In a time when traditional long/short, macro and other fundamental-analysis based hedge funds are losing the war to ETFs and passive investing...
... one group of funds is thriving, and none more so than quant powerhouse Two Sigma which according to the FT, has quietly grown assets under management mark over $50 billion "putting it on a par with Renaissance Technologies as the biggest global quantitative hedge fund, as investors continue to pile into computer-powered investment strategies."
Putting Two Sigma's staggering growth rate in context, the New York-based hedge fund, which was launched in 2001 by computer scientist David Siegel and mathematician John Overdeck, had $6bn in 2011 but soared past the $50bn mark earlier this month, according to FT sources:
"That puts it roughly level with Renaissance Technologies, which manages just over $50bn, and more than DE Shaw’s $45bn. Both are older than Two Sigma."
The reason for the unprecedented growth rate is that while the rest of the hedge fund industry has struggled with poor performance and outflows, investor demand for lower-cost, quant and algorithmic investing has exploded in recent years. Morgan Stanley recently estimated that various quant strategies, ranging from cheap next-generation exchange traded funds to pricey sophisticated hedge fund vehicles, have grown at 15 per cent annually over the past six years, and now control about $1.5tn.
"$1.5 trillion of AuM currently managed under quantitative guidelines could continue its double-digit growth over the next five years. Part of this growth is a ‘pull’ from investors broadening their search for risk premium and uncorrelated returns at lower fees than traditional alternatives. Part of this is a ‘push’, as asset managers see systematic strategies that lend themselves well to automation and scale, offering value over pure ‘beta’ in a traditional active management framework. Relatively small further reallocation by asset owners towards these strategies could still drive significant growth."
To be sure, this invasion of Math Ph.D will harldy come as a surprise to regular readers: back in 2009 we predicted that with central banks obviating fundamentals, it was only a matter of time before the mathematicians and physicists took over. Well, they have:
Quants tend to have a different background to typical hedge funds. More than half of Two Sigma’s 1,200 staff come from outside the finance industry, with most educated in mathematics and computer science. They include the winner of a Japanese backgammon tournament and the “world’s first open-source software artist”, according to a graphic novel handed to new recruits.
As programmers and data scientists have taken advantage of ever-cheaper computing power and ravenous investor appetite, a flurry of new start-ups have emerged in the quant investing field in recent years, But the biggest growth is happening at the largest, most-respected players, according to Emma Bewley, head of fund investment at Connection Capital.
“The big firms are getting bigger,” she said. “There’s a real sense that while a lot of hedge funds are building out their quantitative side, they don’t have the know-how of the established quant firms.”
There are pros and cons to this substantial reallocation to quant funds away from conventional, fundamental "active" managers: on one hand, "the rapid growth of quantitative investing has sparked a ferocious war for talent, with banks, traditional asset managers and hedge funds desperate to attract more coders." But, as the FT's Robin Wigglesworth observes, such clustering creates a risk of all "traders" being on the same side at the same time:
The greater worry for investors and the industry is that the inflows of money into the space is ramping up risks to markets. While strategies can vary greatly, there is concern that with more money gushing in some trades can become “crowded”, and unravel quickly if the market environment shifts.
To avert such concerns, many quant funds are careful to monitor for signs of crowding, and limit how much money a strategy or fund manages at any time.
For example, Two Sigma’s equity and macro hedge funds, which manage about $35bn, have long been closed to outside investors.
And while quants claim their strats are now less aggressive, and use less leverage and deploy more varied strategies, there is no way to know until the next downturn, a downturn which refuses to occur precisely because of quants, whose primary directive it appears is to Buy The Dip, Any Dip before the other Math PhD does, and not only ask questions later, but ideally never ask anything as more greater fools emerge to bid up risk even higher, which luckily these days also includes central banks.