4 investing lessons from a fund that scans 16,000 securities in real-time

Quant investing is all a bit mysterious. It's a black box of algorithms and complicated mathematical modelling to produce supernatural outcomes. 

But for Bruce Apted, head of quantitative equity for State Street Global Advisors, there's a much more prosaic advantage to quant strategies - it takes the human out of the equation. 

"I think the real power in quantitative investing is the unemotional element to it. I think I touched on before that humans tend to be focusing on the short-term and we're very familiar with that as a concept, and that does create mispricing," said Apted.

"So one of the benefits of having a quantitative process is that it just tells you what those scores are, and it doesn't take into account any of those emotions associated with it," he said.

In fact, Apted has found his investment strategy can be broken down into four key pillars which are the basis of bottom-up investing. Apted has learned that it's not a process of elimination and he takes us through his strategy in this video. 

This transcript has been edited for clarity.

Mia Kwok: What are some of the key lessons or key questions that you ask of your stocks as a long-term investor?

Bruce Apted:
So I suppose that really speaks to our investment process, and how we look to find mispricing insecurities. And there are a number of pillars that we look at when we assess companies, and those pillars relate to the quality of the business. 

So, that's sort of a generic term. It means lots of different things to different people. We try and look at it in a very diversified way. 

1.  Quality

So quality to us is one of the first pillars. And for us, it's looking at financial strength.

The pillar of quality is one of many key elements when looking at stocks, and whether they're worthwhile investments or not. And the way in which we try and look at quality is multilayered. So there's not just one way to think about quality of a business. So, some of the most common ways of thinking about, is it sound, is it financially sound? Is this company generating good cash? Is its balance sheet in a good position?

That's definitely one element of quality that we want to capture. But also then it goes to what the operational efficiency is of this business. So is it generating good profit margins? And is it doing that in a way that's sustainable and consistent? And that is often an indicator of just how good a brand or how good a business that is. So that's really important.

And there's another element of quality which people are talking about perhaps more these days with all the climate risks and things like that in companies and around the world. And that's with respect to our environmental, social and governance factors.

So we do incorporate those directly into our quality signal. And that's trying to capture about how well is that business being run with respect to some of those important variables. So that's another element of quality. It's quite different to financial quality that we try and capture. And so thus quality is important, but of course there's other really important elements to assessing companies as well.

2. Valuations

The next one that I'd say is critical is valuations. So the price you pay for security is still very important as to the ultimate return that you will get from that investment. And so we do want to assess valuation opportunity and the rerating potential that a company has. And we do recognise that when companies become expensive, that introduces another element of risk.

And so when they become expensive, they're more susceptible to downside if they disappoint on those sort of growth expectations. So that's definitely an element we want to try and capture. And once again, we think that there's no perfect way to do evaluations, the way to think about value is that there's many different investor types, and they'll all think about valuation differently. We're trying to incorporate valuations from many different perspectives, there's no one way that's perfect.

3. Sentiment

The other element that's really important to us is that you can have a great business that could be reasonably priced, but you also want to think about the timing of that investment. 

So do you want to be investing in that business now, or do you think it's perhaps better to wait a couple of months? And so to get a better sense of that, we actually look to what we call sentiment, which some say is code for 'what's the operating environment like for this business?' Is it improving or deteriorating?

And there's a number of direct things you can look at when you're looking at the operating environment for a company, you can say what the trends are for the earnings, what the trends are for sales, are they improving or deteriorating? 

But in addition to that, there are lots of other things you can look at. So there are supply chain linkages. So what's happening with respect to customers? Is that a good operating environment in terms of the businesses customers, and how does that translate?

And then the other key element around this is investor positioning. So what can we learn from that? We can look at what's happening with respect to hedge fund behaviour, and where they're investing or not investing and that gives us insights into the operating environment for these companies.

4. Risk

There's one final element that I think is quite critical as well. I think this is one of the things that perhaps differentiates us from some of our other cohorts, if you like, or other investors, is that we have a very explicit focus on risk. So our quality variable tends to push us towards businesses that are more stable, but we do very directly look at the volatility profiles of these businesses as well.

And we look at whether they're high-volatile or low-volatile, and all else being equal, we prefer companies that have less volatile profiles, and that allows us to build a portfolio, which is what we would consider to be more defensive and have I think, some very powerful characteristics which we can pass on to our investors.

MK: 16,000 securities is a huge number. Can you elaborate a little bit on the quant strategies that go into that? What are the processes and automation for the screening of these stocks?

Bruce Apted:
It's interesting, you mention the word screening, because that's a classic kind of way in which people might think about quantitative processes, but actually what we're doing is slightly different to screening. So we're not taking those 16,000 securities and then screening on them to end up with a list of 100 securities that we think have got the best opportunities.

For the Australian market, for example, we're looking at 300 securities, which has the ASX 300, and we're looking at the best opportunity set within that market. But we're actually evaluating those elements of quality, value and sentiment and risk, across those 300 stocks every day.

So that's one of the powers of this quantitative method is, that as those relativities change, whether it be something deteriorating with respect to the quality of the company or its valuation opportunity changing, that can be incorporated directly into our process almost in realtime.

And so it allows you to understand some of those discrepancies that are building up within the market very quickly, rather than having to rerun some sort of screening process, which might drill down to say 50 stocks to look at. But that is an interesting, slightly different dimension to how we do things in the Active Quantitative Equity's team at State Street.

MK: So what are the implications of that real-time data? Does that mean you're constantly reweighting and reallocating? 

Or is it more about capturing all this data and using that as part of the process so that you can allocate and find opportunities and mispricings down the track?

Bruce Apted:
It's very much bottom-up driven. 

Every day we will reassess essentially what the best opportunities look like in the market. And then it's a question of whether it's actually worthwhile to move to that new optimal portfolio, if you like, and that you have to take into account the cost of trading and some of those other elements when you're looking at that.

But essentially we're in a very fortunate position where we have the systems and the processes to reevaluate those stocks on a daily basis, and work out where those opportunities are building up. And as the market moves around and those opportunities to move around, we move with that.

So if there's a lot of change in the information and the opportunity set, then we'll probably see greater turnover in our portfolio, but if things are more stable and we're very comfortable with our positions, and they're just slowly grinding out returns, then we'll probably see less turnover, so it's a function of the information, essentially.

MK: What is your takeaway from that? What have you learned about investing from a quantitative strategy or what can investors take from this?

I think the real power in quantitative investing is the unemotional element to it. I think I touched on before that humans tend to be focusing on the short-term and we're very familiar with that as a concept, and that does create mispricings. And so one of the benefits of having a quantitative process is that it just tells you what those scores are, and it doesn't take into account any of those emotions associated with it.

It allows you to go into a stock, when the process tells you that there's an opportunity that's opened up here, we can be unemotional about that, and we can make those decisions knowing that this is a very thorough, well-thought out process, and we're capturing most of the elements that we need to capture. So I think that's the key one, the unemotional side of the equation.

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