Aug. 9, 2018

An Introduction to Quantitative Investing: Dispelling Myths and Misconceptions (Part One of Three)

Quantitative investing involves the systemization of human knowledge or the objective – i.e., unbiased and unemotional – exploitation of data by a machine. Although the concerns faced by quantitative asset managers differ somewhat from those faced by fundamental asset managers, they are largely variations on a theme: traditional managers are increasingly utilizing empirical analyses to inform their trading. Quantitative managers, which currently represent over a quarter of hedge fund assets under management, are also being perceived as a “third pillar” in portfolio management, with barriers to adoption eroding as investor education and empirical evidence of their efficacy increase. This article, the first in a three-part series, provides an overview of quantitative investing and the ways it differs from fundamental investing; discusses the growth of quantitative investing; and evaluates the practical risks and misconceptions of quantitative investing. The second article will analyze regulatory actions and guidance applicable to quantitative managers, as well as the special regulatory risks that those managers may face. The third article will explore the heightened importance of cybersecurity and intellectual property protection for quantitative managers; negotiations with investors over capacity constraints; and methods for quantitative managers to attract and retain talent in the face of stiff competition. See “How Quant Funds Can Maximize Appeal to Investors While Minimizing Cyber and Regulatory Risk” (Apr. 12, 2018).

How Fund Managers Can Navigate the E.U. General Data Protection Regulation and the Cayman Islands Data Protection Law

Investment funds have become voracious consumers of all kinds of data. At the same time, investment funds and various industry service providers come into contact with and process a great deal of personal data – notably on their investors and employees – primarily through the course of normal operations but also through certain marketing activities and working with affiliates. See our three-part series on big data: “Its Acquisition and Proper Use” (Jan. 11, 2018); “MNPI, Web Scraping and Data Quality” (Jan. 18, 2018); and “Privacy Concerns, Third Parties and Drones” (Jan. 25, 2018). As the issue of data privacy has recently gained attention through, among other things, the Facebook and Cambridge Analytica scandal, the scope of regulation with respect to the holding and processing of personal data is expanding. The investment funds industry will not escape this focus. Managers must therefore examine their own data and privacy policies to ensure they comply with new laws and regulations. Investment funds domiciled in the Cayman Islands, in particular, must comply with the Cayman Islands Data Protection Law (DPL) and the E.U. General Data Protection Regulation (GDPR). In a guest article, Jonathan Bernstein, partner at Harneys, examines the requirements of the DPL and GDPR, as well as what fund managers can do to comply with them. For additional insight from Harneys attorneys, see “In Madoff-Related Litigation, Cayman Court of Appeal Holds That a Liquidator May Not Adjust a Shareholder’s NAV, Even When Based on Fictitious Profits” (May 17, 2018); and “Despite Fiduciary Duty Questions, Cayman LLCs Can Offer Savings and Other Advantages to Hedge Fund Managers” (Jul. 21, 2016).

The Impact of the New SEC-CFTC Memorandum of Understanding on Fund Managers

Regulators in the U.S. and Europe have been gravitating toward greater harmonization. The European Securities and Markets Authority, for example, aims to achieve harmony across the myriad regulatory regimes of E.U. Member States. See “ESMA Requires Enhanced Supervisory Role and Tools for Harmonizing E.U. and Third-Country Regulations” (Jun. 22, 2017). In addition, in the U.S., the SEC and the CFTC recently approved a new Memorandum of Understanding (MOU) regarding coordination between the two agencies in areas of common regulatory interest and information sharing. The new MOU is intended to facilitate the discussion and coordination of regulatory action, as well as information exchange and data sharing. CFTC Chairman J. Christopher Giancarlo has claimed that increased harmonization will reduce complexity and lower costs for regulators and market participants, including fund managers. This article summarizes the MOU and discusses the validity of that claim, as well as other effects the agreement may have on fund managers. For more on regulatory convergence in Europe, see “ESMA Chair Calls for Stronger Supervisory Tools to Achieve Capital Markets Union” (Apr. 20, 2017); “FCA Director Lays Out Expectations for Cybersecurity of Financial Services Firms: Identification of Cyber Risks, Detection, Firm Preparedness and Information Sharing” (Sep. 29, 2016); and “ESMA Chair Calls for Increased Transparency and Regulatory Convergence As Interest Rates Rise” (Jan. 28, 2016).

