Maths-savvy, computer-toting investors have already disrupted traditional tactics in asset management. Next in their sights is the red-hot private equity world.
Private buyout funds are basking in enormous investor appetite, and have less pressure on fees than their counterparts in mainstream asset management.
Morgan Stanley estimates that revenues from private capital will reach nearly $70bn a year by 2023, accounting for the biggest chunk of the global investment industry’s overall income by that point.
That is attracting attention in parts of the quantitative investment industry, which sifts through huge data sets and markets for patterns they can exploit through automated, algorithmic trading. Some so-called quants are now exploring whether their systematic, data-intensive investment process can also work in more opaque, private corners of the system, potentially significantly lowering industry fees.
“It’s been a dramatic enhancer of returns in every industry, and private equity will be no different,” said Wray Thorn, who oversees private investments and ventures businesses at Two Sigma, one of the world’s biggest quantitative hedge funds.
Private equity is different from traditional quant investing. The former consists primarily of bespoke, negotiated, multiyear investments in private companies, where information is often murky and exiting a trade can be tricky. The latter is focused on mainstream, liquid and transparent markets such as equities and futures. Trades can last for months but frequently span just seconds, and are largely automated.
There is therefore a variety of approaches being pursued, with varying degrees of complexity, novelty and challenges.
Two Sigma first set up a private investment group in 2008 to manage some of the company’s own internal capital. Last year it was quietly relaunched as Sightway Capital, went on a hiring spree — lifting the number of employees from 15 in 2015 to about 40 today — and is now raising external money for the first time.
The Massachusetts Pension Reserves Investment Trust earlier this year approved investing as much as $500m in Sightway. Two Sigma declined to comment on any fundraising, but Mr Thorn said that “in the coming years, we believe that private equity firms that use more information and advanced approaches to decision science will have better outcomes”.
Sightway’s focus is on financial services and “real assets”, such as infrastructure, real estate and even agriculture, but so far it has primarily started new companies in niche, data-intensive areas such as railcar and aircraft leasing, rather than buying existing ones.
Man Group’s Numeric unit last year launched a fund that attempts to replicate the returns of a typical private equity fund but at a fraction of the cost, by investing in small, listed companies that can mimic the profile of a typical private equity portfolio.
Man Group declined to comment on the fund’s details, citing regulatory restrictions, but Greg Bond, Numeric’s director of research, predicted that this is just the beginning of quant efforts to reshape private equity.
“[Private equity] is a successful business model, but that creates inertia, and we’re at an inflection point where we’ll see the quantitative approaches we’ve seen in the public markets come to the private ones,” he said. “We’ve seen systematic approaches in equities, high-yield, even sports and real estate. Private equity is different, but arguably you can apply systematic principles everywhere.”
AQR, the investment group founded by investor Clifford Asness, is also exploring how to break into the industry, perhaps by buying stakes of existing private equity funds that are traded between wealthy investors to create a cheaper, more diversified and better-performing portfolio.
The Greenwich-based company declined to comment on its plans, but in a blog post in February Mr Asness mocked the private equity industry’s promise of uncorrelated, smooth returns, attributing their potential gains to subjective quarterly valuations. In an interview with the Financial Times in 2018, he said that “there’s a lot of room to charge a third of what they charge and have an interesting product”.
Perhaps the most ambitious project is CircleUp. Initially started in 2012 as a platform to match aspiring entrepreneurs and budding venture capitalists, it has now built a machine-learning system that tracks the digital footprint of 1.4m companies in North America — primary in retail and consumer goods — to gauge how they are doing. It is raising a fund that will systematically invest in the hottest ones.
“Our thesis isn’t that we’ll have better analysis than KKR or Blackstone. But I do believe we can get better, broader exposure through analysis of all this data,” said Rory Eakin, one of CircleUp’s founders.
How successful quants will prove in fields far from their home turf remains murky. Most investors will prefer the familiarity of names such as Blackstone, TPG, KKR or Carlyle to novel efforts from institutions with little record outside the systematic trading. The industry’s giants are themselves setting up data units to help their investment process.
However, some quants argue that the core principles of their field — massive data sets, systematically mined for better insights — will, over time, also invade the private equity industry, just as it has other corners of the asset management world.
“We believe quant will come to private equity,” said Mr Eakin “There’s an opportunity for a much more data-driven approach.”