OK I be more specific. Hedge funds and in fact no actively managed investment vehicle should be paid for beta. Does that make it clearer?
What are possible reasons behind Quant Funds underperforming for past 5 years?
- Thread starter helpme_please
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I understand what you're saying. HFs _shouldn't_ be paid for beta. Yet they are. It seems like we've both been around HFs a long time. HFs are a fee structure, not a strategy. Most L/S funds, in particular, add no value to the investor. What they really get paid for is alpha plus a timing beta. That assumes they have skill in determining an optimal hedge ratio. But, as you're likely aware, they have no market timing skill - yet they get paid as if they do.
This example isn't for you, since you probably already know this stuff, but it might help the casual reader:
Consider a L/S manager getting a 2/20 fee. The manager's gross return is 12%, with 4% alpha. In rough terms, we can say the manager gets 2% + 20% of 12% = 4.4%. In effect, the manager is getting (100% of alpha + part of any upside in a stochastic error term) since 4.4% > 4% alpha. That leaves the LP interests with returns from market exposure, or beta. (Note: This example is for illustrative purposes.)
I started this thread to ask the expert elitetraders for some possible reasons for quant funds underperforming the past 5 years. Unfortunately, a significant number of the posts here are defending quant funds and little about the possible reasons. I hope to see more discussion about the latter. Thank you.
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Now there is something we can agree on. Thanks for the exchange, it's rare people on this site can hold an intelligent exchange of opinions and stick to civilized manners.
Why they underperformed? Could be diminishing edge, but most likely the biggest reason is the relentless surge in equity market due to the incredible amounts of cash chasing yields. Almost all flows into equities and there is very little left for quant strategies to exploit. There are pockets to make consistent coin but the majority of quant funds never figured out how to exploit those niches in the first place. Don't forget, most quant traders are not superstars but self-embellished guys with technical skills from non trading/finance disciplines. They are great at grasping the obvious in the market but the obvious vanished and hence there is not much food left on the table. Those who carry the most weight are oftentimes guys who did not undergo any formal stem based education. They are the ones who make decisions even in quant funds. Very few superstars come to the table with a PhD in physics, they are very rare but also very successful (I mean those who have it all, top notch scientific and analytical training, balls of steel, a mind that runs circles around most others, and quick decision makers.). Most quant funds have a max of 1 or 2 of such guys. All others are mediocre at best. Just my own observations and experience. Ask others and build your own opinion.
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It's true. It's human nature that our pride gets in the way. Fortunately, we both held that in check. Thx for keeping things civil and making me think a little.
LOL! Define civil.
I'll add to what DiceAreCast had to say. I don't know this for certain, but I know other people running factor models (e.g. FF3/Carhart) on US equities and they've all done poorly in recent years. Traditional factor models using accounting objects to ascertain what is rich vs cheap in US equities (i.e. valuation-oriented mean reversion) have done poorly in recent years. However, I've read that the same models have done very well in China. Now, consider how some very simple US intermarket equity spreads (e.g, size, value) have moved in relation to yield curve changes in recent years. Think of that as an omitted variable: government intervention.
In summary, I wouldn't go so far as to say quant isn't working so much as the most common and most scalable form of equity quant hasn't fared well, and that this has been due to unusual circumstances. To be clear, I'm not defending any one type of strategy or fee model. I'm merely doing my best, relying on some data, and mostly anecdote, to describe what I think is happening.
I never claimed that we are always on our best behavior. I'm sure you'll find me being aggressive at times, too.
