(Bloomberg) — Traders are pouring billions of dollars into quantitative-powered stock markets, boosting an investment style that is struggling to gain traction in a Age when simple bets on traditional large-cap indexes have yielded good results.
Money managers have sunk nearly $48 billion into so-called smart beta equity exchange-traded funds this year, either to capture the market's biggest winners or spread their exposures across the equity landscape.
Created by Wall Street's brightest minds decades ago, the rules-based allocation method breaks down stocks based on their characteristics, such as how cheap a company looks, its nominal value, or how fast its stock has risen. its, known as momentum.
After suffering outflows in January, these long-only systematic funds known to the retail crowd — and offered by BlackRock Inc. and Vanguard Group Inc. – have now enjoyed five consecutive months of inflows and are on track to beat 2023's tally.
“Performance holds its own, with growth, momentum and even valuation doing well in US markets,” said Patrick McDonough, managing director and portfolio manager at PGIM Quantitative Solutions. “The diversification focus is driven by investors looking to enjoy the beta flow that Magnificent 7 provided, but who want a divergence away from overcrowded trades.”
If these kinds of inflows continue their buoyant trajectory, 2024 will be a turnaround from last year, when investor interest in factor strategies proved muted — except for those who simply bet on the hottest companies like quality and growth. While the low-volatility factor has seen outflows for the past 14 months as markets remain bearish, ETFs that combine exposure to multiple factors have enjoyed inflows of nearly $12 billion year-to-date, according to the data. compiled by Bloomberg Intelligence.
Smart-beta ETFs are still on an extended streak of underperformance against the tech-led S&P 500 as billions are flying into vanilla equity funds week after week. But according to industry proponents, the investment style is working thanks to stable market conditions — and can help protect portfolios if things go south.
With Wall Street largely making peace with raised interest rates thanks to the stability of the economic cycle, trading conditions have proved stable enough for quantities to achieve stable profits by betting on reliable trading patterns. For example, assets have been rising and falling over a long period, in an incentive to follow the trend and related bets.
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 returned positive gains. A Bloomberg multifactor model — offering exposure to value, momentum, low volatility and profitability factors — has seen a nearly 13% advance.
Read more: Hedge funds ride the wave of trading momentum to net gains everywhere
Of the more than 900 smart-beta ETFs, about 600 have no exposure to Magnificent 7 stocks, according to Bloomberg Intelligence's Athanasios Psarofagis. This, in theory, offers investors a way to get market exposure beyond megacap tech stocks.
“Some categories have much lower concentrations, which may appeal to investors looking for less heavy exposures,” the ETF analyst wrote in a recent note.
The big warning comes from industry advocate Nicolas Rabener. According to him, these types of ETFs typically offer a less sophisticated approach to quantitative investing than a market-neutral trade like the AQR Equity Market Neutral Fund. The latter, which bets on everything from value to spot and places short bets, is up 16% this year.
“It appears that calls for the death of factor investing have been premature and it still represents the most sustainable path for investors looking to outperform the stock markets,” Finominal's Rabener wrote in a research note earlier this year. “However, factors are as cyclical as stock markets, and portfolio construction and execution matter.”