Goldman Sachs quants overseeing $75 billion rolled out a new model for handling COVID-19 risk way back in January. 2 exec walked us through how it works, and how they've fine-tuned it amid market madness.

  • Goldman Sachs Asset Management's Quantitative Investment Strategies team, which manages $75 billion, developed a risk factor specifically for the coronavirus and continue to maintain it today.
  • The signal was first created in January to understand the exposure QIS's Equity Alpha franchise had to the virus.
  • The QIS team has previously created several risk factors based on binary market events with potentially significant tail risk, but this is the longest they've maintained one.
  • A weekly meeting is now held with feedback from fundamental investors at GSAM to understand how to tweak the model.
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A division of $320 billion Goldman Sachs Asset Management (GSAM) has maintained a risk factor focused on the coronavirus' impact to financial markets since the start of the year, illustrating Wall Street's increased use of big data to create signals for one-off events. 

Quantitative investors use risk factors to help map out how sensitive companies are to events that are moving the entire market, and to help guide their investment process and minimize risk to portfolios. 

And since January, GSAM's $75 billion Quantitative Investment Strategies team has been managing a factor to measure the exposure it had to COVID-19 within its Equity Alpha portfolio. 

Read more: Coatue is returning all outside capital in its $350 million quant fund after computer-driven trades broke down in extreme market volatility

Osman Ali, cohead of GSAM's QIS Equity Alpha franchise, told Business Insider that this isn't the first time the group has developed a specific risk factor around what he described as a "binary" market event with potentially significant tail risk. 

Brexit marked the first time QIS had taken such an approach, and it followed up with other elections or geopolitical shocks to the market. But unlike other events the firm has used factors for, the pandemic did not have a set date — like an election — that it was scheduled to hit.

The resulting market stress hit quants hard in March, with names like Renaissance Technologies, Bridgewater, Point72's Cubist, and more falling double digits.Coatue's quant fund returned outside capital as its data feeds struggled to keep up, and Credit Suisse closed its QT fund.

QIS's coronavirus factor is the longest-running signal the firm has had thus far, Ali said, and demonstrates how far they've come with the technique. 

"We've really started to polish and refine," he added.

Read more: Coatue is returning all outside capital in its $350 million quant fund after computer-driven trades broke down in extreme market volatility

The goal of the factor was to minimize exposure 

As concerns over the spread of the coronavirus in China began to pick up at the beginning of the year, Ali said, the QIS team decided to create a factor to measure its exposure to the virus. At the time, the virus was still mostly abroad, so the focus was finding different supply chain or customer-base problems that could arise should China be shut down for an extended period of time — or if the virus spread to other developed economies.

The team used a combination of fundamental insights to create the initial factor, which was then updated with real-time data feeds.

"At the time, we observed our exposure to this factor happened to already be negative," Ali said. "Our goal was to ultimately minimize the exposure to this factor, no matter the sign."

Dennis Walsh, global cohead of the Quantitative Equity Alpha business within QIS, said the factor wasn't about trying to make money betting on a pandemic to hit the US. 

The signal also wasn't about projecting whether a pandemic was actually going to happen, he added. It was merely protecting the firm in case it did.

"When we designed this specific factor it was all about risk, not alpha," Walsh said.

See more: Credit-card data is broken. Here's how hedge funds and banks are being forced to rethink one of the earliest alt-data plays.

The QIS team holds weekly meetings to tweak the signal

Seven months later, QIS's coronavirus signal is still going strong. In addition to the real-time data used to keep the signal updated, QIS reaches out to fundamental investors at GSAM — mostly human stock pickers and fixed-income portfolio managers — to question the firm's models. A weekly meeting is held to essentially figure out '"What are we missing?" Ali said. 

"The hope and goal," Ali said, is that the factor will be retired eventually. However, that decision will be left to a combination of fundamental analysis and data, as opposed to simply listening to the market to tell them when. 

Walsh said a key consideration now is the introduction of a tail event, either positive or negative. The rapid mass-production of a vaccine, for example, would send many names in the market soaring, hurting investors who are in defensive stances, he added.

"As the market prices in the pandemic, and we're going through that evolution now, we believe our models are well positioned to adapt to those changing dynamics quickly," Walsh said. 

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