Quants ease into fundamental firms

Managers use experts to decipher macro trends to get investing edge

Sonia De Zordo
Sonia De Zordo said convergence of the quant and fundamental disciplines was not smooth.

Rather than grasping for straws in the face of lackluster market conditions, fundamental equity and multistrategy hedge fund managers are grabbing quantitative specialists to help them interpret macro trends and hopefully improve returns.

Hedge fund managers as large as Tudor Investment Corp., with $11 billion under management, have brought in teams of experts to help portfolio managers better understand complex market data and to improve real-time trading.

Megamanager BlackRock (BLK) Inc. (BLK), with $4.89 trillion under management, decided in January to combine its $200 million active fundamental equity strategy business, including hedge funds and hedge funds of funds, with its $80 billion scientific — quantitative — active equity unit, according to a memo to employees.

“In a market environment characterized by more volatility, lower beta and increased dispersion, clients are increasingly looking for active equity solutions irrespective of whether they are fundamental or quantitative strategies,” the memo said.

Hedge fund-of-funds specialist Blackstone Alternative Asset Management also has been looking for ways that quantitative approaches might help its investment processes.

The result so far has been the automation of elements that “computers can do more efficiently than humans,” said Gideon Berger, senior managing director and head of risk management at BAAM, which manages $68.6 billion in hedge funds of funds and customized portfolios.

Skeptical of motivations

Hedge fund managers that have been using quantitative strategies all along are skeptical about the motivations of their fundamental brethren in trying to incorporate more systematic analytics into their strategies.

“I think fundamental managers trying to incorporate quant into their approaches is an obvious reaction to their own recent performance issues,” said Michael W. Vranos, founder and CEO of Ellington Management Group LLC, in an interview in his office in Old Greenwich, Conn.

Ellington manages $5.8 billion in diversified credit, relative value, residential mortgage-backed securities, long-only approaches, and quantitative macro and equity strategies.

Another seasoned executive at a pure quant shop, who asked not to be identified, stressed that fundamental firms using quant applications likely will only glean more efficient trading and administrative processes.

“Quantitative investment requires consistent application of analysis, models and never-ending innovation. You can't apply quant measures on a part-time basis,” the source said.

Fundamental equity managers have experienced disappointing returns in aggregate for the first half of 2016, with the HFRI Equity Hedge (Total) index down 0.5% vs. the HFRI Fund Weighted Composite index, which was up 1.2%. The return of the more quantitatively driven HFRI Macro (Total) index was up 2.9% for the period, while pure quantitative approaches in the HFRI Macro: Systematic Diversified index rose 3.99%.

The HFRI indexes are maintained by Hedge Fund Research Inc., Chicago.

Not a smooth ride

Convergence of the quantitative and fundamental worlds has not been particularly smooth, said Sonia De Zordo, managing director of quantitative research at hedge funds-of-funds manager Mesirow Advanced Strategies Inc., Chicago. Quants have worked at building more statistically optimized fundamental portfolios since the 2008 financial crash, when “it wasn't cool to be a quant scientist anymore. Fundamental managers who never cared about risk factors are now trying to add them,” she said.

Whether the marriage of quants and fundamentals results in a hybrid “quantimental” strategy “really depends on where you come from and what your investment DNA is,” Ms. De Zordo added.

Her colleague, Daniel Freel, who is vice president and head of MAS' hedged equity team, said fundamental equity managers have been much more active during the past 18 months in pursuing more systematic investment inputs, but still don't know quite what to do with risk factors such as momentum, value, volatility and size. “Most fundamental managers know the traditional risk factors. It's only a very small universe of bottom-up managers that actually use them to manage their portfolios,” Mr. Freel said. “It continues to frustrate fundamental managers when they adjust their portfolios in response to risk factor signals and don't do well because then they have to explain to investors why they changed their strategy.”

“You really need to do a little of everything,” Ms. De Zordo said. “With markets less rewarding and more efficient, you need all the tools you can get to find alpha

MAS manages $12 billion in hedge funds of funds and customized strategies for institutional investors.

Market data suggest the number of fundamental/quantitative hybrid managers is on the rise, said Lin William Cong, assistant professor of finance at the University of Chicago's Booth School of Business, who takes credit for coining the term “quantimental.”

Mr. Cong said in an e-mail that his research shows the average number of stock holdings has risen in recent years “in testimony to the increasing use of quantitative tools to allow managers to look at larger samples and construct larger portfolios (in terms of the number of companies).”

“I think the quantimental and large-sample approach is going to grow further, especially in places that have been traditionally very fundamentally driven,” Mr. Cong added. n

Bloomberg contributed to this story.

This article originally appeared in the August 8, 2016 print issue as, "Quants ease into fundamental firms".