Prop firm expected RoR on margin capital

[rexd]

Hi all,



Hoping to put my best foot forward with a firm I'm working with while at business school. I am backtesting some strategies I'd like to talk to them about, and wondered if anyone can answer two questions for me:



(1) About how much margin capital should I estimate is required for a book which is balanced long-short with highly correlated equities (assume $50MM long and short)? Is there a back of the envelope calculation I should be using as an estimate?



(2) What sort of rate of return on margin capital do most prop firms (and I'm curious for hedge funds if that is known as well) expect for a new strategy?



Thanks for any advice, I'm hoping not to sound like an idiot with any of what I propose, so you help is much appreciated.



RD

[EspressoLover]

(1) This is a pretty typical example of an equity market neutral fund. 4:1 leverage for an overnight beta neutral strategy in liquid developed market securities. Obviously depends on the specific risk characteristics.



If you or a friend have an IB account with over 100k, you can check their portfolio margin calculator on some sample portfolios. Prime brokers probably will give you better margin, but IB should be around the neighborhood. Depending on your investor though, they might have more stringent leverage restrictions than your prime broker. I wouldn't really recommend advocating for anything much north of 4:1 on an untested strategy, it's not necessarily a good look.

[HitmanH]

I'd echo a lot of what EspressoLover says - and he's spot on re: IB as a good proxy for this - although most hedge funds / prop shops will be able to achieve better (20x for all S&P/N225 names, with no sector bumps is no big deal). However - it's often down to the risk appetite of the firms. While prop shops will mainly focus on the capital usage (and risk / VaR or whatever metric they constrain by), many hedge funds, due to investor concerns won't go over a set leverage number - and while 4-10x is OK for a equity market netutal / FI RV / macro - if this is running in a broad equity l-s - a lot of investors get scared if they see >3x - so depends on the home for the strategies.



As for rate of return - it's not always that simple. I'll start with (most) hedge funds - and actually here not many have margin as a constraining factor (and as said - can get a lot higher than you will be willing to take it up to) - it's that gross number - so what most firms will look for is a suitable % return on the unlevered amout they assign (NB - != margin req). That probably is aiming for a double digit return with a singe digit vol. So - if they run to their investors a 3x limit, and they give you 50m by 50m, so 33 implied 'AUM' want to be looking to make say $4m. Now - they probably aren't only looking at that. The best (yeah yeah, exceptions, but they really are) hedge funds take 2/20 these days - so if you also need to look if the numbers are realistic.



Now - prop shops - I'd say most here will look at infra / desk cost (i.e. you, and required technology), capital (margin) usage, and also risk (expected sharpe / drawdowns / vol). As with above - there are always exceptions - such as offsetting strategies, filling a hole etc - but we're talking broadly here. The 'opportunity cost / desk cost' if often a lot higher than you think it should be - and acts as a way of filtering out marginal strategies. Firstly - pay-out - and I'm talking real, developed quant prop shops - Tower, Sun, IMC, Schonfeld, Engineers Gate category - not come and day-trade and lever our capital and scalp on our infra style shops. I don't see many of them paying out > 50pc of realised PNL - and that is probably (i know one of those firms above) is on Sharpes >7.5 - so look what you are going to get. Clearly - they will pay more for a developed / consistent strategy. So - look how much you can make

As you've said 50 by 50 - this probably isn't a real hft strategy - so lets say (optimistic maybe) you're returning that 4m usd at a sharpe of 2.5-3? Probably will pay out c15% of pnl for that to you - and some might say the desk / infra cost is your basic draw x2.5, or some may pass through itemised tech and infra costs.

Many firms also want to know that for each person in their door - they expect to 'make' 0.5m USD from - again - as a filter - from what they retain - so bare that in mind (desks with tech, data and support in London / Chicago / NY aren't cheap)



Back of envelope - and I've clearly gone way off track here - but hopefully gives some idea on how a lot of firms can think of this.



Happy to chat offline / direct too -I'm actually in the space of running a firm with some external hedge fund vehicles but also some prop strategies - and we've started trying to bring on more people / teams to increase capacity - so have been looking at this a lot (but didn't want t make this sound like an advert or anything - so only people who are really interested and read by drivel above know that now!)

[a路径积分]

>(1)

Agreed with previous posters.

[rexd]

Thanks for these answers, guys. I'm going to digest what you've said and will probably have a few follow-up questions, but right off the top this will make me look a lot more like I know what they're asking for.



Very much appreciated.

[radikal]

In HFT -- 50/50 splits are pretty standard from what I've seen at prop shops if the tech/infrastructure is pretty weak and you're doing almost everything yourself. As you rely more on what the shop provides, you dilute down pretty quickly from there. I don't think I saw any deals on my last round above 45 actually; the firms are increasingly competing for talent in other ways than profit split.