If this is fund deleveraging, what happens upon stabilization?

[scriabinop23]

Its a somewhat rhetorical question, with the assumption that there will be a 'reloading' in a massive way.

Once funds stabilize by meeting proper margin requirements on their subprime debt holdings, isn't it a -very- likely possibility that the very same funds selling stock (and covering shorts) to raise funds to meet margin calls will reload positions ???

I know when I've been on a tight margin what I've done upon getting my account straight -- I quickly reload after shuffling things around.

Fundamentally the quants don't disappear, and their valuation models, derived from painstaking research, will drive their buying and selling decisions.

I see two large primary barriers to a quick 'releveraging of their positions': 1) obvious continued instability of credit markets and its cascading effect on other asset prices (noteably subprime mortgagebacks), 2) impatient hedge fund investors pulling money out of these funds at the most inopportune times, pushing cash out of the funds.

Reading this article I can't help but think that this event of equity selling is as much if not moreso a -technical- event than solely a fundamental event.

The bears are always arguing for imminent recession, and even I will agree financials' depressed valuations may be appropriate in a response to fundamental change in the credit markets -- they will do less business likely.

A broader step of what makes price: In these markets the participants generally agree on terms of valuation (ie P/E, growth estimate, risk premium, etc), but at the same time the -actions- of buyers and sellers are the final say.

ie if you have a market of 10 participants, and 5 of them experience unforeseen adverse medical events, even a stock that makes more $$ when people get sick may go down, since half of the participants may be liquidating positions to cover their mess in personal finance.

So here and in what we see, its clear valuation models are trumped by investor disposable cash reserves when deciding what stock or commodities are worth.


A lesson to those who view valuation and price in more static terms.




Reading the Jim Simons letter per rentec..

Dear Renaissance Investor,

As promised in my July letter, posted today on the RIEF website, I want to share some thoughts on August-to-date performance in order to provide perspective on a most unusual period.

RIEF results through July 31 were below expectations, but not extraordinarily so. I've previously stated that the low volatility Basic System, to which our predictions are added, was not in sync with the market during much of this period. Nonetheless, we remain confident that over time the Basic System will match the return of the S&P and, enhanced by our predictive signals, should exceed it. Since we do not attempt to track this or any other index there will be periods of positive and negative relative returns.

August (down 8.7% through today) is a different story. The culprit is not the Basic System but our predictive overlay. While we believe we have an excellent set of predictive signals, some of these are undoubtedly shared by a number of long/short hedge funds. For one reason or another many of these funds have not been doing well, and certain factors have caused them to liquidate positions. In addition to poor performance these factors may include losses in credit securities, excessive risk, margin calls and others. All of this may not influence the direction of the overall market, but it may certainly alter the relationships of stocks to each other in a dramatic way. Given the undoubted partial overlap of our portfolios, these liquidations have had a negative impact on RIEF.

Other examples of such liquidations are the meltdown of risk arbitrage positions in the October 1987 crash, the forced liquidation of junk bonds around 1990 and the collapse of European bonds in 1994. Some of these were in the midst of a bear market, some not.

Such events tend to occur extremely infrequently. We cannot predict the duration of the current environment, but usually such behavior causes first pain and then opportunity. While we may hedge out some market risk, our basic plan is to stay the course and, as conditions revert to the norm, we anticipate the possibility of an attractive opportunity for RIEF. Our firm remains strong, and although Medallion has experienced some losses in August, it is solidly profitable year-to-date.

We are confident in our approach, and we urge you to contact our staff should you have any questions.

Sincerely,

Jim Simons

 

[makloda]

All these quant guys (DE Shaw, RenTec Institutional, Tykhe etc.) will see massive redemptions from Fund of Funds who will get out on the next possible redemption date. This will be key IMO. What happens to these quant guys when the redemptions hit. Are they properly deleveraged already? Do they have enough cash on hand already to be prepared for redemptions?

Eventually they will come back IMO, relative value trading won't go away. There will always be "cheap" stocks and "expensive" stocks by quantitative measures. I just have a feeling they will be a bit for careful with leveraging their RV quant models 4x ... for a while

 

[scriabinop23]

Quote from makloda:

All these quant guys (DE Shaw, RenTec Institutional, Tykhe etc.) will see massive redemptions from Fund of Funds who will get out on the next possible redemption date. This will be key IMO. What happens to these quant guys when the redemptions hit. Are they properly deleveraged already? Do they have enough cash on hand already to be prepared for redemptions?

Eventually they will come back IMO, relative value trading won't go away. There will always be "cheap" stocks and "expensive" stocks by quantitative measures. I just have a feeling they will be a bit for careful with leveraging their RV quant models 4x ... for a while

This whole issue made me think a little more about it. Posted it on my blog...

http://scriabinop23.blogspot.com/2007/08/deleveraging-big-equity-accounts-where.html

 

[ASusilovic]

Quote from scriabinop23:

2) impatient hedge fund investors pulling money out of these funds at the most inopportune times, pushing cash out of the funds.

