- Barron’s – Black Monday 2.0: The Next Machine-Driven Meltdown
In the rise of computer-driven trading, some hear echoes of the stock market’s 1987 crash. Beware the feedback loop.
Quantitative investors understood early on that betting on stocks based on their characteristics—and not the underlying business fundamentals of a particular company—was a good way to outperform the market. So good, in fact, that many fundamental, or “active,” money managers now use quantitative tools to help construct their portfolios and ensure that they don’t place unintended bets. Nomura Instinet quantitative strategist Joseph Mezrich says that 70% of an active manager’s performance can be explained by quantitative factors. “Factors drive a lot of the returns,” Mezrich says. “Over time, this has dawned on people.” Has it ever. One result has been the rise of indexing and exchange-traded funds. The ability to buy an index fund based on the Standard & Poor’s 500—effectively a bet that large companies will outperform small ones—made the need for traditional fundamental research and stock-picking unnecessary. Since then, indexes and ETFs have been created to reflect just about any factor imaginable—low volatility and momentum among them. Some funds even combine multiple factors in a quest for better performance.