Quants With Moderate AUM Have The Edge: Towers Watson

Quantitative equity managers, or quants, have fallen out of favor in recent years, losing popularity almost as quickly as they gained in the aftermath of the dot com bubble. But the current backlash against quants among many investors seems as unwarranted as the confidence investors had in them a decade ago.

“The history of financial markets is replete with humbled investors and the extraordinary success enjoyed by quantitative strategies proved to be short-lived,” says a recent report from risk management and consulting firm Towers Watson, but that doesn’t mean quant strategies are worthless. “We do not subscribe to the belief that traditional quantitative factors have been permanently arbitraged away.”

Quants: AUM rose too quickly

The problem is that quant strategies saw a huge influx in both assets and competition. Since quants use historical data to find opportunities, and quant insights tend to disseminate quickly through the community, the trades became over-crowded and the traders were often unaware of changing macro factors (something plenty of traders are guilty of, to be fair).

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In addition, many quant strategies are based on the idea that value and momentum are opposing investment styles, and that when one of them is underperforming the other should outperform, smoothing out returns. While this may be broadly true, both momentum and value have underperformed until recently, creating an even more challenging investing landscape. The result has been falling returns and asset outflows.

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Attributes of a good quant

“We believe there are a few quantitative managers that are ahead of their competitors and can demonstrate credible differentiation in their approach,” says the Towers Watson report.

They recommend looking for quants who take a pragmatic approach to investment decisions, using their models to create a disciplined approach but remaining aware of macro trends and the idiosyncratic factors that could throw off their models. Fee structure is always an important consideration, and Towers Watson has noticed a tendency for quants to charge ambitiously high fees, creating a serious drag on investors’ actual returns. They also recommend avoiding quants with very large AUM, but believe that there are still quant funds worth investing with.

“Everything else being equal, a modest level of assets under management is an advantage. Our view remains that it is easier to deliver alpha with total assets of US$1 billion than it is with, say, US$20 billion.”

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