Tech, ExplainedFintech
Concept

Hedge funds and quant trading

Private funds trading on models and judgement.

HOW IT WORKSThe fund raises moneyfrom large investorsResearchers look forsignals in data thatmay predict pricesA model combines thesignals into trades,within risk limitsSoftware sends thetrades to the marketThe fund charges a feeand keeps a share ofthe profitThe fund earns only when its models or its people judge prices better than the rest of the market.HOW IT WORKSThe fundraises moneyfrom largeinvestorsResearcherslook forsignals indata that maypredictpricesA modelcombinesthe signalsinto trades,withinrisk limitsSoftwaresends thetrades tothe marketThe fundcharges afee and keepsa share ofthe profitThe fund earns only when its models or its people judge prices better than the rest of the market.HOW IT WORKSThe fund raises moneyfrom large investors↓Researchers look for signals in data thatmay predict prices↓A model combines the signals into trades,within risk limits↓Software sends the trades to the market↓The fund charges a fee and keeps a shareof the profitThe fund earns only when its models or its people judgeprices better than the rest of the market.
A fund raises money from large investors, researchers find signals in data, a model turns them into trades within risk limits, and the fund keeps a share of the profit.
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A hedge fund is a private investment fund that invests the money of pension funds, endowments and very rich people, and keeps a share of the profit it makes. An endowment is the investment fund of a university or a charity. Quant trading, short for quantitative trading, means letting mathematical models, built from data, decide what to trade. Many of the world's largest hedge funds and trading firms run research and technology centres in India, mostly in Bengaluru, Hyderabad and Delhi NCR.

Hedge funds differ in how they decide what to trade. Quantitative or systematic funds let models decide. Discretionary funds let people decide, using their own judgement. Macro funds bet on big economic changes, such as interest rates or currencies. Multi-strategy funds run many independent teams, each with its own money and its own limits.

Here is how a quant fund works in general. The fund raises money from large investors. Researchers look for signals in data. A signal is a pattern that may predict a price move. A model combines thousands of signals into trades, within limits on how much the fund may lose. Software sends the trades to the market. The fund charges a yearly fee and keeps a share of any profit.

Take, for example, a fund that studies satellite images of car parks outside shops. If the car parks are fuller than usual, the model may predict better sales, and buy the shops' shares. Such images come from satellite imagery analytics companies.

Consider a macro fund that expects interest rates to fall. It may use futures and options on bonds to profit if that happens.

Say a multi-strategy fund has hundreds of teams. An investment management system holds every team's positions and checks each one against its limits.

How is a hedge fund different from a mutual fund? A mutual fund takes money from the public, follows strict limits, and charges a yearly fee that is a percentage of the money it manages, within a limit set by SEBI. Its software is described in asset management. A hedge fund takes money only from large investors, can borrow and bet on falling prices, and keeps a share of the profit. A high-frequency trading firm is different again: it trades only its own money, very fast and very often.

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