Rules – Southeastern Hedge Fund Competition
Declaration of Faculty Coordinator: February 1st, 2019
Submissions Due: March 1st, 2019
Notification of Finalists: March 26th, 2019
Date: April 25th, 2019
Time: 5:00 PM
Location: Georgia State University’s Buckhead Center in Atlanta
The competition is open to teams of students at all colleges and universities in the world. Each team will consist of between one and five undergraduate and/or graduate students and a faculty advisor from the students’ college or university. All students enrolled at the university at any point during the 2017-2018 academic year are eligible to participate. At most two teams from any college or university may submit to the competition. If more than two teams from a college or university want to submit, the faculty coordinator (different position than but potentially same person as the faculty advisor, see below) must decide which two teams will submit. The same faculty member may serve as advisor to both submitting teams.
All submissions must be made through the competition’s website by 11:59 PM EST on Friday, March 2nd, 2018. On the submission page, you will be asked to complete a form indicating the college or university represented by the team, a team name, a title for the proposed investment strategy, the names of the students on the team, the email addresses and academic programs of the students on the team, the name and email address of the faculty member advising the team, and an email address to which all correspondence related to the submission may be sent. You will also be asked to submit a “blind” pdf file that describes the investment strategy. This document may have at most six pages of writing. An additional four pages of tables and figures, including captions, may be included in the document. This document should have the team name and title of the investment strategy at the top of the first page. No other identifying information, such as school name, team member names, or faculty member names, should be indicated on this document. The document must be written so as not to indicate or hint at the submitting team’s school affiliation. This means that the team name and investment strategy title should not hint at the school represented by the team. Guidance on the content of a good submission is given here.
Selection of Finalists
The submissions will be reviewed by a panel of judges chosen by SEHFA. A detailed discussion of the evaluation process can be found here.The top five submissions will be chosen as finalists and invited to the final competition. Teams will be notified of the results of the finalist selection process on Monday, March 26th, 2018.
The final competition will be held on Thursday, April 19th, 2017, at Georgia State University’s Buckhead Center in Atlanta. Each finalist team will present their investment strategy to a panel of SEHFA judges. It is anticipated that the presentation will be an enhancement of the information provided in the initial submission. Each team will have eight minutes to present. The presentations must be done in a manner that does not indicate the school represented by the team. The judges will then have up to seven minutes to ask questions of the team. After seeing all teams present, the judges will confer to determine the first, second, and third place teams. The winners will be announced during a closing ceremony and reception the night of the competition.
Scholarship prizes will be awarded to the top three teams. Hotel accommodations (but not travel) for students on non-local finalist teams will be provided.
Each participating school is asked to select a faculty member to serve as a faculty coordinator by Friday, February 2nd, 2018. The faculty coordinator will serve as a point of contact for distribution of information related to the competition. In the case that a school has more than two teams that want to submit to the competition, the faculty coordinator is responsible for determining which two teams from that school will submit. The faculty coordinator for each school is listed here. If your school is not listed, this means that your school does not yet have a faculty coordinator. Teams at schools without a faculty coordinator should find a faculty member at their school that is willing to serve as the faculty coordinator and inform the competition organizers of who the faculty coordinator will be via email (firstname.lastname@example.org). The faculty coordinator may also serve as a faculty advisor to one or both submitting teams.
Each submission will be reviewed by several hedge fund professionals and evaluated according to the following six criteria on a scale from 1 to 5, with a score of 1 indicating that the reviewer strongly disagrees with the statement and a score of 5 indicating that the reviewer strong agrees with the statement. The submission’s overall score will be calculated by averaging the scores for each criterion across reviewers, and then taking the average criterion-level score across all six criteria. The teams whose submissions receive the highest five overall scores will be invited to the final competition in Atlanta. The criteria used by the reviewers to evaluate the submission are the following.
- The proposed investment strategy is based on a sound economic hypothesis.
- The proposed investment strategy is reasonably novel and distinct from well-known and commonly-used investment strategies.
- The proposed implementation of the investment strategy is well-designed to generate alpha if the underlying economic hypothesis holds.
