Sunday, July 09, 2006

How a Computer Knows What Many Managers Don't

How a Computer Knows What Many Managers Don't - New York Times: "Many mutual funds that make their trades based on the recommendations of a proprietary computer model, known as quantitative or quant funds, have outperformed their benchmarks in the last three years. And investors have noticed. At the Vanguard Group, which created its first such fund in 1985, the amount of money managed by its quantitative group has quintupled in the last three years, to $20 billion at the end of 2005 from $4 billion in 2002.

While no organization keeps track of flows into quantitative funds, they are probably still a very small part of the $9.5 trillion mutual fund industry. The most obvious advantage is that quantitative models can examine a much larger universe of stocks than human analysts. Schwab Equity Rating, for example, analyzes about 3,000 stocks and assigns grades of A through F, based on four metrics: fundamentals, valuation, momentum and risk.

The expense ratios of quantitative funds are also generally smaller than those of comparable actively managed funds. And because the models have rankings of stocks, many employ short-term as well as long-term strategies.

But perhaps the most important attribute of quant funds is their superior risk control. Most models keep sector and equity picks within the benchmark attributes they are built around. This process reduces the risk that may otherwise be introduced by active managers who decide to make a bet on a particular sector or stock. "

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