Quant Investing: What is it and how can retail investors use it in their own investment strategies?
Investors or traders have nothing else on their minds but to consistently make profits. Their preoccupation is to beat the market while managing risks. Various strategies or methods are being applied. However, none of them actually deliver the desired results 100% of the time.
But for institutional investors, hedge and mutual fund managers, the quant investment strategy is the disciplined approach that’s certain to bring positive results and more importantly gains.
A brief on ‘Quant’ investing
What is Quant Investing all about? Amir Hamzah, Assistant Director, Investment Advisory, iFAST Global Markets explains, “Quant investing are strategies that uses detailed statistical models to differentiate stocks. Some quant funds take a “black box” approach which uses computers to make trades without human supervision.”
TJ Tan from DCG Capital defines Quant Investing as the use of developers to code computer programs for stock picking (or any other liquid asset such as futures). “Retail investors can probably use it as a quick and dirty way to create a portfolio of stocks.”
With regards to how retail investors use it in their own strategies, Amir also adds, “Retail investors can allocate a portion of their investable capital to these funds. These funds usually have lower management costs due to their automated nature and thus lower salary requirements.”
The crafters of this investing strategy are called ‘Quants.’ They have elevated technical analysis to a higher level by developing cutting-edge mathematical models and automating them. The backbone of quantitative investing is a powerful technology.
Essentially, the time-consuming process of evaluating investment prospects has been eliminated. Computers are programmed to perform the roles of investment analysts and statisticians. And ‘quants’ carry imposing credentials in the field of economics, engineering, finance, and mathematics.
Quantitative investment strategies have earned its spot as one of the mainstream investment schemes. Portfolio managers and institutional investors that implement this strategy claim higher success rate and superior returns. For as long as the data inputted in the program are right, quants can capitalize or exploit market trends or events.
Major advantages of quant investing
1. A useful model
The quants apply only one model when evaluating investment prospects. It doesn’t matter which sector or industry a company belongs. The approach is at all times consistent and repeatable.
By applying uniformity, picking stocks that have delivered solid earnings or outperformed other stocks from the past to the present is easy to identify. The benchmark is universal but sector and industry weightings are incorporated in the quantitative models. That is the greatest advantage when it comes to valuation and grading investments.
2. No human participation in quant investing
“In theory, it removes the emotional response,” says Tan from DCG Capital.
While quant investing is the brainchild of the human mind, it’s the computers that make the buy or sell decision. Hence, the actual trading or investment process is forthright. There is no emotional component whatsoever that could cloud judgment and eventually lead to costly mistakes.
In fact, Amir from iFAST Global Markets is convinced that this is the main benefit of quant investing. “It takes the emotions out of investing. Quant investing attempts to reduce the investment process to its scientific and statistical core, eliminating emotional and fallible human judgment from the equation as much as possible.”
Investment choices are always objective, minus the sentiments that usually influence a human trader’s decision. The result is buying only the worthy or high-rated investments while unloading the low-rated holdings.
There is also a cost-saving benefit because a lean team of portfolio managers is sufficient to run them.
3. Volume screening of investment prospects
Apart from the enhanced consistency, there is also greater efficiency when screening investments. Fund managers or traders can only pre-screen a limited number of prospects.
The automated model can analyze investments simultaneously regardless of volume. Quants rely on automation because they lightning-fast and can potentially deliver market-beating returns in a timely manner.
4. Overcomes market volatility
Quantitative investing uses multiple computer models in order to highlight the risk characteristics of every company. That way, quants are better positioned to lower, if not overcome volatility.
While in the process of reducing volatility, it tends to produce an ideal portfolio diversification and near-perfect asset allocation. Risks are spread out and therefore there is balance in the portfolio.
Quant investing ensures profit while protecting assets against losses. The models are programmed to recommend variations of strategies designed for short or long for better risk management.
Quant principles retail investors can follow
Retail investors can invest like quants and reap the rewards too. The benefits can be the same if you can follow the key quant principles.
Do not stray away from your financial goals
Quants developed the strategy in order to have discipline, consistency, and accuracy when investing. Their success lies in uniformity and sticking to the plan. They set benchmarks for every financial goal as well as an investment horizon.
Since the complex mathematical models offer various investment options, they can easily adjust and be value investors, growth investors or momentum investors depending on the situation. But whatever the scenario, they are guided by their investment principles.
Quantitative investing is about staying on track to achieve specific objectives. It serves as a reminder to retail investors to evaluate, analyze, and select the investments that will meet short, medium and long-term financial goals.
Never let emotions influence your investment decision
Quants are objective and exacting when making investment decisions. That is precisely the reason why they turned over the decision-making process to independent-working computers.
The interplay of fear and greed in the market are often the reason why investors mess up their individual financial goals. Humans are predisposed to making hasty decisions whenever market volatility arises. It’s a fact of life.
However, quants are accomplished in this aspect. By setting aside the subjective elements of human investing, the ride no longer resembles a bumpy roller coaster. There is recognition of market turbulence yet the strategy is capable of riding them out.
Trust in the power of diversification
Two traits characterize quant investing. They are diversification and asset allocation. As mentioned earlier, if you have the right mix of assets, risks are controlled. Quants found a way to offset losses and preserve gains across the portfolio.
Therefore, retail investors should follow the lead of the quants. Diversification can minimize overall investment risk, preserve capital, and generate returns. An investment product like the exchange-traded fund (ETF) is an example of diversification within a specific asset class or sector.
Pick up the good points of each investment strategy
Quantitative investing is a sophisticated and purely mathematical strategy that has delivered the goods to some portfolio managers. However, keep in mind that it’s just one investing style among the many.
According to detractors, quant investing is not a completely dependable strategy because it disregards subjective criteria. The changes in market sentiment and other factors are not considered. Using only historical data as the basis to arrive at a decision makes it a weak strategy.
“At the end of the day, these quant strategies are created by humans based on a set of past historical data.” Amir from iFAST Global Markets concludes, and further advises the retail investor, “If you want to practise quant investing, you need to know the rules and limitations of the “black box” you are investing in. “
Tan agrees, noting that is is very important to know and understand whether your chosen model will work or not. He then offers one simple but useful piece of advice – “Always invest in things you can understand.”
Nevertheless, a determined investor will not rely on a single strategy to succeed. Retail investors need to be aware of the strengths and weaknesses of every available strategy. Pick up the good points of each then use them where applicable. That’s the dictate of common sense and not a high intelligent quotient.