Smart Beta’s Big Challenge

Factor investing has been ‘crappy’ and quant investors are feeling the pinch.

Cliff Asness is a well-known quant manager and co-founder of AQR Capital. He’s well-positioned to offer an honest assessment of what it’s been like to be a quant investor in recent months. And in his words, it’s been “crappy.”

Performance of long/short, multifactor portfolios—the very same strategies Asness is known for—have been dogged by persistent weakness in the value factor, the core of many quant portfolios. According to Bloomberg, AQR funds have seen outflows of more than $1 billion so far in 2019, following more than $8 billion in outflows last year. The firm manages over $200 billion in assets.

Speaking to a room full of investors, advisors and asset managers at the Morningstar Investment conference in Chicago today, Asness said quant investors aren’t faced with a “confidence crisis” per se, but they certainly need to tackle what he calls a problem of intuition.

‘Intuition Problem’

“We don’t have a strategy problem, we have an intuition problem,” Asness said, pointing out that stock valuations are lofty, at levels resembling the tech bubble. “Factor investing has been crappy lately; many quant strategies haven’t performed well. And this intuition problem makes crappy times feel worse for quants.”

Arguing that quant investors have been bad at stock selection and worse at explaining to investors what their strategies are all about, he says that working to solve this “intuition” problem requires taking specific steps.

First, build a process as intuitive as you can make it, he explains, meaning each factor in your strategy is additive to your goal. Second, size your bet “reasonably.” Also, in tough times, check over and over again every possibility as to why now things might be different—why it isn’t working. And finally, “confront this intuition problem head-on.”

‘Stick To Your Beliefs’

“If you’ve done all of the above, and you haven’t found a smoking gun for recent poor performance, stick like grim death to your beliefs,” Asness said.

In there lies what he sees as the secret to success in quant investing—a long-term horizon at the expense of short-term performance.

So, what makes a quant strategy easier to stick with, even in difficult times?

• Intuition, or clear understanding for when they win or lose; even if it doesn’t make it a better strategy, if you understand it, it’s easier to stick with it
• Strategies with very high Sharpe ratios
• Strategies that aren’t too “maverick”; the more different something is, the harder it is to stick with it—even if it’s better

“Market-neutral multifactor quantitative investing goes zero for three,” Asness said. “One of the most certain long-term failures is investing in a strategy where you go in unlikely to stick with it long term.”

“I’m a lover of multifactor quantitative investing, but it’s hard to stick with it sometimes,” he added.

Contact Cinthia Murphy at [email protected]