Blind to Trend, 'Quant' Funds Pay Heavy Price

Discussion in 'Wall St. News' started by CPTrader, Aug 8, 2007.

  1. I am curious as to people's thoughts on this:


    Blind to Trend,
    'Quant' Funds
    Pay Heavy Price
    Computer Models Failed
    To See Risk Increasing;
    Global Alpha Off 16%
    August 9, 2007

    Computers don't always work.

    That was the lesson so far this month for many so-called quant hedge funds, whose trading is dictated by complex computer programs.

    The markets' volatility of the past few weeks has taken a toll on many widely known funds for sophisticated investors, notably a once-highflying hedge fund at Wall Street's Goldman Sachs Group Inc.

    Global Alpha, Goldman's widely known internal hedge fund, is now down about 16% for the year after a choppy July, when its performance fell about 8%, according to people briefed on the matter. The fund, based in New York, manages about $9 billion.

    The fund's traders in recent days have been selling certain risky positions, according to these people. Early this week, those moves sparked widespread rumors on Wall Street that the entire fund might be shut down. A Goldman spokesman has said the rumors are "categorically untrue."

    Campbell & Co., an $11 billion hedge fund that trades in the futures market as well as in stocks and bonds and is completely driven by such computer programs, was down 10% to 12% by the end of July.

    Quant funds -- "quant" stands for quantitative -- generally operate by building computer models of market behavior and then allowing the computer programs to dictate trading. A recurring characteristic of the recent trouble in financial markets is that many lenders, funds and brokerages were following statistical models that grossly underestimated how risky the market environment had become.

    "Our risk models failed to pick up the fact that we were due for a correction," says Keith Campbell, founder of Campbell & Co. "We were highly diversified. It was the perfect negative storm."

    Campbell's losses occurred because of wrong bets on interest rates, currencies and stocks. While Mr. Campbell declined to disclose just how much leverage was behind his trades, he says Campbell isn't "a highly levered house."

    He told investors that the losses stemmed from "a unique combination" of factors. These included the unwinding of the world-wide carry trade -- where investors borrow money in low-interest-rate currencies to invest in higher-yielding assets -- an investor flight toward less-risky investments and the stock market's reversal.

    Mr. Campbell called the recent market turmoil "very unusual." Critics say that is one of the drawbacks of the investing style. Much of the time, the market can be accurately modeled by computer programs. The times when they don't work are treacherous.

    "All [computer-driven] managers say the models make sense and look like they are working," says Bill Johnston, founder of Bayon Capital, an investment fund based in San Francisco that isn't computer-driven. "But then something happens which statistical probability suggests would never happen."

    Rumors of forced selling in the wake of losses contributed to the volatile ride in the stock market yesterday.

    Not all quantitative funds are struggling. Renaissance Technologies Corp., the most successful quantitative-hedge-fund manager, is holding up despite the market's downturn. Renaissance's flagship Medallion hedge fund is up about 25% so far this year, while the firm's Renaissance Institutional Equities Fund is down slightly, according to a person close to the firm. Medallion made money in July, though it hasn't fared as well so far in August, the person said. The Institutional fund lost about 3% in July, in line with the overall market.

    Other hedge funds declined to disclose to brokers or portfolio managers in charge of so-called funds of hedge funds just how badly wounded they have been by the recent extreme swings.

    In most cases, their losses had nothing to do with the meltdown in the subprime-mortgage market and occurred across all strategies. Moreover, in many cases, those losses were magnified by the use of borrowed money.

    Yesterday, many fund managers were watching for additional knock-on effects of recent losses, which have forced funds like Global Alpha to liquidate certain risky positions. Some think the pain will next be felt overseas, in places such as the United Kingdom and Japan, where asset managers are also likely to begin offloading riskier bets.

    The reliance on models can be especially problematic because many quant hedge funds have very similar models. That means they are often doing the same trades and buying the same shares. Moreover, because the strategies are supposed to be market-neutral, with no net positive or negative bent, the funds often borrow large sums so they can bet more and achieve better returns when things go their way.

    That massive borrowing adds to the pressure when markets reverse course several times in the course of a single day, as the stock market has done repeatedly in recent weeks, or when tried-and-true relationships between different markets suddenly break down.

    --Gregory Zuckerman contributed to this article.

    Write to Henny Sender at henny.sender@wsj.com1 and Kate Kelly at kate.kelly@wsj.com2
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  2. una11


    Perfect Example:


    A "market neutral" mutual fund from JP Morgan they developed after buying Highbridge - take a look at the chart ... :eek:
  3. In part QUANTS are responsible for the market turmoil in last weeks ! I remember several CENTRAL BANKERS warning about "HERD-LIKE MENTALITY" in markets - even thoogh they refered the comments to the developments in credit markets !!

    => ECB Warns of `Herd-Like' Mentality in Derivatives

    QUANTS => meh, meh, meh !! :D :D :D
  4. same chart for all these funds.

    statistically these things should only happen once in a thousand years and then three years down the road their model does not predict that move.

    oh shock.
  5. The ironic part is... Many quant managers were complaining about the lack of market volatility and how their models perform much better when we have more pronounced price swings.

    Shouldn't they love the current environment? :D
  6. I adore VOLA !!! :D :D :D
  7. These quant funds/algo models/automated nuisances are finally getting caught out.Couldn't have happened to a nicer bunch of vultures.All they've tried to do is cheat using technology and huge backing,now the backing is either being lost or pulled.The shame is that they've taken a lot of people out with them too.
  8. dont


    Much easier to sell puts on the index and then blow up.

    Its always the "Perfect Storm" ect etc do me a favour.
  9. dtan1e


    i thought Keith Campbell is a trend follower, since when he become a quant stats arb?
  10. "Campbell's losses occurred because of wrong bets on interest rates, currencies and stocks."

    Wrong bets? Get thee to a casino.
    #10     Aug 9, 2007