Red-Hot Quant Funds Cool Off

Quants have become the hot hedge fund strategy du jour, with the value of their holdings more than tripling since 2009. But as more money pours into the area, that success may be its own undoing.

There’s already some evidence that’s happening. According to a Société Générale survey of more than 100 commodity-trading advisers and quantitative macro funds that Institutional Investor has exclusively obtained, these systematic funds returned a mere 0.04 percent for the year-to-date through February after falling an average of 1.07 percent last year. Meanwhile, the Standard & Poor’s 500 stock index gained 5.9 percent through February, on top of a 12 percent rise last year.

With $76.8 billion, Bridgewater’s Pure Alpha strategy is the largest fund in the group — and a leading indicator. Pure Alpha 18 percent, its largest fund, is up only 0.16 percent through February, with a 2.4 percent return for 2016. Over time, it has done well. Since inception in 1991, it has annualized at 12.3 percent. Pure Alpha 12 percent, which has less leverage, was up 0.2 percent through February and down 2 percent last year. It has produced an annualized return of 9.1 percent since inception in 1991.

London-based Winton Group shows a similar profile. Its $10 billion Winton Futures Fund is up only 1.47 percent this year, after losing 3 percent last year. But it has produced a 12.68 percent annualized return since its inception in 1997, according to Société Générale.

Three older funds run by Man Group repeat the pattern. The $4 billion Man AHL Alpha Fund is up 1.12 percent through February and fell 3 percent last year, and the $5.2 billion Man AHL Dimension is up 0.27 percent this year, after a loss of 1.21 percent last year, the report says. Man AHL Alpha, launched in 1994, has produced an annualized gain of 11.64 percent, whereas Man AHL Dimension, debuting in 2006, annualizes at 5.27 percent, according to Société Générale.

Newer funds aren’t doing so well over time, which may be an indication that the strategy has gotten tougher. Four relatively new funds of AQR Capital Management are up slightly for this year but were deep in the red for 2016, with meager returns since inception. A $12.8 billion AQR managed futures fund with moderate risk, launched in February 2012, is up 1.82 percent this year, after falling 8.44 percent last year. It’s only up 1.56 percent since inception, according to Société Générale.

Another AQR managed futures fund, starting out in September 2009 and running $4.8 billion, is up 2.85 percent, with a loss of 15.42 percent in 2016 and an annualized return of 3.84 percent. Meanwhile a $17 billion fund AQR also launched in 2012 is up 1.72 percent this year but fell 8.66 percent last year, with a gain of 4.07 percent since launch, the report says.

The $2 billion Quantitative Investment Management’s quantitative global program is one of the outliers: It is up 4.26 percent through February, on top of a 16.69 percent gain last year. Launched in 2001, it compounds at 11.22 percent annually. A fund QIM launched in 2015 is up 35.27 this year, after losing 21.71 percent last year. It has produced a compound return of 15.64 percent since launch, according to Société Générale.

Meanwhile, a small quant fund run by Tudor Investment Corp. founder Paul Tudor Jones, the $370 million Tudor Momentum Diversified Portfolio, launched in December 2008, is barely breaking even this year, up 0.15 percent vs. a 4.73 percent gain last year and an annualized return of 1.94 percent, according to Société Générale. Jones, who cut both his fees and staff last year, has said he is considering adding more quant strategies.

The demand is there. Deutsche Bank’s annual alternative-investments survey, released earlier this month, revealed that half of the top-ten strategies investors are looking for in 2017 were systematic, with quant macro the third most popular. It added that 79 percent of investors are allocating to the sector, and half plan to increase their allocation this year.

This follows two similar studies, by Goldman Sachs Group and Barclays, last year. Goldman reported in 2016 that 20 percent of investors were interested in quant strategies.

But a few observers are sounding alarms. Novus calculates that quant strategies now account for 13 percent of all hedge fund assets, compared with 8 percent in 2011, even as their assets have tripled. The research firm looked at eight large quants and found an overlap in ownership in stocks between 17 and 28 percent. Novus cautions that could lead to another meltdown, as occurred in 2007, when all of them sold at the same time.

Too much money following the same strategy is already causing problems. “Good quantitative signals perform well in the short term, but the decay rate is extreme,” according to a Bank of America quant strategy report in mid-March, reported by Bloomberg. “New alpha signals tend to be exploited and then quickly arbitraged away.”

BarclayHedge said managed futures funds alone account for 10 percent of the hedge fund universe, with more than $250 billion in assets under management.