{"id":18347,"date":"2016-11-18T14:47:02","date_gmt":"2016-11-18T19:47:02","guid":{"rendered":"https:\/\/digital.hbs.edu\/platform-rctom\/submission\/quantopian-the-innovation-funnel-meets-hedge-funds\/"},"modified":"2016-11-18T14:55:05","modified_gmt":"2016-11-18T19:55:05","slug":"quantopian-the-innovation-funnel-meets-hedge-funds","status":"publish","type":"hck-submission","link":"https:\/\/d3.harvard.edu\/platform-rctom\/submission\/quantopian-the-innovation-funnel-meets-hedge-funds\/","title":{"rendered":"Quantopian: the innovation funnel meets hedge funds"},"content":{"rendered":"

Quantopian: the hedge fund from the crowd<\/u><\/strong><\/p>\n

The world of hedge funds and proprietary algorithmic stock trading can seem murky, complex, and even dangerous to those unfamiliar with the inner workings of firms engaging in these activities.\u00a0 One Boston-based firm, Quantopian, has built a business model on the idea that trading algorithms can be sourced from anyone, not just highly-paid traders, and is betting on a crowd-sourced model to disrupt equity trading.<\/p>\n

Operating Model<\/strong><\/p>\n

Quantopian was founded five years ago by financial-technology (\u201cfintech\u201d) entrepreneur John Fawcett, who previously sold a fintech software company in 2008 for $28M in cash and stock.[1]<\/a>\u00a0 Heralding the Wall Street Journal\u2019s reporting that \u201cDIY\u2019s newest frontier is algorithmic trading,\u201d the company\u2019s core value proposition is to link investor demand in the form of capital with algorithm supply in the form of crowd-sourced strategies. [2]<\/a><\/p>\n

Quantopian\u2019s community of 100,000 aspiring quantitative traders are equipped with the below tools to test market theses:<\/p>\n

    \n
  1. Software tools leveraging the coding language Python<\/li>\n
  2. Historical data from U.S. equity markets back to 2002<\/li>\n
  3. Backtesting features to simulate how a given strategic would have performed in real market conditions<\/li>\n
  4. Research tools to validate the strength of a given algorithm, and<\/li>\n
  5. Access to capital to trade.<\/li>\n<\/ol>\n

    Quantopian publishes its selection criteria and author upside on its website.\u00a0 Successful quants will create strategies with five key attributes[3]<\/a>:<\/p>\n

      \n
    1. Low exposure, with a market beta of between -0.3 and 0.3<\/li>\n
    2. Consistent returns given risk profiles of a Sharpe ratio consistently over 1.0<\/li>\n
    3. Active portfolios with a target turnover rate of 12 and 500 times a year<\/li>\n
    4. Low correlation to other selected authors<\/li>\n
    5. Strategic intent based on market trends and economic drivers<\/li>\n<\/ol>\n

      At the top of the innovation funnel, Quantopian offers incentives and competitions for users to submit ideas.\u00a0 Any author can tie their code to their bank account and trade their own money. The company then acts as a gatekeeper by evaluating certain algorithms for six months, much like Threadless does with user submissions.\u00a0 If backtesting and live simulations prove successful, the company may deploy capital to trade the company\u2019s or its limited partners\u2019 (currently, Point72 Ventures) capital, in which case the author will receive a portion of all returns.[4]<\/a>\u00a0 To be clear, authors own their algorithm\u2019s IP.<\/p>\n

      The operating model relies strongly on providing powerful software and relevant datasets in order to attract coders, which drastically lowers the cost to attract hedge fund-level talent to create profitable trading strategies.\u00a0 Andreessen Horowitz investor Alex Rampell, a Quantopian board member, thinks of Quantopian \u201cas the next-generation Blackrock.\u201d[5]<\/a>\u00a0 While the two firms have slightly divergent amounts of assets under management, Quantopian may have more favorable tailwinds.<\/p>\n

      \"Figure<\/a>
      Figure 1: Quantopian website & product sample<\/figcaption><\/figure>\n

      Strategy & Business Model <\/strong><\/p>\n

      The typical hedge fund business model relies on highly-paid and intelligent analysts to create a limited set of strategies and algorithms with which to trade capital raised from limited partners.\u00a0 Hedge funds typically charge a 2% management fee and 20% of the positive returns.<\/p>\n

      Quantopian disrupts this model through crowdsourced strategies, very low labor costs (nearly zero) with a different fee structure, and an open innovation funnel.<\/p>\n

