Career Paths for Financial Mathematics Graduates

Thanh-Long Huynh

M.S. in Financial Mathematics (2000), The University of Chicago

Lake Partners LLC, Partner

K&K Capital Management, Chief Strategist

Email : thuynh@kkcapital.com

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Examples of alumni career

Graduates of 2000 :Thanh-Long Huynh - Quantitative strategies for LK2 PartnersRoberto Torresseti - Credit derivatives quant for IMIDavid Gustafsson - Software developer for a hedge fund, former VP at JP Morgan (pension fund forecasts)Graduates of 2006 :Khalil al Dairi – Algorithmic Trading Nghia Huynh – Risk ManagementFlorent Chagnard – Global Asset Allocation

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Major participants in the Financial Industry

Banks (Investment banks & Retail banks)Hedge FundsMutual FundsPension FundsLife Insurance CompaniesRetirement Funds

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Investment Banks & Hedge Funds

MarketsEquityFixed Income & Foreign ExchangeEmerging Markets & Commodity Markets

Fundamental Research and Merger & AcquisitionsPrivate Equity

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What drives profit of banks and hedge funds?

Direction of the markets (stock market, interest rates, volatility, commodities)Flows, Commissions (Prime Broker) Origination (new issues, new products)Fundamental Research, Merger & AcquisitionsAsset ManagementExamples

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Equity Capital Market

Structure Sales & TradingResearch (fundamental & quantitative)

InstrumentsCash (stocks)Derivatives (futures, listed options, structured products)

Where to find quantitative jobs in this departmentThe “quants”Pricers – use of quant models for clientsQuantitative research – investment strategies for clientsRisk ManagementTrading (exotic options, listed options) - Arbitrage

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Quantitative Strategies

“Quants”

Clients

Pricers

Traders Cash

Plain Vanilla options

Exotic Options

Sales Stock

Structured Products

Fundamental Research

Risk Management

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Debt Capital MarketStructure

Sales & TradingResearch

Basic InstrumentsSovereign Debt (Treasury Bonds)Investment Grade Corporate BondsHigh Yield Bonds

Derivatives InstrumentsSwapsListed derivativesSecuritized products – CDO, ABS, MBS,..Credit Derivatives

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Quantitative Jobs in this departmentThe “quants”

Ex: Modeling of the interest rate curveQuantitative research – investment strategies for clients

Ex : Econometric analysis of Treasury-bond based on mean reversal strategy

Derivatives Desk : Sales & TradingEx : Convertible Issues (pricing)Ex : Credit Derivatives Trading (risk must be quantified)

Risk ManagementEx: Validation of the models – always challenging because of the constant creation of different productsEx : Control of derivatives risk exposure

Debt Capital Market

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Financial advise to governments, corporations, endowments, foundations and individuals worldwide from traditional cash management, equity, fixed income and asset allocation to alternative asset classes such as private equity and real estate. Growing demand not just for performance but for sustainable performance with emphasis on the quality of investment styles and risk management. Quantitative Jobs

Portfolio modelingStructured productsRisk management

Asset Management

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Interviews

Do NOT go to interview without basic knowledge of finance-> value of Dow Jones, volatility of index (S&P or Eurostoxx50),

LIBOR, …Examples of interview questions

->If I have a call on SPX and hundreds of calls on all the stocks in SPX weighted in the way as the SPX , what would you prefer? (Goldman Sachs, Fixed Income Strategies, 26 oct 2005)Book about interview questions :“Heard on The Street: Quantitative Questions from Wall Street Job Interviews”

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How to use the Mathematical Advantage?

