In today’s Finshots, we explain a battle between two money management companies in the US and the surprising role India has to play in it.

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The Story

If you own a hedge fund, chances are that you’ve employed a whole bunch of computer wizards.

Simply because you want to use algorithms. You want lines of computer code that will comb through vast amounts of data at an insane speed and tell you which stock to buy or sell. You hope that a well-trained algorithm will be able to look at stocks all across the world. It’ll use datasets to figure out what has worked in the past and what hasn’t. And this will help it to predict certain market movements in the future. This algo is your secret sauce.

And you need top brains from elite colleges like IITs or ones working in Silicon Valley to help you in this quest.

But what happens if one of your employees who was involved in developing the algorithm wants to leave for greener pastures? And by that, we mean a rival firm wants to poach them for their technical know-how.

You’d be quite worried at this point. Your biggest fear is that they’ll take the knowledge of the algorithm with them to your rival. That your secret sauce will be a secret no more. And that your money-making machine is under threat.

So you might try to block the move. Maybe offer higher pay to the employee to get them to stay. And if that doesn’t work, you might eventually sue the rival and this employee saying they’ve stolen your trade secret — the precious algorithm.

And folks, something along these lines is underway in America currently. A hedge fund called Jane Street sued another hedge fund Millennium Management and two of its former employees.

Jane Street’s complaint is that its former employees were involved in developing a really special algorithm at the firm. One that found a counterintuitive opportunity in a non-US market. And this “really awesome” strategy helped Jane Street rake in $1 billion in profits.

But, when these employees jumped ship, they took that secret code to Jane Street’s rival.

How did Jane Street know that it was the same strategy, you ask?

Well, Jane Street said its profits from this special strategy began to drop for the first time ever since its former employees started their new roles at its rival. That could happen if a trade suddenly starts getting ‘crowded’. Or if multiple people are trying to buy and sell the same thing at the same time. And it also says that Jane Street saw signs that a new entity suddenly cropped into the same market and “placed orders mirroring” its own strategy.

Jane Street was worried that its rival would soon rake in similar profits too and consequently attract clients who would’ve otherwise landed up at Jane Street. So it took Millennium Management and its own former employees to court.

Now the court has to figure out whether Jane Street really ‘owned’ the strategy.

Sure, the trading algorithm was probably built on lines of code. And if you simply copy and paste the code elsewhere, you could argue that it has been stolen. But what if the two employees simply used their skill and experience to identify a market opportunity and then built an algorithm to automate trades and make their lives easier? You can’t really say that Jane Street ‘owns’ the strategy, right?

We don’t know.

Or maybe it helps to look at it from the lens of what could happen at a more traditional money management tool — a mutual fund?

See, most folks working in a mutual fund might have a hardcore finance background — a master’s degree or a CFA. Because their job here is to understand balance sheets and profit and loss accounts. They have to then run models on Excel to determine if the stock’s true worth is way higher than what others think. Or even if there’s some financial hanky panky going on that’s a red flag.

Sure, even these folks might use algorithms to test their hypothesis about how a stock has behaved in relation to changes in CEOs and things like that. But at its core, it’s a finance-y job.

Now imagine a hypothetical scenario, okay?

Let’s say one of these fund managers stumbles upon an idea in a book. It details how many years ago, a fund manager in the US figured out the best way to build a long-term portfolio to screen stocks based on x, y, and z parameters. Then evaluate the management of the company. And simply buy and hold the stocks forever.

Let’s call it a “Stuffed Mattress” strategy akin to how people used to keep cash under their beds for safekeeping.

Anyway, this fund manager latches on to the idea, gets a computer guy to create a code that’ll automatically screen and filter stocks based on his inputs and puts the strategy into practice at his workplace.

The quirky name and strategy quickly garnered attention.

Then one fine day, just a few months into this, the fund manager decides to leave for a rival firm. Or maybe start his own gig. And naturally, he wants to set up a similar fund in this new workplace because he believes it’s a phenomenal strategy.

The question is — does his previous firm have the proprietary right to the “Stuffed Mattress” strategy just because he came across the idea when he was employed there?

Anyway, we don’t know the answer to this and we’ll have to wait and see what the outcome of this court battle is.

But one other thing this has done is actually revealed which was that lucrative non-US market that Jane Street was profiting from — it’s India.

Yup, the lawyers let it slip during the court proceedings that Jane Street was trading options in India. Think of options as a way to bet on shares by taking leverage or a loan. So if you believe that a share worth ₹100 might be heading to the moon, you could buy something known as a call option instead of buying the share outright. This way, you don’t have to cough up the entire ₹100 but instead, just pay a fee of say ₹5 that gives you the right to buy the share at a predetermined price later. This way, you’ll be able to ride the upside. And if the call goes sideways, your loss is limited to the ₹5 fee you paid.

Anyway, India’s options market has boomed since Covid. It’s now the world’s largest in terms of the number of contracts that get traded. And 35% of the trades are made by retail traders like you and me.

Now let’s face it, most of these traders aren’t experts. They’re all riding their luck and most of them are actually losing money in the process. In fact, 9 out of 10 of them end up losing money.

So you could even argue that Jane Street might have capitalised on the follies of this group to make its billion.

And maybe, just maybe, this will get even more hedge funds to scrutinise the Indian markets for money-making opportunities.

Until then…

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