Peter Scholtz was one of the first Portfolio Managers at Smith Barney to develop quantitative models during the early-mid 1980s. The model has seen several major revisions (most recently in 2013), but is undergoing constant tinkering.
As a current or prospective client, it is important that you understand the elements that comprise our quantitative model (which we have named the “Momentum Value Model”). The Momentum Value Model is derived from four separate component models which analyze the factors we have found to be vital in determining a security’s attractiveness. The inputs to each component model are (for the most part) financial ratios and concepts that you are already familiar with. Our Earnings Model emphasizes the importance of earnings momentum, quarterly earnings surprises, and analyst estimate revisions. Our Value Model examines Price/Earnings, Price/Cash Flow, Enterprise Value/EBITDA, book value, return on equity, and discounted cash flow. Our Sentiment Model considers short interest and corporate insider behavior. Finally, our Technical Model takes into account moving averages and volumes. These four separate components are then blended in order to compile a composite score for each security. It is the blend and weight we have assigned to each of the component models that makes our process both unique and productive.
Why we use Quantitative Models
The problem that many investment advisory firms face is the inability to adequately investigate the entire investment universe. Without computerized quantitative screening, many firms are often forced to narrow their focus in order to sufficiently understand their investments. Consequently, they become large-cap growth managers, small-cap value managers, or they focus only on certain countries, sectors, or industries. We believe the opportunity costs of these limited viewpoints are high. By contrast, at Scholtz & Company, our initial security selection process does not eliminate securities simply because they do not fall within a particular investment style. Through a compilation of the most powerful techniques of many disparate investment styles, we are able to broaden our universe to include all of those securities for which we can obtain reliable data. From this pool, we focus our efforts by investigating securities whose composite scores on our quantitative model signal the potential for outperformance.
How we use our Quantitative Models
A common misconception is that quantitative models by implication lead to some type of trading system. A “black box” dictates which securities should be bought and sold, and the Portfolio Managers are merely tools to implement the model’s recommendations with no understanding of the investment merits. While this may be the reality at some firms, our models are merely aids to assist with decisions, not make them for us. At Scholtz & Company, the quantitative models perform two separate, but equally important basic functions. The first function of the models is to provide our Portfolio Managers with guidance on potential security selections. Every Monday morning we are confronted with the possibility of examining fresh data on 5,000+ US Equity securities. As we have discussed previously, this flow of information can quickly become overwhelming, and cause a loss of focus. The models allow us to direct our efforts to a select group of securities that the model has identified as attractive. Once we have our focus group, the traditional process of fundamental analysis takes over. We learn about the company’s product lines, examine the balance sheet, read the available analyst research, and speak with the company’s management. If a security survives this additional scrutiny, it becomes a legitimate buy candidate. The second function of quantitative models is to measure the health of our portfolios. A classic problem in the portfolio management process is that it becomes much harder to identify sell candidates than buy candidates. Investors often become attached to their core holdings over time, especially those that have performed well. Having our holdings ranked every Monday morning forces us to examine and assimilate new information that is affecting the value of our securities in near real time. This practice is in stark contrast to many firms that discontinue most research on current holdings until major news forces them to re-evaluate. In this regard, the quantitative model helps identify securities with fundamentals that may be gradually eroding, often before the market wakes up to that fact. As can be seen in our investment performance, we believe it is possible to consistently identify and exploit market inefficiencies that lead to superior investment performance. Our years of experience lead us to believe that quantitative analysis can continue to provide our clients with an investment edge. The world will continue to evolve and change, but our framework is flexible enough to allow us to incorporate new innovations into our quantitative process in order to stay ahead of competitors. This edge will allow us to continue to provide you with the personal attention and feel of a small firm while providing quality investment services. Note: We will never invest in a security simply because our model likes it. Rather, we use the model to screen out investments quickly and highlight names that are worth in-depth fundamental analysis. We feel strongly that quantitative analysis is a tool that must be married with fundamental research.