October 10, 2019
3 min read
Fintech and Innovation
Nicholas Flaherty, Investment Strategist at FWU Invest S.A.
Quantitative investing, often abbreviated to Quant, can sound daunting and complicated, but it need not be, so let’s unpack it for you and give you a holistic picture of what it is all about!
Let’s start with examining how ‘traditional’ investing works, which will give you a better idea of how Quant fits in. Traditionally, investment management is based on stock picking done by investment professionals, who examine individual companies by looking at the balance sheets, income statements, management commentary etc. In other words, the investment process is based on human evaluation of companies, and judgement is then used to determine what makes a good investment and what does not.
Quantitative investing, on the other hand, does not use human judgement to make investment decisions: the whole concept is built around systematic, repeatable processes. In other words, it is ‘rules-based’, whereby mathematical models are developed to find investment opportunities instead of relying on armies of analysts parsing through company data and making a judgment call on what is a good investment. In a nutshell, a quantitative approach lets the machine decide and moves beyond human judgement.
So, which approach is better? Of course, as we are a Quant house, we are to an extent biased, but the reason that we have chosen a Quant approach in the first place comes down to two distinct advantages.
Firstly, by using a systematic, quantitative investment strategy, we avoid falling into behavioural traps, meaning we do not let emotions interfere with our investment approach. This is a very important point because as Benjamin Graham – Warren Buffet’s mentor – noted ‘the investor’s chief problem – and even his worst enemy – is likely to be himself.’ As humans, we can very easily succumb to greed, for example, and hold onto stocks much longer than we should – as the Technology Bubble so vividly illustrated in the early 2000s. We are also likely to succumb to fear, like many did in the wake of 2008 crisis and subsequently missed out on much of the fantastic bull market that followed. But with a Quant approach, we look solely at the numbers, not letting emotion cloud judgement.
Using a quantitative framework, we can also be a lot more efficient. Let’s think about it – using a traditional fund management approach, if you want to analyse thousands of stocks, it means you have to hire a bunch of analysts and portfolio managers to actually sit down and go through balance sheets, income statements and all the rest of it.
But with a machine-driven approach, we can analyse thousands of securities very rapidly. In other words, it is much more effective at processing information and we can form investment decisions much faster. By analysing more stocks, we increase the chances of finding the right ones and, at the same time, we can very easily globally diversify – it doesn’t matter if we analyse 2 stocks or 2000, meaning the entire world of capital markets is at our disposal.
Going forward, as we move deeper into the era of Big Data, the ability of rapidly digesting and synthesising information will become even more valuable, meaning the advantages of Quant are likely to become even more pronounced. Hopefully, then, you have a better idea now of what Quant is and why we have chosen it as our investment approach!