James O’Shaughnessy’s What Works on Wall Street is something of a bible for quantitative investors, and in a recent Investors Podcast, O’Shaughnessy talked about what his vast amount of research has taught him.
O’Shaughnessy says it is critical to understand human nature if you want to succeed at investing. While his book detailed how dozens of quantitative strategies have worked over several decades, he says he wasn’t worried that disclosing the information would lead to hordes of investors piling into the best strategies, and thus ruining them. He “knew that, human nature being what it is, that they might get very excited about it but the moment it stopped working, they would abandon it. I mean, I’ve seen this time and time again. I’ve had investors who have been with me for years, getting great performance, and then suddenly we have a bad year or a bad couple of years, which we’ve told them about ahead of time, right, because we can always show them that nothing works all the time,” and they still bail.
Basing their decisions on short-term results is in fact the biggest mistake investors make, O’Shaughnessy says. Most investors don’t realize that even three years is too short a time to judge a strategy, he says. He also says that, while he pays attention to macroeconomic factors, he does not include them in his stock-selection models.
O’Shaughnessy also talks about rebalancing, saying that he has found that a monthly approach – that is, revising his portfolios each month so that they contain the highest rated stocks according to his models – works best when all factors are considered. And he talks about how he combines value and momentum in his portfolios.
As for where he is finding value now, O’Shaughnessy says he still sees plenty of good US stocks with high shareholder yields. He also sees a lot of value in emerging markets and international stocks, which he says are extremely cheap. But he warns that investors need to have a five-year time horizon if they’re going to invest in those areas.