The Daily Alpha: Real Talk with Nigol Koulajian of Quest Partners

May 5 2017 | 12:50pm ET

Ahead of the SALT Conference in Las Vegas, FINalternatives is launching a Friday interview series with intriguing leaders in the alternatives space. Today, we speak with Nigol Koulajian, Founder and CIO of Quest Partners, a research driven alternative investment firm headquartered in New York.

Bringing more than 20 years’ industry experience, Koulajian specializes in designing and trading short-term and long-term technical systems. He earned an MBA in finance from Columbia Business School and a BS in electrical engineering from Notre Dame. The interview was conducted during the final week of April.

Modern Trader: Tell us your background and what went into the founding of your fund?

Nigol Koulajian: I founded Quest Partners in March 2001 to pursue my passion for quantitative investment research and strategy development, which I have focused on from the beginning of my career in the early 1990's.

After a lengthy period of research, I identified specific strategies using proprietary techniques that exhibited strong absolute returns, significant alpha relative to market benchmarks and attractive hedging characteristics focused on positive convexity. These strategies, which have been continuously enhanced during the past 16 years, became the basis of Quest Partners and the foundation of our successful track record.

MT: What is your take on the broader hedge fund industry’s performance?

NK: A significant component of returns, alpha and Sharpe ratio of hedge fund strategies can be explained by skew. Our research shows that skew is negatively correlated to the Sharpe ratio i.e. strategies or Funds with high Sharpe ratios tend to have negative skew and vice versa. 

Negatively skewed assets and investment strategies can appear to be highly stable, generating ‘alpha’ and delivering a high Sharpe ratio. It is easy to confuse these returns generated in stable market environments for skill. However, adjusting for skew, many investment strategies have little or no alpha. Furthermore, they tend to be highly cyclical, with a large portion of returns earned during a cycle typically given back quickly when the cycle turns.

Hence, we believe it is very useful and important for investors to consider and adjust for the skew of hedge fund returns when evaluating investments and determine if there is true alpha being generated or if the alpha is coming from hidden tail risk.

MT: Talk your strategy for a second. What is the opportunity? And when did you notice the opportunity and potential?

NK: The biggest opportunity is that most investors ignore skew and continue to rely on the standard deviation of returns as the primary measure of risk. As a result, we believe that the true risks of investments and markets are not captured in a comprehensive way. This issue is even more acute in today’s landscape, where eight years of Central Bank liquidity injections and exceptional risk adjusted returns in many asset classes and strategies have caused volatility to decline to multi-decade lows, creating large distortions.

Recognizing this, we have remained focused on generating returns from positive convexity. As fundamental valuation ratios are approaching their highest levels in decades and confidence in risk-on strategies and shorting volatility appears to be at all-time highs, the skew on most assets has turned negative. This is creating strong opportunities for us to go long convexity cheaply in a low volatility environment.

MT: An interesting data point from your appearance on Opalesque, ‘about 90% of hedge funds in the market today are negatively convex, meaning that almost every hedge fund strategy aside from short sellers tends to make money slowly and lose it very fast.” Please expand on this point.

NK: In a negatively skewed world, strategies with high Sharpe ratios and alpha are more frequently realizable. This is capitalized on by the hedge fund industry. The skew of the hedge fund industry is more negative than that of the underlying markets that are traded because of its exposure to trading methods and/or markets where local volatility is muted but quick to expand during market moves. Examples include trading credit markets, less liquid assets, MBSs, spreads, carry trades, smaller capitalization stocks, bottom-picking stocks and writing options. The typical hedge fund incentive fee structure where investors earn 100% of the losses but 80% of the profits also has the effect of increasing negative convexity.

MT: What is the capacity for your strategy? Performance?

NK: Quest’s flagship program, AlphaQuest Original (AQO), has an annual rate of return of +11%, and has produced +6.5% annual excess alpha to the BTOP 50 and +9.3% annual excess alpha to the S&P 500, since its inception in May 1999.

The capacity of the AQO strategy is about $2 billion.

MT: Who else is pursuing a similar strategy?

NK: We believe there are limited alternatives to hedge against negative skew risk. There are market instruments that investors could use to achieve this objective such as being long options; being long the VIX Index; or allocating to Short Sellers. But these options come with a negative return over time. The HFR Short Bias Index would cost investors -4.7% p.a. and similarly, a constant face value exposure to VIX would have cost -5.4% p.a.

Historically, the AQO program has been an attractive hedge, given its focus on generating returns through positive convexity. We continue to maintain the discipline required to generate returns with the skew profile that is highly complementary to most portfolios today. The AQO has delivered annualized returns of +11.5% p.a. (since the inception of the VIX Index in 2004), to attain the same level of hedging characteristics.

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Garrett Baldwin is the voice of the The Daily Alpha, the features editor for Modern Trader magazine, and the author of The Man with The Big Red Balloon. 


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