"We Need More Suckers At The Table" - Quant Funds Stumble As Dumb-Money Disappears

Tyler Durden's picture

The omniptence of artificial intelligence is unquestioned. The 'future' is automation, robotization, and algorithmic domination is the mantra of the new normal prognosticators - and anyone who challenges this world view is a luddite or 'denier'.

There's just one problem - those quantitative, AI-based, computerized algos, that are supposed to be making people obsolete in the financial markets, are in trouble. As Bloomberg reports, program-driven hedge funds are stumbling, a promising startup has closed, and once-reliable styles are showing weakening returns.

This isn’t just normal volatility confined to a single month, according to noted quant fund manager Neal Berger, the founder and chief investment officer of Eagle’s View Asset Management, a $500 million fund-of-funds that invests with 30 managers, half of them quants. Returns have been decaying for a year, suggesting the rest of the market has figured out what the robots are doing and started taking evasive action, Berger said.

Bloomberg notes that June was the worst month on record for Berger’s fund, as usually robust strategies lost their footing and the firm fell 2.4 percent. The worst pain has been among quants in the market-neutral equity space, which take long and short positions to isolate bets on price patterns and relationships.

There's "Turmoil in Quant Land", said Berger in a letter to clients this summer to explain his "candid view why strategies that were once working regularly mysteriously stopped working."

It comes down to two factors:

1.Increased competition: more investors are using algorithms to fight over the same inefficiencies in the market.

“Now every bank has a factor model,” said Benjamin Dunn, president of the portfolio consulting practice at Alpha Theory LLC, which works with managers overseeing about $200 billion.

 

“You’ve had a democratization of a lot of data and analytics that were once the domain of very systematic quant investors. Everything is getting arbitraged away.

2. Low volatility: quantitative funds are most successful in an environment where there is large disagreements in the market over the prices of assets. Today there is little disagreement, and the best way to earn outsized returns is placed highly leveraged bets that the market will remain calm. That's working for some investors, but is far too risky for others.

In fact, the persistently low level of volatility has brought out an increasing number of hedge funds strategies oriented toward regularly selling volatility. Although we believe that this is "picking up nickels in front of a bulldozer", shockingly, these Funds have been some of the best performing strategies over the past years.

 

Although our guess is as good as anyone's, we believe the shockingly low levels of volatility has to do with an increase in computer driven, quantitative trading coupled with banks selling options to offer "yield enhancement" structured products to investors who are starving for this yield.

 

This feedback loop, the increase in assets run by hedge funds, and, the rise of quants, has created unusual patterns, dislocations, and low levels of volatility.

 

While those simply following the broader market indices wouldn't realize anything is amiss, it is our belief that these factors have created a challenging mix for trading oriented strategies. It won't last forever, but, it could last longer than we can.

Additionally, he explains, systematic strategies require an endless supply of victims to thrive, and the growth of quant and passive funds has caused dumb money to behave unpredictably or disappear altogether.

With all the geniuses in quant, high-powered computers, and enormous data, where are the "suckers" who are providing the juice for all of these absolute return quantitative strategies?

 

Simply put, the 'edge providers' have moved aggressively into passive index funds and broader market ETFs.

 

As such, we have a condition amongst the traditional quantitative strategies whereby we have robots trading against robots. Without a steady source of 'edge providers', these 'edge demanders' are just trading money back and forth with each other.

 

We believe increased quantitative trading coupled with passive indexation by retail, and, low levels of realized and implied volatility may be creating a feedback loop that has caused unusual price movements in a variety of securities that have challenged trading oriented strategies.

Eagle’s View is shifting “almost entirely away from mainstream quant strategies due to the fact that we feel that they are too crowed and without enough juice available for all to feast,” Berger wrote.

...the shift toward passive indexation by those investors who have historically been the 'edge providers' has no end in sight. While one might argue that fundamentals always win out in the end (and we agree), we need to make money over a much shorter horizon for our investors and cannot sit idle in a world where hedge funds are expected to produce regular returns and stay ahead of the curve even if fundamentals are irrational. Over my nearly 30 year Wall St. career, I am a firm believer in the adage that "the markets can stay irrational longer than we can stay solvent".

A market neutral version of value is on track to post its worst year since at least 2008, according to data compiled by Bloomberg PORT.

And factors aren’t just performing poorly, some are barely performing at all. With equity markets bathed in tranquility, groups of stocks assembled according to their growth, momentum and volatility traits have never been more muted, the data show.

In order to exploit inefficiency, giant quant firms "need to be dwarfed by large, dumb money," Berger concluded by phone to Bloomberg.

 

"They’re waiting for the sucker to come to the table, but the suckers are fewer and far between."

Don't be the sucker, America.

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order66's picture

Don't worry, plenty of buybacks being executed. That is the dumbest money of them all.

American Psycho's picture

They buy at the top and sell at the bottom.  It is a good way to stay out of a high tax bracket. 

Cthonic's picture

Twenty-seven years ago, West Germany was forced to cough up the costs of reunification. Today, DoD possesses scads of ageing hardware it would like to see replaced.  Also needs some place to dump old ICBM's.

medium giraffe's picture

I have no idea how these clever and complex automated strategies are having a hard time when the indices have been heading in only one direction since '12.  In psuedo-code, the operation seems simple enough:

IF day = weekday, THEN position = buy.

"most successful in an environment where there is large disagreements in the market over the prices of assets"??? - so essentially arbitrage, scalping and frontrunning?  Gaming the system rather than trading flows? That's what they rely on?  And they expect to be taken seriously?

Out-fucking-standing.

