Smart beta suffers from crisis of intuition

Amid withering investor confidence, a prominent quant manager explains how to make the strategies easier to stick to

Smart beta suffers from crisis of intuition

Being a critic of quant-based smart-beta strategies has been easy lately, particularly as long-short multifactor portfolios have suffered from persistent weakness. That has led to investors pulling assets in increasing amounts — and an overlooked problem could be exacerbating the situation.

“Factor investing has been crappy lately; many quant strategies haven’t performed well,” said Cliff Asness, a renowned quant manager and co-founder of US-based AQR Capital, according to

Speaking at the Morningstar Investment Conference held in Chicago last week, Asness was reportedly candid in acknowledging the harsh reality that’s hurting his firm. AQR Capital manages over US$200 billion in assets, and Bloomberg reports that AQR funds have seen outflows of more than US$1 billion so far in 2019; last year, they shed US$8 billion.

The fact that investors are exiting from strategies with lacklustre performance isn’t surprising. Even Asness admitted that while he’s a lover of multifactor quantitative investing, “it’s hard to stick with it sometimes.” But sticking to the strategy is the key to what he sees as the secret to successful quant investing: a long-term horizon at the expense of short-term performance.

At their core, many quant managers focus on the value factor, which has suffered from persistent weakness. That doesn’t mean that quants are following losing strategies; as Asness pointed out, stock valuations are at lofty levels reminiscent of those seen during the tech bubble.

“We don’t have a strategy problem, we have an intuition problem,” he said. “[T]his intuition problem makes crappy times feel worse for quants.”

Many quant managers are concerned about the confidence crisis besieging the space. But Asness argued that they have done poorly at stock selection, and even worse at explaining to investors what their strategies are all about. In his view, providing that intuition — a clear understanding for when a quant strategy wins or loses — makes it easier for investors to stick with it.

“When quant strategies lose, it’s often hard to understand why,” he said. “[It] feels like a black box when losing.”

To overcome the intuition problem, Asness said, managers should follow specific steps:

  • Build a process that’s as intuitive as possible, with each factor in the strategy being additive to the investment goal;
  • Size their bets “reasonably”;
  • In tough times, examine every possibility to determine why things might be different, and why the strategy isn’t working; and
  • Confront the intuition problem head-on.

“If you’ve done all of the above, and you haven’t found a smoking gun for recent poor performance, stick like grim death to your beliefs,” he said. “One of the most certain long-term failures is investing in a strategy where you go in unlikely to stick with it long-term.”


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