Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

How Goldman Sachs Lost One of Its Crown Jewels

The Goldman Sachs booth on the floor of the New York Stock Exchange
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Goldman Sachs is shuttering the hedge fund that was once one of its crown jewels.

The hedge fund , called Global Alpha, was once one of the biggest and best performing hedge funds in the world. At its height, it managed as much as $12 billion.

The fund now has just $1.6 billion in assets. Goldman expects to return between 85 and 90 percent of the funds assets to investors by the end of October, according to an investor in the fund.

Global Alpha was one of the world’s premier quant funds, using complex algorithms to detect trading opportunities. It was founded in 1997 by Cliff Asness, a former University of Chicago academic who developed the statistical models that drove the trading. Asness brought two other former University of Chicago students, Mark Carhart and Raymond Iwanowski, over to Goldman.

Asness left Goldman in part because the firm refused to pay him the way other hedge fund managers get paid—based on the performance of the fund. At the time, members of Goldman Sachs Asset Management, where Global Alpha was housed, were paid based on discretionary bonuses, just like their investment banking brethren.

After Asness’s departure, the firm agreed to start paying the GSAM team based on performance. Carhart and Iwanowski remained at Goldman and oversaw Global Alpha during its best years. It was described by people in the industry as “the Cadillac of hedge funds.”

Carhart and Iwanowski were still at the helm when Global Alpha began to run into trouble. The fund performed poorly in 2006, losing 6 percent, its first decline since 1999. But its most serious losses hit in the summer of 2007, when a so-called “quant bloodbath” erupted.

In July 2007, Global Alpha lost 7.7 percent. Many quantitative funds were following very similar computer driven trading strategies, at the time. The strategies were so similar that losses cascaded in August of 2007 because so many funds attempted to exit similar position at the same time. In August, Global Alpha’s assets dropped 22.7 percent.

There were rumors then that Global Alpha might be shuttered but they proved unfounded. Carhart and Iwanowski attempted to recover but adjusting the trading algorithms. But the fund never really recovered.

Performance in 2008 was actually very good. In a year when the S&P 500 declined by 40 percent, Global Alpha saw positive returns of around 4 percent. Nonetheless, investors continued to withdraw money from Global Alpha and its assets shrunk to just $2.5 billion.

In March of 2009, Carhart and Iwanowski “retired” from Goldman Sachs. Katinka Domotorffy took over as head of the fund. In her first year, the fund saw an impressive 30 percent return. But in 2010, the fund stagnated, ending the year flat.

This was a rocky year for the fund. Global Alpha is down about 13 percent this year, even while similar quant funds have been flat to slightly positive. Two days ago, Reuters broke the news that Domotorffy would retire at the end of year—sparking widespread speculation that Global Alpha would go down.

GS Shutting Global Alpha Fund

Now Goldman has told investors that this speculation is correct. The fund will be closed over the next few weeks. Goldman Sachs has decided to exit quantitative hedge fund strategies altogether, according to Reuters reporters Lauren Tara LaCapra and Svea Herbst-Bayliss.

“For whatever reason, Global Alpha just couldn’t compete in the very market—high frequency, quant trading—it helped invent. It couldn’t keep top people on board anymore because it didn’t have the assets to make the compensation attractive,” a person familiar with the situation said.

The fund has had trouble retaining and recruiting top quants for several years, according to the person.

Goldman Sachs declined to comment.

Ironically, Carhart himself once argued that fund managers cannot persistently outperform the market.

"The only significant persistence not explained is concentrated in strong underperformance by the worst-return mutual funds. The results do not support the existence of skilled or informed mutual fund portfolio managers," Carhart wrote in a 1994 study.

But perhaps the best take on the fall of Global Alpha comes from Benjamin Graham, writing in 1949.

"“The combination of precise formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes . . .Calculus . . . [gives] speculation the deceptive guise of investment," Graham wrote.

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