Published: Jan 9, 2001 7:14 a.m. ET


Quantitative investing has value in a balanced approach



SANTA MONICA, Calif. (CBS.MW) -- We've all heard the phrase don't get emotionally involved. You should play by the numbers and not make decisions based on fear or exuberance as opposed to theory.

"It's our responsibility to be objective. We are shielded from riding a stock to the ground or getting caught up in concepts."
Bob von Pentz,Quantitative Advisors

Quantitative investors take the Mr. Spock approach. They leave emotions out of it and trade by numbers, instituting specific guidelines on what to buy, when to buy and when to sell their investments, good or bad.

Computers or black-box calculations show them where opportunities lie in the capital markets. The machines even spit out specific buy recommendations, how much at what price. To offset new buys, sell recommendations are also issued.

Most financial-planning software is designed to take our place in the market and make decisions for us. Lots of personal and professional investors use numbers instead of intuition.

A persistent feeling

Still, emotions play the biggest part of investing for most of us. We get excited when the market goes up, so we buy. We get worried when the market goes down, so we sell. We do exactly what were not supposed to do.

Quantitative investors set investment models to avoid that. They'll have a particular buying criteria -- when earnings estimates, benchmark estimates and growth patterns align. And they usually have set sell criteria -- when the stock appreciates more than 20 percent, or if growth estimates are overvalued relative to similar companies.

What they often miss are the big gains based on euphoria. After all, emotional investing can't really be programmed or accounted for in a financial model. It's human nature to trend toward hot investments and/or sectors, says Christopher Phelps a certified public account and certified financial planner in San Diego with Rowling, Dold & Associates. But you make money by selling high and buying low, not the other way around.

In 1999, for example, growth stocks as a group turned in a 52 percent return. Most were deemed overvalued by traditional quantitative analysis. The trend continued through last March. A lot of people didn't sell or take profits; they bought more technology stock looking for growth.

By the end of 2000, growth stocks were off 35 percent. The numbers quickly cut talk of new market heights and individual stocks reaching $1,000 per share short. What may have looked like a missed opportunity then, may now be a blessing in disguise.

After awhile, the swings create a steady motion. So what would appear to be short rises and falls is actually a relatively straight line.

Compound the 52 percent gain with the 35 percent loss that growth stocks experienced and you get par. All that volatility and no net gain, quantitatively speaking, that is.

Wherein lies the truth

Many investors found that out the hard way last year, says Chris Brown, an investment adviser with CommonWealth Advisory Group in Gaithersburg, Maryland. Quants, as they are fondly known in the investment business, don't suffer the same type of pathos.

"Our purpose is to look at objective numbers," says Bob von Pentz, a portfolio manager with Quantitative Advisors in Lincoln, Mass. "It can be easy to say: We like this company. We know the management -- they'll bounce back. It's our responsibility to be objective. We are shielded from riding a stock to the ground or getting caught up in concepts."

Take Lucent Technologies. A good and well-managed company by all accounts, Lucent was trading at $60 per share last year. Today, it's around 16. It's products are the same. Its business model and management are the same. But Lucent's stock got whacked with the fallout in technology stocks.

It's easy for a person to rationalize deteriorating numbers, von Pentz says.

To be sure, even crunching numbers requires some human intervention. We program our modeling with sensitivity to trends or earnings estimates, von Pentz says. Some investors find the quantitative numbers and place extraordinary bets. We try to avoid that and diversify.

But as a rule, quants step out of the right side of the brain, which controls emotions. It's a discipline and a process, not a belief system, von Pentz says.

Quant investors can be found in virtually every asset class in every sector. They invest in all types of stocks, bonds, real estate and commodities. Still, quants are mostly found in investment areas that experience extreme volatility like situational arbitrage. And a lot of day traders are quants.

Zeno of Elia, a Greek philosopher, was able to mathematically prove there was no motion in the world. Were all standing still, he professed. Motion is an illusion.

Quants may see it that way. The rest of us suffer with the human volatility factor.

Spock may have been able to set such a logical course. I always rooted for Captain Kirk, however. After all, he'd always get Spock's advice. But he found a way to balance logic with emotion.

That way you're playing by the numbers -- and realizing that numbers are a human invention.

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