In pursuit of a good mix
Just over 88% of this month’s respondents said they invested with managers who use quantitative tools - although we should acknowledge some self-selection bias. Of these, 29% have a specialist quant manager section in their portfolio (and a further 12% only have them in their hedge funds) while 35% have quants working across their entire portfolio.
Respondents are most comfortable with a mix of quantitative and qualitative skills: 25% said they would never invest with a manager that could not use discretion to override models, or had fully-automated trade execution; but 24% also said they would never invest with a manager that used no quant tools at all. Overall, however, the suggestion is that there were no strong opinions: for every category on the spectrum between 100% quant and 100% discretionary, more chose simply to note whether they did or did not invest than chose to state that they would never do so.
While the attitude of several respondents to quants had not changed in recent years, others had become more cautious with experience. “The limitations have become clearer with greater understanding. We are wary about things driven purely by computers or purely by humans - risk assessment is needed for the particular investment manager,” stated a UK fund. An Italian fund added: “We are less confident in a model that relies totally on quantitative analysis, with no room for manager point of view - discretion”; one other respondent was also “less favourable than before”; and another singled out core enhanced-index type managers (as opposed to quant alpha managers) for particular scepticism.
This distrust of ultra-pure practitioners comes through in respondents’ ideas about the single biggest risk associated with quant. Top of the list (29.4%) was the fear that data mining strategies would always be backward-looking and ill-prepared for the future, and equal-second (17.7% each) were the related concerns that they lack a crucial common sense element and can never describe the real world.
Respondents were equally split as to whether, for the purposes of manager selection and due diligence, quants have corporate governance issues that are significantly different from those faced by traditional managers. One UK local authority pensions manager said: “Quant managers are even more disinterested in good governance than others.” This arguably fits with the findings of the article in our special report, ‘Quant surveyors’ (page 58) which warns that the very fact that risk management protocols can be programmed into models (rather than applied as constraints) might lead to complacency. Another respondent warns of the key-man risk associated with the technicians who design models.
Still, one German respondent noted that the fact that quant processes are objective, predictable and repeatable makes due diligence “much easier”. A UK fund observed that quants should be well-set to “spell out” its processes and restrictions operate, with “no room for debate”: “With a discretionary manager, you need to check the whole thing - their processes, buy and sell disciplines, screening, plus the management of the human element.” Others drew a distinction between portfolio risk management (easier with quants) and due diligence (more difficult).
A Swiss fund commented: “With increased specialisation you will probably no longer be able to conduct all the necessary due diligence and risk management in-house. Hence you will have to outsource these tasks and rely more on a third party for important investment decisions.”
Respondents were much more obviously hostile towards high frequency trading. Over 35% of respondents felt the May 2010 flash crash demonstrated that it presents systemic risk to the financial markets, 17.7% said they would never invest in the strategy and 11.8% said that some strategies should be banned. On the other hand, 11.8% believed high-frequency traders provide valuable liquidity for the wider market, and the one respondent that characterised high frequency alpha as “theft from longer-term investors” took this as a reason to invest with them - and not get left out.