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Quant managers have attracted the lion’s share of the assets
in GI’s 2005 and 2006 top 100 asset managers league
table. But once managers have built their models, what
value are they actually adding? Shahnaz Mahmud lifts
the curtain and sheds some light on quant’s box of tricks.

                                   T IS an art to achieve returns through a style          Certainly the bear market changed investor appetite
                                   of management that is often considered to            for risk, and risk control is important for all managers
                                   be too difficult for the average person to            employing quantitative techniques. The evergreen
                                   understand, due to its mathematical nature.          issue of alpha and beta separation also calls for a struc-
                                   Non-quant managers also tend to be dis-              tured investment process, typical to quant. Others
                                   missive of the quant giants, readily                 argue that placing several smaller bets through the
                                   dismissing it as “just passive management”.          quant process widens the opportunity set as opposed
                                   Nevertheless, the quantitative style has             to selecting fewer, albeit high alpha, stocks. This is anal-
                                   proven a force to be reckoned with, having           ogous to placing many small bets at a roulette table in
                                   taken the lead over the traditional, funda-          a casino, to try and increase the odds of making a
                                   mental style in terms of asset-gathering over        return. Whereas, if you bet all your money on one num-
                                   the last few years. But even in quant models,        ber, you have far less chance of hitting the jackpot.
                                   the human element remains very significant.              But demystifying the process of quant management
                         Quant management has grown in popularity since the                                               is half the battle,
                      tech bubble burst, because of disenchantment with tradi-                                            according to many
                      tional techniques. Institutional investors began to see how       “Quant can often                  practitioners. Ralph
                      critical it was to have a process in place to safeguard returns   be perceived as a                 Smith, unit head,
                      when dramatic drops in the market occured. Mike
                      O’Brien, head of relationship management at Barclays              black box shrouded research, atResearch

                      Global Investors (BGI) Europe, says: “The latest wave of          in mystery and                    Centre, says that one of
                      quant is partly due to the failure in performance of some                                           the main reasons the
                      of the flagship asset managers. Investors began to ques-           regarded with                     firm has had success
                      tion whether or not skill existed at these managers.”             suspicion.”                       with its quant strate-
                          gies is due to its ability to
                          clearly articulate its invest-
                          ment process, how it manages
                          investments and how the firm
                          expects to add value. Quant
                          can often be perceived to be a
                          black box shrouded in mys-
                          tery and regarded with
                          suspicion,      says    David
                          Schofield, managing director,
                          European institutional busi-
                          ness at Janus Capital. A
                                                             PanAgora Asset
Jennifer Young,
executive vp, Intech.     fundamental manager may
                          seem more appealing as the
                          process is tangible and easily     PanAgora Asset Management was launched in 1985
                          explained. And as trustees         to provide quantitative equity and fixed income
                          have a fiduciary responsibility,    strategies. The firm has been co-owned
                          they do not feel comfortable       by Putnam Investments and Nippon Life Insurance
                          investing in a process that        since 1997. The firm operates across the
                          they don’t understand.             following jurisdictions:
                             Fortunately, quant attracts
                          investors because of its per-      ^United States: PanAgora maintains a dedicated
                          formance. Eric Sorensen,           team of sales, consultant relations and product
                          president and CEO at               management people through Putnam Investments.
                          PanAgora Asset Manage-              ^Canada (above): A recent relaxation of the For-
David Schofield, m/d,      ment, a subsidiary of              eign Property Rule has led to opportunities for
European institu-         Putnam Investments, points         mandates across a range of strategies. With this in
tional business,          out: “Consultants and others       mind, the firm has developed a strategic relation-
Janus.                    are always looking at per-         ship with Integra Capital Management of Toronto.
                          formance       against     the     It is targeting several additional Canadian institu-
                          benchmark. In the US, quant        tions as clients in 2006.
                          managers have demon-               ^Germany: International joint venture Union
                          strated      much       better     PanAgora continues to conduct business in the
                          performance against the            German investment market. PanAgora has a deal
                          S&P 500 over the last three        with Union Asset Management, one of the largest
                          to four years. Returns have        German asset managers.
