Investors focused on stock market fundamentals have developed 'quant envy,' and some executives say they're making a critical mistake
- Barry Hurewitz, global head of UBS Evidence Labs Innovation, told Business Insider some fundamental investors are making a critical mistake as they chase the returns quant funds have enjoyed over the years.
- Some fundamental investors attempt to use quantitative signals for a single stock instead of an entire population of stocks, which is what it's meant for.
- Hurewitz said many fundamental investors are under pressure from low-fee ETFs and the returns quant funds have achieved in recent years.
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Of the seven deadly sins, greed is the one most people affiliate with Wall Street.
However, according to one UBS executive, it's another vice some financial firms are guilty of that's causing big problems: envy.
Barry Hurewitz, global head of UBS Evidence Labs Innovation, told Business Insider some fundamental investors are making a critical mistake in their attempt to follow in the footsteps of their quantitative-based competitors.
Motivated by achieving the impressive returns quantitative firms have enjoyed over the last few years, fundamental firms have tried to take a page out their books, implementing big data into their trading strategies. Hurewitz calls it "quant envy."
"You have pressure from ETFs on fees, then you have performance pressure from quants," said Hurewitz of what's pushing the change in strategy for some fundamental shops. "And then this explosion of big data and data science all coming at the same time, which is something that they felt they were missing, and so they look to the quants and say, 'I'm going to do what the quants do.'"
The issue, however, lies in the differences in execution. Using mountains of data, quants develop hundreds or thousands of signals for potential market moves that are typically true on average. They then develop an investing strategy based on the signals across an entire population of stocks.
On the other hand, fundamental investor often times are only focused on a small number of stocks. And while a quantitative model is built to be true of an entire group of stocks, the same theory isn't necessarily true for a specific company.
For example, analysis done on retailers is only useful if the strategy is then applied to the entire group of retailers. Taking what might, on average, be true for the entire group and using it to invest in a specific company, such as Amazon or Costco, won't necessarily apply, Hurewitz said.
"It's like a psychological bait and switch," he added. "You need to actually think deeply about what is true for that company and only that company."
Doing so is known as an ergodic switch, Hurewitz said. And while its basic statistics to understand what's true of a population is not necessarily true for an individual, Hurewitz said he sees the issue crop up all the time.
George Mussalli, chief investment officer at $43 billion quantitative investment firm Panagora Asset Management, told Business Insider he's seen plenty of fundamental investors use quants incorrectly. Often it's an issue of not fully embracing the strategy. A quant-based portfolio would be developed only for the fundamental investors to override some of the trades, destroying the entire strategy, he said.
Other times, fundamental investors are only looking for confirmation bias from big data. Mussalli said an analyst Panagora hired last year from a larger, multi-strategy firm had previously been tasked with only pulling data that would validate the fundamental investors' hypotheses.
"You can't pick and choose when you apply it or not," Mussalli said. "It has to be consistent in the portfolio."
To be clear, not every fundamental investor falls prey to these issues, Hurewitz said. Some are sophisticated in their approach to investing. They use the data to understand the key question for a specific company and how to take a different view on it than the rest of the market, he said.
However, others that have been underperforming and are unsettled by what they feel is a changing environment for investing are not being as thoughtful with their approach to using data, Hurewitz said.
"They are doing things because you have people putting pressure on them to do it," he added. "So they're building lots of models around everything, and either the question shifts or its an unstable question."