- The submission has a plan for mitigating risks associated with the investment strategy and for dealing with the situation when the economic hypothesis underlying the proposed investment strategy is proven false.
- The submission is thorough in assessing the liquidity and capital considerations associated with the investment strategy. This in no way implies giving preference to more liquid or less liquid strategies.
- The proposal uses appropriate methodologies to qualitatively or quantitatively evaluate the prospects for the proposed investment strategy, and the results of these analyses provide evidence of the viability of the strategy.
This section is intended to provide guidance for teams submitting to the Southeastern Hedge Fund Competition. The objective is to help teams understand what a good submission might look like. The section has two parts. The first part is intended to give participating teams an idea of what sort of trading strategies the competition might value. The second part is intended to provide suggestions for the components of a good submission. Before reading this section, it is suggested that the readers familiarize themselves with the scoring rubric that will be used by the reviewers to evaluate the submissions, and interpret the content of this guidance within the context of that rubric.
Types of Strategies
The objective of submissions to the Southeastern Hedge Fund Competition is to propose an investment strategy that is attractive to a hedge fund. The types of investment strategies that are of interest to hedge funds are extremely wide-ranging, covering all asset classes and markets. However, participants should keep in mind that this is a hedge fund competition. Therefore, in-depth analysis of a single stock with a proposed strategy of being long (or short) that stock is unlikely to score highly. Additionally, the proposed strategy should be able to deploy enough capital to make it of interest to a small hedge fund. For example, a strategy that earns 20% per year on $100,000 but cannot be scaled to deploy more than $100,000 is unlikely to score well. As a general guideline, the strategy should be able to deploy at least $10 million. Finally, the competition is particularly interested in innovative and novel trading strategies. Participants are encouraged to be creative.
Components of a Submission
The remainder of this document provides guidance on the components of a good submission. As discussed in the rules, the submission document can have up to six pages of written text with up to an additional four pages of tables and charts. The guidance provided here is not intended to provide a strict outline for a proposal. It is merely intended to give some ideas as to the issues that a good proposal should address, along with simple (although by no means complete) examples. The hedge fund strategy used as an example is a simple pairs strategy. A simple pairs strategy is chosen as the example for two reasons. First, it is sufficient to be illustrative of the suggestions made below. Second, it is too well-known and commonly-used to be considered a strong submission. That is not to say that a pairs strategy could not possibly score well. However, a well-scoring pairs strategy would need to be sufficiently different from well-known and commonly-used pairs strategies such as the one discussed here to warrant a high score. It should also be noted that the examples given here are intentionally short. An actual proposal will likely want to go into more depth on several of the points discussed below. Finally, it should be noted that all numbers in the example are completely made up.
The proposal should clearly state the main idea behind the trading strategy.
The main idea underlying our proposed trading strategy is to identify pairs of stocks whose firms are highly similar but whose stocks appear to be priced differently, and to profit from the differential pricing. Specifically, the strategy will take long positions in stocks that appear to be cheap relative to the paired stock and short positions in stocks that appear expensive relative to the paired stock. The strategy will then realize a profit when the differential pricing is corrected.
The proposal should state the economic hypothesis underlying the proposed investment strategy and provide economic arguments as to why the hypothesis should hold.
The strategy is based on the idea that stocks of similar firms should be valued similarly. This hypothesis should hold because stocks of similar firms are likely to generate similar cash flows and have similar risk. Since cash flows and risk are the two primary determinants of the value of an investment, if two stocks are similar along these two dimensions, the stocks should be valued similarly.
The proposal should describe in detail how the proposed investment strategy will be implemented. This should include a discussion of how trading signals are calculated, how the securities to trade are selected, how the position sizes are determined, the timing and execution of the trades, and all other aspects relevant to the implementation of the strategy.
The first step in implementing our pairs trading strategy is to identify pairs of similar firms. We define two firms to be similar if the firms are in the same industry, have similar leverage, and have a high correlation between their stocks’ returns. Specifically, at the end of each month, we look at all firms in the S&P 500 index. For each stock we calculate the leverage of the stock as the ratio of the book value of the firm’s debt divided by the market capitalization of the firm’s stock. We then examine pairs of firms that have the same 4-digit SIC and have a difference in leverage that is less than 0.1. Finally, we use daily returns over the past year to calculate the correlation between the returns of the stocks of each of the pairs of firms that satisfy the same-industry and similar-leverage criteria. We retain only pairs with correlation greater than 0.6.
