Friday, August 20, 2010

A rising tide floats all boats

Interesting that the Quant funds are not doing that well these days. It would appear that too much money went into Quant funds chasing a return the same way that money went into the VC funds with that space not able to deliver the returns promised either.


Shrinking ‘Quant’ Funds Struggle to Revive Boom

They were revered as the brightest minds in finance, the “quants” who could outwit Wall Street with their
Theodore Aronson, a quant fund manager in Philadelphia, has seen his firm’s assets fall by $12 billion since spring 2007.
But after blundering through the financial panic, losing big in 2008 and lagging badly in 2009, these so-called quantitative investment managers no longer look like geniuses, and some investors have fallen out of love with them.
The combined assets of quantitative funds specializing in United States stocks have plunged to $467 billion, from $1.2 trillion in 2007, a 61 percent decline, according to eVestment Alliance, a research firm. That drop reflects both bad investments and withdrawals by clients.
The assets of a broader universe of quant hedge funds have dwindled by about $50 billion. One in four quant hedge funds has closed since 2007, according to Lipper Tass.
“If you go back to early 2008, when Bear Stearns blew up, that’s when a lot of quant managers got blown out of the water,” said Neil Rue, a managing director with Pension Consulting Alliance in Portland, Ore. “For many, that was the beginning of the end,” he added. Wall Street’s rocket scientists have been written off before. When the hedge fund Long Term Capital Management nearly collapsed in 1998, for instance, some predicted that quants would never regain their former glory.
But this latest setback is nonetheless a stinging comedown for the wizards of high finance. For a generation, managing a quant fund — and making millions or even billions for yourself — seemed to be the running dream in every math and physics department. String theory experts, computer scientists and nuclear physicists came down from their ivory towers to pursue their fortunes on Wall Street.
Along the way, they turned investment management on its head, even as their critics asserted they deepened market collapses like the panic of 2008.
Granted, Wall Street is not about to pull the plug on its computers. To the contrary. A technological arms race is under way to design financial software that can outwit and out-trade the most sophisticated computer systems on the planet.
But the decline of quant fund assets nonetheless runs against what has been a powerful trend in finance. For a change, flesh-and-blood money managers are doing better than the machines. Much of the money that is flowing out of quant funds is flowing into funds managed by human beings, rather than computers.
Terry Dennison, the United States director of investment consulting at Mercer, which advises pension funds and endowments, said the quants had disappointed many big investors. Despite their high-octane computer models — in fact, because of them — many quant funds failed to protect their investors from losses when the markets came unglued two years ago.
And many managers who jumped into this field during good times plugged similar investment criteria into their models. In other words, the computers were making the same bets, and all won or lost in tandem.
“They were all fishing in the same pond,” Mr. Dennison said.
Quant funds are still struggling to explain what went wrong. Some blame personnel changes. Others complain that anxious clients withdrew so much money so quickly that the funds were forced to sell investments at a loss.
Still others say their models simply failed to predict how the markets would react to near-catastrophic, once-in-a-lifetime financial events like the credit crisis and the collapse of Lehman Brothers.
“It’s funny, but when quants do well, they all call themselves brilliant, but when things don’t go well, they whine and call it an anomalous market,” said Theodore Aronson, a quant fund manager in Philadelphia whose firm’s assets have dropped to $19 billion, from $31 billion in the spring of 2007.
But Mr. Aronson, who has been using quantitative theories to invest since he was at Drexel Burnham Lambert in the 1970s, said investors would eventually return.
“In the good years, the money rolled in, so I can’t really complain now about the cash flow going out,” Mr. Aronson said. “If somebody can give me proof that this is a horrible way to invest, then I’m going to get out of it and retire.”
Still, some of the biggest names in the business are shrinking after years of breakneck growth. During the last 18 months, assets have fallen at quant funds managed by Intech Investment Management, a unit of the mutual fund company Janus; by the giant money management company Blackrock; and by Goldman Sachs Asset Management.
Even quant legends like Jim Simons, the former code cracker who founded Renaissance Technologies, have seen better days.
Mr. Simons was celebrated as the King of the Quants after his in-house fund, Medallion, posted an average return of nearly 39 percent a year, after fees, from 2000 to 2007. It was an astonishing run rivaling some of the greatest feats in investing history.
But since then, investors have pulled money out of two Renaissance funds that Mr. Simons had opened during the quant boom. After losing 16 percent in 2008 and 5 percent in 2009, assets in the larger of the two funds have dropped to about $4 billion from $26 billion in 2007. (That fund is up about 6.8 percent this year, compared with a loss of about 3 percent marketwide.)
In an effort to woo back investors, some quants are tweaking their computer models. Others are reworking them altogether.
“I think it’s dangerous right now because a lot of quants are working on what I call regime-change models,” or strategies that can shift suddenly with the underlying currents in the market, said Margaret Stumpp, the chief investment officer at Quantitative Management Associates in Newark. The firm has $66 billion in assets under management, and its oldest large-cap fund has had only two down years — 2001 and 2009 — since opening in 1997.
“It’s tantamount to throwing out the baby with the bathwater if you engage in wholesale changes to your approach,” Ms. Stumpp said.
But many quants, particularly late arrivals, are hunting for something, anything, that will give them a new edge. Those who fail again may not survive this shakeout.
“What we’re seeing is that not all quants are created equal,” said Maggie Ralbovsky, a managing director with Wilshire Associates, which gives investment advice to pension funds and endowments.
A version of this article appeared in print on August 20, 2010, on page B1 of the New York edition.

