Quantitative equity strategies have struggled over the past two years. Most have underperformed their more traditional peers in both the market downturn and the subsequent rally that began in March 2009. Some in the investment industry have gone so far as to declare that quants have failed and are now discredited because they were largely powerless to predict the market crisis that erupted late in 2007.
Quants have been labeled as lumbering robots weighed down by backward-looking insights. Furthermore, say the critics, quants have become prone to crowding or following the herd, using similar forecasts and risk models to buy or avoid the same stocks.
Much of this criticism is misguided, even though it is true that quantitative approaches can become overreliant on historical relationships, ignoring the reality that history rarely, if ever, repeats itself. This is why successful quants incorporate a measure of investment judgment or wisdom in their methodology rather than choosing to depend on statistical analysis alone. Quants advocate using judgment in building analytic frameworks, but not emotion in execution. This difference is what distinguishes them from traditional fundamental investors.
And yes, the crowding phenomenon has played a role in the poor performance seized on by the critics. More than a few quant managers have spent too much time looking at asset markets instead of attempting to analyze what their competitors are doing. In other words, they have focused too closely on historical data, ignoring other aspects such as flows in and out of quantitative strategies. Better to look more closely at the actions of competitors. For example, if a manager is losing a substantial number of clients, the stocks it owns will do poorly.