 

johngaltfla's picture

If dark pool trade: Sell to pension funds/Central bankers

If public trade: Fake sale with algo to public, then short their buys

fattail's picture

Speaking of pensions.  Remember the put option sellers in South Carolina and Hawaii.

http://www.zerohedge.com/news/2016-08-22/pensions-latest-stretch-yield-s...

Are they hedged for this black friday?

zebra77a's picture

The algo is only as smart as the programmer..

If (algo ! self-feedback-adaptive) { stop(); }

score_table[] = detune_market_harmonic(rand());

results

(0.85EURUSD - 0.22USDJPY + 0.03OIL) / 0.04 VIX = DJIA[shift left 10 candles]  : Correlation 0.77..

 

rp2016's picture

https://just-a-thought-from-thinair.blogspot.com/2017/08/dear-mr-preside...

Hey ZH, are the warring leaders willing to pay? Learnt a few tricks fro you. Can't believe you are such a teacher.

kehar857's picture

anyone who invests in this market is beyond dumb. by the way I make 7,000 a day in my business. if you want to find out more just visit. baitandswitch.co

Cluster_Frak's picture

all i know is that monkey is out taking the hammer to gold in the asian trade already. If we do not cross and hold 1300, then it's over.

Archibald Buttle's picture

was it over when the germans bombed pearl harbor? hell no!

NoBillsOfCredit's picture

Either that some kind of a joke I don't understand or you don't know shit about history.

skm343's picture

D. Daniel Day......has no grade point average.

skm343's picture

D. Daniel Day......has no grade point average.

Archibald Buttle's picture

obviously you don't understand. /sarc

Yen Cross's picture

   Credit is starting to cave in, just as I suggested about a month ago.

   I can feel the deck chairs on the U.S.S. Shitanic being re-arranged, as I type.

   Just wait and see the carnage that's about to come from the "fake" emerging markets trade.

bugs_'s picture

maybe they aren't playing at your table anymore wall street

kehar857's picture

by the way medium giraffe i knew a few extra large giraffes but no mediums

medium giraffe's picture

:) it's not a reference to my scale, but my psychic ability.

holdbuysell's picture

Someone needs some cheese to go with that whine.

Yen Cross's picture

  The $usd short trade, is about to get squeezed really hard, and you can already see it in Treasuries.

TimmyM's picture

I smell the end game to Exters pyramid coming. A giant ball off risk off circling the toilet bowl before the final aenima. Better learn to swim.

Yen Cross's picture

 But... But.. Thesre's so much money on the sidelines.  </sarc>

  Central banks are already starting to cover their trades.  Look at usd/chf, five minute chart over the last two days, while the eur/usd stayed in a small range. [ I understand there's some option expirations coming up tomorrow morning]

  The SNB is covering equity trades, and it's so obvious. I'm sure BoJ and other global entities are as well. It's hard to track them all.

  If, in fact the BoJ buy paper gold as the yen strengthens, I'd look out below, because gold is getting ready to run higher.

wisehiney's picture

Be sure to tune in at 8:30 a.m.

CPI 

Herky Jerky time.

Grandad Grumps's picture

They can only profit if they can sell. We suckers should make sure they must swallow every byte. In the en they will be bailed out by their criminal cronies.

Grandad Grumps's picture

Not dumb money, corrupt money.

Kprime's picture

not even real money, just a figment of the delusional imagination.

Kprime's picture

bend over and we'll fuck you from behind

bend over and we'll fuck you from behind

bend over and we'll fuck you from behind

bend over and we'll fuck you from behind

"how's it going Joe?,  terrible, just terrible, it's getting really tough to find folks who will bend over.  it used to be so easy.  I may have to close shop.

well Joe, have you thought of becoming a pedophile?  I hear there's a new sucker born every day, just move down the slope.  damn dude, I been doin the kiddies for 3 years now and even that market is dried up. pension funds all shot down, middle class gone, no one saves for college, houses, cars, it's all gone to debt.  .gov bought the entire stock market, all the bonds, all the real estate, cars, everything is gone.

it was fun while it lasted.

wide angle tree's picture

The dumbest of the dumb like Warren Buffet are getting rich just buying and holding.

 

Don't worry one of these days the pigs will be ripe enough to slaughter.

Umh's picture

Algos do what people do only faster, that includes making mistakes.

NoBillsOfCredit's picture

Algorithms cannot do everything that people can do but the part that they do do that people can do they do faster. People think there's such a thing as artificial intelligence when there's not. A better description would be simulated intelligence.

kehar857's picture

i have known psychic elephants and even a lemur or two, but never a giraffe!

Schmuck Raker's picture

Were the lemurs pretty cool?

rp2016's picture

Why are you breaking your head over this, ZH. I told you, one day, I will take everything back .... the entire world now belongs to me... I have put my claim ... now your show is going to be more entertaining ... lets watch how these people loot all the money and run like idiots .... You want some too... ??

Schmuck Raker's picture

" 'Proxy' Quant Fund Index" is a thing.

And yet, some people would deride me for having an interest in Bitcoin.

runningman18's picture

Bitcoin is essentially the same thing. 

NoBillsOfCredit's picture

It is not and you don't know what you're talking about.

Glyndwr will return's picture

The rigged game is now common knowledge - at least to about 20% of the population.

The rest are screwed

fattail's picture

The rest have not recovered from the last ass ramming and haven no money to play.

Except for a few people I know nearing retirement that love to speak of the wonders of dollar cost averaging.  They have outperformed me.  So far.

buzzsaw99's picture

This whole world is out there just trying to score
I've seen enough I don't want to see any more
Cover me, come on and cover me...

JailBanksters's picture

I believe there is World Wide shortage on new suckers that want to play in

the Stock Market Casino.

 

The Question that must never be asked is:

Who's buying all the stocks to Record Highs ?