Strategies that will continue to flourish?

bananashit's picture
Rank: Monkey | banana points 35

Hi all,

Curious on your thoughts.. what type of strategies do you envision to be sustainable and successful over the next couple of years? People have talked about how the quant strategies have started to degrade a lot of the alpha from the L/S shops. But what about other discretionary strategies like global macro/event-driven/credit/distressed or any others?

Is the hedge fund industry structurally changing such that it is becoming increasingly difficult to have any sort of edge across all strategies? Apart from quant, what's changed that's made it so much more difficult for hedge funds to make money?

Comments (40)

Dec 19, 2018

We are moving towards a world where all successful HF's (large percentage of overall AUM) will be residing in quantitative HF's. Humans will be irrelevant in the HF space in 25 years when it comes to making real-time decisions (discretionary human decision making).

Quant funds (and exceptional outliers like Warren Buffett-type fund managers) will have their cake and eat it too.

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Dec 23, 2018
kumarraghu:

We are moving towards a world where all successful HF's (large percentage of overall AUM) will be residing in quantitative HF's. Humans will be irrelevant in the HF space in 25 years when it comes to making real-time decisions (discretionary human decision making).

Quant funds (and exceptional outliers like Warren Buffett-type fund managers) will have their cake and eat it too.

Guaranteed written by a kid fresh out of hs.

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Dec 19, 2018

guaranteed written by a guy who knows nothing about the HF industry

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Dec 19, 2018

and has never worked in the HF industry, has probably never made a single dollar in quantitative trading, and should not write such foolish comments. A quick cursory survey of yours posts here shows that you're an Army vet who is an LP in hedge funds - cool bro! You must know so much about the industry man! I mean, I'm sure you've managed other people's money, and I'm sure you know exactly how quant funds are different from non quant funds, and I'm SURE you know that quant funds crossed 1 trillion in AUM for the first time and are eating away at overall AUM growth. I'm sure you know that hedge funds right now are struggling to do well and and are allocating more and more funds towards quantitative strategies (including crowd-sourcing).

I mean, you're an LP and an army vet, that must mean you're an Einstein, right?

/IDontThinkSoBro

maybe stick to what you're good at and don't chime in unnecessarily?

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Funniest
Dec 23, 2018
kumarraghu:

and has never worked in the HF industry, has probably never made a single dollar in quantitative trading, and should not write such foolish comments. A quick cursory survey of yours posts here shows that you're an Army vet who is an LP in hedge funds - cool bro! You must know so much about the industry man! I mean, I'm sure you've managed other people's money, and I'm sure you know exactly how quant funds are different from non quant funds, and I'm SURE you know that quant funds crossed 1 trillion in AUM for the first time and are eating away at overall AUM growth. I'm sure you know that hedge funds right now are struggling to do well and and are allocating more and more funds towards quantitative strategies (including crowd-sourcing).

I mean, you're an LP and an army vet, that must mean you're an Einstein, right?

/IDontThinkSoBro

maybe stick to what you're good at and don't chime in unnecessarily?

How triggered 1-10

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Dec 20, 2018

IMO, there will be two types of funds in the future:
1- Quant/ai only funds
2- human + quant/ai funds

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Dec 19, 2018

Even quant/ai funds, in the current paradigm, have some human decision making going on, although that "human" involvement is going down (which strategies do you pick to trade? Even that is going to eventually be fully automated by hedge funds willing the push the button and differentiate themselves)

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Dec 20, 2018

I don't necesarily agree with the prevailing sentiment here of "L/S Equity is dead, the future is quants". I think what's happening now with the shutdowns is just an issue of a) cyclicality and b) over saturation (these aren't new ideas of mine, others have talked about this before so I won't pretend to take credit). On a), people get complacent in a long bull market with low vol (#shortvix) and don't think 2&20 is worth paying when the best trade is long the indices. On b), there are a ton of funds out there and, as with all markets, when there's decreased demand, supply will decrease shortly thereafter. Judging by this December, I wouldn't be surprised to see L/S come back into vogue over the next few years.

I think it's fair to say quant/ai will play a more prominently role in all strategies going forward, but this is more of a general global trend not specific to the HF industry in my view so not sure why we should be worried about this.

