Quantocide

It allegedly won’t be announcing any multi-billion writedowns this quarter but Goldman Sachs’s Global Alpha is probably going to lose about $6 billion in assets this year and that’s got to count for something. The 60 percent decline (from an ’07 start of $10 billion) is the result of a confluence of factors including some trades that were meant to come off as ironic (investors asking for their $2billion and counting back apparently didn’t get the joke) and the weather. The good news is that no matter how much money the fund loses, pride in the face of mounting failure–GA lost 9 percent last year–will prevent it from being shuttered. “Goldman as a firm would like not to have the reputation of shutting things down,” Geoffrey Bobroff, an independent investment consultant told Bloomberg. “Smaller isn’t necessarily bad.” Anyone have the letter Mark Carhart and Raymond Iwanowski sent to investors using this “Global Alpha voluntarily lost money because we decided it was getting too big too manage” logic? Send it here.
Goldman’s Global Alpha May End 2007 With Assets Down $6 Billion [Bloomberg]

The Revenge of Quantocide?

Last week unusual movements in the stock markets—with some widely shorted stocks rising even as the broader markets plummeted—had many wondering if we were witnessing a repeat of the events of late July. This afternoon, Dane Hamilton of Reuters hands in his contribution to the rumor mill. “In addition, some traders say they have recently picked up signals that there may be a multibillion dollar market-neutral fund that is conducting an orderly liquidation, raising concerns that such an event may prompt others to do the same and hammer the market,” Hamilton writes.
The game of Who Dun It has already begun. AQR was an early favorite but other names are being bandied about as well. DE Shaw is another popular candidate.
DE Shaw’s hard drive did not return requests for comments.
Hedge fund AQR denies big trading setbacks [Reuters]

Quants on Fire: The Anatomy of Bloodbath

We’re not going to say that we totally let our subscription to MIT Technology Review lapse. But if we had, we’d totally be signing up to renew it now. The latest issue carries a story that gives one of the most “my grandmother would understand this” friendly accounts of the August quant bloodbath.
The basic driver of the story is the Rothman theory. It doesn’t name names or pin the tail on the fund whose unwinding equity positions sparked the bloodbath—hey, why don’t we know who this was yet?—but it does set out how young men armed with computers managed to bring the markets to their knees this summer.
The Blow-Up [MIT Tech Review via Paul Kedrosky]

Simulating The Quant Bloodbath

Hedge Funds Quants.jpgA pair of academics at MIT have published a paper that seems to confirm the Rothman Theory of this summer’s Quant Bloodbath. The Rothman Theory—named for Lehman Brothers analyst Matthew Rothman who laid it out in a note published in the midst of the blood bath—held that the initial quant fund losses were triggered a large hedge fund unwinding one or more market-neutral portfolios.
Now Amir E. Khandani and Andrew W. Lo have used financial models to simulate this summer’s bloodbath, and what they found largely confirms the Rothman Theory.
The findings are likely to be welcomed by the quants, who are still smarting from what they think was biased reporting about their troubles this summer. Their findings suggest that the quantitative nature of the losing hedge funds was incidental, and the main driver of the losses in August 2007 was the firesale liquidation of similar portfolios that happened to be quantitatively constructed. That firesale was likely set-off by a hedge fund facing margin calls or seeking to pre-emptively reduce risk after its credit portfolio was hit by this summer’s collateral and credit crunch.
You can see why this is appealing to the quants. The math magic still works! It’s was just those 25-standard deviation moves triggered by subprime. How were the funds supposed to know they were all following the same strategy? This is why the Rothman Theory was so popular with quants to begin with.
But the quants might not like the conclusions the egg-heads draw. Their findings also suggest that hedge funds may have grown more dangerous since the demise of Long-Term Capital Management in 1998, according to Portfolio magazine’s Odd Numbers blog. Part of the problem is that long-short equity hedge fund returns are increasingly correlated. What’s more, the finding that the source of this summer’s long-short bloodbath seems to lie in a completely unrelated set of markets and instruments—the credit market—suggests that systemic risk in the hedge-fund industry may have increased in recent years.

Hedge funds are becoming more like banks, and the reason that the banking industry is so highly regulated is precisely because of the enormous social externalities banks generate when they succeed, and when they fail. Unlike banks, hedge funds can decide to withdraw liquidity at a moment’s notice, and while this may be acceptable if it occurs rarely and randomly, a coordinated withdrawal of liquidity among an entire sector of hedge funds could have disastrous consequences for the viability of the financial system if it occurs at the wrong time and in the wrong sector.

What Happened to the Quants in August 2007? [SSRN; link downloads pdf file]
Doomsday Clock for Hedge Funds Is Ticking [Portfolio.com]

D.E. Shaw’s Losses No Longer On The D.L.

rumours 1.JPG Amidst the quantocide on the Street, some well-respected news outlets were reporting that D.E. Shaw was reaping losses of up to 20% on some of its funds.
The real losses, according to one D.E. Shaw investor:
DE Shaw composite down 7%
DE Shaw occulus down 3%
Notable, but hardly terminal.