Hedge funds are looking to bulk up their algorithmic divisions to an extent never before seen. A recent Bloomberg Brief article notes demand for quants is outstripping supply, as the mostly chill math geeks prefer a laid back California tech culture to the conformity of Wall Street. Wall Street just might have to adapt, however. But before quants invade Wall Street, pushing for a culture that makes logical mathematical decisions, should the hedge fund or institution have a basic understanding of how to structure a systematic investment?

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Managed futures during crisis 2
Graphic credit: CME Group

Why did it take Wall Street so long to discover managed futures?

The rise of The Quants, the subject of an industry benchmark book, continues to roll-over Wall Street.

Those on the algorithmic side of the coin, for their part, were always wondering how long it would take Wall Street to discover an investment methodology generally noncorrelated to the performance of the stock market during crisis. Oddly this moment in time occurred after MF Global, a direct hit into the regulated derivatives industry and the security of the segregated account structure. How times change.

“I haven’t seen demand for quants from hedge funds like this before -- any hedge fund you can name is looking,” Michael Karp, chief executive of New York employment recruitment firm Options Group, told Bloomberg.

Managed futures during crisis

Managed futures is one kind of quant investment strategy

While systematic trading PhD knowledge is in demand, there are different types of algorithmic investing strategies. At a high level the funds that understand noncorrelated investing at a fundemental level, and a provide market structure thesis for the quants to operate inside, are best suited for the challange.

An example of a fund with a documented understanding of market environment analysis is Balyasny, which the Bloomberg article documented was hiring at least five job openings for quantitative analysts.

All throughout 2015, Balyasny looked at the potential risks in play, with the potential for the Fed withdrawing quantitative dopamine in September as a key risk. According to sources with a familiarity of fund strategy who spoke to ValueWalk throughout the year, this macro concern was synthesized into a noncorrelated market strategy, one primarily executed through long / short stock ratio management but which included other hedged strategies.

Paul Tudor Jones looking to re-tool as quant success comes with market structure understanding first

It is not just Balyasny looking to add quants, but also firms such as Tudor Investment Corp. Paul Tudor Jones, who along with initial employees such as Peter Borish, built a strategy based in part on systematic trend following and other derivatives strategies to which Tudor Jones and Borish were familiar. Borish was a former Federal Reserve Bank of New York employee and was second-in-command at Tudor as well as being former Chairman of OneChicago, the single stock futures exchange.

Tudor-Jones, for his part, no longer with Borish at his side, is taking the $11 million under management and looking to get deeper into the quant world.

Quants on the outside represent complexity. Their work involves PhD level analysis that has a strong grasp of often complex market dynamics.

What isn't said is how the more successful approaches work.

At a fundamental level, those with deep market structure understandings typically organize the process. Internally at a high level a one to four page page document outlines in clear terms how the strategy works. Behind the scenes among quants financial obfuscation is often viewed as a sign of disrespect, the opposite of what occurs in public. The best quant strategies are clearly outlined in a language reasonably intelligent portfolio managers can understand. Breaking down the complex into a simple market understanding is the most valuable -- and sometimes the most protected -- knowledge.

Managed futures is not the only "quant strategy"

"Quant strategies" is one category to describe many different disciplines. One method to start is divide the strategy types at a high level based on value identification or price pattern recognition. An example of this is Bridgewater Associates. When they developed their quantitative unit -- don't call it a quant division -- the firm dismissed the idea that managed futures strategies or algorithmic market environment analysis would take place. They were looking to develop a computer-based method to translate how they think about value and market correlations, synthesize a macro and micro market view point, into a method to uncover fundamental value and underappreciated price anomalies.

A pricing pattern approach is entirely different than calculating a corporations balance sheet to uncover value. In this regards there are several theories on how the methodology should be dissected. The overwhelmingly predominate thought in the industry is that the market environment of price persistence is a driving fundamental force. Understanding market performance drivers is typically the starting place for quants in this niche to begin their discovery. But astute algorithmic market analysts might point to additional market environments and then provide strategic analysis on how they correlate, with a particular emphasis on strategy correlation and performance during crisis.

Typically when a quant develops a strategy there is a mathematical explanation, one often partially used in public that can also serve the purpose of obfuscation. It is the market-based strategic understanding that is sometimes shared among portfolio managers that is most interesting.

Attracting quants is a challenge, as they don't like conformity

Even with a strong framework, however, an algorithmic investment practice is not a guaranteed success. Attracting the right employees, with base salaries ranging from $80,000 per year to $200,000 or more, involves more than money.

Many quants make the majority of their income on incentive bonus. The real winners love it because they enjoy understanding algorithmic market structure, a unique perspective in several regards. They also like the relative freedom that so long as their systems are working properly they can live life as they want.

For hedge funds the issue is in part about creating the appropriate work environment.

Those with a certain type of derivatives industry experience are often accustomed to a generally informal attitude. The often stimulating but entertaining experiences on a derivatives trade desk, framed by occasional Friday cook-outs on the rooftop of the generally cool warehouse office in a loft district, is often the preferred environment.

“Hedge funds may not necessarily be the right fit for some quants,” Jeanne Branthover, a partner at recruitment firm DHR International in New York, was quoted as saying. “In Silicon Valley, you have a cool factor. Hedge funds need to change their culture to catch-up.”