Quants rule performance and asset growth, study says

DARIEN, Conn. — Quantitative managers have bested other managers for the past three years in the most efficient of markets — U.S. large-cap equities — and been twice as successful at gathering assets, according to research by Casey, Quirk & Associates, Darien.

In a report titled "The Geeks Shall Inherit the Earth?" the consultant to money managers noted the 70 quant products in its universe have outperformed 688 "other active U.S. large-cap equity products by (an annualized) 103 basis points over the three years through 2004."

That outperformance has continued into 2005, said Daniel Celeghin, the report's author, and a senior associate at Casey Quirk, in a telephone interview.

The study looked at actively managed strategies rather than enhanced index products that offer lower tracking error. Only "pure" quant managers, as opposed to managers who use quant screens or overlays as part of a fundamental stock-picking process, were included in the pool.

The 32 quant managers in Casey, Quirk's universe have posted strong gains across the board, but three have done particularly well in the asset-gathering sweepstakes, Mr. Celeghin noted. San Francisco-based Barclays Global Investors, especially strong in large-cap core equities; Chicago-based LSV Asset Management, which follows a deep-value style; and Palm Beach Gardens, Fla.-based INTECH, which mostly falls in the growth category, commanded 46% of the quantitatively managed active U.S. large-cap equities at the end of 2004.

Between the start of 2003 and June 2005, since absolute outperformance became striking, INTECH's large-cap quant strategy has enjoyed net inflows of $10.2 billion, followed by $7.8 billion for BGI and $7.2 billion for LSV, said Mr. Celeghin.

While the study didn't focus on the reasons for the success of BGI, LSV and INTECH, Mr. Celeghin said first-rate distribution efforts were the likeliest factor. In a telephone interview, Christopher J. LaCroix, LSV's head of sales and client service, said his firm has worked hard to make what could have been a "black box" into a "Plexiglas box," where clients can feel comfortable with the process.

Overall, the median three-year tracking error for the study's managers was 2.7%, compared with 4.5% for 387 non-quant managers. Quant managers had delivered superior risk-adjusted returns even before 2003, but beginning that year they began, as a group, posting better absolute returns as well: The median quant strategy returned an annualized 5.6%, compared with the 4.5% median for "other" portfolios for the three years through 2004.

That performance has been rewarded. The managers in Casey Quirk's quant group saw their combined institutional assets under management surge to $157 billion from $88 billion during the three-year period, for annualized growth of 21%. The 387 non-quant managers in the study saw their assets climb to $925 billion from $720 billion, or a 9% clip.

Still, the research paper's subtitle — "Quantitative Managers' Recent Edge" — suggests an agnostic view about whether the trend will continue.

From such a brief period, it's tough to say whether quant models have evolved in ways that make them more flexible and effective or whether having long winning streaks by both value stocks and small-cap equities have simply played to the strengths of quant managers, said Mr. Celeghin.

Several quant managers said the five-year run by value stocks has certainly helped them. "You would expect that a quant style would play better in a value style, simply because a lot of the things a value manager looks at are readily quantifiable," said Brian R. Bruce, head of equity investments for Boston-based PanAgora Asset Management. PanAgora, which has a value-core orientation, had $514 million in large-cap domestic equities as of Dec. 31.

Growth managers, by contrast, focus more on things such as product pipelines and R&D efforts that are harder to pin numbers on.

Casey, Quirk's research captured that value tilt, noting quant value managers beat other large-cap value managers by an annualized 120 basis points over the three years through 2004. But even quant growth managers beat out their peers by an annualized 70 basis points.

"We definitely benefited from value doing extremely well" but "we're still doing great" even after that style factor is accounted for, said LSV CEO Josef Lakonishok, in a telephone interview. The ability of quants to avoid behavioral pitfalls, such as falling in love with the companies in your portfolio, may be more important, he said.

Another factor helping quants outperform has been the decline in volatility across individual stocks in recent years, which has made it harder for managers who follow concentrated stock-picking strategies to add value, said William E. Ricks, CEO and North American CIO with AXA Rosenberg Investment Management LLC, Orinda, Calif.

The lack of any big "trend reversals" in terms of which asset classes have outperformed in recent years also has probably swelled returns, quant managers said.

Just as important, though, after the roller-coaster market of the past decade, is that "quants have done a great job" at appealing to clients eager to control risk, said Mr. Celeghin.

There might be 100 things that affect a stock, and portfolio managers may only know a dozen of them, said Jim Scott, who retired in august as president of Quantitative Management Associates, a subsidiary of Prudential Investment Management. The ability of quants to neutralize those factor bets they have little information on can give them an edge in most markets, he said.

While insisting on their strengths, quant managers remain extremely modest about their prospects over any given period: "Three years means nothing," said the head of sales with one leading quant manager who declined to be identified: "I'm not convinced that (quant) is a better mousetrap."

"Just because you've been winning lately, doesn't mean you've become brilliant," agreed Ben Inker, chief investment officer at Boston-based Grantham, Mayo, Van Otterloo & Co. LLC. GMO's assets under management have more than quadrupled in the past five years to more than $90 billion, after tumbling to $20 billion from $30 billion during the stock market bubble of the late 1990s.

"If underlying fundamentals are going our way but the market is going against us," there could well be another stretch where "the market hands our head to us," said Mr. Inker.