Traders Beat Market Indexes Borrowing Tools From Sports


Graham Davidson was in a slump, the worst he’d ever known.

In 15 years as a foreign-exchange trader in Sydney, New York and London, he’d always made money. Now, in the winter of 2011, he seemed to have lost his touch, Bloomberg Markets magazine will report in its April issue.

Davidson’s trades were all in the red -- screaming, fire-engine red. And his mood had turned black. Self-doubt haunted every decision. He hesitated to put trades on. He jumped out of positions at the first hint of trouble, only to see the market turn again, racing ahead without him.

“‘Is my approach still relevant? And how long do I persevere?’ You start asking yourself these questions,” he says.

Davidson, who works at National Australia Bank Ltd. in London, decided to get some help. On a colleague’s suggestion, he turned to Steven Goldstein, a former trader who now specializes in coaching traders and money managers. Davidson, 41, says that just talking to Goldstein eased his anxiety.

“On a trading desk, there can be a lot of bravado,” he says. “We’ll sit around talking about trades but not airy-fairy stuff about how we are feeling.”

Through regular coaching sessions during which Goldstein used techniques adapted from psychology, Davidson says he began to regain his confidence.

Hidden Strengths

Coaching, which decades ago migrated from the playing field to the executive suite, has been slow to penetrate high finance. That’s beginning to change as traders and fund managers scramble for any edge they can find following five years in which many actively managed funds failed to beat broad market indexes.

While many money-management firms refuse to discuss whether they use coaches, some confirm they have. They include London-based Brevan Howard Asset Management LLP and GLG Partners LP; New York–based Tudor Investment Corp.; SAC Capital Advisors LP, the hedge-fund firm run by billionaire Steve Cohen that in November agreed to pay a record $1.8 billion to settle insider-trading charges; and the asset-management division of Deutsche Bank AG.

Coaches in the financial world are borrowing techniques from as far afield as sports, Eastern philosophy and neuroscience to improve their clients’ returns. In addition, a new crop of software companies has sprung up to provide reams of statistics that the companies say can help investors and their coaches uncover hidden strengths and weaknesses.

‘Moneyball’ Stats

Last year, Clare Flynn Levy founded Essentia Analytics Ltd., based in London’s Notting Hill neighborhood, to build that kind of software. A former money manager at Avocet Capital Management Ltd. and Deutsche Asset Management, Levy, 40, points to an array of metrics projected onto her office wall.

“These are basically your ‘Moneyball’ stats,” she says, referring to the 2003 book by Michael Lewis about Billy Beane, general manager of Major League Baseball’s Oakland Athletics. By using data to identify talented players other organizations overlooked, Beane transformed the A’s into a team that could compete against better-funded rivals.

Levy says most of her clients focus on profit and loss, because that’s what determines their compensation. Yet P&L tells you little about how skilled a trader or fund manager is, she says, because luck can play such a large role.

The stats she’s looking at are more illuminating. She says one key metric is hit rate, the percentage of times an investor is right about an investment’s direction, such as predicting that Twitter Inc. shares will rise over the next three months. Another is payoff ratio -- the money made on successful investments divided by the amount lost on unsuccessful ones.

Money-Losing Behaviors

Taras Chaban, chief executive officer of Investment Intelligence Ltd., another London-based firm that makes software to analyze investment decision making, says most professional investors have hit rates that aren’t much better than a coin toss.

Of the almost 100 U.K. and U.S. fund managers in Investment Intelligence’s database, Chaban says, the best hit rate he’s seen is 64 percent; the median is just over 50 percent. Instead, successful investors tend to make money because of superior payoff ratios, and these can be improved with coaching.

Levy says software can aid in that: It can determine whether a fund manager does better with long- or short-term investments, with large-cap stocks or small caps, with long positions or shorts. It can spot money-losing behaviors, such as bailing out of positions too early when a portfolio is underwater.

Old Mistakes

Having identified errors, a coach can start working with a manager to help overcome them, Levy says. Eventually, she says, her software will be able to send an alert to a money manager who’s in danger of repeating old mistakes, prompting the client to pursue a better course of action.

The increased interest in performance analytics and coaching is driven in part by an existential crisis. In the five years through June, more than 72 percent of actively managed U.S. equity funds failed to beat the benchmark Standard & Poor’s Composite 1500, according to the latest data available from S&P Dow Jones Indices.

As for U.S. hedge funds, those with more than $1 billion under management haven’t had a year of average positive returns beating the S&P 500 Index since 2007, according to data compiled by Bloomberg.

Equity Strategies

As a result, institutional money is increasingly shifting to passive strategies -- particularly alternative beta funds that use algorithms to try to beat the market -- while retaining the benefits of index investing’s diversification and low cost, says John Stainsby, head of U.K. institutional asset management at JPMorgan Chase & Co.

By 2012, passive investments accounted for 13 percent of the $62.4 trillion under management globally, up from 7 percent in 2008, even as active equity strategies declined to 50 percent from 60 percent during the same period, according to a 2013 Boston Consulting Group report. (The rest of the money under management went to niche funds, such as convertible bonds, and alternative investments, including real estate and private equity, which also saw their assets grow slightly at the expense of actively managed equity funds.)

“For active managers who want to keep their mandates, they’ve needed to be very clear about what the source is behind their alpha,” Stainsby says, referring to the conventional measure of above-market return.

