Roaring inflation and rapid rate hikes have brought a welcome return of the kind of big swings and dislocations beloved by investing’s smart set, but it hasn’t been a blessing for every breed of quant.
Factor strategies, designed to wring steady money from credit and stock markets by going long and short securities based on traits like how cheap they look or how fast they’ve risen, misfired en masse in 2023.
As assets were lashed by inflation and the craze for artificial intelligence, 10 of 12 long-short factors tracked by Bloomberg lost money in equities. Goldman Sachs Group Inc. data show the four main market-neutral strategies in credit all delivered lower returns than cash.
That failure to exceed even risk-free rates is a particular blow to Wall Street’s portfolio wizards, many of whom consider the return on cash a benchmark. The Federal Reserve’s aggressive monetary tightening has ramped up that hurdle, pushing the shortest-dated yields above 5%, up from essentially nothing over the past decade.
“All of a sudden, cash reestablished itself as a competing alternative, certainly to bonds, but also to risk assets,” Lotfi Karoui, Goldman’s chief credit strategist, said in an interview. “It basically set the bar a little too high for systematic strategies to outperform.”
Of course, the challenge is not unique to quants. As much as they like to tout the opportunities thrown up by the return of positive rates, hedge funds of all stripes now have a tougher yardstick to justify their fees and sometimes restrictive terms. While the cash rate has slipped in recent months as inflation cooled, it still hovers near a 22-year high reached in October. Against that backdrop there are incipient signs that investors now expect higher returns and thresholds for performance fees.
Institutions like pensions usually invest in hedge funds with a target return of 3 percentage points on top of the Treasury bill or Libor rate, according to Jon Caplis, chief executive officer of hedge-fund research firm PivotalPath. That now translates to about 8% annually.
The 10 largest cross-asset risk premia hedge funds tracked by Societe Generale SA rose 6% in 2023. Equity hedge funds overall gained 7% in a PivotalPath index.
“You’re not seeing investors want to pull out,” said Caplis. “But you are seeing a number of them starting to ask questions: ‘What am I doing if I’m not generating above cash?’”
For factor investors, the struggle was compounded by the dominance of technology megacaps in last year’s AI-driven frenzy. The Bloomberg GSAM US Equity Multi Factor Index dropped 4.5% for the worst performance since data began in 2007.