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Down in Puerto Rico, in the cushy Dorado Beach neighborhood outside of San Juan, Glen Scheinberg, a 35-year-old Wall Street portfolio manager, plots and strategizes how to deploy billions in capital to exploit the periodic shifts in the S&P 500, the Nasdaq, the Russell, and myriad other indexes and the trillions in capital benchmarked to them. 

Betting on which companies will be added and subtracted to stock indexes, and how they'll be weighted, isn't a new strategy. Traders have been playing the arbitrage game known as index-rebalance trading since the 1990s.

But thanks in part to a generational shift to passive investing products in recent years, such as index funds and exchange-traded funds, an enormous investment complex has quietly risen up on the buy side dedicated to this space. And Millennium, thanks to Scheinberg and a growing tally of PMs at the fund involved in the strategy, sits at the top of what's been a multibillion-dollar money-printing machine. Despite its bland name, index-rebalance exposure has become so lucrative that it's resulted in a flurry of copycats and a war for talent on Wall Street. 

Millennium is routinely one of the most profitable hedge funds in the world, the apotheosis of what the multi-strategy model can achieve. The $58 billion-in-assets behemoth has over 260 individual teams and about 3,000 employees, and it's lost money once in the past three decades.

In 2020, Millennium was one of the industry's top pandemic performers, producing 26% for its flagship fund and $10.2 billion in aggregate for investors, bringing its lifetime tally to $36 billion, said LCH Investments, a fund of hedge funds. In 2021, the fund cruised to another strong year with a 13.5% return, besting most of its multi-strategy competitors — with the exception of Citadel, which returned 26.3% in its flagship fund.

And at the center of the Scrooge McDuck-style piles of money that Millennium has been amassing in recent years is Scheinberg, a prolific performer and one of the company's most profitable PMs, people familiar with the matter said. Scheinberg and a trio of former Goldman Sachs PMs on his team absorb billions of the fund's capital to deploy toward index arbitrage, as well as a handful of other strategies, and have in turn generated billions in profits.

In the process, they've contributed to a furious pursuit among competitors angling to mirror their success. All the usual suspects — Balyasny, Citadel, ExodusPoint, Point72, and Schonfeld — have crowded into the strategy, as have smaller competitors, pillaging index-rebalance talent from each other in the process. 

"Millennium started it, and everybody played catch up, but nobody could," a senior hedge-fund headhunter who has placed PMs in the strategy said. 

These mega funds are also raiding investment banks, depleting trading floors at the firms that once ruled the index-rebalance trade: Goldman Sachs, Morgan Stanley, JPMorgan, Bank of America, and Barclays, among others. Some have taken action to protect their turf, implementing longer notice periods for program-trading and index-arbitrage desks that have become a primary poaching ground.

"One trend we've seen in the last five to six years is a big transition from the sell side to buy side on index rebalancing. Everyone is moving to the buy side," said Struan Pires, a managing partner at the Wall Street recruiting firm Carrington Fox.

Millennium declined to comment through a company spokesman.

Amid a generational shift to index investing, Wall Street pounces 

Over the past two decades, a generational shift has unfolded in how mainstream Americans invest their savings and retirement funds. Mutual-fund stock pickers who endeavored to beat the market fell out of vogue as ever more Americans came to accept the Warren Buffett aphorism that matching the returns of the stock market broadly was the best outcome for most people. The Oracle of Omaha was particularly sour on the long-term returns of hedge funds — winning the now famous bet that the S&P 500 would outperform a curated selection of top funds. 

Cheaper, simpler funds from Vanguard, BlackRock, and other asset managers gathered steam, aiming to achieve that very objective: Mirror the performance of an index. 

These passive funds — which aim to track their benchmark indexes as closely as possible, for better or worse — have steadily gobbled up more market share, shooting up from 15% of all US mutual fund and ETF assets under management in 2005 to 41% 15 years later, a Federal Reserve paper said. 

Chart showing the growth of passive investment funds from 2005 to 2020.
Passive index funds and ETFs have exploded over the past two decades amid a generational shift in investing.
Federal Reserve; Morningstar

Major indexes have for decades telegraphed their recompositions well in advance — helping copycat funds mimic their performance with almost zero separation. But this dynamic also creates an opening for enterprising traders to pounce when indexes reshuffle, buying stocks in advance that passive funds will need to purchase to match their benchmark and shorting stocks the funds will have to dump. 

As a result, stocks slated to join the S&P 500 or Russell 1000, for example, reliably enjoy a substantial price run-up in advance of their inclusion in the index, while stocks getting the ax see their prices decline, a 2018 study by the asset-management firm Research Affiliates said. The trend typically reverses after the changes are completed, with the ousted stocks outperforming in subsequent months.

