Quant models must adapt to strange times

StateStreet_LogoQuantitative investment models must have the power to adapt to unusual circumstances, such as conditions after the financial crisis or the Japanese earthquake, says Marc Reinganum, global head of active equities for developed markets at State Street Global Advisors (SSGA).

He is in charge of developing the investment firm's quantitative strategies, which seek to inform investment decisions by modelling market behaviour. Reinganum acknowledges these strategies have been criticised since the crisis for being “unresponsive”.

However, he claims sophisticated, “adaptive” models can generate yields even in unusual scenarios, for instance by recommending investment strategies that seem contrary to most investors' instincts.

“A good time to buy equities is when volatility is high,” explains Reinganum. “Usually that's when fear is great and prices are depressed. In 2009 you saw volatility at unprecedented historical levels. That was a time when, if you had the stomach for it, you should go in.”

“That's an example of when you want to have quantitative investing,” he added. “Because you're doing something that seems against the psychology of the moment.”

SSGA claims to be one of the pioneers of quantitative investing due in part to its deep historical databases that go back to the 1980s for most regions of the world. This allows Reinganum's team to test their models in different economic conditions.

The aim is not to predict crises, which in the case of natural disasters such as the Japanese earthquake is virtually impossible. Instead the idea is to model the way investors respond to unusual circumstances.

“It could be coming from a crisis in Greece, a Russian crisis, collateralised mortgages in the US,” said Reinganum. “The cause of the crisis can come from different angles, but how investors react to that is the telltale sign.”

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