The Limitations (?) of Non-Discretionary Trading

Active fund management continues its decline (both in popularity/adoption, as well as in realized performance), even as passive investing moves in the opposite direction. One needs to look no further than [aggregate] hedge fund performance in 2016. Like 2015, yes, you had some notably good performers…only to be offset by notably poor performers.

Concurrently, “quantitative investment management” (which I prefer calling “non-discretionary trading”) remains in vogue. Look no further than the assets under management of AQR and the likes, of the world… or the political influence of Renaissance Technologies (though, in fairness, Rentech has been anything but an ‘asset gatherer’).

Question: What effect – if any – do the simultaneous popularity/success of ‘passive investing’ AND ‘quantitative investment management” today have on their future returns/losses (and the smoothness/volatility of those returns/losses) ?

Let’s oversimplify and say that the ‘alpha’ of the non discretionary participants arise 100% out of the discretionary active participants. If the actives are being pushed out because of both the passive AND quantitative trends… does that not diminish the alpha opportunity set for the non discretionarys? What if I were tell you that some of these non discretionarys use 10x-20x leverage…on their equities books?

Some of you may recall the “great quant meltdown of [August] 2007”, that occurred just under 10 years ago.Seemingly invincible quant funds experienced sudden and meaningful declines (e.g. -5 to -30%).

The likes of Soros, Druckenmiller, Paulson, etc… all great wealth compounders for themselves AND outside investors – eventually experienced real/meaningful drawdowns/losses.

Given that the capital flows towards passive and quant have largely occurred at the expense of active management… i.e., as passive and/or quant become more ‘crowded’ … are they truly immune to what the likes of Soros/Druckenmiller/Paulson all eventually experienced?

I think not.

ADDENDUM on 1/9/2017

Perhaps quant alpha now and in the future, just might (also) be derived from the negative alpha of other quants. For example:
BlackRock Quants Sustain Record Losses in Setback to Fink Plan

BlackRock’s main quantitative hedge-fund strategies — which use computer models to sort through vast amounts of data to pick out patterns — were on track for losses in 2016, according to a monthly client update sent out in late December. Of the five included, four were set for their worst returns on record, data through November showed.

I don’t what the sources of the losses were..but it is a possibility worth entertaining.

 

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