The formula that was supposed to turn fund managers and their clients into multi-billionaires does not seem to be working.
Quant funds, the out of this world computer-driven investment strategies that were once “rising stars” in the financial industry seemed to have lost their luster in the past few years with increased outflows.
Such poor results led many investors and expert fund managers to give them the cold shoulder, and ignore them altogether. Truth is, at its current performance, quants’ pattern-recognition and modeling capabilities may not be sufficient enough yet to survive the market’s complexity and dynamism.
The AQR underperformance says a lot
Cliff Asness, chief executive and founder of AQR, was very honest about his feelings for the situation his firm is facing right now. He described it as having a crappy time. Although quants suffering underperformance have been trending lately, he was very vocal about it.
In a Morningstar Investment Conference in Chicago, Assness shared, “Factor investing has been crappy lately, I have a problem”. He told the attendees of the said gathering, that: “with the kind of weasel words managers like me normally use. They don’t say crappy, they go ‘It has been a challenging environment for our strategy’, which is undeniably true but Richmansn’t sum it up, This is pretty crappy.”
The AQR Managed Futures Strategy Fund, the $6 billion flagship mutual fund of the firm was down 8.8% for 2018. Despite it being up 3.9% year to date, it’s behind three-year numbers to the end of March are -17.1%, putting it on the 25th place out of 28 funds in the Citywire Managed Futures Category.
The $821 million AQR Multi-Strategy Alternative fund fell 13.7% in 2018 and is down 1.92% year to date, and over three years to the end of March is placed 56th out of 57 funds in the Citywire Multi-Strategy category, having returned a measly -11.8% against the peer group average of 5.8%.
The firm started 2019 with a number of layoffs to make up for the tough year wherein the bulk of its funds suffered underperformance and led to significant outflows.
Cliff Asness explains the phenomenon
“What’s bad in the quant world has been the stock selection. If you used quant for say macro decisions or other things, it actually not been a particularly bad time,” Asness said. “But quant stock selection has been terrible. When things are bad people want to understand why,” he added.
He explains that complexity makes it more difficult to explain the underperformance to the investors. Short-term underperformance of multi-factor strategies does sound befuddling to the average ear.
The difficulty in making investors comprehend the situation correlates to the hindrance in convincing investors to hold the line. This is in contrast with simpler strategies where failure and success are almost always written in black and white.
He made an example of a stock picker explaining that a long-only equity fund is down because of bets on a certain company or sector that underperformed, wherein the investor intuitively catches on. “The story is satisfying and simple,” he said.
Asness also disclosed that “We think this intuition problem makes crappy times feel worse for quant.” He added, “You will pretty much always understand big moves in these strategies and understanding helps. Sticking to the strategy is easier if you feel like you get it”.
He also said that it holds true for single-factor funds, ones that are anchored on purely value or purely momentum. “Obviously, I’m a lover of multi-factor quantitative investing, but it’s up against some real difficulties when it hits tough times. On every score that makes it easier to stick with a strategy, it’s a loser” said the calm but deflated Asness.
Exemptions to the massive loss
As in all rules and trends, there is always an exemption. Despite the fact that quant funds suffered massive blows recently, some have been able to thrive because of diversions in the factors they consider. Credit Suisse reports that equity quants had their exposure increased by roughly 9% in the first two months of the year.
Bloomberg Intelligence singled out the smart beta, which basically tracks factors through long-only investments, earned a record $33 billion of inflows in the past three months, led by low-volatility and value. These riskier types including leverage, small size and volatility have outperformed the following indicators that the Fed had become more subtle in its policy.
Future investment trends
It seems like humans are still the leaders when it comes to investing leaving the computers far behind, and will be the case for the foreseeable future.
Since the market involves various stakeholders and players, quants are still not as flexible as seasoned financial experts who have been through various booms and busts. In turn, such experiences have given them the foresight and insight needed to succeed in the game.
The instinct and insight possessed by the human investor simply can not be matched by the hyped quant funds. Meanwhile, investors such as James Richman are understood to still ignore quant investments due to the success of his company especially during financial chaos when others have already thrown in the towel.
Richman does not need it anyway because of his visual pattern recognition, often attributed to his Asperger’s — a high-functioning form of autism believed to be common among some of the world’s most successful individuals including Bill Gates, Nikola Tesla, Bill Gross, and others.