Hedge Fund Managers & Poker – Texas Holdem Hedgies (guest post at MarketFolly)

This article was originally a guest post at MarketFolly.  Many thanks to Jay and MarketFolly for the kind opportunity to post at such a widely-read site.

The hedge fund literature is full of references to the poker exploits of some of the great hedge fund managers. This part of hedge fund lore is one of the main inspirations for the Texas Holdem Investing theory.

The references to the relevance of poker as training for investing amongst the comments of successful hedge fund managers provide a firm basis for the thesis that poker can teach investing.

The following examples of the poker connections of some well known hedge fund managers provides some background on the link between the two fields:

• David Einhorn (Greenlight Capital) – Einhorn demonstrated the link between poker and investing in reverse. After setting up Greenlight and achieving extraordinary investment returns over a 10 year period Einhorn decided to learn poker. Within a few years he had mastered the game and finished 18th in the World Series of Poker. After his victory Einhorn outlined many of the similarities between investing and poker.

• James Simons (Renaissance Technologies) – Simons just retired from Renaissance which he founded in 1977 and which has one of the top hedge fund returns track records, resulting in Simons making some huge performance fee paychecks. Simons was an avid poker player at MIT, and according to Rachel Ziemba in the excitingly named book o “Scenarios for Risk Management and Global Investment Strategies” started Renaissance with a focus on gambling related concepts which were retained in the trading models that underpinned Renaissance’s returns. To complete the link between poker, investing, and education in the case of Simons, apparently he started the “Math for America” program over a game of poker with some fellow investment heavyweights in New York. Math for America is focused on improving math education in America.

• Steve Cohen (SAC Capital) – Along with James Simons, Ken Griffin, and John Paulson, Cohen is one of the top hedge fund managers of the past 20 years. Cohen played poker frequently in high school, often playing through the night. According to his brother Cohen excelled at poker and would have lots of cash stored at his desk. Cohen eventually quit his part time job to focus on poker and says that it taught him how to take risks. Cohen continued to play poker successfully at Wharton while earning his economics degree and developing a fascination with the stock market. One of SAC’s own investors was in awe of Cohen’s poker skills – perhaps it was a factor in making the investment in SAC. Cohen’s poker skill can be discerned in the few public comments he has made on trading. A notable example of his thinking appeard in “Market Wizards” where he stated that 90% of trading is about containing losses – as is the case in poker where most of your time will be spent deciding why not to play a hand to avoid losses.

• Jeff Yass (Susquehanna) – Jeff Yass founded Susquehanna with some of his poker playing friends and has turned it into one of the largest options trading firms in the world. Susquehanna is effectively a hedge fund that specialises in options as its asset class. Poker is now infused throughout the entire hiring and education processes at Susquehanna. The firm has hosted poker tournaments to identify potential employees, and it uses poker as an education tool when training its traders.

• Andy Beal (Beal Bank) – Beal is a long time poker player who participated in one of the most epic games of poker with some of the greatest professionals in recent times. The game was immortalised in the excellent book “The Professor, the Banker, and the Suicide King: Inside the Richest Poker Game of All Time”. Beal Bank, which is effectively a credit hedge fund that focuses, has generated extraordinary returns since the recent credit bubble burst. However, Andy Beal had to wait through “a very long run of awful pocket cards” while the banking world boomed around him for almost 5 years while he made no investments because no opportunities fit his criteria. However, when the bust hit Beal felt vindicated and it must have felt like he was being dealt a lot of full houses. Since the downturn Beal has moved into the Forbes 400 of wealthy Americans through the implementation of a poker like attitude in the world of credit investing.

• Carl Icahn (Icahn Partners) – Icahn generated his first investing stake by winning $4,000 playing poker while in the US Army after graduating from Princeton. He still plays poker at high stakes in Las Vegas. He now uses his skills learnt playing poker to making big activist bets with Icahn Enterprises on companies while looking to read the intentions of both management teams and other investors.

Daniel Strachman takes the comparison one step further in his book ”The Fundamentals of Hedge Fund Management: How to Successfully Launch and Operate a Hedge Fund”. Strachman notes that tracing the explosive growth of the hedge fund industry is analogous the growth in popularity of Texas Holdem poker over the last 25 years or so.

