Thursday, September 13, 2007

Global Alpha, or Global Omega?

Goldman Sachs is the most profitable investment bank in the world. Last year, its CEO was paid somewhere around US$56m. The recent credit correction, however, has demonstrated that even the best and the brightest are fallible.

In news just out, Goldman's quant fund, Global Alpha, was down 22% in August 07, and down 33% year-to-date and 44% from its March 2006 peak. The company's trades, which are based on mathematical formulae, are going terribly awry.

Even with such heavy losses, the fund managers are resolutely holding on to their beliefs in their mathematical formulae:
"We still hold our fundamental investment beliefs that sound economic investment principles coupled with a disciplined quantitative approach can provide strong uncorrelated returns over time,"
At the same time, "Goldman blamed its losses on too many quantitative funds making the same trades, and said in mid-August it would have to develop new strategies."

The same thoughts are probably running through the minds of other quantitative hedge fund managers which trade the markets based on a quantitative approach. Even with their losses they probably still hold to their 'fundamental investment beliefs.'

However, even though these hedge fund managers are probably super-smart and have ultra-high IQs, it means little when there are also other super-smart fund managers pursuing the same strategies. When markets turn against them, their computers simultaneously take the same cut-loss strategies, causing the market to move much more than expected and causing massive losses.

At the end of the day, I do not think that it is necessary to be a super-smart high-IQ individual to beat the market. You just need to think in a Contrarian manner - when the crowd is rushing towards the exits, that is the time to be buying. When the crowd is rushing in, it is time to get out.

And the good news is, Contrarian Investing has very little to do with intellect and IQ, it has much to do with emotional discipline. It has to do with doing your own home work, thinking for yourself, and having the courage to stand against the crowd.

And guess what, if you are contrarian, you will never run into the problem where there are "too many quantitative funds making the same trades," because you'll be making the kinds of decisions that few others are making.

Be a Contrarian today.

No comments: