Despite a dismal performance, quantitative hedge funds have been all the rage garnering a record number of new launches and inflows. Investors are lured by the prospects of uncorrelated and higher returns. Proponents argue that these strategies take time to reach their full potential while critics claim institutions could do better mining other opportunities on the investment spectrum.
Every strategy has its ups and downs. This is a long-term game and focusing on short-term results or looking arbitrarily at timelines can be dangerous.
Penny Aitken
These so-called trend following quantitative black-box hedge funds have been gaining momentum over the past four years with pools of money reaching $266bn, more than any other type of hedge fund, according to US-based BarclayHedge estimates. The initial attraction was the funds’ 21% average gain in 2008 compared to the Standard & Poor’s 500 Index’s 38% drop. However, many also piled in as a backlash against active managers who consistently failed to beat their benchmarks. Reports from S&P show that in recent history, the only time they outshone their passive rivals was during the upheaval following the market crash of 2008-2009 as well during the dot-com bubble at the turn of the century. The other main driver is regulation such as the Volcker rule, which has unleashed a procession of proprietary traders spinning out and starting their own hedge funds. In fact, 2011 saw a bumper crop across the spectrum with quant or algorithmic being among the most fashionable. They accounted for 12% – or 187 – of all new hedge fund start-ups in 2011 and while the numbers for 2012 are still being crunched, they are expected to be higher based on the 40% hike in these strategies seen in the first quarter, according to figures from data provider Preqin. Their growing popularity though does not tally with their latest string of losses even though last year’s was not as dramatic. The Newedge CTA Trend Sub-Index, which tracks the performance of the largest computer- driven, or quant funds, fell 3.4% last year after a 7.9% drop in 2011. Data from Chicago- based Hedge Fund Research (HFR) reflects a similar pattern with the average systematic fund losing 3.2% as of early December 2012 compared to the 4.5% increase for the average hedge fund.
Highs and lows
The star performers were asset-backed bondfocused hedge funds which on average returned 14.5% on the back of a strong rally in the US mortgage market. Credit strategies also boasted an impressive showing with the average fixed income hedge fund climbing 8.9%. The four hedge funds thought to have been hit the hardest were leading lights who had posted double-digit returns back in the day. They included the flagship futures fund of Winton Capital, the world’s largest quant fund, with $26bn under management. It slid 3.5% in 2012, its second annual decline since opening in 1997. Aspect Capital, another large London-based quant fund, dropped 11.7% in the year to November 21 while Blue- Trend, the $11bn Geneva-based fund run by Leda Braga, fell 5.3% in October, bringing year-to-date losses to 3.1%. AHL, the $16bn jewel in the Man Group crown fared better than its peers thanks partly due to a new trading portfolio, but it also slipped by 2.1% in 2012. Other luminaries that suffered included Renaissance Technologies Futures Fund, which was off 6.1% as of mid-November as well as the Highbridge Quantitative Commodities fund, which was down 10% as of the end of October. Not everyone struggled though. For example, Cantab Capital Partners’ $4.7bn CCP Quantitative Fund emerged unscathed, boasting a 15% rise last year following on from a 13% hike in 2011, according to industry reports. The UK Cambridge-based firm, started by former Goldman Sachs Group partners Ewan Kirk and Erich Schlaikjer as well as Chris Pugh, formerly of KBC, profited in December as stocks jumped on expectations that US policymakers would reach an agreement to postpone the fiscal cliff, the combination of tax and spending cuts slated to take effect 1 January. The other difference is that the firm constructs a portfolio of multiple models across three broadly uncorrelated models – value, medium-term momentum and short-term trading. This blend is in contrast to rivals such as Winton and Man Group’s AHL, which are largely mediumterm trend followers. “The most important thing is to have a diversity of sources of returns and as many strategies as you can that are not correlated,” says Schlaikjer, chief technology officer and one of the founders of Cantab Capital Partners.
“Also, it may be appealing to have a bunch of algos but the only way to protect yourself is to have robust software and to ensure that you model on things that make sense such as carry or trending.” Overall though, the performance of quant funds has been patchy since the financial crisis. This is mainly because the models were built to take bets on which assets would rise or fall in value but the rules changed when Lehman collapsed. Securities moved in the same downward direction and volatility became a prominent feature. In addition unbeknownst to investors, many of the quant managers were using similar computer programmes holding the same stocks which led to a convergence in correlations with other active and passive strategies. The markets also became increasingly difficult to predict as they seemingly whipsawed on every shred of news. For example, early in the October 2007-March 2009 bear market, valuation measures betrayed quants as some of the statistically cheapest stocks based on metrics, such as price/earnings and price/ book ratios, continued to fall in price. Later in the bear market, those using momentum- based models turned to steady earners which were posting relatively strong results in the middle of the recession. There was a brief respite but these funds were left behind when the market bottomed in March 2009 and cyclical companies led a huge rally.
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