Hedge Magazine, March 2013. Original article here (p30-33).
Penny Aitken, partner and global head of investment research at FQS Capital.
Penny Aitken is not particularly interested in hedge fund managers with so-called good instincts: “I would rather be with somebody who knows why they are good, than with somebody who thinks they know why they are good.” As global head of investment research and partner at FQS Capital, maths are Aitken’s secret weapon to separate the talented from the lucky: “Sometimes a hedge fund manager can think they are doing one thing, but the evidence says they are doing something completely different. When we share our analysis with the funds, it can make for some very interesting discussions!”
Innovative statistical models sit at the core of FQS Capital’s selection process. The company is the brainchild of maths whizz Dr Robert Frey, who headhunted Aitken while on maternity leave to run the company from London. Business-casual in a navy dress and subtle jewellery, Aitken greets me in a meeting room in the company’s City offices, taking a moment to admire the sweeping view over a frozen London. While her stint in accountancy before heading into investment means she is not afraid of numbers, Aitken’s social sciences degree bears witness to a more qualitative approach: “We do not expect our tools to give us answers; we expect them to give us very strong indications of where we should look. Then we go to meet the manager, review the business, consider all the qualitative and soft factors. We want to really test the thesis and make sure it stacks up from all angles.”
In essence, FQS’s data-churning methods are all about identifying alpha: how much of a returns stream is driven by market factors, and how much is driven by skill and expertise. “We can also use these tools to find ways of filtering funds and search for certain criteria among alpha-driven managers, such as managers with a certain volatility profile or behavioural pattern.” Because, stresses Aitken, investors can go out and buy beta performance with a cheap ETF, so you do not want your hedge fund to do that. “What you want is a diversified source of return, preferably one not coming from market factors.” When she finds a manager with this kind of alpha performance, and Aitken admits this is not that easy, she then looks for signs this can be maintained over time: “We find that kind of investment opportunity very compelling.”
By leaning on quantifiable metrics, FQS’s methods adds a clarity to proceedings in what has at times been an industry lacking in transparency. “The maths, and all of Robert’s expertise, provides us with a very robust ability to handle data, and an ability to generate ways of handling that data,” says Aitken. This also has competitive benefits for the firm: “It means we are not wedded to traditional metrics or tools, or to buying things off the shelf. We can generate our own systems and programmes to process data and spit out results.”
The single fund run by FQS Capital is currently fairly modest in size, at less than $150 million, initially established for Dr Frey to manage his own money. While he is still the primary stakeholder, FQS are now looking to add further investors. Established in 2010, the fund was not fully diversified until 2011 and is still evolving. As to the question of performance, Aitken says the fund has matched the industry average over the past year: “But we have done this on half the risk. On that basis we are pleased with that result, because it is proving our point in terms of our balancing of risks, of our understanding of how you diversify these factors in a portfolio context. It is still early.”
Having said that, the fund’s risk mandate is “conservative”, with a focus on capital preservation: “We are talking about long term compounding effects.” In an effort to identify the desired stability, the FQS data models will draw on up to 30 years of data from a variation of sources to understand what a specific hedge fund is likely to yield. Even when the markets are behaving unpredictably, models are still helpful: “Right now we are in a testing environment where you have low growth and low interest rates. So what you can do is calibrate and make tactical tilts.”
While discretionary managers responded to the lack of predictability following the events of 2008 by becoming more conservative, Aitken points out how quantitative managers were much more able to carry on as usual by programming the new risk factors into their models. But if what we are experiencing now is arguably historically unprecedented, I ask, can historical data really reveal the future?
“This is an interesting question, but there are lots of periods in history where we have seen huge transitions and huge intervention by policymakers. This, in itself, is nothing new,” says Aitken. Of course, if the prediction process could be perfected we would all be rich: “But the 2008 period was interesting because it created a huge data set from a risk point of view, a very different data set to what came before and after. For us it is about how you use that data and calibrate it with the other periods around it. We are data junkies!”
As a new company, FQS Capital has been designed specifically with a concern for survival during a period of industry contraction. This includes keeping a close eye on costs, an issue which Aitken admits may not have been a priority for the industry during the fatter years. FQS also provides advisory services for clients looking to make portfolio decisions, with emphasis on the ability to listen and provide solutions.
A lack of trust in the financial system is still an issue felt across the industry, says Aitken, who believes finance needs to be more transparent: “It needs to be more accessible and it needs to be more accountable. We are trying to do all of those things here. We are trying to not blind people with maths, but to share these mathematical techniques and improve their understanding.”
Cold, hard stats will have the ability to reveal what is really happening in an investment situation, as it is unaffected by the manager’s hopes and dreams. At the beginning of our chat, Aitken references a study (co-authored by London’s Wellcome Trust Centre for Neuroimaging) which suggests the human brain is slightly optimistically wired in terms of processing negative and positive information. In evolutionary terms, this may be healthy to ensure we keep going in the face of adversity, but it is more problematic if you are a hedge fund manager. FQS is attempting to circumvent such bias in its own ranks by keeping records of decisions and assess the outcomes: “We have a huge respect for evidence.”
On that note, Aitken is excited to be building a team and a process at FQS from “a blank sheet”. The opportunity to be part of a developing field is also why she transitioned from traditional asset management to the alternative sector: “With hedge funds you have much more flexibility. You have all these different tools to express yourself. I really enjoyed the challenge of that, and the fact it does not sit still. Hedge funds are constantly evolving at a very rapid rate; you saw that all through the 2000s, all the way up to now when they are probably evolving into a different lifecycle phase. But the challenges do not stop, they just change.”