From the Trader’s Desk: Attack of the Quants!! Billions Recap, S3 Ep3

Greeting’s from the Trading Desk! This week’s recap will be broken down into three parts: the first part will be a bit of a rant before the actual recap, the second, on Axe Capital and the attack of the “Quants”, and last, but not least on the dealings of Axe and in keeping with his God Complex, how he gave two people their “lives” back.

Rant: I need to address Ira and his girlfriend. I usually don’t veer off into the non-financial aspect of Billions, but it was the opening scene, and it pissed me off and had me yelling at my screen.

Ira, if that chick doesn’t want to marry you when you’re broke, why the hell would you want to marry her when you’re loaded? She basically told you she was a gold digger! And, she knows you are in financial trouble, but still orders those damn truffles? GTFO with her. Maybe your revenge was giving her that fugly ring? Ira, go out and get yourself a real woman, not a money grubbing Barbie. It’s women like that who give us GOOD women a bad name.  OK, end of  first rant. (If anyone who knows me and just read that in my 100% Brooklyn accent, thank you!!)

Oh, and one more thing: these people who have can’t live on $320 million or $40 million? WTF is wrong with you? Lara is especially obnoxious. Girl, you love to tell everyone you’re from Inwood, and a tough chick; you came from nothing! I’m sure you can figure out how to economize on $320M! When I was let go from my last job, and decided to go out on my own, it meant that a regular paycheck was not going to be coming in for a time. Financial considerations and priorities had to be changed. Weekly shopping at Prada? Gone. Season Mets and Rangers tickets? Adios. You learn to live within your means, and “like to have” gives way to “need to have”. Lara has never been a character that I liked or believed in, but this put the nail in her coffin for me. Bye Felicia!

The analysts at Axe Capital are freaking out. Taylor is interviewing some dreaded “Quants”!!  It’s causing butt sweat for Mafee, and panic attacks for Ben and Rudy! They are all worried about being replaced by “the robots”.

Recently, there has been a move by pension funds and institutional money out of traditional hedge funds and into quant shops or passive investments (ETFs). These types of investments are less risky and are generally cheaper to invest in. They don’t have the costs of analysts, and don’t charge the usual 2 & 20. This trend has put many fundamental analysts out of work. Running an “algo” on a computer makes a fundamental research analyst redundant.

I was on the buy-side as a fundamental equity research analyst for many years. In that capacity, I researched a company’s financials, management, growth prospects, etc., and would then recommend it to my Portfolio Manager for inclusion in our Large Cap Growth Fund. We had a quant group at our firm, which we called the “goons”, as we looked down on what they did. Our thinking (at the time) was “anyone can feed info into a computer and have it spit out ideas; we actually have to know things!”

That was several years ago, and now quants are a lot more sophisticated and are more than just “goons”. My partner and I run a sort of hybrid strategy – the computer chooses the trades based on the criteria we have set, but that criteria is based on our fundamental knowledge and years (a combined 54 years!!!) of experience in the business.

It’s with this background that I totally get the uneasy feeling floating through Axe Capital and the thought of Taylor wanting to hire a quantitative analyst. The boys are worried, except for Dollar Bill. (I know Axe is my spirit animal, but Dollar Bill is a very close second!) He’s not worried at all, and as I have had to say in my prior two posts, speaks for me when he says “ No computer can get the kind of info I can or know what to do with it the way I do, so buck the fuck up! No Fear!!” I believe the future of investing is a hybrid strategy, similar to the one we run. A computer cannot make a judgment call on the management of a company or see changes in market sentiment due to a breaking news event. Algos are good for trading; analysts are good for investing. There is a big difference between the two.

Wags is not on board with hiring a quant. Over lunch with Axe he vents his apprehension about Taylor’s interviews with some candidates (“wild guesses, with math!”). He has no confidence that they can do as good a job as his people. Axe never used quants. (Wags, don’t you know Axe was the machine; he told Steph he was the Terminator!) Axe gives Wags his orders: help Taylor.

Taylor’s search reminds me of Goldilocks and the Three Bears: one is too soft, one is too hard, and one (seems) just right!

The first candidate is too soft. He can mimic Taylor’s trades, but Taylor doesn’t want that. They need something better! Good-bye!

