The O’Shaughnessy Approach: Guarding Against Narrative-Loving Humans

An article in CityWire profiles the father-and-son investing duo of Jim and Patrick O’Shaughnessy, chief investment officer and chief executive respectively at quantitative money management firm O’Shaughnessy Asset Management.

Jim O’Shaughnessy, who began his career in quantitative investing in 1987 and has authored four best-selling books on finance, explains, “We want to find as much empirical evidence that supports certain ways of selecting securities and – equally importantly – of ignoring securities that would fail under our screen. We want to do that in a dispassionate and unemotional way.”

According to Patrick, “quantitative processes are an exercise in gathering as much interesting and unique data as we can on publicly traded companies over as long a period as we can.” Raw data, he argues, is only helpful if you know how to analyze it properly. Quantitative processes, he says, still require people to build the models.

The article breaks down the O’Shaughnessy quant model into the following steps:

  • Establishing the investment universe;
  • Eliminating “bad companies” using metrics such as such as valuation, price momentum, earnings growth, financial strength and earnings quality;
  • Narrowing down the remaining universe of stocks to “identify the ones with the highest shareholder yield, which is a metric calculated as the sum of a company’s dividend yield (annual dividend) and its buyback yield (annual rate of stock buybacks);”
  • Formulaic weighting of the portfolio, “which allocates to stocks based on a ranking of their factor profiles.”

The article says that the duo will overweight stocks with more favorable profiles but adds that it has consistently resisted getting seduced by a “sexy stock narrative.” Jim explains, “One of the strongest things in the human DNA is our love of a narrative. We love great stories and we get seduced by them.” He adds, however, that he has safeguarded his firm against that, “which is an important but kind of invisible advantage.”