Ed Thorp wrote the book Beat the Dealer in 1962. It was a strategy to beat the casino at blackjack, and exploded in popularity. He followed up with Beat the Market, which applied a similar quantitative approach to investing.
In 1969 Thorp got a call from a young stockbroker named Jay Regan. Regan had just read Beat the Market and wanted to turn Thorpe’s investing strategy into a business.
Thorp and Regan teamed up to create Princeton Newport Partners, which was one of the first hedge funds, and essentially the first quantitive hedge fund.
Over the next 22 years the partnership returned more than 18% annually, without a single losing quarter.
Regan now invests out of a family office, Harbourton Enterprises, which has invested in Collaborative Fund.
I recently chatted with him about how the hedge fund industry has evolved over the last 50 years.
Morgan Housel: You’ve been investing since the 1960s. I’m curious how things have changed over time. One thing we hear a lot about, from both investors and businesses, is the rise of short-term thinking on Wall Street. Is there more of that today than, say, 50 years ago?
Jay Regan: It might be a little bit more pervasive now but it wasn’t a whole lot different back then. People were in and out of things quickly. I don’t know how long you’ve been around, but there’s still the same greedy mentality. Greedy is kind of an unfair word. There’s just this motivation to make a lot of money and I think it’s been ongoing for as long as people have been investing.
One thing that hasn’t changed: Through all the screaming and hollering, the fees really hasn’t changed at all. It’s still two and 20 in the majority of cases. That’s what it used to be.
MH: When there were far fewer funds and less competition for returns, the fees were the same as they are today.
JR: Yeah, that’s right.
MH: Why do you think that is?
JR: Well, it doesn’t make sense on the one hand. [In the 1960s] I took a look at that fee structure and I said, “This has got to be just a great business.” And it’s still the same. If anything, fees have gone up a little bit, like [some funds] getting 50 percent of the profits. Vanity Fair has these great comic ads. It’s got a picture of a highway heading into Greenwich and the sign says “Speed limit: 2 and 20.”
MH: What’s interesting is that we have seen a dramatic fee reduction on the mutual fund and ETF side for individual investors.
JR: That’s a really good point. The argument is that all the really super-smart people that have got a great track record from working at some firm or they’ve got an incredible quantitative mind, one thing after another, they take a look at the hedge fund business and they say, “If I’m going to work, that’s what I got to do, I don’t get paid a salary. I just get paid on how well I do.” If I can raise 100, 200, 300 million dollars, I can make a 20 percent return, you can figure out pretty quickly what you’re going to make.
Back when I started, there weren’t many funds. There weren’t any quantitative funds, but there were funds. I remember the big one, Mike Steinhardt’s fund. That was a two and 20. It just hasn’t changed that much. It’s really quite amazing. Some things changed, fees didn’t. Speed limit, 2 and 20. It’s a great thing, you know?
MH: The hedge fund space is far more competitive today than it was in your day. Median returns are way down. But thousands of funds are able to survive and raise money. What was running a fund like during your day versus what it’s like to operate a hedge fund today?
JR: Let me tell you, by way of example, I had no track record when we started because I was just a lowly stockbroker at Kidder, Peabody. Ed Thorp had a little bit of a tiny bit of a track record. He was doing hedged warrant trades on a handful of individual accounts, okay? That’s all he had. Because of the mystique of Ed and his blackjack stuff, we were able to raise money from some pretty interesting people.
Today that would be impossible. It’s so competitive. Today, if you say “I’m going to start a hedge fund,” you’ve got no chance. If you don’t have a track record, there’s no chance. There’s no unique ideas now anymore. There’s so many ideas that have already been thought up that to come up with a completely new idea that and no one has ever thought of seems incredibly unlikely.
So I’d say the people that start hedge funds now come from some firm or have been part of some team that’s done really well and they decide to leave and start their own hedge fund. It’s very difficult.
We look at a lot of different people coming into the business and the ones that are good are the ones that have already got some kind of a track record, something they can point to that’s really worked well. Not to say you wouldn’t look at somebody who just had an idea, but without a track record the idea would have to be extremely compelling.
MH: You were a pioneer in quantitative investing. Now it’s a large part of the market, both with hedge funds and factor funds available to public investors. Are we too focused on markets and not focused enough on the people and businesses that underly these stocks?
JR: I teamed up with Ed Thorp. He’s a super-quant, and I was really good at coming up with ideas and then putting his magic to work with models to make it work better.
You just can’t do that today. I’ll give you an example of how much easier it used to be.
The futures market is priced based on interest rates. In those days interest rates were 12 to 15 percent. Okay?
So if you had an S&P future with the actual index trading at 100, the future should be at 115. Fifteen percent premium. Then you got to factor in premiums and stuff like that.
Well, when the S&P futures started trading, they were actually trading at a discount, so one-year futures weren’t trading at 100, they were trading at 95.
I started looking at that, and I said “Give me a break, this is absurd.” And so you buy the futures and you short the stocks. Forbes magazine quote me, “It was like taking candy from a baby.” Here it is. You just put it on and you just wait for a year and you take it off. You make all kinds of money.
That’s what quantitative trades used to be like. There was very little competition. Now, if those trades get out of hand by a millimeter, every computer in the world jumps all over them. Quantitative stuff has become much more competitive.
I think that there’s still a high percentage of people that concentrate on management and earnings and all that kind of stuff. There’s a lot of funds out there that have done really well doing that.
MH: If you and Ed were starting out in business as two young men today, could you achieve the type of success that Princeton Newport achieved in its day?
JR: No. It’s too competitive now. We were in business for 22 years and never had a losing quarter.
MH: That’s incredible.
JR: It is, I know. We went through some bad markets. There were a couple of times when the markets just got clobbered and we still did well.
MH: You’ve invested through so many different markets, learning from them all. I’m curious, what’s been the biggest shift in your thinking over the last decade, since the 2008 financial crisis?
JR: The main thing that’s shifted in my mind is, I’m a believer that you really have to be prepared for almost anything out there happening.
When we look at what happened in ‘08 with the markets, it’s remarkable how fast things melted down.
If I were looking at somebody now who was just investing and he tells me he’s a genius at picking stocks, there’s no way I’d have any interests. I’d need to have someone who’s got some defense against bad things happening.
I’m just of the view that virtually anything can happen now.