      In the HBR article Strategy and the Internet<\/em>, Michael Porter argues that the structural attractiveness of an industry relies on five forces, including intensity of rivals, barriers to entry, and threats of substitute products (see below figure).\u00a0 In this industry, Quantopian\u2019s model proves to drastically lower the barriers to test and create trading models by democratizing access to anyone with Internet access and basic coding skills.\u00a0 In addition, trading offerings are more difficult to keep proprietary, as anyone can build similar or identical trading models using the same available data to pressure test market theses.\u00a0 The variable cost of experimenting with a new algorithm is close to zero under this model; at a traditional hedge fund, the firm may need to invest significantly in a trading strategy, and demonstrate its success, before it has the ability to raise capital from LPs.\u00a0 Porter ultimately argues that \u201cInternet technology provides better opportunities for companies to establish distinctive strategic positionings than did previous generations of information technology.\u201d[6]<\/a><\/p>\n

      \"Figure<\/a>
      Figure 2: Strategy and the Internet<\/figcaption><\/figure>\n

      Additional Steps & Conclusion <\/strong><\/p>\n

      Quantopian is well-positioned to expand its offerings.\u00a0 The company can further democratize capital raising, or invest training and development to its top producing authors.\u00a0 Finally, the company can act as a recruiting tool for hedge funds.<\/p>\n

      The classic hedge fund model is under siege, as investors question current fee structures and withdraw money from highly paid firms that struggle to beat market indexes.[7]<\/a>\u00a0 Quantopian developed a distinctive operating model that engages a broad community through the Internet to compete with hedge fund traders, and thus has the impact to fundamentally change the economic drivers within finance and technology. \u00a0(797\u00a0words)<\/p>\n

       <\/p>\n

       <\/p>\n

       <\/p>\n

      [1]<\/a> Advent Completes Acquisition of Tamale Software. 2016. Advent Completes Acquisition of Tamale Software<\/em>. [ONLINE] Available at: https:\/\/www.advent.com\/about-us\/newsroom\/pressreleases\/advent-completes-acquisition-of-tamale-software<\/a><\/u>. [Accessed 18 November 2016].<\/p>\n

      [2]<\/a> Austen Hufford. 2016. Algorithmic Trading: The Play-at-Home Version – WSJ <\/em>. [ONLINE] Available at: http:\/\/www.wsj.com\/articles\/an-algo-and-a-dream-for-day-traders-1439160100<\/a><\/u>. [Accessed 18 November 2016].<\/p>\n

      [3]<\/a> Quantopian . 2016. Quantopian <\/em>. [ONLINE] Available at: https:\/\/www.quantopian.com\/fund<\/a><\/u>. [Accessed 18 November 2016].<\/p>\n

      [4]<\/a> Bloomberg.com. 2016. Andreessen Horowitz, Point72 Invest in Crowd-Sourced Quantopian – Bloomberg<\/em>. [ONLINE] Available at: http:\/\/www.bloomberg.com\/news\/articles\/2016-11-14\/andreessen-horowitz-point72-invest-in-crowd-sourced-quantopian<\/a><\/u>. [Accessed 18 November 2016].<\/p>\n

      [5]<\/a>\u00a0Ibid.<\/p>\n

      [6]<\/a> 性视界 Business Review. 2016. Strategy and the Internet<\/em>. [ONLINE] Available at: https:\/\/hbr.org\/2001\/03\/strategy-and-the-internet<\/a><\/u>. [Accessed 18 November 2016].<\/p>\n

      [7]<\/a>\u00a0Ft.com. \u00a02016. \u00a0Investment: Rise of the DIY algo traders.<\/em> [ONLINE] available at:\u00a0<\/em>https:\/\/www.ft.com\/content\/0a706330-5f28-11e6-ae3f-77baadeb1c93<\/a>\u00a0[Accessed 16 November 2016].<\/p>\n","protected":false},"excerpt":{"rendered":"

      Boston-based fintech company Quantopian lets users test and create equity trading strategies, and deploys capital against crowd-sourced algorithms. <\/p>\n","protected":false},"author":2431,"featured_media":18426,"comment_status":"open","ping_status":"closed","template":"","categories":[259,2583],"class_list":["post-18347","hck-submission","type-hck-submission","status-publish","has-post-thumbnail","hentry","category-fintech","category-innovation-funnel"],"connected_submission_link":"https:\/\/d3.harvard.edu\/platform-rctom\/assignment\/digitization-challenge-2016\/","yoast_head":"\nQuantopian: the innovation funnel meets hedge funds - Technology and Operations Management<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/d3.harvard.edu\/platform-rctom\/submission\/quantopian-the-innovation-funnel-meets-hedge-funds\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Quantopian: the innovation funnel meets hedge funds - 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