Abstract

Quantitative investing relies on stable data generating processes and limited human involvement, which could create lower flexibility in the face of changing economic conditions. In this study, we examine quantitative investors’ ability to navigate a common and material change to the financial data generating process: new accounting standards. We find that returns of quantitative mutual funds temporarily decrease following the implementation of standards that change the definition of key accounting variables. The lower performance we document is relative to more traditional “discretionary” funds that rely heavily on human skill and judgment to make day-to-day investment decisions. Our result is predictably concentrated among value funds, which rely heavily on accounting data, and absent among funds slanted towards price-based strategies, including momentum and size. When we further investigate funds’ operations, we do not find that quantitative investors change their overarching strategies in response to accounting standards, but we do observe excess portfolio turnover. Overall, our results highlight a significant adjustment cost associated with accounting regulation that could become even more significant as more investors rely on quantitative strategies.