Wednesday 3 February 2021

Q&A with Peter Oertmann

What themes that have become more prevalent in quant investing as a consequence of the pandemic? Peter Oertmann, board member of Inquire Europe, shares his insights. 

What is your outlook for 2021?

I expect 2021 to be an above-average year for equities. Currently, the expectation that this year will see a breakthrough in overcoming the Covid-19 pandemic through global vaccination is becoming more solidified. This gives us hope that our life will be more free again and that the economy, which was severely shaken by the global virus outbreak, will recover significantly. The capital markets also started the current year with this basic optimism, which had already become apparent in the second half of last year.

In addition to the positive expectations regarding an effective solution to the global health crisis, all risk-bearing assets are also strongly supported by the sustained ultra-expansive monetary policy of the central banks and the enormous fiscal stimulus in key industrialized countries. Against the backdrop of the monetary situation, in particular the explosive growth in government debt and the growing inflationary expectations in some places, equities will also benefit from their status as a real asset class.

In the difficult search for return opportunities, equities will clearly be the focus of many investors, alongside traditional real asset classes and investments in private markets e.g. for loans or private equity. This structural demand will make equity markets resilient. However, on the way towards significant results in the fight against the pandemic and hopefully a complete normalization of our lives, there will be surprises and of course also setbacks, meaning that the capital markets are likely to remain fundamentally very volatile in 2021.

2020 was a difficult year for many quant funds due to the unforeseen volatility caused by the Covid-19 pandemic. Some experts speculate that this was because there is no historical data to rely on which resembled the shock. Now that this data exists, will quant investors be better prepared to cope with another pandemic, if one should arise?

Although the threat of pandemics is not really something new, the emergence of Covid-19 sent the world into a state of shock in the first quarter of last year. From a capital markets perspective, it was an exogenous shock, almost a textbook example. And because the impetus for entering the crisis was entirely external to financial markets, classical quantitative models did not begin to process the crisis until the new situation was reflected in asset prices and interest rates.

Perhaps quantitative approaches with broad-based modeling of market sentiment or based on alternative data entered risk-off mode a bit faster last February. But the use of alternative data in investment processes is, as we know, quite new territory. Although new data tracks have been laid and new experiences gained, I am not very optimistic that quantitative funds will be able to handle exogenous shocks like a pandemic much better in the future. Exogenous influences are too heterogeneous for that. It is probably a little different each time and therefore difficult to grasp systematically. It is also the case that capital markets are extremely driven by political and monetary policy decisions during global crises. These are often very sudden macroeconomic regime changes with which quantitative investment processes naturally have certain difficulties.

Apart from the recovery from the pandemic, will there be other exogenous factors that could impact your investment decisions/strategies in the coming year?

Very few factors are truly exogenous to the markets. The vast majority of factors with a relevant influence on asset pricing are endogenous, have primarily either a macroeconomic or a microeconomic context, or are anchored in politics, monetary policy or geopolitics. Because market participants have experiences with these, the processing of new stimuli from these directions is highly efficient in the market aggregate. Even such issues as climate change or people's increasing preference for sustainable economic activity are not exogenous, but already firmly integrated into market price formation.

In the current year, the main focus will be on aligning the medium-term strategic asset allocation and the selection of sectors and styles in equities with the so-called new reality. The Covid-19 pandemic is clearly a game changer in our lives and lifestyles. People's preferences will change very noticeably. Business models will disappear and new ones will emerge. This is definitely where the biggest challenge lies in short-term capital investing. Currently, we can only base our decisions on assumptions and we still know little about the new regime of our lives.

What themes that have become more prevalent in quant investing as a consequence of the pandemic?

In 2020, we once again experienced that price formation in today's markets is highly complex in every respect. It was not only elaborate quantitative models that were extremely challenged, but also investment professionals. Who would have thought in March 2020 that the S&P 500 would have already recovered its substantial losses after the Covid-19 outbreak the following summer? But it is not as if nothing has happened. A great deal was playing out in the background. The last stock market year has been marked by significant sector and style rotations. In this environment, tactical skills based on conditional allocation models, for example, were very useful. Perhaps the pandemic was a trigger to review and improve tactical capabilities and risk management through modern quantitative approaches.

At times, there was also the impression that fundamental company data was completely revalued. Some observers thought that they could see that valuations had completely decoupled from the real economy. This means that valuation models need to be thought of much more holistically and set up more flexibly to better handle more frequent regime changes in the capital market.

Finally, today's options for incorporating alternative data into investment processes seem to have become a bit more dazzling again as a result of last year's experience. In all of these areas, machine learning from big data and the development of artificial intelligence will become more important in the investment decision process. Inquire Europe will follow these new themes very closely in its role as a sponsor of applied research and a host of conferences targeting quant investing.