AQR Capital Management is tapping into investors’ deepest fears in its latest push to make quant strategies the next big thing in credit.
The pioneer of systematic trading is seizing on liquidity worries to make the case for its math-powered approach, which dissects assets by their traits like value and momentum. Dubbed factor investing, it’s reaped billions for stock traders — but remains an exotic technique in the land of corporate bonds.
AQR’s managing director says the technology that permits quants to sift through millions of securities makes their portfolios unique and better protected against liquidity risk compared with mainstream yield-chasing funds.
“We have continued concerns about the relative illiquidity of credit markets,” said AQR’s Tony Gould. “I would argue that because there are very few systematic managers, and often we may own different securities, we’re less likely to be affected by stressed liquidity conditions than fundamental managers that own similar positions.”
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Gould joined the factor pioneer in 2016 from JPMorgan Asset Management to help expand AQR’s franchise in fixed-income. Bloomberg News reported in June that the firm managed $3.7 billion in the asset class, up from $1.5 billion a year earlier.
Quants say factor styles exploit time-honored behavioral quirks, while arguing vanilla credit managers tend to outperform by simply bidding up higher-yielding obligations often without being compensated for the liquidity risk.
In this view, computer-driven players are less correlated with the broader credit market — boosting their counter-cyclical firepower in the process.
“A systematic process lends itself to providing liquidity rather than taking it because our models have views on effectively every single security in the credit index thanks to the broad set of systematic signals that we use,” according to Gould.
His critique has a visceral appeal after gut-wrenching swings across assets last month re-ignited fears about market depth. In Europe the average yield on high-grade debt recently fell below the bid-ask spread — a gauge for transaction costs — reducing the incentive to trade in fixed income.
But the claims by the AQR executive remain largely untested in a post-crisis bull market where traditional yield-chasing behavior keeps winning.
Fundamental bond managers argue their skills can stand the test of time. Those methods involve combining financial scrutiny of individual securities with analysis of market-wide risk, default prospects and volatility.
The average expense ratio among the leading 20 is nearly 40 basis points cheaper than what investors paid on average last year.
Poor liquidity is also a big foe for quants themselves — maintaining steady exposure is expensive given the transaction costs and the limited life of individual bonds. Their models constantly refresh signals tracking notes in an index to ride a given factor-investing style.
AQR’s Core Plus Bond Fund with $115 million ranks securities in the product’s universe by qualities like value, momentum and carry. Investment decisions are based on these fundamental perceived drivers of returns, rather than a narrow desire for credit or duration risk.
All the while the boom in exchange-traded products that promise to make baskets of bonds as liquid as stocks continues. AQR is keeping a close eye on the overlap between the holdings of its funds and ETPs, in the event rapid outflows exert pressure on the underlying securities, according to Gould.
“If there are large redemptions from ETFs, you might expect the bid-ask spreads of the names that they own would widen, as there is a pressure to sell those to realize liquidity.” — Additional reporting by Tasos Vossos
