The period known as the “quant winter,” which afflicted quantitative mutual funds in 2018, has transformed, evolving from winter in late 2020 to spring and now into summer as Treasury yields have risen. This progression is not merely coincidental; it appears to be part of a more extended trend termed “quant climate change,” extending over decades rather than a mere season. While the three-year stretch of poor performance still lingers in the memories of quant investors, data suggests that this downturn was part of an ongoing and prolonged shift in the quant landscape.
Analyzing the foundation of quant investor portfolios, which revolves around factors such as value, size, or quality, reveals insights into the long-term trend of quant performance. Instead of focusing primarily on stock selection, quants typically concentrate on constructing a portfolio of factors, refining and experimenting with combinations to optimize returns. Factors such as value, profitability, size, investment, and momentum are widely acknowledged in the quant investment community. The analysis presented here employs these factors, with historical returns dating back to 1963.
The 10-year rolling average of the five-factor monthly average, representing a passive benchmark factor portfolio, exhibits a clear trend. Notably, the average return to this portfolio has steadily declined over three decades, showing a correlation with the path of Treasury yields. The green line in the chart illustrates the factor portfolio’s trend, while the blue line represents the yield on a constant maturity 10-year US Treasury bond. The quant winter, along with the recovery in 2020, is evident in the green line, aligning with the path of interest rates in the blue line.
In the mid-1980s and the first decade of the 21st century, the passive long-short factor portfolio return averaged about 7% yearly. However, by the beginning of this decade, that return dropped below zero before recovering—a manifestation of the quant winter and its recent thaw. The historical connection between factor returns and Treasury yields raises questions about its origin. A paper titled “Duration-Driven Returns” by Niels Gormsen and Eben Lazarus suggests a cash flow duration factor at the heart of many other factors, presenting a unified perspective on various risk factors.
The good news for quants is the apparent end of the prolonged decline in interest rates. Rates have reverted to levels last seen before the 2008 financial crisis, indicating that a replay of the quant winter is unlikely—assuming rates do not experience a sudden collapse again. This shift in the interest rate environment offers a more favorable landscape for quantitative investing, signaling the potential for improved performance in the post-quant winter era.
