Quantitative Investing

Article byRutan Bhattacharyya
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Quantitative Investing?

Quantitative investing refers to an investment approach that involves utilizing statistical analysis, mathematical methods, and data analytics to formulate strategies, manage financial risk, and build portfolios. Individuals and organizations can adopt this approach to find the right moment to carry out profitable investment transactions.

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Quantitative Investing (wallstreetmojo.com)

This investment method depends heavily on technology as it involves using high-frequency and algorithmic trading. That said, human analysis also plays a vital role in testing and developing strategies and monitoring the markets to identify opportunities and trends. This approach allows people to avoid emotional investing and generate consistent returns based on the analysis of historical quantitative data.

Key Takeaways

  • Quantitative investing describes a method of investment that uses algorithms, statistical analysis, and mathematical models to analyze a significant amount of data and help investors make informed trading decisions that result in gains.
  • Some popular quantitative investing strategies include risk parity, artificial intelligence, statistical arbitrage, and factor investing.
  • There are various advantages of quantitative investing. For example, this approach is less costly compared to traditional investment approaches. Moreover, this method allows investors to focus on a large number of securities simultaneously.
  • A key disadvantage of this investment method is that it can lead to increased transaction costs.

Quantitative Investing Explained

Quantitative investing refers to an approach in the investment world that focuses on building portfolios on the basis of investment ideas’ scientific testing, insights driven by data, and advanced computer modeling methods.

Also known as systematic investing, this method uses various models developed for fixed-income and equity markets besides structured products, currencies, and commodities. Such models can help solve issues associated with hedging and asset pricing, portfolio optimization, and risk analytics. A few of these models involve derivative calculations and equity valuation, while other models handle bond yield curves and interest rates. This approach also considers broader market movements, analyzing asset price volatility and studying regime changes.

One can look at the following characteristics of this investing method to understand the approach better.

  • It involves executing and studying fundamental investment insights
  • The approach involves refining the investment-related ideas and rigorous ongoing testing.
  • This approach enables one to utilize the best insights systematically. 
  • It harnesses computing power, processing substantial data while steering clear of human behavioral biases.

Some factors that this approach exploits to beat the performance of a benchmark or fulfill certain investment objectives are as follows:

  • Value Factor: This factor focuses on undervalued stocks utilizing metrics such as rice-to-book and price-to-earnings ratios.
  • Size Factor: It focuses on small companies with growth potential.
  • Momentum Factor: This factor involves targeting stocks that deliver a consistent price performance over a certain duration.
  • Volatility Factor: It focuses on stocks that are of low quality and prone to market swings.
  • Quality Factor: This factor involves looking at companies with impressive fundamentals, for example, earnings stability and low debt.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Strategies

Some noteworthy quantitative investing techniques are as follows:

  • Statistical Arbitrage: This strategy involves spotting misplaced financial instruments with the help of the relationship existing between them. It often utilizes financial ratios to enter long and short positions.
  •  Factor Investing Strategy: It involves using one or multiple factors that resulted in a benchmark index outperforming in the past. A few examples of these factors include value, market capitalization, and momentum.
  • Risk Parity Strategy: This technique aims to balance portfolios through the allocation of assets on the basis of risk instead of capital.
  • Machine Learning And Artificial Intelligence Strategy: Artificial intelligence or AI strategy uses public web data, while machine learning strategies deploy algorithms to check whether financial models are efficient and accurate.

Examples

Let us look at a few quantitative investing examples to understand the topic better.

Example #1

Suppose an investor named Sam allocated his savings to ABC quant fund. The fund managers of the investment vehicle select the financial instruments based on systematic analysis. Precisely, they utilize customized models, software programs, and specific algorithms to identify investment opportunities and the right time to invest. When picking the securities, the quantitative investing system eliminates companies with high leverage. Moreover, it does consider stocks associated with very high volatility. The aim of the fund was to beat the returns of the XYZ index.

Example #2

Kotak Quant Fund opened for subscription in July 2023. The fund utilizes quantitative investing strategies to spot investing opportunities in the market. Managed by a team of experienced fund managers, the fund’s performance will be gauged against the NIFTY 200 TRI index. The main objective of this investment vehicle is to ensure capital appreciation over the long term by predominantly picking stocks and equity-related instruments on the basis of its quant model theme.

Benefits

The advantages of quantitative investing are as follows:

  • Systematic investing has the ability to survey various potential investments in a market, while popular analysts can only focus on a limited number of financial instruments at a time.
  • Quantitative investment strategies used by individuals or organizations are able to exploit opportunities within a market at a shorter timescale when compared to other investment methods.
  • A key advantage of quantitative investing is that it is less expensive compared to other investment approaches as it requires fewer managers and analysts.
  • Systematic investment systems can apply all the set rules consistently. No deviation occurs because of psychological or emotional reasons. Moreover, such systems generally do not miss out on any investment opportunity.

Limitations

Let us look at some key disadvantages of this approach.

  • The success of this approach depends on the model’s quality. This means if the model cannot accurately map market behavior, systematic investing strategies will fail.
  • The success of this approach also depends on developers and analysts as they implement the systematic investing systems.
  • Its effectiveness depends on the substantial volumes of historical and real-time trading data besides the computational resources and networks analyzing and ingesting the information.
  • Low data quality can impact the performance resulting from this investment approach.
  • Some strategies included in this approach can affect market prices and result in higher transaction costs. Moreover, a few strategies require carrying out trades in markets having low liquidity. This can be risky.
  • Utilizing trading algorithms has increased concerns regarding market integrity and fairness. Some regulatory changes can impact specific strategies’ viability.

Quantitative vs Fundamental Investing

The key differences between systematic and fundamental investing are as follows:

  • Systematic investing involves utilizing mathematical modeling, data-driven insights, and statistical analysis to make investment decisions. On the other hand, fundamental investing involves utilizing fundamental insight into any company’s business prospects to determine a stock’s attractiveness. 
  • Fundamental analysis offers greater depth in terms of analysis on a small opportunity set involving stocks. That said, systematic investing offers broader analysis across larger opportunity sets involving equity.
  • Systematic investing aims to steer clear of emotional biases. On the other hand, one may be unable to avoid emotional biases when using the fundamental investing approach.

Frequently Asked Questions (FAQs)

1. Does quantitative investing work?

Yes, it can work for investors and help them generate returns. That said, whether or not one should opt for this strategy depends on various factors, like risk appetite, financial goals, and investment horizon. Also, one must weigh the pros and cons of this approach before using it.

2. Is quantitative investing easy?

One must note that systematic investing is not easy, especially for new investors, as it generally requires one to have advanced skills in computer programming, mathematics, and finance.

3. Can you do quantitative investing on your own?

Yes, one can start using systematic investing strategies to generate gains and achieve their financial goals. That said, they’ll require advanced knowledge of finance and mathematics to build statistical models that give accurate results. If individuals do not have the required knowledge, they can invest in quant funds, which are mutual funds that utilize systematic investing strategies to pick stocks at the right time and generate returns.

This article has been a guide to what is Quantitative Investing. We explain its strategies, examples, comparison with fundamental investing, benefits, & limitations. You may also find some useful articles here –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *