Quant funds move into the ‘Wild West’ of pink sheet stock trading

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Computer-driven investment companies are increasingly trading U.S. stocks over-the-counter, attempting to bring modern algorithmic strategies to a realm that has traditionally been regarded as one of the riskiest corners of equity investing. is seen in

Investors, market makers and investors say so-called quant hedge funds and proprietary traders are being attracted to this corner of the market by a combination of improved liquidity and the increasing difficulty of making money in the large-cap markets. Exchange Officer.

“It’s a good thing investors like us think what we can do,” said Seth Weingram, senior vice president at Acadian Asset Management, who specializes in systematic strategies and runs a microcap strategy that includes OTC stocks. ” “It’s the least efficient part of the equity world, and we’re really interested in the least efficient market segments.”

Over-the-counter stocks are shares of companies that are not listed on mainstream exchanges such as the New York Stock Exchange or Nasdaq. More than 12,000 stocks are traded on the US’s main over-the-counter network, which is operated by OTC Markets Group.

Those 12,000 companies range from dollar-denominated versions of major foreign stocks like Nestle to smaller domestic conglomerates linked to cheaper listing costs, highly speculative shell companies or bankrupt businesses that have been delisted from mainstream exchanges.

Earlier this month, the Financial Times reported that traders have dumped hundreds of millions of dollars into shares of Bed, Bath & Beyond, a defunct retailer since it was delisted from Nasdaq in May, although analysts consider it a waste and a Another company has bought the rights to it. Name.

Although it is difficult to measure the share of quants trading in OTC stocks, hedge funds and proprietary traders account for a much larger share of OTC Markets Group’s recent client growth than previously thought.

Such companies are still a relatively small part of the broader investment landscape, but have made up 40 percent of new customers paying for access to OTC Markets’ data over the past two years. This percentage increases to 50 percent in the first half of 2023.

Matt Fuchs said, “Anyone with a broker relationship can choose single securities or specific positions in which they want to trade, but once they are buying real-time data indicates that they want to trade it as a putting into the larger program or strategy.” , OTC Markets’ executive vice president for market data.

The OTC markets were known as the “pink sheets”, named after the colored paper on which the quotes were published. They were popular among retail traders, but trading was expensive and extremely risky, and prone to “pump and dump” scams.

In total, investors traded nearly $507 billion worth of OTC shares last year — less than at the peak of the meme stock craze in 2021, but still up 50 percent from 2019.

The increased liquidity has made it easier for algorithmic strategies to operate. Meanwhile, with most large fund companies still shunning this space, competition from other institutions remains low.

“The volume of business is very less. , , “There is not as much competition in the traditional standard developed parts of the equity markets,” Vengram said.

The composite index of OTC stocks is up 45 percent since the end of 2018, compared with 51 percent for the S&P 500 and 49 percent for the Russell 2000 Small-Cap Index. However, proponents say there are more opportunities for active managers to add value to the small-cap sector than in more efficient large-cap indices.

PGIM Quantitative Solutions, the systematic trading arm of the $1.3tn asset manager, launched a quantitative microcap strategy last year. “We have seen a lot more opportunities in terms of adding (outperforming) compared to other strategies. , , It’s hard to add value if you benchmark against the S&P 500,” said managing director and chief investment officer George N. Patterson said.

PGIM is one of the few firms that is offering such strategies to clients as an alternative asset class to private equity, which can be used to diversify portfolios and reduce correlation with major markets Is.

However, some investors are skeptical.

“You look at a company and ask is there value here or is it smoke and mirrors, and more smoke than value in the OTC market,” said Scott Sheridan, chief executive of TastyTrade and co-founder of Thinkerswim, Retail. And there’s a mirror.” Focused options trading platform.

He said that although there was always the possibility of a lottery ticket – an obscure stock that rises dramatically in value – it is rare, as it is for companies that trade OTC and then list with regulated exchanges. “It’s not like the little leagues in baseball. There is a reason why these companies are not listed.”

“We have less than zero interest in OTC. There’s a lot of pump and dump out there,” Sheridan said. He added that there were risks for institutions given the regulatory environment. “With pink sheets, you’re asking regulators to come and ask why you’re trading this. are doing.”

PGIM’s Patterson acknowledged that investors still “have to be careful and pay attention to cost management”, but stressed that the OTC is “not the place it used to be 10 years ago”.

He added: “The risk is not low compared to some emerging market strategies or lots in the hedge fund sector. I think it’s a lot less risky than crypto.”