Will a FinTech startup backed by $250m from Steve Cohen outcompete "old style" hedge funds?

The evolution of the multi-manager hedge fund model & the hidden risks of quants

The criticism of hedge funds has been prevalent for the past few years, but 2016 has certainly been the “what gives” year. Many point to the level of dispersion in the market and then ask, “Isn’t that great for stock pickers? Why aren’t hedge funds picking up on this?”

However, when you take a closer look you will find that while there is high dispersion, there is narrow breadth . We’ve all heard the acronym FANG – and there was a Friday in October 2015 where these four stocks single-handedly added the equivalent of McDonald’s market cap to the exchange. So, unless you have participated in a select handful of names, it’s very difficult to keep up with the market.

Interest rates obviously are at lows while equity markets are at highs and continue to grind higher despite a number of global risks on the horizon. This produced an environment where hedge fund managers in general don’t want to load up and take a lot of risk, and yet the market has continued to climb higher. To be fair, this isn’t an environment where seasoned investors expect hedge funds to outperform . However, some hedge fund strategies were able to perform, and managers are trying out different ways to innovate.

Quantopian is a community of over 90,000 quants from 180 countries, who come to this online platform to research, simulate, and implement quantitative trading strategies. These quants have already produced hundreds of thousands of independent strategies on the platform. The firm, which recently got a capital allocation from Steve Cohen’s Point72 of up to $250 million, views the hedge fund business and particularly the quantitative investment business as a production problem.

Inefficiencies come along and they live for a while, and then they die, and the problem with the traditional hedge fund business is that this timeframe has become very compressed. It has therefore become very difficult to operate in a traditional setting as an allocator, because the efficiencies that a single manager might be able to exploit could be gone in six months, in a year, or in two . From this perspective, the limiting input to that production problem is research effort.

So far, the largest multi-manager hedge funds might have something on the order of 200 line items in the P&L, and this is how they achieve scale. Quantopian has been conceived as a tech startup and it could theoretically have thousands of line items in the fund and potentially achieving much larger scale and capacity than the largest traditional-multi managers. Right now, quantitative strategies are still a small percentage of overall equity hedge fund AUM. But if we include things like alternative betas and risk premium strategies, one concern is that it may just take a tiny little wobble in momentum as a risk factor in the beginning of the year to torpedo a number of these quant models.

The hedge is down in Germany as market opens for fund promoters

Metaphorically, the hedge is coming down in Germany, because from 1 January 2018 any type of regulated fund, whether it’s a Peruvian, Chinese or US fund, whatever the strategy , can be sold much easier to German investors. Germany’s public pension system is not capitalfunded but a rollover system, and approximately one-third of these overall payments are funded by the government. Many experts believe this system is not sustainable in the long term, so there is a pronounced need for good investments for (and new distribution options to) the 80 million Germans.

The Opalesque 2016 New York Roundtable, sponsored by SocGen Prime Broking and WTS Tax Legal Consulting, took place with the following experts:

Katherine Grant, Head of US Equity Research, LGT
Darren Wolf, Head of Hedge Funds, Americas, Aberdeen Asset Management
Jonathan Larkin, CIO, Quantopian
Thijs Hovers, Partner & fund manager, Lucerne Capital Management
Alain Courbebaisse, Head of Prime Clearing Services Americas, SocGen
Ted O'Connor, Director Prime Clearing Services, SocGen
Steffen Gnutzmann, Partner, WTS Tax Legal Consulting

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