Demystifying the Quantitative Hedge Fund Investor

Composite of quantitative hedge fund investors leaning over laptop with charts and figures

 

For investors just getting into the field, there is often a lot of information you are expected to take on quickly to avoid making critical mistakes. Among them is concern over various investing platforms, one of which is the quantitative hedge fund

 

Quantitative Hedge Funds

Hedge Funds utilizing statistical data (often in tandem with algorithmic trading) to create and execute investment strategies on behalf of accredited investors. 

 

This model varies against other types of hedge funds, which typically operate on a traditional model, utilizing the skills and talents of experienced financial advisors to make calls on investments. While the traditional model is still the predominant approach used by hedge funds, the quantitative model is becoming more widely used due to its modularity and proven track record of success. 

Investment Strategies

Investment Strategies

Quantitative hedge funds operate based on machine learning. Quantitative scientists (also known as “quants”) feed market data to a computer program from which they develop algorithms—rules or equations used for future investments—to craft investment strategies. 

 

The types of strategies used by quantitative hedge funds vary somewhat depending on the event horizon and acceptable risk level of the investor. Most commonly, they use these strategies: 

 

Strategy Explanation Use-Case
Long Putting fund money into stock with the expectation it will do well  When you believe that a stock will increase in value. 
Short Selling borrowed stocks and buying them back after the price has dropped, keeping the difference When you believe that a stock will decrease in value
Event-Driven Using global events to craft short-term investment strategies Any major global event (Recession, UN Summit, etc.)
Arbitrage Buying a stock at one exchange and selling for more at another, keeping the difference  When markets display different prices for the same good

 

Often, working with a quantitative hedge fund of any type means utilizing several, if not all, of the strategies listed above simultaneously. Quantitative hedge funds in particular are known for their ability to easily and quickly pivot according to changes in market conditions to generate the greatest possible return. This requires the ability to shift between holding long and short positions on the fly or using high-frequency trading methods to conduct arbitrage strategies. 

It is important to note that, while hedge funds often switch between these strategies quickly, hedge fund investors rarely have a say in where their money goes. Rather, those investments go into the larger investment pool which the fund utilizes how they see fit. 

Quantitative Hedge Fund Benefits

The central draw of quantitative hedge funds comes from the commonly held image of them as vehicles for the greatest profit. The word “hedge fund” often conjures images of wealthy individuals in opulent suits driving impossibly expensive cars. 

 

While these stereotypes are not always true—hedge funds can and sometimes do fail—they exist for a reason. Most commonly, quantitative hedge funds are known for their:

  • Efficient, Speedy Processing: The human mind and body are limited by their need for food and sleep. Utilizing an AI-centered approach keeps your investment vehicle moving even when the investor is not. Similarly, humans are limited in how much market data they can process. AI far exceeds human abilities in this regard and will continue to do so as AI technology improves.
  • Improved Maneuverability in Shifting Markets: Because AI never sleeps, it is constantly monitoring the conditions affecting your investment strategy. Similarly, their inherent connection to the market allows them to quickly make and execute investment decisions at an up-to-the-minute rate. This keeps your investment strategy updated and refreshed, prepared for any additional changes.
  • Removal of Human Emotions: Human investors are subject to fear, anxiety, and personal attachments that often keep them from making objective investment decisions. Using a quantitative approach gives investors an unbiased view of the market and tools to easily identify the best possible investments and trades.
  • Better Rate of Returns: Although traditional investment approaches have set the standard for decades, quantitative approaches have been proven on average to yield higher returns. This is especially true in the case of hedge funds, which often utilize high-risk strategies to garner larger results. 

Maybe most general of all, hedge funds have the added benefit of experienced financial advisors who can walk newcomers through the process of investment. For the inexperienced, these services are an essential part of getting acclimated to the investing world. Most importantly, they are often not offered in more accessible quantitative platforms, such as robo-advisors. 

