perpetual alpha: idea for a new fund?
TRANSCRIPT
“Perpetual Alpha: Idea for a New Fund?”By: John F. C. Cheong, Ph.D.
Feedback and comments to: [email protected]
“I’d rather write programs to write programs than write programs.”
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“Perpetual Alpha: Idea for a New Fund?”By: John F. C. Cheong, Ph.D.
1. Academic Arbitrage: A Modest Beginning...2. Decentralized FX Market Trades Round-the-Clock 24/63. Complexities in Equities and FX are Inverted4. Quick! Here’s an Anomaly… How Fast Can You Code?5. Active Management: Continuous Search for Alpha6. Alpha Decay: All Good Things Must Come to an End7. Where to Find a Reliable & Continuous Source of Alpha?8. Irrationality + Inattention: Rich Sources of Alpha?9. How Might a “Perpetual Alpha” Fund Be Organized?10. Fund Objectives? “Consistent Profitability” + “Liquidity”!11. Identifying New Opportunities Along the Value Chain…12. Retool? Review of Prop Trading vs. Fund Management13. Perpetual Alpha: A Multi-Strategy Fund Powered by
“Academic Arbitrage” Betting Against Human Rationality.Feedback and comments to: [email protected].
Academic Arbitrage: A Modest Beginning…
FX: An Asset Class Traded Round-the-Clock 24/6 Globally in a Decentralized Market Structure.
Complexities in Equities and FX are Inverted:Technology vs. Market Structure Knowledge.
Quick! Here’s an Anomaly… How Fast Can You Code?
Lagged response caused by latency?
Active Management: Continuously Searching for Alpha
From Beta to Alpha: Mining the Spectrum of Return Sources.
Alpha Decay: All Good Things Must Come to an End
I quit.Here’s your $1.5B back!
Alpha Decay: All Good Things Must Come to an End
I quit.Here’s your $1.5B back!
“Imagine every day you have to figure out a small part of the world. You develop fantasticmachines, which can measure everything, and you deploy them to track an object falling. Youanalyze a million occurrences of this falling event, and along with some of the greatest mindsyou know, you discover gravity. It's perfect: you can model it, define it, measure it, and predict it.You test it with your colleagues and say, 'I will drop this apple from my hand, and it will hit theground in 3.2 seconds,' and it does. Then two weeks later, you go to a large conference. Youdrop the apple in front of the crowd...and it floats up and flies out the window. Gravity is nolonger true; it was, but it isn't now. That's HFT. As soon as you discover it, you have only a fewweeks to capitalize on it; then you have to start all over.”
“HFT was measurably harder by 2010. Most of our models at that time were running at half-livesof three to six months.”
— Jacob Loveless (“Barbarians at the Gateways”, Oct 16, 2013)
Alpha Decay: All Good Things Must Come to an End
Back to Betain < 3~6 mo.?The horror!
Where to Find a Reliable & Continuous Source of Alpha?
Source: Streambase 2011 FX Technology Survey.
Model-based approach works best!Only if one can find a reliable source of alpha…
Irrationality + Inattention: Rich Sources of Alpha?
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How Might a “Perpetual Alpha” Fund Be Organized?
PredictionMethods
Financial andEconomic Data
Returns, Spreads, Volatility, etc.
{ }{ }{ } HOWwePredict
WHATwepredict WITH
WHATwe predict→ →
How Might a “Perpetual Alpha” Fund Be Organized?
“Trading Desk”(Auto-Pilot Most Times)
LD4
NY4
CH2
“Trading Venues”(All in the Cloud)“The Invisible Hand”
(Works Like Magic, as Always!)
“Swarm Work”(Crowd-Sourced)
Betting on human traders
being irrational?We’re all in!
New York
London
Chicago
Fund Objectives? “Consistent Profitability” + “Liquidity”!
Virtu Financial, Inc.Daily Adjusted Net Trading Income Distribution*(in millions)
But how is that even humanly possible? We’ll need mo’ better bananas.
Just saying…
How to Identify New Opportunities Along the Value Chain? Try Using the “Industry Model Canvas”…
Key Advantages Description1 Small Markets Small capital base generate strong returns even in small markets.
2 No Herding Alpha sources uncorrelated with handful deployed at big funds.
3 No Risk Budgets Can choose how to measure risks and diversify across strategies.
4 Minimal Market Impact Daily turnover of liquid instruments has no price major impact.
5 Anonymity No need for big bank counterparty for order flow or credit.
6 Drawdown Tolerance No high watermark or deployed capital incentive => flexibility.
7 Factor Independence No reliance on Barra risk factors or Black-Litterman allocation.
8 No Window Dressing No need to dress up portfolio for client reporting (perf. or comp.)
9 Cross-Instrument Strategies can cross instruments and markets (vs. pure-play silos).
10 No Benchmark Focus on generating absolute return than relative performance.
11 Wealth, Not Portfolio Allocate asset and manage money, not FoF portfolio allocation slice.
12 No Reporting Little or no regulatory reporting requirements, beyond taxes.
13 No Legacy Rapidly build and deploy best technology, no legacy systems.
Retool? Review of Prop Trading vs. Fund Management
Small Prop Shop
BigHedge Fund
Plenty of parking spots! But only room
for two inside...
Tons of payload capacity… But hard to find
parking!
Perpetual Alpha: A Multi-Strategy Fund Powered by “Academic Arbitrage” Betting Against Human Rationality.
Feedback and comments to: [email protected].
Q: “Would respectable institutional investors, e.g., university endowment funds, find the Perpetual Alpha Fund, headed by a tech-savvy chimpanzee, an attractive investment vehicle?”
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“If you give someone a program, you will frustrate them for a day; if you teach them how to program, you will
frustrate them for a lifetime.”
“I’d rather write programs to write programs to write programsthan write programs to write programs.”