Battle of the Quants

Nine years of stimulating quantitative debate and education

Originally published in the July 2013 issue

Bartt Kellermann, a former IBM Executive, Day Trader and hedge fund capital raiser, spotted a vacuum of quant-only conferences in the hedge fund space, and so the Battle of the Quants Worldwide was born. Mr Kellermann synthesised his experience and talents in each of his former disciplines (technology, finance and marketing) to mastermind the creation of the “Battle”. Mr Kellermann was first to market with the Battle of the Quants’ innovative concept.

Quant has always been vital for finance, with so many new departures in post-war finance made by masters of the so-called hard sciences of physics, engineering, astronomy. In the new millennium the pace of technological advance accelerated as average trade execution times went from multiples of a second to millionths of a second. Trading close to the speed of light (one foot per nanosecond, or billionth of a second), via“dark pools” of selectively visible liquidity, is now part of the daily routine for many investors. Now that more than half of trades are algorithmically executed (including very low-frequency algorithms!), quant investing has gone from a niche activity to a mainstream feature of finance that is central to investing – and regulation. The “Battle” has always been close to the coalface of these transformational changes.

The “Battle” has been successfully hosting sold-out Quantitative Conferences for nine years in New York, London, Tokyo, Singapore and Hong Kong, with Shanghai soon to come. Speakers have included the pioneers of quantitative investing such as My Life as A Quant author, Emanuel Derman, Black Swan author, Nassim Taleb, quant educator and practitioner Paul Wilmott, managed accounts trailblazer, quant allocator and PAAMCO co-founder, Judy Posnikoff, high-frequency expert Scott Patterson, risk guru Aaron Brown, serial inventor Ray Kurzweil, institutional investor Don Putnam and many other internationally renowned quantitative experts.

The global event acts as a symposium to cross-fertilise knowledge amongst academia, systematic traders, allocators, service providers and leading-edge technology developers. The Battle has offered an open forum for both the critics and the advocates of high-frequency trading, for instance, with phenomena such as the 2010 Flash Crash rigorously analysed and industry regulators welcome to attend events. That regulators now want to validate back tests used for indexes, replication products and UCITS funds shows that the regulators are also now fully paid up members of the quant community.

The man versus machine debate is a regular fixture and favourite, where managers have candidly unveiled some very sceptical views about artificial intelligence: “Neural networks have been a disaster when used in investing,” according to Dr Marco Fasoli of Titian. Man versus machine started out as a dichotomous debate but has now become a three-cornered fight, with the “quantamental” half-way house acknowledging the degree to which quant funds are now using fundamental inputs, with some also using discretionary overlays, particularly for risk management, according to investor panels.

Although the Twitter hedge fund proved short-lived, and the Twitter hoax was even more ephemeral, quantitative hedge funds are now using super-sophisticated computers to analyse qualitative and subjective data like news and social media. In this space, the industry has drawn upon the expertise of academics from different disciplines who had no prior finance experience – such as linguistic and psychological experts, who have graced the Battle stage. “Not since Caxton has text been so sexy,” said Rob Passarella, now of Dow Jones, which turns news into actionable trade signals. Tim Brown of Reuters contends that news signals can be “applicable at all trade frequencies” – not just high-frequency – and can also be “complementary to traditional quant investing”, because the news signals are not correlated to other trading signals.

The Battle’s often overflowing cap intro roundtables have showcased many innovative and lucrative strategies from all over the world. Winners of the Battle of the Quants award have ranged the biggest quant fund in Asia – Macquarie’s $1.6 billion Australia-based vehicle – to boutiques such as Amsterdam-based HiQ which runs less than $100 million, with Dr Heiko Bailer’s Zurich-based Pulsar volatility trading fund a 2013 winner. This issue of The Hedge Fund Journal has brief teasers of the seven funds that presented in London this year; interested investors can join Financial Diligence Networks to connect with these funds, and many others. The largest pension funds, family offices, endowments, foundations, funds of funds, and high-net-worth individuals are regular attendees at battles, with coffee breaks and cocktail parties providing ample time for networking.

Highlights of London Battle, June 2013
The man versus machine debate saw panellists pointing out that the best chess computer programme, written a year ago by a pianist, could beat any human player – and that no human can digest 25 terabytes of data. The ability of humans to interpret politics and paradigm shifts, however, was seen as a discretionary advantage when QE may have made QI more difficult.

