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Quantitative Methodologies on the Ascent

Feb 26, 2018

Fundamental investing, traditionally considered to be the dominant investment approach, is slowly giving way to a quantitative methodology. The use of algorithms and machine learning has allowed technology centric investors to analyze a wider range of equities at a more granular level than was previously thought possible. But as Dimitris Melas explores in his piece “Do factors stand up to FAANG?”, while multi factor quantitative investing produces superior results to traditional counterparts, it too is not perfect. Investors focusing solely on these metrics may have significantly outperformed the overall stock market, buy may have also missed on wealth creation opportunities.

FAANG technology stocks (Facebook, Apple, Amazon, Netflix, Google) have provided early investors with a significant return on investment. Quantitative traders who invest using factors such as high profitability and stable earnings (quality factors) or on attractive valuation metrics (value factor) may not have recognized the potential for growth that these industry disruptors possessed. Active managers, those who rely more on fundamentals and market sentiment to invest, were more likely to capitalize on these opportunities. But does this mean that traditional investing is the better alternative to multi factor investing? A historical analysis would decidedly indicate that it is not.

Despite some misses, quantitative investing has proven itself to be the superior strategy when taking a broader view. MSCI conducted a back test on the use of quantitative factors for investing to identify just how profitable the strategy was over the past 3 years. The result of the study showed that a quantitative approach consistently outperformed market returns over that time. This is largely due to the performance of the FAANG stocks, which should be discounted as outliers. The use of quantitative factors and algorithms to make investment decisions has forever altered the asset management landscape, and the results are a testament as to why this is the case.

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