6 ms·

Shrinking ‘Quant’ Funds Struggle to Revive Boom

24 points by nsoonhui 16y ago

akshayubhat 16y ago
does the analysis also includes HFT traders? Also I remember hearing that Goldman Sachs didn't have a single day of trading loss. Maybe the smaller Quant funds are loosing out on talent to the bigger firms?
- jakarta 16y ago
  Just look at the Goldman Sachs Alpha Fund as an example of a quant fund with a big firm that had terrible performance. To clarify: the size of the fund is not necessarily an indicator of whether it will be successful or not.
  - akshayubhat 16y ago
    interesting http://www.forbes.com/2007/08/09/goldman-sachs-alpha-markets-equity-cx_er_0809markets07.html http://www.forbes.com/2007/08/09/goldman-sachs-alpha-markets... says that the fund failed in ~ 2007, while this article talks latest debacles. Thanks for the reference.
- akshayubhat 16y ago
  on an unrelated note: I monitor visitors to my online resume and I just got an email saying someone from GS.com visited my resume. I guess there is an GS developer amongst us, may be he can elaborate.
- retube 16y ago
  As a former trader, I can assure you that's bollox. No desk trading anything has never had a losing day.
  - smanek 16y ago
    An individual desk might not, but it's not that unlikely for the firm as a whole to.
    - retube 16y ago
      No, it's not. GS take big risk, they run large exposures as a bank. They'll have their down days.
- ezl 16y ago
  You are referring to Q1 2010, GS had 3 months without a single day of trading losses. During the same period, JPM, C, and BAC also had a perfect quarter (1). While its true that HFT groups tend to have great win/loss records (2), those "trading profits" basically have nothing to do with the banks' HFT groups. The banks basically all had very big carry trades on -- they were borrowing at short term rates from the fed and lending at higher rates to others and collecting the spread. Since the Fed was desperate to pump money into the system, they allow banks to borrow cheaply and essentially guaranteed the carry trade for the short term. That sort of trade tends to be highly stable in static rate environments and you get very smooth return profiles. Since they knew the Fed was essentially backing the trade, they piled onto the trade and that particular component of the firms' total daily P&L just dwarfs the rest of their "real" prop trading operation P&L. Of course, it won't last forever. Its the sort of trade that works until it doesn't -- Long Term Capital Management basically had super levered carry trades on which gave them a really high sharpe ratio until things got choppy and they blew out. 1: http://www.businessweek.com/news/2010-05-11/-perfect-quarter-at-four-u-s-banks-shows-fed-fueled-revival.html http://www.businessweek.com/news/2010-05-11/-perfect-quarter... 2: Tradeworx claims to have not had a down day in 4 years, reference http://dealbook.blogs.nytimes.com/2010/05/17/speedy-new-traders-make-waves-far-from-wall-st/ http://dealbook.blogs.nytimes.com/2010/05/17/speedy-new-trad...
BenoitEssiambre 16y ago
There is kind of an odd tone to this article as if the shrinking of the quant economy is a tragedy when in fact it should be the natural course of this sector if it is not too corrupted. The efficient market hypothesis and information theory tells us that using probabilistic models to extract a competitive advantage can only give good returns when your method is better than all of your competitors'. When two firms have similarly optimized tactics, they bet against each other and the margin of money than can be skimmed off their betting market will shrink to almost nothing. I don't mean that the profits will be split between the two. I mean the bidding war will push the price towards its optimal value where no money can be extracted. In a competitive quant market, as all the firms perfect their mathematical models, they should all move asymptotically towards the best probabilistic model possible given the available information and eventually erase each other's gains. The boom in computing technology of the past thirty years was an immense opportunity for mathematicians to make money by racing to perfect their models before others. However, as this industry matures it should eventually take only a few very good systems to extract a thin margin that will barely cover the cost of running the systems themselves. Moving towards that point of efficiency is a capitalist and libertarian victory that people (at least those who believe in capitalism) should celebrate. The conclusion is a market so efficient that little money can be extracted by betting in it. That means money going to the real economy instead of the wall street casino and more value for everyone. The fact that the sector is shrinking indicates the free market is actually working. I don't believe in the free market everywhere but I think when it actually works well and create value we should be glad, not lament the loss of the casino profits. This allegory illustrates the efficient market hypothesis nicely: http://agoraphilia.blogspot.com/2005/03/doing-lines.html http://agoraphilia.blogspot.com/2005/03/doing-lines.html
- joshu 16y ago
  Yes. There's been a huge hedge fund boom for years, and it'd been buoyed by the rising market. (a proper hedge fund ought to be uncorrelated to the market, else it would be cheaper to go long the market more directly. But I digress) This is the natural evolution of an underperforming asset class.
  - 16y ago
quanticle 16y ago
From the article: "Still others say their models simply failed to predict how the markets would react to near-catastrophic, once-in-a-lifetime financial events like the credit crisis and the collapse of Lehman Brothers." The fact that they still believe those events were "catastrophic," or "once-in-a-lifetime" means they still haven't grasped the fact that markets aren't Gaussian. As first Mandelbrot, then others showed, financial markets exhibit a much larger number of extreme events than a standard Gaussian distribution. Therefore, any trader that doesn't update his or her models to use a non-Gaussian model won't just be wiped out once. They'll be wiped out again and again as they get blindsided by the "once-in-a-lifetime" price swings that happen to happen every decade or so.
- SkyMarshal 16y ago
  Indeed. For anyone that hasn't read it yet, Taleb's Edge essay on the nature of randomness in 'Fourth Quadrant' domains is a good read: http://www.edge.org/3rd_culture/taleb08/taleb08_index.html http://www.edge.org/3rd_culture/taleb08/taleb08_index.html And a more technical discussion of Mandelbrotian market models from Wilmott magazine: http://arxiv.org/abs/cond-mat/0501292 http://arxiv.org/abs/cond-mat/0501292

