Fundamental value investors always have difficulty grasping quantitative techniques. Perhaps most perplexing is when a fundamental analyst asks a quant such as Cliff Asness what he thinks about the market and he say’s he doesn’t know. You see quants don’t have opinions on the market that drive their decisions, which is the key difference between the fundamental types – and a point of confusion.
Enemy is being prisoner of past
“As a quantitative manager, our enemy—and probably the enemy of many qualitative managers as well – is being a prisoner of the past and finding odd relationships that have worked in the past because your computers and databases are big,” Cliff Asness said in a recent CFA Institute Magazine piece. Quantitative managers such as Cliff Asness make decisions based on mathematical formulas that detect market environment. In a momentum strategy these funds buy or sell when then detect market price trends that have the potential to continue in one direction.
While fund managers such as Cliff Asness, founder of AQR Capital Management, with over $100 billion under management, might not have a daily opinion on market fundamentals, that doesn’t mean their quantitative investment methods aren’t rooted in economic logic. “We’re pretty hard-nosed about requiring an economic story as to why something works,” he said in the interview. “I cannot think of anything we trade where we say, ‘We have no idea why this works. It’s just phenomenal.’”
Cliff Asness: Momentum success is rooted in behavioral issues
One of the primary quantitative trading strategies is a momentum strategy known as trend following. On a fundamental basis, the strategy has its root in economic supply and demand, which create market price trends in one direction or another. The more significant the economic supply and demand issue, typically the more significant the market price trend. Market price trends have different lifecycles and market participants get in at various stages adding to the trends strength. A robust trend typically expires when the final stages of demand are met, and the supply / demand equilibrium in a market switches. This is the basis for the most popular strategy, which has spawned a variety of sub-strategies and trading methods. Other strategies include relative value and volatility strategies that are correlated to different market environments.
Why do momentum strategies work? “It’s very hard to come up with a non-behavioral story for momentum,” he said. “That may be why the growth in these strategies has been slower, though we view this as an opportunity.”
Cliff Asness bullish on academia
AQR has a deep research department but also maintains extensive ties to academia. When asked if he can have too much academia in his approach, “If anything, I’d like more rather than less,” he responded. “I like ideas that get people thinking really hard, even if they’re early in the food chain and closer to pure research. Some of this but we’re long-term greedy. I don’t think we’re close to the point where we have too many people doing pure academic work. I do acknowledge that you could go too far, but I don’t think we’re close.”
Too big to fail
When he considers the government providing a failure guarantee to certain firms, he is pragmatic. “If you’ve actually ever let someone fail, you have a lot more credibility, and markets don’t gain by challenging you in that way,” he said. “It’s not a perfect prescription. I make no claim this is easy. There will be countless events—from monetary policy for government to demonstrate that it will, in fact, permit failure and painful times to occur.”
The full monthly issue of CFA magazine can be found here.
