I came across a post titled Pseudo-quants that is in all honesty pretty dumb but gives me an excuse to rant for a bit so I will take it. Please enjoy the fruits of my mild ennui.
The gist of the article (it is quite short so by all means do go ahead and read it if you feel my summation might be unfair) goes roughly like this: A reference to this article by Jason Zweig followed by a jab at Rob Arnott’s funds in particular and factor-investing- and smart-beta-type funds in general, stating that they did not perform like investments by ‘real’ quants which the author goes on to describe as mathematicians who enter the business without a background in finance and who (or so the writer insinuates) consider themselves distinct from more traditional investors. The author then attempts to explain the reasons behind this distinction (finance is not a science, nothing works forever in finance, the scientific method cannot be applied to finance, all evidence indicates that academic finance has failed miserably), denounces the Sveriges Riksbank Prize in Economic Sciences (which in all fairness I do agree is somewhat bad taste) bashes finance some more because of its supposed inability to make predictions and ends (not a moment too soon) by declaring pseudo-scientific funds’ cataclysmic downfall.
Oh my.
Let us begin with the whole ‘pseudo-quant funds are underperforming’ spiel that is rife with bias of the not-so-subtle kind. Comparing the multi-decade outperformance of Renaissance Technologies to five years of a recently struggling all asset fund to imply the objective superiority of quantitative investing is about as meaningful as racing Usain Bolt against a moderately competent scavenger hunt enthusiast… in a marathon. It is all sorts of misrepresentative. Different time periods, underlying assets, goals & benchmarks and stages in their life-cycle (Might the author have intentionally cherry-picked a fund down on its luck instead of a top performer among its kind more analogous to Renaissance Technologies? I certainly think so) – for a post on a site claiming to oppose fraudulent financial advice this looks pretty dodgy. But OK, maybe the person with a background in mathematics (presumably; no indication as to who the author/s might be) is just bad at contextualizing data.
Finance is not a science
Finance is not a science but an art – sayeth our anonymous author. That may be true. Also true however is the fact that many of the tools used in finance are no less rooted in science than say mathematics seeing as that is precisely whence they stem (could not resist). It seems a tad dismissive to discount the merit of an entire (and comparatively young) field employing the scientific method and its tools on the basis that the scale of its subject matter is messier than that of particle physics. Finance, like engineering, may not be a science in the way that geology fits the category but it certainly is not completely random voodoo to the point of uselessness either, far from it. And regarding predictions I would say those of finance do not lag far behind the ones of evolutionary biology. It is functionally impossible to say with specificity how a species might change over the course of millions of years but we nevertheless have a framework of natural selection and are indubitably richer because of it. Prediction need not purely refer to foreseeing specific future events. Describing the dynamics of a system in the abstract in order to better understand the patterns of real life definitely qualifies. Finance is terrible because it is not science is a silly excuse for a logical argument.
Nothing works forever in finance
It is not untrue that markets tend to erode easily quantifiable trends over time due to competing participants. That is the nature of the game. But that applies not just for traditional funds but also (even especially) for quants. This is the opposite of an argument for and I quote:
Clearly, the most successful quant funds do not consider academic finance as part of the quant world. Let us understand why.
The scientific method cannot be applied to finance.
The scientific method can be applied to literally anything. Even finance. That is the point.
All evidence indicates that academic finance has failed miserably
Really? Not most or some evidence? All of it. Huh. The more you know.
Where are the billionaire financial academics? There are no billionaire Nobel Prize winners in Economics. If you could make accurate financial predictions, would you not act on them, if for no other reason to prove a point? No academic financial theory has generated substantial investment returns for their authors.
Academics are precisely that. Their work revolves around research and understanding and not monetary gain (in a perfect world that is). And perhaps there is more to getting rich than just having the know-how. What about access to capital, personal ambition, networking and luck?
Also: economics is not primarily concerned with wealth management but with the functioning of economies. Economics != finance. There are plenty of billionaires with a finance background.
The gullibility crisis
Many investors have been misled to believe that financial products originated in academic finance are scientific. Pension allocators have poured hundreds of billions of dollars in so-called “factor investments” and “smart beta funds”, not because they perform well, but because they have a good academic pedigree.
I do not think that investors have been misled for the most part but rather that they lack financial literacy, restraint and are constrained by structural dynamics that disconnect incentives from long-term performance. If anything it is not people’s trust in science that is exploited but their willingness to obey authority figures. There indeed are bad apples in the world of finance – quants included.
And that’s a key flaw of academic financial models, that they are public: Humans will always find a way to turn a purported financial “law” on its head, and profit from those gullible enough to believe in it.
Right, every single human being has the inclination and resources to exploit market trends… That is why momentum does not exist – no wait. This is not how it works. And since when are finance papers concerned with figuring out how to beat the market? That is the job of active investors. CAPM, EMH & co. are attempts to dissect how and why pricing mechanisms in markets play out the way they do, not recipes to outsmart them.
I could go on about the many flaws and misconceptions of that post but I really do not feel any need to do so. As you can see, even among the people lamenting the taking of false credit there are those brazenly feigning expertise.
It really is a peacock’s world.
Tom
The Financial Flâneur 