24 points by nsoonhui 16y ago

does the analysis also includes HFT traders? Also I remember hearing that Goldman Sachs didn't have a single day of trading loss. Maybe the smaller Quant funds are loosing out on talent to the bigger firms?

jakarta 16y ago
Just look at the Goldman Sachs Alpha Fund as an example of a quant fund with a big firm that had terrible performance. To clarify: the size of the fund is not necessarily an indicator of whether it will be successful or not.
- akshayubhat 16y ago
  interesting http://www.forbes.com/2007/08/09/goldman-sachs-alpha-markets-equity-cx_er_0809markets07.html http://www.forbes.com/2007/08/09/goldman-sachs-alpha-markets... says that the fund failed in ~ 2007, while this article talks latest debacles. Thanks for the reference.
akshayubhat 16y ago
on an unrelated note: I monitor visitors to my online resume and I just got an email saying someone from GS.com visited my resume. I guess there is an GS developer amongst us, may be he can elaborate.
retube 16y ago
As a former trader, I can assure you that's bollox. No desk trading anything has never had a losing day.
- smanek 16y ago
  An individual desk might not, but it's not that unlikely for the firm as a whole to.
  - retube 16y ago
    No, it's not. GS take big risk, they run large exposures as a bank. They'll have their down days.
ezl 16y ago
You are referring to Q1 2010, GS had 3 months without a single day of trading losses. During the same period, JPM, C, and BAC also had a perfect quarter (1). While its true that HFT groups tend to have great win/loss records (2), those "trading profits" basically have nothing to do with the banks' HFT groups. The banks basically all had very big carry trades on -- they were borrowing at short term rates from the fed and lending at higher rates to others and collecting the spread. Since the Fed was desperate to pump money into the system, they allow banks to borrow cheaply and essentially guaranteed the carry trade for the short term. That sort of trade tends to be highly stable in static rate environments and you get very smooth return profiles. Since they knew the Fed was essentially backing the trade, they piled onto the trade and that particular component of the firms' total daily P&L just dwarfs the rest of their "real" prop trading operation P&L. Of course, it won't last forever. Its the sort of trade that works until it doesn't -- Long Term Capital Management basically had super levered carry trades on which gave them a really high sharpe ratio until things got choppy and they blew out. 1: http://www.businessweek.com/news/2010-05-11/-perfect-quarter-at-four-u-s-banks-shows-fed-fueled-revival.html http://www.businessweek.com/news/2010-05-11/-perfect-quarter... 2: Tradeworx claims to have not had a down day in 4 years, reference http://dealbook.blogs.nytimes.com/2010/05/17/speedy-new-traders-make-waves-far-from-wall-st/ http://dealbook.blogs.nytimes.com/2010/05/17/speedy-new-trad...

