Quant hedge fund primer: demystifying quantitative strategies
Quantitative hedge funds are investment firms that use advanced mathematical and statistical models, as well as computer algorithms, to make investment decisions. In this piece we explore quantitative investing and provide insights into the most common quantitative strategies. For each of the quantitative strategies we provide a description, we discuss common signal types and look at how each strategy historically performs in different markets and its historic risk and return profile.
Despite talk of automation it is people that conduct the research, decide on the strategy, select the universe of securities to trade, what data to utilise, what hardware and connectivity is needed, among many other things.
Most common quant strategies
- Equity statistical arbitrage
- Quantitative equity market neutral
- Managed futures/CTAs
- Quant macro
- Alternative risk premia
The above list is far from exhaustive, but these broad category definitions are used by Aurum’s Hedge Fund Data Engine to capture/classify funds in the quant universe. One could also include additional strategy categorisations such as:
- Multi-strategy quant – there are not a large number of peer funds that fall into this category, so funds that trade multiple asset classes and/or combinations of short-term equity statistical arbitrage and longer-term models, are currently classified as ‘statistical arbitrage’.
- Quant volatility – if a fund’s investment premise is to capture shifts in volatility, known as trading volatility, even if this is executed using a quantitative process, this is currently classified as ‘volatility arbitrage’. If the fund is trading volatility in combination with other quant strategies, we typically would group it with ‘statistical arbitrage’.
Risk return summary
|Statistical arbitrage||QEMN||CTAs||Quant macro/GAA||Alternative risk premia|
|Typical assets traded||Equities||Equities||Liquid futures – equity, fixed income, commodities.||Similar to CTAs + cash instruments, bonds, FX, ETFs, Derivatives||Primarily equities, but may also trade some derivatives and instruments similar to quant macro|
|Typical market directionality /neutrality||Primarily market neutral||Primarily market neutral||Generally directional||Generally relative value. Some have directional positions||Generally market neutral long-term (some exceptions)|
|Observed beta to traditional assets (equities and bonds)||Typically very low||Typically very low||Typically low||Typically low||Typically low to moderate|
|Long/short bias||None||None||May be directional but should have no systemic bias to be long or short over the long-term||May be directional but should have no systemic bias to be long or short over the long-term||Typically no bias|
|Historical volatility||Lower volatility than typical HF universe||Lower volatility than typical HF universe||Higher volatility than wider HF universe||Higher volatility than wider HF universe||Potential exposure to large factor moves – can be large/long drawdowns|
|Typical factor exposure||Tightly hedged to generic factors||May be hedged to generic factors, but tends to take specific exposure to certain equity risk premia||Typically highly exposed to momentum||Varied, may be tightly hedged; could have a momentum or value bias||High factor exposure by design. Typical ARP fund looks to offer diversified exposrue to many risk-premia factors|
|Liquidity||Generally highly liquid||Generally highly liquid||Generally highly liquid||Generally highly liquid||Generally highly liquid|
|Leverage||Can vary significantly: typically 3-8x||Can vary significantly: typically 3-8x||Typical 2-4x (with MTE typically 10-30%)||Typical 2-4x (with MTE typically 15-40%)||Varied (typically 1.5 to 2.0x)|
Equity statistical arbitrage
Quantitative equity market neutral (“QEMN”)
Quant macro and global asset allocation (“GAA”)
Alternative risk premia
Computer algorithm – in the context of quant funds, this is a computer program that works through a pre-defined set of instructions (an algorithm) to place a trade. Trading in this way is faster and more frequent than a human could execute.
Signals – Signals in the context of quant hedge funds refer to mathematical models and algorithms that analyse large volumes of financial data to identify patterns and trends. These signals are used to make investment decisions and execute trades.
Nowcasting – the practice of using recently published data to update key economic indicators that are published with a significant lag, such as real GDP. The main purpose of nowcasting is forecasting near-term information flow. Unlike traditional economic forecasting, which relies on historical data and assumes stable relationships between variables, nowcasting seeks to capture the latest information on economic conditions and adjust for potential changes in relationships caused by shocks or structural shifts. Specifically, it is an automated process for predicting what forthcoming data reports may show, based on advanced information and an appropriate dynamic model.
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*The Hedge Fund Data Engine is a proprietary database maintained by Aurum Research Limited (“ARL”). For information on index methodology, weighting and composition please refer to https://www.aurum.com/aurum-strategy-engine/. For definitions on how the Strategies and Sub-Strategies are defined please refer to https://www.aurum.com/hedge-fund-strategy-definitions/
Data from the Hedge Fund Data Engine is provided on the following basis: (1) Hedge Fund Data Engine data is provided for informational purposes only; (2) information and data included in the Hedge Fund Data Engine are obtained from various third party sources including Aurum’s own research, regulatory filings, public registers and other data providers and are provided on an “as is” basis; (3) Aurum does not perform any audit or verify the information provided by third parties; (4) Aurum is not responsible for and does not warrant the correctness, accuracy, or reliability of the data in the Hedge Fund Data Engine; (5) any constituents and data points in the Hedge Fund Data Engine may be removed at any time; (6) the completeness of the data may vary in the Hedge Fund Data Engine; (7) Aurum does not warrant that the data in the Hedge Fund Data Engine will be free from any errors, omissions or inaccuracies; (8) the information in the Hedge Fund Data Engine does not constitute an offer or a recommendation to buy or sell any security or financial product or vehicle whatsoever or any type of tax or investment advice or recommendation; (9) past performance is no indication of future results; and (10) Aurum reserves the right to change its Hedge Fund Data Engine methodology at any time and may elect to supress or change underlying data should it be considered optimal for representation and/or accuracy.
This Post represents the views of the author and their own economic research and analysis. These views do not necessarily reflect the views of Aurum Fund Management Ltd. This Post does not constitute an offer to sell or a solicitation of an offer to buy or an endorsement of any interest in an Aurum Fund or any other fund, or an endorsement for any particular trade, trading strategy or market. This Post is directed at persons having professional experience in matters relating to investments in unregulated collective investment schemes, and should only be used by such persons or investment professionals. Hedge Funds may employ trading methods which risk substantial or complete loss of any amounts invested. The value of your investment and the income you get may go down as well as up. Any performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable indicator of future results. Returns may also increase or decrease as a result of currency fluctuations. An investment such as those described in this Post should be regarded as speculative and should not be used as a complete investment programme. This Post is for informational purposes only and not to be relied upon as investment, legal, tax, or financial advice. Whilst the information contained in this Post (including any expression of opinion or forecast) has been obtained from, or is based on, sources believed by Aurum to be reliable, it is not guaranteed as to its accuracy or completeness. This Post is current only at the date it was first published and may no longer be true or complete when viewed by the reader. This Post is provided without obligation on the part of Aurum and its associated companies and on the understanding that any persons who acting upon it or changes their investment position in reliance on it does so entirely at their own risk. In no event will Aurum or any of its associated companies be liable to any person for any direct, indirect, special or consequential damages arising out of any use or reliance on this Post, even if Aurum is expressly advised of the possibility or likelihood of such damages.
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