Quants and the Media

Yesterday, the Wall Street Journal (WSJ) printed four articles in what appears to be a 17 article series on what they call ‘the quants.’  I was so excited to see these articles because I think you could fairly describe some of the strategies that we pursue as quantitative in nature.

Unfortunately, I was turned off immediately.  The second paragraph of the first article talked about how the quants use ‘high powered computers to construct abstruse models’ to ‘instantaneously analyze an amount of data that’s too vast for the human mind.’

The third paragraph goes on to say that ‘these quants have grown so powerful that they now control about a third of all trading on US stock markets today.’

Oh brother.  I’m not generally one to complain about the media, but so far, these articles appear to be following the old editor’s note from The Economist who told reporters that their jobs were to ‘simplify, then exaggerate.’

Since it would take too long to critique the WSJ articles paragraph by paragraph, let me start with the simple statement that being a quant can be many things.  Just as there are many fundamental strategies, there are many quant strategies.

When we talk about quants, we simply mean strategies that are rules-based, as opposed to discretionary.  Value investing can offer a simple example.

A classic value investor typically looks at the balance sheet and income statement of a company to estimate or forecast its intrinsic value. This investor then compares their estimate of the intrinsic value compared to the market price and if the market price is cheap compared to their estimate, they buy the stock.

A few decades ago, academics found that, on average, similar results could be achieved simply by looking at all of the companies trading in the market, sorting them by their relative cheapness using a measure like price-to-book, price-to-earnings or price-to-sales, and then buying the cheaper third of all of the companies.

This process doesn’t take high powered computers or abstruse models (their word, not mine), but, on average, it works about as well as the value manager looking at stocks one at a time.  That’s the beauty of quant investing: you can apply the same ideas, like buying cheap stocks, and do it in a diversified, transparent way and get the same basic results without the idiosyncratic choices of an individual manager.

Over the years, I’ve written a lot about how assets are flowing out of traditional actively managed mutual funds into passively managed index funds.   While a lot of the flows into passive funds are going to simple market-cap based funds, a lot are going into quantitative strategies that are now called ‘smart beta’ or factor based strategies.

As these funds get larger and grow in market share, it only makes sense that they would be responsible for more trading.  Of course, some of the strategies do require a lot of trading, but not all of them do.

For example, I think that you could make the case that DFA Funds are quantitative since they don’t have managers exercising discretion, but they are famous for their low turnover approach.

I should acknowledge that there are a number of strategies and funds that pursue very complex strategies.  We are pitched these funds from time to time and we summarily reject them if we can’t understand the basic idea within a few minutes.

It’s important to use funds with transparent approaches because all strategies, discretionary or quantitative, go through bad periods and understanding what’s happening is important to sticking with it.

For me, this is the beauty of quantitative versus discretionary since I am more apt to trust a series of rules that have stood the test of time over the judgment of a single person (like, say, a certain Newport Beach based fund manager a few years ago).

Maybe the not-yet-published articles from the WSJ will be better at describing how we think of quant.  Unfortunately, I suspect that you can make better headlines and article leads from the wild and wooly corner of quant finance than you can from the much larger and simpler segment of the quant community.