Quant Fund Carnage: Are Market-Neutral Funds Facing Another August 2007?

Tyler Durden's picture

For equity market-neutral funds, there is a phrase more chilling than "worst since Lehman" and that is the quant meltdown in "August 2007" that put many funds out of business. While the mainstream media remains focused elsewhere, the last two weeks have seen equity market-neutral funds 'crash' - and today it has gotten much worse - as momentum factors diverge and memories of the 2007 bloodbath come back as this forced unwind drives the current ramp.

As detailed at the time, during the week of August 6, 2007, a number of high-profile and highly successful quantitative long/short equity hedge funds experienced unprecedented losses.

The losses at the time were initiated by the rapid unwinding of one or more sizable quantitative equity market-neutral portfolios.

 

Given the speed and price impact with which this occurred, it was likely the result of a sudden liquidation by a multi-strategy fund or proprietary-trading desk, possibly due to margin calls or a risk reduction.

 

These initial losses then put pressure on a broader set of long/short and long-only equity portfolios, causing further losses on August 9th by triggering stop-loss and de-leveraging policies.

It appears more than one quant fund is aggressively deleveraging and/or unwinding...

Chart: Bloomberg

We have been explicitly focused on the HFRXEMN - hedge fund equity market-neutral fund index - since April 2009, warning at the time that the increasingly self-confirming equity trading community was, ultimately, an unsustainable and fragile condition...

As more and more quants focus on trading exclusively with themselves, and the slow and vanilla money piggy backs to low-vol market swings, the aberrations become self-fulfilling. What retail investors fail to acknowledge is that the quants close out a majority of their ultra-short term positions at the end of each trading day, meaning that the vanilla money is stuck as a hot potato bagholder to what can only be classified as an unprecedented ponzi scheme. As the overall market volume is substantially lower now than it has been in the recent past, this strategy has in fact been working and will likely continue to do so... until it fails and we witness a repeat of the August 2007 quant failure events... at which point the market, just like Madoff, will become the emperor revealing its utter lack of clothing.

While quant funds have many factors and many styles, one of the most popular in recent years has been 'Momentum'.

Momentum-trading is the magic-sauce that makes a genius out of every trader in a bull market. The last few years have seen 'strong' momentum stocks drastically outperform 'weak' momentum stocks. However, the last 5 weeks have seen the biggest unwind of this trade since records began... as it is clear that equity market-neutral funds models are blowing up and they are liquidating...

Chart: Bloomberg

And the last 3 days have ravaged it even more as the squeeze bounce has sent every Tom, Dick, and Day-trader piling into the worst of the worst momentum stocks:

Chart: Bloomberg

So while the ramp of the last few days feels great from a headline index perspective, not only is it a squeeze of the "most shorted" stocks but a forced liquidation unwind of Momentum Long/Short funds (i.e. buying back the weakest momo names) has exaggerated the rally. Sooner or later, if this continues, as in Aug 2007, the selling pressure (and liquidity suckout) will systemically weigh on all names.

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stocktivity's picture

It's all Bullshit!!!   Every day doomsday. BTFD is the only thing that's worked for 7+ years. Fucking banksters can keep the rigged casino going much longer than most people think.

Boris Alatovkrap's picture

Bankster is maintain subtrefuge in Bank-o-sphere™ until every last dollar is spend, until ever last job is gone, until every last young man is die on battle field. Never underestimate depth of Bankster depravity and scheme employ to maintain status quo larceny.

Soul Glow's picture

Right, and then it's all gone.

Tyler Durden Philosophy Of Life - Fight Club

https://www.youtube.com/watch?v=CWRTqMGvdpc

Say What Again's picture

Back in the days of QE, we knew the time of day when the FED would do their POMO.   You would see the market move in the minutes after the FED gave the primary dealers the newly printed fiat.  Is some other central bankster doing a QE?

Government needs you to pay taxes's picture

If you purchased the international Central bankster subscription, you'd get the courtesy heads up about the timing of the purchase programs.

sgorem's picture

bernie madeoff Bureau of Prisons Register #61727-054. hi Boris, i'm bernies' roomie here @ butner medium security. gotta run, we have a tee time @ 2pm, but just wanted to let you know that bernie still says he was framed. have a wonderful day.............s

Soul Glow's picture

What are you even talking about?  Have you no understanding of market history?  Stocks have huge crashes all the time!

