Quant traders limit risk as losses mount

By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) - Robust returns for a group of powerful hedge funds that thrived for years using sophisticated trading programs may be a thing of the past after a "Black Swan" event hit global markets this year.

The carnage in financial markets worldwide, what many viewed as a so-called Black Swan event because it was out of the ordinary and had severe repercussions, has scorched returns for most of these funds. That forced them to embrace new models that place less capital at risk and employ little or no leverage.

With the failure of many investment systems that ran on algorithms created by mathematicians-turned-traders, quantitative funds, also known as "quants" are also veering away from models with longer-term horizons. They have instead focused on high-frequency strategies, or very short-term trades that often are executed in seconds.

"It is a confusing time to be running money ... using quantitative approaches where recent events create statistical outcomes so out of step with the past that historical analysis is of limited value," said the New York-based Roger Ehrenberg, formerly president of DB Advisors and now an active early-stage investor in financial technology and digital media.

"Clearly, a massive deleveraging had taken place and quants are running far less levered strategies than (before)."

Quants had racked up large gains in the past, some as high as 60 percent, not because of any superior stock-picking ability, some analysts say, but due to the high level of leverage they were allowed to take on.

But 2008 is a different story. The typical hedge fund has fallen by nearly 20 percent so far this year, according to Hedge Fund Research. In October, the HFRX Global Hedge Fund Index lost 9.26 percent, almost doubling its year-to-date loss to 19.79 percent.

HFRX's Quantitative Directional index, the closest measure of systematic traders' performance, showed a loss of 7.20 percent in October, falling nearly 20 percent this year.