Quants throw tradition out the window

Quantitative equity firms this year are seeing their strongest inflows since the global financial crisis, and some managers predict their growing use of “big data” — or non-traditional data sources — could leave them better positioned than before to put hefty client allocations to work.

Exploiting a growing trove of newly available data — from Chinese investor blog posts on mainland stocks to Google searches for big-ticket items — has helped BlackRock Inc.'s quantitative equity strategies achieve “good results” over the past five years, with investments that are different from “a lot of other competitors,” said Jeff Shen, San Francisco-based managing director and co-head of investments for the firm's $80 billion scientific active equity business.

While declining to provide specific numbers for outperformance, Mr. Shen noted that more than 80% of the firm's SAE portfolios were outperforming their benchmarks on a three- and five-year basis.

With the continued availability of big data, and its promise of offering up different ways to harvest signals for investment, a real case can be made “for a revival of quant,” said Kevin Anderson, a Hong Kong-based senior managing director and head of investments, Asia-Pacific, with State Street Global Advisors.

The pursuit of “differentiated” portfolios is a case of “once bitten, twice shy,” Mr. Shen said.

Institutional investors' previous, passionate embrace of quant firms — between 2004 and 2007 — ended badly when a number of those firms' computer-driven models left clients with leveraged exposures to the same market segments.

When global equity markets unraveled starting in late 2007, the hangover for quant firms — in terms of client flows — persisted long after the damage to performance, which was mostly confined to 2008 and 2009. Flows for quant firms only turned broadly positive in 2014.

BlackRock's scientific active equities business — perhaps the quant industry's hardest hit, with $124 billion in net outflows between 2009 and 2014 — finally saw positive net inflows last year, of $1.7 billion, according to the firm's latest annual report.

A Hong Kong-based BlackRock spokesman reported first-quarter net inflows of $1.2 billion, suggesting a further pickup in momentum.

Other firms that turned positive in 2014, after years of outflows, included Chicago-based LSV Asset Management, with inflows of $1.7 billion that year improving to $3.1 billion in 2015, and Philadelphia-based AJO LP, which saw inflows rise from $668 million to $1.1 billion.

Firms with longer stretches of gains include Boston-based Man Numeric Investors LLC, with $8.9 billion in net inflows split roughly evenly over the three years through 2015.

The firm had record AUM of $19.6 billion as of March 31.

Market veterans say relatively strong performance — as well as growing asset owner interest in strategies built around factors, such as minimum volatility or momentum — have powered the pickup in flows.

“Traditional managers and hedge fund managers have had disappointing returns while quant managers have performed well,” noted William Jacques, president and CEO of Boston-based quant boutique Martingale Asset Management LP.

Martingale, with record assets under management of $5 billion as of March 31, saw net inflows of $548 million in 2015 — its fourth positive year in a row — and an additional $254 million in inflows for the first quarter of 2016.

“The last few years have been strong for quant firms — partly because of good performance,” but also because plan sponsors' increased desire to control portfolio risk has sparked interest in risk-managed products such as low-volatility strategies, said Harindra De Silva, president of Los Angeles-based Analytic Investors LLC.

Analytic had record AUM of $15.6 billion as of March 31, with net inflows of $717 million for 2015 and $1.3 billion for 2014.

The recent performance of some managed volatility strategies shows why some asset owners might be taking notice.

For example, according to eVestment LLC data, Boston-based Acadian Asset Management LLC's $9.2 billion global managed volatility equity strategy beat its MSCI World index benchmark by 12.63 percentage points for the 12 months through March 31, while Analytic's $3.8 billion global low-volatility equity strategy exceeded its benchmark by 9.01 points and Martingale's U.S. low-volatility large-cap equity strategy added 8.2 points for the same period.

Recent flows, while improving, remain well off the feverish pace of 2004 through 2007, when, for example, boutiques such as Acadian and LSV garnered combined net inflows of $30 billion and $25.1 billion, respectively.

Still, quant veterans say crowded trades are an issue for a broader range of asset managers now, including hedge funds, and a lingering — if not immediate — concern for quants as well.

“It's definitely something we pay attention to all the time,” but at this point the pickup in flows hasn't amounted to a “wall of money,” and there aren't significant concerns about concentrations in specific strategies, said Wesley S. Chan, senior vice president and director, stock selection research, with Acadian Asset.

The “quant crisis” of 2007 was caused by a combination of crowding and leverage, said Michael Even, CEO of Man Numeric Investors. Compared with that period, leverage doesn't seem to be a big issue at present, he added.

Even if it's hard to tell, it's logical to think there's more crowding now than there's been since 2008, and other signs, including a significant hiring boom by quant firms, makes it a matter of concern, he said.

Others believe the pain of quants' last run-in with crowded trades will provide some degree of immunization this time around.

“The point to be taken from that earlier period is that crowds form, leverage makes the crowd larger, and unwinds are ugly,” said Stacey R. Nutt, CEO, chief investment officer and lead portfolio manager of San Diego-based Clarivest Asset Management LLC.

“Anything beyond that with a specific focus on quants is simply speculative,” he said, adding that as the group most hurt by the last unwind, quants are the ones most likely to have learned something from the experience.

Clarivest had AUM of $4.4 billion as of March 31.

For Mr. Shen, BlackRock's growing use of big data counts as one of the lessons his firm learned about avoiding crowded positions.

“If you can innovate, if you can come up with new research insights or new beta sources, or new ways of looking at the market,” Mr. Shen said, portfolios can be less exposed to crowded trades.

In contrast to the fundamental economic data quants have focused on for decades, about which it's “difficult to ask different and interesting questions,” data such as satellite images at five-minute intervals of trucks going through major Chinese industrial areas can elicit 15 questions, Mr. Shen said.

Even so, a number of executives warned that extracting investment-worthy needles from that data haystack could prove very challenging.

“The seduction of data mining” — the conviction that if a firm can get its top minds to wade into this sea of data they'll inevitably come up with compelling insights — is intense, noted Churchill Franklin, the CEO of Acadian.

Acadian works with non-traditional data sources, but “we work hard to stay with the core of our investment thesis,” he said.

As of March 31, Acadian had AUM of $68.8 billion.