Two Degrees of Wall Street Separation

Chaotic markets don't give you a lot of time to think clearly. That's what computers are for. Or at least used to be.

The recent stat arb QuantMare was brought on by a group of close knit people. Intelligent for sure, but none too street smart. A lack of liquidity was partially to blame for their woes, which is something their knuckle dragging fundamental counterparts think about day in and out. Chalk up one for mere mortals.

This is not the first time we have seen a strategy get crowded. The convertible bond market has seen it share of ups and downs over the past decade. Too much money tumbling into arbitrage strategies ruined it at least twice over the past decade if memory serves me right. Did you see this one coming?

Chances are all those alums of DE Shaw and Goldman did.

The recent stat arb problems were almost inevitable. 1) Spreads have been getting very tight requiring more leverage to maintain returns but the banks want out necessitating liquidation of mean reversion positions 2) Due to losses in OTHER areas investors are redeeming and quant funds are very liquid 3) Clients now demand more transparency and over time trade secrets have leaked into the marketplace allowing less competent funds to try to emulate the better ones. Loose lips sink ships. 4) Fund employees left to start their own firms but with the SAME strategy DNA eg Goldman Sachs Asset Management to AQR or DE Shaw to Tykhe 5) In some areas of stat arb, capacity was surpassed a while ago but many funds continued to take in assets. It is not just the AUM in a fund, the total AUM in an industry-wide strategy also matters. Hedge Fund Blog

Perhaps the blame, if there needs to be any assigned, should go to the people who continued to fund these strategies. Money managers rarely turn down new money, and this time was no different.  The managers knew the trade was getting crowded.

Dangerous stuff, given the nickel collecting might have been more accurately described as penny collecting by July 2007.

As always, go read Veryan Allen’s take on the chaos. The title of his latest piece is somewhat uninspiring, perhaps he should have used a phrase we can imagine the highly compensated quants bandied about in the aftermath of the carnage.

Shit Happens

Quant hedge fund chaos
Hedge Fund Blog
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The content contained represent the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

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