money.cnn.com/2006/04/19/magazines/moneymag/computers_moneymag_0605 -> money.cnn.com/2006/04/19/magazines/moneymag/computers_moneymag_0605/
Stephen Gandel, MONEY Magazine staff writer April 20, 2006: 11:16 AM EDT NEW YORK (MONEY Magazine) - It's no surprise that George Sauter, the chief investment officer of index fund king Vanguard, argues that most investors are wasting their time and their money when they try to beat the market. So why is Sauter launching funds that will attempt to do precisely that? Because he believes that while man can't outperform, a machine can. "Computers," Sauter says, "can systematically take advantage of all the mistakes we humans make."
Research) now runs nine quantitative, or "quant," funds in which computers make buy and sell decisions based on their constant crunching of hundreds of thousands of numbers. Of the five Schwab funds that have three-year records, four have whipped at least 75 percent of their peers. "This strategy has a lot of teeth," says Jeff Mortimer, Schwab's equity investment chief. Vanguard's first computer-run fund, Strategic Equity, has risen 27 percent on average for the past three years, putting it near the top of the hot midcap category. In April the firm launched a small-cap fund, and Sauter thinks there's room for more.
Research) and American Century have jumped on board as well. The popularity of quants stands in sharp contrast to that of the late '90s, when investors lost interest in the funds because they couldn't keep pace in the Internet bubble. In the seesaw market that has followed, however, quant funds have done well. In the past five years, they have returned an average of 61 percent a year, according to fund research firm Lipper, vs. To be sure, that's too short a period to declare the contest between man and machine over. But supporters like Sauter say that computer-managed funds can beat the market with less risk than human-run funds.
Research) Asset Management concluded that while over 15 years a human manager can beat a quant fund in absolute terms, once you adjust for the extra risk the human manager had to take to get that result, the quant fund comes out ahead. "Quant funds are a well-established strategy for institutional investors," says Coral Gables, Fla. "They are becoming a story for individual investors, and for most people they probably make good sense." Just the numbers, Ma'am Both man and machine evaluate investment prospects by comparing financial statements and share prices, looking for stocks that are cheap relative to assets, earnings or some other quantifiable measure. Most human fund managers then visit the management of those companies, try out their products or do whatever it takes so they can make an educated guess about how a business will do in the future. Computers, on the other hand, buy and sell strictly by the criteria they have been programmed to watch. Vanguard compares stocks with others in their industry and buys those with the best growth prospects and lowest valuations. Schwab's computers, which rank 18,000 stocks, focus on those that are increasing earnings faster than expected and are rising in price. Janus, on the other hand, cares more about stock movement. Its computers buy shares of companies that go up and down regularly, and try to make money from that volatility. So how do quant funds compete without doing hands-on research? For starters, computers can follow far more stocks than can a manager who is out visiting executives. The average quant fund tracks thousands of stocks and owns hundreds.
But the real advantage machines have over people is that they're not human. Emotions trip up professional money managers like they do the rest of us. Pros hold on to plummeting stocks, not wanting to admit a mistake. "Computers don't have bad days or biases," says Richard Thaler, a University of Chicago economics professor and principal of Fuller & Thaler, a money management firm that tries to exploit human error in the market. "A computer won't like a company just because it went to the same college as the CEO." Finally, unlike human managers, computers don't earn six-figure salaries or require legions of analysts to support them. Vanguard's Sauter says he can run his funds with a third of the people needed by the typical mutual fund. So computer-managed funds should be able to charge lower fees than other funds. According to Lipper, computer-managed funds charge investors 13 percent of the portfolio in fees a year on average, only a hair less than actively managed funds. And all those data give quant funds itchy trading fingers, driving costs up and returns down. But the second hurdle they have in trying to outperform is a tougher one: Quant funds have trouble anticipating change.
MONEY 65, recalls that in the 1970s quant funds failed to understand that the ramp-up in inflation would drive the market. Similarly, even before the Internet bubble, quant funds lagged because they didn't foresee that technology was the next big thing. The best human investors have a much better chance of significantly outperforming the market than computers do. On the other hand, human managers are also much more likely to lose you a lot of money. The ones below have modest expense ratios, and they could help you squeeze a tiny bit more return out of your portfolio without taking on big risk. That's not a Buffett-size gain, but they're not making any more of him. Computers, on the other hand, get better with each new model.
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