Two Sigma, a self-styled technology company and research lab-cum-money manager, is about to launch risk factor-based strategies to meet the demand of institutional investors for its particular brand of computer-driven, model-based investment management.
Growth, thanks to large inflows from institutional investors over the past five years, has been spectacular — up 414% to $25.2 billion under management as of April 1 from $4.9 billion as of the same date in 2010.
The Two Sigma group is made up of legal entities Two Sigma Investments LLC and Two Sigma Advisers LLC that share space in buildings across the street from each other in New York. Both entities manage assets and share the same investment platform; Two Sigma Advisers also provides customized strategies for institutional investors.
In fact, Two Sigma attracted so much institutional money that it had to close its quantitatively managed hedge funds, permitting new investors or additional allocations only when redemptions or a new source of alpha expanded capacity in the funds.
With so little room to accept new investors, Two Sigma dropped off the radar with some investment consultants and engendered frustration with others.
Alex Da Costa, director, hedge fund research and consulting, in the Montreal office of Pavilion Advisory Group Ltd., said he rates Two Sigma highly but because its hedge fund offerings have been “hard-closed for some time … we have had very little contact recently.”
The new suite of investment strategies, scheduled to launch in the third quarter, likely will bring investors and consultants back to Two Sigma, but not for its hedge fund prowess, observers said.
Two Sigma will apply its big-data analysis and research capabilities as well as a massive technology infrastructure to identifying and isolating both traditional and alternative risk premiums, said sources with knowledge of Two Sigma's intentions who asked not to be identified.
This will allow institutional investors to simplify their risk management systems and combine the factors into liquid alternatives portfolios to meet their precise requirements.
Key to Two Sigma's potential success with its new investment approach is that risk factor-based investing is not capacity constrained in terms of available market instruments to gain exposures, observers said.
By contrast, Two Sigma's hedge fund strategies, which have produced positive alpha every year since trading started in 2002, are limited by the availability of scarce alpha-generating investment opportunities, said Nobel Gulati, CEO of Two Sigma Advisers.
Given the burgeoning popularity of risk factor-based investment strategies (Pensions & Investments, May 4) and the zeal with which asset owners have invested in Two Sigma's hedge funds, the sources predicted strong interest from the institutional community.
Carter M. Lyons, managing director and head of investor relations of Two Sigma Investments, declined to comment.
After the 2008 financial crisis, the firm's client base started to change from friends, family and high-net-worth individuals, sources said.
Asset owners — pension funds, endowments, foundations and sovereign wealth funds — made up about 50% of the two firms' $26 billion of assets under management as of May 31, Mr. Gulati said. Combined with investments from institutionally oriented hedge funds of funds and intermediaries, nearly 100% of assets now come from the institutional community.
Two Sigma's current client list includes major institutional investors such as the C$238.8 billion ($193.9 billion) Canada Pension Plan Investment Board; $132.4 billion Teacher Retirement System of Texas; $30.2 billion Indiana Public Retirement System; United Technologies Corp.'s $32.7 billion global defined benefit plans; the 4.2 billion Swiss franc ($4.5 billion) European Organization for Nuclear Research; and 3.7 billion Swedish kronor ($450 million) Nobel Foundation.
Two Sigma was co-founded in 2001 by ex-D.E. Shaw Group hedge fund quants John A. Overdeck, a statistician, and David M. Siegel, a computer scientist and artificial intelligence specialist. Both wanted to apply big-data analysis to money management.
From the outset, Mr. Siegel said, he and Mr. Overdeck were intent on creating a state-of-the-art, scientifically driven investment firm armed with the world's best computer systems.
“We had a very narrow focus in building this firm. We put every last ounce of our energy into building a big-data company,” Mr. Siegel said, noting somewhat wryly that he and Mr. Overdeck didn't imagine their big-data firm would become a big company.
Mr. Gulati described the firm's co-founders and co-chairmen as “big-data guys who looked at the world of finance … and realized that this industry was ripe for innovation. Every other industry in the world has been completely reinvented through technology, so why should investment management be an exception?”
“What you can do with supercomputers and the vast amount of data that's available, often unstructured data, is really changing the way people can — and should — invest,” Mr. Gulati said.
Using a single technology and research platform that strives to provide a 360-degree view of what drives the price of securities, Two Sigma's systems analyze massive amounts of data to produce hundreds of forecasts. Those forecasts are integrated with risk management, portfolio optimization, efficient trading and swift execution to guide investment in thousands of securities, including equities, fixed income, commodities, currencies and liquid derivatives.
The strategy works because it invests in such a diverse universe of securities to produce consistent, risk-adjusted uncorrelated returns, Mr. Gulati said. He would not provide returns of Two Sigma's investment funds.
Even as the firm's hedge funds were closing to new investors, Mr. Gulati said Two Sigma was working on customized solutions for institutional investors, including asset allocation, portfolio construction and improvements to internal trading execution.
Two Sigma's Beta One strategy, composed of long-only and 130/30 approaches, also has gained traction with about $3.5 billion under management to date.