“That’s amazing,” said a client. “Why doesn’t everyone invest that way?” Much as it pains The Value Perspective to admit it, the client was not enthusing about value investing but the potential of ‘quantitative’ funds, which rely on sophisticated technology and computer algorithms to analyse data and then buy and sell stocks according to set market strategies – all in the blink of an eye.
While we would agree these ‘quants’ funds can do some amazing things, However, investors should never lose sight of the fact they are only as good as their underlying programmes and systems – and, crucially, the people who type in those programmes and manage those systems. Some do this very well but others, as a number of high-profile cases have dramatically illustrated over the years, do not.
Take the recent example of Everbright securities in China, the stellar record of whose trading system was somewhat tarnished on the morning of 16 August – all in the blink of an eye. In just a couple of seconds, the system managed to generate 26, 082 ‘buy’ orders, snapping up every single stock that was for sale on the shanghai composite index at the time and pushing up the whole stockmarket by 5.62%.
According to the China Securities Regulatory Commission, this was “an extreme case without any precedent” since the Chinese stockmarket was established and the body is still looking into the matter. At present it appears a number of layers of examination and risk control all failed at the same time and the system was also missing a particular fail-safe component.
No human error as such has been identified although the two seconds of computer-generated chaos was brought to a close by a very human action. When traders realised something was amiss and there was no other way to stop the ‘buy’ orders being generated, they pulled out the internet and power cables – a very low-tech solution to a very high-tech problem.
Living as we do in an age of extraordinary digital innovation, people tend to think of computers as all-knowing and rational, but the truth is they are only as all-knowing and rational as the all-too-human human beings who type in the data, monitor the systems and so on. Unlike humans, computers always do exactly as they are told. That can indeed prove amazing – though not universally in a good way.
Whether they work with active or quants-based strategies, all professional investors have emotions and they can make mistakes – and, just as a value-driven or indeed any other equity investment style relies on the skill and judgement of the manager in charge, a quants fund is reliant on those programming the computers. It follows that, just as investors need to ensure they trust any active fund managers they use, they need to ensure they trust the people behind a quants process as much as the process itself.