The news and sentiment panel updated us on the latest refinements analytics. James Cantarella of Reuters argues that their systems can now turn qualitative into quantitative data. Ravenpack’s director, Peter Ager Hafez, explained how their systems slice and dice the data across a growing spectrum of multi-dimensional axes to sift out the most relevant and significant items. Victor Long of Meta Alpha said that his machine learning algorithms could handle “Big Data”, which he defined as millions of variables.

On the high-frequency panel, Peter van Kleef of Lakeview raised concerns that proposed transaction taxes would ultimately just get passed on to end investors – reversing the collapse in trading costs (both commissions and bid/offer spreads) that has occurred in parallel with the rise of high-frequency trading. The logistical challenges of trying to tag and label algorithmic orders were also something that regulators would need to get to grip with, panellists thought.

Don’t miss your flight to Shanghai
The final panel in London whetted delegates’ appetites for the next Battle, scheduled for Shanghai this November. Exchange Solutions director, Miem Warringa, flagged up Shanghai’s ambition to overtake Hong Kong as a financial centre, as soon as 2020, and gave her vote of confidence that this will be achieved. Laurie Pinto of NSBO opined that China’s financial markets, the world’s second largest, are less efficient because 96% of the volume comes from retail investors. NSBO is experienced at navigating the intricacies and vagaries of Chinese regulations to assist those who want to do business in China, and recently hosted the Chinese banking regulator in London. That some 500 stocks making up 20% of the market can now be shorted, said Michael Cooper of BT Radianz, also opens up scope to run market-neutral, hedged equity strategies, in these inefficient markets. Russell Newton of Global Advisors, which is starting a fund to trade local Chinese commodity futures, argued that China is genuinely committed to opening up its markets – and Pinto agreed, citing the growing issuance of quotas for overseas investment into China. There is in fact a two-way flow of funds. Asset raisers can no longer afford to ignore China, now that 65 domestic groups have been authorised to invest trillions of local savings and capital reserves overseas, according to Pinto. The absence of intellectual property laws makes IP rights a contentious question when entering into joint ventures, Pinto said, which may help to explain why many JVs fall apart. Warringa also cautioned that WOFI (wholly owned financial institutions ) can be fraught with regulatory complexities, which Exchange Solutions has dealt with before. All of these unique features and opportunities of China’s markets will be explored in much greater depth at the event in November. Looking forward to next year, 2014 will mark another milestone: the 10th anniversary of the Battle.

Cap intro roundtables: teaser profiles
The Dacharan Capital Foreign Exchange Strategy trades liquid G10 currencies, using shorter-term momentum models that spot patterns over time-frames from hours to days. Their edge comes partly from the entry barriers entailed in higher-frequency trading, such as data inputs, execution platforms and other operational requirements. Annualised returns since inception in July 2008 have been 26%. The return profile is positively skewed and shows very low correlation to conventional asset classes, other hedge fund strategies and generic currency strategies. Dacharan think this niche strategy, trading 45 FX pairs, is capacity-constrained. The fund was originally seeded by veteran trader David Kyte’s The Kyte Group, which remains invested. The team have worked together since 2004 and have significant personal co-investments in the fund. All five partners were part of the same team before forming Dacharan, which is now based in Zug. David Beddington, Antii Aitio, Ramanan Navaratnam, Ari Andricopoulos and Charles Phan researched, analysed or traded options for Shooter and Curtis and at Shooter Fund Management with some of them also overlapping at market-maker Mako. Two have quantitative PhDs, with Dr Andricopoulos having had articles published in the Journal of Financial Economics.

Plenum’s Pulsar fund won this year’s Battle of the Quants award in New York. The fund has been outperforming peers in the volatility space by a large margin. Pulsar has twin goals. It can act as a standalone investment, with equity market-equivalent volatility – or it can also be a powerful diversifier for equity, bond or CTA exposure. The Zurich-based fund currently trades liquid volatility instruments on the S&P 500 and on the Eurostoxx 50. The strategy can be accessed via an offshore BVI fund, or an onshore Luxembourg-listed daily dealing certificate, structured by BNP Paribas – who also seeded the strategy with $20 million. The strategy was originally developed as part of discretionary client mandates for Credit Suisse private bank. Plenum decided that the strategy would work best if operated on a completely systematic basis. The fund takes both long and short exposures to volatility according to various proprietary indicators including the type of volatility regime. Pulsar may be open-minded about acceleration capital deals.

