By Matthew Dove
The emergence of quant trading seemed a perfect demonstration of technical innovation yielding concrete results under market conditions. For almost a decade, quant funds performed well year-on-year. However, that all changed in 2018 and the picture is barely any brighter today.
So, what went wrong and what does it have to do with a hangry grandpa with a Twitter fixation? Furthermore, what does the solution have to do with WeChat?
Virginia-based Quantitative Investments Management (QIM) rose from the ashes of 2008’s global economic crisis and, like the proverbial Phoenix, enjoyed blue skies despite the chaos unfolding on the ground below. By 2017, the fund was up by an annualised 16%, putting on an impressive 60% in that year alone. Alongside other sector leaders like WorldQuant and AQR, QIM appeared to be proving the theory that hitech can be used to safely navigate volatile markets.
The benefits of quant trading are abundant.
Quantitative trading uses mathematical functions (trading algorithms) to automate trading models, with market data being applied to multiple trading scenarios to identify profitable opportunities.
Algorithmic trading allows for the optimised exploitation of huge data sets and all but eliminates the vagaries of human traders (pride, sloth, avarice – you know the ones!). This in turn stabilises markets and reduces the level of risk investors are exposed to.
That’s the theory anyway, and until the big quants starting taking baths left, right and centre, it seemed to be bearing fruit. By October of last year QIM was down 3.2%, its only other annual loss coming in 2015 (when the fund lost 5.8% of its value). Elsewhere, major players like WorldQuant and Cubist barely scraped a 1% return, whilst Och Ziff was down by the same amount for the year. The most notable nosedive however was performed by AQR, which ran at a loss of 10% for 2018.
As the larger funds faltered, institutional backing for smaller concerns dematerialised too. Manoj Narang’s Mana Partners, which only began trading in 2017, had the plug pulled by its primary investor, JPMorgan Chase & Co.’s asset management unit. The 930 million USD fund based in New York sought to combine high-frequency trading and statistical arbitrage, ventured south of 400 million USD before losing 8% for 2017.
By October of last year QIM was down 3.2%, its only other annual loss coming in 2015 (when the fund lost 5.8% of its value).
With the honeymoon for quants ending in separate beds and early flights home, some have begun to blame “quantitative strategies” for all manner of ills. Disgruntled investors have accused quant trading of worsening general downturns in the stock market over the past 18 months. The reasoning follows that when algorithms get it wrong, they get wrong big and they get it wrong fast.
AQR founder Clifford Asness told the FT in January that such claims are “insane”, arguing instead that wider market trends have influenced the performance of quant funds and not the other way around. Assuming the lion’s share of the blame for himself, Asness was also keen to deflect a little responsibility elsewhere;
“We’ve done lousily, and I’m not blaming others…I’m sick of people saying this without a theory for why (quants exacerbate volatility) … Markets move for reasons like corporate news, economic data, or what the president or the central bank says”
Asness isn’t the first to draw a correlation between what “the President says” and the volatility of the market. Perhaps diplomatically, many commentators have identified ongoing US/China trade tension as a major source of turbulence (alongside other geopolitical maelstroms like Brexit). Mo Mayet of quant headhunters Westbourne Partners confirmed as much when told TFT;
“We saw big winners and losers in the quants market last year. This was largely driven by geopolitical uncertainty i.e. Brexit, US/China trade relations etc. In addition to this, most funds were looking to diversify strategies and look into new areas of research – some approaches which we’ve been told have lost money.”
many commentators have identified ongoing US/China trade tension as a major source of turbulence (alongside other geopolitical maelstroms like Brexit)
Others have been a tad more direct…
Donald J Trump’s sabre rattling jingoism won him the 2016 US election as well as a number of fans on Wall Street who foresaw his ascent as the second coming of Reagan. Unfortunately, despite his pro-business attestations, Trump is less a free-market Reaganite and more an egotistical nationalist.
Il Douchebag’s Twitter account is enough to cause an international incident by itself:
Trump’s foreign policy is seemingly tied more to his conception of himself as the strongman saviour of a weakened America than anything resembling economic reality. This makes him unpredictable, a quality quantitative algorithms find difficult to compute. Mark Hamrick, senior economic analyst at Bankrate.com recently told Fortune that;
“His decisions on trade have been negative for business sentiment and also for the real economy.”
How then can the humble quant offset the volatility of a post-truth world?
We need look no further than the very nation the Donald so routinely pokes with a stick.
China boasts 800 million internet users (roughly half the population) with social media platforms proving particularly dominant (WeChat recorded 1.08 billion users for Q3 2018). It’s no surprise then that China’s approach to bringing stability and predictability to the quants market involves data, lots and lots of data…
Chinese quant developers are busy ferreting through the social media posts of the country’s 147 million retail investors in order to predict buying and selling habits. The process is supplemented by AI analysis and fuelled by vast caches of data purchased from the likes of Tencent Holdings.
Chinese quant developers are busy ferreting through the social media posts of the country’s 147 million retail investors in order to predict buying and selling habits.
Never knowingly late to the buffet, Western funds like Blackrock are already getting in on the act by scrutinising the chatter found on investment sites like Eastmoney.com and Xueqiu.com. When they’re not paying George Osborne his pocket money or trying to short the Post Office, the guys and gals at the world’s largest asset manager can be found pouring over 100,000 investment related posts a day.
With Big Tech’s advances into financial services continuing unabated, how long will it be until we see the Chinese model coming to the attention of Messrs Bezos and Zuckerberg (ed. – heaven forbid!!!)?
The choices we have, it seems, are two; the Orwellian nightmare to the East or a capriciously Trumpian rollercoaster in the West. Put another way, we may soon find ourselves caught between a Blackrock and a very hard place indeed.