Why Decades-Old Quantitative Strategies Still Work Today
June 2, 2015
by John Reese
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For much of the past decade, Crispin Odey has been waiting for inflation to rear its ugly head. The fund manager has been positioned to take advantage of rising prices in his flagship hedge fund, the Odey European Fund, and has been trying to warn his investors about the risks of inflation through his annual Read More
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For some – particularly those who believe in efficient markets – a successful quantitative investment strategy is akin to a beautiful, quiet, undiscovered beach: Enjoy it while you can because once the masses get wind of it, its secluded beauty will be no more.
Other critics say that quantitative strategies become ineffective as times change. Approaches designed decades ago can’t possibly work today because the investment landscape has evolved so much.
I couldn’t disagree more. In fact, I’ve seen first-hand how winning quantitative investment strategies can continue to work long after they’re well known and decades after they’re developed.
Take the strategies of Benjamin Graham, the “Father of Value Investing” and Warren Buffett’s mentor. I recently read a piece contending that Graham’s approaches can’t work in today’s environment because times are so different from when Graham managed money. The reasoning sounds logical – after all, there was no high-frequency trading back in Graham’s day, markets were far, far less global and the 401(k) and retirement-account investing that drive a lot of today’s equity purchases weren’t factors. Plus, certain variables can go in and out of fashion as investors develop new techniques for evaluating businesses and stocks.
But my experience and testing show that successful strategies continue to work long after they are created and revealed. In fact, the “guru strategy” I base on Graham’s Defensive Investor approach is one of the top-performing models on my research website despite the fact that Graham published it 65 years ago.
Below is a table of 10- and 20-stock model portfolios picked with the Graham model, using various rebalancing frequencies. I have tracked these portfolios since mid-2003. On each rebalancing date, they are adjusted so that they include only the stocks that score highest according to my Graham-inspired model. As you can see, each portfolio under all rebalancing time periods has outperformed the broader market, as defined by the S&P 500. The strategy does exhibit more year-to-year variability than the market (although in 2008, the portfolios all avoided major losses due to the exclusion of financial stocks), but the outperformance has also rewarded investors for the extra risk they may have taken by investing in the strategy.
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