Reading this article I can't help but think that this event of equity selling is as much if not moreso a -technical- event than solely a fundamental event.

You hit the nail on the head ! The BOYZ had to learn their lesson the hard way, i.e. recalibrating and "RISK"-adjusting their L/S, RV and whatsoever "models"...but more importantly : they will think twice about the meaning of LEVERAGE and HERD LIKE MENTALITY meh, meh, meh....

Characteristically, I found on a website of HARVARD UNIVERSITY the perfect mataphor to describe their behaviour impressively ( unfortunately no chance to paste it into this thread ! ) :http://eecs.harvard.edu/~nesson/sequencer.html

Funny enough the band´s name =>"SHEEP BEATS"...they are not beating the markets....HAHAHA...

 

[Cdntrader]

Quote from scriabinop23:

Its a somewhat rhetorical question, with the assumption that there will be a 'reloading' in a massive way.

The great liquidity boom is over.

There will be no "reload".

 

[Spectre2007]

one can make a argument, that the recent trends over the past 2-3 years were a result of these models themselves, the models were in essence pyramiding upon themselves and it was self recursive.

thus all those lines of price action and low volatility were these funds with a combined levered power that controlled the market.

the next trend will be what will these funds research grab a hold onto for committing funds. Then a new set of pyramiding will ensue.

similar to 2000, when self recursive models, pyramided prices, the first ones to get out or scraped their models saved their funds, and the ones that delayed took the largest hits.

it would be interesting to know, who triggered the it, and they must have modeled how these funds were working, and the achilles heel behind them. And smashed it. Then like a house of cards, everything fell apart.

the common american consumer, triggered it, by taking out home equity loans that they couldn't make payments on. This massive amount of debt, was too much even for these juggernauts.

 

[Cache Landing]

Quote from Cdntrader:

The great liquidity boom is over.

There will be no "reload".

There will be a reload. The question is whether it will be next year or next decade. I can't believe anyone is suggesting that traders "learn their lesson". That is the funniest concept I've ever heard.

The other question is what industry will be the next "internet", "housing", etc....

 

[scriabinop23]

Quote from Spectre2007:

one can make a argument, that the recent trends over the past 2-3 years were a result of these models themselves, the models were in essence pyramiding upon themselves and it was self recursive.

thus all those lines of price action and low volatility were these funds with a combined levered power that controlled the market.

the next trend will be what will these funds research grab a hold onto for committing funds. Then a new set of pyramiding will ensue.

similar to 2000, when self recursive models, pyramided prices, the first ones to get out or scraped their models saved their funds, and the ones that delayed took the largest hits.

it would be interesting to know, who triggered the it, and they must have modeled how these funds were working, and the achilles heel behind them. And smashed it. Then like a house of cards, everything fell apart.

the common american consumer, triggered it, by taking out home equity loans that they couldn't make payments on. This massive amount of debt, was too much even for these juggernauts.

this is a fascinating view, and perhaps the perfect explanation for lack of market volatility during the past 2 years. Good ideas.

One could extend this concept and say this was an inevitable result of all the progress made in tech, extending into markets. With the computing power now at disposal of funds, they are all playing the same quant/AI game. Too bad AI/neural-networks aren't actually *intelligent*.

So the flip side assumption of the new trend going forward being a reload is actually an evolution towards taking advantage of this volatility. That implies a rangebound market inclusive of large swings -- good for us.

 

[Spectre2007]

the models work because they are piggybacking off of macro economic situation at work.

if the models aren't working, it means something is changing on the macroeconomic front, that the models can't ignore.

the new macro economic trend can be counter to the last for a year or two, similar to 2000, a recession of sorts.

in Schwager's 'Stock Market Wizards', David Shaw's interview is in it. A good read.

 

[ASusilovic]

Some smarter QUANT players will argue the incidents of the last weeks have been the statistical outlier in their "models" => see RENTEC´s Jim Simmons arguing exactly this way :

Form one of Jim Simmon´s investor letters lately :

"Other examples of such liquidations are the meltdown of risk arbitrage positions in the October 1987 crash, the forced liquidation of junk bonds around 1990 and the collapse of European bonds in 1994. Some of these were in the midst of a bear market, some not.

Such events tend to occur extremely infrequently. We cannot predict the duration of the current environment, but usually such behavior causes first pain and then opportunity. While we may hedge out some market risk, our basic plan is to stay the course and, as conditions revert to the norm, we anticipate the possibility of an attractive opportunity for RIEF. Our firm remains strong, and although Medallion has experienced some losses in August, it is solidly profitable year-to-date."