Picking Stocks

The new software can help firms prove they have this alpha -- and that their returns aren’t just due to luck, says Simon Savage, a fund manager at GLG, which is owned by Man Group Plc, the world’s largest publicly traded hedge-fund firm.

GLG, which has $28 billion under management and whose European Long-Short Fund returned an annualized average of 9.5 percent from 2009 through the end of December, is using Essentia’s software.

Even before the financial crisis, GLG built its own software to determine which of its outside brokers consistently suggested good investment ideas.

In 2008, it decided to turn the system on its own money managers. Savage says GLG, which had been making some investments based on macroeconomic analysis, discovered it did a poor job of calling the direction of the market; it did better when picking stocks that would outperform their sector.

Athletes’ Knowledge

Sensing a business opportunity, the team that built the software split off from GLG in 2009 and started Investment Intelligence. (GLG remains a customer.)

Once GLG had the data, Savage says, coaching was the next step. During the 1990s, he played lacrosse for the English national team. Savage says he was struck by the contrast between athletes’ deep knowledge of their abilities and professional investors’ almost willful ignorance.

“There was no understanding of what the skill actually was and no evidence of any desire to improve it,” he says.

For most professional athletes, the better they are, the more coaches they have, Savage says.

“Whereas in our profession, most people are embarrassed to even acknowledge they have a coach,” he says.

GLG currently works with Lawrence Evans, a former Salomon Brothers Inc. trader–turned-coach. He asks managers to list the factors that make for a good investment and then use that list to gauge whether they’re putting the most money behind the best ideas.

“The humble checklist, like the humble diary, is a simple tool, but it works,” Evans says.

Unconscious Patterns

Some coaches go beyond checklists and adapt explicitly psychoanalytic approaches to their clients.

New York–based Denise Shull, another ex-trader who became a coach, says unconscious patterns often rooted in childhood strongly influence how an investor responds to the market. She says she has assisted investors who stubbornly cling to positions because they need to prove how smart they are.

“Fund managers are supposed to use conviction to guide their investment decisions,” she says. “But how much of that conviction is about the here and now and how much of it is about wanting their father or mother to say, ‘Good job. I’m proud of you’?”

As was once the case in the world of professional sports, some financial practitioners are wary of psychological coaching. Richard Michaud, chief executive officer of New Frontier Advisors LLC, a Boston-based investment technology and asset-management company, says a lot of coaches’ advice may be worse than none at all.

Psychoanalytic Coaching

“Some of this stuff isn’t just bad investing practice; it isn’t even good psychology,” he says.

Psychoanalytic coaching might make managers doubt themselves, Michaud says. Plus, he adds, it doesn’t help an investor adhere to modern portfolio theory, which focuses on diversification and balancing expected risk with return. He says that’s the most reliable way to manage money.

Doug Hirschhorn, a New York–based trading coach who played baseball in college and once worked as a bond trader, occupies a middle ground between Shull and Michaud.

“You didn’t hire me to make you feel better or make you a happy person,” he says.

Like a personal trainer, he sees his job as providing an external source of motivation and accountability to heighten a trader’s discipline, strip emotion away and focus on proven investment tactics.

Immersive Focus

The link between mind and body represents the next frontier for investment coaching, says Steve Ward, a London-based trading coach with a background in sports psychology. He advocates using biofeedback and meditation, long practiced by elite athletes, to help traders regulate their emotions.

Ray Dalio, founder of the world’s largest hedge-fund firm, Westport, Connecticut–based Bridgewater Associates LP, credits Transcendental Meditation with contributing to his success. Ward says traders can use meditation and other mental exercises to achieve flow -- a period of immersive focus that many traders associate with improved returns, similar to athletes’ sensation of being “in the zone.”

Investment Intelligence says it’s integrating its software with biometric data from wristband monitors made by Basis Science Inc. These devices track heart rate, caloric consumption and sleep patterns, among other things. The goal is to find correlations between, for example, a steady heart rate and astute investment decisions.

Mental State

John Coates, a University of Cambridge neuroscientist who has conducted research on the physiological effects of trading, says human biology studies rarely find a correlation greater than 20 percent between two variables -- such as a certain heart rate pattern and a period in which a trader might report both immersive focus and higher returns.

“One chance out of five -- do you really want to bet on that?” he says.

Coaches don’t like talking about what their services cost, although they say clients should expect to pay from $400 to $1,000 an hour. Some coaches, like Shull, charge a retainer as well as ask for a bonus amounting to a slice of the client’s profit.

Davidson, the National Australia Bank trader, says coaching is worth the price. He says that when he’s in the right mental state, he has the confidence to be patient.

“You don’t have to swing at every ball,” he says. “The hard part is getting in that state of mind.”

During his coaching sessions with Davidson, Goldstein used cognitive reframing -- a psychological technique -- to encourage Davidson to put his recent losses in the context of his entire career.

“I learned to take the pressure off myself,” Davidson says. “If you are losing money, you will inevitably feel pressure to get that money back as quick as possible, and that breeds bad process. Now, I think: ‘If I don’t make money today, it’s not a big issue. There are 250 trading days in a year, so there’s plenty of time.’”

Time was on Davidson’s side. By the end of 2012, his trading book was profitable again -- and it stayed that way even through the bumpy early weeks of 2014.