What is Quantamental? The Definitive Guide and FAQ
A growing number of people are interested in this strange word, quantamental. So, we wanted to provide the first (according to Google) definitive guide and FAQ on quantamental investing. But, we also wanted to make sure that it could be understood by smart, but not necessarily Wall Street, folks.
Most people will NOT find this article spell-binding except for maybe the picture. But, we offer an informative guide from the perspective of someone that has invested billions of dollars professionally and developing a quantamental analysis system at Quantavista Labs.
Where is quantamental and what does it mean?
Quantamental combines two types of investment strategies, quantitative and fundamental. Quantitative investing generally uses Ph.D’s with complex algorithms, large computer systems and lots of data to invest in many securities. Fundamental investing uses analysis based on the bottoms up fundamentals of a company a la Warren Buffett.
How does quantitative investing work?
Using computer models and large amounts of current and historical data, quant investors try to predict the future prices of securities by looking at historically recurring patterns that look similar to current situations. The combination of data sources and patterns are called “signals” and used to predict the price of a security. Will it continue its trend(“momentum”) or will it reverse direction (“mean reversion”)? Important “signals” that define the performance and characteristic of a stock are called “factors” or risk factors. By far the most commonly used and successful factors over time have been Value (cheap stocks) and Momentum (stocks that are working). Surprise, surprise. Other popular ones are Growth,Volatility, Leverage, Size and Profitability.
What does quantamental investing generally mean?
The term generally refers to fundamental investors adding some type of quantitative analysis. Factor based idea screening provides an easy quantitative concept for fundamental investors. This means that fundamental investors will use an idea generation tool (often in Excel… yikes) that uses factors. This creates a small pool of ideas to spend more fundamental research on. One screen could be “Find me stocks that are the top 25% cheapest stocks and among the top 25% highest momentum stocks”. There are obviously more robust approaches to this that involve complex software. Another often mentioned quantamental approach uses using alternative data (see below).
Going quantamental helps fundamental investors performance since it : A) increases the level of discipline and process and B) leverages the power of machines. Unfortunately, the investing industry generally avoids change and we are likely years from a more systematic approach to fundamental investing.
Why is quantamental becoming an increasingly popular term these days?
The term is almost exclusively used by fundamental investors often for marketing purposes. These investors have two huge problems which this approach helps address: A) poor performance leading to asset outflows and lower revenues and B) high employee costs. This investing style adds discipline that reduces the emotional error that humans often make. It can also require a fewer number of expensive human investors.
Ironically, you will almost never hear of a pure quantitative firm talking about quantamental. The successful quant firms are conspicuously quiet, but smiling from ear to ear as their winning formulas mint money.
What is alternative data? How is it used?
Alternative data often gets mentioned as part of quantamental analysis. The term generally refers to data from non-traditional sources. The most commonly referenced examples in the press are satellite images, credit card spending data and foot traffic. A very small number of world class quantitative investing teams make a fortune out of harvesting these types of data sources. But, there are only a handful of stocks where this data can be applied, the data is usually noisy and the lack of a long data history makes the statistical significance questionable. It does make for great story telling though.
If everyone starts to know the winning factors and signals doesn’t this drive down returns for quant investors?
Yes! We are getting close to peak quant investing hype which seems to happens about every 10 years. The hangovers are usually pretty rough. Here’s a short history:
1987 — Portfolio insurance peaks then has a large hand in the Oct crash
1998 — LTCM rapid rise then liquidation
2007 — Goldman’s Global Alpha fund peaks at $12b before poor performance and eventually closing
2017–18?
But, during these types of bubbles, a virtuous cycle starts. Investors chase performance which adds assets to quant strategies. They in turn buy the stocks that are also owned by the other quant funds which further increases performance and inflows. The smartest guys in the room are even smarter when they’re winning. Wall Street loves to chase returns and what has worked until it stops.
One last thing:
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Originally published at quantavista.com.
