Too Clever by Quant

by

Ross M. Miller
Miller Risk Advisors
www.millerrisk.com
September 13, 2010

I have had a busy summer and I am trying to wrap things up before the full brunt of the fall semester hits me. The calendar gods were smiling upon me. Although in the infinite wisdom of New York State my classes started a full week before Labor Day, I got all of the past week off from teaching. I am writing this while taking a breather from writing a chapter about "quantitative methods and risk management" for a handbook on institutional investing from my good friends at Wiley. It is also worth mentioning that I have an article, written at the beginning of the summer, that is due to appear in World Economics any day now. It is already available on SSRN and various blogs, including one at the Wall Street Journal, have picked up on it. The article is an update on my active expense ratio work that is targeted at a fairly broad audience. It includes some fraction of the wisdom that I have picked up from being deemed an expert on mutual fund expenses. There is no need for me to say more about it here just yet.

A natural result of having written something like a million words for external consumption is that writing comes easily and naturally to me. If this were sixty years ago, I'd have no trouble writing pulp fiction for a living, the perfect vocation for someone who can churn words out. The main reason that writing is easy is because I have trained myself to just let the words flow, which has the unfortunate side effect that my writing has a plethora of typos that need to get weeded out somehow, often not by me if at all. (It also helps to be oblivious to some of the finer points of English grammar.) While I never suffered from writer's block, that is not to say that written does not get psychically painful at times. Sadly for my piece of mind, this chapter on quant stuff has been anything but natural. I hope that such suffering is good for the soul.

There are several problems with writing about quants, especially when one's target audience is pension fund managers and their ilk. In theory, quants are doing amazing secret things, which, were it true, would make writing about them impossible. In practice, quants who want to gather substantial outside funds to manage must reveal something about what they do. From what I've seen, quants tend to reveal way too much and what it tells me is that many quants are not adding any real value. What quants excel at is the gaming of the mechanisms that are used to judge their performance, which gives the perception of adding value.

I spent a good two weeks preparing for the chapter by reading lots that was written by quants and non-quants about quants. Much of it was merely to jog my memory about all the stuff that no one is willing to write about. The stuff that pops up on Google searches is mainly from the quants who are failed physicists, since they like to pontificate (a word that by now should be pejorative). I won't mention any names because some of them are known to sue at the drop of hat, but they know who they are and many of my readers do, too. They are good with technicalities and enjoy bashing economists, but much of what they write totally misses the point.

The quants with physics Ph.D.s think that everything in life is about IQ despite the plentiful empirical evidence that above some fairly low point IQ (or the mental maladies that accompany it) IQ becomes detrimental to many human activities, including making money. While financial physicists worship Richard Feynman to the point of narcissistic emulation, they forget that he claimed to have been measured with an IQ of 124. I knew Feynman, and the number is believable as what might come as the result of an IQtest, and not just one of the tales he's was known to spin. True genius comes not from drowning in the technical details, but from being able, for reasons of sloth or stupidity, to work around them. (Feynman, by the way, greatly annoyed Murray Gell-Mann, whom I also know, but not on particularly friendly terms; and Murray, who had severe writer's block, is much more like the financial quants in temperament; and it is often tempting to me to write my commentaries in the style of the late David Foster Wallace; however, years of editorial indoctrination have attempted to train me to keep me sentences and paragraphs short, something I fruitlessly try to get my students to do, but I do follow the rule of keeping remarks within parentheses to a single sentence, no matter how long and convoluted that sentence gets.)

The only truly enjoyable part of writing prep was reading Scott Patterson's recent book on quants and how they almost destroyed the financial world. While the writing is disjointed and the grasp of technical details is just what one would expect from a Wall Street Journal reporter, the book does provide a lot of insight into the big-name quants, the kind of insight that would cause any reasonable person avoid them like the plague. The only conclusion that can be drawn from Patterson's book is that quantitative models are merely McGuffins. A McGuffin (also spelled MacGuffin) does not reside beneath the golden arches; instead, it is a term coined by Alfred Hitchcock to indicate a central object in a movie that serves to distract the audience from what is really happening. Quant managers, and not their models, make all the decisions that really matter. The models are just marketing, and that marketing value has plummeted of late.

I plan to continue avoiding dealing with the current financial marketplace too directly in my fall commentaries. The world is in some very real sense already bankrupt and it does not want to come to grips with that fact, what else is there to say. High mutual fund fees and quants are small potatoes by comparison.