Research

Man versus Machine: Quantitative Hedge Funds

The rise of computer-driven strategies in the hedge fund sphere has caught considerable interest from the investment community over recent years. These quantitative hedge funds incorporate automated trading strategies, enabling them to capitalise on price discrepancies in the markets through executing trade positions within a very short span of time. While these systematic hedge funds have been employing methods of technical analysis into their trading strategies, sentiment analysis is also an up and coming feature in investment decisions. Text-mining data collected from various sources could be an indicator of ground sentiment during key market events, which can then be used as inputs in trading models or for risk control.

Based on the Eurekahedge database, Figure 1 shows the breakdown of instruments traded by quantitative hedge funds with derivative, equities and currency being the top three traded instruments, having a collective share of 60.41% among them. Other instruments traded are commodities and fixed income which account for more than one-quarter of the pie whereas other instruments account for the remaining portion.

Figure 1: Types of instruments traded
Eurekahedge Quantitative Hedge Funds types of instruments traded


The performance of quantitative hedge funds across different regional mandates against the Eurekahedge Long/Short Equities Hedge Fund Index since December 2006 is compared in Figure 2. Among regional mandates, North American focused quantitative hedge funds have gained 100.11% over the period analysed outperforming the Eurekahedge Long/Short Equities Hedge Fund Index which gained 75.10% over the same period. Quant funds focusing on emerging markets have also outperformed the main index with gains of 88.09% since December 2006. Globally focused quantitative hedge funds have also showed considerable strength, gaining 73.20% though slightly underperforming the Eurekahedge Long/Short Equities Hedge Fund Index.

Figure 2: Performance of quantitative hedge funds across regional mandates
Eurekahedge Quantitative Hedge Funds performance across regional mandates

Table 1 summarises the key performance statistics for quantitative hedge funds across regional mandates. Key takeaways include:

  1. North American quant funds have posted positive annual returns since 2011, with its returns over the past year outperforming other regional peers and the Eurekahedge Long/Short Equity Hedge Fund Index.

  2. Barring 2016, Asia Pacific and Emerging Markets mandated quantitative funds have posted positive annual returns since 2011 with Asia Pacific quant funds outperforming regional peers in 2013 and coming in a second close in 2014.

  3. Over the three and five year period, North American quant funds posted the best Sharpe ratio among regional mandates – 0.69 and 0.79 respectively.

  4. In terms of volatility levels, North American quant funds posted a low five year volatility of 3.05% as compared to its other regional peers and among the lowest volatility level over the three year period, second only to Europe.

  5. Over the three and five year period, quantitative hedge funds with North American, Asia Pacific and Emerging Markets mandate posted good risk-adjusted returns with the respective five-year Sharpe ratio outperforming long/short equities hedge funds..

Table 1: Performance in numbers – quantitative hedge funds by regional mandate

Global
North America
Europe
Asia Pacific
Emerging Markets
Eurekahedge Long/Short Equity Hedge Fund Index
2011
(0.94%)
3.76%
(2.71%)
4.74%
5.47%
(5.93%)

2012

(0.54%)
2.22%
(0.63%)
5.15%
4.85%
8.57%
2013
2.97%
3.40%
3.85%
3.70%
2.88%
16.10%
2014
9.42%
6.65%
5.98%
7.31%
9.83%
3.71%
2015
0.59%
(0.05%)
0.90%
4.64%
5.02%
3.22%
2016
(0.60%)
5.12%
(1.70%)
(4.30%)
(3.96%)
3.93%
2017 February year-to-date
0.85%
(0.36%)
(0.03%)
1.80%
2.78%
2.74%
5 year annualised returns
2.12%
3.12%
1.19%
3.12%
3.75%
6.31%
5 year annualised volatility
4.90%
3.05%
2.97%
3.39%
3.92%
4.99%
5 year Sharpe Ratio (RFR = 1%)
0.23
0.69
0.06
0.63
0.70
1.06
3 year annualised returns
3.22%
3.51%
1.07%
3.53%
4.58%
3.87%
3 year annualised volatility
5.35%
3.19%
2.85%
3.22%
4.62%
4.87%
3 year Sharpe Ratio (RFR = 1%)
0.41
0.79
0.02
0.79
0.78
0.59

