For more than a decade at Goldman Sachs Group, Mark Carhart helped run the giant bank’s famed Global Alpha hedge fund. Under Carhart and Raymond Iwanowski, the quantitative fund became one of the largest and most successful in the industry, yielding annualized returns of 12 percent over a dozen years. At its height in mid-2006, it had more than $12 billion in assets. Then came the summer of 2007, when Global Alpha, like nearly all quant funds, dramatically stumbled. It ended the year down 40 percent; 18 months later, Carhart and Iwanowski retired from Goldman.
Now Carhart, 44, is launching his own quant shop, Kepos Capital. Having learned from 2007 — and from 2008, when the entire hedge fund industry almost melted down — he aims to show that quantitative global macro is stronger than ever. Carhart had better deliver. “Hedge funds need to prove they can add value,” says Michael Rosen, CIO of Santa Monica, California–based investment consulting firm Angeles Investment Advisors, which has invested in quant hedge funds in the past. “There are so many ways that investors can be hurt — high fees, poor transparency, misalignment of fees.”
Deep in fundraising mode, Kepos is avoiding the press. But last year, Carhart gave Institutional Investor his views on how he thinks the asset management industry should evolve. Investors, he said, must do a better job of separating alpha and beta — and refuse to pay 2 and 20 for market-driven returns. Kepos charges a standard management fee but only applies an incentive fee to net alpha returns.
Carhart has recruited an impressive team. Kepos’s 27-member professional staff includes director of research Giorgio De Santis, former co-head of research at Goldman, and chief risk officer Attilio Meucci, who was previously in charge of research at Alpha, Bloomberg’s portfolio analytics and risk platform. Robert Litterman, a 23-year Goldman veteran who headed risk at the bank and advised Singapore’s sovereign wealth fund, chairs the academic advisory board.
That body comprises six academics, among them John Cochrane, AQR Capital Management Professor of Finance at the University of Chicago’s Booth School of Business, and Kent Daniel, professor of finance and economics at Columbia Business School and another Goldman alum. The board offers Kepos — which is predictably secretive about the precise nature of its trading algorithms — access to the latest academic research. It will also act, the firm’s prospectus says, as “a critical sounding board when we present our new research in our internal seminars” and “will also function as a recruiting platform.”
If this sounds like some idyllic college think tank, don’t be surprised. Carhart, who taught at the University of Southern California’s Marshall School of Business and was a senior fellow at the Wharton School of the University of Pennsylvania, has a decidedly professorial air.
But for Kepos, which began trading partners’ capital this month and aims to start running client money in January, business won’t be about how many Ph.D.s it can hang on the walls of its offices, in the Renzo Piano–designed New York Times Building in midtown Manhattan. Institutional investors want to know that the lessons of 2007 weren’t lost on Kepos and other quant funds. “Quantitative managers need to prove that they have a robust investment process in place,” consultant Rosen says. “No investor should commit capital without having done their own deep due diligence and making sure they really understand the process. ‘Trust me’ is not a good enough answer.”
Carhart has told prospects that he learned several things from 2007. First, size is important. Most quants trade in so-called liquid markets, but there’s only so much alpha, and liquidity vanishes fast in a crisis. It’s tough for larger funds to unwind positions. Global Alpha got too big, some involved with it now admit. The second takeaway was the value of new ideas. Quant hedge funds had piled into similar trades; using strategies that weren’t so secret after all, they often bought and sold on the same signals. Hence, Kepos’s heavy reliance on research and idea generation.
The last, and maybe the most important, lesson was risk management. In the past, says a former Goldman partner who worked with Carhart, quants didn’t factor the proverbial black swan into their portfolio construction. Running at full tilt, they had no capacity left to deal with an extreme event.
As the ex–Goldman partner points out, Carhart began applying these lessons at his old firm. In 2008, one of the worst years ever for hedge funds, Global Alpha finished up 2 percent. Last year, using new strategies that Carhart and Iwanowski helped build, the fund surged 30 percent. Carhart was always a fast learner.
