Retail funds launch into quant ETFs after $48 billion

(Bloomberg) — Traders are spending billions of dollars on quantitative stock trades, bolstering an investing style that has struggled to gain traction at a time when simple bets on traditional large-cap indexes have largely carried their losses. fruits.

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This year, fund managers have invested nearly $48 billion in smart beta exchange-traded funds, either to ride the market’s biggest winners or to spread their exposures across the equity landscape.

Pioneered by the smartest minds on Wall Street decades ago, the rules-based allocation method dissects stocks based on their characteristics such as how cheap a company looks, called value, or how cheap it looks. rate at which its shares rose, known as momentum.

After suffering outflows in January, these long-term systematic funds popular with individuals – and offered by companies like BlackRock Inc. and Vanguard Group Inc. – have now enjoyed five consecutive months of inflows and are on their way to reach the milestone of 2023.

“The performance is evident, with good growth, momentum and even valuation in the US markets,” said Patrick McDonough, managing director and portfolio manager at PGIM Quantitative Solutions. “The emphasis on diversification is driven by investors who are looking to take advantage of the beta upside offered by the Magnificent 7, but want to move away from overly crowded trades.”

If this type of inflow continues its dynamic momentum, 2024 will mark a turnaround from last year, when investor interest in factor strategies proved moderate – with the exception of those that simply bet on the hottest businesses like quality and growth. While low-volatility factors have seen outflows over the past 14 months as markets remain risk-skewed, ETFs that combine exposure to multiple factors have enjoyed an inflow of nearly $12 billion. dollars since the start of the year, according to data compiled by Bloomberg Intelligence.

Smart beta ETFs are still on a long streak of underperformance versus the tech-dominated S&P 500, while billions flock to vanilla stock funds week after week. But according to industry advocates, this style of investing works through stable market conditions — and can help hedge portfolios if things go south.

While Wall Street has largely made peace with high interest rates thanks to the resilience of the business cycle, trading conditions have proven stable enough for quants to make consistent gains by betting on reliable trading models. For example, assets have risen and fallen over an extended period of time, which has boosted trend following and associated betting.

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About 11 of the 13 long-short factor styles tracked by Bloomberg are up so far this year, a turnaround from 2023, when only two investment styles generated positive gains. A Bloomberg multi-factor model – providing exposure to value, momentum, low volatility and profitability factors – recorded a gain of almost 13%.

Of the more than 900 smart beta ETFs, about 600 have no exposure to Magnificent 7 stocks, according to Athanasios Psarofagis of Bloomberg Intelligence. In theory, this offers investors a way to gain market exposure beyond mega-cap tech stocks.

“Some categories have much lower concentrations, which may attract investors seeking lighter exposures,” the ETF analyst wrote in a recent note.

The big warning comes from industry promoter Nicolas Rabener. These types of ETFs generally offer a less sophisticated approach to quantitative investing compared to a market-neutral transaction, such as the AQR Equity Market Neutral Fund, he says. The latter, which bets on everything from value to momentum and places short bets, is up 16% this year.

“It appears that calls for the death of factor investing have been premature and still represent the most viable path for investors seeking to outperform stock markets,” Finominal’s Rabener wrote in a research note. early this year. “However, factors are as cyclical as stock markets, and portfolio construction and implementation is important.”

–With help from Justina Lee.

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