This Hedge Fund's Machines Are Making the Right Calls on Oil

By Kelly Bit

The quants are winning.
Hedge funds that rely on computer programs to trade are producing some of the highest returns in the industry after a particularly profitable November. Two Sigma, a $24 billion firm run by a former artificial intelligence academic and a mathematics olympian, rose 10 percent last month in one of its strategies and is up 47 percent this year.
Cantab Capital Partners jumped 18 percent in its main fund in November and has returned 32 percent this year and Aspect Capital advanced 12 percent for the month, doubling its return in 2014.
Scientists, mathematicians and engineers are beating star managers by capturing price discrepancies across markets, making money from a plunge in
oil prices and on government bonds that human traders dismissed. The Newedge Trend Index, which tracks firms that that use models to profit from market trends, has advanced 17 percent this year through November, compared with a 3.7 percent gain for funds across strategies.
“Discretionary traders did not see value in buying and holding sovereign bonds in the U.S., U.K. and Germany,” which benefited quantitative funds, said Anthony Lawler, a money manager for GAM Holding, which invests in hedge funds. “Short energy was a large winning trade, whereas discretionary traders were by and large not in,” he said, referring to bets against the industry made by human decision-makers.

Paulson Losses

Quants are succeeding as some of the most well known stock and bond pickers struggle in forecasting the outcome of corporate mergers or gauging the impact of central bankers on markets. Richard Perry, Jeffrey Altman and Paul Tudor Jones are underperforming equity and credit indexes this year; billionaire John Paulson has lost 27 percent in his event-driven fund and hedge funds are closing at a rate not seen since the financial crisis.
Jim Simons, a former military codebreaker and chairman of the mathematics department at Stony Brook University, is regarded as a pioneer of investment strategies that use computer models. He formed a firm that became East Setauket, New York-based Renaissance in 1977 and hired scientists and engineers to mine data from financial markets looking for relationships among stocks, bonds, derivatives and commodities.
Assets overseen by quants have more than doubled to $796 billion since 2008 after the firms returned 21 percent that year, according to Hedge Fund Research Inc. and Newedge’s trend-following index. (SPX) The average hedge fund declined 19 percent, according to data compiled by Bloomberg, and the Standard & Poor’s 500 Index dropped 38 percent.

Replicating Success

Computer-driven firms haven’t always replicated that 2008 success, losing money in at least two of the past five years, according to Newedge and data compiled by Bloomberg. In comparison, hedge funds on average made money during the period except in 2011.
Quantitative firms this year have been boosted by the more than 40 percent drop in oil prices since June.
Firms that follow trends, such as rising stocks or falling commodity prices, gained an average of 7.3 percent in November and those that use models to make decisions on macroeconomic themes returned 4.6 percent. The average hedge fund rose 1.2 percent, according to HFR.
Two Sigma had the best-performing strategy in its Compass Enhanced fund, which trades futures and currencies.
The New York-based firm was founded in 2001 by David Siegel, the former chief technology officer at Tudor Investment Corp., who received a PhD in computer science from MIT, and John Overdeck from D.E. Shaw & Co., who was an International Mathematics Olympiad Silver Medalist in 1986.

Backgammon, Billiards

Its website boasts of the firm’s technology pedigree rather than connections to Wall Street. Two Sigma touts the first open source software artist, billiard and backgammon champions and the founder of Hungary’s first commercial internet service provider among its employees.
This year isn’t a fluke. The Two Sigma Compass Enhanced fund has posted an annualized return of 30 percent since inception in 2005, according to a person with knowledge of the matter, who asked not to be named because the information is private.
Others making money this year include Aspect, a $4.8 billion London-based trend-following firm. Its Aspect Diversified Fund has gained 24 percent for the year, according to a person briefed on the returns.
Renaissance, with $25 billion, rose 4.2 percent last month and is up 12 percent this year in its Renaissance Institutional Diversified Alpha Fund, according to a person briefed on the returns.

Algorithmic Funds

Not all algorithmic-driven funds have done well this year. Quantitative Investment Management, the $1.9 billion Charlottesville, Virginia-based firm, fell 8.7 percent in its main fund after losing 0.1 percent last month on bets against German stocks and wagers on the Japanese yen, according to a performance update, a copy of which was obtained by Bloomberg News.
The firm’s more volatile Quantitative Tactical Aggressive Fund surged 27 percent in November to bring year-to-date gains to 2.3 percent, according to the update.
Returns at quant funds can be turbulent. Cantab, the $3 billion firm co-founded by Goldman Sachs Group Inc.’s former quantitative trading head Ewan Kirk, had its best month in November since starting, according to a person with knowledge of the returns. Aristarchus, the largest share class in the $3 billion quantitative fund, is up 32 percent this year after losing 28 percent in 2013.

Ackman Competition

This year some stock and bond pickers have also been competitive with programmers. Bill Ackman’s Pershing Square International fund rose 4 percent in November and 38 percent in 2014 by taking concentrated bets on companies. Other luminaries, such as David Einhorn and Daniel Loeb, are up 11 percent and 9.1 percent this year through November.
The upper hand is still with the quants. In previous years the firms had been deprived of markets where assets held direction for an extended period, said Tim Bruce, director of traditional research and partner at NEPC LLC, which advises clients on hedge fund investments.
“If you don’t have a trend that persists for four, eight or 12 weeks, you really can’t get any traction and make money,” said Bruce. “That’s been the challenge for the past couple of years. This year you’ve seen some trends develop.”
Spokesmen for the firms declined to comment on the returns.