Bill Miller Is Correct (For Now): 'Value' Funds Burying Quants

Bill Miller is patting himself on the back for "burying" quant funds as this just released Bloomberg article notes: its timely appearance is critical as this is easily the most important theme in the current market dislocation. Bill, after the worst year in his career, may be careful with the timing of his self-congratulations though...

Investors in so-called “quantitative momentum” funds --which speculate that the worst stocks in the past 12 months will continue to decline -- have become this year’s biggest losers after banks and companies that rely on consumer spending surged. Quant momentum managers may have tumbled 27 percent this month in the U.S., the most since at least 1993, while those in Europe may have lost 20 percent in March and 24 percent in April, according to data compiled by JPMorgan Chase & Co.

“Not in a million years would we have expected this gyration to be as vicious and enduring as it has been,” Steven Solmonson, the head of Park Place Capital Ltd., a hedge fund that oversees $150 million, said in an interview from New York.“The quants got whipsawed badly.”

The turnaround battering investors who use mathematical models to pick stocks is making heroes out of last year’s worst-performing money managers. Bill Miller, who lost 55 percent in 2008 running the Legg Mason Value Trust after beating the Standard & Poor’s 500 Index for a record 15 straight years, is topping the measure again. Value investors buy companies that are the cheapest relative to their earnings or assets.

It is gratifying that Bloomberg, which some consider borderline Mainstream Media, is finally catching on to this most critical of topics. We hope Bill Miller enjoys his likely last 30 seconds of fame as he relishes in the "crap" stocks of his "value" fund. Unfortunately, for him he is caught in a cul-de-sac: i) If marginal buyers continue purchasing stocks into oblivion, the implosion of the biggest quants will spell the end of the capital markets as we know them, ii) if and when fundamentals finally catch up with the rally before too much damage can be done to the topology of the market, his positive YTD results will swing back down so violently he won't know what hit him.

To point i), Zero Hedge would like to present our readers data we have received compliments of Innovative Quant Solutions, LLC, which performs the tricky task of calculating quant fund performance based on various models. The March data should result in a plethora of red warning signs.

IQS Commentary for March 2009

Summary

The IQS model was down -16.8% over the past 5 weeks, while the sector-neutral model was down 16.9%. [TD: discussion with the appropriate people indicate that April is on par for even worse performance, which is why Zero Hedge has been sounding the clarion call for normality - if market neutral Quants drop 40% in two months, it is truly game over]
·
Balance Sheet and Value added to performance, Improving Financials underperformed slightly, while Sentiment and especially Momentum underperformed.

What Happened?

What does it mean when momentum stops working? The stocks that lost the most over the past few months (dogs of the dow and S&P 500?) outperform the most. (See IQS S&P pdf report for astonishing examples and IQS analysis.)

Without an economic catalyst, fundamentals based model would not predict (nor should they) this “dead cat” bounce. Are we witnessing a sustainable rally for these stocks? It’s possible, but not very likely. Some of these companies are financials, and the “risk” to this industry changes daily, but remains high. However, some of these companies are not financials, and investors are buying up these low priced stocks with the hope that the economic turnaround has started and will continue to improve. With reporting season upon us, guidance will help determine the direction and magnitude of the market during this period. If financials show an improvement, the market may take off. If most
companies continue to post low or negative earnings without a clear picture of a turnaround, the market may retract.

Weights

The IQS dynamic weighting system made small changes this month to the weights. With the market and economic conditions still weak.

Some weight was added to Improving Financials (mid), while a little weight reduced Momentum (mid), from Value (low), Balance Sheet (mid).

What is the IQS Model telling us about Sectors? No significant changes from last month.

Best – Aerospace, Retail, Medical, Utilities, Consumer Staples

Middle –Business Services, Oils/Energy, Industrial Parts, Transportation, Technology, Basic Materials

Worst – Autos, Finance, Construction, Conglomerates, Consumer Discretionary

We are at a critical crossroads for the future of efficient markets. If the bear market rally persists, Bill Miller and 401(k) holders will be happier temporarily, however the end result would be a broken market. Readers who took offense to the photo of the Challenger explosion earlier, should wake up and realize that we are on the verge of the very same event occurring within the fabric of the free and efficient market system. The threat to the equity markets is not being exaggerated. If the powers that be are intent on raising stock prices one day at a time continually, then even as retail investors enjoy another day of moderate gains, in a few short days/weeks markets will reach a point of no return, and the resultant collapse in confidence in the free market system will force the majority of investors to forever depart from investing in equity markets. The consequences of this would be beyond the scope of even my blog.

Comments

[User 305589:]

Tyler, I truly appreciate your insightful articles, especially those covering the otherwise hardly dealt with world of quants. However, I really can't see why the collapse of the quants will destroy the markets. Volatility will rise, yes, bid-offer spreads will widen, yes. But none of this changes the fundamentals of any business that is being traded every day. The stock's fundamentals remain the same. Alas, couldn't it be that the destruction of the quants will be a necessary step to reduce leverage in the entire system and return to markets that drive on fundamentals, rather than 'momoentum'. Apart from some short term pain (a couple of months or a year, perhaps) I see longterm gain from the disappearance of the quants. Unless, of course you happen to be a bagholder of Goldman Sucks and Co. (but given the fact that GS and JPM have virtually taken over the US of A they will always find a profitable venue, I am sure)

Apr 20 04:07 AM

[sundrenched:]

I'm not a professional investor so I'm not 100% sure I'm getting your arguments correctly in this series of articles.

Are you basically saying that some very large quant funds didn't get enough time to close their huge short positions and are now effectively insolvent? Or are they merely hurting? 27% down is bad but a far stretch from a forced liquidation.

Can anyone clarify? Thanks.

Apr 20 05:46 AM

[kotika98:]

Wow, man - that's some serious hubris. The efficient markets are hanging in the balance? Or maybe some momentum following fools about to part with their money?

And IQS? One look at the performance of their "paper" portfolio shows they outperform the market by a stable 12% per year, with little or no volatility - can you spell Madoff?

Apr 20 08:29 AM