Inside Two Sigma’s Billion-Dollar Private-Markets Gambit

Illustration by Leonardo Santamaria

Illustration by Leonardo Santamaria

A famed quant shop opens its internal private-equity fund to outside investors for the first time.

When software engineer Patrick Leung joined Two Sigma last May, the firm was revving up for what was arguably its most aggressive play beyond the systematic hedge funds that had turned the darling quant shop of Wall Street into a $60 billion powerhouse.

For the first time, Leung knew, Two Sigma was opening up its internal private-equity portfolio to outside capital. The new vehicle was called Sightway Capital, and Leung, a former engineering lead at Google, had been tapped to oversee technology and data science efforts at Sightway and its VC counterpart, Two Sigma Ventures.

“Private markets — specifically, private equity — were at a very nascent stage in terms of their adoption of data science,” he explains. The allure for Leung was decidedly simple: to be on the leading edge of applying data science techniques to these private markets, a vast playground largely untouched by the quant methods that have come to dominate the public markets.

Five months later, Sightway had closed its first fund, raising $1.2 billion from investors — including Massachusetts’ $76 billion pension fund — on the strength of Two Sigma’s claim that it could leverage its hardcore skill set in this new arena.

Skeptics might wonder whether Two Sigma’s quantitative abilities can actually translate from the hedge fund world to private equity — an asset class where general partners have traditionally relied on personal networks and fundamental analysis to source and evaluate deals. As it is, private equity is a crowded field — one where uninvested capital is piling up, competition for deals is fierce, and general partners are under pressure to shell out for companies trading at prices more than ten times their earnings before interest, taxes, depreciation, and amortization.


As Leung and other insiders knew, however, Two Sigma is no private-equity novice. The hedge fund firm has long invested in private markets using its partners’ capital — and as PitchBook’s Wylie Fernyhough points out, Sightway “wouldn’t have attracted $1.2 billion if it didn’t have a good track record.”

Still, the private-equity analyst doesn’t see how there could be much overlap between the Sightway strategy and Two Sigma’s systematic hedge funds. In general, “quantitative investing is really about high-frequency trading — and that kind of data doesn’t really transition to long-term private-equity investing,” Fernyhough says. “I wouldn’t expect to see many quant funds make the jump to private equity.”

But Two Sigma has made the leap. Can Sightway stick the landing?

Two Sigma likes to promote itself not as a hedge fund firm, but as a leading technology company. And according to the official line from Two Sigma — a firm long in control of its own narrative, and one that hews closely to talking points — Sightway presents just another opportunity to leverage its technological expertise.

“Two Sigma’s mission and vision has been to find opportunities to find value in the world’s data,” says chief investment officer Wray Thorn. “Private investments [are] an area where we’re endeavoring to build businesses that can employ that same mission. From our standpoint, I think it’s consistent with our mission as a company.”

According to Thorn, Sightway’s strategy is to identify “asset-intensive” industries in which to build portfolio companies from the ground up, hiring handpicked executive teams and growing each business using data science.

“The market environment is competitive,” he says. “This is an area that is less competitive. There are not very many firms that focus on this type of investing or focus on these verticals. When you overlay that with data science to help companies succeed, we like to think that differentiation is quite significant.”

Two Sigma is far from alone in wanting to expand its private-markets presence — and with good reason. Over the last several years, while many hedge funds have suffered redemptions, private equity has been veritably drowned in cash. Investors are laughably eager to commit to private-equity funds — and are willing to pay high fees for the privilege of doing so. Hedge funds, in turn, are looking to meet investor demand, with roughly a quarter of hedge fund managers surveyed by EY last year reporting that their firms offered a private-equity product.

As Sightway’s promising start might indicate, Two Sigma meets several criteria that experts say are necessary for an asset management firm to break into private markets. For one, it helps to have a strong brand within the investment community, according to top asset management consultant Kevin Quirk, a principal in Deloitte’s Casey Quirk practice. Two Sigma has this advantage, as does another hedge fund firm currently pushing into private equity: Elliott Management Corp. The activist firm, led by Paul Singer, last year raised $2 billion for buyout deals, according to The Wall Street Journal.

Other requirements for expansion, according to Quirk, include strong leaders who can navigate the transition, sufficient scale to support the new business, and a rationale for the move that’s not based purely on the amount of money pouring into the asset class.

“In order to position themselves for success, firms need to have a good story for why they’re expanding,” says Jack Tamposi, a senior analyst at Cerulli Associates. “If they’re just expanding into a space for the sake of raising assets, that is not going to resonate as well with a long-term investor like an endowment or foundation.”

It helps that Two Sigma is not new to private markets. As Thorn explains it, Sightway the brand may have only existed for two years — but Two Sigma began developing its private-equity business as far back as 2008. Thorn himself joined the quantitative investment firm in 2012, when he was brought in to build out a team and portfolio of privately held companies. The launch of Sightway in 2018 coincided with the decision to tap outside institutional investors for the additional capital needed to “grow our companies in greater size and scale,” Thorn explains.

