The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

TRADITIONAL AND QUANTITATIVE APPROACHES TO EQUITY PORTFOLIO MANAGEMENT

At one level, there are as many ways to manage portfolios as there are portfolio managers. After all, developing a unique and innovative investment process is one of the ways managers distinguish themselves from their peers. Nonetheless, at a more general level, there are two basic approaches used by most managers: The traditional, or qualitative, approach and the quantitative approach. Although these two approaches are often sharply contrasted by their proponents, they have been converging over time and actually share many traits. Both apply economic reasoning to identify a small set of key drivers of equity values; both use observable (historical) data to help measure these key drivers; both use expert judgment to develop ways to map these key drivers into the final stock-selection decision; and both evaluate their performance over time. What differs most between traditional and quantitative managers is how they perform these steps.

Traditional managers conduct stock-specific analysis to develop a subjective assessment of each stock’s unique attractiveness. Traditional managers talk with senior management, closely study financial statements and other corporate disclosures, conduct detailed, stock-specific competitive analysis, and usually build spreadsheet models of a company’s financial statements that provide an explicit link between various forecasts of financial metrics and stock prices. The traditional ...