What If Lower Volatility Is the Wrong Goal | Open Interest | Ep.25

Episode Overview

• Quantedge's leadership discusses the mechanics of systematic trading, how to harvest risk premia, and the structural design required to survive and thrive with high-volatility strategies.
• The conversation covers the math and philosophy of portfolio diversification, showing why adding truly uncorrelated assets like commodities and Insurance Linked Securities (ILS) is necessary to insulate capital.
• The guests explain the operational and structural choices behind managing an $8 billion fund, including the strategic use of investor lock-ups, focusing on a single product, and aligning employee incentives.

Key Concepts

• Risk Premia and the Insurance Model of Trading: Systematic trading operates much like an insurance company, where a capital provider accepts specific market risks in exchange for a premium above the "fair value of risk." Harvesting this premium across equities, bonds, commodities, and currencies provides a reliable long-term source of return.
• The Power of Uncorrelated Bets: True diversification requires combining assets with entirely independent risk profiles. While individual strategies (such as Insurance Linked Securities) can have highly skewed "tail risks," combining many uncorrelated bets mathematically averages out individual losses and trims the overall portfolio downside.
• Active Volatility Targeting: Rather than minimizing volatility to comfort institutional investors, targeting a higher volatility level (such as 25%) is an intentional strategy to maximize long-term compound growth, provided the portfolio is sufficiently diversified to prevent the risk of ruin.
• True Asset Class Diversification vs. Equity Illusion: Standard equity-only diversification across different global markets is often an illusion due to high positive correlations during market stress. Genuine portfolio resilience requires integrating commodities and structured, non-exchange-traded assets like catastrophe bonds.
• Strategic Investor Alignment and Lock-Ups: High-volatility strategies require structures that manage investor behavior. Implementing multi-year lock-up periods prevents panic redemptions during sharp market drawdowns, ensuring the fund is not forced to liquidate assets at the worst possible time.
• The Power of Single-Fund Focus: Resisting the urge to launch multiple niche products ensures a firm's talent, energy, and resources remain entirely dedicated to optimizing a single, unified portfolio.

Quotes

• At 13:50 - "Am I just leaving risk on the table? Could I be taking more risk and, as a result, getting higher returns?" - Explaining the philosophical shift from minimizing volatility to intentionally targeting higher risk to maximize long-term compound growth.
• At 15:31 - "We're trying to collect and put together as many independent, uncorrelated bets as possible... and if they are truly uncorrelated, then over time you're sort of trimming the tails." - Detailing how diversification across uncorrelated risks mathematically dampens the severe downside of any single strategy.
• At 16:58 - "When people sort of look at equities and say 'Look, I've got a diversified book,' but if they are referring to just one market, that is hardly diversification. In fact, even across markets, there is actually quite a lot of positive correlation between equity markets." - Clarifying the misconception of equity-only diversification and emphasizing the necessity of adding uncorrelated asset classes like commodities.
• At 21:11 - "The systematic nature of the ILS (Insurance Linked Securities) investments we do would be confined to the way that we analyze the deals... we want to achieve the same kind of diversification that we do in our general markets portfolio." - Explaining how structured, non-exchange-traded assets like catastrophe bonds can still be managed via systematic risk budgeting.
• At 22:17 - "That's essentially what's driven us to create a portfolio that accepts and targets a higher level of risk in order to get a higher level of return." - Outlining the fundamental philosophy behind maintaining a high-volatility, high-return target.
• At 31:01 - "The priority at QuantEdge is to continue delivering high returns. So we will not expand the fund and take in more money if we think it dilutes returns." - Emphasizing the firm's focus on return quality and capacity management over gathering assets under management.
• At 38:20 - "How about giving assurance to everyone in the fund that every single investor is required to sit through the volatility because they're locked up? So there's no second guessing." - Explaining the strategic value of lock-up periods in preventing panic redemptions during drawdowns.
• At 48:29 - "March of 2020... we lost 29 percent. So that was to me actually the toughest time that we had." - Recalling their largest monthly drawdown during the COVID-19 crash and the operational resilience required to navigate it.

Takeaways

• Look beyond equities and bonds for true diversification by seeking out uncorrelated risk streams, such as commodities or alternative assets, to insulate against market-wide shocks.
• Determine your target volatility based on long-term growth objectives and risk-of-ruin thresholds rather than industry-standard benchmarks.
• Align stakeholder incentives by requiring team members to invest their own capital in the strategies they manage, building shared commitment and long-term focus.
• Use structural constraints, such as investor lock-ups, to protect portfolio execution from human behavioral biases and emotional panic during market drawdowns.
• Guard against asset-gathering dilution by prioritizing strategy performance and return quality over the expansion of assets under management.