                          doubled for quant managers         ^Japan: PanAgora recently renewed its alliance
                          whereas fundamental man-           with Nissay Asset Management (NAM) for five
                          agers have been flatter, with       years. The exclusive arrangement sees PanAgora
                          single digit returns.”             providing advisory services to NAM’s non-Japan
                                                             securities business across a variety of products
                          Fundamental drivers                and structures.
Rodney Fernandes,         But not all managers who say
head of European          they are quant-driven are
quantitative manage-      100% grounded in this style.         Axa Rosenberg is another firm that employs quant
ment, Northern Trust      For instance, GMO, while          strategies, while not claiming to be a full-blown quan-
Global Investments.       well-known in the market-         titative manager. Rosenberg, which originated as a
                          place for its quant products,     quant shop, has just celebrated its 20th anniversary.
                          does not consider itself to be    Axa Investment Managers acquired the firm in 1999
a pure quant house. “Our process is driven by common        as part of its strategy to offer strong quantitative prod-
sense fundamental investing, not by maths and com-          ucts. “Axa IM views itself as a multi-specialist and we
puters. But, we use quant to add ideas consistently         are one of those specialists,” says Gideon Smith, deputy
without human errors,” says Paul Bostock, managing          CIO of Axa Rosenberg. “With regard to this specific
director of the UK operations. But GMO employs a            style, we think we are doing what traditional managers
highly structured, complex system, he adds. “We aim         do, but we are using quant techniques extensively in
to understand the underlying reasons behind patterns        order to carry them out.”
we find unsatisfactory.” GMO has not veered from the            Axa is not the only manager to acquire quant tech-
value and momentum path since it started. “Value            niques to complement its fundamental offering.
reflects the belief in investing in fundamentals - in       Northern Trust’s business is now one-third quant-
identifying profitable company opportunities, which          based, says Rodney Fernandes, head of European
is a long-term strategy. On the other hand, momen-          quantitative management at Northern Trust Global
tum is much more short-term, typically with a one-          Investments. The firm boosted its quant activities in
and three-year time horizon. But we’re still looking for    2002 when it acquired Deutsche Bank’s global passive
companies that perform well and will carry on               equity, enhanced equity and passive fixed income busi-
performing well.”                                           nesses. “We have a multi-factor stock selection model
                                                                                GLOBALINVESTORMAGAZINE.COM APRIL 2006
                                                                                            Of these, 50% are managed internally and 50% exter-
                                “We aim to                                                  nally. “We think quantitative strategies can generate
Manager AUM           Quant     understand
                                                                                            high, stable returns for the pension fund, but we take
                                                                                            the view that the quant and fundamental approaches
Axa Ros j432bn $84bn
                                the underlying                                              should complement one another,” she says.
BGI       £881bn £295bn                                                                       But she adds that one of the advantages of the quant
GMO       $115bn      $103bn    reasons                                                     style is that it can handle a wide range of information.
          $600bn $210bn
                                behind                                                      “We take the view that the quant
PanAgora$192bn        $18bn     patterns                                                    and the fundamental approaches
          $1.44trn $172bn *
                                we find                                                      should complement one another.”
Intech    $148.5bn $44.7bn      unsatisfactory.”
*in active equities
                                PAUL BOSTOCK,                                               ABP Investments has an in-house dedicated team of
                                M/D, GMO.                                                   seven people to manage its proprietary quant models,
                                                                                            which were created to have a competitive edge. “You
                                                                                            need to have a high level of competence across your
                                                                                            whole process, such as data, modelling, technology,
                                                                                            good execution and analysis, to be successful. You need
                                                                                            excellence in at least one area, that’s our way of think-
                                                                                            ing,” says Neal.