Having identified the pairs of similar stocks, we then determine whether the stocks are similarly valued using the price-to-earnings ratios of each stock. For each stock in each pair, we take the price-to-earnings ratio to be the price of the stock divided by forecast earnings over the next year. We require that there be at least a difference of 1.0 between the price-to-earnings ratios of the stocks in the pair. Pairs not satisfying this criterion are discarded.
Finally, for each remaining pair, we will take a $1 million long position in the stock with the lower price-to-earnings ratio and a $1 million short position in the stock with the higher price-to-earnings ratio. We will hold the positions for the duration of the next month, at which point the current pairs will be liquidated and we will repeat the process.
The proposal should describe in detail the risks associated with the strategy and how any unwanted risks will be mitigated.
There are two main risks associated with this strategy. First, there is the possibility that the stocks that the strategy has long positions in have, on average, different betas than the set of stocks the strategy is short. This would result in the portfolio having exposure to moves in the overall market. To remove any potential exposure to moves in the overall market, we will calculate each stock’s beta with respect to the S&P 500 index using daily data over the past year. We will then take the portfolio’s beta to be the average beta of the stocks the portfolio is long minus the average beta of the stocks the portfolio is short. If the portfolio’s beta is not zero, we will hedge the portfolio’s exposure to overall moves in the market using S&P 500 index futures.
Second, it is possible that our pairs selection strategy has overlooked something about the firms chosen as pairs and that the firms are not truly similar. To mitigate the possibility that a single pair experiences a large loss, we will monitor the profits of each pair and liquidate the pair if the total losses on the long position and the short position in the pair add up to more than $100,000, or 10% of the initial long (or short) position size.
Liquidity and Capital Considerations
The proposal should discuss how liquidity may affect the implementation of the trading strategy and how much capital the trading strategy might be able to deploy.
Since we will implement our trading strategy only on stocks in the S&P 500 index, the stocks we will trade are very liquid. We therefore expect that we should be able to scale up the strategy quite easily. Since almost all S&P 500 index constituent stocks have more than $100 million in dollar trading volume every day, trading $1 million in any stock should have very little price impact. While the trading strategy as we propose it would take $1 million positions in each stock, there are many ways the proposed trading strategy could be scaled to take on more capital. Specifically, instead of only trading at the end of the month, we could initiate new positions each day, and then each day only liquidate the positions that were initiated one month prior. Assuming 20 trading days per month, this would scale the strategy from approximately $1 million in each stock to $20 million in each stock. Since each month we identify on average 50 tradable pairs, this would enable us to grow the portfolio to have total long positions of $1 billion and short positions of the same size.
Analysis of Strategy Prospects
The proposal should provide some analysis of the expected returns and risk associated with the investment strategy. In cases such as this pairs trading example, this can be done by simulating the strategy historically. However, for a wide range of strategies, it may not be possible to historically simulate the strategy. For example, the strategy may be particular to current market conditions that have not existed in the past, or the data necessary to simulate the strategy may not be available. If the strategy cannot be simulated, then alternative techniques should be used to, as best as possible, assess the risk and expected returns of the strategy. It may be a good idea to tabulate the results of your analysis. In the example, it is assumed that there is a table accompanying the text.
To assess how the strategy has performed historically, we simulate the strategy during the period from 1980 through 2017. The data used for the simulation come from Bloomberg. The results of the simulations are shown in Table 1. The strategy generates an average monthly excess return of 0.4%. The standard deviation of the monthly excess returns of the strategy is 2.0%. The annualized Sharpe ratio of the strategy is therefore 0.69. The worst drawdown experienced by the strategy began in August 1994. The low point of this drawdown was realized in February 1996, at which point the strategy had lost 14% from its previous high. The drawdown ended in April 1997, at which point the strategy overcame its previous high-water mark.