CHALLENGE: The demand for quantitative competence is rising in IT departments and trading desks across Wall Street. But the supply of talent with strong math, programming and technology skills is hard to find.
Why It's Important: Algorithmic trading in equities is becoming more pervasive and is expanding from foreign exchange (FX) into fixed income, options and futures. But as markets become more efficient due to high-frequency trading, algorithms that used to work for a year in FX now are viable for only 90 days, so there will be a constant need for new quants to come up with new ideas and build new algos. However, the supply of quants is scarce and firms will need to retain them. As a result of the recent credit market crisis in subprime mortgages and CDOs, there also is a focus on building or revising risk management systems. Hedge funds will not be able to attract money from institutional investors or funds-of-funds unless they can demonstrate an effective risk management system.
Where the Industry Is Now: There always has been demand for quants to work close to front-office trading and structuring positions. Lots of quants work in the derivatives areas of large investment banks doing derivatives pricing and risk management. The biggest explosion occurred in credit-related derivatives, or credit default swaps, as a way to isolate and, for the first time, hedge the credit risk inherent in equities, fixed income and derivatives. One hot area is writing cross-asset or hybrid contracts that span all asset classes. It's rare for quants to work in IT; most often they are working for the business unit or a centrally organized quant group. But there are quants sitting in proprietary trading groups, risk groups and sales positions.
Focus in 2007: Sell-side firms will recruit quants to work on algorithmic trading systems to design new algorithms, program the models and back-test them against historical data. With the growth of high-frequency trading, prime brokers and investment banks also are employing quants with backgrounds in physics and math to figure out how to process more trades in the back office. And because of the recent turmoil in the credit markets, there will be demand for quants to help firms recalibrate their risk management systems.
Industry Leaders: All of the top investment banks have groups developing algorithmic trading strategies for other asset classes. Banc of America Securities is expanding its algorithms beyond equities into futures before the end of 2007, starting out with the plain vanilla equity-linked index futures that trade on the CME. BAS plans to add more-complex contracts, such as Eurodollars and equity options, down the road. On the buy side, Barclays Global Investors and State Street Global Advisors are said to be at the top of the quant game.
Technology Providers: There are third-party providers of analytics on the market, such as SuperDerivatives and NumeriX, for pricing OTC derivatives. In terms of building models, Numerical Algorithms Group (NAG) supplies libraries of analytical code that quants incorporate into their models (clients include Fidelity, S&P, Wachovia and Deutsche Bank). Another contender is Quantstar, a services company that provides financial analytics and quantitative consulting. The founder is John Birge, a quant who leads the financial engineering program at University of Chicago. But most of the sell-side firms build their own proprietary platforms for algorithmic trading. However, Weeden & Co. partnered with Pragma Financial Systems, a third-party algorithmic development shop in New York.
Price Tag: Total compensation for quants with two to three years of experience is about $150,000 to $200,000 annually, and the recruiter typically earns anywhere from 25 percent to 30 percent of the candidate's first year salary, which is guaranteed. More senior quants can make anywhere from $200,000 to more than $1 million. Sell-side firms recruit from universities that offer masters in financial engineering programs but usually like to hire quants with two to three years' experience in finance.Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio