The Intertek Group

Survey on Trends in Equity Portfolio Management 2006

Management Summary

This study follows on the 2003 study Trends in Quantitative Methods in Asset Management and attempts to register changes that have occurred since then. In all, managers at 38 asset management firms participated in the 2006 study; of these, 21 or 55% also participated in the 2003 study (Trends in Quantitative Methods in Asset Management – 2003 Update, The Intertek Group, 2003). The home market of participating firms is: North America 15 (of which USA 14,  Canada 1) and Europe 23 (of which the UK 7, Germany 5, Switzerland 4, Benelux 3, France 2, and Italy 2). Equities under management by participating firms range from €5bn to €800bn.

While most firms whose use of quantitative methods is limited to performance analysis or risk measurement declined to participate in this study (only 5 of the 38 participating firms reported no equity funds under quantitative management), the study does reflect the use of quantitative methods in equity portfolio management at firms managing a total of €3.3 trillion ($4.3 trillion) in equities; nearly two thirds (63%) of the participating firms are among the largest asset managers in their respective countries. It is fair to say that these firms represent the way a large part of the industry is going with respect to the use of quantitative methods in equity portfolio management.

Methodology

This 2006 report is based on survey responses and conversations with industry representatives. Conversations with the latter helped upfront in defining the issues to be covered by the survey and, with survey results in, contributed to a greater understanding of the results. Participants include persons responsible for quantitative equity management and quantitative equity research at large and medium-sized firms in North America and Europe.

Of the 38 participants in this survey, 2 responded only partially to the questionnaire. For some questions, there are therefore 36 (not 38) responses.

Management Summary : Key Findings Among the Sources

• Almost 30% of the survey participants (11/38) report that more than 75% of their equity assets are being managed quantitatively; this includes a wide spectrum of firms, with from €5 billion to over €500 billion in equity assets under management.

• 84% of the survey respondents (32/38) report that the percentage of equity assets under quantitative management has either increased with respect to 2004-2005 (25/38) or has remained stable at about 100% of equity assets (7/38). The percentage of equities under quantitative management was down at only one firm.

• One significant change with respect to the 2003 study: quantitative methods are now being widely used in active equity management, to find alpha.

• With the use of quantitative methods now so prevalent, participants say that it is getting hard 1) for long-established quant funds to differentiate themselves and 2) to improve on performance or find alpha given that everyone is using the same data, the same intuition, and the same modeling methods.

• 55% of the respondents (21/38) report that at least part of the equity assets are now being managed automatically with quantitative methods; another 3 plan to automate at least a portion of their equity portfolios within the next 12 months.

• The most important factor contributing to a wider use of quantitative methods in equity portfolio management is the positive results obtained with these methods; the prevailing in-house culture is cited as the most important factor holding back a wider use of quantitative methods.

• Phenomena most widely modeled are momentum and/or reversal (86% or 31/36) and trends (78% or 28/36).

• With assets under quantitative management and trading volumes up, modeling both the impact of trades and fund capacity have gained in importance: 67% (24/36) of the respondents model the impact of trades and 56% (20/36) model fund capacity.

• Modeling methodologies most widely used include regression on common factors and company-specific predictors (100% or 36/36), momentum and/or reversal modeling (78% or 28/36), cash flow analysis (47% or 17/36) and behavioral modeling (44% or 16/36). The increased use of behavioral modeling is perhaps the most significant development in return modeling; factor models and momentum and/or reversal models were adopted earlier.

• Modeling methods such as cointegration and non-linear methods are being used at roughly 20% of the firms (7/36 each). While these techniques have not been widely implemented, the use of these methodologies has grown with respect to the 2003 study.

• A greater use of multiple models for return forecasting is behind an increased awareness of the need to mitigate model risk: model averaging/shrinkage are used at one fourth (9/36) of the participating firms.

• 14% of the respondents (5/36) use high-frequency data (HFD), to identify profit opportunities and improve return forecasts; another 3 plan to use HFD within the next 12 months.

• Risk is measured at all firms: Risk measures most widely used include variance (97% or 35/36), VaR (67% or 24/36) and downside risk measures (39% or 14/36). Conditional VaR and extreme value theory (EVT) are used at 4 (11%) and 2 (6%) firms, respectively.

• Over 90% (92% or 33/36) of the respondents use some form of optimization: this is a significant development with respect to previous studies where most firms said they eschewed optimization. Among the optimization methods used, 83% of the respondents (30/36) perform optimization with mean-variance; 42% (15/36) use utility optimization and 25% (9/36) robust optimization methods. The use of optimization (together with return forecasting) is central to automating fund management, which 55% of the respondents have implemented for at least part of their equities under management.

• Stochastic optimization is being used at only 1 participating firm: Asset management firms wanting to play a role in asset allocation will have to master this technique.

• While investments in the IT infrastructure (data, computers, storage devices, software) are company-specific, three quarters of the respondents (28/38) report that they have increased the number of quantitative equity researchers.

• The profile of the portfolio manager is increasingly quant-oriented, but what is required is a skill set that also encompasses finance and economics.

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