In fact, the two strategies are unlike enough so that they perform differently, according to Gita R. Rao, Ph.D., a quant who works for MFS, the giant financial company in Boston.
Which is why it seems to make sense to put together a portfolio that includes both strategies—as MFS has.
Which strategy does better seems to depend on (1) the stage of the economic cycle, (2) how intensively investors are emphasizing valuation, and (3) inflection points (when the market’s leadership changes).
At a press conference in New York City, I asked Rao: What’s the correlation between the two strategies, and does it change? Generally the strategies agree 30% of the time, she answered, and yes, the percentages can change dramatically.
A quant, she went on, can try to enhance an index…or practice active investing…or focus on alternative investments…or use a 130/30 strategy.
Rao advocates the 130/30 strategy, which uses 30% leverage—and shorts 30% of the assets. So that, all in all, the portfolio is net 100% invested. But it is better protected on the downside, because of the shorts, yet better positioned on the upside because of the borrowed money. In sum, unlike conventional managers, the strategy allows additional funds to be allocated to the most attractive stocks, while taking a position against the least favored stocks..
The fund prefers to buy stocks that are attractively rated on both fundamental and quant analysis. When the fundamental or quantitative outlook deteriorates, the stock becomes a sell – or even a short.
Back to how the two strategies differ:
Quants refresh their screens frequently, and – using computers – they can cover thousands of different companies. Of course, “behavioral biases” are reduced. You don’t hold onto a stock just because you inherited it from your beloved aunt, and you don’t sell it because the CEO just gave a lot of money to your unfavorite Presidential candidate.
Fundamental investors -- quals, we should call them, because they’re somewhat qualitative – get in-depth, first-hand information by, for example, going to company meetings and assessing the management. (That’s why they can more readily identify inflection points.) They also analyze the quality of earnings and make predictions about future valuations.
Rao used this metaphor to explain the difference: Fundamental investors use a pole when they go fishing. Quants use a net.
Also speaking at the conference was James Swanson, MFS’s chief investment strategist, who shrewdly examined the arguments for and against a recession -- and concluded that one is unlikely. “The empty-house problem won’t drag down the economy” was how he put it.
David Antonelli, chief investment officer, was skeptical of U.S. small-caps, but bullish on foreign stocks. “There has been a real transition from value to growth, from small to large,” he said. As for the supposed greater correlation between U.S. and foreign stocks, it’s been declining – an argument for diversification. How much should a portfolio be in foreign stocks? His suggestion: 35%. He recommended looking for high-quality names.
As for emerging markets, “They look expensive but not scarily so. But don’t add to them.”
On the fixed-income side, Donald M. Mykrantz recommended high-quality debt. As for high-yield munis, “They may be okay but there are landmines out there.” MFS is not pursuing high-yield bonds in general. And emerging-market bonds are “not cheap.” What he did like: senior secured floating-rate loans.