Readings: Quant funds’ factor models, Renaissance hedge fund, Financial engineers
- Financial News: Quant funds must innovate to regain investor confidence
Sometimes known as “black box” funds, they use computerized programs based on proprietary algorithms – to which even their investors are not privy – to make day-to-day investment decisions. Inside these black boxes are what are called factor models. In the case of equity quants, these pick the stocks to buy and sell based on various complex formulas.
Key characteristics of target companies are weighted, including value, market capitalization, quality, growth and liquidity, as well as price-focused factors such as momentum and reversal – the probability that stocks will bounce back from peaks or troughs.
More and more, though, the models incorporate innovative factors such as mean reversion (to deal with short-term corrections of prices), management behaviour and even press coverage, and are constantly being evolved to stay ahead of the competition.
“August demonstrates what we already suspected – that quant models cannot, whatever their complexity or relevance, adapt to brutal changes in market conditions”.
- Reuters: Renaissance hedge fund: Only scientists need apply (dated)
“We hire physicists, mathematicians, astronomers and computer scientists and they typically know nothing about finance.”
The firm’s scientists tap decades of diverse data in Renaissance’s vast computer banks to assess statistical probabilities for the direction of securities prices in any given market. Experts attribute a breadth of data and the firm’s ability to manipulate it for its consistent success in beating the markets.
“Almost any good viable predictive signal will almost certainly erode over five years,” he said. “You have to keep coming up with new things. The market is working against you.”
- MIT Technology Review: Financial engineers merely keep the markets running
Just as batfish do not construct the reef but are essential to its health, quants do not create the structure financial markets depend on but do preserve the conditions that make markets function. So it would be misleading to suggest that quants were responsible for this summer’s meltdown in the subprime-mortgage market or for the broader troubles that followed (see “The Blow-Up“).
I find it completely appropriate that quants now prefer the euphemism “financial engineer.” They are certainly not “financial architects.” Nor are they responsible for the mess in which the financial world finds itself. Quants may have greased the rails, but others were supposed to man the brakes.
Please share any details on quant engineers & funds in India.
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