Forests like the amazon have been growing unabated for millennia. In so doing, many interesting sub ecosystems have therein formed, allowing for live to thrive in many different forms and features. The main variable behind all this growth? Time. Time also plays the same role in long only investing.
The premise behind long only investing is to take only long positions, seek undervalued securities, and reduce volatility and downside risk by holding equity, cash, fixed income, or other basic assets. This investment style is driven primarily by fundamental analysis, where analysis is based on characteristics such as a company’s profitability, financial strength or risk.
The idea behind this strategy is intuitively impressive because of its simplicity. However, curiosity leads one to wonder about how this strategy can be improved when it is combined with modern technologies. This is where quantamental investing comes in.
Quantamental Investing attempts to combine both Fundamental and Quantitative Investing. Blackrock has supported this investment philosophy by shifting $30 Billion in assets, representing 11% of its assets, to strategies that rely more on algorithms and models rather than human intuition to select stocks.
Also, research from Morgan Stanley’s Applied Equity Advisors team reveals that factors such as valuation, growth and quality (i.e. fundamental factors) have been responsible for 65% of a global equity manager's relative(or excess) return. The remaining 35% is driven by stock selection, which is where quantitative investing plays its role.
Quantamental Investment Strategy Illustration
The quantamental strategy presented below combines a quality factor, as represented by Return On Equity, and a technical factor which in this case would be a cross-sectional momentum factor. To be more precise, the strategy aims to identify high-quality companies and then tactically rotate into those high-quality companies with the best momentum. The rules used in this strategy are presented below:
The Universe used is the Q500US
Apply a quality filter, which will select the 50 stocks with the highest ROE. Out of the 500 stocks that we started with, we are now left with 50 high-quality stocks.
Of the 50 high-quality stocks that remain, we buy the 20 stocks with the strongest relative momentum.
Thereafter we only enter new positions if the trailing 6-month total return for the S&P 500 is positive.
This strategy is rebalanced once a month, at the end of the month. When rebalancing, we sell any stocks that are no longer in our high momentum list and replace it with stocks that have since made the list. We only enter new long positions if the trend following regime filter is passed
Any cash not allocated to stocks gets allocated to Treasuries.
One feature of this strategy that I find fascinating is the universe of securities used in the quantamental strategies construction. Similar to what was discussed in a previous article, Q500US is a pipeline filter that only trades securities that comply with a predetermined criteria. The benefit of trading such a universe of securities instead of a fixed number of securities over the investment horizon is as follows:
Such a construction reduces the risk of an order(to trade a security) not being filled; and
This construction also allows for more meaningful comparisons between strategies as now securities in the Q500US filter will be used as the standard universe for all algorithms tested.
Now that we have went over the rules, it is now time for a visual demonstration of the strategy.
The risk metrics for this strategy are presented below.
Conclusion
Typical of strategies discussed on Quantopian's forum, the strategy presented in this article significantly outperformed its benchmark. Another interesting feature about Quantopian would be that profitable strategies like the one mentioned in this article are often further optimized by the community once they have been posted. This is a perfect illustration of the saying that power is gained by sharing it, not by hoarding it. And this is what makes Quantopian a powerful learning instrument. Complement this article with the following video.
References
Long-Only Absolute Return Funds Enter the Alternative Investment Universe, EurekaHedge.com
Equity Asset Valuation[3rd Edition], Wiley.com
Building a Quantamental Investment Team,hedrick.com
Quantamental Investing: The Future is Now, MorganStanley.com
Animation Machine GIF By Gareth Fowler, Instagram.com
The Q500US and Q1500US, Quantopian.com
Presenting the "Quality Companies in an Uptrend" Model, Quantopian.com
Backtesting with Python and Quantopian, IridiscentCapitalProjects.com
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