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Dec 23, 2018

It's funny, I just discussing more or less the same question at a dinner with some very smart people. The answer is "depends in what area", but here are a few interesting points that people brought up today:
- besides crowding (which is certainly real), it's possible that the recent underperformance of the HF industry is due to relative lack of volatility. Now that the QE is more or less over, we can probably see some opportunities (as it was phrased, "the oversupply of long vol from the Fed Put is now gone"
- multi-manager model is not really working for most of the industry due to lack of economy of scale and misaligned PM incentives. In the near future we might see a return of single-manager multi-strat funds that are also mixing quant and discretionary under a single roof.
- capacity constrained strategies are very interesting to invest in, but bigger players are finding it hard to attract these managers and so far nobody seen a good model to do so. Larger platforms don't want small PMs due to the netting risk while capacity constrained traders are not willing to work for other PMs due to IP leakage.
- the LS business will gradually shift towards true market neutral approach, since it's not fair to charge investors for access to beta. A lot of managers will not be able to cope.

PS. I am too drunk to sleep :/

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Dec 25, 2018

Can you please elaborate more on these points

Larger platforms don't want small PMs due to the netting risk while capacity constrained

What do you mean by "netting risk" in this context?

capacity constrained traders are not willing to work for other PMs due to IP leakage.

If you are a quant trader working on such a strategy, can't you just wait out your non-compete and then move to the new PM with your own IP ? Or maybe I am missing your point again?

People in 1903 thought horses will always be needed.
Dec 23, 2018
slumbering_programmer:

Larger platforms don't want small PMs due to the netting risk while capacity constrained
What do you mean by "netting risk" in this context?

When you are working for a platform like MLP, you have a contractual payout that is passed-through through to investors. Now imagine that you have 2 PMs, one of whom is up and one of whom is down - the platform has to pay the PM that's up and adsorbs the losses from the PM that's down. If instead you had a senior PM with a large team of traders, the PM does the netting and it's beneficial for the platform. Because of that, most platforms prefer larger PM teams (there are other arguments for it, like the economy of scale etc).

slumbering_programmer:

capacity constrained traders are not willing to work for other PMs due to IP leakage.
If you are a quant trader working on such a strategy, can't you just wait out your non-compete and then move to the new PM with your own IP ? Or maybe I am missing your point again?

Imagine that you have found interesting strategy that can produce up to 5 million a year. You probably want to keep it as hush-hush as possible so your alpha does not decay. If you go to work for another PM, he now knows what you do and even if you leave he can probably continue doing it. So you get fucked from both ends - on one side, you now will have alpha dilution and on the other side you are not making enough money to get paid really well.

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Dec 23, 2018

Illiquid credit. Technically not a hedge fund strat but would be very difficult for this to ever be automated

Most Helpful
Dec 23, 2018

I guess this question really comes down to what you think hedge funds do. Originally, global macro and equity long-short funds had information asymmetries that allowed them to outperform the market (at least at times). I know some excellent stock-pickers, but all of their knowledge can be programmed into an algorithm. Even very traditional l/s guys have invested massively into technology (guys like Maverick, for instance, who essentially had to reinvent themselves to survive). I think that if you want to compete on the quality of your analysis, that's a game a human loses in the near-term to a machine.

I started my career as a global macro trader and got out of the business early precisely because it was a long-term losing gambit. It was clear to me more than a decade ago that I wouldn't make it to 40 before all the macro PMs were put out of business. I still have some friends who trade for top funds, and I wish them luck over the next few years because I don't see a lot of LPs writing checks to open new macro funds 5 years from now, so they need to make their money while they can. As it turns out, being a trader doesn't really prepare you for doing anything else with your career.

That said, there are a lot of dumb LPs. The best talent in finance doesn't generally go into endowment, pension fund, foundation or family office investing. At least, historically, that was the case. We have definitely seen a professionalization of the space over the past decade, but there are plenty of hangovers from the old days whom I wouldn't trust to babysit a box of Fruit Loops let alone my money. The problem is, there is money all over the place. It doesn't just sit in NY, SF, Chicago, etc. There is endowment money in Indianapolis, St. Louis, KC, Omaha, etc. But there aren't a lot of analyst or associate programs or any investment banks in those cities, so there isn't a meaningfully-sized pool of juniors to take up positions within the LP community in those cities, so the institutional investors rely more heavily on investment consultants than they probably should. And those investment consultants aren't exactly top talent either.

