Quantamental

Quantamental is an investment strategy commonly used by hedge funds where human traders use the results generated by artificial intelligence and machine learning to improve the performance of their funds. The same has emerged by combining fundamental and quantitative methods or approaches to buying various financial instruments such as stocks, bonds, derivatives, etc.

Thus, it combines the fundamental and quantitative approaches in during investing, with the objective of earning maximum returns. It brings human insight and the power of computer together with the hope of superior returns. Armed with huge and relevant data, investors hope to harness profitable investment opportunities.

• Quantamental is a hedge fund investment strategy that involves human traders using artificial intelligence and machine learning to enhance fund performance. It combines fundamental and quantitative approaches to purchase financial instruments like stocks, bonds, and derivatives.
• Warren Buffet, the most successful investor and multibillionaire, is one of the leading proponents of fundamental investing. Quantitative investing includes categories such as option and macro strategies.
• The future of financial investments could be transformed in a highly positive way, with the actual value matching market value, or in a disastrous way, with more events like the flash crash.

Quantamental investing is investing where mathematical principles and statistical methods are used along with traditional finance methods to invest and build portfolios. It is a blend of fundamental investing and quantitative investing.

The process involves merging of computer power with human insight. The blending of man and machine brings together the benefit of power of data as well as the huma knowledge to identify some winning strategies that can be used for investing and earning maximum returns. By combining the historical data and patterns and analysing the current market scenario the investors try to identify the various trading signals so that they can make financial decisions more confidently. For this reason, the current trend of using satellite images for interpretation of sales volume and market performance.

Like all technologies, quantamental funds has its own merits and demerits. It might change the future of financial investments in an extremely positive direction – where true value is equal to market value, or in the direction of disasters – more incidents like the flash crash. Moreover, like every other technology, it is upon humans to see what can be done using these investing methods. Nevertheless, before that, we should not be clouded by the ego of what can and cannot be done so that we forget to see what should and should not be done.

However, this method is also currently under strict pressure due to competition, even though some purely quant firms have managed to generate the best returns in the industry.

Warren Buffet, the billionaire investor, is one of the prime promoters of fundamental investing and the most successful investor. Through the years, investors have pursued new techniques to invest in companies and build portfolios. However, over the past 3-4 years, Mr. Buffett has underperformed in the S&P market. We shall dwell on how and why this happened, but let us look at what fundamental and quantitative investing are.

The Fundamental

The prices of any financial instrument (stocks, bonds, derivatives, etc.) are a measure of their value. The prime assumption of economists is that, with time, information flows from the known to the unknown, and as the information flows, the ability to realize the value of a financial instrument grows. That being said, there is always a difference between the price and the value we get. If your methods are strong enough and you realize that the price is less than the value, you buy the instrument and wait till the value is realized and vice versa.

Fundamental analysis is a way to measure such value. If we take the example of a company, the company publishes multiple documents that try to explain what the company is doing currently, what it plans to do, and where it will stand. We look at the assets of the company and its liabilities. We try to measure what the future for the industry will be and how the company will fare with the overall growth of the economy. Considering all these, we can look at the book value of the company and other metrics that help us in gauging the value of the company. Once the value is measured, market prices provide us with a trading route.

• Value > Price – Long the stock and wait
• Price > Value – Short the stock and wait.

The Quantitative

With the growth of computers, coding, and processing power, it is not just with a fundamental analysis that we can realize profits. There is always a gap between the value and price of a financial instrument. In addition, as long as such a difference exists, there is a way to make profits.  Quantitative investing uses the principles of statistics, combined with machine learning, to see patterns in movements of prices and try to invest in multiple places.

Hundreds of metrics are available to analyze the trading patterns in the market; look at the movement of stock prices, look at the price of options, analyze the buying and selling patterns, look trends, look at industry movements, and look at correlated stocks. Machine learning uses such statistical inefficiencies in the market to gauge how the stock prices might move and use them as an investment strategy. In short, quantitative looks at just the prices and formulates trading strategies.