An Interesting article that describes how Commodity markets are manipulated.

On the back of the articles that I have posted previously discussing manipulation of sugar, oil and cocoa, this article describes manipulation in the metals market and investigations that the regulators have begun. Aivars


Wild Trading in Metals Puts Fund Manager in Cross Hairs

Christopher Pia was the quintessential hedge-fund success story: a hard-charger from a working-class New York City neighborhood whose trading prowess earned him a top job at fund giant Moore Capital Management. He bought a sprawling house in Armonk, N.Y., and tooled around town in an orange Lamborghini.
Heather Johnson/Redux
Christopher Pia left Moore Capital during a probe by regulators.
But his 18-year relationship with Moore Capital and its founder, hedge-fund tycoon Louis Bacon, came to an abrupt end in late 2008. Mr. Bacon forced out his onetime head trader, friend and protégé, and Mr. Pia launched his own fund.
The story behind the rupture is only now surfacing, and it involves allegations of a kind of improper trading that regulators worry is becoming more widespread. The Commodity Futures Trading Commission is investigating whether Mr. Pia's trading at Moore involved market manipulation, according to a person close to the situation. Specifically, CFTC investigators are looking into whether Mr. Pia improperly tried to push up prices of platinum and palladium, possibly to boost Moore's returns and his own compensation, this person says.
In late April, the CFTC filed a civil complaint against Moore claiming that an unnamed former portfolio manager attempted to manipulate prices in the futures markets. People familiar with the case say the former manager is Mr. Pia. Moore paid a $25 million fine to settle the matter, without admitting or denying wrongdoing, but the investigation of Mr. Pia is continuing. A spokesman for Mr. Pia declined to comment.
The hedge-fund industry has been rocked over the past year by allegations that fund managers reaped illegal profits by trading stocks based on inside information. The investigation of Mr. Pia and the case against Moore suggest that commodities trading also can be an insiders game—a market where big investors may be able to throw their weight around to move prices to their advantage.
Prices in the futures markets for commodities help determine how much consumers pay for everything from a carton of orange juice to a gallon of gas. Cases involving investors trying to artificially move commodities prices are nothing new. But abusive trading practices have become more prevalent, says Bart Chilton, a CFTC commissioner, because regulators, until recently, have lacked the tools needed to aggressively go after and punish wrongdoers.
Over the long term, supply and demand dictates prices in the commodities markets. What concerns regulators, for the most part, are efforts to move prices over the short term. The growing number of large investors speculating in commodities has created "aberrations" that can present the "opportunity for foul play," says Mr. Chilton.
The recently enacted financial-reform bill, Mr. Chilton says, will give the CFTC more enforcement tools to pursue more cases involving disruptive trading practices in the commodities markets, and to levy stiffer penalties.
One way investors bet on commodities is through the futures market, where they enter into contracts to buy or sell raw materials at a set price on a specified date. In its complaint against Moore, the CFTC said the unnamed portfolio manager engaged in a practice known on Wall Street as "banging the close." That involves trying to move the price of futures contracts by inundating the market with orders just before trading ends.
Moore's aim, the CFTC said, was to push up prices of platinum and palladium futures contracts. The CFTC didn't say why the unnamed trader engaged in the alleged behavior, or whether Moore or the trader made money on it. If Mr. Pia was banging the close, it could have lifted the value of his existing portfolio of futures trades, which in turn might boost his compensation, according to people close to the situation.
