Why Academic Factor Strategies Rarely Deliver Sustained High Returns

# Most successful investors using academic-based framework?


# Most successful investors using academic-based framework?












What are the most famous/best performing absolute-return funds employing approaches based on mainstream finance theory (i.e., theory presented in Journal of Finance, AER, Econometrica, using typically factor models)? I am asking because I know certified outstanding managers using fundamental analysis (e.g., Buffett, Robertson, Cohen), and bottom-up algorithmic approaches (e.g., Simons, Thorpe, Malyshev). However, the typical quant asset managers that use some kind of factor model are either institutional investors with mediocre performance (and usually actively managed to a benchmark), or absolute return fund managers with either terrible performance (GSAM, LTCM), or unremarkable one. In short, does anyone have an example of such a fund with average returns in excess of 15-20%/year over an extended period of time?

## Answer by olaker (score 14)

https://quant.stackexchange.com/a/989

One might probably mention Yale's Endowment under David Swensen which generated returns of 13% per annum over the past two decades (as compared to the 8 or 9% average return of college and university endowments).

Now, I would not label Swensen's approach to portfolio management with a pure absolute return strategy tag but he definitely uses some insights from the academic finance theory. Swensen speaks about his investment philosophy in this lecture (which is a part of Robert Shiller's course on Financial Markets).

## Answer by bill_080 (score 10)

https://quant.stackexchange.com/a/990

That's a tough question to answer. The "quant business" is a business. Some quants sell low-grade/low-volatility results, some sell fast-moving/unpredictable results, some sell industry targeted results, etc. It depends on what the buyer wants to buy. There's a market for everything. Haven't we all met people that think they're going to win the Lottery? ...beat Vegas? ...predict the price of gold? It's their money. If they want to waste it, there's always someone willing to get on the other side.

Then there's a part of the quant market that is real. They spend a lot of time trying not to lose money, and to make money in a less volatile way. I don't have money with the following guys, but here's a big, medium, and small organization:

Ray Dalio, Bridgewater Assoc - http://www.bwater.com/home/our-company/company.aspx

Cliff Asness, AQR Capital - http://www.aqrcapital.com/cliff.htm

John Hussman, Hussman Funds - http://www.hussmanfunds.com/

## Answer by Tal Fishman (score 8)

https://quant.stackexchange.com/a/1512

I believe the reason no one has been able to come up with an example of a quant fund employing the academic factor-based approach with stellar performance is because there aren't any (at least not any with decent sized AUM). For a while, now, there has been a debate amongst institutional investors and quantitative professionals as to whether quant is dead. The alpha factor approach is definitely not the kind of magic bullet many people thought it would be. In part I believe the reason for its perceived failure is that expectations were too high to begin with. Even @gappy's question, which asks about 15-20%/yr over an extended period, shows this. Such returns are simply not possible on a large asset base.

Over time, the alpha factors have morphed into risk factors. The latest fad now appears to be factor timing (see EDHEC, Deutsche Bank, JPMorgan, Bernstein, Macquarie, and others). Yet practitioners acknowledge that factor timing is much harder than it appears. There also seems to be some emphasis on finding new and original data sources, but after a while even these "new" data sources will become old. The paradigm itself is being called into question. In fact, much of the debate now is as to whether there ever really was an edge in these factors, or perhaps GSAM, AQR, and the other major quant equity firms were merely benefiting from the huge inflows into the space pushing valuations in their direction.

On a final note, I've never heard of Malyshev, but it's not clear that Simons and Thorp didn't/don't make abundant use of academic finance research generally. Merely that they do not employ the factor paradigm as an organizing principle behind their primary strategies. Even Simons, btw, has his own foray into traditional factor-based quant equity in the form of RIEF. Reportedly, this has not worked so well, with the fund seeing major losses in 2007, 2008, and 2009.

## Answer by tragen907 (score 6)

https://quant.stackexchange.com/a/8538

This is the question I've been waiting for! I work at a large outsourced CIO shop and spend a lot of time evaluating different managers and the strategies they come to us with. I also know a number of people I went to school with that are now at quant funds. There are a couple of important points to keep in mind:

- Every respectable quantitative manager has a flagship strategy that will never accept capital from outside investors. Most of the ones I've seen tend to have around $1 bil of capacity and never open up to anyone not employed by the firm. The returns I've seen for those funds are all incredible (over 20% CAGRs, with Sharpe ratios over 5), but if you don't do what I do or work for a quant shop, you're never going to know about these funds.

- The lifecycle of quant funds tends to be different than other funds. If you're Julian Robertson, Chase Coleman, or John Griffin, you have an investing acumen or edge that would take someone years to mimic, assuming they can even come close. Quant funds are only as good as the unpublished investment anomalies they've analyzed. As published research catches up to their research, their performance will deteriorate. So, you tend to see fewer quant firms that have long, impressive track records.

- Lastly, because they rely on investment anomalies to earn their bread, most quant funds focus on asset gathering rather than straight outperformance. A great example of this would be the plethora of low vol strategies coming to market. These funds look great in backtests because they all exploit the low vol anomaly, and they have a ridiculously high capacity because most low vol stocks tend to have large market caps. If you have the mutually exclusive option of generating higher outperformance by making a few tweaks to a low vol strategy or sacrificing some performance so you can take in another five billion, you're going to go for the option that puts more money in your pocket.

Hope that helps answer your question.

## Answer by Steve Severance (score 4)

https://quant.stackexchange.com/a/1882

If it was possible to simply pick up some papers and adapt them and produce returns that trade would quickly disappear since it would be an inexpensive way for firms to produce excess returns. If you have a factor that produces alpha you had best not publish it or all returns associated with it will disappear.

I have found most of the value in the academic literature unlocked by our group to have come from other quantitative disciplines with signal processing problems. Generally most of the academic literature on finance is either behind the times or not possible to implement in a profitable way.

## Answer by Ram Ahluwalia (score 0)

https://quant.stackexchange.com/a/1513

Joel Greenblatt (Columbia Business School) has some outsized returns. However, he does not use an equilibrium factor model framework. I would consider him a practitioner who has done well and therefore teaches.