If you have bought into our arguments that the capacity of alpha is finite and that the leading managers of automated trading methods can achieve “winner-take-all” performance characteristics in the sources of alpha that they target, then it stands to reason that the causes for where assets are concentrating and which funds are closing are related. Without even looking at track records, these two facts lead to the conclusion that systematic strategies are more consistent than, and therefore, winning a battle over allocations to traditional, fundamentally-oriented and “manual” strategies in modern markets.
Something amazing – and, potentially terrifying – is happening at the crossroad of asset management and global markets. The drumbeat of clues in support of this theme is increasing and those observers with keen insights into market dynamics are beginning to notice. Alphacution has played a small role in giving voice and illustration to this theme by placing a bow around a unique interpretation of unprecedented market phenomena worth paying attention to, most relevantly to this part of the story in our recent salvo, When Market Makers Ate Their Own.
However, despite the sounding of warning bells, the picture of what is happening is difficult to bring into focus. Because, when you are trying to predict the timing and impact of milestones for a slowly melting glacier, almost all of us lack the attention span and wide-lens perspective to appreciate the subtle signals beyond an occasional spark of gut instinct.
Yes, factors like volatility, interest rates, liquidity, and securities inventories – among others – have been key drivers in shaping the positioning of strategies and players on the global asset management “map” -which Alphacution broadly defined to include hedge funds and market makers in its recent study, The Context Machine.
But factor analysis and impacts is not what we are getting at here. What we are getting at here is the impact of strategy automation, its role in fostering persistent discovery and capture of alpha, and the rising dominance of systematic hedge fund managers.
The success and mythology of “quant” fund managers is not new by any stretch, as some of the legends in this category have been in operation for decades; some of which having risen to god-like prominence over the last decade or two. The oldest – and largest – of these (and all other hedge funds, for that matter) is Ray Dalio’s Bridgewater Associates, founded in 1975. Jim Simons’ Renaissance Technologies was founded in 1982.
What is new here is their level of dominance in the segment of Alphacution’s asset management map called the “relative value zone” where, unlike the neighboring zones, the primary objective is to optimize the balance of assets under management (AUM) and performance – a goal that requires a very specific and quantitative approach to understanding the capacity of their various sources of alpha. In most cases, these players could gather and grow assets at will, and yet they don’t – on purpose.
In short, if you have bought into our recent arguments that the capacity of alpha is finite and that the leading managers of automated trading methods can achieve “winner-take-all” performance characteristics in the sources of alpha that they target, then it stands to reason that the causes for where assets are concentrating and which funds are either declining in AUM or closing altogether – all within the same relative-value zone – are related. Without even looking at track records, these two facts lead to the conclusion that systematic strategies are more consistent than, and therefore, winning a battle over allocations to traditional, fundamentally-oriented (aka – “manual”) strategies in modern markets.
To be concise: Not only have market makers been eating their own, hedge funds have been eating their own, too. Of course, this effect is indirect. The hypothesis is that sources of alpha once more easily discovered and harvest manually is now being discovered and harvested systematically at greater speed and scale.
The next question is: How far does this theme go? Certainly, we don’t believe that the application of automated methods to all things financial is anywhere near over…
Now while you are considering that idea, place your bets: Has the segment of leading managers in our “asset maximizer zone” been eating their own, as well? Stay tuned…
In the interim, the anecdotal evidence – if not, the solid proof – for the shifting of the hedge fund space may not be hard to find. According to Institutional Investor’s 17th-annual Hedge Fund 100 ranking of the 100 largest hedge fund firms in the world as of year-end 2017 (published August 2018):
“A handful of quantitative firms have continued to gobble up large sums of assets, catapulting many of them to the top of [the rankings]. The four biggest hedge fund firms — and six of the ten biggest — on this year’s ranking rely largely or fully on computers to make their investment decisions and have continued to attract assets in spite of underwhelming performance in some cases. At the same time, many well-established, recognizable firms with long track records have once again suffered a sharp reduction in assets or are shutting down altogether.”
Those six firms include:
#1. Bridgewater Associates, (~$125 billion)
#2. AQR Capital Management (~$90 billion)
#3. Renaissance Technologies (~$57 billion)
#4. Two Sigma Investments (~$52 billion)
#6. D.E. Shaw & Co. (~$39 billion)
#9. Marshall Wace (~$33 billion)
Of course, this list still does not include noted quant-oriented firms like Citadel (~$30 billion), Millennium Management (~$36 billion) or Man Group (~$109 billion, ~$29 billion of which is allocated to absolute return strategies).
The list of those hedge fund managers who are shrinking or closing shop altogether are equally as notable – and none of which are known for being weighted towards systematic methods:
According to Bloomberg and Hedge Fund Research, as of late 2017, hedge fund closures had outpaced launches for the third year in a row, with a few notable players deciding to head for the beach. Some of these include David Einhorn, Greenlight Capital; John Paulson, Paulson & Co; and Alan Howard, Brevan Howard Asset Management. Blue Ridge, Eton Park and Hutchin Hill were also notable closures for 2017.
And finally, just last week (October 4) Dmitri Balyasny shuttered his aptly named Atlas Fundamentals Trading fund due to outside investor withdrawals – and to help us hammer our point! (Not to worry, BAM was still home to ~$11 billion as of March 2018.)
Anyway, you get the gist…