Quantitative Strategies, Past and Future
The following nuggets come from a Battle-of-the-Quants conference held in New York this January. As organizer Bartt Kellermann says, ˘â‚¬Ĺ“A brain trust of investors, quantitative managers and advanced technology enablers had the opportunity to exchange ideas and hear the best and brightest offer their perspectives.˘â‚¬ť He has ˘â‚¬Ĺ“Battles˘â‚¬ť planned for London (June) and Singapore (November).
Comments made at the NYC event have been condensed and edited.
Model vs. Judgment
Karsten Schroeder of Amplitude, a high-frequency trading shop, was the moderator of a debate on machine vs. human intelligence. One of his questions: how would you allocate your children˘â‚¬â„˘s trust fund between discretionary and systematic strategies?
The reply below is from Arzhang Kamarei, chief operating officer at Tradeworx, a quantitative hedge fund with medium- and high-frequency strategies.
It depends on the state of quantitative investing. As models get better, they can utilize more data. You can evaluate alpha and risk systematically. I would allocate 60% to 70% to systematic strategies.
It is not the goal to automate everything. But the balance favors systematic as less vulnerable to biases.
Frank Holle, managing partner of Quantitative Asset Management, on different types of markets. The firm, founded in 2003 in Singapore, has Asian and global equity funds.
Frustration with the discretionary approach is why I went systematic. For more efficient markets, the systematic approach is superior by far. But, for example, for distressed debt investing where the market is inefficient, you need humans.
Joseph McAlinden, chief executive of Catalpa Capital Advisors LLC, a global macro hedge fund, on why discretion matters.
The data that gets into quantitative processes is not stable. Apple Computer now is not the same company it was five years ago. Discretionary managers have judgment into the process. Combining discretion with quant tools improves management. If I were stranded in the Kalahari desert, I˘â‚¬â„˘d prefer to be guided by a bushman rather than R2-D2 (the Star Wars robot).
What Investors Want
Terri Chernick, chief investment officer of the Koffler Group, a family office, on what she looks for.
We like early-stage groups, will seed and introduce them to other family offices. But the key for us is a track record of at least two years, with a statistically significant number of data points. For operating risks, you have to vet the back office. We look for managers that combine back office best practices with entrepreneurship and track record in the front office.
What you will do when the fund goes down 5% has to be worked out ahead of time. Better to have that systematized. When I interview managers, regardless of the strategy, the manager has to have hard rules on what they will do when the losses come. Bad things happen.
There is more trading in the markets now and a lot happening in the macro space. They have to manage changing market betas and risks. Can they manage? We track some of the trend followers. It will continue to be a difficult type of environment for them.
Brian Chung, senior portfolio manager of the fund of funds group at SSARIS, an affiliate of State Street Global Advisors, on the current trading environment.
2010 is likely to be tricky. Equity and fixed income markets went up more than expected. In ˘â‚¬Ĺ“convergent˘â‚¬ť markets, the participants act rationally. In ˘â‚¬Ĺ“divergent˘â‚¬ť markets behavior is not rational. 2009 was somewhat divergent in how much markets went up, but commodity trading advisors, who do well in divergent markets, did poorly. We˘â‚¬â„˘re in convergent strategies now but if markets move a lot we will move to divergent bets. They work well in catastrophic situations.
Quantitative methods are pervasive, they˘â‚¬â„˘re used everywhere. Some strategies like trend following are very difficult to do with a discretionary approach. But when markets change dramatically, quantitative systems are off. It˘â‚¬â„˘s a cycle.
Vassilis Vergotis, head of Eurex Offices- Americas, on trading trends. Eurex is an international derivatives exchange.
We think equity index trading will continue to grow. Fixed income trading volumes bottomed out in 2009, but given the macro implications for interest rates, we expect increased activity in fixed income.
Our internal technology is open to clients, so prop trading shops and hedge funds can integrate several risk parameters to customize their strategies. This information is important for risk management, especially in view of the concerns that high-frequency trading algorithms might bring down markets!
Trading of single-stock dividend futures started recently on Eurex and will likely attract significant investor interest. Through our ongoing cooperation with the European Energy Exchange, last year we started to offer our customers futures based on Phelix, the physical electricity index. These are EEX's benchmark and most actively traded products.
