Trends Watch: Algorithms

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Bert Mouler, CEO & CIO, Profluent Group.

What is your outlook for alternative investments?

In general, with the Fed stepping in and buying more and more assets, it’s clear to us that the value of cash dollars is going to suffer in the upcoming years. In this regard, we are looking for alternatives to holding cash, as it will become significantly expensive in our opinion. Alternative investments encompass a variety of different concepts. When evaluating these we look to grow our capital and to diversify our return streams in terms of correlation, geography, and skewness and kurtosis of returns. Even classical factor investing approaches, which attempt to select investments based on quantifiable attributes that are supposed to predict future returns, continue to do well in developing countries and we believe investors should take note of what has worked in the U.S. and examine if the same would not work elsewhere. We’ve had a lot of luck utilizing models in Asian markets that have long stopped working in the U.S.

What are the greatest opportunities you see and why?

I’ll speak to hedge funds and other trading-related vehicles specifically as this is where our firm’s expertise lies. We focus on algorithmic trading and are generally not investing in any classical stocks and bonds portfolios but instead focus on short- and medium-term alpha opportunities generated by dislocations in liquidity across global financial markets.

We believe that global metals statistical arbitrage and cryptocurrency statistical arbitrage are going to be more and more interesting as more volume is flowing into these markets due to the general reduction in volatility that accompanies QE in developed markets as well as the fear of inflation that is spreading across the globe as central banks print more and more money. Of course, we have yet to see if this reduction in volatility will occur again this time around as we are at relatively high levels of S&P 500 volatility currently.

Nonetheless, we also see significant opportunities in the U.S. equities space, but mainly in exchange-traded options. With the recent spike in volatility, many market makers blew out, widening spreads. Making markets in options is generally a trade we favor because the increased complexity of this business raises the barrier to entry and exposes an inherent source of alpha that traders are able to exploit.

What are the greatest challenges you face and why?

Finding proper talent has and always will be the greatest challenge for our firm. There are simply too few individuals in the world that have any significant grasp of objective reality and this is the exact (if not only) skill required for successful algorithmic trading. Sure, there are plenty of overeducated “geniuses” out there, but none of them are able to generate alpha in reality.

One of the biggest challenges for me personally is literally convincing people to make money. We have hired trading groups for whom we provide infrastructure, the exact trading algorithm, and capital. All they have to do is code it up and run it; yet, for some reason, they are unable to do so. I know it may not make sense but we see this time and time again. It seems that the world is divided into three types of individuals: those that do, those that can’t, and those that can but for some reason do not want to. One of my personal greatest challenges if figuring out how to enable the latter type of person to become a doer.

What keeps you up at night?

One of the things our firm focuses on is the proper evaluation of counterparty risk in an environment that lacks transparency. It’s quite difficult to get a deep look at the books of the financial institutions we trade with and while we know our risk, it is clear from every market crash or melt-up that many of the other firms in the market do not know theirs. We try to focus on trading with the largest and most long-standing firms out there but there is no guarantee that this filter is viable. Unfortunately, due to the inherent rarity of outlier events in our world, they are difficult to model statistically. In this case, we try to adhere to the following principle: if you buy $100 worth of Apple Inc. without leverage, your risk is $100. Building models from that perspective allows us to sleep more soundly knowing that we have generally overestimated our risk. However, it is difficult to estimate the second- and third-order risks in an increasingly globalized and interconnected financial system.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.

Securities trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than their initial investment. Risk capital is money that can be lost without jeopardizing one's financial security or lifestyle. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results. The views and opinions expressed above are not intended to be investment advice and do not necessarily reflect the views of Profluent Group or its affiliates.