Gibson Dunn Attorneys Analyze Lynn Tilton Trial: Controversial Forum, Key Takeaways and Defense Themes (Part One of Two)

Victories against the SEC in proceedings before SEC administrative law judges (ALJs) are rare. At a recent Alternative Asset Management General Counsel Luncheon hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA), Gibson Dunn attorneys explained how they prevailed at the trial of Patriarch Partners and Lynn Tilton, the so-called “diva of distressed,” who had been charged with investment adviser fraud in connection with the management of certain collateralized loan obligations. The program featured Reed Brodsky and Mary Beth Maloney, partner and of counsel, respectively, at Gibson Dunn. This article, the first in a two-part series, explores Brodsky’s and Maloney’s views on the fairness of SEC administrative proceedings, the key takeaways from the trial and the primary defense themes, including due process and equal protection claims about ALJ proceedings generally. The second article will evaluate the SEC’s three principal charges against Tilton. For additional commentary from Brodsky, see “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices” (Mar. 28, 2013). For discussion of another Gibson Dunn trial, see “Attorneys Discuss the Trial Victory of Hedge Fund Manager Nelson Obus, the ‘Lamest Insider Trader in History’” (Aug. 1, 2014). For coverage of a prior program hosted by MLA, see our two-part series offering perspectives on internal compensation arrangements for investment professionals: “Carried Interest and Deferred Compensation” (Mar. 15, 2018); and “Hedge Fund Compensation and Non-Competes” (Mar. 22, 2018).

ACA-IAA Investment Management Compliance Testing Survey Covers Best Execution, Soft Dollars, Advertising, Individual Clients and Cryptocurrency Trading (Part Two of Two)

For the fifth consecutive year, cybersecurity remains the most prominent compliance topic, as noted in the 2018 Investment Management Compliance Testing Survey recently completed by ACA Compliance Group (ACA) and the Investment Adviser Association (IAA). The results of the survey were discussed in a recent webinar presented by Enrique Carlos Alvarez, senior principal consultant at ACA; Sarah A. Buescher, associate general counsel at the IAA; and Sanjay Lamba, assistant general counsel at the IAA. This article, the second in a two-part series, analyzes the survey’s findings on best execution; soft dollars; advertising and social media; individual clients; cryptocurrency; cybersecurity; and other compliance trends. The first article examined the portions of the survey that covered compliance program testing; fees and expenses; socially responsible investing; sub-advisers; alternative data; trade surveillance; and custody. For coverage of ACA’s 2017 compliance survey, see “Continued SEC Focus on Compliance, Conflicts of Interest and Fees, and Common Measures to Protect MNPI” (Jun. 1, 2017); and “Variety in Expense Allocation Practices and Business Continuity Measures” (Jun. 8, 2017).

New Dechert Partner Steven W. Rabitz Discusses Revocation of the DOL’s Fiduciary Rule

Dechert has added Steven W. Rabitz as a partner in its employee benefits and executive compensation group. Based in the firm’s New York office, Rabitz’s practice focuses on the fiduciary responsibility, prohibited transaction and funding rules of the Employee Retirement Income Security Act of 1974 (ERISA); related tax code provisions; how they relate to financial products and services; and how they affect retirement plan consumers. Hedge Fund Law Report interviewed Rabitz in connection with his move to Dechert, and this article presents his thoughts on his practice as an ERISA lawyer, developments in the area and the revocation of the Department of Labor’s fiduciary rule. For more from Rabitz, see “Recent Developments Affect Classifications of Control Groups and Fiduciaries Under ERISA” (Apr. 14, 2016); and our three-part series on considerations under ERISA for European hedge fund managers: “Liability and Incentive Fee Considerations” (Sep. 24, 2015); “Prohibited Transaction, Reporting and Side Letter Considerations” (Oct. 1, 2015); and “Indicia of Ownership and Bond Documentation Considerations” (Oct. 8, 2015). See also our four-part series by Rabitz and his colleague Andrew Oringer, “A ‘Clear’ Guide to Swaps and to Avoiding Collateral Damage in the World of ERISA and Employee Benefit Plans”: Part One (Jul. 28, 2016); Part Two (Aug. 4, 2016); Part Three (Aug. 11, 2016); and Part Four (Aug. 25, 2016).

The HFLR Will Not Publish Next Week and Will Resume Its Regular Publication Schedule the Following Week

Please note that the HFLR will not publish an issue during the week beginning August 13, 2018, and will resume its normal weekly publication schedule the following week starting August 20, 2018.