Top Quant Analyst Rebukes the Industry: ‘I’m No Longer a Quant’

(Bloomberg) -- One of the most famous quant analysts on Wall Street has launched a stinging industry rebuke as the pandemic thrashes systematic trades anew.

Inigo Fraser Jenkins is ratcheting up his critique of rules-based allocation methods, calling them out for being over-reliant on backtests, diversification and mean reversion.

Strategies that look good on paper like value keep misfiring in the real world in large part because systematic methods are failing to grapple with profound changes in the global economy, says Sanford C. Bernstein's top quant.

“If quant investing has to rely on such backtests and a diversified framework, then I am no longer a quant,” the analyst wrote in a note.

Systematic managers comb through decades of data to detect price relationships and then apply those across large swathes of securities for trading. For instance, factor investing is based on the idea that stocks with certain quantifiable characteristics outperform.

Yet that approach has faltered for years amid growing doubts that those theories are either junk to begin with, or have vanished with their popularity and a changing economy. Now, the pandemic has deepened such woes.

A Bernstein sample of U.S. quant managers has trailed their benchmarks by 3.3% this year, compared to 0.6% of outperformance by their fundamental peers, according to strategist Alla Harmsworth. Equity market-neutral quants have lost money on a one-, five- and 10-year horizon, a Hedge Fund Research index shows.

The value strategy of buying cheap stocks illustrates the potential pitfalls of the typical approach. Though low rates and working from home have fueled a boom in pricey tech stocks, quants have doubled down on value because their backtests say cheap shares must eventually outperform -- a costly bet this year.

Fraser Jenkins, who once called passive investing worse than Marxism, is hardly alone in his criticism of traditional quant methods. Yet his latest missive speaks to the existential crisis roiling the world of systematic managers.

Among the industry headaches are fast shifts in market regimes. As the government becomes more active in managing the economy in the wake of the pandemic, mean reversion -- or the return to historical relationships -- may take longer than ever.

Quants also tend to have more diversified portfolios, since they are counting on the patterns they detect to hold over a large sample rather than insights about particular stocks. That could be a problem in a world where equity leadership is increasingly narrow. The average quant growth portfolio has 151 stocks, compared to 73 for fundamental ones, according to Bernstein.

“For quants a confluence of high stock correlation, high factor correlation, narrow leadership by mega caps amounts to a perfect storm,” Fraser Jenkins wrote in the note published Friday. “Perhaps life is too short to wait for mean reversion?”

The analyst suggests practitioners incorporate macro views, apply their wits to ESG and allow portfolios to be more concentrated.

All that would be a radical shift for an industry priding itself on tried-and-tested rules designed for all-weather trading.

“I was hired by my current employer with a job title that involved the phrase ‘quantitative strategy.' I have come to the conclusion that I have no idea what that label really means,” he wrote. “The rules are changing for investors to a degree we have not seen in decades.”

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