Political wrangling
Conditions seemed to stabilise at the beginning of last year with stocks rising although at a slower rate than in 2009’s rally. However, quant funds’ efforts were hampered by the political wrangling over the US fiscal cliff, the ongoing European sovereign debt crisis and the continual pumping of liquidity into the system by central banks. “The problem is that moves such as the European Central Bank’s long-term financing operation and the speech last July by the European Central Bank president, Mario Draghi saying he would do whatever it takes to save the euro could not have been predicted and factored into models,” says Philippe Balthazard, a senior fund manager with Lyxor Asset Management. “The announcements countered the natural behaviour of free markets and reflected policymakers’ intervention.” The “RoRo” – risk on and risk off – trades proved particularly tricky to navigate. For example, many of the funds, known as managed futures or commodity trading advisors (CTAs), came into October 2012 with “risk on” trades, such as long positions on equities and commodities, and a short position on the US dollar. However, these trends reversed and went against them in multiple markets.
“These risk on, risk off quantitative strategies were more susceptible last year,” says Frances Hudson, global thematic strategist at Standard Life Investments. “However, I think the performance was also affected by the overcrowding effect. The bulk of the new start-ups have been in the algo space and it all comes down in effect to the same skill set. The result is that they have more in common with each other and the outcomes are not as diversified as in the past.” Penny Aitken, partner and head of research at FQS Capital, believes that investors will be rewarded in the long term. “Every strategy has its ups and downs. Cyclicality is partly driven by investors’ behaviour as well as market conditions. They have to understand that this is a long-term game and focusing on short-term results or looking arbitrarily at timelines can be dangerous.” Balthazard adds: “Clients have to realise that these strategies will not always lead to profit in every quarter. Take the example of Warren Buffett who is a value investor. He had periods of being under pressure particularly during the dot-com bubble but he stuck with his strategies because they were based on a prescribed method. It is the same with quant investing. They have come under pressure but long term will deliver superior returns.”
Easy come, easy go
Trends also come and go. As Andrew Rubio, chief executive of Throgmorton, a mid- and back-office service provider to hedge funds, notes: “Algo or quant funds seem to be the flavour of the month. Institutional investors like the idea of a strategy driven by a model with little human intervention. Since the market gyrations of 2007 and 2008 managers have much more information available and they can draw on extreme scenarios to build a picture. The big question of course is how reliable are these models?” Adjustments have been made so that the models can better respond to volatile and abnormal markets. Many now take into account investors’ reaction to the investmentrelated data and other trading information that can then be used to predict the types of assets they should buy or sell next. The data or characteristics that are currently being analysed range from share market volatility to aggregate measures of share valuation, the price gap between high priced and low priced stocks, short-term interest rates and credit spreads. However, despite the tweaks, investors’ forbearance may wear thin if 2013 is a repeat performance of 2012. Investors could pull the plug and look for greener pastures. There may also be fewer funds to choose from due to the increasing set up costs. “There is a lead/lag time from the genesis of an idea to actual launch,” says Aitken. “It is also becoming harder and taking longer because the barriers of entry are higher due to the new regulatory and compliance requirements.”
Comments