Moore also settled charges that it failed to properly supervise its trading operations. In a statement, Moore said no one else has "been accused of any wrongdoing" in the matter. Mr. Bacon declined to comment.
Zuma Press
Louis Bacon
The regulatory action was a black eye for Mr. Bacon, who has a long track record of heady returns and has appeared on published lists of the highest-paid people on Wall Street. It came on the heels of another unwelcome incident. In March, a Moore trader in London was arrested by British authorities for alleged insider trading. Moore said it doesn't believe any funds managed by Moore are involved in that matter.
Mr. Pia, 44 years old, grew up in the Astoria neighborhood of Queens and met Mr. Bacon when both were working at Shearson Lehman Brothers. When Mr. Bacon, 54, launched Moore Capital in 1990, he asked Mr. Pia to join.
Moore is a "macro" hedge fund, making broad bets on the economy and the markets by trading in commodities, currencies and various securities. The fund company grew rapidly and now manages roughly $15 billion. Mr. Pia eventually oversaw its trading operations.
Mr. Pia liked to tell colleagues about his modest upbringing, and that he is a devout Catholic. He complained about hedge-fund managers he considered elitist. On the trading floor, he often twirled a string of rosary beads. Callers to his cellphone heard the Batman theme song.
Moore's success turned Mr. Bacon into a billionaire. From 1990 through last year, Moore's flagship fund notched an average annual return of 20.5%, after fees.
Mr. Bacon bought a house in London with a squash court, another in the Hamptons with a polo field and a golf-driving range. He had homes in Manhattan, Paris and the Bahamas. He and Mr. Pia would go duck hunting together on a 145-acre island Mr. Bacon bought off the coast of Long Island.
At Moore, Mr. Pia had enormous amounts of capital at his disposal, and he was known to deploy it in complex trading maneuvers.
In 2008, for example, Mr. Pia entered into a trade under which Moore would get a $25 million payout if the New Zealand dollar rose to a certain level. Goldman Sachs Group Inc. was on the hook to make the payout. If that level wasn't hit, Moore stood to lose $1 million.
As the trade's expiration date approached, the New Zealand dollar was trading about 25 cents below the price at which the contract would pay out. Mr. Pia got clearance from top Moore officials to spend billions buying New Zealand dollars, hoping the currency would hit the set price, according to the person with knowledge of the trade. Fifteen minutes before the contract expired, Mr. Pia began buying billions of New Zealand dollars, lifting the currency to the price at which Moore was able to collect the $25 million, the person says.
Gary Cohn, Goldman's president, later congratulated Mr. Pia on the trade, the person says.
A spokesman for Moore declined to comment on the matter.
Over the years, there have been several notable cases of attempted manipulation of the commodities markets. In the 1980s, regulators accused the brothers Nelson Bunker and William Herbert Hunt of attempting to corner the silver market. In 2007, the CFTC charged the now defunct hedge fund, Amaranth Advisors, with attempted manipulation in the futures market for natural-gas contracts. That case remains unresolved.
"As you get down the scale to commodities like palladium, futures markets are almost by definition less liquid and more susceptible to this kind of conduct," says Scott Early, a securities lawyer and former general counsel of the Chicago Board of Trade. But it becomes easier for regulators to catch such activity in thinly traded markets, he says.
Closing prices in futures markets are set differently than they are in the stock market, where they are determined by the last trade each day, at 4 p.m. In the futures market, the "settlement," or closing price, is the weighted average of all trades during the last few minutes of trading. For palladium, for example, the "closing period" is from 12:58 to 1 p.m., and for platinum, it is 1:03 to 1:05 p.m.
