Mystical Stuff
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It was still fun to watch the good-looking talking heads with their witty banter and colorful, flashy graphics. I would normally watch them from the elliptical machine at the Equinox Fitness while I was trying (and failing) to lose the 20 pounds I had gained since moving to NYC. But it was complete and total fiction. More fictional than Tolkien and Castaneda combined.
The real world was one where gigantic “institutions” managed portfolios according to one of several “portfolio theories,” which would tell you which assets to buy and sell using entirely quantitative inputs. Then they would tinker around with some opinionated positions to have something to talk to their clients about besides a bunch of boring equations.
Trying to beat the market with finger-in-the-air stock picking, that was a ’90s thing. It had since been completely discredited in the professional investing community. No one believed that an active manager could beat the market, at least not without access to inside information, which was illegal. To be sure, there were true believers in active management, but they were mostly treated as cranks.
However there was still some hope to make money in the markets, but you needed quant powers.
What you were really after was something called “systematic alpha.” The “systematic” part meant you needed to be able to fully automate the strategy. In other words, trades were selected using a system, or algorithm. You wouldn’t necessarily automate everything in reality. Many systematic desks do all of their work manually. In fact, many prefer to do this to keep the know-how out of the hands of lowly computer programmers like me. “Alpha” was quant-speak for “returns in excess of a benchmark.” The benchmark was usually the return of the S & P 500 index.
This quest for alpha was what everyone was talking about on Wall Street. Some said alpha wasn’t real; that investors were being “Fooled by Randomness.” It was hard for me to understand why, if picking stocks was no longer possible, that one could have more success in selecting “asset classes”, “factors”, “sectors” or other methods which were ultimately just fancy ways of picking stocks in groups.
Others argued that alpha was real, but that it was a scarce and elusive thing. According to them, there was a finite supply of alpha in the universe. You might discover a hidden source of systematic alpha. But before long, a competing band of quants would catch on to what you are doing and try to steal it from you!
So, competing groups of quants battling each other for this mystical stuff was the reason why markets were so liquid with low volatility. That was the explanation for the Great Moderation.
I’m not making this up. It’s some wizard shit. And somehow it had gone awry. Anyone could see that. But in order to know how it had gone awry I would have to understand it myself, in my own way.