Clear understanding of valuation models=> Understanding of assumptions of the models and consequently

the risks involvedConsequences

a MUST for Risk Management : interesting & challenging job without the pressure of the front officeBasic rule in trading (risk / reward) : understanding involved risks in a position is necessary for a consistent tradingA good asset for a sale : much more confident to explain the product

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The Importance of Computer Programming

Implementing a portfolioEx : Global asset allocation, Statistical Arbitrage

Independence and EfficiencyEx : Test of quantitative trading strategies (if 10% of strategies work : it is excellent!!!)Ex : Avoid to rely too much on ‘pricers’

Significant advantage compared to a pure mathematics person or to a new graduated MBA professionalImportance of Program Trading :Program trading in the week ended Sept. 1 2006 was 31.3% of New York Stock Exchange average daily volume of 2.6 billion shares

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Tendency

Numerous opportunities in risk management with very competitive salary and bonusFixed Income Market : Numerous opportunities in structured products, proprietary trading due to equity uncertaintyEquity Market : Numerous opportunities in structured productsEurope : Strong hiring in investment banks US : Many opportunities in alternative investment industry and investment banksAsia : Japan starts to recruit intensivelyHighest bonuses in 2005 in proprietary trading and equity markets for investment banksHighest bonuses in 2004 in proprietary trading and fixed income markets for investment banks

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Hedge Funds & Mutual Funds

Some NumbersMutual Funds : $ 8 trillion under managementHedge Funds : $ 1.2 trillion under magagement

Definition Mutual Fund : security that gives small investors access to a well-diversified portfolio of equities, bonds or other securitiesHedge Fund : private pools for wealthy, financially sophisticated investors, organized as partnerships

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Differences between a mutual fund and a hedge fund

PositionsMutual funds : Long onlyHedge funds : Long and Short

ReturnsMutual Funds : Relative to BenchmarkHedge Funds : Absolute Returns

PortfoliosMutual Funds : DiversifiedHedge Funds : Concentrated

Leverage Mutual Funds : Little or no leverage ( a few exceptions now)Hedge Funds : Use of leverage available

Derivative useMutual Funds : not widespreadHedge Funds : significant use

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Major types of strategies for a hedge fund

Long/ Short Equity Funds : invests in relative misvaluations of companies or sectors by simulateously buying and selling securitiesEvent-driven Arbitrage : Purchase securities expected to appreciate from a corporate event (spin-off, change of management,…)Merger Arbitrage : Purchase the Target and sells the Acquiring Company

Ex: Trading the spread until consummation of the acquisitionConvertible Arbitrage :Buy convertible bonds and dynamically trading the company’s equity to extract the value of the embedded optionMacro currency : Invests in money markets (with derivatives) of countries with high expected real returns and finances in money markets with low expected real returnsStatistical strategies : Purely quantitative strategies to take positions on all the possible markets

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Another category of fund : the fund of funds

Strategy : Invests in pool of fundsRequired Competences:

Understanding of strategiesEvaluate the risks for each fund and the risks within a basket of fundsAnd … it constitutes almost 1/3 of all the assets in the hedge fund industry

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About Mutual Funds

Numerous categories of mutual funds:Stock Funds (54%), Taxable Bond Funds (12%), Municipal Bond Funds (7%), Taxable Money Market Funds (19%), Tax-Free Money-Market Funds (3%), Hybrid Funds (5%)

How to use the maths?Build up efficient portfolio relative to an index

(by minimizing the tracking error)

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About Pension Funds

Definition : Forms of institutional investor, which collect, pool and invest funds contributed by sponsors and beneficiaries to provide for the future pension entitlements of beneficiaries

How to use the maths?Build up long-term efficient portfolio under numerous constraints

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About my work

Manager of a multi-strategy statistical arbitrage on-shore fund (80% of my time) LK2 Partners

Consultant for a fund of funds (20% of my time) Lionheart L.P.

Help other people to set up their own fund to develop their own trading strategies

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One day as single-fund manager

In Chicago8:30 : Market opens 8:30 – 10:00 : Review the positions in the portfolio (especially losses) + overview of financial newspapers10:00 – 10:30: Discussion with the partners about the portfolio and the market10:30 – 13:00 : Testing of new ideas 13:00 : Conference call (potential/actual manager, partners)14:30 – 16:00 : Trading, Construction of the portfolio and update of the database16 :00 –16:30 : Discussion and Review of the new positions (long/short/risks) with the partners

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One day as fund of funds consultant

8:30 : Meeting with Okumus Opportunity FundPresentation of Okumus Opportunity FundStandard Questions : risks involved with the strategy (risk exposure, liquidity, …), due diligence

