Factor quants faced unusually trying times this year as previously-tested strategies underperformed and investor patience wore thin. Now, the task is to win back investor confidence with revamped strategies.
Justina Lee filed this report for Bloomberg:
Quants who failed to diversify into winners like low volatility are in soul-searching mode. Are factors like value structurally broken? Can market-neutral styles roar back to life over the long haul? “Some of the themes we expected to diversify our returns in a period of underperformance of value haven’t worked as well,” said Ian Heslop, London-based head of global equities at Merian Global Investors.
It’s not all gloom. A bunch of long-only factor strategies are posting 20%-plus gains this year. But they’re still lagging cap-weighted indexes. Sanford C. Bernstein estimates systematic long-only managers have lagged their benchmark by 2 percentage points on average.
Market-neutral quants with strategies including factor styles gained 1.2% this year as of Nov. 26 compared with 9.8% for equity long-short funds and 8.7% for discretionary macro funds, according to data on Credit Suisse Group AG’s prime-brokerage platform.
The short legs of factor strategies have been a drag on performance this year, reinforcing recent research by Robeco that argues the value of the investing style mostly comes from the long leg.
Another culprit may live in the bond market. As interest rates dominated factor returns this year, diversification benefits weakened, strategists led by Joseph Mezrich at Nomura Instinet LLC posited. Factor correlations have risen, especially in Europe where they’re now the highest in a decade, according to Bernstein.
Fund managers steadfast in their conviction that value was poised for a rebound this year have been left disappointed. Since reviving briefly in September, the factor has flatlined since. Its outlook continues to divide quant land between bears citing low yields and weak growth, and bulls touting cheap relative valuations.
For Roberto Croce, the problem is the lack of diversification. Too many equity quants have been exposed to factors that are sensitive to risk appetite like value. The fund manager at BNY Mellon Investment Management touts defensive styles like low volatility which stems from behavioral anomalies. The strategy is booming as investors pay up for havens to hedge recession risk. “It’s important to have a portfolio that is balanced across the underlying macro drivers of risk,” Croce said.