Strachman draws some interesting parallels between Texas Holdem and hedge fund management:

• The barriers to entry are low in both fields. A budding hedgie can have a fund set up and launched for $50,000 all-in (excuse the pun). Although theoretically a Texas Holdem player could start with far less, to start in the Texas Holdem arena aiming for success would require a reasonable bankroll – $10,000 would be a good starting point. Also, from a regulatory standpoint setting up a hedge fund is considerably easier than starting a mutual fund. As for the regulatory situation in Texas Holdem – well there is none unless you’re the person that wants to open a casino. And in some ways it is ironic that getting approved by the Nevada Gaming Board to run a casino may well be more difficult than becoming a market maker (the Wall Street equivalent of the “house” in the casino).

• Hedge fund management and Texas Holdem poker both offer great wealth to successful players in each field. The scales are different, because hedge fund managers can accumulate vast wealth by leveraging off their clients money (as Bruce Kovner said) but good Texas Holdem poker players can earn many millions of dollars.

• Both fields started to gain critical mass in the early 1990s and then took off into the stratosphere in the early 2000s:
  • The hedge fund industry benefitted significantly from the crash of 1987 as many investment managers and support services were laid off and then began to move into the hedge fund arena. The hedge fund concept was quite old at that point, given that Alfred Winslow had started the first hedge fund in 1957. However, clever individuals in Wall Street repackaged the concept with slick marketing and the perception of privileged access. And at the same time some of the best investors on Wall Street moved into the hedge fund space such as George Soros, Julian Robertson, and Bruce Kovner. But the supernova “moment” came after the dotcom crash occurred in early 2000. As general stock markets (and markets of many other kinds) tanked the hedge fund industry in general managed to either not lose money for investors, or even make money. Suddenly funds poured into the industry from 2002-3 onwards until the inevitable happened in 2007 and even the hedge fund industry found it hard to cope with the global recession.
  • The Texas Holdem market started to grow rapidly during the 1980s as the World Series of Poker got larger and larger. Then clever casino executives started to package the whole Texas Holdem experience with slick marketing, and moved it away from the backroom smoke filled rooms into bright casinos and onto popular TV properties such as the Travel Channel. Texas Holdem had its own “lift off” moment in 2003 that, like hedge fund performance during the dotcom crash, demonstrated the money that could be made from Texas Holdem. This occurred when the complete unknown Chris Moneymaker won the World Series of Poker and a $X million payoff. New “fish” players swarmed to the offline and online casinos. But as with hedge funds even Texas Holdem’s popularity waned with the rest of the casino word in the face of the 2007 global downturn.

Having reflected on these similarities I have added some further points to Strachman’s list which emphasise the connection between the fields of investing and poker, albeit with a cautionary final point.

• Texas Holdem and the hedge fund arena are two of the most capitalistic activities in the world. The score is kept brutally in financial terms, and at the end of each day neither the Texas Holdem player or the hedge fund manager can hide from the results.

• The capital preservation mindset of both fields is similar – avoiding losses is a vital element of success. With Texas Holdem one of the key objectives is to minimise losses during bad runs of cards and so have maximum bankroll to benefit from successful situations. Hedge funds don’t focus on the benchmarks that plague the mutual fund industry – the main objective is not to lose investors money, even if it means underperforming the broad market in good years.

• Although seemingly glamorous occupations in reality they are very difficult and stressful. It is easy for an outsider to look in and see the ease of sitting at a poker table or a Bloomberg terminal and speculating with large sums of money with the click of a mouse or flick of a chip. But mentally both professions exert tremendous strain on the participants. Human nature is such that the negative emotional effects of monetary losses are much greater than the positive effects of gains. The fortitude required to endure protracted periods of Texas Holdem or investing losses is immense.

• While the upside of both hedge fundery and Texas Holdem can be quick and massive, the downside can be equally fast and quite devastating. One year of a bad run of cards with poor money management will bankrupt even the most successful Texas Holdem player. One year of poor returns and mass client redemptions can hit even the best hedgies, as the impressive managers at Drake Management and Ospraie Management found out in 2008. Some of the fortresses of the hedge fund world also had scary moments in 2008 such as Ken Griffin at Citadel.

The strong connection between investing, trading, and poker is demonstrated by the examples cited in this article. And a final key similarity between both fields is the part played by luck. It is important, but over the long run the good investors and players can outperform the randomness of the market and the cards.

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Tagged as: andy beal, david einhorn, Guest Post, Investing, jeff yass, MarketFolly, poker, Steve Cohen, Texas Holdem Investing, texas holdem poker