Back to October 2019

Can quant square the circle?

  • Asia
  • Global

Quantitative or quant investing depends on mathematical and frequently computer-driven models to such an extent that it can be almost a black box, where the investor committing money to the strategy has to take its performance on trust based on past data, with only the most basic understanding of what goes on inside the box. This may not be a question of conceptual complexity or obscure algorithms, but rather the sheer muscle and number-crunching required to do the analysis that delivers the results. This barrier to understanding does, however, put more of an onus on quant to explain itself, and to validate its investment case.

That may be rather more of a challenge in volatile and difficult times. A sceptic might well ask, what’s the value of arcane calculation as a guide to stock or bond performance when visible market shocks like a trade war or drone attacks on a Saudi oil field have far more impact on stock and market performance? It’s a legitimate question, if only as a guide to how much money and resources an investor should be committing to quant rather than other strategies. After all, quant strategies are likely to be right at least some of the time; the question is how much of the time, and during what times.

You might argue that quant has had an easy time of it, up until recently. The popularity of passive index-tracking strategies over active ones ought to undermine the case for quant, you might think. But in fact, with expectations and performance targets geared overall to what passive index-tracking can achieve, the benchmark for quant to outperform is correspondingly low. In other words, quant may be able to get away with being less active when the market as a whole is passive.

And yes, this comes down to the fundamental dilemma of active versus passive investing. Active investing may have had a bad run of popularity lately, at least in less volatile times, but most clear-eyed investors would admit that that has to do with costs as much as performance. When passive strategies drive down their costs so much, active investors have that much harder a case to prove versus the passive approach in terms of the ultimate return on investment.

Yet this has led to the bizarre paradoxical situation where financial markets that insist on low costs are desperately hungry for yield. Is it surprising if they won’t pay for it? Maybe quant can square that circle: something probably has to. After all, passive index-tracking in a highly volatile environment looks more like a switchback ride.