‘Hold Your Nose’

Peter Sleep is standing pat with AQR, even while some of his colleagues at Seven Investment Management LLP in London have sold out. The senior portfolio manager owns trend-following and style premia funds from the quantitative manager.

“AQR gathered a lot of assets with people putting money on trends, and trends haven’t worked out,” Sleep said. “But you have to do your homework, hold your nose, and place bets in the long term that you’ll get an equity risk premia.”

And for some, exiting is just a temporary tactic, and says nothing about confidence in the quantitative giants. At the start of the year, Sierra Investment Management held one of the largest position in the AQR Equity Market Neutral mutual fund, worth about $22 million, according to filings. Because Sierra jumps in and out of factors based whether they’re predicted to outperform, it sold out mid-year as the mutual fund moved into a “confirmed downtrend,” according to Terri Spath, chief investment officer at the California money manager.

“Factor tilts aren’t reliable over a shorter time frame,” Spath said. “We use our own rules to decide when to play in the sandbox with the quants and the rules that dictate their play.”

And the funds are hardly alone in suffering through October. ETFs also struggled, with the Goldman Sachs ActiveBeta U.S. Large Cap Equity and iShare MSCI U.S. Multi-factor ETFs each dropping more than 7 percent, both funds’ worst month since launching in 2015. Pure momentum and pure value funds from Alpha Architect fell more than 16 percent and 7.5 percent, respectively, compared with an S&P 500 decline of 6.9 percent.

Diversification Fail

Meanwhile, it’s difficult to say whether selling from factor funds had a big impact on wider markets, but something certainly is amiss.

Drivers like the dollar and yield curve have lost their explanatory potency -- equity returns are now best explained by factor exposures, Evercore ISI’s risk models show. Macro risks only accounted for 26 percent of the S&P 500 Index’s returns at October’s end, falling from 41 percent over the span of three weeks, according to the firm.

“It is not the macro backdrop driving factor volatility, but likely something more specific to quant positioning,” said Dennis DeBusschere, Evercore’s head of portfolio strategy.