Rick Bookstaber: What’s Going On with the Quant Hedge Funds?

Rick Bookstaber:

Rick Bookstaber: What’s Going On with the Quant Hedge Funds?: There are a host of very large and well-managed quantitative equity funds that are up against the ropes, all seeing big losses at the same time. And these are market neutral funds that spend a lot of time and resources monitoring risk and systematic exposure.... Yet they are all getting hammered. Why is this happening?

If I were to venture a guess.... [Q]uantitative funds are highly levered... they have strategies in common... share a common lineage: Goldman’s Global Alpha Fund and AQR; Tyke and DE Shaw. The bread and butter strategies for many of these larger quant funds are momentum and stock valuation, with some factor-based allocation strategies sprinkled in. There aren’t a whole lot of different ways to measure momentum.... The same is true with stock valuation and factor strategies.... [A]t the end of the day each of these funds will be long and short similar sorts of stocks.... Finally, in aggregate... the money employed by these strategies might be more than the market can absorb.... They have not been doing very well [recently], which suggest there might be too much money chasing the opportunities.... The quant fund crisis is as close as it gets to a pure example of the point in my book that it is liquidity and market dynamics, not economics, that spawns market crises. These are funds that invest substantially in talent and systems, and focus on keeping clear of anything systematic. Yet they are embroiled in a liquidity crisis. If it can happen to them, it can happen to anyone.

To me, it looks as though two things have happened:

• Credit spreads have returned to normal levels, and those who bet that they would stay low have lost big.
• The market has overreacted. Quant funds that are undercapitalized or lily-livered and sell will have lost big, and will close down. Quant funds that are well-enough capitalized to maintain their positions will do well enough in the end. Those who are liquid enough to buy what the undercapitalized quant funds are selling will be acclaimed as geniuses.