IMPORTANCE OF QUANTITATIVE INVESTING
CORAL GABLES, FL.; MAY 2018 -- If you don’t have quantitative strategies in your investment portfolio you might be missing out. Automated, algorithmic investments is the single fastest growing investment category and may be the dominant style of investing process in the future. Morgan Stanley’s estimated that “quant” strategies have grown 15% annually over the past six years and control ~$1.5TN in assets under management. The trend is likely to continue for years to come as many traditional investment managers, hedge funds and even mutual fund groups are reinventing themselves as more computer-driven firms.
What is quantitative investing: The idea of quantitative investments is often misunderstood. Contrary to popular belief, it is not robo-trading in a back room nor is it a high-frequency trading based on math and physics models without regard for economic or investment principles. Today’s quantitative investing covers a wide range of investment approaches from simple factor investing to strategies powered by artificial intelligence. All these approaches have one thing in common – they are based on a principle of systematic implementation of traditional investment principles harnessing the power of computers to quickly process vast amounts of data.
Why go quant: Quant approaches can deliver a wide range of benefits from better performance and lower fees to portfolio optimization and low correlation benefits. According to a study by Phillips, Hager & North, a broad range of quants outperformed fundamental investors seven out of the last 10 years.
Systematic approaches can avoid emotional pitfalls in investing. Greed, fear and holding onto positions for too long to recover losses are common emotional reactions when investing that are eliminated by using quantitative investing. Another reason to consider quants is that they often run on a lower cost basis than many traditional investment managers. Assuming a 10-year investment horizon and a 10% annual return, a mere 0.5% difference in annual fees would lower value of an investment portfolio by 12% of the initial investment or 4.5% of the future value. Finally, investors should not ignore diversification benefits. Well-executed quantitative and fundamental approaches can each deliver strong uncorrelated performance results. Combining them could significantly enhance your portfolio.
Quantitative vs fundamental investing: Performance of quantitative and fundamental portfolios are driven by very different things. Traditional fundamental investing relies heavily on company or industry-specific factors (product, business plan, industry dynamics, quality of management, etc). More often than not, these factors are hard to quantify and difficult to apply systematically. As a result, fundamental portfolios tend to be more concentrated with high exposure to specific companies. Quantitative investing, on the other hand, focuses on market-wide factors (momentum, growth, niche market anomalies) and tend to have a large number of holdings with small individual positions. Quants’ ability to quickly and systematically analyze the data provides them with a clear edge in this area.
What to look for in quants: Not all quantitative strategies can deliver outperformance or can demonstrate credible differentiation in their approach. Here are a few things to look for:
- Unique insights: To avoid the issues resulting from the crowding of factors, look for hard to identify and unique insights, differentiated data sources or proprietary signals. Strategies that leverage less-exploited relationships between data and expected returns tend to do better.
- Low assets: Everything else being equal, a modest level of assets under management is an advantage. A fund (and quantitative funds are no exception) cannot grow indefinitely without sacrificing potential performance. This is particularly true for higher portfolio turnover approaches which use short time investment horizon for unlocking value. Look for funds that understand this limitation and are willing to limit assets under management to prioritize returns for their clients.
- Suitable fees: Higher fees drag the performance of your portfolio. Be aware of fees that are too high for the expected added value.
While higher quality risk-adjusted returns strategies may warrant higher fees, simpler and highly automated factoring strategies should be balanced with relative low fee structures.
Quantitative strategies are likely to be applied to a larger share of your investable assets in the future. Understanding advantages and potential pitfalls of this investment category can add a significant value to your portfolio today.
Sources: Financial Times; Phillips, Hager & North; Guzman & Co.
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