How Storm-Predicting Methodology Can Help Predict The Markets
Investors are like tornados — generally unpredictable, but not enough so that an algorithm can’t offer insights. That’s what Efrem Hoffman found when analyzing radar patterns in college, and that’s the impetus for his market analysis platform, Running Alpha.
Using the storm-predicting methodology, Hoffman helps investors make sense of uncertainty in the financial markets and act on analyses of appropriate time horizons.
Benzinga: What are you trying to accomplish with Running Alpha?
Hoffman: A lot of people today think that they need to get information faster, or they need to get different types of information because the faster they get it, the more they’ll be able to get ahead of the pack. But pretty much all the information today has been commoditized, and even the most sophisticated types of information are being used by just about every top manager out there.
However, if you peer into how decisions are made and how those decisions braid together in the order book, we can get ahead of what the output is. So we want to understand the underlying nature of the process that produces asset pricing.
Benzinga: What’s different about the way Running Alpha interprets the markets?
Hoffman: We don’t see information as other people see it. Most investors view facts or news stories coming into the marketplace as king. What we see is that it’s not important what the actual facts are; it’s the biases of decision-makers who are already embedded within the marketplace, and how they’re actually going to translate those news facts and stories into an impactful decision, that will come together in the order book and produce a trend persistence.
We take a very different approach, and part of the reason is my background comes from originally hunting down tornados in the weather space and taking a physics approach.
Benzinga: What’s your background and how does it come into play?
Efrem HoffmanHoffman: My background and passion comes from originally hunting down tornados in the weather space and taking a physics approach. Back in my undergraduate years, the University of Manitoba was working on a project with Environment Canada at the time -- trying to see if there were ways to actually understand how patterns come together in the complex chaotic mode of the atmosphere -- for predicting tornadoes and extreme aviation weather phenomena. What I found is that by studying three-dimensional radar patterns as they reflect off of cloud droplets in the sky, I was able to predict in a time-wise fashion what was actually going to happen in the underlying formation of storm systems across time and space.
Through that research I ended up getting mentored and noted by a number of finance professors at the University of Manitoba as well as a number of ex-floor traders, and worked on their private equity and hedge fund portfolios. Basically, what we found is that the methodology that I was using for trying to capture underlying weather patterns in Doppler radar imagery had direct applications for understanding the capricious nature of how people and machines interact in the financial marketplace.
Benzinga: What do you offer on Running Alpha?
Hoffman: So there are three subscription products. One is the Grid 100, which includes the top 100 equities spread across different industry groups; but we also go further and try to tag them based on their individual micro categories and present that in a heat map.
The other side of the product that we provide is much more customized -- we license low-volatility portfolios and these Running Alpha portfolios to institutions as well as portfolio managers and hedge fund managers.
Then we also have a Focus 15 list which is a concentrated portfolio of 15 equities that have the best internal structure for keeping volatility low, but also at the same time having a very low asset turnover with lots of trend persistence for keep trading costs and investor anxiety levels in healthy check across all the relevant investable time-lines.
Benzinga: So you’re recommending all those stocks to every customer?
Hoffman: Not every investor has the ability to buy 100 stocks. So what if you have a situation where an investor subscribes and they just tend to only pick 3. Are they going to get into trouble? What we’ve found over time is that 5-8 is optimal if you want to really good diversified portfolio.
If you do that, it doesn’t matter which 5 or 8 you pick. The average alpha that’s generated above the market is constant across all time scales, no matter which way you slice it, which makes it very attractive without having to change or modify what we’re providing depending on what type of investor you are.
Benzinga: How do your portfolios work?
Hoffman: What we’ve found in our Running Alpha list of equities is if an investor buys into those portfolios, it has a natural organic hedge against market uncertainty. Which basically means that if unknown events come into the market, let’s say a positive event comes into the market, what will tend to happen is that each component and as a whole in the portfolio the beta will tend to magnify the impact of the positive news and lessen the impact of negative news.
It’s kind of like crash testing a car. We don’t care about trying to figure out every possible scenario that could impact the car. We’re more interested in how much stress could the car actually withstand.
Benzinga: Do you have anything else in your pipeline?
Hoffman: There is a very exciting product that’s in the works right now. We’re in the process of partnering with an index developer to produce a real-time index with alternative performance metrics and unprecedented levels of transparency; that will go live on the market exchange and major financial media terminals; and be available for licensing opportunities to a wide range of index publishers & producers, and ETF providers. So we’re looking forward to getting this product out of the lab and into the trading room this year.
This article is exclusive to Nasdaq.