Glitchy coronavirus markets cause quant funds to misfire

Some of the best-known computer-powered hedge funds have struggled to adjust to the chaotic markets rocked by the coronavirus, with Renaissance Technologies, Two Sigma and DE Shaw seeing some of their biggest funds hurt this month. 

So-called quantitative funds rely on high-powered computers, vast data sets and algorithms to systematically exploit patterns in securities prices. Their success has spawned a multitude of copycats and led many traditional investment groups to try to emulate their techniques. DE Shaw, Two Sigma, and Renaissance — considered the gold standard of quant funds — now manage close to $200bn combined.

But the ferocity of the recent market turmoil has inflicted some painful losses, forcing many quants to ratchet back their positions. One big investor in hedge funds described the numbers from his quant portfolio as a “disaster”, while some say the setbacks resemble a “quant quake” — a reference to a brief but traumatic period for the industry in August 2007.

Credit Suisse estimates that quant funds as a whole have nearly halved the size of their positions since the beginning of the month, and that the average quant fund has lost 14 per cent this year. “This rapid unwind is indicative of the magnitude of the broader shift in attitude towards the economic fallout from Covid-19,” the bank’s hedge fund desk said in a note to clients on Sunday.

“There are weeks when risk becomes difficult to manage,” said Mark Connors, global head of risk advisory on Credit Suisse’s prime services desk. “Most funds have had a tough period with both longs and shorts in this environment.” 

Renaissance, one of the industry’s most fabled names, has seen losses deepen lately. Its flagship Renaissance Institutional Equities fund, which tends to have mostly long positions, has dropped 18 per cent in March, increasing its year-to-date fall to 24 per cent, according to people briefed on the numbers. Renaissance’s Institutional Diversified Global Equity fund is down 15.8 per cent for the year, as of Friday.

The Long Island-based group, founded by the mathematician and former codebreaker Jim Simons, has during the past two decades notched up an enviable record of performance. Its flagship Medallion fund was so successful it kicked out external investors in 2005, and has since restricted itself to managing the money of Renaissance’s own executives. Mr Simons last year said that Medallion had delivered an annual average return of about 40 per cent since 1988, net of fees.

Two Sigma has also found the environment unusually tricky. Its flagship Spectrum fund is down close to 2 per cent for the year, according to a source familiar with the results. But its “global macro” Compass fund has fared worse and is down 13 per cent as of Friday, while its Absolute Return fund has lost 3 per cent.

Two Sigma was founded in 2001 by computer scientist David Siegel and mathematician John Overdeck, who met while working together at DE Shaw (where they overlapped with Amazon founder Jeff Bezos). Although a younger company than Renaissance and DE Shaw, Two Sigma has grown rapidly over the past decade and is widely considered to be at the cutting edge of the systematic investment industry.

Meanwhile, DE Shaw’s main fund Composite — which has suffered just one down year during the past two decades — lost 2.6 per cent in the month to last Friday, tipping it into negative territory for the year.

The New York group’s global macro fund Oculus has dipped 0.8 per cent this month, but remains an outlier in the hedge fund world with a 2.5 per cent gain so far in 2020. But the early-year resilience of DE Shaw’s pricey “statistical arbitrage” hedge fund Valence faded during last week’s extreme volatility. It has now fallen more than 9 per cent for the month and is down 4.6 per cent for the year. 

The fact that even Valence has been hit highlights how markets have become increasingly treacherous. Valence charges a 3.5 per cent fee for assets it manages and takes 35 per cent of the profits it generates, nearly treble the industry average. 

Statistical arbitrage — systematically exploiting small but reliable relationships in markets — was DE Shaw’s first strategy when it was started by computer scientist David Shaw in 1988. The company ranks as the fifth-highest returning hedge fund of all time, according to an annual ranking by LCH Investments.

The trio’s performance may still be broadly better than the quant industry average, yet is a reversal in fortune from previous bouts of volatility that the group has largely managed to navigate. For example, the flagship investment vehicles of Renaissance, Two Sigma and DE Shaw all notched up big gains in 2018 despite choppy conditions that year.