Based on conversations with friends at stat arb shops and stuff I've read in WSJ, it seems that May and June have been very red months for most hedge funds. My friend at a stat arb long/short equity market, sector and industry neutral fund had very May and June. He claims it was because of the broad based selling in the market. Can anyone provide insight into why the longs would lose so much more than the shorts gained in such a situation? At first I assumed their risk measures were faulty, but he claims most stat arb market neutral equity funds had terrible May and June.

These funds work in similar ways. They start with a bunch of historical data: price histories, fundamental data, and more. They look for correlations, cointegration, and other statistical anomalies that will help devise a profitable trading system. First one or two were doing it, then ten or twenty, now maybe the number is in the hundreds?Regardless of the exact equations and methods used, it's a safe bet that most of these funds got roughly the "same answers" during their research tests.Many of them are in the same trades. When a trade start going bad, what can they do? Some one or two funds decide they want to reduce their exposure, so they bring in their shorts and sell out their longs. This exaggerates the difference for the next few funds who do the same thing. Pretty soon you have a large scale unwinding of their positions. Now consider this across multiple securities.Suddenly correlations that never existed before exist because the hedge funds provide a connection across the previously disconnected securities. A set of previously uncorrelated pairs trades all have correlation, and they are all going in the wrong direction for most of these funds. It's just a sign that there are too many people out there doing the same thing.By the way, these stat arb shops are all longer term? Or are some of them doing high frequency trading across these pairs? Usually the high frequency guys can adapt more quickly.

QuoteOriginally posted by: kwoksun2000Can anyone provide insight into why the longs would lose so much more than the shorts gained in such a situation? At first I assumed their risk measures were faulty, but he claims most stat arb market neutral equity funds had terrible May and June.Perhaps it is not a falling market which caused them to lose money, but their losing money which caused the market to fall.These traders are ultimately taking inventories in various commodities and industrial capacities same as any other participant in the economy. To the extent the economy is an interdependent network of counterparty expectations, you can expect all counterparty expectations - and the prospects facing all speculators whether in shoes or in crude oil - to decline simultaneously.

QuoteOriginally posted by: kwoksun2000Based on conversations with friends at stat arb shops and stuff I've read in WSJ, it seems that May and June have been very red months for most hedge funds. My friend at a stat arb long/short equity market, sector and industry neutral fund had very May and June. He claims it was because of the broad based selling in the market. Can anyone provide insight into why the longs would lose so much more than the shorts gained in such a situation? At first I assumed their risk measures were faulty, but he claims most stat arb market neutral equity funds had terrible May and June.I think we need to differentiate stat arb funds, one example is pure math stat arb funds vs. long/short equity funds. To my knowledge pure math stat arbs did ok in those months based on talking to a friend in a fund. I don't know much about the long/short equity funds though. However to answer your question, most of the time long/short equity funds are not fully market neutral in a mathematical sense. For example they might be 75% long and 25% short in their portfolio, some try to hedge that by going long on bonds for net long position in their portfolio or do nothing. This might be the reason why they had two losing months.

quantumar's hypothetical percentages are eerily accurate - from what I've heard, most long/short funds were around 70-80% long going into May, and that is why they lost money. That was an eye-opener for me, as I just assumed that they would always be 50/50, at least through index hedges where they were not trading pairs or clusters. Turns out "long/short" means "can be long or short" rather than "market neutral".

I looked up "statistical arbitrage" in wikipedia and they mention Goldman, Deutsche Bank, TD Securities and Morgan Stanley as major players in the stat arb business. Can anyone suggest other banks with large stat arb operations.Also, thanks for the input in regards to the May/June returns. My friend's fund is beta neutral and does not vary the long/short exposure. Though the neutrality is based on trailing data, which apparently did not hold up.

At the end of June, how is the Stat. Arb. space doing. Especially with Vol. shooting up I guess most mean reversion models should be doing well.- hedge Q.