In India as investors there are no quantitative funds I know of that we can invest in as of Apr 2017. This style of investing is yet to pickup in this country even though some high frequency prop desks continue to use this technology to their advantage. So I thought I should put some views out there about this methodology.
How much concentration is good?
The value investing books and folklore will tell you that diversification dilutes returns and the famous line by Charilie Munger was "3 stocks is probably enough diversification" but in the quant world you are talking probabilistic bets and you will probably need more than 3 stocks in the portfolio. Our retail stocks algorithm limits 8% as the maximum concentration in a single stock which means that we have to have at least 13 stocks in the portfolio. Due to other factors that build the portfolio the number is rarely 13 and more like 30 on an average.
What if you are missing vital details that algorithms cannot analyse like reputation?
It is true that a fundamental analyst will probably pickup factors that are not really analyse-able (for lack of a better word) by humans. But the thing with non-quant factors is that they are based on opinion and 2 very highly capable analysis may differ in the their opinion about that factor which means that inherently there is a bias in the factor.
What are the advantages of the quant over the fundamental strategy?
The biggest advantage is that the quant system can analyse all 4000 stocks available on a minute by minute basis which even a 10 person analyst team will have trouble doing. The number of factors it can look at are also much higher than what an analyst can do - even with a long checklists. The killer is that the quant strategy can also look at which factors have actually impacted returns over time and focus more on those rather than what should matter. So for example if the P/E ratio is often priced into the stock then it may not be a good factor but if something like inventory turns is not it could increase its weightage in stock selection for that factor.
Here is a table of advantages and disadvantages versus an analyst:
|Number of securities analysed||Very high||Low|
|Non Quant factors like reputation||Unable||Able|
|Number of factors analysed per security||High||Low|
Whats the verdict?
No one strategy is perfect or does everything. The fundamental style of investing is followed by many and thus is a crowded space. The quant style in India as of now is not so crowded and thus we believe there is opportunity there.
Here is the performance of our quant stocks strategy that you can invest in today (from Jun 2016 when it was launched):
Here are the backtest results of the same strategy over the last decade: