I’ve recently been working-on and trading an equity strategy that has some great characteristics and some interesting challenges. The great characteristics revolve around its profitability, volatility and simplicity. The challenges start with the fact that the strategy generates alpha on the short side – thus, you are intrinsically swimming against the tide and can conceivably be ruined in a hurry. Your broker might also be unable to find inventory to short. Other challenges include the native capacity of the strategy – it’s not fundamentally scalable as a strategy and only a relatively small amount of money could be put against it without incurring increasingly onerous costs and risks. In any case, it’s been a fun strategy to develop as it’s an interesting puzzle and it makes money.
Discussing the strategy recently with a potential client, they observed that such a strategy wouldn’t be acceptable within their environment (apart the capacity issues) as their risk management practices required all strategies to maintain dollar neutrality – for any dollar of x that they used to buy something, they needed to sell a dollar of y. This led to an interesting experiment for me, the results of which I share with you below.
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performance analysis, portfolio management, strategy development
I’m very pleased to present our first guest blogger to this space – Scott Johnston. Scott’s an experienced hedge fund exec who’s currently a PM and principal at the
Belstar Group, an asset allocator and fund-of-funds. This post has been excerpted, with permission, from his monthly newsletter. Contact him at sjohnston {AT} belstargroup [DOT] com.
The biggest single impediment I see for investors contemplating an investment into hedge funds is “blow up” risk. How can they think otherwise, with all the hype? The media enjoy little more than the self-immolation of a hedge fund – Rich Guys Get Theirs! Blow-ups score a 10 on the CNBC schadenfreude scale. (Note: for institutional investors, blow up risk translates more specifically into “headline risk,” which is basically the risk of losing one’s job if a hedge fund you invested in ends up in the papers for the wrong reason.)
How common are hedge fund blow-ups? How often do they happen? What do they do to returns? These are questions I wanted to get to the bottom of.
Fishing around, I found surprisingly little research on the subject, so I thought it might be useful to conduct a survey of our own. Specifically, we will look at hedge fund blow-ups through the years to see what kind of conclusions we can draw. For the sake of argument, we will call anything greater than a 50% loss a blow-up.
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books, guests, hedge funds, portfolio management
He didn’t look like much, but old Rocky Marciano put his back into every awkward punch he threw. More remarkably, he remains the only heavyweight champion to have ever been smart enough to get out of the game on top. He was that rarest of characters – a winner who knew when to engage and when to step away.
I’ve written a good deal about losers and ideas that might not yield the results one’s looking (hoping) for, but I haven’t written too much about life’s winners. This, of course, is absolutely par for the course amongst traders. People aren’t in the habit of giving away trade secrets, leaving sums of money on the sidewalk or revealing their trading strategies. When they do (or claim to) is likely a good time to keep an especially watchful eye on your possessions…
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back-testing, performance analysis, portfolio management, strategy development
This week I attended another of the excellent quant seminars I’ve written about before. This time the talk was about stochastic modeling of equity markets and was presented by Robert Fernholz of Intech. Intech is evidently a subsidiary of Janus which manages some large amount of money presumably based on some of the portfolio management theory on which Dr. Fernholz is an expert. If you visit their site, you’ll be greeted by a bigger version of their credo which I’ve, um, honored as this post’s banner: “Math is power.”
Right then. While Mao would likely have been capable of convincing me otherwise, it’s probably best for everyone involved that portfolio managers are running around with esoteric mathematical models rather than the sorts of munitions favored by 20th century Chinese revolutionaries…
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events, monte-carlo methods, portfolio management
This past week I had the opportunity to see MIT’s Professor Andrew Lo present his paper “What Happened to the Quants In August 2007?” as part of the seminar series on quantitative finance presented by NYU and Columbia and sponsored by BlackRock and other relevant institutions. If you’re in the NYC area and interested in such things, I recommend attending any lectures which might capture your fancy.
I had read his paper some time back and implemented, within the Puppetmaster environment, the mean-reversion trading strategy he used as a microscope into what transpired last August. I was interested to see him speak as he’s a seminal thinker on hedge funds and quantitative finance, but also because the strategy he described works pretty well and I thought he might hint at various improvements.
I’ve stolen a line from his paper to serve as the title of this post as it captures one of the central dilemmas faced by algorithmic traders.
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events, performance analysis, portfolio management, strategy development
