The artful science of investing

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Perpetual Investments

Should investors rely on art or science? Each approach has its advantages – that’s why the debate continues.

The question of investment as art or science has been the subject of debate for years. In the scientific corner, are those who invest based on quantitative analysis – so called quantitative investors (or “quants”). In the artful corner, there are those who look beyond the numbers and base their decisions on crucial intangibles like competitive advantage and management quality.

A scientific foundation

Scientific investing is based on quantitative analysis. Numerical values are assigned to variables and plugged into complex mathematical models to evaluate investment decisions. It is a way of measuring factors like risk, yield and value. It can be very successful if the models analyse the right data quickly enough to predict and exploit market events and trends.

One key argument for quant investing is that it takes human biases and emotions out of investing. Computers can’t “fall in love” with a stock or over-react to the latest headlines.

Quantitative investors analyse publicly available data such as market prices, company balance sheets and earnings forecasts. Often these financial indicators are used to produce ratios that are compared to other companies in the same industry, or the overall market. To take one example, a quantitative investor may look for anomalies within a specific industry sector, and respond to the data by purchasing shares in a company with a low price-to-earnings ratio relative to its peers.

But do numbers tell the whole story? A company's last financial statement may contain positive numbers but may not reflect the impact of a subsequent management change or emerging corporate scandal.

Quantitative patterns are based on historical data but they are no guarantee of future market behaviour, even if the data was gathered yesterday. These models cannot predict unexpected economic or political changes. As Warren Buffett noted, “If past history was all that is needed to play the game of money, the richest people would be librarians."

Factors computers can’t compute

"Human judgment, good and bad, will drive investment decisions and financial-market outcomes for the rest of our lives and beyond." Robert Shiller, Nobel laureate in economics.

If algorithms and big data provided all the answers, financial markets would be seamless systems with perfectly priced assets. They're not, thanks to the human factor. And that's where the art of investing comes in. Looking at elements you can’t plug into a computer. The strength of a company’s brand, its competitive advantage and the reliability of management.

Art is experienced judgment

The art of investment is often derided as speculation based on hunches and gut feel. This misses the point. The real art is in understanding the science but not being constrained by it. Of going the extra mile, speaking with a company's management team and walking the factory floor. Having the investment experience to consider all factors and make the right judgment on when investments become opportunities.

The complete picture

At Perpetual, our team of investment professionals draw on multiple sources of market intelligence to complete the picture. What really counts is the experience and judgement behind the analysis.

Interested in learning more? Watch Perpetual's investment experts discuss whether they see investing as a science or an art.