"You know the index funds have to buy at no matter what the price. You know the price will be higher. So you have a month to preposition yourself," said Rob Arnott, the founder of Research Affiliates and a coauthor of the study. "All the hedge funds out there have that same month. And they're all trying to guess what the other is doing."

By 2015, with passive assets having swollen to over $4 trillion, Wall Street banks and hedge funds had started to garner some attention for exploiting Main Street's migration, with Bloomberg calling it the "hugely profitable, wholly legal way to game the stock market."

Pearl clutchers saw Wall Street profiting on the back of average Joe investors who predominantly invest in index funds, whose costs increased as a result, studies showed. 

Others were less miffed by the so-called front running. Hedge funds and banks have the speed and savvy to execute nuanced, complex strategies that aren't available to a retail investor — but that's the case in just about any asset class or strategy. The Wall Street investors also supply extra liquidity at a period of heavy demand, proponents say.

And as the Bloomberg columnist Matt Levine said, if indexes are broadcasting the companies that will be added or dropped ahead of time, how much speed and savvy is really required? 

After a wave of trading surrounding the addition of American Airlines to the S&P 500 in 2015, Levine wrote:

"You didn't need to be a sophisticated low-latency computer algorithm to trade ahead of American's addition to the S&P 500 index. A regular human retail trader could have read the S&P news release on Monday afternoon, had dinner with friends, seen a movie, gotten a good night's sleep, spent Tuesday morning doing research to confirm that American was in fact going to join the S&P 500 and that a lot of index fund money tracks the S&P 500, gone out for a two-martini lunch, had 40 martinis, gotten blackout drunk, woken up in the hospital, spent 48 hours recovering and still had time to buy the stock before it joined the S&P on Friday afternoon."

"If it takes you more than four days to push a button, don't go around complaining that other people are too nimble and fleet-footed," he added.

People got bored of the controversy and moved on to new and more interesting sources of outrage, but index investing continued to steadily expand. Three years later, in 2018, passive investing would overtake actively managed equity funds.

Last year, passive investments climbed to $6.2 trillion, or 54% of the US equity-fund market, Bloomberg Intelligence reported, "driven largely by the growth of funds tracking the S&P 500, the total U.S. stock market and other broad U.S. indexes."

Efforts by so-called smart-money investors to get rich off the trend quietly continued to grow in tandem. Hedge funds may have lost the bet with Buffett, but in an ironic twist, some of them would profit handsomely by exploiting the very index funds that the Oracle wagered would defeat them. 

Millennium's SRBL team mints billions

No hedge fund has capitalized on the index and ETF explosion like Millennium — and in particular the young pod of former Goldman Sachs traders led by Scheinberg, whose team industry experts credit with helping turbocharge demand for copycat strategies and traders to run them.

In 2014, Millennium poached 27-year-old Scheinberg from Goldman Sachs' program-trading desk — the team at Wall Street banks responsible for trading large baskets of stocks using algorithms. Along with him came three Goldman colleagues: Michael Rems, a Midwest transplant who landed at Goldman in 2004; James Brophy, the most seasoned at almost 40, who worked at S&P Global for four years before joining Goldman as a senior index strategist in 2010; and Richard Li, a recent Duke grad who joined the bank in 2011.

Scheinberg helmed the pod, but the quartet of PMs became known internally by their initials: SRBL. The group operates a variety of strategies, people familiar with the matter said, from statistical arbitrage and volatility to event-driven and fixed income. But in recent years, index rebalance has been their top play, a barn burner that has sent ripples across the industry.

In 2020, index-rebalance specialists started off in disarray as fallout from COVID-19 that March nixed planned index rebalances that hedge funds had been anticipating, which caused significant losses, Forbes reported.

But as with the market overall, the strategy rebounded and had a monster year. The SRBL pod was the best performer on the Street by a wide margin, generating about $3 billion in profits, people familiar with the matter said, much of it from index rebalance. 

Conceptually, the trade is simple: With a healthy head start, buy or sell the stocks that passive funds will have to trade to match the index's performance.

But sophisticated players such as SRBL and those at rival hedge funds aren't just reacting to the announced changes in indexes. They're predicting the moves indexes will make, often using reams of data and quantitative-trading strategies.

Size and scale play a role. Teams involved in index rebalance often operate like accordions, industry experts explained, their capital expanding and contracting between each index reshuffling. During an event period, they roll out large piles of money to make their bets on how the ETFs will shake out — sometimes piling on leverage to amplify their swings.

