Benchmarking Hedge Fund Algorithms

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Transcript:

Dr. Anna Becker:

Let’s focus on who does the stories already. What are the good guys are doing, and why are they succeeding? 

We need the stories in order to convince ourselves that we’ll be able to do so, right? So after these attempts of working on the system, I also tried to go to the big hedge funds and work with them and see why they succeeded. 

For me, it was extremely important to figure out what is the key to success for the hedge funds. And luckily, again, as Jeremy said, I got the opportunity to work with Fund to Funds. Fund to Fund is an organization that does the diligence, tests multiple hedge funds, and decides whom to invest. So I got to the Fund to Fund that gave me the carte blanche to go and check all Algo trading funds in the country. So I went to 35 funds, and I had a very personal conversation with them about technology, algorithms, and everything.

And again, this is not a joke because everybody is asking me, why would they tell you this? Why would they tell you their story? Why would they tell you about… And apparently, these people are also very much alone. They have nobody to tell and to share about what they do. And because they look like I look, all of them were really willingly sharing with me all the details of their frustrations and what work, what doesn’t work. And what I got from it, it’s very interesting statistics. First of all, I noticed that people that succeed are between ages 40 and 50 and even closer to 50. So this was weird for me because you have much more creative energy, the beginning, and like, why would it happen? It’s not so hard to build a system. Come on, every 20-year-old guy that knows a little bit of programming and can build a system.

So I started to do the mathematical thing. I decided, okay, I want to quantify it, I want to do all the things right and figure out what’s going on. So I created four phases system. Each fund got a grade from me. What phase he is in. Apparently, all the people who go into the trading industry go through the phases. They don’t have mentorship schools that nobody showed how to do that, so you have to do it on your own. You have to do it by yourself. 

So, first of all, in phase one, people create a successful algorithm. And usually, since they’re smart, they try to do it as HHH. They don’t try to fool themselves. Sometimes it happens because, again, you’re lacking information, but you’re lacking understanding, but still, usually this first phase is easiest. So you’re taking the history of the different assets, you’re trying it, you’re succeeding it, boom, you’re going to your friends, and you’re saying, “I know how to beat the market. Look at these numbers. Let’s put some money together.” So this is the first phase. And luckily for some, their friends have a lot of money. So you can become a hedge fund just because you got to some nice idea, and your friends gave you a few minutes.

But then what happens? And this is such a painful face. Lots of the guys fail on the first one; why? Because you start trading, and this is a big story that it just fails, it just doesn’t work. And you have no idea why. You lack this understanding of why, especially if you build a black box system. If you build a system that you don’t understand yourself how it works, this is a big issue for most beginners. They don’t understand how it works.

So suddenly, it stops working, and they don’t know how to bring it back. I remember the story that I was in one of the offices, and it was like 20 people trying to figure out why their systems stopped working. And I would ask them, “Guys, so how did you build it? What are you basing it on?” And they were not 

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