So what is going on with the quants? Goldman North American Equity Opportunities is forced to sell off assets. Rumors say it may close down entirely. Tykhe Capital hit with losses of about 20%. Unconfirmed rumors circulating about the demise of quant giants such as AQR. (Update: We’re hearing from very reliable sources that AQR is off 6% in primary market neutral fund down 9% in smaller stock selector fund just this month). Black Mesa Capital is telling investors that the liquidation of a big hedge fund or investment bank trading portfolio is totally ruining their financial models.
This morning the Wall Street Journal offered a somewhat unenlightening view that “Computers don’t always work.” (That’s a bit unfair but it’s not really a day for fairness.) One theory that some on Wall Street are subscribing to says that the trouble with quants began in the credit portfolios of a few large multi-strategy quantitative hedge funds. After the subprime meltdown and the troubles at two Bear Stearns hedge funds revealed that many formerly highly rated credit products could not be easily sold in the market at the values that had been assigned to them using financial models, hedge fund managers may have realized that they were facing significant losses in their credit portfolios.
To stem possible losses, the managers sought to scale back their leverage. But selling the illiquid credit products risks uncovering even deeper losses as the credit positions were marked-to-market instead of marked-to-model, so these managers likely de-levered by selling more liquid assets—namely, US stocks.
“As these managers unwound significant factor based portfolios, these factors started to behave in unexpected and potentially troubling ways. Short names started to rally and long names started to fall as these trades started to hit the market. As most quantitative managers use similar quantitative factors, this abnormal factor phenomenon was not confined to a few funds. Rather, a large number of quantitative managers have seen their models begin to behave in unexpected ways. Again, it is no longer only the multi-strategy managers, but now pure quantitative equity managers who have started to see their portfolios ‘misbehave,’ both U.S. domestic and global fund managers,” explains Lehman Brothers analyst Matthew Rothman in a memorandum published today.
The situation could get even more extreme, some fear. Recent sell-offs by two Goldman funds and others demonstrate that hedge fund managers are continuing to de-lever by selling off assets. This could have the effect of forcing further departures from the computer models of the hedge funds—additional “misbehavior” as Rothman scoldingly puts it. In addition, the funds may face new pressure to liquidate positions from redemptions and increased collateral requirements.
Some consider this scenario unlikely and unduly despairing. Rothman, for instance, says that there “are reasons for optimism here.”
But even when he wants to sound upbeat at the conclusion of his memorandum, Rothman ends up using a dark, almost creepy image.
“We like to believe in the rationality of human beings (and particularly quants) and place our faith in the strong forces and mutual incentives we all have for orderly functioning of the capital markets. As drivers of cars down dark roads at night, we learn to have faith that the driver approaching on the other side of the road, will not swerve into our lane to hit us. In fact, he is just as afraid of our swerving to hit him as we are of his swerving to hit us. We both exhale as we pass by each other headed into the night in our respective opposite directions, successfully avoiding both of our destructions,” Rothman writes. “We believe, and earnestly hope, that is how things are headed here, that is how events will play out – that stability will win, and that calm will soon prevail. The stakes are too high for all of us for anything else to be a realistic final resolution.”
All that hoping and believing is hardly the way we expect quants to sound. In fact, it sounds downright religious. Maybe what they say about the absence of atheists in foxholes is true after all.
CAXTON, AQR, TYKHE, DE SHAW, PALOMA, RENAISSANCE, CANTILLON, MAN, MILLENIUM, THALES, HIGHBRIDGE, ETC ETC
You can delever a portfolio in this way and that might help, but you’re still stuck with the dog sh*t b/c you can’t sell it. I suppose that’s better than closing the whole shop though (I could be wrong here).
said dog sh*t may still be levered as well
I seem to recall a phrase: Past performance is no assurance of future results.
Looking back, kinda seems like quant may just rely on past performance a little too much. “But its the best rear view mirror ever ever built. Ever.”
As much as I hate RenTec, I doubt that they’ve blown up. They’re probably up 20% YTD. Which makes me hate them even more.
