A significant trend in quant investing is the growing overlap between market-making trading firms like Citadel Securities and Hudson River Trading, and large hedge funds such as DE Shaw and Millennium. This convergence, emerging since 2020-2021 and becoming more apparent recently, signals a reordering of systematic trading, where prop trading firms are increasingly resembling hedge funds, and vice versa. This shift is partly due to the diminishing profitability of "low latency trading" in high-frequency trading (HFT) because of intense competition and physical limits, leading firms to explore "mid-range" trading strategies.
Proprietary trading firms, which make bets with their own capital, are evolving beyond the pure speed game by holding positions for minutes, hours, or even days, a territory historically dominated by hedge funds employing statistical arbitrage. Hudson River Trading's Prism unit, for example, reportedly generated over $2 billion in profits last year from these strategies, while mid-frequency trading now accounts for 25-30 percent of Tower Research's revenues, up from under 10 percent a few years prior. Jane Street, a major market-maker for ETFs, achieved $8.4 billion in net trading revenues in the first half of 2020 by holding positions longer than standard.
This convergence presents implications for both industries and the markets they operate in. Hedge funds are seeking high Sharpe ratio strategies, which are typically lower-latency, to complement existing strategies. Conversely, successful prop trading firms are finding it easier to add slower trading strategies than hedge funds are at speeding up. This trend also means that prop trading firms will likely raise more external capital, while hedge funds might consider hiving off their top trading strategies into internal funds. However, increasing competition in mid-frequency trading, generally in the 1-5 day range, could lead to crowding in certain signals, exacerbating risks, as potentially seen in the "quant quiver" experienced in July. This also highlights a capacity issue, as firms invest heavily in research and compute and need to deploy more capital to justify these high fixed costs.
