Quants seeking formula for rebound

Quantitative money managers are retooling their formulas and product lineups as they attempt to reverse the drought that began almost three years ago, when spiking market volatility turned the quant feast to famine overnight.

A turnaround can't come soon enough for some quant managers, who have seen continued outflows short-circuit the benefits rebounding equity markets have provided the broader money management industry in the past year.

During the latest quarter, quant firms of all sizes reported continued outflows — from giant BlackRock Inc., which reported $8.8 billion in quant-related outflows, to midsize INTECH Investment Management LLC, which lost $4.3 billion, and boutique Clarivest Asset Management LLC, down $503 million.

Quant firms suffered $100 billion in net outflows from 2007 through 2009. During the boom years between 2002 and 2006, net inflows reached $200 billion, according to data from Casey Quirk & Associates, Darien, Conn.

On the positive side, a number of quant firms in recent months have reported that the return of more stable market conditions this year is allowing their computer-driven investment models to outperform their benchmarks again.

For example, executives at INTECH parent, Janus Capital Group, on a conference call to report March 31 results, noted that while none of INTECH's strategies had outperformed on a 12-month basis, near-term results were improving. They said that more than 75% of the strategies had outperformed their respective benchmarks over the last six months.

But investor skepticism remains.

Yariv Itah, a partner at Casey Quirk, said the performance of quants during the recent financial crisis has tested their investment models. First quant managers suffered dramatic losses in the August 2007 meltdown. Too many firms seemed to be holding the same stocks, setting off a vicious cycle as redemptions mounted — putting their models under a cloud of suspicion.

He said plan executives are worried that these models could result in dramatic losses again.

“There is a perceived risk, probably exaggerated, that you are only one day away from disaster,” he said.

He predicted that flows for quant firms will remain “broadly negative,” which could result in a number of firms going out of business in the short to midterm.

Mr. Itah said successful quant shops will be those convincing investors that their models are different from competitors' and more apt to withstand market turmoil.

Jim Neill, a consultant with Wilshire Associates, Santa Monica, said some quant managers — including BlackRock — are introducing more dynamic models that take into account global macro factors.

“Some of the old models missed the inflection point in '09. As the market improved through 2009, the models didn't adapt to the shift,” he said.

BlackRock officials were not immediately available for comment, but in a May 12 letter to clients and consultants, Blake Grossman, vice chairman and head of scientific investments for the firm, confirmed the changes.

In his letter, obtained by Pensions & Investments, Mr. Grossman said officials were making a number of enhancements to the investment process, “including a shift in the company's approach from relatively static tilts toward more dynamic portfolio positioning suited to the specific market content.”

John Cuthbertson, director of research with Ten Asset Management, a quant manager in Encinitas, Calif., said his firm is fighting back by adding new factors to its model — including a corporate governance metric that looks at good government practices and tracks picks of activist funds — to help pick winning stocks.

Assets dropped to $436 million as of Dec. 31, from $950 million at the end of 2007. Mr. Cuthbertson said Ten Asset recently won a $10 million commitment from an institutional investor and he is hopeful of obtaining other mandates. He said he knows the firm has to show results, especially with market conditions becoming more favorable again for quantitative firms.

“The spotlight is on us,” he said.

Like Ten Asset Management, San Diego-based Freeman Investment Management LLC had been struggling to rebuild assets with new clients. It didn't work. An informed source said the firm recently sent a letter to clients saying it was shutting down.

Neither John Freeman, CEO and chief investment officer, nor Peter J. Johnson, director of client service and marketing, returned phone calls and e-mails asking for comment. Freeman had $397 million in assets as of March 31, down from $4.3 billion at the end of 2006, according to eVestment Alliance data.

Stacey Nutt, CEO and CIO of San Diego-based Clarivest, said his firm has added new factors to its models, after a stretch of weak performance in some of its strategies saw assets under management drop to less than $1.8 billion as of March 31, from more than $4 billion shortly after its March 2006 launch.

“I believe we probably had overconfidence in the robustness of the process we built,” he said of his firm's quant model. “The entire vessel of the process we built was robust to any environment we had seen historically or .... in the past 20 years. But it was not robust, which we found out, to an environment that was threatening to be the next Great Depression.”

While Clarivest showed net outflows of $1.8 billion over the past 15 months, Mr. Nutt said he sees signs that investor sentiment is turning, with two new commitments totaling $500 million or more in the works. The attraction, he said, is evolving quantitative models at Clarivest that focus more on longer-term earnings power. Mr. Nutt said Clarivest software now also analyzes news articles for positive mentions of companies or their products.

Some boutiques hit by the general quant backlash of recent years are reporting signs that newer strategies, tailored to the post-crisis needs of institutional investors, have begun to revive their growth prospects.

Martingale Asset Management's assets under management tumbled to $2.3 billion as of March 31 from $5.3 billion at the end of 2007. Now, Martingale executives are gearing up to pursue a “big opportunity in the area of low-volatility strategies,” portfolios of low-beta stocks offering greater protection when the market is falling than they sacrifice in gains when the market is rising, said William Jacques, CIO of the Boston firm.

For the current quarter, Martingale is poised to garner several hundred millions in low-volatility mandates, which will lift assets in those strategies from less than $10 million as of March 31 to well over 10% of the firm's assets under management by June 30, Mr. Jacques said. He declined to name the clients or the total amount of the mandates.

Also, Martingale recently announced an advisory board that Mr. Jacques calls “all-star intellectuals” — academics he says have studied the “risk anomaly” that underlies the firm's newest strategies. Board members are Luis M. Viceira a finance professor at Harvard Business School; Robin M. Greenwood, an associate professor of business administration at the Harvard Business School; and Andrew Ang, professor of finance and economics at the Columbia Business School.

Clarivest's Mr. Nutt said the managers who survive ultimately will be willing to adopt varied techniques, whatever it takes to make the best investment decisions.

“Now, the kind of manager that will succeed, quant or traditional, is the manager that uses every tool at his disposal to help perform,“ he said.

Those tools include “talking to CEOs, using a quantitative model, or using a risk model, or finding an iPad and checking it out. Whatever tools he can use ..., that's the manager that will survive. Not the guy who defines himself as a quant or a traditional. ... That guy won't survive because he's already made a box for himself and he's already going to have trouble.”