Paul Kedrosky writes:
Paul Kedrosky: Further Misadventures in Quant Land: Bad for the Grass: I'm hearing from a few sources out in quant funds that troubles are building again. After August's misadventures when quant funds lost upwards of 8 percentage points in some cases, things settled down for a while in September, and even bounced back to flat in many cases. Now, however, the bleeding has apparently begun again. More than a few quant funds are seeing a steady 10 basis point loss on an almost daily basis, and that is happening across all quant strategies....
The culprit? No-one knows for sure, but a reasonable guess is that a host of smaller recent arrivals to the business, and some incumbents, are being forced to steadily unlever their portfolios. Where many of these funds had ratcheted things up to high levels of leverage to deliver results in the increasingly crowded quant long-short neutral market (see the following figure), that leverage is now being dialed back. The inevitable result: Falling prices on long bets, and increasing prices on shorts -- both of which are bad for the grass (to borrow from Chinatown).
This may or may not be true. But unless there is macroeconomic consequence--unless something happens to change the value of the underlying and thus the cash flows coming into the financial sector or the interest rate--these forced or semi-forced liquidity sales are a zero-sum game. Somebody is making the money that the deleveragers are losing, either in the likely value of their positions going forward or even in profits they can book. They are just not talking about.
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