Traders have learned a lesson on just how hard it is to apply factor investing, which conquered equities, to credit markets.

“The circumstance that we are talking about is a demand from the financial system and from the economy for liquidity that is really unprecedented,” the fund manager said from New York.
His team’s $US1.6 billion ($2.5 billion) BlackRock CoreAlpha Bond Fund has returned 2.4 per cent this year, beating most of his peers but lagging its benchmark.
As buyers vanished during the market rout, quants have had to determine the trade-off between following their algorithmic buy-and-sell signals and paying for the transactions. On many occasions last month, it simply wasn’t worth it.
Robeco fund manager Patrick Houweling says the sell-off has shown just how much human oversight is needed in systematic trading in stressed situations.
At BlackRock, as liquidity freezes, the team’s model automatically demands a much stronger signal to warrant transactions, driving turnover “way, way down”, Rosenberg said.
A typical multi-factor credit portfolio might have lost 12 per cent last quarter, narrowly beating the market’s 13 per cent drop, according to JPMorgan Chase & Co.
But more realistically the systematic cohort would be down 14 per cent after excluding the least liquid names, which investors are unlikely to have been able to trade.
In the high-yield market, a multi-factor portfolio would lag even without liquidity constraints, strategists Shivam Ghosh and Saul Doctor wrote in an April 9 note.
Blessing in disguise
For now, the inability to offload positions may turn out to be a blessing in disguise.
The credit market has calmed after extraordinary intervention by the Federal Reserve. US investment-grade bonds are yielding 2.1 percentage points above Treasuries, compared with as much as 3.7 percentage points in March the highest since 2009.
Regardless, quants are picking through the debris to see what lessons they can take from what ultimately looks like a once-in-a-decade event.
Robeco fund manager Patrick Houweling says the sell-off has shown just how much human oversight is needed in systematic trading in stressed situations.
“We still have some discretion in the execution and in timing trades or deciding whether to do it or to postpone,” he said. “Especially in these exceptional circumstances, it’s better for a human being to watch over shoulders of the model.”
It took his firm days or even weeks to re-balance portfolios, much longer than normal. That means if models were flashing big opportunities, quants found it hard to pounce.
Some systematic funds were forced to intervene in their algorithmic models to capture the game-changing shifts in economic and market conditions spurred by the virus essentially acting more like their human peers.
Rosenberg has had to “downweight” the fundamental signals in his credit strategy because of an epic gap between pre-virus corporate data and today. His $US949 million BlackRock Systematic Multi-Strategy Fund is narrowly ahead of its benchmark.
Relative value
Of course, it all depends on how these strategies are implemented. Long-short factor returns were positive throughout last quarter, since they tend to be a bet on higher volatility, according to JPMorgan.
Factors that do well when credit spreads are falling have dragged down returns this year. These include carry, which bets on higher-yielding notes, and value a wager on debt that’s deemed cheap relative to fundamentals, according to Harald Henke, head of fixed-income portfolio management at Quoniam, a German quant shop.
At Robeco, value and size a factor exposed to small caps detracted from performance. But momentum, low risk and quality helped, says Houweling.
His credit fund outperformed its benchmark and most rivals thanks to its defensive tilt. Like his discretionary peers, he has hopes that large dislocations in the wake of the market shakeout will now fuel better returns.
“Some sectors or companies will be hit more than others and mispricings will be larger or momentum scores will be more different,” he said. “In market downturns, you’ll see larger dislocations and more relative-value opportunities.”