The second is too hard. He can’t figure out the puzzle Taylor has tasked him with, so he busts it up. He’s way too cocky for Wags (did he really call Wags “Queen”?), and way too emotional for Taylor. See ya! (Just for the record, if someone came to my firm wearing flip-flops for an interview, I’d have shown them the door before a word was even uttered!! RUDE!)

And, the third one is just right! (Or so it seems.) 20 years at NASA, calm, cool and confident,“Major Tom” even impresses Wags (which unless you’re a stripper or a sushi master, is hard to do). He gives Axe Capital access to his model for a day, so that Taylor can see how the algo works in real time, during market hours.

It performs great (even Wags thinks so; second red flag!), but unlike in Goldilocks, Major Tom is a no-go as well. Taylor saw that his model was one that would make a recommendation/trade, and then thru a “back door” be able to support the transaction. In other words, Dollar Bill could tell Major Tom to put in a trade on info he obtained in his usual way (which is quite unusual!). If the trade was questioned, the “back door” would allow info to be imputed so that the trade would seem like it was generated by the algo itself.

Taylor knows Wags orchestrated the whole thing, and wants to know why he is so desperate not to hire a quant. Here Wags gives us a peek on why he is so loyal to Axe.

While Wags was still working at Lehman Brothers,  he saw firsthand what a “bunch of brilliant kids who thought they solved the secrets of the market” could do to a firm. (Lehman was one of the first dominoes to fall and start the financial panic of 2008.) No one really understood what these “kids” were doing, but as long as they were making money, no questions were asked. At a chance meeting at a golf outing, Axe told Wags to jump ship, and saved Wags from financial ruin. Wags sold his Lehman stock at $50; by September 15, 2008 Lehman Brothers had declared bankruptcy, resulting in the stock plunging 93% from its previous close.

Wags fears being in the position of not knowing or understanding what is happening at Axe Capital, and having a Lehman moment again.

Taylor points out that there were many other reasons Lehman went under (yes, being 31x leveraged when the wheels come off will do that), but understands Wags resistance. Taylor makes an executive decision: they will not hire a quant – they will build their own algo. The only one who can truly understand what type of strategy Axe Capital needs is Taylor. The android will program the algo!

Axe and Lara realize that in a worst case scenario, they may “only” be left with $320 million. Axe needs to get more money in a way the government, who are bad as “mob bosses”, can’t get to or see. Axe is a man with a plan.

He goes to his old friend Raul Gomez, former NYPD and now on the Board of its Pension Fund. Raul is retired, and out of the game, just like Axe. But, he tells Axe he knows he needed to move on; can Axe do the same? Axe misses “walking into a room, knowing there were ten guys who’d been in front of me, 5 waiting for me to leave.” His “favorite sound in the world was the one I heard on the way out, when those saps in the lobby were told that their meetings were canceled.” I doubt Axe can move on. He needs that dominance, beating everyone in a room, being “the man”. The chip on his shoulder is as huge as his ego. Can Raul understand that? Can he help him out?

Raul wants to help Axe out, but even a hint of impropriety would be disastrous. But he knows what Axe can bring to the table. If Axe can set something up with no trace back to him, Raul just might be interested.

At the Whitney Museum, Axe meets with Michael Panay, who is in the process of selling everything and closing down his fund. He’ll walk away with “only” $40 million, which would be enough for us mere mortals. Axe is on a mission; he convinces Panay there is no way he can live off that pittance and that actually Panay (yes, with $40M) is “broke”. Panay panics; he can’t fly commercial! He’ll give anything to get back in. Axe offers to help Panay “get your life back”, but the question is: at what cost? (I find it interesting that he basically gives the same speech to Ira, equating money and wealth with life. He tells both men they are basically nothing without money.) Axe is like Dr. Frankenstein – he is creating “life” only because of his own vanity, and God complex. He cares nothing about these “monsters” he is creating; only about how it will benefit him.

Over burgers and billiards, Axe introduces Raul to Panay. If Raul can get Panay in front of the Pension Board, Axe will make sure Panay is a hit. Raul agrees and the game is afoot!

Panay does well at the meeting and is now indebted to Axe. How could he not be? He just got his “life” back.

As “Hans and Franz” (or as Wags calls them, the New Halls) barge into Panay’s office and give it a good security sweep, Axe lays down the terms of the deal.

