The financial turmoil of recent years has caused scores of professional investors, CEOs, and everyday Americans to reevaluate their ways of thinking about the world, about their businesses, and about how they invest. Things that worked in the past haven't been working as well in today's changed environment, leading many folks to question their previously held beliefs. This experience has held especially true for one beleaguered segment of the investing industry.
Falling down on the job
While stocks and the mutual funds that love them have been hit hard across the board in recent years, one particular approach to investing has fallen down especially hard as of late – quantitative-based investing. Mutual funds that rely on quantitative methods to identify attractive stocks have been in the doldrums in recent years, lagging their peers and the broader market, often by a wide margin.
Investment research firm Inc. tracked a group of 65 quant funds and has noted that this group has lagged 72% of their peers over the past three years. Likewise, according to Morningstar data as of the end of July on popular quant fund managers Bridgeway and Goldman Sachs, seven out of eight Bridgeway quant funds landed in the bottom third of their category over the most recent three years, while the same is true for six out of eight of Goldman Sachs' quant funds.
While quantitative stock-picking methods have had great success in years past, these methods appear to have missed the boat in the troublesome investing environment of recent years. Value-oriented quant methods flashed a buy signal during the bear market, but stocks kept on falling in price. Then computer models signaled a move into higher-quality, economically sensitive companies in anticipation of recovery, but by that point, the funds had missed much of the rally in that sector so they continued to lag their competitors. All of this has led some investors to question whether the quantitative approach works at all anymore, given our new economic realities.
Changes are afoot
But despite its clear struggles, I wouldn't be so quick to write off quant investing as a broken approach. The fact that quant methods worked so well for such a long time does speak to their long-term staying power. There's also a fairly good chance that quant methods have only temporarily fallen out of favor in the market.
While I don't want to make excuses for quant funds' generally poor performance in recent years, this has been a unique time period. I'd be willing to bet some quant funds, especially those that focus on companies with solid earnings, will begin to make up some ground in the near future. Quant managers across the board are also taking a new look at their models, adjusting various factors, and tweaking how they invest based on recent developments in the market. That means quant funds could be a more powerful force in the years to come.
Secondly, even if the whole quant investing business is undergoing a meaningful revision, I think this sector's recent troubles highlight the benefits of diversifying your portfolio by investment type. If you're like most investors, you probably already invest in stocks or funds of varying size, large and small, as well as foreign and domestic names.
But you can also add another layer of diversification by buying a quant fund or two to complement the majority of funds that take a fundamental approach to investing. Quant funds won't always look this bad, and they can provide an alternate angle to investing that may help boost your portfolio when fundamentals-based funds stumble somewhere down the road.
A few good funds
Furthermore, there are some solid quant-focused mutual funds that haven't completely lost their way in recent years and remain solid investments. One of my favorites in this arena is SSgA Emerging Markets (SSEMX). The investment team here uses quantitative models to identify attractive foreign stocks. Like most quant managers, they have recently adjusted some of the factors in their models to better account for today's realities.
The fund currently has a decent allocation to emerging financials, at 29%, with China Life (NYSE: LFC) among the fund's top picks. Vale (NYSE: VALE), China Mobile (NYSE: CHL), and Petroleo Brasileiro (NYSE: PBR) also play prominently in the portfolio, reflecting the team's recent heavier emphasis on dividend yield, profitability, and free cash flow within their models. Although the fund trailed its benchmark and its peers in 2008 and 2009, over the past 15 years, SSgA Emerging Markets outranks nearly three-quarters of all emerging-markets funds.
Likewise, I still think better days are ahead of the Bridgeway family of funds. This quant shop has made a name for itself via its time-tested quant-driven models and first-rate long-term performance. Returns have been somewhat shaky in recent years, but given the shop's focus on companies that consistently beat earnings, things should look up here before too long. Bridgeway Large-Cap Growth (BRLGX) is one good choice for the future. The fund invests in fast-growing companies with a history of meeting and exceeding earnings expectations. Right now, Bridgeway sees tech companies Apple (Nasdaq: AAPL), IBM (NYSE: IBM), and Google (Nasdaq: GOOG) as full of potential, and all of them are big players in the portfolio right now, so the fund has plenty of ammunition under its belt.
Quantitative investing has hit a roadblock during these last few years of financial crisis, and investors should definitely be aware of the risks when investing in quant funds. But before you write off the whole approach as a failure, keep your eyes open for funds that could lead the pack once market sentiment and investor focus swing back in their favor.
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