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Quant Funds: They're Back


Can you succeed without this type of massive computer firepower? Of course you can, but remember, your competition is firing 50 caliber rounds compared to a 38.

Last month the press and media focused on the trouble brewing at many of the biggest and most successful Quant Hedge Funds. There were calls that these "Masters of the Universe were done" and "The Emperor wears no clothes."

Well, they're back. It appears their demise was greatly exaggerated. When the final numbers are in for September I expect a sharp rebound for Quant funds including some of the biggest that were hit the hardest in August. If they stuck to their strategies I am sure they were rewarded handsomely.

In past articles I have said that the quantitative models weren't flawed but the massive use of leverage was. The unwinding of this leverage was the principal reason for the large draw-downs. Yes, it has been a good month for most investment styles but I think last month's losers will lead the pack.

For the uninitiated, let's have a quick review of what Quant funds do. All stocks possess hundreds of factors, i.e. PE, Debt/Equity, Price/Cash Flow, Estimate revisions for four weeks, eight weeks and on and on and on. These quantitative masters program their computers to analyze the data points and then back test these strategies through all sorts of market conditions. Some are so detailed they can analyze whether the distance of the Earth from the Moon is a data point worth considering. In essence they are searching for the Holy Grail. A good Quant recognizes there is no Holy Grail and evolves the model like a living breathing animal.

The best of these strategies live on the cutting edge of investment research. Stocks like Dryships (DRYS), CVRD (RIO), Arcelor Mittal (MT), Mobile Telesystems (MBT), Freeport McMoran (FCX) and others reside at the very top of many quant models and have pushed performance in these funds for the last few years. They possess the characteristics that Quants salivate over: massive growth along with reasonable valuations.

Do these strategies get overbought? Sure they do, just like stocks. I suspect we are at or very close to that point right now. The stocks mentioned in this article are all over-bought and due for a rest but after their pullbacks I expect them to resume their upward momentum. If they don't I am sure the good quant models will pick up on the reason and eliminate them from their portfolios.

Can you succeed without this type of massive computer firepower? Of course you can, but remember, your competition is firing 50 caliber rounds compared to a 38.

It's 2007. Embrace Hal. There are countless affordable screening and quant like tools available to assist you in identifying stocks that are likely to beat market averages. Will you do as well as the PhD's running these investment vehicles? Probably not, but who says you have to? If it increases your batting average by just a small amount it will be more than worth the effort.
No positions in stocks mentioned.
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