Blind trust in computers – this is an often-heard prejudice regarding quantitative investment strategies. Computers are indeed an essential tool in analysing prices of hundreds of stocks. They also help you keep a cool head and choose the best stocks for your portfolio on the basis of objective data. Our more than 10 years of experience shows that added value can be generated with our in-house stock-picking model, which is a quantitative approach that is not based on our own forecasts. Our track-record also demonstrates that outperformance is possible even on highly efficient markets.
As with discretionary management, quantitative management features many different approaches to investing on the equity markets. There are both highly focused concepts that concentrate on a single factor such as momentum, and highly diversified, multi-factor variations. As varied as they might be, all these approaches share in common the specific advantages of quantitative management.
Its first advantage is its ability to systematically cover a large investment universe. Let’s take the European equity market as an example, as represented by the Stoxx 600 index. A quant manager is able to track and analyse the price performances and fundamentals of all 600 stocks in this index at all times and to make his selections backed by the information produced by his model. He can thus address a broad investment universe and enhance his opportunities for selecting attractive stocks and taking on successful exposures. A discretionary manager, in contrast, can research only a limited number of companies in depth and is therefore limited in his selection opportunities. This lessens his probability of outperforming. In our portfolio we select 100 stocks from the Stoxx 600. This gives us greater opportunities to find attractive stocks while allowing us to be better diversified, which limits losses as much as possible.
The second advantage of quantitative management is that stock-picking is based on prescribed rules that are presented to investors in detail and that can be disclosed transparently. Moreover, the systematic use of these rules makes it possible to measure their efficiency in a precise manner. The fund manager is thus able at all times to analyse and explain the results achieved. Seen from this angle, quantitative management is fundamentally far more transparent than discretionary management. However, there are also differences here among quant managers. When investment decisions are made on the basis of complex mathematical models it is difficult or impossible to illustrate in a detailed manner the various factors underlying investment decisions and to explain the logic behind each one of them. This “black box” phenomenon is often encountered in models that are based primarily on mathematical or statistical optimisation.
There is a third advantage to quantitative management – the almost complete elimination of “emotions”. Studies in behavioural finance have found that emotions play an important role and can ultimately be counterproductive, particularly in times of market stress. To hedge this risk, the quant manager takes a systematic approach and applies it in a consistent and disciplined manner. Trend-following momentum strategies can even achieve outperformance by systematically taking advantage of market participants’ irrationality (this part can be cut out or put into a footnote if it is essential). During the 2008 financial crisis our portfolio suffered relatively steep losses compared to the market as a whole. At the time, the temptation was great to flout our own rules. And yet, we stuck to the guidelines of our model, a decision that ultimately paid off. Our portfolio had no problem in making up its underperformance in the following year. This is in no way an exception. In a very tense market our discipline almost always pays off, as phases of underperformance can very quickly be made up through outperformance. Our portfolio also tends to underperform when market prices are being driven by macroeconomic factors, such as in the aftermath of the election of Donald Trump or the Brexit referendum. However, as these phases do not usually last very long, we quickly make up the ground we have lost.
In both discretionary and quantitative management the choice of fund man