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Quant funds in turmoil

With the losses recorded by one fund of top quant manager, Renaissance Technologies, and three other funds of Goldman Sachs, the quantitative management industry might be facing its first real crisis.

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Based on highly secret mathematical models and a staff composed of the most brilliant mathematicians and physicists in the world, Renaissance Technologies is probably the best hedge funds of all time.

With more than 35.5% of annual returns since 20 years, its flagship fund -the Medallion fund- has made the success of Renaissance Technologies and its founder Jim Simons, who is now one of the richest men in the world with a total income above $ 1.5 billion in 2006.

However, the "subprime" crisis has somewhat affect negatively the firm image. One of its funds, the Renaissance Institutional Equities Fund lost indeed more than 9% in August; the firm estimates however “to have suffered from fire-sales of long-short quantitative hedge funds".

Actually, Renaissance Technologies is not the only fund in such a situation. Several other quantitative funds, including Tykhe Capital, Highbridge and Barclays Global Investors also experience difficulties. But the most spectacular case is probably Goldman Sachs’ fund.

The top investment bank has been forced to use up to $3 billions to bail out its Global Equity Opportunities Fund and claimed not to liquidate the two others equity funds in turmoil, Global Alpha and North American Equity Opportunities. Global Alpha has lost nearly 30% since the beginning of the year, half of this loss accounting for the month of August.

The U.S bank had invested up to $ 30 billion in hedge funds over the past decade and now is truly facing a tough period: few millions dollars were invested in the Amaranth fund, which went bankrupt in 2006. The top management of the bank believes that many quant funds are in trouble and said that "several factors such as volatility, have raised concern over most of the algorithms used in quantitative strategies”.

This statement may raise some questions. On one hand, models and systematic trading systems are supposed to provide with enhanced decorrelation to markets and a protection against "emotional behaviour" of traders during crisis. On the other hand, liquidity risk is well known and widely taken into account in top managers’ risk management. So how can we explain these double-digit losses posted by most quantitative funds?

According to Fabiano Duarte, a former fund manager, “As the models were designed to detect market phenomenons such as mean-reversion, correlation or volatility arbitrages, automated trading systems continued to trade while the market as whole was in panics. In normal market condition, these bets would have been winning bets but, in this specific scenario, they have actually largely underperformed. Mean-reversion turned out to be trend acceleration". However, he adds, "we must not throw the baby out with the bathwater, it is still too early to put quantitative management on trial. We should wait until the end of the year to make a first assessment".

Moreover, in a letter to its investors, Renaissance Technologies says that its models has detected "very promising new signals" that would allow the fund to achieve attractive returns in the long term.

Goldman Sachs believes that the mark-to-market values of assets of various funds show a discount unexplained by fundamentals and the $3 billion invested in the fund should enable it to take advantage of opportunities that exist in current market conditions.

Yann Olivier , August 2007

Article also available in : English EN | français FR

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