Benjamin Graham first established the idea of purchasing stocks at a discount to their intrinsic value more than 80 years ago. Since then, academic research has shown that low price to fundamentals stocks have historically outperformed the market. Even though this is a widely known phenomenon, value-based strategies continue to outperform the market. How is this possible? The answer relates to a fundamental truth: human beings behave irrationally. We are influenced by an evolutionary history that preserved traits fitted for keeping us alive in the jungle, not for optimizing our portfolio decision-making ability. While we will never eliminate our subconscious biases, we can minimize their effects by employing quantitative tools.
"Quantitative" is often considered to be an opaque mathematical black art, only practiced by Ivory Tower academics and practitioners with their heads in the clouds. Nothing could be further from the truth. Quantitative, or systematic, processes are merely tools that value investors can use to minimize their unavoidable instincts. Quantitative tools serve two purposes: 1) to protect us from our own behavioral errors, and 2) to exploit the behavioral errors of others. Our tools do not necessarily need to be complex, but they do need to be systematic. Broad-based academic research overwhelmingly demonstrates that simple, systematic processes outperform human experts.
Alpha Architect's Quantitative Value (QV) philosophy is best suited for value investors who can acknowledge their own fallibility. Much of the analysis conducted by value investors-reading financial statements, interpreting past trends, and assessing relative valuations-can be done faster, more effectively, and across a wider swath of securities by an automated process. Gut-instinct value investors argue that experience adds value in the stock-selection process, but the evidence doesn't support this interpretation. The reason value investors underperform simple models is that when value managers exploit qualitative signals, like all humans, they unconsciously introduce cognitive biases into their investment process, and these biases lead to predictable underperformance. Alpha Architect's approach is not infallible, but it does promise one thing: a value investment strategy that is Built to Beat Behavioral Bias.