Quant world: what next?

I enjoyed a lot reading this Bloomberg article by Justina Lee about the quant fund industry having reached a moment of reckoning. In March 2020 quant funds—with their math-powered rules-based trading strategies—entered into a vicious cycle of selling off securities en masse and causing more market volatility. This event shows that there is something “structurally broken” in the quant world, which is the use of rules-based methods built on historical data. The solution? Either letting humans override models (quantamental) or improving the number crunching techniques such as by using alternative data. Of course, the two paths are not mutually exclusive.

According to Marcos Lopez de Prado—a former quant at AQR Capital Management—systematic traders should leverage machine learning to mine alternative data like image satellites of retailers’ parking lots or email receipts and learn about what Andrew Lo has called ‘adaptive markets’. According to Lopez De Prado, many quantitative firms have suffered losses because they are stuck with forecasting rather than ‘nowcasting’.

Whether one prefers the discretionary quantamental solution or the nowcasting (or a combination of both), we should all set for an organizational culture that encourages the ethical use of algorithmic trading. According to Christian Borch, ten years after the 2010 flash crash we should make sure that quantitative traders learn from algorithmic crashes. Those companies “whose cultures, business models, and algorithmic designs emphasize market integrity offer a way forward in ensuring the health and stability of financial markets.” 

Quant funds might have lost money in March 2020, but someone is flying high in China. High-Flyer Asset Management is combining machine learning with knowledge of local markets to fight competition from US firms such as D.E. Shaw, Two Sigma and BlackRock's quant unit. According to the article, High-Flyer got “more assets last year than the combined collections of the dozens of foreign funds jostling for a piece of the market.” Wow! So much about American funds conquering China.

Let’s end with the latest gossip on Twitter. Nassim Taleb—the author of Black Swan—engaged in an argument with AQR Capital Management’s Cliff Asness. They began to argue about tail-risk hedging and ended up insulting each other at a personal level. However, I think Cliff Asness’ point makes more sense: tail-risk bets—which are investment strategies designed to benefit from ‘black swan’ market events—are often not worth the money spent buying options to hedge against such ‘black swan’ events.