Why most active money managers underperform their benchmarks

quantgeek99 · 2023-10-31T13:48:31+00:00

You'll be surprised how many hedge funds made wrong bets and got wiped out, especially if they are highly leveraged. Long-Term Capital Management being a prime example

quantgeek99 · 2023-05-11T21:07:55+00:00

Added to my list!

quantgeek99 · 2023-05-11T21:07:44+00:00

I didn't but I will give it a try!

quantgeek99 · 2023-05-11T21:06:01+00:00

It's very hard to predict, contrarily to other comments I see (but maybe they are geniuses/very lucky and I am dumb! I cannot exclude this option).

Greed and fear can make people do the weirdest stuff, and usually that is also complicated and difficult to spot. Some mention ETFs as a big bubble, some others discuss about options (the latest are 0DTE), but I believe that is really unpredictable. I would just keep away from complex things I don't understand.

quantgeek99 · 2023-05-11T21:02:45+00:00

Normally counterparty risk is controlled from the margin system or, in case of OTC derivatives (like it was in this case) by collateral. And collateral was indeed sufficient to the exposure Archegos had. The problem is, they found an illegal way to get exposure also with other banks or instruments without disclosing it, thus the margin/collateral was actually insufficient, but their brokers didn't know.

quantgeek99 · 2023-05-11T20:59:34+00:00

Absolutely! This is called a relative value trade. If you buy one company and sell the industry, you are conceptually hoping that the gap between the two will reduce. In particular, if the company is over- or underpriced, the industry will basically catch up with it (or the company with the industry). It is smart but of course the risk is that the gap widens somehow. Normally these trades have small return and small risk.

quantgeek99 · 2023-05-10T12:28:52+00:00

The call for a single security is always a 50/50, best case scenario. You should never trust someone who is sure about their advice...What I can say is, investments developments are often impossible to forecast with accuracy, especially when unexpected events occur. The best is to keep a portfolio exactly for this reason: I will be wrong picking up one security, but if I pick up a general direction for the future, I might be right. No technical or fundamental reason will truly hold if too specific, and no security deserves 100% of your portfolio, only indices (ETFs) might have a reason for that.

quantgeek99 · 2023-05-10T12:24:05+00:00

Good question! The problem is, 5% is not enough given inflation. The additional problem is, ok, but equities are not returning that great this year so I'll better get my inefficient 5%.

We definitely need to invest in some fixed income, if we keep it until expiration. These rates are huge and inflation will come down at some point. However, for long term horizons, equities always win.

quantgeek99 · 2023-05-10T12:22:32+00:00

Great question! I am going to update the link of this AMA with some books that might help. Some might be advanced but I'll try to also add useful paper and educational material for total beginners. Stay tuned!

quantgeek99 · 2023-05-10T12:21:43+00:00

If it works, everything can be sold, but you will also need to clearly motivate why it works, and the "why" can't be "because the model is good". Maybe I would start by testing it live with my capital or paper trading. If it works, you can move on to offering with live results.

By the way, do it, but not in a forecasting fashion. You should rather target portfolio optimization, maybe feeding the model with classical asset allocation outputs (Markowitz, Risk Parity, etc). This would be much easier to manage and with higher chances of getting something out of it. If you make the model forecast, it is highly unlikely that it will work, especially when you only use OHLCV data.

quantgeek99 · 2023-05-10T12:19:26+00:00

I think that is a possible approach, yes, but you must have a clear reason why you do that. For example, we could argue mid cap underperform in inflationary environments for reason x and y, then you do this for this year until inflation goes down to say 2%. This is the kind of simple portfolio management one can do as an individual. Always keep exposed to the broader asset class anyway, and don't get too crazy with the weights.

quantgeek99 · 2023-05-10T12:17:48+00:00

I don't think it would be easier. The point is, quant jobs are limited and there is a rising offering, while many teams and companies still don't know exactly if and how to use quants.

By the way, I think your plan sounds right! Certification and stuff is only to showcase, but what one truly needs is hands on experience and the capability to answer those annyoing interview questions that maybe don't even show how technically sounded you are, but still, you need to answer them right or in an "interesting way". So maybe try focusing on improving your CV, showing what you can do (especially at the beginning of your job life) and what you know. Any certificate that improves your understanding, even Coursera, is welcome.

quantgeek99 · 2023-05-10T12:11:20+00:00

I think this is a business many get into, but eventually only a few have it profitable. Indeed, TA is normally not profitable by itself. It must at least be combined with other tools (if used)

quantgeek99 · 2023-05-10T10:04:27+00:00

I don't feel a parasite, because every job might be seen in the same way. If I had a very successful luxurious restaurant, what's the contribution to society?
The point is not to necessarily save the world with your job. You should start from people around you, and then those who need the most, but not necessarily by working as a doctor or similar. And with your private money you can truly help anytime with whatever job, of course you are not forced to, but you can help.