10:30 : Meeting with our fund of funds advisor12:30 : Lunch with a classmate friend14:30 : Meeting with Laurus US fund (micro cap long only), potential new manager16:30 : Meeting with Jolly Roger Fund (event driven), due diligence – double digit loss in 3 months

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Development of new productsSynthetic CDO

2005 : 1.6 trillion USD2004 : 1.0 trillion USD2003 : 600 billions USD

Credit Derivatives Insurance productsUsed to create (synthetic) CDOEx : Credit Default Swap (2004) : 8.4 Trillion of notional value

Hybrid Funds (leverage hedge funds, option on hedge funds, hedge fund + private equity component,…)

⇒ More complex products⇒ More work to do….and can be a good source of profit or

loss…

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Appendix : Investment Process and Due Diligence

FOUR STEP

PROCESS

DUE DILIGENCEIn-depth research on a selected subset of managers

6000+ Existing hedge fund managersMANAGER DISCOVERY

PORTFOLIO CONSTRUCTION1 to 5 new managers become eligible for funding per year

MONITORING AND RISK MANAGEMENTDetailed monthly, quarterly and annual reviews

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Appendix : Investment Process and Due Diligence

Referrals

Strong professional and personal relationships create access to a network of managers with proven track records and high potential for future success.

Screening

Managers are selected based on matching risk and return profiles with expectations. Basic qualitative and quantitative screening is performed utilizing information from various sources including, but not limited to, Bloomberg, Firstcall, Compustat, Dow Jones/Reuters News, SEC filings, company interviews and discussions with competitors, suppliers and distributors.

MANAGER DISCOVERY6000+ Existing hedge fund managers

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Appendix : Investment Process and Due Diligence

In-depth research on a selected subset of managersDUE DILIGENCE

Qualitative and quantitative due diligence continues with a more comprehensive analysis of specific managers and an assessment of their individual investment process and business structure with a specific focus on sources of return, strategy risks and business risks.

Reference checkClient baseManagement/OrganizationProfessionalism of managerTrack recordInvestment objectivesPerformance consistent with investment philosophyAbility to produce appropriate returns in the futureTrading styleRisk management (liquidity, credit and market)Potential conflicts of interestReporting capabilitiesLegal/Regulatory

QUALITATIVEQUALITATIVE

Benchmarking against appropriate indicesRisk/Reward studyVolatility analysis – VaR analysis, correlation studies, etc.Peer group studiesReview of leverageDiversificationDrawdown and time to recover analysis

QUANTITATIVEQUANTITATIVE

100% investment committee approval is required to add a new manager.

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Appendix : Investment Process and Due Diligence

1 to 5 new managers become eligible for funding per yearPORTFOLIO CONSTRUCTION

Bottom-up manager selection from the best managersTop-down strategy allocation based on economic and market conditionsTarget returns and volatilityRisk and exposure analysis:

• Sector concentration/Diversification• Hedging techniques• Leverage• Stress testing• Scenario analysis

Portfolio is constructed to achieve overall investment objectives by combining and balancing funds with appropriate characteristics and investment strategies.

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Appendix : Investment Process and Due Diligence

Detailed monthly, quarterly and annual reviewsMONITORING AND RISK MANAGEMENT

Attribution analysis of concentration by industry, position and geographyPortfolio and manager level monitoring and analysisQuantitative models used to analyze risk exposuresAssessment of leverage, credit and net exposuresStress tests and correlation analysisReview transparency and liquidity issuesInformal review of monthly financial dataPeriodic audit of financial records and operational controlsAdherence to investment guidelinesFrequent communication with managersOngoing review of market, manager and industryReview changes in managers’ style and investment strategy

The portfolio and portfolio managers are monitored on a comprehensive and proactive basis to ensure adherence to investment guidelines and appropriate risk management.

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Appendix : Investment Strategy Breakdown

Fixed Inc.14%

Event Driven9%Stat Arb

4%Multi-Strategy

3%

Eq. Mkt. Neutral1%

Equity L/S17%

Distr./Hi Yld10%

Relative Value1%

Mortgage Arbitrage2%

Conv. Arb3%

Asset Backed Finance

24%

CTA/ Macro7%

Asset Backed CBO1%

Environmental Credits

1%

Other3%