Sunday, September 16, 2007

Quant Portfolio Construction

One of the more scientific ways to invest is to actually create a quant portfolio and simply rebalance it periodically. Sounds very chim huh? But it's actually quite straightforward. But unfortunately, it is not exactly suitable for retail investors unless

1. You have tons of money
2. You have tons and tons of money

Well, but it's still quite useful to know how quant works, so don't yawn. And don't click the "x" at the top right corner.

Quant is simply the short-form for Quantitative and it is named as such because it uses mathematical models to drive investment decisions. Quant can be very successful because it reduces emotional influences (screw Mr Market man!) and can generate as well if not better an investment performance as fundamental analysis or other types of investment analysis. (Woah that's a statement huh?)

As a very simplistic introduction, we introduce a 2-step quant portfolio construction process here.

1. Use criteria or factors like PER, PBR, ROE, EV/EBITDA to screen out a list of stocks and buy the top 30-50 stocks.

2. Rebalance the portfolio after the pre-determined period like 6 mths or 1 year etc. (ie repeat Step 1 after 6 mths or 1 year.)

Ok, analogy time, say we want to create a 50 stock portfolio and rebalance it every 6mths and we want to use 2 factors, Low PER and High ROE.

For retail, Poems have quite a good screen in its system so can just utilize that. If not, can ask those good-for-nothing Citibank/UOB privilege sweet-young-bankers to generate these screens. Of course, that's like trying to strike Toto, bcos chances are, they ARE good-for-nothing.

Anyways, so you get this list of stocks, and just simply buy the top 30-50 names on it depending on how many stocks you want to hold. But it has to be at least 30 names in order to smooth out the idiosycracies of individual stocks. So now we know why you need lots of money, to buy that 30-50 stocks.

So that's Step 1. And after 6 mths, simply do the screen again, and buy the top 30-50 names. Of course, if the same stock appeared on the first list. You don't sell off what you hold and buy back the same stock lah. Unless you are trying to please your good-for-nothing Citibank/UOB privilege sweet-young-bankers or something.

So simple as that, if you can do this based on some winning factors (that's the catch huh!). Chances are you can make some money. May or may not beat the market average (to do that, the odds are slightly better than finding a good-for-something sweet-young-banker), but you should not have negative return if you invest over the long run (ie 20 yrs or more).

See also Investment Horizon