Breaching the untapped potential in capital markets through quantitative research
Thursday, 1 August 2013 01:22
Quantitative research (quants), although vastly popular in leading financial institutions, is an unfamiliar discipline in Sri Lanka. The popularity of ‘quants’ in capital markets started in the US during the1970s, when investors began using concepts such as the currently mainstream modern portfolio theory and the Black Scholes Model in their decision making process.
In the local market, we are yet to see this level of maturity for various reasons. However, with growing domestic and foreign interest in the local markets, quantitative analysis offers a substantial advantage for companies, asset managers, and high-net-worth investors with regard to risk reduction strategies, diversification strategies, and yield enhancement trades.
In terms of the local stock market, the potential to attract a largely untapped investor class such as quant investors would increase both foreign and local investor participation. Quantitative research essentially entails the use of mathematical and statistical models and methods to provide solutions to the problem of capital allocation.
It can also be efficiently used for trend and time series analysis, data interpretation, forecasting exchange rates and key interest rates using econometric and financial models, Asset and Liability Management (ALM) performance reports, hedging support, and portfolio optimisation.
A quants team is essentially a broad range of expert financial engineers and usually consists of derivatives and portfolio analysts, risk experts, index support experts, economists, statisticians, and technology experts, among other areas of expertise. These teams mainly support investment banks, asset managers, pension advisors, and brokers. The use of core quant areas, such as mathematical and statistical modelling, is usually combined with economics, technology, and finance to cater to capital market requirements in areas of macroeconomics, commodities, FX, fixed income, and credit.
The main advantage of using quants in capital markets or any other discipline is the use of a scientific methodology, which can be logically modified based on the obtained results and reason. A large part of the “gut feeling” or instinct is taken out of the equation and quantified for an optimal result. This does not mean that the benefit of a gut instinct or a feel for the market is ignored, but rather a precise quantified model is established as a reference point, on which judgement calls could be made.
Through such analysis, companies and individual investors have the ability to approach investments in a logical manner, thereby reducing sentiment-driven errors. Such methodologies also result in efficient data management and the ability to dive deeper into research areas of interest and potential investments. This approach lends itself to larger scale, as tasks are modular and can be organised. Additionally, investors could accurately measure performance history and make intelligent adjustments, thereby enhancing the overall future performance.
An area critical to quants is technology. Almost all practical problems in quants are solved by technology. The ability to handle large databases, run genetic algorithms to solve complicated optimisation problems, and store and retrieve information from databases requires familiarity with technology.
The advantages that come with the use of technology, such as the automation of manually-intense processes, the high-speed execution of repetitive tasks and even scheduling email blasts, and other tasks, result in efficiencies that benefit most parts of an overall operation. Technology is also used to develop capital market applications such as pricers and dashboards, as well as to build databases that can store complex information.
Although quants services are a relatively new phenomenon to the local market, the Quantitative Services team at Amba Research Lanka (Amba) has been working alongside leading international investment banks, asset managers, pension advisors, and brokers for over six years.
The Quants Research team at Amba consists of three main areas: mathematical modelling, which concentrates on portfolio optimisation, factor back-testing, and correlation co-integration; quants-equity, which comprises mainly pairs trading modelling, stock filters, and market modelling; and capital market technology, which concentrates mostly on the use of programming languages such as .NET, VBA, and C++ (such languages are used for process automation and customised application development).
The core skills of the team encompass varied skill sets within the four main areas of mathematical modelling, statistical modelling, financial analysis, and programming. In addition, team members must have an interest in capital markets and finance.
Clients use Amba’s quantitative services to add statistical and mathematical rigour to a host of analyses, to back-test trading strategies and allocation decisions, and to better calculate and manage their risks.
Offshoring such tasks to Amba has helped portfolio managers, strategists, quants analysts, and risk managers to focus more of their time on building client relationships and take on a larger number of tasks. In addition, the development of quants in the local context means that graduates in fields such as engineering, mathematics, statistics, and computer science will have an alternate career path in the future.
(Chamara Gunetileke, CFA, is Senior Vice President and Head of Quantitative Research at Amba Research Colombo. Lakshini de Silva is Senior Associate Vice President, Quantitative Research at Amba Research Colombo.)
(Amba is the largest independent capital markets specialist outsourcing firm. Amba is ranked #1 in the investment research and analytics space according to independent customer satisfaction surveys. A majority of the top 15 global sell-side and buy-side firms use Amba in areas such as equity research, fixed income and credit research, quantitative research, sales and marketing, corporate finance, and compliance. Asset managers, brokerages and investment banks have not only saved over US$ 700 m by using Amba over the past nine years, but also built a new operating model that helps them win market share and outperform while eschewing inflexible cost structures. For more information about Amba, please visit www.ambaresearch.com.)