Are ‘quant funds’ to blame for volatility – MoneyWeek

Quantfundstendtokeeptheirexactstrategiestopsecretinaso-called‘blackbox’,butallshareafondnessforgearing–borrowingbigmultiplesofthefund’sowncapitalinordertoinvest。

Soforevery£1contributedbyoneofitsinvestors,another£5ofborrowedcashmightbethrownatthefund’schosenstrategyontopofthis。

Thisisbecausethepricedifferencestheyaretryingtoexploitareoftenverysmall–LongTermCapitalManagementoncedescribeditas“hooveringupnickels”–soyouonlymakedecentmoneybyinvestingfrequentlyandinlargeamounts。

Thisalsomeanthefundsarehuge。

Somereckonthatupto50%ofrecentequitytradingcanbetracedto‘statarb’fundsandLehmanBrothersestimates,quotedintheFT,suggestquantfundsmaycontrolupto$1,500bnglobally。

Abigchunkofthemarket’srecentvolatilityisblamedonquantfunds。

Quantfunds:whyuseacomputeratall?

Therearesupposedlytwomainbenefits。

Firstly,theopportunityNickLeesonspotteddidn’tlastforeverasotherpeoplecopiedthetrade,andsothegapbetweenthetwopricesfortheNikkei225closed。

Intoday’sfinancialmarkets,whereinformationtravelsatlightningspeed,thiscanhappenveryquickly–sometimesinamatterofseconds。

Thustofindandexploitopportunitiesrequirespowerfulprogramscapableofreadingandanalysinghugeamountsofpastsharedataandthenreactingbyplacingbetsmuchfasterandmorefrequentlythanahumantradercould。

Secondly,computersdonotmakeerrorsofjudgement–‘thereisnoemotionintheinvestmentprocess’,asCharlesSchwabputit。

Allinvestmentdecisionsaredowntoasetofsupposedlybrilliantprogrammedassumptionsundilutedbythewhimsofafundmanager。

Andunliketherestofus,theblackboxcan‘think’andtrade24hoursaday。

Quantfunds:sowhat’stheproblem?

BasicallyalotofquantstrategiesarebackfiringaftertherecentmarketvolatilitytriggeredbytheUSsubprimemeltdown。

ThismonthGoldmanSachsattributed$3bnoflossestoquant-drivenhedge-fundactivity。

Itsmulti-strategyGlobalAlphaFundisdown27%thisyear,saystheFT。

Therearerumoursthatcountlessotherquantfundsareintroubleandsellingassetstomeetmargincallsandfundlosses。

Therearetwoproblemswiththesefunds。

Thesheersizeandfrequencyoftradesisthoughttohaveexacerbatedrecentmarketvolatility–quantshavebeendumpinghugevolumesofsharestocoverlossesonportfoliosinvestedinhigh-riskassets。

Secondly,inathrow-backtotheLongTermCapitalManagementcrisisin1998thereseemstohavebeenafailureonthepartofprogrammersadequatelytoassessrisk。

GoldmanSachschieffinancialofficerDavidVinier,tryingtodefendthebank’srecentfundlosses,describedthelatestgyrationsintheequityandbondmarketsas‘25standarddeviationevents’。

IneverydayEnglish,thismeanshebelievestherewasaroughlyonein244millionchanceofthemoccurring。

Yetclearly,crasheshappenfarmorefrequentlythanthat。

Amorelikelyexplanationisthatevencleverprogrammerssometimesgetassumptionswrongandforgetthatthepast–whichthesefundsrelyonentirely–isnotalwaysaguidetothefuture。

Theircreationsarenowbeingblamedforsimplycarryingoutanultimatelyhumanandflawedsetofinstructions。

Quantfunds:whatdoesthismeanforme?

Thegoodnewsforequityinvestorswithsteadynervesisthattheindiscriminatesellingofperfectlysoundcompaniesbythesefundsmaypresentgreatbuyingopportunitiesoncethemarketcalmsdown。

Manycommoditystocks,suchasBHPBilliton(LSE:BLT),Shell(RDS)andRioTinto(LSE:RIO)lookevenbettervalueattheselevels,giventhatglobaldemandformetalsandoilisunlikelytobedentedbythecurrentturmoil。

Tosumup,staycalmandshopselectively,andyoucouldturntheCity’sprogrammingmistakesintoprofits。

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