AlphaHedgeFundInterviews by Amanda Cantrell, Michael Peltz,		Imogen Rose-Smith and Stephen TaubHallofFame
THE SEVEN NEWEST MEMBERS OFTHE HEDGE FUND HALL OF FAME —THE FIRST TO BE INDUCTED IN
FIVE YEARS — HAVE INDELIBLY
SHAPED THE INDUSTRY		
THEY HELPED TO BUILD.

Alpha Hedge Fund Hall of Fame

“We couldn’t
be sure		 until weD

actually started
trading whether oursystem would
work as well as
we expected.
But it did.”
DAVID SHAWDavid Shaw has always considered himself a scientist first and foremost.
When he decided in 1986 to leave his position teaching computer science atColumbia University to join the automated proprietary trading group at
Morgan Stanley, he was attracted by the opportunity to try something different and the chance to significantly increase his net worth. Two years later
Shaw left Wall Street, but he didn’t return to academia. Instead, he hooked
up with fellow Hall of Famer S. Donald Sussman, whose firm, Paloma Partners, staked him $28 million to start D.E. Shaw & Co., a quantitative-based
hedge fund firm. Known as much for its secretiveness as for its consistently
strong risk-adjusted returns (13.6 percent annualized after fees from 1989
through July 2013), D.E. Shaw made it cool to be a quant, recruiting top
Ph.D.s in math, physics and other sciences to work on its sophisticated investment models and teaching them finance. Although D.E. Shaw endured
its share of adversity, losing $200 million in proprietary capital in 1998 after the near-collapse of hedge fund firm Long-Term Capital Management,
it has persevered by adhering to its founder’s core values, putting integrity
ahead of profits. Shaw has solved what is arguably the hedge fund industry’s
most challenging problem: management succession. By 2001, Shaw had
transitioned himself out of the day-to-day management of the firm. Today
it is run by a five-person executive committee, which oversees $31 billion inassets across a variety of quantitative and qualitative investment strategies. The 62-year-old Shaw has returned to his first love as chief scientist atD.E. Shaw Research, a 100-person lab he founded that is designing specialpurpose supercomputers to simulate the motions of biologically relevantmolecules.
Alpha: How did you persuade investors to give you money to start aquantitatively based hedge fund firm after just two years at MorganStanley?
Shaw: I was introduced to Donald Sussman, and he really understood
this sort of thing. He believed in the power of quantitative methods,
and he was willing to invest in developing techniques rather thanjust saying: “Here’s money. Start managing it from day one.” He said,“You know, I understand this is a research thing, and if you want todo this, you can have a year to hire people and do the research, andthen start trading.”
How did you know you were ready to start trading?
Well, we’d done a lot of work with historical data. We were working
with a big database, and when we came up with a hypothesis for amodel, we were very careful and made sure to test it on different dataand not fall into the trap of overfitting the data, thinking that we hadsomething real when it was in fact purely random. We had also donesome live trading tests by that point just to make sure that if you placed
an order, you’d get it at that price and not move the market too much.
Still, we couldn’t be sure until we actually started trading whether oursystem would work as well as we expected. But it did.

