Quant Investing: Getting The Big Things Right

Includes: SPY
by: Paul Novell

Keep it sweet and simple. That's the fit-for-publishing version of KISS. And it is critical for being successful in the long term with quant investing. The biggest mistake I see new quant investors make is over complicating things. This just leads to failure. By focusing on a few high impact factors a quant strategy can still significantly outperform while being relatively easy to maintain. In today's post I will present a KISS quant strategy has provided plenty of outperformance while being easy to maintain.

Before I dive into the KISS quant strategy let me throw some stats at you. I have a link to Portfolio123 in most of my quant posts and I am also part of their affiliate program. Of all the clicks on my blog over to P123 only 6% of people have chosen to sign up for a free trial. Of those 6% only 9% have actual signed up for a paying P123 membership. That is 0.5% of people who showed more that some passing interest in quant investing have actually committed to use the tool. Needless to sat the affiliate program has been a total bust for me. Now, this is just pure anecdotal data. I have a really small blog and P123 is not the easiest tool to use but it jives with other stats I have seen others quote about quant investing in general. A big part of the problem is people over complicate things. They try to shoot for the stars with super aggressive strategies with high failure rates. It doesn't have to be like that. By focusing on a few big things you can get 'enough' outperformance from a quant strategy to make a huge difference to your wealth.

Here is an example KISS quant strategy. We start with the S&P 500 index of stocks. 50% of the portfolio is in a pure momentum strategy based on 6 month returns (10 stocks rebalanced every 4 weeks). The other 50% of the strategy is in the Value Composite strategy (VC2, 10 stocks, rebalanced every 4 weeks). A rebalancing between the momentum and value portions of the portfolio is done once a year. We also use a recession crash filter (SPY-UI) based on the unemployment rate. That's it. What this strategy does is to focus on a few big areas of potential outperformance that have proven themselves over long historical periods.

  • Equal weighting
  • Concentration (10 stocks for each strategy)
  • Momentum factor
  • Value factor
  • Recession filter

Here are the simulated results for this strategy going back to 1999.

Pretty powerful. Significantly higher returns and lower drawdowns than the SPDR S&P 500 Trust ETF (SPY). No need to chase complex implementations of factors, or esoteric indicators, or rebalance the portfolio every day/week. Keep it simple. Maybe you'll actually be able to stick with it.

Whatever your view of stock returns going forward even a few percentage points of outperformance and lower drawdowns consistently applied across a long period of time can be life changing. Most quant investors miss this. Break out Excel and model the impact of even a few percentage points of outperformance and lower drawdowns over a significant period of time. That's the potential and the ultimate challenge.

In short, try hard not to over complicate quant investing. Focus on getting a few big things right and keep it sweet and simple.