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Could Quants Worsen the Next Financial Crisis?

Posted in Insights

Investors keep pouring money into quant funds, which hit a record $500 billion in assets last year, and this shift shows no signs of slowing down. Over the past seven years, quant funds attracted 29 percent of total inflows despite only accounting for 17 percent of hedge fund assets under management.

Clearly, systematic strategies are going to play a huge role in the future of the investment industry, but not everyone is singing their praises. In fact, one hedge fund is warning clients that the increasing move towards quant funds and passive investing could worsen the next financial crisis.

Boston-based Highfields Capital Management, a hedge fund with $13 billion under management, recently voiced these concerns to investors in a letter that was obtained by Business Insider. The firm’s founder, Jonathon Jacobson, drew similarities in the current environment to the way investors relied heavily on “portfolio insurance” in the lead-up to the 1987 financial crisis. Jacobson argued that portfolio insurance contributed to a complacency among investors riding market gains, and that passive, systematic strategies are currently having the same effect. He wrote:

“We are convinced that 'quant' funds, which have attracted hundreds of billions of dollars in the last few years and a significant portion of which use leverage, and whose models and various strategies are largely based on price action and correlations extracted from the reasonably recent past when volatility has been low (largely of their own making), have contributed mightily to the illusion that market risk is low.”

As the founder of a firm that employs fundamental strategies, and clearly has no plans of shifting to a full-blown quantitative approach, Mr. Jacobson is obviously biased in his opinion. But at the same time, he could have a point.

Relying on programmers, data scientists and the algorithms they create to passively implement strategies, versus putting faith in professional investors to actively manage investments could present a huge risk if and when the market turns. But digital transformation and extracting value from technologies like big data and artificial intelligence (AI) is a top priority for nearly every company and industry in the world, so it would be tough for investment firms to sit back and risk being left behind.

There’s good news – as technology becomes more accessible and easier to use, asset and portfolio managers may not have to make the choice between a quantitative or fundamental strategy. They can have the best of both worlds.

This is exactly why Elsen was founded – to eliminate the reliance on highly-skilled engineers and programmers and enable intuitive, quant-like tools. The Elsen nPlatform provides a foundation for large financial institutions to quickly build and deploy web-based applications that are easy to use and capable of crunching massive amounts of data. This means that fundamental managers will no longer need others to build and test their strategies. They’ll be able to build and iterate on their ideas in a fraction of the time it takes through current processes.

A few months ago, we took a significant step toward this reality when Thomson Reuters unveiled a new product, QA Point Powered by Elsen. Using QA Point, any portfolio or asset manager can create and backtest investment models in minutes, vs. the days it used to take. The introduction of QA Point was so successful in North America that Thomson Reuters quickly rolled it out in Asia, months ahead of schedule to meet customer demands.

To learn more about how Elsen nPlatform can enable financial institutions to put quant-like tools into the hands of fundamental managers, visit https://elsen.co/platform or get in touch at hello@elsen.co.

Zac keeps Elsen running. From recruiting and managing a top-performing executive team, to driving critical decisions and developing partnerships with world-class companies, he ensures all areas of the business are aligned with the company’s strategic goals.

An engineer by training, Zac worked at Schneider Electric before catching the finance bug. During a later position at Credit Suisse, he applied his engineering and programming skills to macroeconomic research. His ability to create solutions that address complex problems in manageable ways gave him the tools he needs to solve difficult finance problems.

What Zac loves most about Elsen is its talented team of dedicated people who want to do something awesome every day. When he’s not leading the team, he enjoys longboarding, surfing, cooking, watching Chef's Table, and playing board games.

Zac holds a B.S. in Mechanical Engineering from Northeastern University and holds several patents for cool stuff like fluid mechanics.