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How do fundamental and quantitative analysis differ?
In fundamental analysis managers analyze the unique aspects of a firm. For example, a manager doing fundamental analysis on Microsoft would study Microsoft’s new products, understand Microsoft’s profit margins, threats from specific competitors, etc. You use this information to forecast the future cash flows of Microsoft to estimate the fundamental value of Microsoft.
In quantitative analysis you do not analyze a specific firm. Instead, you build a model that attempts to predict stock returns using various factors. For example, you might believe that stocks with low P/E ratios are undervalued and you test this using historical data. If you find support for this prediction you then overweight stocks that have low P/E ratios and underweight stocks with high PE ratios. This approach does not estimate fundamental value, but instead focuses on relative valuation (i.e., low P/E firms are undervalued relative to high P/E firms).
What are two advantages and two disadvantages of Quantitative investing?
Two advantages of quantitative investing are: 1. Because of its statistical nature, it removes much of subjective judgment from the decision making. As a result, it removes (or at least reduces) emotions and other cognitive biases from the investment process. 2. It allows you to analyze many (1000s) of stocks very easily. It also allows you to analyze many potential factors. Analyzing more factors offers a valuable breadth advantage. The more valid factors you find, the less likely it is that a quantitative investment strategy will underperform.
Two disadvantages of quantitative investing are: 1. The strategy relies on the assumption that past statistical relationships may continue in the future. There is no guarantee that this will hold. 2. Many quant strategies, such as short-term reversals, require very high turnover. While the strategy may appear profitable, transaction costs can easily erode any profits.
In fundamental analysis managers analyze the unique aspects of a firm. For example, a manager doing fundamental analysis on Microsoft would study Microsoft’s new products, understand Microsoft’s profit margins, threats from specific competitors, etc. You use this information to forecast the future cash flows of Microsoft to estimate the fundamental value of Microsoft.
In quantitative analysis you do not analyze a specific firm. Instead, you build a model that attempts to predict stock returns using various factors. For example, you might believe that stocks with low P/E ratios are undervalued and you test this using historical data. If you find support for this prediction you then overweight stocks that have low P/E ratios and underweight stocks with high PE ratios. This approach does not estimate fundamental value, but instead focuses on relative valuation (i.e., low P/E firms are undervalued relative to high P/E firms).
What are two advantages and two disadvantages of Quantitative investing?
Two advantages of quantitative investing are: 1. Because of its statistical nature, it removes much of subjective judgment from the decision making. As a result, it removes (or at least reduces) emotions and other cognitive biases from the investment process. 2. It allows you to analyze many (1000s) of stocks very easily. It also allows you to analyze many potential factors. Analyzing more factors offers a valuable breadth advantage. The more valid factors you find, the less likely it is that a quantitative investment strategy will underperform.
Two disadvantages of quantitative investing are: 1. The strategy relies on the assumption that past statistical relationships may continue in the future. There is no guarantee that this will hold. 2. Many quant strategies, such as short-term reversals, require very high turnover. While the strategy may appear profitable, transaction costs can easily erode any profits.