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By Samuel Lee | 09-18-2014 11:00 AM

Complexity Doesn't Equal Value

A cheap, rules-based, quantitative approach that minimizes behavioral biases is a better bet over time than overly complex strategies, says Alpha Architect founder and Drexel professor Wes Gray.

Sam Lee: Hi, I'm Sam Lee, ETF strategist with Morningstar, here at the Morningstar ETF Conference 2014.

Joining me today is Wes Gray, a Drexel University professor and founder of Alpha Architect, a quantitative investment firm.

Wes, thanks for being here.

Wes Gray: Sam, thanks for inviting me.

Lee: Wes, your firm is, and you yourself are, a strong proponent of quantitative, systematic investing strategies. Could you explain what that means and why this is your preferred approach?

Gray: Unlike typical quantitative managers, where you think about black box, mathematical witchcraft, we're a little bit different. We're basically fundamental investors who use quantitative tools to minimize our behavioral bias. If you ever dive into the stacks of academic research from psychology that actually examines the performance of simple, rules-based models relative to overpaid experts, the evidence is very clear that simple, rules-based models beat experts about 90% of the time.

We are humbled by that evidence, and we've chosen to implement it as part of our investment process.

Lee: Could you describe a strategy that you've used? You call it the Quantitative Value Strategy, I believe.

Gray: The strategy, the book's title, Quantitative Value, is exactly this sort of idea. We take the book Security Analysis and Ben Graham's great ideas about the value investment philosophy-- we love all that stuff. We've used a computer to basically automate a lot of the lessons learned from that literature. Instead of having a human analyst do all that work, we have our computer do it, because we like the idea of being rules-based and systematic.

We don't ever call up a CEO, and he tells us, "Yeah, my firm is amazing; we're going to knock the cover off earnings." But he is suffering from overconfidence, and we're now insider-trading, doing illegal stuff. We don't want to be in that business at all; we don't like it. We think it's dirty, and we just don't think it works.

We're fundamental guys using systematic tools to get the job done.

Lee: From your book, it seems like your strategy is very concentrated. It's very different from other systematic trading strategies. Could you explain that?

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