Mon, 09/10/2006 - 07:00
The word 'quant' or 'mathematics' as an approach to investing rarely causes any excitement, rather, it causes some investors to walk away and others to either fall asleep or at best raise their eyebrows. We do not think this is justified, as quant is not just bean counting. We believe that a quant approach to investment is superior to a traditional discretionary approach and to show this, we list some of the main advantages of quant.
For all these reasons we don't think that you have to be a quant to understand the advantages of quant. Hardly surprising then that many of the biggest and the best performing fund managers are quant.
Why should Quants improve with time?
Recently, there has been a tendency amongst hedge fund investors to pursue hot new managers. This is justified on the basis that managers are more exciting early on as they are hungrier for returns and that their competitive edge declines with time. This is presumably because managers expand too much and lose alpha as they get too big at the same time during which they lose their competitive edge. But the obvious problem is that in absence of hard evidence, selection needs to be made on 'gut feel' and other soft criteria such as reputation (often in a different field!!!) or following the herd.
Not surprisingly, such an approach is not likely to bear fruit for many. Often start ups have failed to perform to expectations and we are aware that in the recent days at least one multi billion dollar quant start up is closing down after not much longer than a year.
We are not surprised with the difficulty in picking early stage quants, as good quant managers are unlikely to do better earlier rather than later on for the simple reason that good models do not decline but improve with time. As more and more data becomes available, better calibration can be made of the existing models and new strategies can be added to the process. This includes models that rely on data that can only be obtained in real time, as no historical databases exist for it. Such models are often called 'the Insider Models' as they do not rely on publicly available information but the manager's own databases. And the more such data exists, the better. Furthermore, the stronger the investment process, the more it makes sense to increase return and volatility targets. This is what comes with time.
Style Arbitrage Sharpe ratio since inception is 1.2 with 1.5* over the last 2 years. We strongly believe that our Sharpe ratio is going to stay as strong in the future. This is why we feel confident in offering a double-geared version of the strategy, which will target returns in excess of 20% p.a. with volatility in the range 12-14% p.a. Even though it is unlikely that many other managers can deliver this level of return consistently, we don't believe this target to be unrealistic due to the strength and ongoing enhancement of our investment process:
The message is clear - 'Past performance is not indicative of the future performance. In the case of a good quant, it should get better!' Ignore established and successful quants at your peril.
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