Back to Community
Differing schools of thought on investment philosophy

I've been trying to wrap my head around the massive difference in opinion between quantitative investors on one hand, and value investors on the other. I'm reading "The Five Rules for Successful Stock Investing" by Dorsey, and in the book it's stated that "stock price movements convey no useful information", "the long-run performance of stocks ... has very little to do with what the stock did over the past week or month", "Most of us would be better investors if we could just block out all those graphs of past stock performance because they convey no useful information about the future.".

Now (as per my limited understanding) these statements directly fly in the face of the quant philosophy. I'm curious as to what causes some proponents of value investing to completely disregard the quant philosophy (and also the other way round). Is it because in their experience, the other style of investing has never worked out? In that case, wouldn't it simply be an empirical justification of not believing in the quantitative investment philosophy? Or is there any solid theoretical reasoning behind sticking ONLY to value or quant investing?

Also, even if there is plenty of empirical justification against the quant philosophy, isn't this chain of reasoning similar to what quants use in the first place? (there is plenty of empirical evidence that suggests so-and-so stock will do well in the future, hence invest in it <==> there is plenty of empirical evidence to suggest that quant style of investing doesn't work, hence avoid it).

Disclaimer: With my limited experience, I have no predisposition to either school of thought. At this stage, I'm just trying to understand the merits and disadvantages of each style of investing.

5 responses

It depends on timeframe mostly, and how you define a "stock". If you view a stock as an investment into an individual companies future then current stock movements hold no bearing on your success other than how cheap or expensive the stock currently is to own relative to it's fundamentals. If you view a stock as an price instrument (basically, a series of numbers on a screen) that profit can be made from by buying low and selling high in the short term then you care only about short term patterns in the price movement that you can make money from. Forex is primarily a quantitative investment, mostly bought and sold based on short-mid term price movements because countries don't generally grow or die quickly. It would be silly to invest based on a countries percieved "value", but stocks can go either way because even though they fluctuate short term, they also can grow or die on an individual investor's timeframe so value matters.

Personally, I think value investing is an outdated concept, but will be come back eventually. Back before computers the stock market was truely value driven because most investors didn't have up to the nano-second price information and decisions were made based on how viable the company was in the future. Now, we live in an instant information age where companies can have large price movements regardless of how much or how little money they make simply through investors and hype, any new information is digested by algorithms instantly (or even earlier with insider information leaks) and the value is priced in. Basically, the market is getting too efficient for your average value investor to find many good deals. That's not to say the deals aren't out there, but it's not worth it IMO when you can buy and sell on a short time frame and make more money regardless of the fundamentals.

It can't keep up forever though, value has to eventually matter again but it might not be within my investment timeline (my lifetime) so I ignore it.

Why do you think value investment won't regain prominence within your lifetime? Is it because algo trading hasn't become mainstream yet, or is it because there may still be more technological advances that may supersede even the current algo trading regime?

Also, why does value have to eventually matter again?

Agree with those points. A lot of quant strategies are much shorter term than fundamental strategies, which may involve holding a stock for years. The market might not recognize a turnaround immediately and you might have to hold a stock for a year for the investment to pay off. You could have made hundreds of profitable short-term trades in the meantime. Much of the fundamental information has been priced in already, although I think that custom financial metrics and external data sources could turn up some new value opportunities. I'm thinking about momentum and mean reversion for fundamental metrics, not just price action. Also consider economic theories and value traps.

Well the main argument the author puts against short term trading is the transaction costs + tax. He compares the two investment styles - one with a (say) 3-yearly turnover, and the other with a 6-monthly turnover. The horizon is the same - 30 years. The returns after 30 years for both methods are compared and it turns out that value investing gives superior returns. But is it really fair to keep the same horizon of 30 years for both methods? Wouldn't a much shorter horizon make sense for the quant method?

Keeping the 30-year horizon for both methods is certainly all fair and square. It is important for an investment/trading strategy to consistently generate returns over a long time period so that you can be sure that it really works and the returns aren't just a result of good luck. Most trading strategies that you think work today should also have worked 30 years ago. Whether they'll keep performing well in the future is another question.

Quant trading is much more short-term because the trading hypothesis is based on things like institutional investors needing some time to move their money from one stock to another (resulting in very short-term momentum), empirical statistical likelihood estimations that might or might not have any economic reasoning, and noise traders making investment and trading decisions affected by systematic psychological biases and heuristics (resulting typically in short-term momentum or mean reversion). In my opinion, quant trading (based on price action, macroeconomic factors and sentiment proxies) and value trading/investing are complementary. Employing both methods enables you to have a more diverse basket of strategies, which is beneficial in the same way that having a diverse basket of stocks is. However, transaction costs can easily kill a quant strategy due to these strategies' short-term focus. That is just one of the risks that you expose yourself to in exchange for being less exposed to systematic market risk.