Trading Insights: Unpacking innovations in quantitative investment strategies (QIS)

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Arnaud Jobert: We set up that business five years ago as a markets business, fully integrated across all asset classes, trading and structuring combined. Now, that business has been catering both for retail and institutional investors. The retail business continues to be a big driver. But recently, we've seen more growing demand from retail investors to access more sophisticated content. On the institutional side and over the last couple of years we've seen more hedge funds now embracing the space for various reasons.

Eloise Goulder: Hi and welcome to ‘Market Matters,’ our market series on J.P. Morgan's Making Sense. I'm Eloise Goulder and today I'm delighted to be joined by Arnaud Jobert who is co-head of the Strategic Indices business for markets here at J.P. Morgan and also global head of the Equity Structuring business to discuss the growth in and the alphas behind the QIS, or the Quantitative Investment Strategies business. So, Arnaud, thank you so much for joining us here today.

Arnaud Jobert: Thanks a lot for having me.

Eloise Goulder: So, could you start by introducing yourself and your business?

Arnaud Jobert: So, I've been at J.P. Morgan coming up to 20 years, starting actually in equities quant research, following my PhD before moving to equity structuring in Europe. Then over the years, I grew to include our U.S. and Asia regions within equity structuring together with all asset classes within our Markets strategic index business. Which does cover the full range of all our systematic trading strategies that we deliver to our clients on a cross-set basis. They are commonly referred to on the street as QIS, to your point, standing for Quantitative Investment Strategies. But the latest acronym at J.P. Morgan is Strategic Indices.

Eloise Goulder: We refer to your business as the Strategic Indices business, and it has witnessed enormous growth over the years, with total notionals doubling over the last five years. So, Arnaud, could you describe the evolution of the business?

Arnaud Jobert: Yes, this year, we have reached a significant milestone in terms of crossing 100 billion of notionals on the platform. We set up that business five years ago as a markets business, fully integrated across all asset classes. Innovation continues to be a big driving factor of what we do together with execution capabilities and finally customization at scale.  Now that business has been catering both for retail and institutional investors in the past. Roughly speaking, as 30-70 split. The retail business continues to be a big driver of the business.  We continue to have a large fixed income index annuity business on the insurance side. But recently, we've seen more growing demand from retail investors to access more sophisticated content. On the institutional side, when you think of Quant Investment Strategies, historically pension funds started becoming very active in that space, close to 15 years ago, with the first risk premium mandates that we delivered in that space. The objective was, very much unconstrained, absolutely return driven, looking for uncorrelated returns versus equities and bonds. And then post the quant winter, which is pretty much 18-19, we've seen a shift towards more defined investment objectives from the asset owner community. And that's where we started seeing growing demand for, for example, defensive portfolios, carry overlays that fit within the strategic asset allocation of those big asset owner clients. We continue to see that demand, for example, in 2022 as you can imagine, a lot of those clients were looking for campaigning alternatives to fixed income. That's where styles like trend following, rates volatility, dispersion became top of mind for many investors. And over the last couple of years, we've seen more hedge funds now embracing the space for various reasons. One, very simply is execution outsourcing in one asset class where they don't really have execution capabilities. And the typical beneficiary of that trend will be areas like commodities or equities volatility, and the other, even more recent trend is hedge fund clients looking to invest into QIS at the central risk book overlay to better manage the portfolio returns.

Eloise Goulder: It's so fascinating to hear about these drivers, because of course, they're reflected across so many other themes that we monitor, the growth of the retail investor, not only in terms of their share of volumes in U.S. equities but also in terms of their desire to have access to more sophisticated products, but also the growth in hedge funds wanting to take advantage of cost efficient solutions, and to the extent that it's a buy or build type decision for many of those asset managers, do they invest to build capabilities in a certain asset class, or do they outsource? Absolutely makes sense to me that there should be growth in that space as well.

Arnaud Jobert: And to the point on the central risk book overlays QIS can be a very powerful part of the toolkit for those hedge fund investors to hedge some of the portfolio returns top down. And a very efficient way for them to isolate or harvest a given source of alpha for the portfolio returns.

Eloise Goulder: So turning to harvesting alphas, could you outline some of the key products that you do offer and, also, how those products have evolved through time?

