By Dan Wilchins
NEW YORK, Aug 13 (Reuters) – Quantitative trading strategies turned in a good performance on Friday, potentially reversing up to 70 percent of the decline from the previous four days last week, said Matthew Rothman, global head of quantitative equity strategies at Lehman Brothers.
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But Rothman, speaking on a conference call, said further wide swings in financial markets were likely and that quantitative fund managers, who control more than $1 trillion of assets, need to adjust their models.
The improving performance on Friday was a glimmer of positive news for “quant funds,” which have suffered big losses in recent weeks as the widening subprime crisis has battered equity markets in unexpected ways.
Earlier on Monday, Goldman Sachs Group Inc
Friday’s improving markets do not mean that quantitative funds took back 70 percent of their losses from earlier in the week. The funds’ leverage may have magnified losses when the strategies were losing money.
As funds pared back their borrowings to reduce risk, the lack of leverage may have tempered their gains on Friday, said a fund manager who asked not to be named.
Difficulty for quantitative hedge funds began as multi-strategy funds lost money in their credit portfolios, and sold liquid stocks to raise cash, Rothman said. That created unusual patterns in stock price movements, making the most common strategies for quantitative funds perform poorly.
For example, hedge funds using quantitative strategies might look at the ratio of stocks’ operating earnings to enterprise value, and use that combined with recent share price movement to determine which shares are the most attractive.
But with recent share movements knocking valuations out of traditional ranges, quant funds’ strategies were not working as well, so they pared down positions and the selling snowballed.
Central banks globally began pumping money into the financial system on Thursday, with the U.S. Federal Reserve doing so on Friday and again on Monday.
RETOOLING MODELS
The fact that global pressure on stocks led so many quantitative funds to lose money suggests funds are making too many trades that are too similar to one another, Rothman said.
“There is something breaking down, and we need to rework our models, and adjust strategies that are too correlated,” Rothman said.
With the weakness in quantitative returns evidently driven by market movements instead of more fundamental economic reasons, it may make sense to add exposure to the sector, but there may be some more wild market movements ahead, he said.
“Is this a train you want to step in front of? Perhaps, but with caution,” Rothman said.
A series of hedge funds have turned in declines for the year, including Goldman’s Global Alpha fund and North American Equity Opportunities fund, and the $26 billion Renaissance Institutional Equities Fund.
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