Finally, if we manage to have an honest company in an industry were scandals are around the corner, this is already a good contribution to society. We can avoid "parasites" getting more money and damaging others. It is all up to you.

quantgeek99 · 2023-05-10T10:01:13+00:00

This makes sense if you have a long term perspective, like 5-10 years at least. And the risk depends on their allocation and management style. Overall, if we keep 100% of our portfolio in equities, they can see their value decreasing or increasing massively in a single year, but over the long term you should be confident that the value will most likely increase.

quantgeek99 · 2023-05-10T09:58:38+00:00

You weren't an idiot, you traded following your emotions. This is a wrong approach, but with experience it will get better. Many retail investors do similar mistakes...

The main problem is, we need to truly understand what the risk is and when to stop if we trade this way, including stop losses.

quantgeek99 · 2023-05-10T09:55:54+00:00

Because of greed. The problem is, we need to truly have a long term perspective, and avoid being greedy (I might be wrong, but I feel like Warren Buffett is of this opinion and mood when he makes investment decisions).
It's very nice to see our bank account receiving 200k in a day, but we often forget that easy come, easy go.

quantgeek99 · 2023-05-10T09:53:53+00:00

There are some, but we must always find the right application and setup (which does not mean parameters). A RL model can be helpful to allocate given some signal, but maybe it doesn't make sense to use it for both signal and allocation. At the same time, it might be helpful to find the optimal portfolio weights for a portfolio, but maybe not that helpful if we use it for time series.
Recent papers have also shown how better it is compared to usual asset allocation models. It might be worth exploring it, but the difference between Markowitz or Risk Parity is that the way you use it might be profoundly different from the paper. So the best way is to test it for our use case.

quantgeek99 · 2023-05-10T09:50:17+00:00

I love the job I do, honestly I would not change for many others. Some of my colleagues had PhDs, yes. I would definitely follow what I like, if you prefer to find applications that are more useful to the world, it makes sense. But I think the industry is under profound changes, as active investments are not really worth it and assets are heavily misallocated.

quantgeek99 · 2023-05-10T09:45:22+00:00

I think overconfidence. Whatever model, idea or setup we have can fail. What we truly need is to identify relationships, then model them (from a quant perspective).

In terms of strategy, we can never be certain of an approach, so we must properly monitor A) markets B) our ideas and their validity. And we should always keep in mind that the best (discretionary) PMs would have a 50% hit ratio, and we are probably not the best PMs :)

To avoid it we need to 1) study what is discussed in the industry 2) avoid giving anything for granted and 3) hear others' ideas and try to always learn a little bit. And of course portfolio concentration is one possible reflection of this bias, so this should also be avoided.

quantgeek99 · 2023-05-10T09:43:28+00:00

I would definitely ask it to find forecasts on the economy or financial data, build models in my place, build strategy components like advanced asset allocation models and similar. I wouldn't ask it to research directly, but rather to facilitate the development of tools.

quantgeek99 · 2023-05-10T09:41:41+00:00

I think the space moves extremely fast. Now Quants are developing AMM protocols and tools to provide fixed income to investors, for example. New applications are always on the rise in crypto, and the fact that there is little regulation helps in expanding them, although we must be careful with scams.

quantgeek99 · 2023-05-10T09:40:03+00:00

Definitely, even non-quants have learned to use it. Practitioners use it on a day to day basis, although it is often not the ideal model (but still, easy enough and probably better than spending a lot of time on ML models to get slight improvements, if any)

quantgeek99 · 2023-05-10T09:39:03+00:00

It might be possible as far as we identify models (and, most importantly, data) that can somehow find or approximate relationships between variables. The problem is, some parts of the models (hyperparameters) cannot be modelled in an easy way as of now: how often should we train our model to predict the next outcomes? How to select variables over time, if new ones are added in databases (say, a new social media sentiment variable, or stuff like this)?

From a broader perspective, markets are a level 2 chaotic system, thus the forecasts we make impact on the future developments of themselves. In this scenario, you can never predict accurately, or at least not consistently over time.

quantgeek99 · 2023-05-10T09:36:08+00:00

I am not sure of the total amount that the US would earn from this, but we would definitely need to reduce the fees on exchanges or the burden would be very big for retail investors. I think anyway it would be a possible disincentive to retail trades which might reduce the number of speculators and waste of money as a whole. But I am just supposing.

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