By A Paris – The volatility experienced since the start of the Covid-19 pandemic in March 2020 has largely been a positive development for alpha-hunting hedge fund managers who were able to take advantage of the arbitrage opportunities available. However, various market forces saw those at extreme ends of the investment approaches come under pressure – causing the convergence of quantitative and fundamental philosophies to rise in appeal.
The spectrum of investment approaches is very diverse – with fundamental investors using traditional metrics like balance sheet evaluations at one end, and strictly quant managers whose investment decisions are driven by statistical models.
“The investment spectrum has shifted in an incredible way. People who were purely fundamental investors are being pushed to use new data sources and the quant side is starting to understand the value of the human element,” says Michael Perlow, founder of Epsilon Asset Management.
An article by S&P Global Market Intelligence outlines some of the reasons why the pandemic has driven the need for the two approaches to come together – particularly for the fundamental analysts to move towards the use of alternative data.
As regulators extended filing deadlines, investors relying on company guidance and financial reports had to wait longer than usual to access the information. Further, auditors and accountants struggled to assess inventory, account receivables, and revenues. “When reports are ultimately filed, they may have reflected an environment from the recent past which bears little resemblance to current conditions. Corporate decision-makers often lack visibility into their own supply chains as the situation on the ground is so fluid that they lack the tools to make reliable forecasts,” the data provider notes.
“Following such a structural break, there is a need for timely, forward-looking information that may fill the gap left by the absence of familiar tools,” the article continues.
Quant funds also faced their own struggles. Having underperformed between 2018 and 2020, in what some have described as a “dark winter” for the sector, these funds were under pressure to deliver throughout the pandemic. However, data suggests some of these machine-driven funds missed the mark.
Through the end of November 2020, hedge funds overall were up over 6 percent according to PivotalPath’s Composite Index. However, quant funds, as measured by the PivotalPath Quant Equity Index, were down over 6 percent.
PivotalPath CEO Jonathan Caplis commented: “What’s gone under the radar is that most quant strategies haven’t made much money in several years. They make up 55 percent of funds that have posted losses since 2016; these strategies were supposed to revolutionise trading but they didn’t do that.”
Against this backdrop, its not a surprise that the rise of so-called “quantamental” investing is being heralded as a compromise.
“Returns motivate behaviour more than most other factors, thus our clients have certainly seen the performance benefits of combining a quantitative approach with a fundamental way of investing,” highlights Alexander Chadwick, vice president of sales engineering at Novus, a portfolio intelligence and data automation platform leveraged by both allocators and managers, across all asset classes.
“The Covid-19 pandemic has also led to increasing volatility and more froth in the market. This is promoting a focus on leading indicators as investors are trying to stay ahead of market-moving information. Also, as competition increases, managers value being able to tell a better story supported by quantitative information,” Chadwick continues.
Making the change
Balyasny Asset Management outlines the growth of this approach: “The term “quantamental” has been increasingly used to describe the convergence of fundamental and systematic investing. Driven by the explosion in data over the last decade, open-source computing and the continual search for alpha, our portfolio managers and their analysts are blending the best elements of these two distinct approaches to help deliver consistent returns to our investors.”
“I would think that having fundamental analysts and quants working together is probably the optimal strategy,” remarks Perlow. “However, it can sometimes be as though both sets of professionals are speaking different languages. Therefore, although this divide is certainly closing, you still need to have professionals like product managers or specialists who can act as a bridge between the two approaches.”
Deepali Vyas, senior client partner and global head of the AI and FinTech practices at executive search firm Korn Ferry, agrees with the need to invest in change management to “bridge the divide between traditional approaches and an even greater reliance on analytics.” She underscores that the organisational aspects of introducing the approach can be daunting. “These include large up-front costs, scarce talent, a lack of definitional clarity around quantamental processes, and the worry that traditional analysts (professionals steeped in years of experience with fundamental investing) will view the new system as a risk, not a useful tool,” Vyas writes in an article.
Perlow recommends managers considering this approach to be fully committed to making it work and be willing to adapt their processes and systems to help the transition. He says: “I’ve seen fundamental managers hire data scientists to augment their fundamental approach. However, they sometimes did not have the infrastructure set up with this in mind.
“For example, I’ve consulted with hedge funds which only use excel documents. From a data management perspective, this is just one step up from using pen and paper, which is a challenge for any data scientist.”
Some firms may be better placed to benefit from a quantamental approach. Chadwick outlines: “Managers that already have access to a very strong administrator and clean data are set up to succeed. Also, those with a longer history and a higher number of trades are probably better equipped to employ this approach, simply because they have more data available.”
He also underscores the importance of the cultural dimension: “A layer of behavioural introspection is key. If you don’t have people at the top supporting this shift, then it probably won’t happen.”