Quantitative Hedge Fund Risks

Although the hedge fund’s propensity for profits has garnered a widespread reputation, the truth is that they often carry associated risks. When entering into an arrangement with a hedge fund, most investors are willing to accept these risks in exchange for the promise of exceptionally high returns. Nonetheless, it is essential for anyone considering services with the hedge fund to know what these risks are. 

The risks associated with quantitative hedge funds are similar to risks associated with quantitative strategies in general, such as:

  • Use of High-Risk Strategies: Many of the strategies utilized by quantitative hedge funds are designed to yield the highest possible return. Doing so implies a certain level of risk commonly associated with the attempt. For example, shorting a stock can potentially leave investors on the hook for much more than even their initial investment assuming the stock gaps up instead of down. 
  • Pure Impartiality: Although the ability to make unbiased decisions is often touted as the central benefit of a quantitative model, investors also need to understand that the objective analysis of AI models only applies to the market and not the investor. Often, this means making decisions without accounting for the personal considerations of your personal life. 
  • High-Value Investments: Unlike other platforms which offer quantitative services for a more accessible fee, hedge funds across the board require significantly higher dollar amounts to become clients. We discuss this further in the sections below, however, the general takeaway is that the dollar amount of any investment is amplified by the exceptionally high buy-in. 

Whenever undertaking a quantitative investment approach, investors should consider consulting with experienced help. This is often what makes the hedge fund model so appealing as it offers financial advisors to provide precisely this kind of assistance. These services, however essential, cost the investor a great deal more than other platforms. 

Quantitative Hedge Fund Fee Structure

Traditionally, hedge funds apply a “2&20” fee structure model. This model consists of two annual fees:

  • A 2% AUM (Assets Under Management) Fee which is collected regardless of whether or not the stock increases in value.
  • A 20% Performance Fee is cut from the investor’s profits once they exceed an agreed-upon level (usually around 8%). 

More pertinent to newcomers in the investing world is the initial buy-in to start as a client with a hedge fund. Although this amount varies depending on the individual firm, the rates typically start at a minimum of $100,000 and go as high as 10 million dollars depending on the size, power, and reputation of the relative firm. 

These amounts should explain the relative power and high yields commonly associated with hedge funds. Because each of their clients is contributing such a large amount to begin with, hedge funds often have a greater deal of leeway to conduct the types of strategies that they want. It also allows them to be pickier about who they take on as clients.

Who Can Invest With a Quantitative Hedge Fund? 

By law, hedge funds are limited to taking on clients who qualify as an “accredited investor.” This refers to individuals who:

Accredited Investors
Have an income of $200-300k Are knowledgeable employees of an investment company. 
Hold a valid series 7, 65, or 82 license  Have a net worth of $1 million or more 

 

Limiting their clientele to accredited investors only is precisely what allows quantitative hedge funds to conduct more high-level investment strategies. By contrast, something like a mutual fund would not be able to do things like shorting stocks on behalf of investors, instead being contained to lower-risk strategies like going long. 

For investors unable to meet one or more of these requirements, they often have to consider secondary platforms. In terms of quantitative strategies, this leaves robo-advisors as the largest draw, however, they are not perfect. The platforms often yield relatively smaller returns and lack the consultation experience to allow new investors to make informed decisions. 

Quantitative Hedge Funds And You

As you might have guessed, the services offered by quantitative hedge funds are often not available to the average investor. The fee structure is exceptionally inaccessible, the risks are statistically high, and successful investment strategies require time and disposable income that most people do not have access to. Although this reality might be disheartening for newcomers hoping to invest with a hedge fund, it is important to understand that profitable alternatives exist. 

Interested investors should consider platforms in lieu of quantitative hedge funds. Companies like RIMAR Capital utilize a quantitative approach to various investment strategies to generate the highest possible yields for our investors. Best of all, our services are available for a starting investment of just $1,000, making it a far more accessible option for new investors than a quantitative hedge fund. Contact us to set up an initial consultation. 

Ryan Gordon

Ryan Gordon

Ryan is a qualified chartered accountant of South Africa. Ryan is an avid sportsman who also enjoys reading and spending time with friends and family in his down time. Ryan joined the RIMAR Capital team in 2019 as a business development manager.

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