Three senior structurers at top investment banks discussed the evolution and emerging trends in the quantitative investment strategies (QIS) space.
Many investors don't necessarily have an understanding of how QIS are designed. To answer this question, the first step is to understand the power of hedging.
Hedging is like buying an insurance contract for your house, according to Sandrine Ungari (pictured), managing director, global head of QIS structuring at Société Générale (SG).
“You want to be hedged against all of risks [associated with] the house, but not at a cost of high premium. So, what you need to do is to look at the features you want to be insured against, and each has a given price,” said Ungari.
A straightforward all-weather hedge is to buy at-the-money (ATM) put options with a short expiration (one-day for instance) to protect the house from any risk, or your portfolio from market downturns. However, this would be prohibitively expensive.
Effective hedging therefore requires the optimisation of the cost associated with various risk scenarios.
“Ultimately, it boils down to portfolio construction, which leads to diversification. The goal is to try to figure out the type of scenarios you want to hedge and understand the fact that there is no common sell-off,” said the SG executive.
Every sell-off is unique by nature, be it a crash, a flash crash or a downside market led by macroeconomics like the outbreak of Covid-19.
Using put spreads as an example, Ungari noted that the key is to map out the hedges with two different downside market scenarios.
“So, a single all-weather hedge in a way doesn't exist. You need to create an all-weather portfolio of hedges that aim to work in every situation against a portfolio,” she added.
Left to right: Sorin Ionescu, Jagadish Chalasani, Sandrine Ungari and Imene Moussa (moderator)
The adoption of QIS has shifted from pure systematic call options and put buying programmes to a broader approach focusing on asset allocation and diversification, according to Jagadish Chalasani, co-head of linear FICC and cross-asset strategic indices at J.P. Morgan.
Compared with long put options, QIS such as trend following, long variance across asset classes and reactive strategies which can take positions intraday, may bring a similar or even better outcome without being contractual with the counterparty in nature, said the executive director.
“If you look at QIS-oriented hedging solutions today, they started with the baseline of collar strategies before [turning] quickly into more statistical hedging tools," he said.
Jagdish also pointed to the shift from quarterly to daily hedging for smother risk mitigation.
Sorin Ionescu, managing director, head of QIS structuring at Deutsche Bank, has observed an increasing adoption of these strategies over the past decade.
The German bank rolled out its first cross-asset defensive portfolio for a pension fund in the Nordics in 2014, Ionescu recalled.
“Since then, this field has evolved tremendously in terms of the nature of the clients all the way now to even discretionary portfolio managers, but more importantly, the technology to select these strategies to construct portfolios, as well as the range of candidate strategies available,” he said.
Another major shift at Deutsche Bank is the way the merits of each individual strategy are evaluated to potentially become candidates in portfolios.
“We have gone from an original approach where we were simply looking at the strategy profile in different drawdowns, to now using a cross-asset risk model to evaluate the macro factor sensitivity of each strategy, such that we get a much better handle on how each candidate strategy is likely to behave in a future scenario,” said Ionescu.
In addition, Deutsche Bank is now able to deliver individual strategies related to the macro scenarios that clients are concerned about, such as in an equity down & inflation up scenario vs an equity down & inflation down scenario.
This macro factor modelling is also employed in the evaluation of ‘funding strategies’, which are increasingly used by investors to mitigate a negative carry in their portfolios alongside their defensive strategies.
“Understanding the macro factor sensitivity of each strategy and using that information in the portfolio construction is crucial in our view,” said Ionescu.
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