Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 163

Quant plus fundamental: two methods are better than one

When it comes to market forecasting, too many people thinking the same thing is almost always cause for concern. That said, in the current environment, an enormous amount of creative optimism is required to formulate a contrarian view.

Central bank activity saved the financial system from collapse in 2008 and stimulated the second-longest bull market in stocks. Unfortunately, the tools at their disposal were insufficient to engineer a return to high and inclusive rates of economic growth or durable financial stability. Terms like the New Normal, the New Neutral, or Secular Stagnation describe a global economy with sluggish growth, rising inequality, high unemployment and ever-increasing market volatility.

Rising demand for absolute returns

There has been significant asset price appreciation since the GFC. However, over the past 10 years, a traditional balanced portfolio allocating 60% to equities and 40% to fixed interest securities has only outperformed what most would consider a reasonable investment objective of CPI+5% in 41% of months on a rolling five-year basis. It is therefore not surprising that financial advisers and their clients are increasingly looking for new ways to build absolute return portfolios, where the investment objective is wealth creation rather than beating a traditional benchmark.

Portfolio construction, diversification, and the incorporation of alternative investment strategies all have roles to play in this endeavour. An ideal portfolio would likely contain non-correlated assets with positive return expectations. This means that all the assets in the portfolio would go up and down at different times - although the general direction would be positive. The ups and downs would partially cancel each other out and the investor would have a smooth, stable and stress free journey. Unfortunately, such assets are very difficult to come by, particularly for retail investors in Australia.

A fundamental approach to managing equity funds is normally associated with human insight and in-depth forward looking analysis across a narrow range of companies. With quantitative funds, the association is usually unbiased, disciplined, repeatable and scalable across a broad universe of stocks.

For some time, fundamental managers have recognised the value of incorporating quantitative techniques into their processes. Common examples of earlier approaches are: fundamental managers relying on quantitative screens to filter a large universe of stocks; and using multi-factor models to help managers control and eliminate exposure to unwanted risks.

Quantitative plus fundamental using unique data insights

The recent arrival of big data has ushered in a new era of investing, sometimes referred to as ‘quantamental’, which requires the seamless integration of quantitative and fundamental techniques. Obtaining valuable insights, often relating to future corporate earnings, from unrelated and unstructured sources requires the skills of creative analysts, expert programmers and significant computing power.

Twitter offers an intuitive example of this. It is now possible to obtain insights and indications of current stock trends by accessing all real-time tweets (approximately 6,000 per second) delivered via the Twitter Firehose service. People are better at many things but such analysis is beyond human capability. The demands are even greater for those managers who store tweets historically to reveal a changing pattern of sentiment and provide an advanced signal for a short term trading strategy.

The most valuable data is also the hardest to obtain and insights should be fundamentally generated from unique data sources, many of which would only ordinarily be used by the members of individual industries. Quantitative techniques are then used to scale these insights across a vast universe of industries and global stocks. Our new fund aims to deliver market neutral returns by simultaneously going long the companies with the best long-term prospects and short-selling those with the worst.

In the pharmaceutical industry as an example, the portfolio manager has developed an automated process to extract data from websites that allow doctors and patients to log complaints about the side effects of drugs. This frequently provides glimpses into future issues these companies or others providing drugs with similar chemical compositions may encounter. Trading strategies may then be developed which short sell these companies and go long on the companies marketing drugs with similar therapeutic application, but with fewer complaints.

The airline industry provides another good example of how the manager combines generally accepted valuation metrics with unique but common sense insights. In most developed countries, departure and arrival times of all flights are published electronically. If flights of a particular airline tend to take off late but arrive on time, it is likely that they have burned more fuel to catch up. That airline is thus operationally inefficient. An astute quantamental analyst can also rank airlines in order of baggage lost. Used in conjunction, these signals provide insights about future revenue because airlines with more late flights and more lost baggage are unlikely to retain their customers.

At its most simple, the quantamental approach involves two things. The first is the obtaining, aggregating and processing of information from numerous sources. The second is applying fundamental principles to generate differentiated returns. The result should be the construction of a well-diversified investment portfolio that provides superior outcomes in these challenging market conditions.

 

Adam Myers is Executive Director at Pengana Capital. They have brought the Pengana PanAgora Absolute Return Global Equities Fund to the Australian market. This article is general information and does not consider the circumstances of any individual.

 


 

Leave a Comment:

     
banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

Policy proposals allow young people to access their super for a home bought from older people who put the money back into super. It helps some first buyers into a home earlier but it may push up prices.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.