The Jefferies Multi Strategy fund does not easily fit into any box or bucket. The eclectic approach is multi-strategy, multi-asset class, and uses multiple factor inputs. The fund is multi-strategy in that it has both trend-following and counter-trend signals, and trades over time horizons from hours to days. The versatile vehicle is multi-asset class in trading 3,000 US cash equities as well as 55 highly liquid futures contracts. The hybrid inputs are mainly technical, including price, volume and volatility – but fundamental data and events can also feed into signals for trading equities. Altogether more than 100 strategies are pursued and allocations to them remain stable. The track record dating back to 2006 has achieved a Sharpe ratio in excess of 2. Head of division, Vlad Portnoy, previously did statistical arbitrage and algorithms at a group called Vector that was later bought by Bank of America. The Jefferies fund uses algorithms and low latency infrastructure to improve the efficiency of its order routing and trade execution, minimising market impact and slippage.

Key Quant always has either long or short exposure in all 50 markets traded, and CIO Raphael Gelrubin believes in applying the same systems to all of those markets. Having launched in 2009, with co-founder Robert Baguenault de Vieville, the strategy had a very strong 2010, making 43%. Weightings to various trend models are dynamically varied – and so is the volatility target. If traditional trend-followers expect to capture 40% of a trend, Key Quant aims to pick up as much as 70% of a market move. One technique employed is top slicing positions ahead of expected trend reversals. A Global Economic Factor indicator is also used to try and gauge the strength of trends. As well as the price inputs used by most CTAs, Key Quant uses behavioural non-price inputs in the form simulating the utility functions of 100 types of investors. The Key Quant strategy offers a wide menu of investment avenues: a UCITS seeded by French group Emergence, a Cayman fund, the Alphametrix and DB Select platforms, and also dedicated managed accounts – which can be tailored to investors’ volatility targets.

Following The Trend author Andreas Clenow runs the Globalanced Systematic Fund, which is housed by the $250 million Zurich-based ACIES family office. Clenow likes to follow trends, but is not always active in all markets; he prefers to be more selective about only trading 20 or 30 markets showing the strongest trends. Turnover is quite low with typically five or six trades per week. Profitable trades can last as long as two or three months while loss-making trades are often stopped out within a week. The fund also has a counter-trend overlay, which sometimes takes shorter-term positions in the opposite direction of the trend, doing so several times for the Nikkei index this year. Some manual discretion is allowed over trade execution within a multi-hour time-frame. Fees are 1 and 15, and the programme has made 300% since 2004, including a strong 2010 up 25%, with 2008 the standout year, up 81%. The fund, which has over 50 investors, is now net short of government bond markets. Clenow had previously been head of equity and commodity quantitative modelling at Reuters.

Iskandia’s Jean-Louis Azoulay and Stephane Lamoine have developed a statistical arbitrage strategy that applies extra filters when choosing pairs. Historically high correlations are not sufficient; the two legs of a pairs trade must also be similar fundamentally, to increase the chances of mean reversion in relative pricing. The key driver of returns is what Iskandia terms as “velocity”, or the speed of circulation in equity markets. This is proxied by daily turnover, and the strategy has had some of its best days when stock market turnover surpassed $50 billion. The higher the market velocity, the quicker the pairs mean revert, which allows Iskandia to harvest profits more swiftly and then recycle the proceeds into new trades. Historically the transactions costs associated with high portfolio turnover consumed a relatively chunky proportion of returns, which have been 35% since inception in December 2007. Going forward, Iskandia has arranged to receive exchange rebates, which should substantially reduce trading costs. With $20 million of assets in a Cayman fund, Iskandia may be open-minded about acceleration capital deals.

Global Advisers’ principals, Danny Masters and Russell Newton, have spent a generation working together. Trading oil at Shell taught them all about fundamentals and logistics while Phibro was a lesson in speculation, and running J.P. Morgan’s energy prop trading business in the 1990s was an insight into institutional investing. Global Advisers launched a Jersey-based commodity trading programme in 2005 which became fully systematic in 2007. Last year Global Advisers set up a vehicle devoted to China’s 40 or so local commodity futures markets, where turnover has reached a trillion Renminbi a month. Simulations suggest that Global Advisers’ multi-factor models would have worked far better in the Chinese markets – which include futures for plastic, glass and chemical acids – than in western commodity markets. This may be because Chinese commodity markets were historically isolated from western commodity markets, making the mainland markets much less efficient. Global Advisers is establishing joint ventures with a Shanghai-based mainland Chinese company in order to access these markets, and to offer the product to Chinese investors.