One of the guys above mentioned how much of a relationship game the HF space really is. This is true for the vast majority of private investments. It's all about your ability to raise and retain capital. But CIOs aren't placing new money with under-performing managers against the advice of their investment consultants just based on relationships. Track record trumps relationships, and huge swaths of HF strategies have just sucked recently.

The argument used to be that hedge funds generate alpha, outperfoming in all market conditions. That story has morphed, with IR spin doctors now claiming they're 'hedge' funds and that their performance in bull markets might underperform and their performance in bear markets should outperform. But that's not true at most funds. There are loads of funds out there just swinging for the fences, missing, and proving they're really offering levered beta. No one should be paying any sort of management fee for levered beta.

But those same LPs are going to keep trying to beat not just the market, but one another, so they're going to keep trying to pick winners. You see, a lot of their pay packages are not just based on outperformance over some market benchmark, but how they compare to a specific peer group. If you're a not-for-profit hospital endowment, for instance, you're going to be compared against other similarly sized endowments at peer institutions. So long as their asset allocation doesn't materially change, you have little incentive to alter yours because even if you're right, you're not going to get compensated much better than if you're just slightly better than your peers.

While there may be anecdotes of CIOs operating differently, in aggregate, you tend to see their incentive structures more or less play out as I just described, so it may take a decade or more before you really see the death of many strategies. That gives some funds enough time to reinvent themselves and survive. As a result, I don't think it will all be pure quant funds in the future, but all funds are going to be more quantitatively-driven, and the ones that survive will be the ones who have invested and continue to invest in technology.

If you want to work in markets in the future, you'd be far better off getting an engineering, math or physics degree than anything else.

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Dec 23, 2018

most of the comments here are focused on the "asset side" of edge, but the "funding" side is more durable, just like with any bank the best advantage is a great depositor (funding) base. The only enduring edge for any fund or strategy is having permanent capital. The second assumptions most L/S and quant masters of the universe implicitly presume is that alpha comes from being smarter and faster than the next guy in nyc. in reality having an investment culture that emphasizes common sense and being less dumb can be good enough.

Dec 24, 2018

I think for the hedge fund model it's becoming increasingly clear that you need to be the fastest guy. Maybe this year is an outlier but it seems to me simply making smart decisions won't cut it due to the fact that almost all hedge funds run some sort of leverage.

It's the whole drunkenmiller price-signal relationship breaking down.

In two months time it's quite possible that oil is down 50%. Apple is down 50%. Amazon is down 50%. Banks are down 50%.

As I type this all these things are within shouting distance. Now I might agree that these things were too "high".

Any human hedge fund running money leveraged will be getting crushed. Honestly something is deeply wrong with market structure. I think it's coming from quant land. But part of me think quants are pushing out fundamental guys cuz funds guys can't manage risks in this.

Also I think fama-French might be dead. Sort of by the if too many people are watching a signal it becomes meaningless. But I'd have to do more analysis. Strange factor moves all year. And I don't for an instant understand how a momentum factor can work now. Seems like I see stocks that were momentum turn into zeroes in a short time.

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Dec 24, 2018

Shareholder Activism

Dec 27, 2018

I believe event driven investing has a strong future, especially within the healthcare context. Given the highly technical nature of healthcare events (e.g clinical trials - phase II/III outcome based investing), they will not be completely automated in the near future. Sure, data driven statistical analytics will play a greater role in discerning winners from losers but basic scientific research involved in making such trading decisions (e.g disease development pathways, drug mechanism of action, etc) cannot be automated. Thoughts on this?

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Dec 27, 2018

So called "quant funds" are largely just a fad. Just another form of snake oil that the industry is now pushing as it continues to be exposed. Suddenly all the fundamental guys are now "quants."

Don't get me wrong, the Quant funds will dominate the industry, but it's currently a bubble. A lot of these funds will completely bomb when the recession comes.