How the Individual Investor Can Get a Quantitative Edge

Brendan Byrnes: So there are clearly a lot of value investors out there but I think when people look at the quantitative side of it they see, they picture, these big Wall Street firms a bunch of PhDs all of this advanced software and they say how can I compete with that. So what do you say to that? How can individual retail investors use the quantitative side to their advantage?

Wesley Gray: Well, I think there's a lot of structural issues with institutional money management on why -- like, for example, systematic value can't be employed. So, what we've identified is that the problem with doing any sort of value strategy, especially these systematic value strategies where you may get a lot of industry drift or what have you is they have terrible tracking error. Right? So we know over a three to five year rolling CAGR, Comp Annual Growth Rates, they're going to probably beat the S&P 80 to 90% of the time. The problem is on any quarter, any year, you know it's a crapshoot and they can under perform for a long time. They don't track well to S&P 500 and Russell 2000-type benchmarks which makes it very difficult for institutional managers to actually do these sort of things.

I get calls all the time saying, hey, great idea but clearly you guys have tons of industry drift, etc., etc., that's -- I can't implement that.

So I think there's actually an edge in the sense that an individual investor who's not constrained by the agency problems associated in institutional investment management can actually engage in these strategies if they're able to have a long horizon. So that's what I think one advantage is.

Now, the second advantage is when you look at the names that pop out of these quantitative value screens it's like literally you want to like puke on yourself. Like six, seven months ago RIM (BB -0.86%) was on there. Who would want to own RIM?

Blackberry, you know, there's Android from Google (GOOGL 0.04%) there's Apple's(AAPL 0.88%) iPhone, they're taking over the world ...

Brendan: RIM had a nice little run up but lately it's ...

Wesley: Exactly, exactly and recently the irony now, Apple is now in our screens. Now and clearly two months ago Apple was like the most loved stock in the world, it never showed up on our screens, but it's blown up so hard it sort of showed up on our top EBIT screen, now on our quality metrics clearly this is a high quality firm.

Now, there's hair on it! There's a lot of issues going forward but that's the whole lesson of this book is that empirically if you force yourself to buy firms that have been doing -- like have evidence for economic mote in the past and you pay the correct price on average you're going to do well.

Now, the question is can you do that as an individual? Can I sit here right now on every single news article and every report is saying Apple's like the biggest turd on the planet, can I actually do that? Probably not but if I have a model that just says here's the evidence, we had a hypothesis, we tested it, here's the systematic evidence, just do what the computer says, by thinking in that framework you're actually going to more likely going to engage in that. Whereas if you're trying to pick and choose a lot of times you look at these things because I've done it before but I'm so like quant-minded at this point, I gave up on other things. So I have the problem that I'm like too quant probably.

I just do the model, period! Because I know the minute I start tinkering with it, it screws it all up.