Axe may have given Panay his life back but there’s a cost. The mental and emotional one is not quantified, but the financial one is plainly spelled out: Panay will charge the Pension Fund the usual 2 & 20; but half of that will go to Axe (who will then split it with Raul!) in the form of cryptocurrency so that it is not traceable.

I have been asked to give an example with numbers to explain exactly what 2 & 20 is, and to show the dollar amounts we are talking about here. If the Pension Fund is investing $2.2 billion with Panay, right off the top, the management fee is 2%, which works out to $44 million ($22 million of that goes to Axe, who will then give Raul $11 million). The 20% is the percentage of the profit that Panay will take from performance of the Pension Fund’s investment . If the return on the investment is 15%, that is $330 million. 20% of that is $66 million. Panay gets $33 million, Axe gets $16.5 million and so does Raul. I do hope Panay can live off of that.

Panay will sign documents agreeing to everything, and Axe will hold on to them, just in case.

Axe gave Panay his “life” back, but did he really? What kind of “life“ is it? His life is not his own; it’s all in the hands of Axe. It’s not Panay’s resurrection that Axe wanted, but his. That was the whole point.

Panay is “in” and all is as it should be in the world, or at least in Axe’s world that is.

22 thoughts on “From the Trader’s Desk: Attack of the Quants!! Billions Recap, S3 Ep3”

  1. LT,
    The third quant had a framework — “stock market is representation of the psychology of the entire world at any given moment.
    data is an exact thumbprint of that moment.”

    Could you see that beyond stock market? Could it be applicable to any market involving humans — currency, commodity, bond etc?

    Can human psychology/nature be modeled? Understand it might be hit/miss on a individual stock. But indexes are different as they represent a collective. Aren’t they?

    1. Good morning Time,

      I do think certain aspects of human behavior but not all. Humans can be unpredictable (look what happened in our last election!). You can program a model for a high probability, but you just can’t predict events, or how people (or the market) will react.

      It’s why I do think you need a combination of human knowledge to try and navigate as best you can through those situations, but using a computer that is way faster than a human to execute the trade.

  2. Thank you for this update LT – that is unbelievably helpful – and the math! Loved the math!

    I knew something didn’t sit right with Lara’s $320million line – besides the obvious – and you hit the nail on the head – based on her background she shouldn’t be talking like this – didn’t she send her boys off to a boot camp because they were being “soft?” Sounds like she’s the one who needs to enroll now.

    And I assume you called that third Quant “Major Tom ” on purpose yes? Because of that song’s connection to Costabile? Very clever.

    1. Good morning!

      I knew you would love the math, and I tried to add a spreadsheet to lay it out a bit more.

      Yes, Lara loves to go back to her “roots” constantly, (and yes, sending the boys to boot camp, and making them dig for clams were examples of trying to make them appreciate what they have), but know acts shocked she may “only” have $300M? It sounds like she’s all in it for the $$. just as Ira’s girlfriend was.

      I didn’t know there was a connection to DC and that song! I only named that character Major Tom because he said he worked at NASA. What’s the connection?

      1. I’ve never actually watched the show (although at some point I will binge it) but I knew about this because it was DC.

        1. Breaking Bad is certainly one of the BEST things that happened to TV. And David Costabile is amazing, a completely different character than Wags, on the show. I really thought “Major Tom” was a reference to David Bowie 🙂 How fun it is to find this connection!

    1. Fun! Did you guys know that Costabile was also in The Wire? What a great bunch of folks they gathered here in Axe’s World. 🙂

      1. oh yes. And a few others. I basically could’ve written his IMDB profile. It’s kinda sad actually.

      2. I guess I’m going to have to admit that I never saw the Wire either! (But I have seen every episode of Doctor Who at least twice!)

  3. I love you and your Brooklyn accent, my friend! 🙂 It seems Ira is an idiot who has special talent in having himself surrounded by terrible people. That said, he has been dating that woman for some time. Ironically, we heard about Ice Juice for the first time at Craft, at the same restaurant that Ira and Chuck were having a “double date” when Chuck was separated from Wendy. And Ira was talking about knowing the CEO of Ice Juice, etc probably to impress his 20 year old girlfriend! I am impressed by Axe who has diagnosed the weakness just right! 😀 And, hey, could he have picked a fuglier ring? Still, for a recession special, not bad at all!

