From www.hedgeworld.com - login required [...]No market has been isolated and Mr. Rothman said that the credit crisis has had an effect on the models because it dried up liquidity. The starting point, he said, was most likely that some large quant managers experienced losses in their credit or fixed-income portfolios. In an attempt to de-lever their illiquid credit funds, or to avoid having to mark those portfolios to market, those managers sought to raise cash, he said. They may have sold long positions that they would have held longer in normal times. In addition, these quant managers may have covered their short bets by buying those securities in an attempt to exit those positions. "Short names started to rally and long names started to fall as these trades started to hit the market," Mr. Rothman wrote. As most quant managers use similar models, those trades were not confined to a few funds. As a result, he wrote, models are working in a "perverse manner. . . . The names that are short are outperforming often notably while the names that are long are underperforming, although less severely." Speaking on a conference call, Mr. Rothman said that the performance of quantitative strategies improved on Friday, and reversed around 70% of the losses from the first four days of last week, Reuters reported. But he said that the market will continue to be volatile and that models need to be adjusted as a result. [...] Based on a study of $204 billion worth of long stock positions owned by quantitative-driven hedge funds, Mr. Kostin ( Goldman Sachs ) determined that lack of liquidity was an important factor behind underperformance of these funds. In fact, illiquidity of a given stock was more of a determinant of poor performance than either volatility or equity capitalization, he wrote. He measured liquidity as an aggregate quant fund's ownership of a stock divided by its average daily volume. The difficulty in selling shares in the current market drove the bad performance during the July 19-Aug. 8 period studied by Mr. Kostin in his research. Within quant funds, stock positions with the least liquidity underperformed positions with the most liquidity by a significant amount, he noted. In terms of performance numbers, Mr. Kostin found that based on his stock sample, the least liquid stocks posted a 9.2% loss from July 19 to Aug. 8, while the losses for the most liquid positions were limited to 3.6%.[...] In a research noted titled "A Challenging Environment for Quant Strategies," Keith Miller, head of global quantitative research at Citigroup, pointed to correlation as a factor driving bad performance. Quant models are built based on several factors or variables. Lately, correlation among those factors, such as valuation, price reversal, earnings momentum and profitability, has been on the rise, Mr. Miller wrote, which is problematic because higher correlation leads to more risk.
This crisis shows that quants funds are not so good especially in market conditions where they should be compared to human managed funds...
ASusilovic, The explanation for the sequence of events looks elementary, raise cash. Makes sense to me. If this is the case then shortly this crisis should be over, there is a bottom in sight and the cycle should begin again and the market should go up and everyone (maybe not as many players) should re-enter the market. There shouldn't be hesitancy about returning because the crisis is not with equities but with the hedge funds models. Comments?
I agree. It´s all about accomodation...Personally, I have NO doubt that QUANT models work...but maybe by scaling back leverage they would be working much more "reliable"...
the problem with most quant funds, is that to get returns that are reasonable in this environment you have to use leverage, and its all ok except once every 10 years where an event happens and the fund blows up. They can use less leverage while they trade and give up substantial gains during the rest of the years and not blow up, but then is the return high enough to bring in investors. Simply put, since its about fees (2/20) strategies that blow up every once in awhile are preferable to those that survive and have inferior returns. Ie: everything else being the same fund 1 shows historical performance of 15% fund 2 shows historical performance of 10% Most investors are going to go with #1 even tho #1 will blow up once every 10-20 years (lose everything). (assuming everything else is equal) Because many are using shared strategies, they are taking away the edges, which decreases return, which in turn requires more leverage to exceed normal S&P returns. So its not accident it ended up this way The solution, of course, is uncorrelated and unique strategies.
"The solution, of course, is uncorrelated and unique strategies." If they all go to the same schools, drink at the same places, compete in the same sports. Thier characteristics and backgrounds are all the same. They dress the same, want the same things. Not likely you'll end up a maverick.
One does not have to forget that the funds we are talking of have already proved their edge - they performed consistently well, at least one can argue with Simon´s RENTEC this way...but what they are telling us is that this kind of "blow up" scenario happened three days in a row last week - I mean the "statistical ouliers"...
Its laughable to think that all of these guys could be in the same trade and no one is expecting to lose. For someone to win, someone has to lose. Quants live in a bubble... while these strategies look great on paper, you have to realize that the simpliest of economic factors, supply and demand, still rule the day. Get your head out of the book, eggheads and really take a look at whats going on. P.S. the fed shouldn't bail these clowns out, they should have to take their losses like anyone else. Make them sell their commodity positions so that John Q Public no longer has to pay $3/gallon for gas to subsidize some quants hamptons home.