The 'Quant Cycle' in action?

23 Jun 2022

Dear investors

In the past we have claimed more than once that quant investors were going through tough times... We often drew parallels with the dotcom bubble, which up until the 2018 - 2020 period had been the worst period for investors adhering to a systematic, multifactor approach.  Just like during the dotcom bubble, money flew blindly towards growth potential in recent years, despite the already bloated valuation of these companies. This in turn lead to underperformance of well documented factors - like value, profitability and conservative investing – and indeed to a very bad streak of performance for quant investors. When markets peaked during the first quarter of 2000, sentiment turned quickly and quant investing made a sudden comeback.

In this newsletter we will draw similarities between the bull run-up of the dotcom-bubble (03/1998-03/2000) with the bull run-up of the FANGMANia (*) (12/2019-12/2021) around the covid pandemic (in the graph, t-24 up until t0). As markets are currently falling off a bit, we can now finally also compare how quant factors held up during the early days of the dotcom bubble with how they are currently standing their ground. During the dotcom bubble the market bottomed out from its peak over the course of 3 years (t0 up until t+36). In the current climate it is anyone’s guess what the market will do; we can only know for sure that the market has been trending down from its peak for the past 5 months... The data used for this analysis is from Kenneth French’s data library and pertains to the developed markets factors they track.

As you can see, most factors (value, profitability, investments) started to pick up again in the months leading up to the relative peak in market valuations, both during the dotcom bubble (blue) as during the FANGMANia (orange). As both valuation and quality factors are starting to get priced in the market again, this is leading to a recovery of quant investing as a whole. While the current recovery in quant performance has been strong you can see that - if the past would be a good predictor for the future and both periods are in fact similar - there still is a long recovery to go. From the fifth month up until the end of the dotcom bubble a quant model outperformed the market by about 50% in absolute terms. If the orange line follows a similar pattern during the next 31 months, we would be very happy indeed!

As the headwinds for quant investing are slowly dissipating, we are (finally) being rewarded for sticking to our strategy and continually refining instead of throwing overboard our quantitative models. Vector Navigator is proving very resilient against the market downturn. As of the end of May Navigator fell by ‘only’ 3.3%, outperforming our peers by about 6%. Vector Flexible, is reaping the benefits of our stock selection alpha as well as its market hedge (~47% hedged through futures or cash positions), while being practically immune for the interest rate policy of central bankers. This combination allows the fund to show a positive return of 0.75% per the end of May, which compares quite favourably with the average Flexible Allocation manager who lost 7.6% over the same period!

Best regards,

Werner, Thierry and Nils

(*) FANGMAN is an acronym for Facebook, Amazon, Netflix, Google, Microsoft, Apple and NVIDIA.