• Photographed by Mike McGregor on July 12, 2013, in New York, NY

Alpha Hedge Fund Hall of Fame

What have been the main drivers of the D.E. Shaw group’s success?
But I think there may be a bit less of a focus among our employees on
The people are by far the most important thing. The most obvious
doing whatever it takes to get the largest share of the bonus pool so you
thing is that the firm is extremely selective in its hiring. The ratio of apcan buy the largest yacht.
plications received to offers made is incredibly high. But there are also
D.E. Shaw was once deemed one of the most secretive hedge fundsome very specific things that we cultivate in our people once they getfirms. Do you think the firm was somewhat misunderstood because
here. One of them is a very rigorous way of thinking. This applies to all
you didn’t reveal a whole lot about what you did?
of our people — not just the quants but also the ones who are involved
In the early days we really were unusually secretive. Back then wein qualitative strategies. There’s also a very strong emphasis on clear,
were just a quant shop, and the value was in our computational modunambiguous communication. And then the other big one, which may
els and in the minds of the people who made them. If stuff had leakedsound like a cliché but which really is important around here, is a deepout, that would have been really bad. Even small things could givecommitment to doing the right thing: staying
people clues in the aggregate if a bunch ofaway from gray areas when it comes to legal
things leaked out. So I used to say to our peoor ethical issues, treating each other in a way
ple: “This is like you’re in the CIA. You can’t
that’s respectful, that sort of thing.
talk about any of this.”
How would you describe the culture at D.E.
Did you get pressure from investors to giveShaw?
some insight into what you did?
One key thing is that it tends to be very coopSometimes. In the early days, though, Donald
erative. People who spend all their time lobwas our main investor, so we didn’t have tobying for power and trying to advance their
say much to anybody else for a while. Someown interests find out pretty quickly that theyyears later, when we started accepting other
don’t fit in very well here. The people whoinvestments, there were some investors who
do best here are the ones who are inclined
were used to getting more information about
toward cooperation and collaboration andhow different trading strategies worked than
who focus on the company as a whole, andwe could share with them. We ultimately figthat helps to shape the overall culture of theured out a way to give our investors enoughfirm. One way this shows up is that people
transparency to make them comfortable while
often share responsibilities. The most visstill protecting the integrity of our proprietaryible example is that the firm is run jointly bysources of alpha. Investors generally undera five-person executive committee, not by astood the reasons we couldn’t tell them everysingle individual. They’re used to thinking
thing, and the feedback they gave us helped us
first about what’s best for the firm and not for
figure out how we could provide them with thethemselves individually. It’s a very unusual
sort of information that was most important totype of environment and culture. It really is.
them without killing the geese that were laying
Did the idea for the executive committee happen
their golden eggs. As the firm grew we also added a number
organically, or did you envision it when you were lookingof investment activities that we could say a lot more about,
D.E. SHAW & CO.
at how to transition yourself out of the firm?
like macro and distressed credit.
We already had an executive committee during the days
FOUNDED IN 1988
Do you miss the investment side of D.E. Shaw’s business?
when I was directly involved in the operations of the firm,
It was a great experience, but I’m really enjoying what I’m$22.9 MILLION
and we tended to reach decisions more or less by consen(what $1 million invested on
doing now, and I’m happy leaving the investing to otherday one would be worth now)
sus most of the time even then. It wasn’t the sort of thingpeople. Every once in a while, I’ll stumble on a new mathwhere I’d say: “Thanks for the briefing. I’ll tell you tomorematical or computational technique in the academic
row what my decision is.” So when I transitioned out of active manworld that seems like it might be applicable to quantitative investagement, it was a very natural thing to simply pass the baton to thement management, and sometimes I’ll say, “Hey, have you looked into
executive committee. It’s still kind of amazing to me that a company
this general area?” And usually the answer is something like, “We’recan run so well with this sort of shared leadership structure, but at
already on it” or “We’re not actively pursuing that for the following
least in our case, it really does.
reason,” so I don’t wind up adding much value. But if our quants are
Is that a reflection of the people in the roles?
always a step ahead of me, I guess that’s a good sign.
Yes. All five members of the executive committee have been here forThe firm has a lot of cool things that it does, and I enjoy asking quesmore than 20 years, and they have a shared vision of what the firm istions about them at our board meetings. But if I wanted to go back into
all about. They trust each other, and they work really well together.
investment management at this point, it would probably take me a year
Do you think making money is less important at D.E. Shaw than it
or two just to get back up to speed. And I don’t feel any temptation tomight be at other firms?
do that.
Certainly not in terms of the results we try to produce for our investors.
— Interview by Michael Peltz

DAVID SHAWThis reprint is provided for the reader’s information only and does not constitute investment advice or convey an offer to sell, or the solicitation of an offer to buy, any security
or financial product. The D. E. Shaw group does not endorse any information, beliefs, or opinions presented in this article and makes no representation as to their accuracy
or adequacy. Please note also the date of the article, as the information contained in it has not been updated for any information that may have changed since its publication.
Past performance should not be considered indicative of future performance. The historical return figure presented in this article represents, and the cumulative
dollar return presented in this article is derived from, the aggregate capital-weighted lifetime net return of various alternative investment strategies and vehicles deployed or
managed by the D. E. Shaw group over time. Accordingly, no investor experienced the aggregate performance presented in this article. The D. E. Shaw group also deploys
investment strategies (including certain benchmark-relative equity strategies and certain closed-end private investment strategies), the historical returns of which are notrepresented in the figures presented in this article. Had the returns of such strategies been included, the figures presented in this article might have been materially different.
Further, the use of other time periods would yield (in some cases materially) different results.
No assurances can be given that any aims, assumptions, expectations, and/or goals described in this article will be realized or that the activities described in the article didor will continue at all or in the same manner as they were conducted during the period covered by the article.
Reprinted from the Summer 2013 issue of alpha Magazine. Copyright 2013 by alpha Magazine. All rights reserved.
For more information call (212) 224-3675.