Money: Investing By The Numbers

You know how to pick a good stock, right? Read up on a company's products, listen to what the CEO has to say, figure out where the industry is headed. Well, that's rubbish and pure distraction, according to quants, a breed of computer-loving money managers, many of them ex-mathematicians and physicists, who are gaining a following among ordinary investors.

Quants (short for quantitative analysts) combine hundreds of data points--cash flow, earnings growth, inventory turnover, trades by company executives--for thousands of stocks into elaborate computer programs that then say to buy certain stocks and sell others. Which the quants do, unflinchingly. "The emotional element is one that we want to remove from our decision-making process," says Zili Zhang, who runs quant research at mutual-fund firm American Century.

Quants have been on Wall Street since the 1970s and have been popular with institutional investors like pension funds since the tech bubble burst in 2000. In the past few years, the run-of-the-mill investing public has started to catch on while fund companies like Vanguard, Janus and Charles Schwab have beefed up quant offerings.

It can be hard to spot quant funds by name alone. You may have to call the fund company or dig through prospectuses. Morningstar, a firm that rates investments, recommends Vanguard U.S. Value, Bridgeway Large-Cap Growth and Janus Adviser Intech Risk-Managed Growth.

The increased interest owes in part (maybe mostly) to the fact that quants have done quite well of late. Casey, Quirk & Associates, an investment-management consultancy, took a look at institutional pools of money buying the stocks of large U.S. companies and found that those run by quants have consistently beat those run by nonquants since the beginning of 2003--by up to 2 percentage points a year.

But raw performance isn't what quant shops are about--at all. Quants are coolly confident that managers who hit it big one year are likely to stumble the next, so their goal is simply to beat a benchmark index (say, the S&P 500 or the Russell 1000) by a few percentage points a year. "We're about hitting lots of singles," says Ronald Kahn, who runs advanced equity strategies at Barclays Global Investors. The Casey, Quirk survey found that quants take about half as much risk as nonquants. Over time, that habit of not losing as much money in down years adds up.

Then why the recent spike in performance? One thing quant funds have had going for them lately is a market that favors value. Hyped-up fast-growing companies haven't done as well as more established, steady firms--and the latter are the sort of stock that quant investors often end up with. That's because their process, which usually includes hypothesis-testing an idea before it's added to the computer model, relies on historical data, and growth companies tend to work because of what has yet to happen. The fabulous returns of the past few years are "a rare occurrence," says Daniel Celeghin, an associate director at Casey, Quirk. "I wouldn't bet on it happening again anytime soon."

And that's just fine by quants. "What we're really trying to do is deliver a consistent value added," says Joel Dickson, who runs quant investing at Vanguard. Translation: Slow and steady--and a little nerdy--wins the race.