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Text on screen: What are some of the potential advantages of quantitative investing?

Images of PIMCO trade floor

Nick Granger: I think people tend to use quant and systematic fairly synonymously. What we mean by either is really a process whereby the day to day trading decisions are delegated to a predetermined rule,

Text on screen: Nick Granger, Portfolio Manager, Quantitative Analytics

rather than every single trade being thought through by a human being.

Full page list graphic – Title: Potential advantages of quantitative investing:  Bullets: Creating diversification by removing biases, Greater scalability

And this approach, at least to my mind, has two distinct advantages over a more traditional discretionary approach. First of all, by being systematic, you can create sort of inherent diversification, by taking human biases out of the investment process.

I think another advantage of quant is, it allows for greater scalability. A lot of quantitative strategies rely on exploiting a small edge, which you want to repeat many, many times, be that across many markets, or multiple times through time. Quant traders are sort of thinking at a slightly higher level, in terms of building, researching, and refining the models that are themselves going to make those trading decisions.

So, our decision making is really about how we build the models and then how we allocate those models once they're active.

Text on screen: Do you think the markets for quant strategies have become crowded?

When you go and look at the data, you just don’t see that. It’s just not there in the data at all.

Images of Wall Street and the New York Stock Exchange

Given the way quants trade, especially things like trend following, there’s no way systematic strategies are going to be affecting S&P futures. They're just too small a part of the market.

But there are parts that it could affect. So if you look at small futures markets, things like orange juice, that is diversifying, it’s logistically easier to trade, quants tend to love markets like that, those are the places that you would go and look for crowding.

Split Screen: Text on Left – We don’t seen signs of crowding in small niche markets, Image on right: Orange juice cartons moving on a conveyor belt.

And again, we don’t see the signs of crowding any more in those small, niche markets than we do in the big markets.

I think something we have found, is the markets that tend to get crowded tend to be the ones quants like to trade. So, specifically, equities, and the vanilla futures markets. Once you move away from these, to emerging markets, to swaps, to mortgages, credit, some of the more esoteric commodities like iron ore, carbon emission, things like that, quants tend to be less active in these markets. There’s perhaps a slightly more healthy ecosystem where, if you take the

Images of an iron ore quarry

example of commodities, they're more dominated by producers and consumers than systematic traders. And that’s meant, on the one hand, diversification of these markets has remained high, but on the other hand, perhaps there is a little bit more alpha to exploit as quants are playing in a space where there are less quants operating.

Text on screen: How can investors think about incorporating quant strategies in their portfolios?

So, managed futures, I think, is a really good example of the benefits of a systematic approach.

Image: TITLE – Systematic trend-following. A line graph shows investing from a trend perspective, with no position at choppy markets, enter position when breakout move signals new position, and exit position when reversal of prior move signals position exit.

So, for our purposes, managed futures really means trend following, and it is as simple as this chart would have you believe. Essentially, you buy stuff if it’s going up, and you sell stuff if it’s going down. The skill is very much in the implementation: so, what type of trends do you target, how do you scale in and out of those trends, what’s the universe of assets you cover, and so on?

Trends has a number of really appealing properties, specifically diversification. And when you talk about human biases, and systematic being able to overcome these biases, trends is a great example, and then there’s a very common human bias to cut winning positions, and to cut winning positions too soon and take profit. And a trend following strategy, with the appropriate controls, is able to stay in those trends that go on longer and further than perhaps most people would expect.

Image: TITLE – Trend-following has historically provided diversification. SUBTITLE – When it was most needed. A chart shows the 10 worst quarters in S&P 500 since 2000, including S&P 500, SG trend, and difference.

But I think perhaps even more important, is it has extremely valuable defensive properties. And this means it tends to perform well in stressed environments, when volatility is going up, typically when equity markets are selling off

It’s been very good around some of the most recent crises, particularly the GFC in 2008.

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DISCLOSURE

The use of quantitative investment strategies to evaluate securities or securities markets based on certain assumptions concerning the interplay of market factors is speculative and may increase the risk of loss. Models used may not adequately take into account certain factors, may not perform as intended, and may result in a decline in the value of an investment, which could be substantial.  Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be appropriate for all investors. Managed futures contain heightened risk, including wide price fluctuations and may not be appropriate for all investors. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Swaps are a type of derivative; swaps are increasingly subject to central clearing and exchange-trading. Swaps that are not centrally cleared and exchange-traded may be less liquid than exchange-traded instruments. Derivatives and commodity-linked derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss.

References to specific securities and their issuers are not intended and should not be interpreted as recommendations to purchase, sell or hold such securities. PIMCO products and strategies may or may not include the securities referenced and, if such securities are included, no representation is being made that such securities will continue to be included.  It is not possible to invest directly in an unmanaged index.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product in any jurisdiction. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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CMR2021-0614-1680314