In between, their balance sheet contracts in size as they research trades for the next event.  

The SRBL team is known to take hefty, multibillion-dollar wagers — making Millennium, with almost $60 billion in assets under management, an ideal venue for index-rebalance trading. But Scheinberg and company are viewed in the industry as highly skilled traders and researchers, not just custodians of a giant pool of capital. 

Among those familiar with the group or their exploits, they've achieved mythic status. They are "the smartest people I've met," said one senior hedge-fund executive who crossed paths with the SRBL squad.

Tesla and the 'mother of all S&P 500 rebalances'

The growth in index funds means more money sloshing around in the periodic rebalancing frenzy, like blood in the water for alpha-hungry hedge funds that have chomped at the opportunity.

Electric-vehicle maker Tesla's addition to the S&P 500 in late 2020 created one of the most significant index-rebalance events in history, and it illustrates just how much money is at stake.  

Tesla stock soared 57% between November 17, when the S&P announced the stock's coming inclusion, and December 18, the final trading day before it was officially added to the index. In the 10 days leading up to that date, $33 billion in Tesla shares traded per day on average. And on the last day before its addition, $154 billion in volume changed hands, a Research Affiliates report said. 

Investors who'd anticipated Tesla's inclusion even before it was announced stood to make even greater profits. 

With a stock as popular as Tesla — which attracts investors of all stripes, including hordes of Elon Musk fanboys — it's not always clear who or what is driving it. But its stock price appreciated significantly leading up to the S&P's November announcement — Tesla shares climbed 190% in the preceding six months — amid bullish views toward the electric-vehicle industry, as well as the "price pressure from the long-anticipated S&P 500 rebalance itself," the report said.

"Given the size of its market-cap and the hype around the company, Tesla's addition to the S&P 500 in December 2020 was the mother of all S&P 500 rebalances," the report said. 

Hedge funds with index-rebalance strategies feasted on the event, including Millennium, which loaded up on Tesla stock in the third quarter of 2020. It's not clear how much Scheinberg's team made on the Tesla rebalance, but it likely played a material role in SRBL's multibillion-dollar haul for 2020. 

"It was not just a big event of the year. It was one of the biggest events in five years," an index-rebalance portfolio manager told Insider. "The last time something that big happened was Facebook in 2013."

Of course, it's not just the S&P 500 attracting hordes of traders sniffing around for index-rebalance profits. Every June FTSE Russell reorganizes the composition of its various indexes, and with tens of billions of dollars changing hands, the event is considered by some the biggest trading day of the year — or as Gordon Charlop of Rosenblatt Securities called it in a Reuters interview, "the greatest show on earth" when it comes to trading.

"Most of the money is made in plain old indexes, which have been around forever," a portfolio manager in the strategy explained, citing long-standing index providers such as S&P Global, Russell, and MSCI, which have trillions benchmarked against them.

The war for talent

For Scheinberg's team, 2020 wasn't a one-off. The group, now comprising about 25 people, was up more than $2 billion through the first three quarters of 2021, people familiar with the matter said. 

Millennium has continued to hire teams and personnel focused on index rebalance, which has become one of the largest strategies at the fund, the people said. 

When the industry's top multi-strat leans into a strategy and produces blockbuster results, others take notice. 

"Hedge funds copy each other. If they see people making a ton of money in a strategy, they want to get involved," said Dyllan Beck, a headhunter at Carrington Fox who works with Pires and has focused on index-rebalance strategies in recent years.

And many have. Millennium is the largest player in this realm, but top rival ExodusPoint has planted a flag as well, investing significantly in the space.

Giants such as Balyasny, Citadel, Schonfeld, and Point72 have also hired index-rebalance PMs, as have midsize players such as Centiva Capital and Ergoteles Capital, a secretive fund backed by Paloma Partners that manages more than $5.5 billion. 

Quant-trading firms such as Squarepoint Capital and Jump Trading have also gotten in on the action.

It's become so popular that even investment firms you may not expect are chasing index-rebalance riches. Bain Capital, which operates a small long-short hedge fund, has also pursued the strategy, a person familiar with the matter said.