Source: Eurekahedge


Table 2 shows the correlation matrix of quantitative hedge funds across regional mandates and the Eurekahedge Long/Short Equities Hedge Fund Index. Interestingly, North American mandated hedge funds and managers with a global mandate have shown the strongest correlations whereas the strength of correlation between global and other regional peers are much weaker. The correlation strength is the weakest between globally mandated funds and Asia Pacific focused peers, which could be a potential case for regional diversification across the spectrum of quantitative strategies. While some Asia Pacific hedge funds also have exposure into emerging markets, it is interesting to note that the correlation strength between Asia Pacific and emerging markets is moderate at best. From this correlation table, we can also see that Europe and Asia Pacific mandated quantitative hedge funds posted relatively stronger correlation to the Eurekahedge Long/Short Equities Hedge Fund Index, which could indicate the instrument-weight traded by managers of these mandates.

Table 2: Correlation matrix
Eurekahedge Quantitative Hedge Funds Correlation matrix


Figure 3 depicts the 12-month rolling volatility of quantitative strategies by region with emerging market focused funds posting high volatilities between 2007 and 2008. On the contrary, North American and European mandated counterparts have delivered lower 12-month volatilities over the same period analysed. Comparing the 12-month volatility for the year ending 2016, we see that Europe and North American quantitative hedge funds have the lowest volatilities – 2.22% and 2.91% respectively. This is in comparison to the Eurekahedge Long/Short Equities Hedge Fund Index which posted a volatility of 5.65%. All other regional mandates posted lower volatility levels for the same period although globally mandated quantitative hedge funds posted a volatility of 5.63% somewhat close to that of long/short equities hedge funds.

Figure 3: 12-month rolling volatility relative to Eurekahedge Hedge Fund Index
Eurekahedge Quantitative Hedge Funds 12-month rolling volatility


In Table 3 we see how the performance of quantitative hedge funds vary across regional mandates against the backdrop of key market risk events. As quantitative strategies seek to identify the presence of trends, performance across regional mandates vary depending on how funds are positioned. Key takeaways include:

  1. Among regional mandates, North American quantitative funds have been positive in nine out of 11 monthly risk events identified. In comparison, long/short equities hedge funds were positive for three out of 11 monthly risk events.

  2. With regards to idiosyncratic risk events such as Trump and Brexit, North American quantitative funds have outperformed other region-focused peers, and the Eurekahedge Long/Short Equities Hedge Fund Index. Global focused quantitative funds outperformed region-focused peers and the Eurekahedge Long/Short Equities Hedge Fund Index during Brexit, with gains of 2.56%.


Table 3: Quantitative hedge fund returns during key market risk events by regional mandate

Date
Event
Global
North America
Europe
Asia Pacific
Emerging Markets
Eurekahedge Long/Short Equities Hedge Fund Index
Nov 16
Trump Win
(0.71%)
1.26%
(0.35%)
(0.42%)
(3.37%)
0.61%

Jun 16

Brexit
2.75%
0.80%
0.89%
(0.06%)
(0.02%)
(0.62%)
Feb 16
Oil Price Dip/China growth concerns
1.81%
1.42%
(0.84%)
(3.40%)
0.58%
(0.72%)
Jan 16
Oil Price Dip/China growth concerns
1.73%
0.01%
(0.30%)
(0.36%)
0.27%
(3.82%)
Aug 15
China Equity Crash
(1.86%)
(1.92%)
(1.72%)
(0.42%)
0.05%
(2.71%)
Jul 15
China Equity Crash
1.58%
0.85%
0.97%
(0.06%)
1.26%
(0.76%)
Jun 15
Greek referendum
(2.73%)
(1.16%)
(0.61%)
0.46%
(0.90%)
(1.01%)
Jan 15
Swiss Franc De-pegging
3.13%
1.56%
0.76%
0.66%
1.36%
0.03%
Sep 14
Oil Price Dip
1.07%
1.53%
0.98%
1.18%
3.30%
(1.13%)
Jun 13
Taper Tantrum
(1.45%)
0.48%
(0.17%)
(0.32%)
(0.87%)
(1.48%)
May 13
Taper Tantrum
(1.30%)
0.26%
(0.36%)
(1.44%)
0.16%
1.59%

Source: Eurekahedge


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