Hedge Funds: “We ask investors what they like”
After almost 10 years of talking to hedge fund managers, this is a first. Erich Schlaikjer, co-founder of the Cambridge, UK-based systematic managed futures specialist Cantab Capital, is showing me what his firm’s trading and research systems can do. He’s just called up a chart and clicked on it, and a window full of code pops up. Moreover, Schlaikjer fully expects me to understand every line.
“Programming is today’s literacy,” he says. “If you can’t programme you can’t read or write, as far as I’m concerned.”
This level of transparency marks Cantab out as one of the new breed of institutional hedge funds. You can tell it launched in 2007, rather than 1997. But this is not just about transparency for journalists and clients, but across the firm itself. I can see all of the amendments and improvements that have been made to that coded algorithm over time by several of the team, tagged by name and time.
“You must answer ‘yes’ to three crucial questions to maintain good governance,” Schlaikjer says. “Can everyone see what everyone else is doing? Do you have an audit of everything that everyone has done? Can you roll everything back?”
This takes us back to his expectation that everyone should be able to program. In most systematic investment houses, the ‘quants’ who come up with the trading ideas work in spreadsheets or C++ before passing it over to the ‘geeks’ who re-code it for the trading infrastructure. At Cantab the geek-quant divide is discouraged.
“Newcomers here love this integrated ecosystem,” says partner Genia Diamond.
They love the efficiency with which ‘blue-sky’ research ideas can be developed, coded, shared, tested and improved. This gives the enterprise an academic feel, befitting its close ties to the University nearby. Professor Chris Rogers, chair of statistical science, is a consultant research director, and before I arrived two researchers from the cosmology department had been explaining how a nested algorithm for picking out galaxies from the microwave background might recognise patterns in financial markets.
Powerful and integrated technology means Cantab can establish, within minutes, whether that kind of idea is worth pursuing, making ‘blue-sky’ commercially viable. That underpins a genuinely multi-model programme, which may explain why recent performance, despite tricky conditions, has been better than that of many trend-following peers.
But there are harder benefits for institutional investors. When millions have been spent on technology, everyone has access to every piece of data and everyone is compensated in the same way, that creates operational and governance robustness. Cantab has executed more than 40m trades with an exceptionally low level of trade breaks. CEO, CIO and co-founder Ewan Kirk says that tracking error between managed accounts and funds is measured in the “tens of dollars”.
“We’ll spend an hour talking about our business continuity plan with pension funds,” he adds. “That doesn’t happen with high net worth individuals or even most funds of funds.”
Sophisticated technology is key to scaling up operations for institutional allocations – and that is not just about gathering assets, but doing so fairly. It enabled Cantab to calculate with some assurance that the capacity of its Quantitative fund would be about $5bn. It closed at just under that in November 2012. The firm could have just quietly down-weighted its most capacity-constrained short-term models and slowed down its algorithms, becoming yet another $25bn medium-term trend-follower. “But that’s the equivalent of exchanging your existing investors’ alpha for your new investors’ assets,” says Kirk.
There is no magic bullet. To create its new product, Core Macro, Cantab did indeed remove the most capacity-constrained models and least-liquid assets, slow down the system, reduce the volatility target (from 20% to 12%) and pre-scale assets as if it were already managing $25bn. That future-proofs today’s investors’ alpha. But Cantab went further: to reflect the low cost of production of the new programme and to put new investors on a level footing with the Quantitative fund’s investors, it went from 2-and-20 fees to 0.5-and-10. Volatility-adjusted and net-of-fees, both products are designed to deliver the same return. “That whole process took about 15 months,” says Kirk.
Cantab is not the only hedge fund firm moving in these directions, but all of this helps explain why it was consistently cited for good client relations by the consultants IPE spoke with for this month’s report – not to mention the fact that Core Macro raised $700m during six difficult months for managed futures.
“We ask investors what they like,” as Kirk puts it. “That’s very different from telling them what we’ve got and hoping they like it, which is what normally happens.”