                               within enhanced indexation, so we have many differ-          New model army
                               ent ways to generate outperformance,” says Fernandes.        For quant managers, the model is the keystone of their
                               Another key component of the model is its price to           process, but the percentage of good working models is
                               earnings forecast. “We look at each fraction because         not great, according to Paul Wilmott, quantitative
                               we are using a computer to cover the entire universe.        finance guru. A lot of organisations, primarily banks
                               At the end of the process, we have an alpha generator        using over-the-counter derivatives, don’t bother to test
                               within each universe,” he explains.                          their models. When the equity markets go up, so does
                                 Intech is another quant house part-acquired by a           the capital return. But, the inverse is true, as well.
                               fundamental player - Janus has an 83% stake in the           Regardless, they use the same model. Wilmott says
                               company. Jennifer Young, executive vice president,           that hedge funds, whilst not always as sophisticated as
                                                                                            the banks, have more creative models, which are also
                               “These models don’t assume                                   more flexible. “These models don’t assume a theoret-
                                                                                            ical ‘no-arb’ world. This is why they have a vastly
                               a theoretical ‘no-arb’ world.                                different philosophy from the banks,” says Wilmott.
                               This is why they have a vastly                                 Watson’s Keutgens agrees to a certain extent. He
                                                                                            says that in order for quant managers to do well they
                               different philosophy from the banks.”
                               says that Intech is assuredly mathematically-based:
                               “We developed the business this way to add value rel-
                               ative to the benchmark - to be equivalent to or provide
                               less risk than the benchmark index. A quantitative and
                                                                                              Axa Rosenberg
                               mathematical orientation implies a structured invest-          Rosenberg Institutional Equity Management was
                               ment process with a level of risk control.”                    created in 1985 to manage broadly diversified
                                                                                              equity portfolios. Axa Rosenberg was formed as a
                               Just a phase                                                   strategic alliance between Axa Investment Man-
                               But will quant last, or is this just a phase? As markets       agers and Rosenberg in 1999. Its investment
                               improve will we see investors switching back to more           process is based on the analysis of fundamental
                               traditional fundamental active managers? Peter Keut-           data, which gives insights into the mispricings of
                               gens, a senior investment consultant at Watson Wyatt,          thousands of stocks.
                               says that quant has enjoyed a tail-wind, due to the bear         Axa Rosenberg believes investors can profit from
                               market. “We expect the trend to persist, particularly          purchasing stocks that are underpriced. Using fun-
                               in the realm of core equity or core markets, but I’m not       damental financial data, and comparison with
                               sure if the quantitative style would have achieved the         similar businesses, it is possible to determine a fair
                               level of returns they have under other conditions,”            value for each stock in the investment universe.
                               he says.                                                       This is adjusted to reflect the near-term prospects
                                  But Dutch pension fund ABP has devoted a great              for a stock by estimating year-ahead earnings,
                               deal of time, energy and resources to quant, suggest-          analysing the market response to earnings
                               ing it sees the style as useful in more than just a bear       changes and reviewing relevant opinion data.
                               market. Whilst the fund has invested in quantitative           By comparing the fair-value determined in this
                               strategies for many years, it improved its activities over     process with the current market price, the firm
                               the last four years both internally and externally, says       establishes the degree of mis-valuation for every
Gideon Smith,                  Edwina Neal, head of equities. Around half of ABP’s            stock in the universe.
Axa Rosenberg.                 equity funds are managed in a quantitative manner.
                                                               that it is currently examining how to fit long/short strate-
                                                               gies within the quant style. Janus also recently launched a
                                                               global core equity capability for institutional investors
                                                               catering to demand for a global active risk managed prod-
                                                               uct that correlates to the firm’s US offering, says Schofield.

                                                               Hedge fund competition
                                                               Upgrading the model will become a necessity, how-
                                                               ever, as the quant space is becoming increasingly
                                                               overcrowded, says Mercer’s Miller. There are now
                                                               more start-ups, typically founded by former hedge
                                                               fund managers using their arbitrage experience. And
                                                               hedge funds are, in some cases, aiming to use the
                                                               experience of quant managers to develop more
                                                               comprehensive valuation models, according to GMO’s
                                                               Bostock. The kicker is that they have the advantage
  Intech                                                       of using the same information and resources as
                                                               quant managers, but without the same constraints.