"There are a lot of tourists in this strategy. A lot of people come in and go out," a senior PM involved in the strategy said.

h2">>Hedge funds furiously hired index-rebalance traders in 2021

Millennium

  • Steve Manzoni resigned from Bank of America to join
  • Gabriela Baez, Laura Magnani, and Chaim Pizem joined from Barclays

ExodusPoint

  • Amit Singh joined from Barclays
  • Kevin Foote joined from Morgan Stanley
  • Brooks Cutright joined from Bank of America

Citadel

  • Ryan Sandor joined from ExodusPoint
  • Paul Jefferys, previously the head of central risk at Citadel, started a new index-rebalance desk
  • Nina Zhao joined from Balyasny

Point72

  • Shantanu Agarwal joined from Goldman Sachs in Hong Kong

Balyasny

  • David Qian joined from ExodusPoint

 

Investment banks used to dominate index-rebalance trading but have been ravaged by the shift to hedge funds. 

What you've seen is a mass exodus from the banks. They just can't compete.

Goldman has long boasted a top program-trading and index-arbitrage operation on the sell side, regularly reaping north of half a billion in annual revenues from desks involved in index-rebalance trading, a person familiar with the matter said. But the bank has continuously lost talent to the buy side, and in recent years those revenues dipped even as overall ETF and index activity has exploded, the person said. 

Amid the wave of defections, Goldman has lengthened its notice period for program-trading and index-arbitrage desks, people familiar with the matter said. JPMorgan recently followed suit with similar measures for quants and algo traders, eFinancialCareers reported.

Representatives for Goldman Sachs and JPMorgan declined to comment.

Millennium poached a number of people from investment banks this past year, including Steve Manzoni from Bank of America and Gabriela Baez, a highly regarded index research strategist at Barclays, along with colleagues Laura Magnani and Chaim Pizem. Baez had originally agreed to join Citadel before Millennium persuaded her to change her mind, people familiar with the matter said. 

ExodusPoint last year brought aboard Brooks Cutright from Bank of America and Amit Singh from Barclays.

"What you've seen is a mass exodus from the banks," said Beck, who mapped the New York index-rebalance market and estimated that there were more than 40 buy-side PMs or teams trading some variation of the strategy. "They just can't compete."

Millennium's prodigy decamps to paradise for hedge-fund tax savings and bird-watching

Despite its success, much about the SRBL team remains shrouded in mystery.

But star PMs at Millennium can net up to 25% of the profits they bring in, people familiar with the hedge fund's compensation structure said, which suggests that the young SRBL leaders have generated sizable fortunes in recent years that run into the hundreds of millions.

A source at the fund said Scheinberg was the top-earning PM at Millennium in 2020 and among the most profitable last year as well. 

People familiar with Scheinberg said he moved to Puerto Rico last year, in part to take advantage of the territory's favorable tax regime and pocket a greater share of his profits. Fellow PM Richard Li has also spent time there. He registered an LLC in November 2020, Puerto Rico Department of State records showed, with an address that corresponded to an 8,000-square-foot mansion in Dorado that sold that same month for $5.6 million, according to Zillow. 

They're not pioneers in this regard.

Billionaire hedge-fund manager John Paulson said in 2018 that he would pack his bags for the Caribbean once his kids went off to college because "it's the only place a US citizen can go and literally avoid, legally, all their taxes." (He has subsequently said he had no plans to move.) 

Both Millennium and chief rival ExodusPoint have set up subsidiaries on the island, and the latter's cofounder Hyung Soon Lee moved there in 2020, Bloomberg reported.  

How does one of Wall Street's wealthiest and most successful young hedge-fund stars live? 

Scheinberg started leaving some digital clues a year ago, around the time he began his new life in paradise. He posted reviews for the Ritz-Carlton and other tony long-term residences in Dorado, as well as for restaurants and tour companies. He had solar panels installed at his home by a local company.

Of course, money isn't everything. Scheinberg has embraced more relaxing, nonmonetary pursuits afforded by island life, such as bird-watching.

An occasional ebird.org user, Scheinberg in his short time on the island has reported spotting the ​​Greater Antillean grackle, the common gallinule, and the white-winged dove.

The growth in passive investing isn't expected to slow down anytime soon. More than $1 trillion assets flooded into ETFs in 2021, bringing the global tally to $9.5 trillion, Morningstar data indicated — both record highs. 

Riches from those like Scheinberg who play the rebalance-arbitrage game could continue to rain down, absent a market flare-up like in early 2020. But with ever more hedge funds crowding into the strategy, and banks angling to hold on to their turf as well, it may get harder to reap the rewards.

Beck, the headhunter, said, "When you have multiple multi-strats with multiple teams, and then quant firms and macro funds trying to break into the strategy as well, that naturally creates an overcrowded space."

Bradley Saacks contributed to this story. 

Source : https://www.businessinsider.com/millennium-hedge-funds-glen-scheinberg-index-rebalance-tesla-2022-1

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