    Not that I am familiar with how exactly they use quants in trading but since we also use a combination of traditional and quantitative techniques in social science research, I have an idea and completely agree with you that a combination of the two should be the future. Numbers bring a lot of power to the table but yes you always, as a human being, bring the experience, and experience is a different kind of power. That said, Dollar Bill is probably talking about doing it his way in his own research. And he has a point. The machine cannot bribe people to see company inventory and stuff like that 😀 😀 😀 So Dollar Bill definitely has an advantage over his colleagues 🙂

    I love it how you liken Axe to Dr. Frankenstein especially regarding Panay. And they are completely different situations but it is equally fascinating that Wags’ loyalty to Axe started with Axe giving him his life back, too! And it tells us Axe and Wags do not have the long past Axe and Wendy do. Wendy was there long before Wags was.

    Ahhhh, shouldn’t we be thankful for the lives we do have? No hassle to deal with the pilot, the driver, the horse-trainer? 😀 It was beyond me that Axe and Lara talked about their separation only for a second and directly went ahead to talk shop. I still think there is something more going on there especially with Axe that he is trying to protect Lara through separation and stuff but… When they talk about separation, Axe is like “it happens.” And when they talk about 320 million, he is like “it is not enough.” And Lara does not protest at all when he says he has an idea! 🙂 She obviously knows it cannot be anything legal! Still, I give credit to Lara for at least admitting she cannot believe she is saying that before saying 320 million would not be enough 😀 I would love to see the Axelrods flying commercial with the mortals 😀 That would be epic!

  4. Idk why everyone’s so hard on Iras girl. She seems wise in her context to me.
    Always the contrarian I must say I saw the Axelrods as very sad at the separation negotiations. I rather honor Lara’s reaction to Bobby’s betrayal “If we’re not united then let’s not pretend anymore”, my words. Again I don’t believe they are over.
    Whatever standard of living I’ve had and it’s been a spectrum believe me, I’ve never wanted to go back to less. So I give them that.

  5. That you and I, at opposite sides of the political divide, are both pissed off by what went down in this episode….well, I’d say these folks know how to write an episode, amiright?? 🙂

    Fun fact I didn’t get to mention in my post, and may eventually talk about once Taylor devs their own algo: Part of my work is teaching a machine algorithm how to do my job. It’s interesting as all hell to play a part in developing artifical intelligence. Also, quite frustrating that there are still and will always be things the machine just does not get. You can put 12 Stanford PhDs on the job of refining string matching in every conceivable way and STILL the humans will beat the machine. That’s what Wendy was trying to tell the guys. And it’s TRUE! Quants will be cheaper and, if Axe Cap does end up using them, they may make a small uptick in the graph and be long term cost-effective and positively influence the bottom line, which is what companies like Axe Cap are about in the end. But, still, the creative solutions, the ability to see nuance where no machine, or even another similarly trained co-worker, can see it, will be lost if/when a company starts getting rid of humans. Thus humans have nothing to fear. As long as they get smarter in relative proportion to the machines getting smarter, a smart human will always beat a smart machine. (Now, if humans choose not to get smarter, and, instead, go backwards in developing critical thinking, etc…then, Battlestar Galactica, here we come)

    1. Yes! These writers know what buttons to push! And the feelings that we have, because we are so invested in these characters also is because of the great writing.

      It will be interesting if they follow through on the slgo story line, even if it’s just because I’d love to see what Taylor comes up with!

      I agree with you (again!!). Machines are good for many things, but will never replace humans (unless they give the machines and emotion chip!)

  6. I just came back from some business at my bank, Standing at the counter next to me was a younger guy explaining to the teller what happed in episode 3 of Billions. The teller had not yet seen it. The fellow was so excited I just had to butt in and add my agreement, It was surprising to me, since Showtime is a bit costly around here and not a lot of people seem to have it. Same was true for Homeland of course. Actually, way back with the airing of Band of Brothers, I had trouble finding people who watched it on HBO; once it moved to the History channel there were more viewers. Anyway, I wanted to share that as it made my day in an afternoon of running tedious errands!

    1. How fun, Connie! I sometimes overhear people talk about Billions at the next table in restaurants, and I love it!

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