The Quantamental Investing Buzz

Everyone’s doing it, but almost no one’s really doing it.

Quanta-what?

Quantamental is not even a real word and even feels like it has some dotcom-ish type hype. It generally implies investing based on the combination of quantitative + fundamental research. But, in late March ’17 Blackrock added legitimacy to the concept by announcing they’re shifting $30 billion(11%) of fundamental assets to this style. How has an investing style that’s not actually even a real word achieved such hype and billions of dollars of investments? In an other wise dismal active equity investing landscape it’s an alluring marketing story that combines the fundamental investing style of Warren Buffett and [Hedge fund manager X during his/her glory days] with the quantitative analysis of firms like AQR, Two Sigma and Bridgewater. 1+1 = 3, right?

But, these two types of investors approach investing in very different ways. Fundamental investment funds generally try to get a large edge on a fewer number of stocks (75–200 positions) and have longer holding periods (12–24 months). Fundamental analysts generally think about competitive advantages, returns on capital, market share, valuation, build financial models, visit factories and meet with management. Quantitative firms know far less about each stock, but have a deep understanding of the statistics and probabilities and typically have more assets and a larger number of positions (600–1,000+), but generally are shorter term oriented. They are trying to systematically extract smaller amounts of alpha edge from many more names.

This raises a lot of questions in a blended quantamental system even for companies like Blackrock. Which approach wins in terms of concepts like # of positions and holding period? What if the quantitative and fundamental analysis contradicts? What kind of skills do the analyst need? Do they spend their time analyzing data sets and applying statistics or visiting factories and thinking about structural advantages? What approach do they lean toward when the eventual large drawdown comes?

Everyone’s Doing It

There’s no official definition of quantamental and it’s a good story. So, many fundamental asset managers and hedge funds are talking about adding some quantitative-lite processes and calling their process quantamental. Most fundamental investment firms at the very least have some version of an idea screen, from a basic Excel spreadsheet screen using things like high earnings yield and returns on capital(Greenblatt’s magic formula) to maybe even using a multi-factor/screen that has been “successfully” backtested. But, these idea generation techniques just scratch the surface of a true quantamental process. Quantamental investing with a capital Q really means an integrated data driven approach throughout the investing process that leverages quantitative insights. Just like the moneyball philosophy in the MLB and dating in 7th grade, everyone says their doing it, but the reality is a much smaller number.

Almost No One’s Really Doing It

Implementing a quantamental investing approach is not just a technical problem for most fundamental asset managers. The bigger issues are the organizational problems:

1. Large upfront costs. Truly implementing a Quantamental process means hiring and building an entire quantitative research team and system. Making a multi-million dollar investment for a system when revenues and fees are under pressure is a tough ask. It’s much easier for a CIO/CEO to take a small, consistent reduction in revenue and hope for better performance tomorrow than to bite the bullet and take a large upfront cost on the unknown.
2. Scarcity of quantamental talent. There are only a small number of talented quantitative research experts to begin with, but developing a quantamental investing system is a different beast. There are few people that have a strong background in fundamental research + statistical/quant research+ software development. A common quantitative signal is short term (<5 days) mean reversion. What does a fundamental investor do with that information?
3. Product definition. There is no clear cut definition of what a quantamental system or process looks like.
4. Interaction with current fundamental analysts. Will the current fundamental analysts and portfolio managers feel see the quantamental system as a tool or a risk?

Imagine your boss saying this to you: “So, you think we should commit to spending millions of dollars on a system, finding unicorns for talent for an unknown product with unknown results?” Okay, when you put it that way it doesn’t seem so easy. This is why very few firms will likely fully embrace the quantamental approach. That is also why there is only one Theo Epstein. If it was easy everyone would be doing it. The few firms that do quantamental and do it well will be the winners of the current fundamental investment industry carnage.

It goes without saying that it is much easier for existing quantitative organizations to go quantamental than for fundamental ones. It’s no surprise that firms like Blackrock and Citadel are leading the way. Almost every fundamental asset manager will likely attempt some quantamental effort, but only a few will really make the leap and be successful.

Peak Machine Learning, AI and Big Data Hype

While we’re talking about buzzwords we have to mention concepts like machine learning, AI and Big Data that feel like an 11/10 on the hype-o-meter. Gartner seems to agree (see chart below). Fundamental investment firms are getting anxious and feel the “need for Ph.D.’s that can help with machine learning and AI.” It’s amazing how a few words can stir our imagination. Machine learning implies something futuristic out of Minority Report or Terminator where robots are building robots. But, if we call it data mining, it sounds more mundane. We can further deflate the hype by calling it automated data clustering. This is still an incredibly useful tool that a quantamental system should use, especially when combined with the unbelievably low cost, high power computing of the cloud. But, it’s not quite the sci-fi of tomorrow.

Gartner’s hype chart is always good. Machine Learning at the peak of peak.

Quantamental and dotcom Will Probably Have Similar Endings

To bring things full circle, dotcom was another made up word that actually became an official word in the Oxford dictionary in 2003. But, by then the term lacked the same meaning as almost every business was leveraging the Internet. (Whatever happened to Trilogy, pud and fc.com anyways?) We suspect quantamental may become an official word in the coming years, too. But, by then we’ll probably all drop the “quantamental” term and it will just be the way that most investment analysis is done. After all, why would you not want to combine quantitative and fundamental analysis?

For more information on quantamental investing, you can read “What is Quantamental? The Definitive Guide and FAQ”

What do I do?
After nearly 20 years in investing (including managing over $3 billion at Goldman Sachs Asset Management) and software development, I founded Quantavista, a company that offers predictive analytics and visualization software for institutional investors.

One last thing:

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