Hedge fund trading, on the cheap

A JPMORGAN Chase & Co quant unit has amassed a US$100bil derivatives-powered trading book, offering hedge fund-like investing on the cheap to investors of all stripes. 

The bank’s Strategic Indices business has been at the forefront of the boom in what are known as Quantitative Investment Strategies, or QIS, which turn well-known systematic trades into swaps or structured notes – making copycat products that are easier and more cost-effective to deploy.

QIS have been a hit with the likes of insurers and pension funds for providing classic hedge fund-style exposures such as trend following and options selling at a fraction of the cost.

Lately even the fast money – once-hostile to these competing investing products – has been warming up to the strategies. 

Against that backdrop, the underlying value associated with these trades, or notional exposures, has risen an average 15% annually over the last four years at the JPMorgan unit.

Now, the Wall Street bank says it’s increasingly broadening out its quant offerings across assets, including commodities like natural gas and options on emerging- market currencies and overnight rates. Even trades tied to mortgage-backed securities are next in its sights. 

“We want to continue finding new market opportunities and help our clients get exposure to many more of those markets which frankly can be more challenging to access,” said Arnaud Jobert, JPMorgan’s London-based co-head of global strategic indices.

“Unlike a lot of the funds out there who do have a flagship offering, we can tailor very quickly bespoke profiles for many of our investors.”

Crowding Criticism

JPMorgan’s US$100bil is the outstanding notional amount of exposures, rather than actual cash invested, since the strategies often take the form of swaps.

By one estimate, QIS units across 13 broker-dealers were running a record US$573bil as of last June, according to an Albourne Partners survey seen by Bloomberg News. 

In a typical trading unit of this kind, a bank draws up and implements a rulebook for each strategy, but the investor can customise the exact details and decides when to move in and out of the trade.

Critics argue the swaps are blunt tools – cost-effective and easier to trade, but unable to respond to shifting markets in the way a money manager could. And unlike asset managers, banks selling QIS have no fiduciary duty to the purchaser. 

The business has also come under fire for channelling too much cash to winning strategies, harming performance as a result.

One example is intraday momentum, a trade that goes long S&P futures if the index starts the day with a strong gain (or vice versa) and exits the position by the close.

After its famous success during the Covid selloff of 2020, the strategy had deteriorated badly by 2021 and many quants blamed crowding – and more specifically, QIS. 

Jobert disagrees, pinning the decline of intraday momentum on changing options-dealer positioning. To him, these now widely known strategies exemplify where QIS have seized market share.  

“Trend is a good example of an investment strategy that has become relatively commoditised and QIS can do a very good job in delivering that trend beta at a fraction of the cost,” he said. 

The bank has unveiled an iteration of the strategy that uses short-dated options, as well as new trades surfing intraday moves in single stocks that are part of the US$100bil leveraged ETF complex.

The reasoning is simple: market makers hedge their exposures so that if, say, Tesla Inc keeps rising in the day, they have to buy more of the stock.

JPMorgan declined to identify the stocks it targets, but Tesla and Nvidia Corp are among the largest names traded by these kinds of amped-up exchange-traded funds.

Hedge Fund Fans

Institutions like pensions and insurers make up roughly 70% of JPMorgan’s QIS business, with hedge funds accounting for a high-single digit percentage. The rest comes from retail investors, who are exposed through structured products and annuities, mainly in the United States.

While QIS have traditionally competed head-to-head with hedge funds, some fast-money managers have started using the swaps to easily add trades.

These days, the overseers of their central risk books – who examine the fund’s aggregated bets from the top down – are also using bank products to hedge things like factor exposures, Jobert said.

“We were perceived to be a threat for hedge funds and now I think the pie can grow for everybody,” he said. “Ultimately execution outsourcing will allow hedge fund managers to focus on alpha opportunities.” — Bloomberg