Wall Street’s quant wizards often argue that many of their math-driven strategies are designed for the long-term. But they’ve rarely had to shout this loud.
Global equities posted the worst run in six years in “Red October,” and it tore through the investing styles that slice and dice assets based on traits like momentum and growth. Most factor funds, as they are known, fell in concert with stocks. That not only capped an already miserable year, it threw into doubt their diversification benefits -- forcing advocates onto the defensive.
Cue Cliff Asness, godfather of quant investing and co-founder of the firm which helped popularize factors, AQR Capital Management. In a 23-page, 17,000-word blog post in October he acknowledged the strategies AQR favors have had “tough times,” predicted no miracle bounce back, but argued the evidence and common sense dictate they will ultimately prevail.
“I admit I’m nervous. Not about the efficacy of our strategies,” Asness wrote. “But I admit I’m nervous about how our clients will react (this is correlated with my writing this fairly giant essay). Will they truly stick with what we’ve started together for the long term?”
The lengthy apologia and Asness’ concerns speak to how the recent performance of factor strategies is becoming a huge test of the quantitative-investing boom. Evidence is growing that assets are under pressure, and critics claim that unwinding from funds under duress helped lash equity markets last month, compounding the declines.
Factor funds haven’t been “diversifying to the market when you’ve needed it this month,” Maneesh Shanbhag, who co-founded Greenline Partners LLC after five years at Bridgewater Associates LP, said. “They get correlated repeatedly over time, and marketing pitches of these funds have largely ignored that.”
Value Hit
For AQR, which oversees $226 billion, the challenge has been particularly acute.
The firm’s equity market neutral mutual fund declined 4.7 percent in the three months through Tuesday, versus an average drop of 1.4 percent for all equity market neutral hedge funds, according to Hedge Fund Research. While that was only a little worse than the S&P 500’s 3.6 percent slide in the period, it took AQR’s full-year losses to 13 percent compared with a 5.3 percent gain for the main U.S. stock gauge.
Market neutral funds aim to eliminate broader market risks through hedging. It’s a key part of the AQR proposition, which is to offer liquid strategies that have low correlations to traditional assets. Asness and his colleagues argue recent moves haven’t negated their funds’ diversification benefits -- they’re uncorrelated over the long haul, not hedges for day-to-day losses.