Quant funds suffer dismal ‘QE’ losing streak

November 6, 2013 10:04 am

Quant funds suffer dismal ‘QE’ losing streak

By Sam Jones

How does a hedge fund react to losing a quarter of its investors’ money in a matter of months? Double-up? Blow up? Or buy Lego and wait? Cantab Capital, a multibillion-dollar quant hedge fund, run by computers (or rather, run by maths geeks who run computers) went for option three. The irreverent – and until this year, highly profitable – Cambridge-based firm, set up by Goldman Sachs’ former head of quantitative trading, spent £2,000 on Lego to boost staff morale this summer after a painful losing streak struck hundreds of millions off its trading portfolio’s value.Cantab’s travails speak for a vast swath of the $2.5tn hedge fund industry: so-called managed futures funds, which use computer models to spot and ride trends in global futures markets, have had a dreadful ten months.

And perhaps the best thing they should do is nothing at all.

According to data provider Hedge Fund Research, the average managed futures fund lost about 3.7 per cent in the first three quarters of 2013. October has been a good month, say industry insiders – but not good enough to pull managed futures managers back into the black. In any case, the medium-term story is grim too. Managed futures funds have made their investors money in only one of the four previous years (2010).

It is a losing streak that would give anyone pause for thought. And the question that seems to rise time and again is: is the managed futures model broken? For Man Group, the world’s second-largest hedge fund manager, this questioning – and the stuttering of its huge flagship managed futures fund AHL – has utterly destroyed shareholder confidence in the company. London-listed Man used to be in the FTSE 100. In mid-2008, it had a market capitalisation of $20bn. Now it is $2.5bn.

The stakes are therefore high.

There are two things the managed futures model needs to do well: uncorrelated markets and markets that move with sustained momentum for a given period of time. This is logical enough since, in its most simple incarnation, a managed futures fund bets on anything that is exhibiting a price trend – let’s say, three days of falls – and it does this in dozens of different markets. Diversification helps it to iron out volatility.

Herein lies the problem. For it is almost as if central bankers, policy makers and politicians had consciously developed a set of responses to the financial crisis perfectly calibrated to mess with managed futures-style trading.

Firstly, if one was being uncharitable, one could point out that the historical returns from managed futures funds were bolstered in part thanks to income from the large cash hoards they held. As firms which primarily, if not exclusively, trade futures contracts, interest from treasuries or cash-like securities they kept as collateral was an easy source of return. In the current zero-interest rate environment this is anything but the case.

Secondly and probably more importantly though, the very fundamentals of the managed futures trading style has been disrupted.

High correlations between markets and choppy, but ultimately rangebound movements within those markets mean most managed futures models keep tripping up. Take one, very simplified example: a computer might have hopped on to a falling euro contract, for example, only to get suddenly caught out by an announcement by Mario Draghi that panicked investors. The same computer might then have gone long the contract only to get hit as once again sentiment turned on eurozone cohesion a week later.

But while this is an intractable problem, it is also surmountable. When QE ends, fund managers reason, there will be nothing to stop the computers churning out big returns once more.

Cantab’s financial modellers are not the only ones sanguine enough about their condition to go out and buy toys. Senior figures at all of the world’s biggest quant funds – AHL, Winton Capital, or BlueCrest’s BlueTrend – believe that nothing is fundamentally wrong with the way they trade.

All of which points to an attitude that many hedge fund investors would do well to learn from too: have conviction, and don’t go chasing returns.

A wave of money flowed into managed futures funds in 2009 and 2010 after many spectacularly beat the market in 2008. Now a wave of money is flowing out.

If the US Federal Reserve makes good on its well-telegraphed promise to scale back its programme of quantitative easing next year, then this could be precisely the moment at which the worm turns for managed futures funds.

In the meantime, sources tell the Financial Times, work on Cantab’s Lego Death Star is ongoing.