Raising a fund to support an existing portfolio of companies put Sightway in a unique position. On the one hand, they had what one investor describes as “proof of concept” and “several years of success” investing inside money. On the other, investors had to be sold on the fund’s existing portfolio companies in addition to Sightway’s overall investment strategy.

This dynamic is seen in the investment made by the Massachusetts Pension Reserves Investment Management Board, which committed up to $500 million to Sightway in early 2019, according to plan documents. However, not all of the Sightway-backed companies were seen as a good fit for MassPRIM’s mandate — so the investment was made through a separate account that has exposure to some, but not all, of the comingled fund’s portfolio, according to a person familiar with the matter.

Another challenge that Sightway — and every other Tom, Dick, and Harry trying to mimic Two Sigma’s gambit — faces is the relative lack of data available in the private markets, where companies are not required to report financial data and other information.

“Private markets have different challenges than public markets because there’s a lot less readily available financial and operational information out there,” says Leung. “It’s a lot more difficult to create these more quantitative models that you have in the hedge fund world.”

It was this challenge that lured Leung to Two Sigma from Google, where he had worked as an engineer on projects including, most recently, developing an artificial-intelligence-based conversational system called Google Duplex.

In his new role as chief technology officer for Two Sigma Private Investments, Leung works with both Sightway and Two Sigma Ventures, a venture capital unit founded in 2012. Like the private-equity division, Two Sigma Ventures is also expanding its reach, having just closed its first fund raised primarily from external investors. The $288 million venture capital fund, closed in January, will invest primarily in data-driven startups.

Two Sigma is not the only firm trying to bring quantitative investing to the private markets. CircleUp, founded in 2012 by TSG Consumer Partners alum Ryan Caldbeck, uses a machine learning platform called Helio to help it source potential deals in the consumer retail sector. Other private-equity firms, particularly the “larger players,” have similarly been eying ways to incorporate data analysis into their portfolios, according to PitchBook’s Fernyhough.

“Data has shown itself to be something that can be a competitive advantage,” he says. “Data is one of the most valuable assets out there, and private-equity firms are looking for any way possible to take advantage of it.”

Still, Leung claims that Sightway has a “huge advantage” as part of Two Sigma. “The company has developed a sizable team dedicated to data discovery, and there are data sets [Two Sigma] is already using for public markets,” he says. “We are tapping into that huge existing pool of data to give us a head start in terms of applying data science, and we are taking full advantage of Two Sigma’s well-developed capability to discover and license new data.”

Sightway can, for instance, access Two Sigma data sets that include private companies to quantify employment information and other factors that can help the team determine which investment opportunities to prioritize. But perhaps the most meaningful implementation of data science comes later, after portfolio companies have been established.

Take, for example, Dext Capital, a medical equipment leasing company that launched in October 2018 with Sightway’s backing. In founding Dext, Sightway’s goal was to build a company that could use data science to more effectively evaluate potential loans.

“In that case, we didn’t have an executive in mind, so we set about finding an executive, meeting everyone we could meet that we could work with to build the company,” Thorn explains. “We were fortunate to find a CEO, Kyin Lok, who had quite an affinity for applying data science and data-driven decisions in underwriting and throughout the business process.”

With Lok on board, the Sightway team got to work identifying data sets that could give Dext better insights into a company’s creditworthiness and allow the lender to more accurately predict default.

“Dext is a good illustration of Sightway’s strategy,” Leung says. “Introducing data science can be a change for the company’s culture — as well as the way it does business. We’re getting in there early with a management team versus trying to turn around a company that’s been doing business a certain way for decades. The earlier you get in there, the less kind of inertia and resistance you’re going to run into.”

Or, as Thorn puts it, getting in early allows Sightway to build its own technology platform, as opposed to “inheriting someone [else’s].”

“Sightway’s primary strategy is to build,” he says. “Buying companies is quite competitive — and it’s quite expensive. We’re focused on creating new companies with teams of executives that we think are strong, and growing those companies by originating and growing assets.”

An investor in Sightway speaks positively of the team’s ability to identify “good management teams to work with” across “a pretty disparate set of industries.” No matter how technology-driven Sightway and its portfolio companies may be, “you’re betting on a management team” at the end of the day, the investor argues. “You still have to have that level of trust with the people you’re working with and believe they have the right management skills,” because however “hands on” Two Sigma is, “they’re not trying to manage these businesses within the four walls of Sightway.”

Whether this is the right move will of course take years to discern — unlike the almost instantaneous feedback common for quant managers. Which may, in the end, be the hardest thing about private equity for Two Sigma and those firms sure to follow it.