We plan to expand operations into Canada, where we hope to be able to distribute Eurex's full product suite including equity index options and single stock futures. We˘â‚¬â„˘re also closely monitoring the developments in Brazil in order to identify new opportunities.
Mark O˘â‚¬â„˘Friel, chief executive and founder of MOF Capital, a hedge fund focused on Asia, on reactions and limits to high-frequency methods. Before starting MOF Capital, he was with Steel Partners Japan GK as managing director and head of the Tokyo office.
High-frequency technologies are resisted by regulators and the public. Historically, trading gets faster as markets develop. The issue is how to educate people who don˘â‚¬â„˘t have the experience.
You have to ask, high-frequency compared to what? People always want to be faster than the next best trader. It is an arms race to be the quickest. The shorter the trade duration, the more the constraint on capacity. The longer the trade duration, the more capacity you have.
Irene Aldridge on algorithmic trading trends. She is managing partner and quantitative portfolio manager at ABLE Alpha Trading Ltd., a specialist in high-frequency systematic trading, and author of High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems, published by John Wiley & Sons.
Time horizons are shrinking in algorithmic trading, driven by technology. The current high speed of execution was not fathomable 20 years ago. There is a lot of opportunity. The reason high-frequency shops don˘â‚¬â„˘t take more money is that they have to find staff to put more money effectively to work.
Regulatory change in 2005 caused a big change in the way markets function. Before then, there had to be market makers. Now, anybody can make markets. If your bid-ask spread is better than other people˘â‚¬â„˘s, you are the market maker and your bid-ask is displayed on exchanges.
Scott Ignall on changing markets and technology. He is chief technology officer of Lightspeed Financial Inc., a provider of direct market access trading technology and brokerage services.
You need a fast service but it also has to be stable and reliable when markets are very active or there are large market moves. Trading goes on even when there are big financial events. In the 1987 crash market makers backed away, but in 2008 markets were extremely orderly. There are no market makers anymore. If regulators clamp down on trading, there will be insufficient bids and offers to sustain the market!
Steven Posner on statistical arbitrage. He is risk manager at Ikos, a quantitative hedge fund with around $1.7 billion in assets. Previously he worked in risk management at Morgan Stanley and as a derivatives quant at Goldman Sachs.
Our core business is the CTA but we also have a small statistical arbitrage program. There could be changes in statistical arbitrage. A new system and declining spreads now allow arbitrageurs to trade more names. Trend followers did poorly in 2009 but other systematic managers, including CTAs, did well.
Alexandre Guillaume on what market changes mean for strategies. He is senior portfolio manager of Sabre Adaptive Trading Fund, a quantitative futures program launched by Sabre Fund Management Ltd. in 2009.
Markets have stabilized, so it is more about relative value strategies than directional strategies now, at least in the short run. You can expect spikes, as in the Dubai and Greek debt crises. Our trend-following is self-hedged but we are reducing our exposure. A CTA does not have to be trend following. We trade spreads and like interest differentials.
One of the many insights presented by William Ziemba, professor of financial modeling and stochastic optimization emeritus at the University of British Columbia and visiting professor at the Mathematics Institute, Oxford University. He has been a futures and equity trader since 1983, as well as a money manager. Ziemba Investments is a multi-strategy firm.
Professor Ziemba has a large number of publications and says he is currently working on a book with Edward Thorp˘â‚¬â€ťfamed blackjack player, math professor, author and hedge fund manager.
I˘â‚¬â„˘ve studied the ˘â‚¬Ĺ“January effect˘â‚¬ť for years. The effect is that small-cap stocks outperform large-caps in January. From 1926 to 1995, almost every year the smallest stocks did the best. Now, the January effect still exists, but it is confined to December.
There was a huge difference between the Russell 2000 and the S&P 500 this December, but not in January. I got in by December 15th and got out before the end of the month. It was pretty good.
If January is a positive month (for stocks), that is a powerful signal that the rest of the year will look up. If January is negative, then the rest of the year tends to be noise, up or down 50/50. This year it was initially positive, then petered out.
Over-betting and not diversifying is key to all hedge fund disasters. Great
investors are more interested in not losing money than winning. You have to be
diversified in all scenarios.
Opalesque Futures Intelligence
Thursday, February 25, 2010
Insider Talk: What do managers, investors and brokers see happening in quant strategies and investing? A lineup of insights.