Clearly this guy is not familiar with the prisoner’s dilemma…
Trading desk is like a car – trader is mashing the gas pedal trying to make it go faster; risk manager is pushing the brake trying to slow the thing down; the quant is looking out the back window shouting “turn left”
I guess this is yet another example of buisness fundamentals trumping statistical models. Particularly with regards to the common business sense in investing in these MBS and CDO issues and their underlying cash-flows. As LTCM proved, and many many other classic examples show, the line “past performance is no indication of future performance” shows that the longer the ship sails the closer it gets to being swallowed by the sea…
I stole this from a post at Calc. Risk
From Leh Bros”
Turbulent Times in Quant Land
Investment Conclusion
As market conditions have calmed, the performance of equity market neutral
managers has become more challenged. We believe performance of most factors,
particularly value factors, have turned perverse in a dramatic fashion. It is
unclear how long current situation will persist, but stability will be
facilitated by understanding that underperformance is systematic, not due to
individual model misspecification, in our view.
Summary
* July 2007 saw returns to quant factors increase dramatically, with
volatility at 2 to 3 times normal levels. In July, the misperformance of the
factors was driven primarily on the long side.
* Factor returns for the first 5 trading days in August have been roughly of
the same magnitude for what we experienced for all of July, however, now
model misbehavior has primarily been the results of shorts outperforming.
* Factor performance does not appear to have notable sector biases so we
discount the possibility of sector rotation being responsible for observed
dynamics.
Over the past few days, most quantitative fund managers have experienced
significant abnormal performance in their returns. It is not just that most
factors are not working but rather they are working in a perverse manner, in
our view. The names that are short are outperforming, often notably, while
the names that are long are underperforming, although less severely.
Moreover, there appears to be very little news coming out surrounding these
names and all of this is occurring against the backdrop of the general
markets appearing to calm down. This has led to our fielding a large number
of calls from our quantitative asset management clients, trying to understand
what is occurring in our market.
It is impossible to know for sure what was the catalyst for this situation.
In our opinion, the most reasonable scenario is that a few large multi-
strategy quantitative managers may have experienced significant losses in
their credit or fixed income portfolios. In an attempt to lower the risks in
their portfolios and being afraid to “mark to market” their illiquid credit
portfolios, these managers probably sought to raise cash and de-lever in the
most liquid market – the U.S. equity market.
As these managers unwound significant factor based portfolios, these factors
started to behave in unexpected and potentially troubling ways. Short names
started to rally and long names started to fall as these trades started to
hit the market. As most quantitative managers use similar quantitative
factors, this abnormal factor phenomenon was not confined to a few funds.
Rather, a large number of quantitative managers have seen their models begin
to behave in unexpected ways. Again, it is no longer only the multi-strategy
managers, but now pure quantitative equity managers who have started to see
their portf
This is hilarious. billion $ portfolios being traded by alleged genius acting like total newbie amatuers. Sell the winning positions to subsidize the losers, keep the loser with no stop loss strategy, blame the market for being “wrong” about the value of their assets, get stubborn and hold your position “until the market comes back in our favor”. or until the margin clowns liquidate this whole bloated herd to the slaughterhouse to which they are now stampeding. guess which one comes first.
fools. thanks for the laughs though.
As eric m. said uh prisoners dilemma anyone? Dont’ these PhD schmucks have to take at least one game theory class anymore?
also anon 4:58 great analogy to whats going on. Clearly history has not been as good a teacher as we’d like to think.
DONT SWERVE!
roger – I understand your point, but they have no other choice. If they can’t sell the crap, they have to sell the non-crap and pray to the Bloomberg to turn this thing around.
what about collussion (er cooperation)?
Kinda like the Apalachin Meeting just hopefully without the disasterous outcome.
Dummies’ guide:
(1) 22 year old builds spreadsheet for hedge fund.
(2) One input cell is “credit rating”
(3) Moddy’s designs defective credit product consisting of poo wrapped up in a nice shiny AA wrapper.
(4) Product unwrapped; poo revealed; model explodes.
(5) Many other “investment grade” products widely suspected of perhaps being poo also.
(6) Margins called; bids vanish; market stops.
eddy, I just changed my email sig to include your dummies guide info.
Best,
Dummy
(1) 22 year old builds spreadsheet for hedge fund.
(2) One input cell is “credit rating”
(3) Moddy’s designs defective credit product consisting of poo wrapped up in a nice shiny AA wrapper.
(4) Product unwrapped; poo revealed; model explodes.
(5) Many other “investment grade” products widely suspected of perhaps being poo also.
(6) Margins called; bids vanish; market stops
August 9, 2007
Dear Renaissance Investor,
Results in July were quite disappointing. Returns ranged between negative 4.0% and 4.5%,
bringing the year to date to profits averaging a bit over 1.0%.