Traders can push settlement prices around by inundating the market with orders during the last two minutes of trading. Trying to push prices higher in that way—banging the close—is in some cases considered market manipulation under commodities laws. It is loosely akin to an illegal stock-market practice known as "pump and dump," where traders push up the price of thinly traded stocks by disseminating misleading information, then sell shares before the price falls again.
In 2008, several traders complained to the New York Mercantile Exchange about someone entering the market near the close and aggressively buying platinum and palladium futures contracts, two people familiar with the matter say. Around the same time, the CFTC began detecting unusual trading patterns in the two markets. CFTC enforcement lawyers began questioning Mr. Pia about his trading, says one of the two people.
The CFTC complaint against Moore doesn't specify the day or days on which the trades in question took place, nor does it disclose whether Mr. Pia was the trader involved.
Often, at 12:58 p.m., two minutes before the close of the palladium market, the unnamed trader—Mr. Pia, according to people familiar with the matter—or an associate would send instant messages to a trader in that market with "directions that indicated that he wanted to push prices higher," according to the CFTC complaint. That trader waited until the last 10 seconds of trading to relay the high-priced orders to a floor clerk in the trading pit of the New York Mercantile Exchange, the complaint said. Moore sometimes repeated the sequence during the closing period for platinum futures, the complaint said.
Fewer than 10 traders typically participate in the thinly traded market for palladium, the CFTC said, and the Moore trades accounted for most of the volume in the two markets during the closing period.
In a series of interviews, CFTC investigators asked Mr. Pia whether he intended to push prices higher through the trading in question, according to one person familiar with the matter. Mr. Pia denied doing anything wrong. He admitted to waiting until the last minute to place the orders, but said he simply was buying what the floor traders were selling and the market would go up, this person says. Mr. Pia said his last-minute timing was intended to thwart rival traders who often would try and buy ahead of Moore's orders, this person says.
The ongoing CFTC investigation is looking into whether Mr. Pia tried to boost his compensation through the trades in question, according to a person familiar with the investigation. Among the questions being examined by the CFTC is whether Mr. Pia was trading ahead of Moore's commodities orders through a portfolio he managed within the firm, possibly in an effort to increase his pay, this person says. Such tactics can give traders an unfair advantage because pending orders—which aren't known to the public—can affect prices when executed.
Mr. Bacon grew concerned about Moore's liability in the matter, according to another person familiar with the matter. Soon, Mr. Pia left the firm.
A Moore spokesman declined to comment on the firm's commodities positions. He said Moore has "been unable to ascertain any economic motive for the end-of-day platinum and palladium futures trading as described in the CFTC order. The trading did not result in any artificial price or any improper gain or loss."
The month after it settled the case, Moore's flagship fund notched its largest monthly loss ever, dropping 9.2% in May. It is down 4.46% for the year, through Aug. 5, in part because of misjudgments concerning the financial turmoil in Europe.
After leaving Moore, Mr. Pia launched Pia Capital Management. Like his former employer, it is a "macro" hedge fund. The new fund, headquartered in Greenwich, Conn., has about $500 million under management, and is down 0.6% for the year, through Aug. 6. There are no indications that his new fund is under investigation.
Write to Susan Pulliam at