Quantamental investing, as the name suggests, uses both of the above strategies to invest in companies.

#1 - Option analysis

Quantamental funds involving options will work along the following lines:

• Scrub through thousands of equities
• Look at the respective option chains
• Calculate the options with the highest chance of yielding payoff.
• Add fundamental analysis to the same.
• Reassess the probability and price of the options.
• Formulate appropriate strategies

#2 - Macro analysis

• Look at all the past economic data
• Predict the future markets based on current conditions using fundamental analysis
• Predict arbitrage opportunities using big data and formulate trading strategies.

Below are the examples of quantamental research. Let us try to understand the concept in detail with the help of the below mentioned examples.

Example #1

Implementing strategies looking at fundamental and quantitative metrics is quite interesting. One such interesting scenario is: JCPenney outperforming the markets in the second quarter of 2015. Such positive results suddenly led to an increase of 10%, and every one of the major investors was caught off-guard. However, one company, RC Metrics, a big data firm for investors, used the satellite imagery of JC Penny's parking lots to invest in the company.

RC Metrics realized that the number of cars in JC Penny's parking lots, which are counter-suing satellite imaging, is continuously rising. The algorithms pick this data that might be left off as trivial as a helpful metric and used to invest in the company. Everyone was surprised by the profits, not RC Metrics – they were prepared. This is a positive side of how quantamental research can be used.

Example #2

To see when and where Quantamental investing is currently implemented and how it affects the trading strategies in investment companies, let us look at one of the most famous events of financial history – The Flash Crash.

2010 Flash Crash is a financial event where machine-led algorithms triggered a sale causing a sudden crash in the market without any reason. However, in about an hour, the market regained its previous status. However, imagine the loss it caused to margin traders – who trade not on the full amount but margins. Billions of dollars were lost, and some traders lost their entire savings. There are many theories about how it happened. Still, one famous theory is that the machines started selling after Associated Press's Twitter account was hacked and a fake tweet regarding a white house bombing was tweeted.

Algorithms, trained to learn, used Natural Language Processing to read this tweet and realized that something negative and big was about to happen. It is a basic metric – something wrong has happened in the government and will affect the markets. This is how real strategies work – gauge the scenario and act on it. However, it was not triggered by humans but by machines. In addition, once one machine triggers the selloff, the algorithms are trained to act quickly. In a scenario of falling prices, they assume the worst and trigger a further selloff. It snowballed into a crash, and markets are down by 9%.

The Dow Index lost about 998 points in one hour. All this is because one machine looked at a tweet and began to sell. This is another side of Quantamental investing. The idea behind it might be right – but implementing machine learning algorithms to act with human intelligence is not yet as advanced as it should be to handle such scenarios.

As every financial concept has their own advantages and disadvantages, so does this concept. Let us try to understand the advantages first.  

• All investing is a measure of information and analyzing it. Using quantamental analysis to analyze the essential information is a step toward more open financial markets.
• This kind of investing is, by essence, a better method of realizing value than fundamental or traditional investing.
• Quantamental analysis increases the flow of information and finds a reasonable way to use the information to assess its value.

Along with the advantages, it is necessary to look for the disadvantages also.

• Machine Learning algorithms are black boxes, and we can never gauge how sudden events must be handled.
• The ability to manually analyze the value of the financial investment goes down, and future algorithms will reflect the same.
• Incidents like Flash crashes can be more common.
•  Investment companies have to be aware of the competition's methods to trigger the machines – Humans have an intuitive sense, but not machines.

This has been a guide to Quantamental Investing and its meaning. We explain its various strategies, types, along with examples, advantages & disadvantages. You can learn more about financing from the following articles –

• Invest in Currency
• M2 Measure
• Trading vs Investing
• Books on Bond Investing
• M2 Measure