Most large lively fund managers today have each fundamental and quantitative investment teams. Historically, these two groups have sat in separate silos, and for good reason: they’ve different approaches to the investment process and speak different on a regular basis language.
The root of the gap lies of their respective educational backgrounds. Fundamental investors study economics and learn a bottom-up investing process that goals to find out the longer term value of a single stock. Quants learn math and engineering and take a top-down approach to investment decision-making that starts with an enormous amount of market data.
But fundamental investors have begun to include more quantitative screenings and models into their fundamental research as relevant data becomes more accessible and data science tools turn out to be more user-friendly. Today, most fundamental investors have at the least one typically spreadsheet-based quantitative screen – designed to discover valuation mismatches, environmental, social and governance (ESG) assessments, etc. – that informs their investment process. Some have a number of screens – and a resident quant analyst sits next to them.
It’s an issue of evolution.
The term “quantamental” could have elicited more eye rolls than approval out there, but prefer it or not, even essentially the most die-hard fundamental investors have gotten quantamental.
In many forward-thinking corporations, quantitative research leaders rise to leadership positions where they’re tasked with bridging the gap between the corporate’s fundamental and quantitative investors—or at the least leveraging resources from each groups.
But finding common ground is simpler said than done. Fundamental investors still hold a lot of the power inside these corporations and infrequently have little interest in coping with the quants. At best, they find it obscure the language; at worst, they perceive the Quants as a threat. Meanwhile, true quantitative researchers often find that fundamental investors cling to old and outdated ways of pondering. In fact, many quant-only shops emerged from a rejection of the elemental approach.
So which of the 2 philosophies produces higher returns? Since there’s little scientific research on this topic, there isn’t any clear answer. Campbell R. Harvey, Sandy Rattray, Andrew Sinclair and Otto van Hemert compared hedge fund managers from 1996 to 2014. and located little or no difference between the performance of systematic and discretionary managers, particularly in stocks. More recently, in a study of US stock funds from 2000 to 2017Simona Abis concluded that quant funds outperformed their discretionary peers during non-recession periods, while mutual funds outperformed their quant counterparts during recessions.
Both primary schools and quantum schools have their strengths. The former provides clear explanations, consistency over time and between possibilities, and subjective evaluations of complex topics. The latter now uses some great benefits of scaling, objectivity and sensitivity evaluation. But these two philosophies have natural conflicts. It is difficult to be objective and subjective at the identical time, to strive for clear explanations within the face of complicated equations, and to consistently discover real alpha-generating opportunities fairly than data mining artifacts.
But on a recent call with a head of quantitative strategies at a big and predominantly fundamental asset manager, we explored the similarities between quantitative and fundamental investing – and I became much more convinced that success in today’s market requires a hybrid approach that’s one of the best uses from each worlds.
When we explained that at Essentia we use behavioral evaluation to assist fundamental managers take into consideration their very own decision-making, this quant expert was really excited. “This is the same approach we would take to develop a quantitative strategy,” he said. “We look for the factors that make a difference in performance. But you put it into language that the basic managers will understand and tools that they will use. This will be intuitive for them. I could see that being really helpful.”
In other words, he identified behavioral evaluation as a natural way for fundamental managers to fill a spot of their process by applying quantitative evaluation to their very own decision-making to check and refine their existing human-driven investment models.
And what if more quant managers subjected their very own processes to such scrutiny? Finally, we’re all aware that quantum models keep in mind the biases of their human creators. Furthermore, few quantitative strategies are fully computer-driven each day: human decisions often take precedence over the model, or at the least update it periodically. While quants thoroughly test the algorithmic decisions their models make, they have an inclination not to use the identical objective and rigorous evaluation to their human decisions.
While fundamental and quant managers may not formally merge their investment approaches within the near future, each will profit from acknowledging that they’re increasingly combining human and machine-driven aspects – just at different scales. And each will find value in it Reflection on the standard of the selections made within the investment processwhether this process is controlled by people or machines.
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