Practical analysis for investment professionals
12 April 2012

Does Quantitative Investing Have a Future?

CFA Institute recently asked its members if quantitative investing has a future and, surprisingly — at least to me, nearly one-third expressed doubts.

What a difference a few years make! It wasn’t that long ago when quants were rock stars on Wall Street. Since they first arrived on the scene in force in the mid-1990s, there have been great successes, including LSV Asset Management and Renaissance Technologies, as well as the occasional and spectacular failure, like Long-Term Capital Management. By and large, though, quantitative investing enjoyed a nice run until 2007. But from the second half of that year through well into 2009, quants underperformed both traditional managers and the market indices by significant margins. Since then, according to Morningstar, relative performance has stabilized. Quants edged out their peers in 2010 and then beat them soundly in 2011.

Be that as it may, the recent CFA Institute member poll results strongly suggest that quantitative investing has a perception problem.

CFA Institute Member Poll: Does Quantitative Investing Have a Future?

There are myriad hurdles for practitioners who pursue this style of investing. The headwinds facing quantitative investors were addressed in great detail in Challenges in Quantitative Equity Management, a Research Foundation of CFA Institute monograph published in 2008. Through surveys and interviews, authors Frank J. Fabozzi, CFA, Sergio M. Focardi, and Caroline Jonas sought to understand the factors that contributed to the recent period of poor performance as well as the ongoing challenges faced by quantitative managers. The monograph remains relevant today and is a quick and interesting read.

A few highlights:

Quantitative Investing’s Appeal

The authors identified three primary objectives motivating investment management firms to pursue a quantitative process: tighter risk control, more stable returns, and better overall performance. An earlier study by Casey, Quirk & Associates in 2005, titled “The Geeks Shall Inherit the Earth?,” found that quantitative-driven processes did offer better risk-adjusted performance than did fundamental managers. Product diversification and scalability were also cited as reasons for implementing a quantitative process.

Assessing What Went Wrong

It is widely believed that the primary reason quant funds stumbled badly beginning in mid-2007 was correlation between managers, compounded by leverage. Common metrics of value and momentum, the argument goes, led quants to hold similar stocks. Then, when stocks began to sell off, many quant managers found themselves racing for the exits at the same time. Leverage employed by some players only compounded the problem. The authors confirmed this hypothesis in the monograph, quoting one manager as follows: “Everyone in the quant industry is using the same factors. When you need to unwind, there is no one there to take the trade.” As the financial crisis unfolded in 2008 and 2009, the value bias of quant managers drew them to beaten-down financial and cyclical stocks — the proverbial falling knife. And as the market rebounded in 2009, they were too slow to fully recover.

The improved performance of quants over the past two years may be attributable to the funds’ momentum-based models adjusting to the market’s upward trend as well as less competition on both the buy and sell side, as quantitatively-managed assets have — by some estimates — been halved in recent years.

Challenges Ahead

Going forward, the authors argue, the significant challenges facing quantitative managers include correlating markets, style rotation, fundamental market shifts, and insufficient liquidity. They also point to “too many people using similar models and the same data” as a critical issue facing the industry. Underscoring this observation, the quant managers surveyed by the monograph’s authors cited innovation, or the identification of new or unique model factors, as the most important strategy for improving performance.

Quant managers and their investors would also be well-served by reading “The Quant Delusion: Financial Engineering in the Post-Lehman Dodd-Frank Landscape” by Stephen Blyth, managing director and head of internal portfolio management at Harvard Management Company. In this March 2012 CFA Institute Conference Proceedings Quarterly article, Blyth discusses how the post-financial crisis investing landscape has been altered — and how quantitative investors must adapt to reshaping forces. In Blyth’s view, uncertainty abounds: government interventions, including quantitative easing by the U.S. Federal Reserve and the Swiss National Bank’s efforts to weaken the franc, have distorted traditional value assessments in some fixed-income markets. Similarly, quantitative managers must assess the market impact of new and evolving regulatory reforms, including Basel III and the Dodd-Frank financial reform legislation in the United States.

So does quantitative investing have a future? The answer likely hinges on the industry’s ability to adapt and innovate.

Those themes should sound familiar to all investment managers. Fans of Fabozzi, Focardi, and Jonas, in particular, will appreciate the trio’s more recent monograph entitled Investment Management after the Global Financial Crisis.

Business abstract illustration from Shutterstock.


About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

6 thoughts on “Does Quantitative Investing Have a Future?”

  1. I have never thought about Quantitative Investing and what is all about but as you all discussed, now I have also confusion about the success of quantitative investing. Thanks for informing me.

  2. Thanks David. Interesting stuff!

    Its interesting that the ESG/RI world is quite bullish about quant strategies, the latest to announce a new appointment being La Compagnie Benjamin de Rothschild & I appointed one several years ago when I headed the AXA IM ESG team.

    Cynics could say this was because the RI world is behind the curve! I wonder whether it might be because ESG quants are using data that “not everyone uses”? Eg at AXA IM we used human capital management data which even qualitative analysts believe (erroneously) not to be available.

    I wonder if there is enough ESG quant activity to do a proper research project into whether there is a difference of sentiment exists and if it exists, whether ESG quants are “out-performing” traditional ones?

  3. Some indices that are optimised based on carbon data – with weights adjusted using carbon footprints – are outperforming underlying benchmarks. See “S&P/IFCI Carbon Efficient Index Outperforming” in the ESG Asia 2012 special report,

  4. Well one new innovation that I like… Portfolio123 has a new marketplace that directly connects any quant with a strategy to subscribing investors. This will open the market and hopefully democratize the finance world. This will mean more work for model developers since there is more demand driven by non-accredited investors wanting sophistication and active management. It lowers fees as investors pay a token amount for strategy only and allows strategy developers to make lower liquidty models that massive funds could never trade.

    Its called Ready-2-Go models and they only accept automated quant models. Worth looking at in my opinion.

  5. Mathfinance says:

    Thank You for Sharing useful information! all points are good and it will be helpful me in future.

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