Crowded quant trades prove a headache for UBS hedge fund picker

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(Bloomberg) -- Turns out that human investors aren’t the only ones prone to following the herd.

Quantitative hedge funds, especially those that bet on rising and falling stocks, have by and large moved in tandem since the beginning of last year, mimicking moves by broader market benchmarks. For UBS Hedge Fund Solutions, the world’s second-biggest investor in hedge funds, that’s proving to be a problem.

“Despite going to great pains to build diversity in our equity book it reacted for the most part in unison at the very time we would have wanted diversification to kick in,” Andrew Craighead, head of Investment Specialists at the $35 billion asset manager, said in an interview in Singapore. “It makes us want to bang our heads against the wall.”

Investors from Steve Cohen’s Point 72 Asset Management to Singapore’s sovereign wealth fund GIC Pte are embracing quantitative models as they seek to gain an edge amid muted market returns. Yet, the surge in popularity of such strategies has resulted in a flood of capital chasing the same investment themes. And that’s impeding efforts by investors to build portfolios that are uncorrelated to market moves and deliver benchmark-beating performance.

“We believe one of the reasons is the amount of capital that’s gone to some of the large managers which has led to crowding of trades,” said Craighead. “We were disappointed to find that some of the big platforms, some of the more sophisticated funds, were exposed to common factors that had an impact across the board.”

The HFRI Equity Hedge Quantitative Directional Index advanced 5.2 percent this year through May, beating the 3.3 percent return posted by the overall hedge fund industry, according to data from Hedge Fund Research Inc. Still, it trailed the MSCI World index of global stocks, which advanced more than 9 percent over the same period. Last year, equity quant hedge funds trailed the industry for the first time since 2011, the data show.

UBS Hedge Fund Solutions is the world’s second-biggest hedge fund of funds after Blackstone Alternative Asset Management, according to the Institutional Investor website. The unit of UBS Group AG employs about 110 staff in North America, Asia and Europe and has 36,000 hedge funds in its database while on average starting research on 400 funds per year, it says on its website.

Craighead isn’t alone in pointing to deficiencies in one of the fastest-growing areas of investment management.

Sometimes those funds “can move in correlation with each other,” Eric Nierenberg, chief strategy officer at the Massachusetts Pension Reserves Investment Management Board, known as PRIM, said this month.

The reason is “probably because quantitative processes start with a conceptual mindset that’s similar. Even though the specific trading algorithms and portfolio construction methods may be different, there is probably some sort of common exposure that runs through quant processes that can cause them, at certain times, to be more highly correlated,” Nierenberg said.

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