Arnaud Jobert: Yes, going back to this 100 billion of client nationals, you can think of it as 60-65 percent of that out-of-equities and the rest outside equities, in commodities and in rates and our multi-asset business. So starting with equities volatility, this year it's all been about carry, vol has been realizing very low in equity markets. The fact that you have so much liquidity now, especially in the S&P options market, in this so-called short-dated options, does allow us to really harvest exposure to specific market parameters, skew is one of them. Now we can reduce as much as possible any type of lag between, for example, the selection of the options we have in a given portfolio and the time at which we execute. And that edge on execution does allow us to really harvest in a much better way some of the given well-known risk-premier solutions such as vol ceiling or skew monetization in equity markets. So that's one. Talking about our quant equity factor platform, we've seen a very strong revival of equity factors post-quant winter with the likes of quality, value, low vol, momentum. And this multifactor approach has been driving returns over the last few years for the asset owner clients, but also for the fast money clients who are actively looking to hedge their equities portfolio. Moving outside equities, commodities alpha has been very much in focus over the last few years as a way, for clients to get uncorrelated returns versus equities and bonds. We've been enhancing our commodity alpha solutions, combining, for example, things like carry and value, but also maximizing synergies between what we do on a cross-asset basis and what is relevant for commodities. One item I would like to mention is trend. We've been obviously growing a trend following franchise for many years. If you look at the first half of the year, unlike my example around 22 and investors looking for alternatives to fixed income, trend following did remarkably well. But this year, it's been tough. We've built on the alternative trend side of things, looking to harvest specific metrics like skewness on a cross-asset basis reversals across markets, including commodities, so the synergies between commodities and cross-asset are very material.

Eloise Goulder: It's so fascinating to really dive into all of those areas of product innovation, whether that's across the volatility space, the equity factors space, the commodity space, the trend space and the cross-asset space. And what really rings to me is the power of scale, that by having all of these strategies cross-asset, you can then cross-synergize from one to the other, for example, factor trends. And factors, have historically shown more trend, than single stocks. There is some autocorrelation. There is some persistence in factors. So, of course, that can be a powerful strategy. But in order for you to do that, you need to have a true cross-asset trend platform and you need to have a true factor platform. And it's the combination of the two that can be so effective. It's also so interesting to me to hear you discuss the relationship between innovation and execution, because as investor time horizons shrink, isn't the space very blurred in that you can't truly differentiate the alpha opportunity and the execution opportunity. A given alpha opportunity will only exist if you can execute at a given cost. And as soon as the execution costs increase, those alpha opportunities may be eroded. So, of course, you've got to look at the two together.

Arnaud Jobert: I fully agree. And I think that that linkage between innovation and execution, is all the more impactful in this vol space. It's also true if you go back in time and you look back at our intraday platform, that we set up 10 years ago having this capabilities around continuous execution, means you can be much more reactive. There are some markets where continuous execution can be a way for clients to either get more convexity in stress scenario, because people are looking for fast react type of strategies that will deliver convexity on the downside and also potentially monitor genuine alpha opportunities. Obviously, there is so much AUM that we see behind levered ETFs on tech names. All the growth in levered ETFs, obviously to accelerate intraday type of patterns behind those single names, because on the back of the gamma hedging activity of dealers. So, the fact that we do have this continuous execution now on all single names on the platform. So, we actually started 10 years ago in S&P futures means the opportunity set in terms of alpha opportunities is huge.

Eloise Goulder: On the topic of alphas, I understand that some alphas exist as a function of inefficiencies in the market, and you just described that with the rise in lever DTFs and intraday options and the fact that that's leading to gamma imbalances, which leads to an alpha opportunity intraday, how do you think about the whole space of alphas and how they are evolving over time? Is it as simple as to say that the space is becoming more commoditized over time and therefore, we have to continuously explore new alternative markets and explore higher frequency investment horizons in order to continue to generate those alphas? Or is that perhaps a bit simplistic and are there still very rich opportunities out there which are failing to erode, perhaps because of persistent biases or inefficiencies that just exist in the market?

Arnaud Jobert: I think it's a bit of both, when I look at the alpha opportunity set, yes, we do have the traditional risk premia that clients keep coming back to. And when we think of building up diversified portfolios for clients across multiple styles, whether it be looking for absolute return or looking for defensive and convex profiles, we are trying very much to achieve, a good balance between those styles. And now, in those fast changing market conditions, it's actually reflected in the way we now also deal more and more with the hedge fund clients coming to us. The way we need to service those clients is not just buy to hold we have a much more regular engagement in terms of what's happening in the market? How does it impact my portfolio? People are looking for carry with some smart hedges on the side. How do you look at these two? We need to look into the flows of the market. Auto calls have been very popular, they tend to supply a lot of volatility around the one year points. So, now, it does give you an interesting opportunity for you to buy a bit of volatility on this part of the curve to hedge some of your carry solutions. So, this alpha opportunity set is constantly evolving. We need to take into account all the flows we see in all asset classes. So, we need to be constantly on top of what's happening in the market, in order really to best equip our investors, which is the most point in time information for them to navigate those portfolios.

Eloise Goulder: And it goes back to the importance of understanding the reason that alphas exist. In the intraday vol world, the reasons they exist is often because of a gamma imbalance. And you need to understand the flows, as you say, to understand the gamma imbalance, to understand the alphas. And so understanding the drivers of a given market inefficiency or alpha historically existing can be so powerful.