Onshore LLC Offshore LP
July YTD July YTD
Series A -4.50% 0.61% -4.55% 0.19%
Series B – 3.96% 1.34% -4.00% 0.97%
Series C -4.40% 1.31% -4.45% 0.89%
Series D -4.38% 1.49% -4.43% 1.08%
Returns are for continuing investors.
While much of the damage was due to weak markets, our system experienced meaningful
relative losses during the first two weeks of the month. Thereafter these relative losses
decreased, but the markets proceeded to decline substantially. As I reported at our mid-
July investor meeting, the principal culprit was our Basic System, the platform upon which
almost all of our predictions are added. The predictions themselves performed adequately
during the month, but not sufficiently to overcome the down-draft in the Basic. As I
showed at that meeting, while the Basic System is a low volatility approach, which, over
time, should match the S&P and other indices, it does not track them, and excursions of this
size and larger (in either direction) may be expected to take place.
Research continues at a strong pace, with three very promising new signals in final stages
of release. Such continued work and our share of good luck should ultimately produce
attractive rewards.
Regrettably we have not had good luck during these last few days. We have been caught in
what appears to be a large wave of de-leveraging on the part of quantitative long/short
hedge funds. These undoubtedly share some signals in common with our own, and the
result has been losses for RIEF of the order of 7% at the time of this writing. Many
investors have called to see how we are faring, and after the close today we will send an
e-mail to all with an update and additional color on the situation.
Sincerely,
Jim Simons
Dear Investor,
Further to our earlier email, here is a communication from Jim Simons to all our clients regarding our recent performance. Please do not hesitate to call Mark or Sebastian with any questions and/or comments.
___________
Dear Renaissance Investor,
As promised in my July letter, posted today on the RIEF website, I want to share some thoughts on August-to-date performance in order to provide perspective on a most unusual period.
RIEF results through July 31 were below expectations, but not extraordinarily so. I’ve previously stated that the low volatility Basic System, to which our predictions are added, was not in sync with the market during much of this period. Nonetheless, we remain confident that over time the Basic System will match the return of the S&P and, enhanced by our predictive signals, should exceed it. Since we do not attempt to track this or any other index there will be periods of positive and negative relative returns.
August (down 8.7% through today) is a different story. The culprit is not the Basic System but our predictive overlay. While we believe we have an excellent set of predictive signals, some of these are undoubtedly shared by a number of long/short hedge funds. For one reason or another many of these funds have not been doing well, and certain factors have caused them to liquidate positions. In addition to poor performance these factors may include losses in credit securities, excessive risk, margin calls and others. All of this may not influence the direction of the overall market, but it may certainly alter the relationships of stocks to each other in a dramatic way. Given the undoubted partial overlap of our portfolios, these liquidations have had a negative impact on RIEF.
Other examples of such liquidations are the meltdown of risk arbitrage positions in the October 1987 crash, the forced liquidation of junk bonds around 1990 and the collapse of European bonds in 1994. Some of these were in the midst of a bear market, some not.
Such events tend to occur extremely infrequently. We cannot predict the duration of the current environment, but usually such behavior causes first pain and then opportunity. While we may hedge out some market risk, our basic plan is to stay the course and, as conditions revert to the norm, we anticipate the possibility of an attractive opportunity for RIEF. Our firm remains strong, and although Medallion has experienced some losses in August, it is solidly profitable year-to-date.
We are confident in our approach, and we urge you to contact our staff should you have any questions.
Sincerely,
Jim Simons
Anon4:58 great i wish i could make that my green bar
I think I remember seeing that same email from LTCM…
any time paloma starts selling it’s time to buy.
Funny how often six sigma events occur. I guess it’s time for more back-testing and monte carlo simulations to tweak the models.
Ha ha, anyone can be a hedge fund manager these days. Shit, Joe Jett has one. I guess taking remedial history isn’t required at the Sacred Heart School for Bizniss Learnins, which explains why nobody saw this coming except for some of us internet blowhards.
Crash and burn, bitches, the fund where I work is raking it in on your backs – and don’t forget to join the New York Real Estate Fire Sale next year after you get fired and have to move back to Boise! Schwing!
anybody out there willing to post a memo written by matthew Rothman about recent quant fund failure? many cite it, but I’d like to read the entire anaysis. thanks in advance.
parker…go back to lehman story and its there at the bottom.