August '07 Quant Meltdown: Investors Learned a Lesson, but Did Managers?

by: Christopher Holt

“We essentially have 10,000 Ph.D.s looking at the same data.”

That’s how Vadim Zlotnikov, CIO for growth equities at AllianceBernstein, described the world of quant funds to the Annual Meeting of the CFA Institute last week in Vancouver.  Zlotnikov was talking about the findings of a new paper by the Research Foundation of the CFA Institute based on a survey of asset managers, consultants and investors.   

A press release announcing the study confirms what is now commonly believed, that August’s mayhem was mainly the result of quant hedge funds yelling “Fire!” and running for the exits (see related posting).

Larry Siegel, the Director of the Research Foundation of the CFA Institute (see previous guest posting), points out the supreme irony of this development:

…a discipline that was designed to avoid the herd behaviour of fundamental analysts wound up, in effect, creating its own brand of herd behaviour.

The majority of respondents to this survey said that it was “getting harder to find profit opportunities” and that a combination of quantitative and qualitative research would improve performance going forward.

But surprisingly, 77% of respondents still felt that the field would continue to be dominated by a few large players.  Such concentration must surely work against the diversification so valued by respondents.

So will the average quant dollar become more differentiated or less differentiated going forward?  It almost seems as though respondents (31 asset managers) aspired for differentiation, but realize that the structure of the investment management industry will ultimately prevent this diversity.

The study itself (available here for free) provides some more insight into what’s going on in the heads of quant managers. 

It turns out that the managers surveyed for the study didn’t actually rank diversification at the top of the list of factors motivating their decision to adopt a quantitative (or at least “partially quantitative”) approach.

Investors, on the other hand, rank diversification near the top of the list.  A survey released early this week by event partner Terrapinn suggests that investors feel “the need to identify funds that are less correlated with other quant funds” was the top issue when investing with a quant manager. (Note that they could give a hoot about mixing quantitative and qualitative approaches).

Larry Siegel is right to point out the irony here.  At the end of the day, there seems to be a continuing risk that the key investment lesson from August may be trumped by the business of investment.

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