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How to beat the investment returns of all those brainy data scientists

Quants have evolved to focus on exploiting big data and machine learning to take advantage of market inefficiencies at light speed.

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How can the average investor hope to beat the market in an age of real-time, data-driven, quantitative strategies? The secret may lie in one overlooked, contrarian theme: long-term, fundamental investing.

"Stocks for the long-term is an all but forgotten concept," Savita Subramanian, Merrill Lynch's head of U.S. equity and quantitative strategy, writes. "One of today's greatest market inefficiencies may stem from the scarcity of capital devoted toward long-term, fundamental investing."

The risk-reward profile of holding stocks improves over time, while valuations are unmatched in their predictive power for long-term returns, the report said.

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Short-term investment methods have attracted vast sums of money in recent years, at the expense of fundamental investing.

Quants have evolved to focus on exploiting big data and machine learning to take advantage of market inefficiencies at light speed.

"Jobs advertised for data scientists and quantitative analysts outnumber those for fundamental analysts by a factor of eight," Ms. Subramanian said.

The number of fundamental analysts per $1-billion (U.S.) worth of market capitalization has declined from about 14 to less than one in the last 30 years.

That's not to say fundamental investing is dead. In fact, the rise of the quants may have made fundamental opportunities more abundant.

"What should be an increasingly efficient market has shown signs of becoming less efficient over the long term," Ms. Subramanian said.

Quant models quickly arbitrage away short-term opportunities, but with fewer resources dedicated to fundamental investing, long-term inefficiencies seem to be on the rise, she said.

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"Fundamental signals significantly improve in efficacy over longer time horizons," the report said. "While trading stocks over a one-day period can be considered to be only marginally better than a coin-flip, the probability of losing money plummets to 0 per cent over a 20-year time horizon."

Only two decades in the past eight have produced negative total returns in U.S. stocks: the 1930s, which saw a return of negative 1 per cent, despite the Great Depression, and the 2000s, which was book-ended by the bursting of the tech bubble and the global financial crisis, which generated a -9 per cent return.

And, in predicting those returns, valuations are virtually all that matters. They explain almost 90 per cent of the variability in S&P 500 returns over a 10-year time frame, the report said.

"We have yet to find any factor with such strong predictive power over the short term."

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About the Author
Investing reporter

Tim Shufelt joined the Globe and Mail in August, 2013, primarily to cover investments for Report on Business. Prior to the Globe, he worked as a staff writer at Canadian Business magazine, a business reporter at the Financial Post, and covered city news and courts for the Ottawa Citizen. More

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