BenoitEssiambre 16y ago

There is kind of an odd tone to this article as if the shrinking of the quant economy is a tragedy when in fact it should be the natural course of this sector if it is not too corrupted. The efficient market hypothesis and information theory tells us that using probabilistic models to extract a competitive advantage can only give good returns when your method is better than all of your competitors'. When two firms have similarly optimized tactics, they bet against each other and the margin of money than can be skimmed off their betting market will shrink to almost nothing. I don't mean that the profits will be split between the two. I mean the bidding war will push the price towards its optimal value where no money can be extracted. In a competitive quant market, as all the firms perfect their mathematical models, they should all move asymptotically towards the best probabilistic model possible given the available information and eventually erase each other's gains. The boom in computing technology of the past thirty years was an immense opportunity for mathematicians to make money by racing to perfect their models before others. However, as this industry matures it should eventually take only a few very good systems to extract a thin margin that will barely cover the cost of running the systems themselves. Moving towards that point of efficiency is a capitalist and libertarian victory that people (at least those who believe in capitalism) should celebrate. The conclusion is a market so efficient that little money can be extracted by betting in it. That means money going to the real economy instead of the wall street casino and more value for everyone. The fact that the sector is shrinking indicates the free market is actually working. I don't believe in the free market everywhere but I think when it actually works well and create value we should be glad, not lament the loss of the casino profits. This allegory illustrates the efficient market hypothesis nicely: http://agoraphilia.blogspot.com/2005/03/doing-lines.html http://agoraphilia.blogspot.com/2005/03/doing-lines.html

joshu 16y ago
Yes. There's been a huge hedge fund boom for years, and it'd been buoyed by the rising market. (a proper hedge fund ought to be uncorrelated to the market, else it would be cheaper to go long the market more directly. But I digress) This is the natural evolution of an underperforming asset class.
- 16y ago

quanticle 16y ago

From the article: "Still others say their models simply failed to predict how the markets would react to near-catastrophic, once-in-a-lifetime financial events like the credit crisis and the collapse of Lehman Brothers." The fact that they still believe those events were "catastrophic," or "once-in-a-lifetime" means they still haven't grasped the fact that markets aren't Gaussian. As first Mandelbrot, then others showed, financial markets exhibit a much larger number of extreme events than a standard Gaussian distribution. Therefore, any trader that doesn't update his or her models to use a non-Gaussian model won't just be wiped out once. They'll be wiped out again and again as they get blindsided by the "once-in-a-lifetime" price swings that happen to happen every decade or so.

SkyMarshal 16y ago
Indeed. For anyone that hasn't read it yet, Taleb's Edge essay on the nature of randomness in 'Fourth Quadrant' domains is a good read: http://www.edge.org/3rd_culture/taleb08/taleb08_index.html http://www.edge.org/3rd_culture/taleb08/taleb08_index.html And a more technical discussion of Mandelbrotian market models from Wilmott magazine: http://arxiv.org/abs/cond-mat/0501292 http://arxiv.org/abs/cond-mat/0501292