The chief executive of one of the world’s top hedge funds says the asset management industry will face further disruption as markets speed up and investors become even more discerning about what skills they pay for.

“If you think about the asset management industry as a whole we have done a pretty lousy job of putting the client at the centre,” Noel Gulati, the chief executive of $US51 billion New York-based Two Sigma Advisors told an audience at a hedge fund conference in Sydney.

“This industry has been designed by asset managers legitimised by consultants by creating hundreds of categories and thousands of products without ever asking what the objective is the [investor] is trying to solve for,” he said.

Mr Gulati, who has helped run one of the most acclaimed quantitative hedge funds in the world, was interviewed at the Alternative Investment Management Association conference.

Overdeck worked alongside Bezos at Amazon in the early 1990s.
Overdeck worked alongside Bezos at Amazon in the early 1990s.

AP

He said active fund managers who have come under pressure from the rise of low passive or index tracking investing would now face a greater threat as investors begin to realise that their strategies or styles can be replicated at a lower cost, through risk “premia”.

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These broadly describe strategies such as “value”, “momentum” and “quality” in which rules are followed to systematically capture returns.

But Mr Gulati said the “wrong fee structure was being applied by active managers that were either knowingly or unknowingly, deploying these strategies.

“It’s a good source of returns and investors should get compensated, but the fees should reflect that.”

Two Sigma was founded in 2001 by John Overdeck and David Siegel who had previously worked at DE Shaw.

That hedge fund is where Amazon founder Jeff Bezos applied his skills before setting up the e-commerce giant.

In fact Overdeck worked alongside Bezos at Amazon in the early 1990s.

Mr Gulati joined Two Sigma in 2007. During that time the quantitative hedge fund has grown its assets from $US3.7 billion to over to $US50 billion.

The company has 1,500 staff, mainly young data scientists and mathematicians

“We benefit where there is a level playing field – where the information asymmetry edge that humans have is less, and where computers can play and win,” he said.

The fund accesses over 10,000 data sets to make its investment decisions including processing satellite images of car parks to count cars to predict sales at retailer.

“That’s the most used and overused example but yes we do that,” he said.

That is not as simple as it seems, or perhaps even more complex than it appears, he explained.

“In reality you have to deal with climate conditions, cloud cover and snow. And counting cars is easier said than done. It relies on all sorts of complicated forms of machine vision algorithms.”

Several Australian institutions are investors in Two Sigma, including the Future Fund and MLC, as more investors embrace quantitative investing.

Less mystery than active managers

Mr Gulati said some investors are still averse to investing in what they perceive as “black box” computer driven strategies – but he said active managers arguably had a more mysterious process.

“The human brain is the ultimate black box. In our case everything is audited and coded, and there is logic to everything,. Try get a human to explain to you why they made a decision.”

He says quant funds have not changed financial markets, or the investment process. What has changed is the “abundance of data.”

“If you look at a Bloomberg machine it’s not designed for humans anymore. You could stare it all day long and how many pages can you call up? A hundred or a thousand?” he said.

“It has an enormous amount of data that is not meant for human consumption.”

Quantitative funds are also often blamed for creating crowding in the market as they are perceived to follow the same signals.

But Mr Gulati said this was evident in any form of investing and was not limited to quant funds.

“That risk is very real. But that applies to anything that is overly fashionable.

“We try to stay ahead of that and recognise that yesterday’s alpha will become tomorrows beta.

“We have hundreds of different models to track daily performance to see if there are signs of crowding. That is why we have 1,500 people – because it is that massive of an endeavour.”

Mr Gulati said the advent of technology in asset management has meant that information gets integrated into markets quicker.

That has made markets more efficient, albeit prone to violent corrections.

“Things are all happening at lightening speed where they would have taken days or weeks to profligate decades ago.”

“That is one of the reasons volatility is at historical lows. Risk is just absorbed in the market but that means that when that tail risk happens – the things we are not talking about – its going to be particularly violent.”

“That has nothing to do with quants. It is just a structural evolution of the market.”

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