Financial Times‘ John Authers is blogging from a quant conference in Vancouver as managers and analysts try to figure out just what the hell went wrong with quant strategies in August of last year. I thought it would be an echo chamber of rationalization and justification from a sector that was hit particularly hard by the mortgage meltdown (a sector that was supposedly immune from such disasters), but according to Authers some hard truths are being realized. The problem, he reports, boiled down to this:

  • First, quants had too much leverage (and available data could not tell them that this was going on).
  • Second, they crowded into trades, although this worked differently from the normal perception. The overlap in their holdings of stocks, which would have shown up in quite a lot of publicly available data, was not that great. Rather, they were crowded into particular “factors” — such as staying long in stocks with a low price-to-book ratio. This created the downdraft for them when the market turned in early August.
  • Third, they were over-confident and continued to bet that relatively cheap stocks would beat relatively expensive stocks, even though by 2004 the spread between the two, after a half a decade of outperformance by value strategies, was historically low.

“I strongly disagree that subprime was either unanticipated or unknown,” said Vadim Zlotnikov of Alliance Bernstein. “How many of you didn’t know that credit spreads started to widen in August? This was the most forecast, predicted and discussed event.”

Refreshing candor. Let’s hope the rest of the investment industry follows suit.

Read the whole thing at www.ft.com.