Arnaud Jobert: Absolutely.

Eloise Goulder: So, can we move to what's next? Arnaud, how do you think about the future?

Arnaud Jobert: There's a lot going on. We have what we call innovation roadmap, which is basically the way we frame our business strategy in terms of product innovation. We've spoken a lot about equities and commodities, I would like to share a few thoughts on the fixed income as well. When it comes to doing more in fixed income, we've been trying to expand the investment universe. EM is a great example. When you look at some of the risk premia, whether it be even rates carry or FX carry or even in credit, there's really little going on available in EM space. And that is very much an objective that we started at the beginning of this year, is to onboard EM IRS, interest rate swaps, into our platform. So, now, our EM coverage is so much more complete. Another example when it comes to fixed income is, new markets, TBAs, mortgage, invoice spreads, asset swaps, futures-based asset swaps. We are now making them available to investors on the QIS platform. Equities hedging is a big topic in QIS format. We've seen all these pension funds actively embracing systematic hedging programs on the equity side for many years. I think what we've seen less so is hedging in rates and FX. And now this year, we've seen a massive interest in that space. As you can imagine, rates hedging has been very topical in Japan over the last year and a half. But with all the talk about dollar weakness these days, FX hedging is also at the top of everybody's mind. So with the QIS technology, we do have a very comprehensive FX hedging framework, FX scorecard, weighting the alternative between simple FX forwards, which is your baseline in that space, together with more enhanced option-based strategies. Wrapping up the fixed income side, is JPMaQS dataset. So JPMaQS is a very unique premium dataset, covering macro fundamental data, that is very broad, it's got a very long history, and most importantly, it's point in time; which for any type of quant investors is crucial because we've all wasted so much time on trying to backtest strategies with revised data, which obviously just defeats the whole point of backtesting a systematic strategy. That is a game changer for us. And we a plan to roll out a new suite of macro strategies powered by JPMaQS across rates, equities and FX. So that is going to address growing demand we see from investors moving away from the more traditional risk premia and looking into more alpha seeking, return seeking trading strategies, the style of country rotation, sector rotation as well, which could be quite complementary to what you typically do with your traditional risk premia along the lines of value, momentum and carry.

Eloise Goulder: And it's worth noting, we did hear from Ralph Zippel from the macro synergy team on the JPMaQS dataset on this podcast series very recently, JPMaQS standing for the J.P. Morgan Macro Quantumental System.

Arnaud Jobert: And finally, wrapping up on innovation, nothing would be complete if we don't talk about AI and machine learning. We've been launching this new cross-sectional EMFX strategy, which is called EMFX MacroTrader, which is very orthogonal to what you will be harvesting in the likes of FX value and FX carry. And when it comes to LLM and AI in general, we need to keep making better use of all the tools available to us so productivity gains start from simple things like writing factor commentaries, performance commentaries, and so on so that the teams can focus on the core of the subject matter expertise and coming up with innovative alpha strategies. We are trying to reduce the time to go to market. So very practically, we see more and more of these use cases at play as well through the entire lifecycle of our index business.

Eloise Goulder: It's incredibly exciting to think about the scale of the platform that you and the strategic indices business together have built in the sense that it is truly cross-region, truly cross-asset, covering both volatility and cash and increasingly covering very tactical opportunities with shorter and more intraday, in some cases, investment horizons. And it does highlight the power of scale and the power of leveraging cross-markets execution capabilities given that, there really is a blurring of the lines between an alpha opportunity and an execution opportunity in that the two have to be viewed together.

Arnaud Jobert: Absolutely. And one other platform I would like to mention on that theme of blurring the lines between innovation and execution is our Nexus platform. You can think of it as a synthetic managed account type of platform, in some sense, covering all asset classes. You can think of the QS business as J.P. Morgan IP. You can think of the Nexus platform as client IP. Our clients come to us to outsource execution. They obviously run their own model. They run their own IP. They just deliver the execution through the Nexus platform. So, if you think of those two platforms combined, the ambition is for us to occupy the full spectrum of client use cases. And we do see some of our asset owners, investors, who might see the benefit of combining some of this active manager exposure in a synthetic exposure format through Nexus, together with some of our QIS strategies. And the beauty of having those two platforms fully integrated is that we can very much deliver the best of both worlds.

Eloise Goulder: Well, Arnaud, thank you very much for explaining in such granular detail what you’re doing and the aspirations for the business going forward.

Arnaud Jobert: Thanks a lot for having me. I very much enjoyed it.

Eloise Goulder: Brilliant. And thank you also to our listeners for tuning into this bi-weekly podcast series from our group. If you have questions on the QIS or the strategic indices business, then please do get in touch with your sales representative. Otherwise, if you have questions for our team, then do go to our website at https://jpmorgan.com/market-data-intelligence and you can always contact us via the form there. And with that, we'll close. Thank you.

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