  Intech was formed in         returns that outperform         Traditional managers have also gained more
  1987. The investment         the benchmark index,                                            sophisticated        tools
  process is based on a        whilst controlling risks                                        and technology and
  mathematical theorem         and trading costs.                                              are launching quant-
  that attempts to capi-          Intech says that it                                          based strategies as well.
  talise on the random         pioneered the invest-                                           For example, Franklin
  nature of stock price        ment process that                                               Templeton         Invest-
                               relies on pure mathe-                                           ments, through its
  Its goal is to               matical relationships                                           newly formed Franklin
                               rather than on fore-                                            Global Advisors (FGA)
  achieve long-                casts of market                                                 platform,     will     be
  term returns                 changes or company                                              deploying a blended
                               earnings. It offers risk-                                       strategy, incorporating
  that outperform              managed portfolios in                                           both fundamental and           Reprinted with
  the benchmark                the large cap core, large                                       quantitative       styles,     permission from
                               cap growth and large                                            called Risk Efficient          Global Investor
  index, whilst                cap value disciplines,                                          Equity, says Jeffrey           magazine. The
  controlling                  as well as an enhanced                                          Applegate, CIO. Its            views expressed
  risks and                    index portfolio. The firm        “One of the main                approach is to use fun-        in this article are
                               is a part of Janus Capi-                                        damental stock analyst         exclusively those
  trading costs.               tal Group. In February          reasons SSgA                    research and incorpo-          of its author(s) as
                               this year, Janus                has had success                 rate        quantitative       of the date of
  movements. Its goal          increased its stake                                             techniques through the         the article.
  is to achieve long-term      in the firm to 83%.              with its quant                  use of algorithms in           The views are
                                                               strategies is due               FGA’s        proprietary       provided for infor-
                                                                                               model.                         mational purposes
must continue to evolve their models. “Managers need
                                                               to its ability to                  It is not surprising        only, are not meant
to be continuously monitoring the markets, searching           clearly articulate that this trend is occur-                   as investment
for new signals,” he says. A danger exists, as well, for                                       ring, given the fact that      advice, and are
those managers who are using signals they don’t
                                                               its investment                  quantitative and funda-        subject to change.
understand, which could result in the portfolio lack-          process.”                       mental        managers         PanAgora cannot
ing meaning.” Diane Miller, manager researcher at                                              already compete with           guarantee the
Mercer Investment Consulting, says that managers               each other. But BGI’s O’Brien says he would not argue          accuracy or com-
have to be smarter to stay ahead. “Managers need               that quant is better than the fundamental approach.            pleteness of any
more computing power or new angles in which to gar-            “The two sit alongside one another. In truth, our              statements or data
ner signals for their models. Managers have to be able         view is that a lot of our signals apply to traditional         contained in
to think outside the box.” This can become an issue of         stock prices,” he says. Bostock’s personal view is that in     this material.
cost, as well, she says, as while more sophisticated           five to 10 years’ time, the quantitative and fund-             PanAgora
computing power does require extra IT spend, that has          amental approaches will converge. “Quant managers              disclaims any
become cheaper and more accessible for new entrants.           are looking for depth of meaning, for real-life sub-           obligation to
   SSgA says that it is working on its model. The firm, based   tleties, whereas the traditional managers are putting          provide any
in Boston, Massachusetts, has the luxury of being situated     more resources in risk tools,” he says. The good man-          updates on the
close to the Massachusetts Institute of Technology (MIT).      agers will still stand out but the growing issue of            subject in the
SSgA has been working in tandem with MIT to create a new       overcrowding means that there are a lot who are not            future. Past
language processing system referred to as text-mining to       really adding value, says Mercer’s Miller. Nevertheless,       Performance is
capture signals from news-flow that have never been cap-        she believes the quantitative style has a long-term            not a guarantee
tured before, says Smith. And ABP Investment’s Neal says       place in investing.                                      g     of future results.
                                                                                                             GLOBALINVESTORMAGAZINE.COM APRIL 2006

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