Quantitative Investment Strategies

Quantitative strategies and funds leverage rigorous use of fact-based financial and economic data to drive investment decisions and minimize discretionary decisions. As reliability and investment process repeatability have grown in importance, advisors and investors are increasingly investing in quantitative (or systematic) strategies and funds. Increased transparency, better performance, and more consistent, better diversification are the top reasons investors cite as reasons why quantitative funds are growing increasingly popular with investors.

With these factors in mind, Registered Investment Advisors (RIAs) and wealth managers should be looking to integrate quantitative investment strategies into their practices at some level.  

Below, we explain some of the key benefits of quantitative strategies and funds, compare them to traditional/discretionary funds, and break down the components that make them effective.

Key Benefits of Quantitative Investing

Quantitative strategies and funds try to improve the investment process by operating in a more rigorous, fact-based, data-intensive, and objective fashion than traditional funds of days past. They seek to process large amounts of data, quickly and reduce bias to increase consistency in investment process and outcomes.

Here are some of the chief benefits of quantitative funds and strategies for RIAs:

• Reliability & Repeatability – Quantitative methods intensify the use of data and scientific models in order to reduce reliance on individual biases, preferences and ad-hoc analysis.

• Transparency – The mathematical operations and models that power most quantitative methods can be complex, but their outputs are straightforward, transparent, and easier to communicate.

• Capital protection – Quantitative methods can rigorously enforce diversification and capital protection mandates starting from portfolio construction and flowing all the way through to risk exposure management and trading operations.

• Risk management – Models can consistently monitor and quantify risks as they emerge and execute strategies to provide enhanced risk management.

For these reasons and more, quantitative investing has seen a steady rise for over 25 years since around 1997, while more fundamental investment approaches have been steadily declining over roughly the same period. Quantitative analysis also overtook fundamental analysis between 2011 and 2013, and it is likely to continue growing in the years to come as data and compute power proliferate.

Quantitative vs. Discretionary Investing

Quantitative investment management is quite different from discretionary investment management. In the legacy approach, an investment manager’s discretion is the primary mover behind investment decisions. That discretion may have quantitative elements, but the ultimate deciding factor is often tinged with personal partiality—experience, preference, etc.—that are inevitably subject to non-transparent amounts of emotion, bias and, ultimately, less rigorous analysis of all available data.

Components of Quantitative Investment Strategies

Quantitative strategies and funds take many shapes and forms. They can be somewhat passive, very active, or somewhere in between. And they can prioritize or exclusively focus on investment niches, like arbitrage, or simply apply quantitative analysis across all focuses within a portfolio strategy.

At the most basic level, however, all quantitative strategies and funds share these qualities:

• Data Collection and Analysis – Quantitative strategies begin with robust data collection and aggregation, which includes carefully curating data sources such as macro-economic statistics, risk factors, and company-specific data like financial statements. This data is then used to generate powerful statistical models and train algorithms to generate investment insights.

• Factor Selection and Model Construction – Quantitative strategies often target one or more risk factors such as profitability, value, growth, market capitalization, or market-wide phenomena such as unemployment or interest rates. This concept is known as factor investing and plays a crucial role in quantitative strategies, as there are several hundred risk factors can be isolated and used to understand security risks and opportunities.

• Portfolio Construction and Optimization – The processes of data collection, analysis, and interpretation all converge in sound construction and management of investment portfolios. Assets are selected because of their fit to particular goals, such as mean-variance optimization or retirement yield (total return over a long drawdown period). 

Aside from these defining qualities, some quantitative strategies take a more rigorous approach to improving tax efficiency and increasing retirement portfolio total yield.

A Systematic Approach to Tax Efficiency

For many portfolios, tax efficiency is often an afterthought. Something relegated to an end-of-year activity. A major benefit of quantitative strategies and funds for RIAs is the capacity of some to mitigate and manage risk with low taxable turnover. This produces tax efficiency for taxable accounts.

Case Study

Taxes are more important than many investors and even advisors realize. In the tax brackets that we encounter most often at Markin, taxes on mutual fund gains distributions in recent up market years have totaled more than 100bps. We know how to invest efficiently. Our strategies can and have reduced tax burdens to less than 20bps without distorting portfolio composition.

Not all approaches to tax efficiency are created equal. At Markin, we construct strategies that systematically seek lower taxable capital gains by algorithmically controlling taxable turn-over without significantly altering portfolio composition. We believe this approach improves on ad-hoc tax loss harvesting that can distort portfolios to obtain a single-cycle tax result.

A Systematic Approach to Higher Yield Income in Retirement

Another benefit noted above is the potential for quantitative strategies and funds to maximize long-term income by targeting a high yielding investment approach over a long drawdown period like that of a thirty-year retirement. This facet is particularly useful in retirement accounts.

Case Study

Returns and yields are very different things. Over a period like several decades, a high return investment (like the S&P 500) will almost certainly provide less income than a balanced portfolio. Why? Because a sound income portfolio is likely to experience fewer large losses, so an investor’s money is more likely to be there when needed. This enables the investor to draw more cash from the portfolio each year than they could from a higher returning, more volatile portfolio. For this reason it’s critically important retirement portfolios are systematically less exposed to large losses. For example, 2022 proved difficult for many retirement portfolios. Because investors lost so much, they weren’t withdrawing their usual income for fear of impairing future income. Markin’s capital preservation and income preserving solution proved very beneficial for our RIAs and their investors. Utilizing systematic capital protection and dynamic risk allocation, our clients experienced a better way. 

Quantitative strategies and funds help RIAs improve their clients’ retirement outcomes in a purposeful and straightforward manner that is directly linked to the long-term objective function of retirement clients.

Optimize Your Quantitative Investment Strategy

Moving forward, RIAs and investors can increasingly benefit from quantitative strategies and funds as they come to appreciate the benefits of greater transparency, investment process reliability, tax-efficiency and investment effectiveness.

Rigorous quantitative investing is fundamental to the philosophy of Markin Asset Management. To learn more about how it can benefit your practice, get in touch today.