Key Points:
– Large active fund managers now have both fundamental and quantitative investment teams.
– Fundamental investors focus on bottom-up analysis while quants take a top-down approach.
– Fundamental investors are incorporating more quantitative screens and models into their research.
– Some firms have heads of quantitative research to bridge the gap between fundamental and quant investors.
– There is no clear answer on which approach produces better returns.
– Fundamental investing brings clear explanations and subjective evaluations, while quant investing leverages scale and objectivity.
– A hybrid approach that combines the best of both worlds may be necessary for success in today’s market.
Most large active fund managers today have both fundamental and quantitative investment teams. Traditionally, these two groups have operated separately due to their different approaches and languages. Fundamental investors study economics and employ a bottom-up investment process to determine the value of individual stocks. On the other hand, quants focus on math and engineering and use a top-down approach that relies on vast amounts of market data.
However, fundamental investors are increasingly incorporating quantitative screens and models into their research. This trend is driven by the growing accessibility of relevant data and advancements in data science tools. Many fundamental investors now use spreadsheet-based quant screens to identify valuation mismatches and ESG scores that influence their investment process. Some even have dedicated quant analysts working alongside them.
This integration of fundamental and quantitative approaches can be seen as an evolution in the investment landscape. Although the term “quantamental” may not be universally embraced, even the most traditional fundamental investors are adopting quantitative techniques to some extent. In forward-thinking firms, heads of quantitative research are taking on leadership roles and working to bridge the gap between fundamental and quant investors.
However, finding common ground between these two groups is not always easy. Fundamental investors typically hold most of the decision-making power and may be reluctant to engage with the quants. They may struggle to understand the language and see the quants as a threat. In contrast, many quant researchers view fundamental investors as clinging to outdated thinking. Some quant-only firms have emerged as a rejection of the fundamental approach.
When it comes to deciding which approach produces better returns, there is no straightforward answer. Limited academic research has been conducted on this topic. One study compared hedge fund managers from 1996 to 2014 and found little difference in performance between systematic (quant) and discretionary (fundamental) managers, especially in equities. Another study of US equity mutual funds from 2000 to 2017 concluded that quant funds outperformed their discretionary peers in non-recessionary periods, but mutual funds beat quant funds during recessions.
Both fundamental and quant investing have their strengths. Fundamental investing offers clear explanations, consistency, and subjective evaluations, while quant investing leverages scale, objectivity, and sensitivity analysis. However, these two philosophies naturally conflict. It’s challenging to be both objective and subjective, to strive for clear explanations in the presence of complicated equations, and to consistently identify true alpha-generating opportunities rather than data mining artifacts.
A recent discussion with a head of quant strategies at a large fundamental asset manager highlighted the potential benefits of a hybrid approach. The use of behavioral analytics to help fundamental managers reflect on their decision-making resonated with the quant head. He saw it as a way for fundamental managers to apply quantitative analysis to their own decision making, filling a void in their process. This example demonstrates the value of leveraging the best of both worlds to achieve success in today’s market.
In conclusion, while fundamental and quant investing may not merge their approaches completely, acknowledging the increasing combination of human and machine-led factors is crucial for both. Reflecting on the quality of decisions generated by the investment process, whether driven by humans or machines, can lead to better outcomes. Ultimately, a flexible and adaptive approach that integrates the strengths of both philosophies may be the key to success in the ever-changing investment landscape.
