Fundamental vs. Quantitative Investing Strategies

You may be investing for retirement, a child’s education or building your portfolio for other dreams. The “why” is personal to every investor, but the analysis of “how” can be challenging. With literally thousands of mutual funds and financial products to choose from, it can make your choices difficult. To boost your knowledge, we break down two approaches to managing stock portfolios.

Two Investment Strategies

Investment professionals use various approaches to manage stock portfolios. We’ll take a closer look at two foundational methods that have been around for decades—fundamental and quantitative. 

Fundamental Analysis 

Often referred to as “traditional” investing, this approach uses an in-depth analysis of a company’s business, management team and market opportunity to determine the stock’s attractiveness. It relies on investment manager expertise to make informed decisions about which stocks to buy and which to sell.

Quantitative Analysis 

Also known as “systematic” or “scientific” investing, this approach uses data-driven analysis to evaluate a broad universe of stocks. It relies on factors identified over time by portfolio managers and academics to build portfolios of stocks with attractive characteristics.

Both approaches aim to get clients to the same financial destination: to help reach their goals. They also attempt to beat a market benchmark. For example, two stock funds—one traditional and one quantitative—might both be managed against the S&P 500^® Index (a common U.S. stock market benchmark).

Even though they share the same broad investment goal, the strategies and tools the portfolio managers use are different. In a general sense, quantitative/systematic equity money managers view investing as a science, removing emotional biases and buying stocks with specific traits. Fundamental/traditional managers could be said to see investing as more of an art, relying on their judgment and experience.

Fundamental vs. Quantitative: A Breakdown

Capitalizing on Market Inefficiency

Both traditional and quantitative managers believe that stocks can be (and often are) mispriced. This means the current price of a stock is out of line with the managers’ estimate of its value, either now or in the future.

Such mispricing can come from legitimate differences of opinion about a company’s business prospects. Or, it can result from any number of irrational reasons—fear and greed being the most obvious cited for the bubbles and crashes that periodically upset markets.

In addition, investors and academics found that certain types of stocks tended to have specific performance characteristics, and these factors have been identified in numerous studies.* Armed with modern computing power, researchers sought to uncover more and more of these predictable, readily identifiable attributes to find market inefficiencies.

These documented market inefficiencies and the wide availability of financial data spurred the launch of quantitative active strategies in the mid-1980s. The core tenets of quantitative investing are:

• Behavioral and market inefficiencies create investment opportunities.

• Capturing these inefficiencies is best done using a multi-factor model. These factors are typically grouped into four broad categories: value, sentiment (sometimes also referred to as momentum), growth and quality.

• Using multiple factors in stock selection may improve the consistency and predictability of performance.

• Managing risk and minimizing transaction costs are essential components to delivering active returns to investors.

Contrast this approach with that of traditional/fundamental managers. The core tenets of fundamental investing are:

• A company’s business, its management team and a host of other considerations may determine a company’s future prospects.

• This analysis of a company’s inner workings and growth trajectory has to be combined with some assessment of the stock’s valuation.

Which Is Better–Fundamental or Quantitative?

There is no clear winner. Both approaches seek to outperform a market benchmark—they just take different roads to get there.

In our view, one isn’t better than the other, but both serve a purpose within a well-diversified portfolio. Rather than set quantitative and fundamental approaches against one another, we believe they are complementary. Quantitative strategies may be seen as a third “style” of equity investing, along with fundamentally based growth and value disciplines.

To learn more about using either a fundamental or quantitative investment process in your portfolio, please call us.