Understanding the difference between quantitative and fundamental investing.
Portfolio managers, also known as investment managers, employ various styles and approaches when it comes to managing money. One well-known style is called fundamental investing. With fundamental investing, a portfolio manager looks at individual company stocks and analyzes each security based on various factors such as earnings, debt or profitability.
The portfolio manager will also look at more ‘qualitative’ aspects of a company. These are things that can’t easily be measured, like the quality of its management team and strategic plans. Evaluating these may require calls or meetings in person to get a better sense of capabilities and strategy.
Based on this analysis, the portfolio manager will build a portfolio of stocks that he or she believes have the best prospects for growth.
Quantitative vs. fundamental investing
With quantitative investing, a computer-based model is used to screen and evaluate multiple factors, including risk levels, sectors or securities. For example, if a model is analyzing companies, it would measure things like earnings per share, cash flow or share price.
It’s up to the person who programs the computer-based model to decide what makes one investment more ‘attractive’ than another, and to set up the parameters accordingly. The goal of a quantitative-based mutual fund is the same as many other investment funds – to try to provide higher returns for investors while managing risk.
Potential benefits and risks of quantitative investing
One of the biggest potential advantages of quantitative investing is that it takes the emotion out of investing because a computer-based model is making the final decision to buy or sell a security. Of course, a person is deciding what factors the model will consider, so the success of the model depends on that person choosing the right factors at the right time.
That leads into what may be the most significant risk of quantitative investing. These models attempt to predict how the markets in general, as well as individual securities, will behave in the future based on what has happened in the past. Unless the model takes multiple factors into account and can adjust for different scenarios, this can result in rigid interpretations.
In actuality, no model can really forecast the future since historical patterns are not always repeated, so a surprise economic or market event can lead to unexpected performance – and there is always the possibility of losses. Of course, investment funds that rely solely on fundamental analysis can also post negative returns if the analysis proves to be inaccurate. There is merit to both quantitative and fundamental analysis, as each method takes a distinct approach to uncovering attractive investment opportunities.
Is quantitative investing right for you? When combined with more traditional investment funds, it may be a good way to diversify your holdings. To learn more, contact your financial advisor or visit AGF.com.
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