​Quants: Smart Beta Solutions for the Passive Investing Problem

Henry Truc  |

Passive investing has increasingly become the dominant strategy in today’s market. Whether it’s the enormous capital inflows into ETFs or the rise of robo-advisors, passive investing is drawing more and more investors of all kinds. In 2016, actively managed funds in the US saw net outflows of $340 billion, while $505 billion moved into passive financial products, according to Morningstar. What’s more, passive investors are on pace to control over half the US equity and bond markets by 2021, according to Moody’s.

There are a lot of reasons why investors are choosing passive investments over active strategies, from lower fees to tax benefits to increased simplification and transparency, and of course, outperformance. The number of active funds that consistently beat their benchmarks is astonishingly small. So, investors are increasingly looking to invest in the benchmarks themselves.

But passive investing is quickly becoming, as they say, a crowded trade. But it’s important to remember that even the strongest of bull markets correct and revert to the mean, and sometimes will overshoot to the downside as no trend goes up in a straight line. As such, prudent risk management must be an integral part of any investment portfolio.

Hence, the smart money has been turning to smart beta strategies that help them mitigate risk and create alpha opportunities. Smart beta, as it’s called, offers investors the best of both worlds: They can remain passive while also incorporating factors that enhance their target investments, whether an ETF or a fully constructed portfolio.

Now, fintech startup Quants, Inc. wants to bring optimal smart beta solutions to the masses, and for all types of investments–bonds, stocks, ETFs, what have you. The company has developed technologies to implement derivative strategies as an overlay on top of any underlying portfolio.

“This is for anybody who doesn’t currently have derivatives overlaying in their investment strategy,” said Gokhan Kisacikoglu, Founder, CEO and CIO of Quants. “We have been quantitatively developing risk management solutions with derivative overlays for over a decade. We are preparing the white papers for our indices and we will publish them to demonstrate that they are optimal strategies. What our technology does is, you input your portfolio and it analyzes the historical return and volatility. Based on these, it structures the best possible derivative overlays that will provide you basically the optimal risk and return trade-off and tax-efficient re-balancing. It’s similar to an iron condor option strategy in a synthetic portfolio, but you can override the amount of optimization however you prefer.”

Quants: All of the Good, None of the Bad

The basic premise is that Quants will pinpoint how much of the portfolio’s excess return an investor can sell via out of the money calls, then apply the proceeds of the sale to buy puts that protect the downside. Essentially, it creates a guardrail of sorts for the underlying portfolio. The strategy does not depend on market timing to implement, but rather, Kisacikoglu says it’s determined by analyzing historical volatility levels of the assets for the optimal point to allocate the option overlays.

“How it chooses the options is what the system optimizes,” he said. “It just constantly allocates and rolls over. It is constantly evaluating the volatility levels and constantly positioning you. So, with sudden volatility spikes, this works really well. It actually creates alpha, literally. When volatility jumps, you basically cash out your options, and all of a sudden, you now have so much more cash to buy more equities at cheaper prices. When your portfolio comes back up, you may end up with better returns, otherwise, you are better protected against the adverse effects of market declines.”

In other words, the Quants Investment Technology enables investors to enjoy a market recovery while avoiding the sell-off that precedes it, all the while without having to try to time the market. It’s a concept known as antifragility, coined and popularized by noted economist Nassim Taleb, in which a system actually gets better in a failing environment.

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Smart Beta Investing for Everyone

Quants wants to make its derivative overlays technology available to investors in a number of ways. The company has developed the Quants Smart Beta Index ™, which consists of traditional benchmark indices with Quants’ smart beta derivative overlays incorporated. The company has also created the Quants Fund™, which is a fund that tracks the Quants Smart Beta Index™, targeting about twice the return of a typical index portfolio on a better risk-adjusted basis. The fund has received interest of over $100 million AUM thus far.

“Historically, the typical index portfolios are comprised of 60% large cap stock and 40% government bonds yielding about 6-7% annual returns. We are targeting to double these returns without adding no more than 15% derivatives exposure for optimal risk mitigation and re-balancing,” he said.

Beyond that, the company will expand the number of indices it tracks through Quants Smart Beta Indices and Overlays™. Since the application of its derivative overlays is easily scalable as the liquidity in the derivative markets has tremendously grown over the past decade, Quants can track various kinds of existing indices, such as sector- or asset-specific portfolios.

The company intends to fully democratize its smart beta system with derivative ETFs and even a robo-advisor service. According to the company, Quants Exchange-Traded Funds™ will be building block ETFs that will bundle the Quants Smart Beta Overlays™ to help investors eliminate the costs of development and complexities of derivatives trading.

In addition, the company is developing the QuantsPlus™ Online SaaS Platform, which would serve as its own robo-advisor service for investors, empowering them with the tools to transform their portfolios into smart beta portfolios with derivative ETFs. Quants says the platform will “support and meet the needs of a range of financial institutions including small and large broker-dealers, banks, insurers, 401(k) platforms, and other advisory firms looking for a digital wealth management platform to increase customer loyalty and grow advisory assets.”

Quants, Inc has created four subsidiaries to execute on its strategy:

  • Quants Investment Technologies™, Inc.: is for the core quantitative investment research and software development.
  • Quants Capital Management™, Inc.: develops, markets through partnerships and operates the fund products.
  • QuantsPlus™, Inc.: is the online platform for the marketing and distribution of the investment technologies and products.
  • Quants Clearing™, Inc.: is planned to perform the trading desk operations for the structured and derivatives portfolios.

Investing with Quants

Established in 2010, Quants combines over a decade of research and validation of its risk management technology with derivative overlays. It’s currently seeking funding in a Series-A round. The proceeds of the raise will be used to market the Quants Fund and ETFs once they’re launched, and to further develop the robo-advisor platform.

To learn more about Quants, Inc., visit https://quants.com/


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