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The Subprime Meltdown Hits Quant Hedge Funds

If you had asked me where the subprime meltdown was going to hit first, I would never have guessed "heavy-quant hedge funds." Yet so it has:

Blind to Trend, 'Quant' Funds Pay Heavy Price: by Henry Sender and Kate Kelly: Computers don't always work. That was the lesson so far this month for many so-called quant hedge funds, whose trading is dictated by complex computer programs. The markets' volatility of the past few weeks has taken a toll on many widely known funds for sophisticated investors, notably a once-highflying hedge fund at Wall Street's Goldman Sachs Group Inc. Global Alpha, Goldman's widely known internal hedge fund, is now down about 16% for the year after a choppy July, when its performance fell about 8%, according to people briefed on the matter. The fund, based in New York, manages about $9 billion. The fund's traders in recent days have been selling certain risky positions, according to these people. Early this week, those moves sparked widespread rumors on Wall Street that the entire fund might be shut down. A Goldman spokesman has said the rumors are "categorically untrue."

Campbell & Co., an $11 billion hedge fund that trades in the futures market as well as in stocks and bonds and is completely driven by such computer programs, was down 10% to 12% by the end of July. Quant funds -- "quant" stands for quantitative -- generally operate by building computer models of market behavior and then allowing the computer programs to dictate trading. A recurring characteristic of the recent trouble in financial markets is that many lenders, funds and brokerages were following statistical models that grossly underestimated how risky the market environment had become. "Our risk models failed to pick up the fact that we were due for a correction," says Keith Campbell, founder of Campbell & Co. "We were highly diversified. It was the perfect negative storm."... He told investors that the losses stemmed from "a unique combination" of factors.... "All [computer-driven] managers say the models make sense and look like they are working," says Bill Johnston, founder of Bayon Capital, an investment fund based in San Francisco that isn't computer-driven. "But then something happens which statistical probability suggests would never happen."... Renaissance Technologies Corp.... is holding up despite the market's downturn.... Other hedge funds declined to disclose to brokers or portfolio managers in charge of so-called funds of hedge funds just how badly wounded they have been by the recent extreme swings...

"Our strategy is fine. We were just hit by a sixteen-standard-deviation event." "Then it didn't happen: the universe isn't old enough for even one sixteen-standard-deviation event to have ever happened."

Tails are fat.