New York – In the world of performance measurement it has always been important for research providers to be compared against their peers. This is because of the plethora of research methods and other differences being applied to investment ideas. One way to determine various peer groups is by the number of shares they cover. Investars performance measurement system uses three coverage categories to create peer groups; including RPs that cover 100 or less stocks, those that cover between 100 and 500 and, those that cover over 500 stocks.
Integrity utilizes Investars information on an aggregated basis and uses it to generate articles on performance of research providers. By inspecting the research provider business models, we conclude that the vast majority of quantitative research providers (quants) cover in excess of 1000 stocks and the firms that cover between 100 and 1000 stocks are mostly fundamental (fundies), or analyst-driven models. Our question of the data is, “On average, what are the differences in performance, stocks covered, recommendation holding periods and volatilities between the quants and the fundies?”
The table below details the information we are interest in reviewing. The first item of comparison is the one year returns of the buy and the sell recommendations between the two providers. Here there is little difference between the two methodologies. Nor is the volatility accepted by investing in the recommended stocks much different. Because this analysis has not been carried out over a number of time periods, it is difficult to assess whether this always the case, or whether is changes over time.
Buy Recommendation Data covering the year-ended Jan 4, 2011
|Model||1-Yr Buy Performance||Number of Recommendations||Number of days Held||Volatility (Annualized)|
Sell Recommendation Data covering the year-ended Jan 4, 2011
|Model||1-Yr Sell Performance||Number of Recommendations||Number of days Held||Volatility (Annualized)|
There are significant differences in the number of recommendations and the period of time that a recommendation is held. Because quants are machine-driven, based on ratings models, there have much more recommendations than do the fundies per unit of time. Over the period covered the quants generated 13 times more buy recommendations and 87 times more sell recommendations than the fundies.
As well, while the quants had roughly equivalent numbers of buy and sell recommendations, the fundies had 7 times as many buys as they did sells. This translates into a sell-to-recommendation ratio of about 12.5%. The Global Research Analyst Settlement raised the issue of research analysts and their connection to the banking business of their employers. One of the indicators of biased in stock picking was that the ratio of sell to total recommendations remained fairly stable even in deteriorating business cycles. The current ratio of 12.5% is only slightly higher (better) than it was at the time of the settlement in 2003.
The other major difference between the quants and the fundies is the holding period for recommendations. For the quants the holding periods are quite short. For example, the buy recommendation holding period is only 74 days. Some quants have average holding periods as little as 20 days per recommendation. So while the quants have similar performance to the fundies, the reality is that an investor following all of the recommendations of a quant would have something the area of 13 times the commission costs compared to investors following the fundies’ recommendations.
As in any analysis of summary statistics, we have gained general perspective at the cost of lost detail. We have no definitive winner between the quants and the fundies. Still, we do have some general results that help us understand the differences in the methods and the performance of the two styles of research.