It’s no surprise that the quants are a strange bunch. Last year, when their strategies cascaded to recorded losses, they blamed the markets for misbehavior. Now it seems a hedge fund looking for someone with quant skills has placed a particularly strange ad on Craigslist.
We’re hearing that a Boston based quant fund has been liquidating its positions today, perhaps concerned about margin calls from its brokers. So far, we haven’t been able to track down a name. J W Henry & Co are the only quants in Boston who come to mind but they haven’t returned our calls yet. And it hardly seems fair to tag them as liquidating positions just because they are the only folks who came to mind. Then again, four out of five of their “programs” had losses, last year. Two had double digit losses.
Update: Probably not JWH. Assets under management down below $300 million so probably not enough to move the markets. And we’re told that they’ve had a gangbuster January. (Although JWH still hasn’t returned our phone calls. Not cool at all.)
But new clues have emerged. DealBreaker is told that State Street prime brokerage services the fund. Numeric, which is based somewhere near MIT, has emerged as a favorite contender among the rumor mongers.
We’ve noted more than once around here that November’s market volatility was likely to have hit quant funds particularly hard, although there’s no evidence that it caused the kind of cascading losses and sell-offs we saw this summer.
More evidence for this call comes this morning from the New York Post’s Roddy Boyd, who reports that AQR Capital Management’s$4 billion AQR Absolute Return fund dropped an additional 5.8 percent in November after a 3.17 percent loss in October.
November was a rough month for most fund strategies, although several are said to have recovered from steep losses early in the month thanks to the post-Thanksgiving market rally.
AQR’s Quant Loses Muster [New York Post]
Just because the markets rallied yesterday doesn’t mean we’re letting go of the sell-off of the previous week. Sure the Dow was up 319 points. But that’s still less than half of what it lost in the previous four sessions. The skeptics of our theory of a quant sell-off last week persist in the view that the coordinated movements across many markets was simply the aggregate results of many independent decisions by investors, and not a cascading quant fund effect along the lines of what we saw this past summer. The quants have wised up, they insist. They have new strategies, and aren’t all following the same path like so many ducks in a row.
We suppose there’s some sense the theory that the humans running quant funds and the super-powered computers they work for are smart enough to have adjusted their portfolios–and to have done so in ways different enough to not leave them vulnerable to another cascade. But last week’s sudden fall in tech stocks, mixed with a sell off in the broader US equities market and a dash of upside in widely shorted stocks certainly raised eyebrows.
And it wasn’t just US stocks. Monday saw a saw sharp reversals for gold and oil, and emerging markets declined. The yen is still rallying. So what is going on? John Authers of the Financial Times thinks the quant cascade theory gets it right. It’s far more likely that the similar move in so many unrelated markets were caused by shifts in the trading books of quant funds, he says.
But don’t take our word for it. Watch his Financial Times video segment here. (Hmm. Second video link of the day. Seems to be a trend. Maybe we should go for three videos to start off the morning.)
Reversal In Market [Financial Times video]
Two days ago, we told you the there were widespread rumors that a large quant fund—possibly AQR Capital Management—might have run into some liquidity problems. Yesterday the post reported that the Greenwich-based hedge fund had scrapped its planned initial public offering after a dismal performance caused several large investors to pull their cash out of the fund. AQR hasn’t returned our calls. Time to move this story ahead despite the, uhm, lack of actual information.
Watching the markets move in the last few days—particularly with the heavy sell off in the NASDAQ—has many wondering if we’re witnessing yet another quant liquidation like we saw in late July and early August. It would make sense that if one or more funds was facing redemption notices from investors, we might see a sell-off of typical quant positions in order to raise cash. Last time around, stocks the quant funds tended to be long in plummeted, while their shorts rose. It is now part of the conventional wisdom that some of this was due to one or more quant funds liquidating both long and short positions.
So how are the heavily shorted stocks doing? Pretty good, as it turns out. Unless you are short them. Indymac BNCP, Nutrisystem, MGIC Investment CP, KB Home, MVRLP, Ryland Group, and CROCS Inc. are all up today despite the declines in the broader market. The Amex Broker Dealer index is up nearly 1.5%. With this many heavily shorted stocks rising together, it’s at least possible that some of the movement in the markets this week has been due to another quant liquidation.
Morgan Stanley’s quantitative strategies group, which lost $480 million during the quarter ended August 31, disclosed in a regulatory filing today that out of its 14 losing days, on its best one, $390 million was misplaced. The securities firm said that it was “caught off guard” by “widespread” investor selling, which their models had not been designed to account for.
Morgan Stanley Traders Lost $390 Million in One Day in August [Bloomberg]
A 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.
Can the quants fix their problems? After last week’s quant bloodbath, this is a question that hedge fund investors and the quant fund managers have been asking. But one popular solution—reducing the risks from too many quant funds following the same factors by bringing in new factors—may create even more problems for at least some of the funds.
In one sense, the solution is obvious: if the problem is too many ducks in row, the solution is to have the ducks take different paths. But do all paths lead to profit? Can the ducks even find new paths?
But let’s back up for a minute and take a look at how we got here. More after the jump.