When I first joined the asset management industry there was a clear view that it was very much ‘Man (or woman) versus Machine’ or rather, fundamental versus quant. At some firms this is still the view; never shall the two meet.
I have always disagreed with this. I believe that both fundamental research and pure quant strategies can be greatly enhanced through their combined power. The landscape has already changed significantly given the technological improvements seen in our industry and more generally. It has made the combined use of fundamental and quantitative approaches easier and, in my view, absolutely necessary.
Reckitt Benckiser is an example of bringing together a quantitative and fundamental approach
Back when I was creating the Kames screening process (not to be confused with any ethical screening!), Reckitt was generally understood to be one of the best-managed companies in the world. Yet fund managers were often drawn to the cheaper Unilever, even though at the time it was a less well-run company. The appeal was the difference in valuations.
But the quant screen told you that the valuation gap was warranted, Reckitt Benckiser, a ‘Kames Rank 1’ (i.e. our top quintile), was incrementally improving its financial strength and cash flow on a year-by-year basis. Unilever, ‘a Kames Rank 4’, was not. It was clear that Reckitt was the stock to own, but the cheaper valuation was enticing fund managers to seek a bargain. Thankfully, the screen helps show that it was cheaper for good reason.
Up until Reckitt Benckiser’s management changed (in 2011), and even beyond for a time, the screen’s ability to ignore valuation and focus on the fundamental view would have delivered significant outperformance compared to if you had invested in Unilever.
At the core of this example is the way you can successfully combine quant and fundamentals. It isn’t simply about the screen score, the fundamental work, or the valuation in isolation. It is about using each of these inputs together to build a picture about individual stocks in absolute terms and relative to other stocks.
By using both quant and fundamental research together we are able to improve outcomes for investors
Quant systems are great for quickly analysing lots of data (if I was being trendy I would call it big data!). But it has its limitations. For example, you might know the data is wrong for a specific reason; there may have been management changes; ongoing M&A or other factors. Fundamental research can sort through these issues.
Fundamental analysis takes time. Having a screen that points you to the most likely group of stocks to outperform saves wasted research time and enables us to have a small and focused team that can make decisions quickly. Fundamental analysis can also blind humans to changes that the quant data can look at in a cold-hearted manner and highlight this change to the analyst.
Quant and fundamental analysis do work well together, our well-defined investment process is proof of this.
Opinions and views from the Equities team at Kames Capital are not an investment recommendation, research or advice and should not be considered as such. Content discussing investment strategies and stocks is derived from and solely relates to the investment management activities of Kames Capital.
About the author
Neil Goddin is Head of Equity Quantitative Analysis and also has joint responsibility for managing funds within the Global Equities team. In addition to investment management responsibilities, he leads the team responsible for building and maintaining the Kames equity investment screen, which is used across the equity team, and advising on optimising risk levels in the funds. Neil’s role differs from most typical quant professionals as he sits within the fundamental team, has joint responsibility for managing funds and is an integral part of the equity team; rather than the more traditional model where quant teams sit separately, away from investors. Neil joined us in 2012 from LV Asset Management where he was Head of Investment Risk. Prior to that, he worked for WestLB Mellon Asset Management and Deutsche Asset Management in various risk-management roles. He has 19 years’ industry experience and is a Certified Risk Manager by the Global Association of Risk Professionals*.
*As at 28 February 2018.