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One 'Quant' Sees Shakeout
For the Ages -- '10,000 Years'
[FONT=times new roman,times,serif][FONT=times new roman,times,serif]By KAJA WHITEHOUSE
August 11, 2007; Page B3[/FONT]
[/FONT]
Matthew Rothman is used to working with people who pride themselves on their rationality. He's a "quant," after all, one of a legion of Ph.D.s on Wall Street who use the emotionless rules of mathematics to pick trading positions. But this week, he caught a whiff of panic.
The trouble started Aug. 3, when stocks started moving not only in ways that commonly used models didn't predict, but in precisely the opposite direction from what was expected. Equally troubling, the moves were far more volatile than models based on decades of testing assumed were likely. Those relatively minor anomalies escalated quickly this week, exploding into a global rout for quantitative funds by Wednesday.
Matthew Rothman As the global head of quantitative equity strategies for Lehman Brothers Holdings Inc., Mr. Rothman has an inside view into what went wrong. His story paints a situation that quickly snowballed out of control, as events damaged fund managers' confidence in their models and led them to take steps that made matters worse. By Thursday, Mr. Rothman was so concerned that he wrote an extraordinary plea to the industry to remain calm.
"Wednesday is the type of day people will remember in quant-land for a very long time," said Mr. Rothman, a University of Chicago Ph.D. who ran a quantitative fund before joining Lehman Brothers. "Events that models only predicted would happen once in 10,000 years happened every day for three days."
The extent of the damage remains unclear, but people involved agree that a wave of losses hit quantitative investors in recent days, dragging down performance for a universe of investors that includes hedge funds and proprietary-trading desks at some investment banks.
According to data from Hedge Fund Research Inc., as of the end of June there was $40.7 billion invested in hedge funds following market-neutral strategies, a typical quantitative approach that some say was hit hardest.
Quant-fund managers tend to remain calm when markets turn sour, because they are able to profit from both up and down markets. Results aren't determined by the up or down moves of the market, but by how well positions perform relative to expectations laid out in models. Designing those closely guarded models is where Ph.D.s like Mr. Rothman come in.
In recent days, quant managers have been anything but calm, exacerbating losses with swift selling, which observers said only begat more selling.
"It's the contagion affect, one market affecting another seemingly unrelated market," said Gregvan Inwegen, director of risk management and quantitative research for fund of hedge funds Ivy Capital Management. "So then once you have this butterfly flapping the wings, the thing just continues to affect other areas."
It took a few days for investors, including Mr. Rothman, to realize that the shakeout had struck not just a few managers but the whole group. That led to the realization that the knee-jerk response to big losses -- a quick exit -- could lead to a broader meltdown.
On Thursday, Mr. Rothman published an industry note explaining the situation and pleading with quant investors to remain calm. "Self-fulfilling prophesies of losses can come true if investors stampede and head for the door in unison," he said in the note. "We certainly hope this situation does not materialize and stress the need for investor calm."
For the Ages -- '10,000 Years'
[FONT=times new roman,times,serif][FONT=times new roman,times,serif]By KAJA WHITEHOUSE
August 11, 2007; Page B3[/FONT]
[/FONT]
Matthew Rothman is used to working with people who pride themselves on their rationality. He's a "quant," after all, one of a legion of Ph.D.s on Wall Street who use the emotionless rules of mathematics to pick trading positions. But this week, he caught a whiff of panic.
The trouble started Aug. 3, when stocks started moving not only in ways that commonly used models didn't predict, but in precisely the opposite direction from what was expected. Equally troubling, the moves were far more volatile than models based on decades of testing assumed were likely. Those relatively minor anomalies escalated quickly this week, exploding into a global rout for quantitative funds by Wednesday.
"Wednesday is the type of day people will remember in quant-land for a very long time," said Mr. Rothman, a University of Chicago Ph.D. who ran a quantitative fund before joining Lehman Brothers. "Events that models only predicted would happen once in 10,000 years happened every day for three days."
The extent of the damage remains unclear, but people involved agree that a wave of losses hit quantitative investors in recent days, dragging down performance for a universe of investors that includes hedge funds and proprietary-trading desks at some investment banks.
According to data from Hedge Fund Research Inc., as of the end of June there was $40.7 billion invested in hedge funds following market-neutral strategies, a typical quantitative approach that some say was hit hardest.
Quant-fund managers tend to remain calm when markets turn sour, because they are able to profit from both up and down markets. Results aren't determined by the up or down moves of the market, but by how well positions perform relative to expectations laid out in models. Designing those closely guarded models is where Ph.D.s like Mr. Rothman come in.
In recent days, quant managers have been anything but calm, exacerbating losses with swift selling, which observers said only begat more selling.
"It's the contagion affect, one market affecting another seemingly unrelated market," said Gregvan Inwegen, director of risk management and quantitative research for fund of hedge funds Ivy Capital Management. "So then once you have this butterfly flapping the wings, the thing just continues to affect other areas."
It took a few days for investors, including Mr. Rothman, to realize that the shakeout had struck not just a few managers but the whole group. That led to the realization that the knee-jerk response to big losses -- a quick exit -- could lead to a broader meltdown.
On Thursday, Mr. Rothman published an industry note explaining the situation and pleading with quant investors to remain calm. "Self-fulfilling prophesies of losses can come true if investors stampede and head for the door in unison," he said in the note. "We certainly hope this situation does not materialize and stress the need for investor calm."