As ZeroHedge readers are keenly aware, 2008 kicked off the largest financial engineering experiment in history – namely, the beginning of 12.3 Trillion in QE and the lowest interest rates in 5,000 years. The plan, hatched by Bush-era Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson, created a ‘Fed Put’ underneath the markets first made popular by Alan Greenspan – an implicit guarantee that no matter how bad things got, the Fed would actively combat financial disaster.
As a result, markets experienced an unprecedented rally of nearly 400 percent since the March, 2009 lows – corresponding with a renaissance in computerized trading thanks to lightning fast Silicon Valley innovations.
Rise of the machines
As markets worked their way out of the giant financial crater created by the credit crisis, erratic surges in volatility and historically low interest rates created the perfect conditions for asset managers of all sizes to employ sophisticated trading algorithms to try and beat the market while dispensing with costly human employees. Between Wall St. firms and the various technologies adopted by exchanges around the world, countless billions have been spent on raw processing power, low-latency long-distance trading networks, and an army of programmers.
In March, Blackrock’s Larry Fink boldly stated that the era of the “star stock picker” is coming to an end amidst a firm-wide shift by the world’s largest money manager towards automated strategies.
JP Morgan estimates that up to 90 percent of all daily volume across all exchanges is computer driven, or systematic trading – with just over half of the volume attributed to risky High Frequency Trading (HFT) algorithms. This massive shift from active-investing (humans) to passive-investing (algos) effectively means that Trillions of dollars are sloshing around the exchanges, traded almost exclusively by automated systems.
Perhaps most troubling about the shift to algos is the fact that Wall St’s mindless robots have never had to participate in a rate hike cycle, the unwinding of central bank balance sheets, or a secular bear market. Couple that with that fact that many systematic trading schemes use massive amounts of leverage, and it’s clear that we are entering into uncharted territory as market conditions change.
Choking on bytes
When the Fed began printing money in December of 2008, the erratic volatility which accompanied the QE experiment ushered in a period of underperformance by active money managers who couldn’t compete with hyper short-term, passive trading algorithms.
Unfortunately for algos – which hit their stride during ‘easy money’ market conditions, the future may not be so bright. In addition to creating volatility, sparking flash crashes (they need liquidity like an engine needs oil), and frontrunning orders, automated trading systems have been suffering from diminished returns amid an investment landscape now comprised almost entirely of robots.
In August, the Fed’s Janet Yellen warnedof the “larger presence of algorithmic traders in markets,” voicing concerns over liquidity during stressful conditions. In short, the industry-wide ‘rise of the machines’ has ushered in new types of systemic risk while diluting the performance of once-dominant strategies.
“…algorithmic traders and institutional investors are a larger presence in various markets than previously, and the willingness of these institutions to support liquidity in stressful conditions is uncertain.” –Janet Yellen
And as the Financial Times reported last year, algos have huge blind spots when it comes to market disruptions, noting that while “any large market moves in one direction for a period of time the trend following computer will be able to profit,” algos are entirely unable to respond to irrational events they weren’t programmed to deal with.
Their conclusion was logical:
“Until computer traders can develop genuine artificial intelligence they will remain unable to gain an edge over the best human investors in spotting a catastrophic disruptive threat to an industry, or a revolutionary emerging technology.
Raw processing power may have its uses in financial markets, but until scientists develop a truly intelligent investing system, rather than a trend follower, the truly skilled human fund manager has no reason to fear.“
Enter Blackrock’s Elite Alumni
Like John Connor leading the resistance against a mindless army of terminators, three former Blackrock money managers, Chris Coolidge, Edward Dowd, Rich Mowrer and industry marketing veteran James McCaffrey have teamed up to outmaneuver Fink’s SkyNet and the rest of the Wall St. robots. Their firm, OceanSquare Asset Management, LLC (www.oceansquare.com) was formed to take advantage of what they believe to be the coming shift back to active, fundamental investing in both fixed income and equity after a decade of synthetic, Fed-sponsored growth.
Based out of Wayne, PA, these guys are no joke – having managed tens of Billions for Blackrock with 54 years of combined experience, the team has navigated multiple market cycles – something Wall St. algorithms have never done.
“The investment world is in the crosshairs between man and machine. From algorithms to computer-driven portfolio management, the automation against our clients is underway and it’s our responsibility to deliver to them the active solutions they deserve.” –Chris Coolidge, President & CIO of Fixed Income
In short, the days of easy money are over. With markets at all time highs, thanks in large part to algorithmic ping-pong, the principals of OceanSquare are gearing up for the return to fundamentals-driven, high-conviction stock and bond selection – which means humans analyzing companies run by other humans, who are making long-term business decisions to adapt to economic conditions and purchasing decisions of – you guessed it, humans.
OceanSquare is also unique in that the fixed income and equity PMs will collaborate on their products and will all jointly run a Global Multi Asset Absolute Return product that will be a concentrated ‘best ideas’ portfolio with a benchmark-agnostic approach.
Edward Dowd, OceanSquare’s CIO of Equities and former manager of BlackRock’s $14 billion Capital Appreciation fund, feels confident going head to head against the robot army:
“OceanSquare intends to outwit the computers through portfolio concentration and long holding periods,” Dowd said, adding “While the computers have the edge in short term trading, it is OceanSquare’s belief that fundamentals eventually align with price over a time horizon greater than a year. Larger global asset managers will be challenged to effectively offer concentrated portfolios due to their size and focus on short term performance measurements. Additionally, it would require them to shrink as well, which is never fun for investment staff or their investors.”
With the army of Wall St. terminators already suffering from fatigue, OceanSquare Asset Management and its team of star stock pickers may be the John Connor that active clients need to guide them into the future.
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