Quantitative Investments

Do you know that Quantitative Investment Strategies have significantly outperformed the S&P 500 in bull and bear markets over the past 20 years?

In a world where technology has changed nearly every facet of our everyday life, fund managers and investment banks have aimed to get a leg up on their peers, employing quantitative analysts (“quants”) to build superior trading strategies. The work that these quants perform is called quantitative analysis. It involves building complex computer models to parse through massive data banks to build trading strategies. These strategies can search for specific trading patterns to predict the direction of securities, and or specific ratios or combinations of ratios like Price-To-Earnings (P/E), and Debt-To-Equity to spot inefficiencies in the market before others do. 

The ultimate goal of these proprietary models is to generate superior returns while maintaining rigid risk control.  There are more than 65 quant ETFs to choose from, as well as a large number of quant mutual funds. 

Why use Quantitative Investment Strategies?

Given that computers can analyze large groups of investments simultaneously and implement screening processes to rank them, they clearly have a significant advantage over the average individual investor or research team. Not only can they crunch enormous volumes of data at a rapid pace, but they can rank this data objectively. This is a massive benefit, as the results derived from the models are void of confirmation bias. Of course, the benefit of consistency and objectivity is only as good as the quants running the strategy. 

The other major advantage is discipline, with quant trading strategies not subject to emotion when executing trades. Allowing human emotion to seep into a given strategy can weigh significantly on investment returns and is often the downfall of the average individual investor. There is clear evidence of this outperformance in historical returns, with the average quant fund returning more than 15% annualized over the past twenty years, well above the returns of the S&P-500 (7%). The best quant funds have returned closer to 19% annualized over the past 20 years, and have also outperformed since the secular bear market bottom of 2009.

While there are clear benefits to quantitative strategies, there are risks, with the major one being the shortcomings of relying on historical data. As we saw in 2020, the humans beat the quants with the top-10 performing hedge funds dominated by stock-pickers with returns ranging from 30% to 74%. This shouldn’t be overly surprising as there’s no way to model a once-in-a-century event like a global pandemic. 

Quantitative vs. Qualitative

Quantitative analysis focuses on information about quantities, and therefore numbers.Quantitative Investment Strategies are governed by sets of rules and are typically rigid, aiming to deliver higher returns by uncovering inefficiencies in the market. Many of these models typically involve analyzing balance sheets, cash flow statements, and ranking stocks based on relative attractiveness to build portfolios. Other Quantitative Investment Strategies use patterns to predict market direction, or combining dozens of inputs together. These strategies can include mean reversion and momentum, relying mostly on technical signals for their inputs. 

Qualitative analysis focuses on data that is descriptive, which can be observed but not measured.  Qualitative Investment Strategies focus on the qualitative characteristics of both stocks and assets, and this analysis is much more subjective. This could involve personal views on a currency or global market related to a projected shift in monetary policy or taxation, or views on a stock’s eventual profitability based on its new product, or the hiring of a new Chief Executive Officer or Chief Operating Officer. 

While quantitative funds have outperformed many non-quantitative funds over the past 20 years, the importance of qualitative analysis should not be minimized. This is because even if a company has a superior product or service, it could fail miserably without the right management team, the right management style, entry into the wrong market, or adverse upcoming changes in government regulation/taxation. Given the ever-changing landscape and disruption to many industries, qualitative analysis can often spot potential value traps much better than a quantitative strategy that dispassionately focuses solely on financial statements, and not the big picture. 

How to Invest Using Quantitative Investment Strategies

The massive benefits of quantitative investment strategies cannot be understated, with the average quant fund easily outperforming the S&P-500 over the past 20 years, with a (+) 15% annualized return. Some of the major pros and cons worth considering are as follows: 

PROS

• Less scope for human error, with mathematical models taking care of stock selection, and risk control.
• Dispassionate decision making, with investors not missing out on opportunities due to their inherent biases or the biases of their fund managers. 
• Systematic transaction timing, with quant strategies being able to navigate volatile markets without being exposed to fear or greed, which plagues most individual investors, and even some of the best fund managers occasionally. 

CONS:

• Quant funds are only as good as the humans that run them, so quant fund managers should be vetted just as much as the strategy.
• Quant funds might be able to decipher the past 50 years better than any group of humans, but they struggle to predict the next 10 years, and lack the creative abilities of typical fund managers. 
• Quant funds are less likely to pay attention to important qualitative aspects like company culture, leadership quality, and the regulatory, environmental landscape, which cannot be ignored in an increasing ESG-focused market landscape. 

Given that there are dozens of different quantitative investment strategies out there, and tens of thousands of different variations, knowing which quant strategy to employ is not easy. The solution for those looking to profit from quantitative investment strategies is investing in quant ETF and mutual funds with proven track records and decades of data, which have uncovered the superior blend of strategies to fit most market cycles. A simple search on Magnifi indicates numerous ways for investors to access Quantitative Investment Strategies with low fees.

Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.

The information and data are as of the October 27, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.