectively, and riddled with conflicts of interest."

[ghufran_syed]

I understand that - what I'm hoping is that dcaisen will clarify what exactly their concern is with DE Shaw. I'm claiming that other than conflict of interest, having firms like DE Shaw make lots of money is not a problem. I'm hoping that if there is some non-conflict-of-interest reason why it's harmful, they'll explain and I'll learn something useful

[dcaisen]

Oh I don't disagree with you, and I think your points are all very valid - a firm like DE Shaw is much less bad than the market participants with active conflicts of interest. Perhaps my rant is a bit misplaced on this thread.

Some basic arguments against are:

1. They are providing a service that adds no (or at least dubious) value to society. And again, I do think it's possible to have highly liquid, highly efficient markets where the amount extracted by prop trading firms is much smaller. But you're right that's an arbitrary statement, and who am I to say it's not already down to a reasonable level. 2. They do extract a lot of value. Maybe they're just siphoning it from banks and other hedge funds, in which case kudos (not to pick on hedge funds - they're just not a sympathetic victim). But probably at least some of it is extracted from mutual/index funds, pension funds, etc. Not the worst thing in the world and good on them for figuring out ways to make money, but it doesn't feel great. 3. Opportunity cost to society of the brilliant folks who wind up working there. Meh.

Way less bad than conflicted parties hurting their clients for their own gain. But I don't think they should be glorified either.

[carlineng]

I'll let dcaisen speak for himself, but I don't get the impression that he believes DE Shaw is actively harmful; just that the service they provide (market liquidity, low spreads) comes at a relatively high cost. "How?" is a perfectly legitimate question, and it looks like a problem he's actively working on as the CEO of Proof Trading.

[auntienomen]

If he believes that, then he doesn't understand what DE Shaw's business is. It's like confusing a bakery for a flour mill.

[SideQuark]

>But secondary trading is still a zero-sum game.

No, since stocks can uniformly rise. Thus I can trade a lower performing stock (which can still increase) for a higher performing one, so that was not zero sum for me. The buyer could have turned cash into those stocks, so he could have gained too.

So we both gained from the transaction didn't we? Doesn't seem zero sum while stocks grow, and there's no mathematical requirement them to return to those previous prices.

This also doesn't cover value for price signalling, the empirical fact these patterns have returned significant money to investors through lower spreads, or the fact that primary markets don't function without functioning secondary markets.

Calling it zero sum is a bit shortsighted I think.

> you have to wonder why so many firms like these continue to print money year after year

They haven't. A few have - most don't do so well. Buffet's hedge fund bet ended pretty spectacularly. As a group hedge funds have underperformed index funds for some time (if not always, net of costs), so they're not extracting money, except from investors.

Net gains from the top 20 or so funds are around $20B annually, while managing a few trillion in assets. This seems like an incredibly small amount of gain for the assets managed.

[whymauri]

Higher frequency transactions between high frequency traders trends towards zero-sum, or at-least very-near-zero-sum. It's a bit of an edge-case, but relevant for what GP is talking about.

[xxxtentachyon]

D.E. Shaw is not a high frequency shop. I would be very surprised if their daily transactions was more than 5% or so of their total book.

More broadly, quant shops are not out to place bets on what they think will happen in the next few seconds. They're much more like traditional hedge funds than HFT firms in terms of their betting horizons. It's just that the trades they choose to make on those horizons are generated algorithmically.

[ChrisLomont]

So they’re both zero sum and extracting wealth from others? That’s a neat trick.

The firm under discussion isn’t HFT. But both HFT and the firm under discussion trade with everyone; they’re not in some walled off market. As such they provide liquidity, and participate in the same trades as the entire financial system. It’s hard to claim this is zero sum by any means.

[KKKKkkkk1]

With all these ruthless profit-maximizing firms on Wall Street, it's nice that Silicon Valley VCs have given up on maximizing profits since the early 2000s [0]. Gives them more opportunities to focus on making the world a better place.

[0] https://blogs.cfainstitute.org/investor/2020/02/17/venture-c...

[objektif]

They now maximize ad click which will save all of us do not worry.

[jackcosgrove]

I think VC is a combination of status seeking, fun, and genuinely trying to advance things. Making money, not so much.

[nradov]

The standard justification is that these firms provide market liquidity which lowers the cost of capital for all businesses, thus boosting economic growth. But I've never seen a rigorous quantitative analysis. How much growth do they actually cause in the real economy relative to the value they extract?

[cma]

Being one microsecond faster is worth all the profit, but did the market gain as much with one microsecond less latency as with 1 second or one minute less latency? No. But the payoff for achieving it is just as high, winner takes all to whomever is fastest, so the market will put as much money into shaving off an additional microsecond as a minute, if it makes the difference on being first.

[nv-vn]

I can see where you're coming from, but it's important to remember that what they are competing on is not only time but also spreads. Spreads have tightened substantially over the past couple decades thanks to these firms [1], which means that the total amount to be made per trade has dropped significantly. On top of that, the landscape has become so competitive that trading firms are now purchasing order flow, which basically subsidizes broker commission fees for trading. This is a huge win for retail investors, as the cost of trading has made it much more accessible -- in the past you would have had to buy many more shares and make a much higher return to offset these additional costs of trading.

[1] https://awealthofcommonsense.com/2016/04/trading-costs-the-n...

[ghufran_syed]

I'm pretty sure that if you have lots of firms trying to be "1 microsecond faster", then that creates more liquidity than you would have otherwise.

https://www.modernmarketsinitiative.org/hft-provides-continu...

Note that the link looks like it's some kind of industry group, but the listed references look like a useful place to start if you want to read more

[cma]

It's winner take all for whoever has the shortest path (for something like index arbitrage). There is no value added to anyone if another competitor invests millions in microwave relays or custom hardware parsing to snipe the previous low latency winner and beat them out. It's just wasted money, other than knock on effects of more demand for hardware growing the hardware industry faster.

[badfrog]

Prop traders / HFTs definitely provide liquidity. It's not clear that quant funds do the same.

[airstrike]

Quant funds correct mispricings, I think the argument is. And in doing so, help with price discovery which is good for every market participant.

[MrMan]

Rents like 2 percent management fees and 20 percent incentive fees for private equity and hedge funds? Lack of antitrust enforcement of tech firms? Sell side firms and their business models are the least of our problems in my opinion.

You mentioned data in passing - middlemen who extract rents as data purveyors are extracting huge rents and it is largely unremarkable upon maybe because west coast people are the shadiest rent-seekers of all time. At least financial mstket data is mostly not acquired by surveillance of users, though that is changing with the advemt of "alternative" data.

[jackcosgrove]

I have heard that quant trading firms build software systems that have sub millisecond response times to data feeds.

Are the signals coming though these data feeds (reports by government agencies, news events, corporate filings) really occurring that fast? Or do the systems simply need to have low latency for responding to infrequent events (infrequent relative to the response time)? Or are the trading systems trading against each other in a kind of feedback loop long after a signal comes in over the wire?

[nv-vn]

>But secondary trading is still a zero-sum game.

This is a claim that I think you really need to back up with some kind of proof, because it is so central to your line of thinking. All the points in your comment follow if this is true, but they are also all questionable if this is not true.

[airstrike]

> But if the forces of capitalism are truly working, you have to wonder why so many firms like these continue to print money year after year

Because so many other counterparties don't continue to print money year after year. An incredibly high number of funds isn't successful. I think you're ignoring survivorship bias.