Larry Robbins' Bridge-Traffic Arbitrage

by: Felix Salmon

Bess Levin has got her hands on a spectacular letter to investors from hedge fund manager Larry Robbins, in which he explains what alpha is by means of an analogy to traffic on the George Washington Bridge:

The entrance to the GW Bridge from the Palisades Expressway has a seven lane tollbooth, through which all of the traffic merges back into two lanes to enter the bridge. When I first moved to the area, I thought I had found a classic case of “short line long line” where people were simply lazy and didn’t move over to the left two lanes which had the shortest lines to the tollbooth. However, with experience and analysis, I found that the third lane from the left had a slightly longer line to the tollbooth for good reason – despite the longer line, it was meaningfully faster. The reason is simple enough once analyzed. As the seven lanes merge to two, lanes #4 and #5 combine, #6 and #7 combine, and then those two sets each combine – so in aggregate if you are anywhere in the right four lanes before the tollbooth, your lane becomes every fourth car in the right lane once merged. On the left, lanes #1 and #2 combine, and lane #3 has no partner. Then lane #3 combines with the set of #1 and #2, which results in lane #3 becoming every other car in the left lane once merged. As such, you move twice as fast in lane #3 as any other lane in the tollbooth. That’s alpha.

Robbins already won the mixed-metaphor award earlier on in his letter, with this:

As we discussed, the third and fourth legs of the stool – economy and liquidity – were subject to change rapidly, and we were focused on closely monitoring both to identify storm clouds on the horizon.

But the corker is probably this line:

The best analogy I can think of to describe the current environment, in contrast with 1995-1999, is bowling.

I do hope that Robbins wasn’t closely monitoring the legs of stools in an attempt to identify storm clouds while driving in lane #3 on the George Washington Bridge. Or maybe he was, and that helps explain why his fund fell 4% in the second quarter of 2010.