The efficient markets hypothesis (EMH) and capital asset pricing model (CAPM) have led many to rely on market capitalization-based portfolios and models parameterized with historical price data.

These theories assert there is no utility in stock picking since market prices reflect all available information. They also encourage the notion of stocks as volatile random lines on charts. This misguided notion of risk intimidates many investors and leads to sub-optimal investment strategies and portfolios (e.g., emotion-fueled decisions and market capitalization-weighted portfolios).

Market prices embed more noise than signal. As a result, many investment models and strategies suffer from garbage-in-garbage-out (GIGO) issues that can negatively impact performance.

Market price volatility is approximately two times the magnitude of the underlying long-term returns. As a result, investment models parameterized by or calibrated to market price data may rely on more noise than signal. Despite sound models, results may be tainted as market noise can overwhelm the calculations for historical returns, volatilities, correlations, and other input variables.

Factor models have helped unmask fundamental signals and identify drivers of stock returns. While the empirical evidence and supporting behavioral explanations are convincing, issues and limitations still exist.

Academic research and impressive track records clearly indicate the utility of factor models. Despite their success, they are ultimately limited by their statistical framework for relating factors to stock returns. For example, the relationships between factors and returns are not necessarily causal. Moreover, regression-based models generally do not fully address inter-factor dynamics (e.g., non-linearity).

FUNDEQ has created the first structural model for equity performance. Our next generation model addresses many of the issues with statistical factor models and offers many advantages.

FUNDEQ’s core structural model strips away market noise and isolates the true signal – comprehensive fundamental performance. Our innovative fundamental and valuation models provide many performance advantages including improved risk forecasting and management. In addition to the empirical benefits, FUNDEQ’s core model is intuitive and its output is aesthetically pleasing.