Hedge funds that use quantitative techniques to spot opportunities, even those focused on equities, have generated some envious returns in a year marked by huge losses in both stocks and bonds.
Take equity quant strategies, which are up 5.1 percent year-to-date through November, according to PivotalPath’s index tracking these funds.
“Anything touching equities being up at all — and up more than 5 percent — is going to feel pretty good for investors,” said Jon Caplis, CEO of PivotalPath.
Risk premia funds — some of the largest are managed by AQR, Bridgewater Associates, and D.E. Shaw — increased 4.6 percent for the year through November, according to the hedge fund research and analytics firm’s risk premia index. Risk premia funds systematically target sources of returns from well-known factors such as size and value. Risk-premia and equity quant have had a bad run, underperforming between 2015 and 2020. Multi-strategy funds, which aren’t pure quant funds but still fall into the category, are flat for the year.
Managed futures and a related strategy, global macro quant, are the category’s biggest performers, up 14 percent and 16 percent, respectively.
But it’s the drivers behind the comeback in performance of risk premia funds — and to a lesser extent, equity quant — that are particularly notable in today’s market.
The resurgence of the value factor, a premium — or style of investing — focused on cheap stocks, is one big reason. Value was a losing proposition for years before it began to rebound in 2021. This year, through November, value is up 23.5 percent, using the Dow Jones Market Neutral Value Index, after returning 17.2 percent in 2021. (PivotalPath uses the Dow Jones’ index to assess value performance because it is highly correlated to the Fama French value factor, which reflects the thinking of Professors Gene Fama and Ken French, who published pioneering research on the premium in 1992. But the benchmark does short growth stocks.)
Calling it a comeback is real: Value declined for years, including a 29.5 percent loss in 2020, and with the exception of 2016, the index posted significant losses every calendar year between 2015 and 2019. This year’s performance is in line with value’s peak in 2009, when it returned 24.1 percent.
But it’s not just value that’s driving risk premia and, indirectly, equity quant, according to an analysis by PivotalPath for Institutional Investor. Surprisingly, a deeper dive shows that other common factors such as size, momentum, and quality are also behind the comeback.
Quality, for example, has enjoyed a big turnaround. The Dow Jones Market Neutral Quality index is up 8.8 percent through November. Caplis said that the last time the index was up more than that was in 2017, when it returned 9.8 percent. Before that, you’d have to go back to 2008 — when the index returned 15.9 percent — to find higher returns. The index lost money in 2019 and 2020.
Another well-known factor, momentum, has also delivered solid returns this year. Measured by the Dow Jones Market Neutral Momentum index, the factor is up 10 percent year-to-date through November. That’s the best performance since 2015, said Caplis, noting that returns were only bigger in 2007.
Meanwhile, the size factor, part of the Fama French 3-Factor Model, was up 1.5 percent — not huge, but a stark contrast to the significant losses recorded every calendar year between 2017 and 2021. Low-beta stocks also delivered this year, with returns of 16.2 percent through November. “Size, value, and momentum are mainstays of risk premia, [and they’re] delivering in a year where most sectors are down,” he said.
Investor obsession with the underperformance of value may have obscured data that showed that these other premiums — with years of academic research behind them, including the Fama French Three-Factor model — were not working. Meanwhile, articles on value — and the potential reasons for its downfall — were everywhere, including II.
In the end, of course, nothing can be perfectly modeled. “The analysis tells you that it’s very difficult to forecast when factors will perform well and when they won’t,” said Caplis. “Just when people write them off for dead is exactly when they come back — [that may even be] part of the reason they come back at all.”
Caplis was referring to “crowding”: When investors crowd into a trade, whether it’s small cap stocks, merger arbitrage, or residential real estate, the asset itself becomes distorted by the behavior of humans. “Money flies out and capital is removed from the market and then these risk premia come back. What’s important comes down to having diversification in your portfolio at all times.”
While quant has come back, not everyone will benefit — again because of behavior. Many abandoned these strategies after years of losses, and perhaps because of a misunderstanding of the evidence behind factors and how they may or may not work.
“Investors have certainly questioned the viability of quantitative strategies between the period of 2015 and 2020. And some have ruled them out completely, redeeming after six years of being roughly flat while the S&P 500 returned over 100 percent.”