Not all Quants are created (e)Qual

Qualitative analysis is hugely underrated in what is an increasingly quant driven world of investing. My belief is that both disciplines are required to build efficient strategies and it is when it comes to the balance between these two disciplines that herein lies the debate. 

Quant-driven strategies, smart beta, ETFs, ETCs you name it, unless they are a plain vanilla index tracking instrument have all been originated with a qualitative or subjective discipline. An acquaintance of mine once referred to the art being in the creation and thereafter the strategy effectively runs programmatically. They are right, someone has to create the program and have the original ideas. 

Both fundamental analysis and traditional investing have evolved substantially and it appears that although we are well into the multiple re-incarnations of modern portfolio theory that Markowitz coined in the 1950’s, modern qualitative analysis is here to stay. Take sustainable investing for instance, where there has been huge growth. Any given investment will need to meet specific criteria that is not necessarily number-driven but moreover a measure of what that investment aspires to achieve such as making an impact on society, climate, the planet or other. The numbers, while still important, really play second fiddle to that. 

Warren Buffett is certainly a qualitative man and has a well publicized principle of only investing in companies or products that you would consume yourself. He enjoys a Coca-Cola so he invests in Coca-Cola. Buffet suggests if you do not understand an investment, why bother investing?

That’s fair in part, but the quantitative element that is provided more often than not by analysts should provide an insight or edge that aids an investment managers decision, backed up by the qualitative work. There will of course be quantitative aspects to construction that determine what ideas are allocated to within a portfolio - it may be a particular asset class or sector, a target weight or how that idea either compliments or hedges versus existing assets. That unique idea with quant driven factors will be well researched and value-add will come from having been through a qualitative lens at some point during the process be that an active strategy or not. 

Where a qualitative approach really comes to bear fruit is in assets such as private equity, private assets and smaller companies. Numbers, often forecasts, can look extremely promising, however what they might not show you that an in-person meeting would is beads of sweat on a CFO’s brow within an air conditioned room or a lack of eye contact during a presentation that speaks to your gut feeling. The numbers on page could be great, the analysts are waxing lyrical about the opportunity, but something’s not right - that’s the power of qualitative work. EQ is just as, if not more important than IQ.

The same applies to assessment of managers where qualitative work is of utmost importance. Morningstar or your financial information tool of choice will filter out what you will be seeking from a numerical perspective where you again would have pre-determined what is relevant to the portfolio. When you are ready to invest and have the opportunity to meet the manager, akin to meeting a company whose stock you are considering, what questions come out of that meeting from a qualitative perspective is exhaustive. Is the manager a “star manager” who really relies on teams of analysts? What is the team dynamic like? Are they likely to leave? How long have they worked together? How do they generate their ideas? And so on. 

The simple message is one should always do one’s homework. Bitcoin's astronomical price rises keep attracting “investors”. Let’s remember you can lose millions of dollars not due to uncovering issues in the numbers but because you once threw out the wrong hard-drive and it’s in landfill.   

The two great foundations of investment research, quantitative and qualitative analysis, are here to stay, getting the edge lies in finding the right balance and often trusting your gut...unless of course, a Reddit thread or Tweet from a well-known entrepreneur play havoc with your thesis!