Quantitative (quant) or systematic investing refers to the process of constructing an optimal portfolio based on multiple signals or factors using data and computer systems. The diagram below shows the typical process that quant firms go through to create a portfolio.
Quant investing has become an increasingly popular route to accessing equity markets; according to eVestment, there has been a 174% increase in quant strategies over the past 10 years. This compares to a 103% increase in fundamental strategies over the same period. Our team have spent a lot of time researching such strategies on behalf of our clients. We outlined our approach to researching quant strategies in this blog.
But with increased popularity comes increased competition, and so quant managers must hone in on their strengths to set themselves apart from the rest. To somewhat oversimplify the world, we see quant managers falling into two key strength camps:
The first is the behemoths
These managers aim to use their size to out-research and out-analyse their competition. The more unique data streams they have, the better – as this results in differentiated trade ideas.
But to achieve this they need big teams, and paying for these teams requires a large chunk of capital funded by a large pool of assets. However good the research, having a large pool of assets can be a drawback, since it reduces liquidity, making portfolio turnover increasingly difficult. This makes the relatively more effective, shorter-term signals redundant and limits investment to the bigger, more efficient end of the market.
This further fuels the need for strong differentiation and alpha in their factor research.
The second camp belongs to the agile
Here, the aim is to be nimble, focusing on the less efficient areas of the market. These strategies will typically have a much higher turnover.
But with fewer assets comes smaller teams and fewer resources. While their factors may be less cutting-edge as a result (unless people are willing to pay high fees for the research), we still expect to see strong alpha here in the form of access to niche, inefficient market segments and the use of higher turnover, shorter-term signals – such as momentum.
So, which camp is best?
Although there’s no right way of going about quant investing, we want to avoid going too far in either direction. For the behemoths, their sheer size means that no matter how much resource is ploughed into differentiated research, they won’t be able to overcome the inevitable alpha headwind that is too many assets. And for the agile strategies, it’s not enough to simply focus on inefficient markets and access to high-turnover signals – there needs to be sufficient resources invested into differentiated research too.
Through our research, we believe we’ve managed to identify a select few quant managers that fall between these two camps, offering clients the right balance of agility and factor differentiation. To find out more or to discuss a potential manager selection exercise, please get in touch: tom.baird@redington.co.uk
Unless indicated, these are the views of the author and may differ from those of the firm.
