Wall Street has built a $370 billion business by cloning quant trades -Dlight News

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(Bloomberg) – Deep down on Wall Street, a surprisingly successful counterfeiting operation is afoot: the world’s largest banks have created a booming business conducting fake quant trades.

JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley are among the providers of the products known by the deceptively dreary name “quantitative investment strategies” or QIS.

It is the latest chapter in the ongoing demystification of high finance. These deals — which number in the thousands and are delivered to pension funds, family offices, and the like — replicate strategies Developed by Ivy League academics and systematic fund managers like AQR Capital Management.

The kicker is that QIS aren’t funds — the banks convert the deals into swaps, or structured notes, so they’re easy to package and sell so customers can choose what they want. It’s a buffet, not a tasting menu.

QIS encompasses a range of quantitative investing styles that attempt to make money from market patterns established in academic research, such as a tendency for cheap stocks to outperform or for assets to trade in the same direction for a period of time. They originally flourished after the financial crisis, when banks, under pressure from new regulations, began to transform their internal trading strategies into salable products.

After a performance pick-up in the post-pandemic era along with the broader quant industry, QIS’s businesses have grown steadily in recent years and are now worth around $370 billion, according to an estimate by consulting firm Albourne Partners.

Last year “It was probably the best year I’ve ever seen,” said Spyros Mesomeris, global head of structuring at UBS Group AG. “What people have been asking for is simply strategies that work in an environment of turbulent stock and bond markets.”

QIS trades come with a manual that explains exactly how they work. For example, go long on S&P 500 futures when they have risen above a 20-day moving average, to use an oversimplification. The idea is to make them transparent, and because investors only buy what they want, they tend to be cheaper than most money managers, proponents say.

At Veritas Pension Insurance in Finland, which manages around 4 billion euros ($4.3 billion), chief investment officer Kari Vatanen has turned to QIS for more control over the company’s money without trading teams from the ground up to have to build.

“The good thing is that they are completely transparent – we know how they are set up,” Vatanen said. “It’s basically in our hands, like ETFs are in stock markets.”

Skeptics point out that banks don’t have a fiduciary duty — the obligation to act in a client’s best interests — like a wealth manager does, and they don’t focus as much on minimizing transaction costs as they do too carry out business. Some also say the strategies are unoriginal and oversimplified.

“The things that we do on the alpha side, or even the risk premia side, can’t be written down in a simple set of rules,” said Deepak Gurnani, founder of Versor Investments, which has about $1.8 billion under management, including hedge funds and risk premia strategies.

Still, according to an Albourne survey of 13 banks, assets under management by QIS have grown at an average of 3% annually over the past six years, reaching about $370 billion by mid-2022.

Evelina Klerides, a partner at the consultancy, said the demand came from investors looking for products with high transparency and lower costs. The downside is that the rapidly expanding range of providers and strategies “requires careful selection and monitoring,” she said.

While the company is typically viewed as a hedge fund replacement, UBS’s Mesomeris and JPMorgan’s Arnaud Jobert are increasingly turning to QIS to quickly add new exposures to their arsenal.

The notional value linked to JPMorgan’s QIS indices rose 30% over the past year after being broadly flat over the three years to 2020.

“You had to find some diversification, and bonds were no longer a solution,” said Jobert, co-head of global investable indices at the Wall Street giant. “Things like trend following or price volatility were quick and immediate overlay solutions.”

Given the opacity of the business and the size of the deals, it’s difficult to generalize about returns, but data provider Premialab estimates that 61% of the roughly 4,000 strategies it’s tracked made money in the past year, the highest proportion since at least 2016. More than 1,000 new QIS were also created – the most in six years.

This year was a more mixed picture as investor attention shifted from inflation fears to the possibility of a recession and interest rate cuts. A Bloomberg-GSAM index of cross-asset risk premia — a mix of typical styles — is down 1.5% so far in 2023. Premialab’s breakdown shows big reversals in some of last year’s successful trades, such as: B. Trending in fixed income but better days for carry strategies.

Nor are QIS immune to criticism of the type of systematic hedge funds that have popularized many of these strategies. An academic 2021 learn argued that these trades generally don’t offer much of an advantage over more traditional benchmarks.

“You can’t say that one part of the market is doing a much better job than the other,” said co-author Antti Suhonen, who is also a consultant at investment firm MJ Hudson. “Most of these strategies don’t really add diversification, especially when Things are going really bad.”

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