People were saying stocks would go up forever before the '29 crash and then came the Great Depression.  People said everything was fixed in the '80s then in '87 stocks tanked and Japan has never been the same (Japan was 3xs higher than it is now, and that is after decades of ZIRP).  People thought the tech bubble would last forever and we just made it back to those highs last year.  And in '07 no one saw the Fall of '08 coming.

And when you consider real return on equity - that's minus inflation - then we haven't made new highs, stocks are just muddling along.  Sure, a handful of hedge fund guys and NYC traders are making a few million, but so what?  They'll burn in hell for eternity.

Where would you rather be?  On earth being a good person if it means you make a living and don't own a boat or mansion, or you make a few million a year but your soul is as ugly as Hillary Clinton's face.

Choose wisely.

Eireann go Brach's picture

Stop peddling fiction white boys! 

Atomizer's picture

Go fuck yourself. See below. 

Atomizer's picture

Sure they are, no new taxpayer redistribution in sight. Until our Uncle Tom President repeats another American recovery and reinvestment stimulus plan from 2009. 

Just ask Carrier.

Still Report #628 - Carrier Corp Got $5M Obama Stimulus - YouTube

 

 

yrad's picture

It looks like the only way to curb ZH traffic is to have a +200 DOW surge. It's crickets in here!

ShreysFinanceBlog's picture
ShreysFinanceBlog (not verified) Feb 17, 2016 1:47 PM

Thanks for this article regarding whether we are headed for another August 2007 or not; I really enjoyed it and am definitely recommending this blog to my friends and family. I’m a 15 year old with a blog on finance and economics at shreysfinanceblog.com, and would really appreciate it if anyone could follow, read and comment on some of my articles, and perhaps reblog and share some of my posts on social media. Thanks again for this fantastic article.

NoDebt's picture

Did you actually write all those articles yourself or is your name a pseudonym like Tyler Durden is here.

8th Estate's picture

If the global economy was a single organisation and you looked to assess its organisational health from its dress code..........

 

  • For hundreds of years it came to work in a suit.
  • A few decades ago it stopped wearing a tie.
  • Around the turn of the century it went sports casual.
  • A decade ago it came to work in shorts and flipflops.
  • Five years ago it started wearing clown shoes.
  • Today it comes to work in full clown outfit and makeup, riding a unicycle.
Parp parp. If your friends and family can't see the markets are broken by now, they never will.
Lady Jessica's picture

But an Albino Jewish Hobbit with a Romulan haircut is the Fed Chairwoman so EVERYTHING IS FINE.

hendrik1730's picture

I like this very much. Some addenda :

  • For hundreds of years it came to work in a suit. ( and they knew what they were talking about )
  • A few decades ago it stopped wearing a tie. ( why not, flower power, be cool )
  • Around the turn of the century it went sports casual ( yep, and needed a calculator to add 100+50 ).
  • A decade ago it came to work in shorts and flipflops ( sure, stoned like hell ).
  • Five years ago it started wearing clown shoes ( well, if your brain gives finally away .... ).
  • Today it comes to work in full clown outfit and makeup, riding a unicycle ( and holds the position of FED chairman ).

Laughing out loud is allowed ( for now ! )

withglee's picture

What retail investors fail to acknowledge is that the quants close out a majority of their ultra-short term positions at the end of each trading day, meaning that the vanilla money is stuck as a hot potato bagholder to what can only be classified as an unprecedented ponzi scheme

That is not the "only" way of classifying it. In fact, it is not even a good way of classifying it. The right way of classifying it is a "musical chairs" game. Being able to front run gives you insight into when the music is going to stop.

Add a random delay to the time stamps and listen to the HFT elite squeal.

bnkrs vs Humanity's picture
bnkrs vs Humanity (not verified) Feb 17, 2016 3:09 PM

But ...but...but does anyone really think that the fed is going to let us all down? i'm really nervous now.