I was talking about quant funds this afternoon, and got to wondering what on earth they’re doing these days, given that their m.o., up until say the summer of 2007, was to find trading ideas, backtest them, try them out in real life for a while, and then pull the trigger and actually trade on them.
The question then becomes: what now? When you backtest, do you backtest through the quant blow-up of 2007 and the stock-market meltdown of 2008? If so, do you really think that’s going to give you the kind of trading idea which will make money going forwards? And if not, then what do you ignore, and why do you ignore it, and what makes you think you won’t run into a third period of high volatility which will lie well outside any reasonable assumptions you might make?
Up until 2007, the problems with quant funds was that the models didn’t remotely conceive of the world as it transpired. Now, the problem with quant funds is that they can’t help but conceive of the world as it transpired — and basing your trading strategy on black-swan events which happen only very rarely is not a way to make lots of money.
I did express some hope, over the course of a fine bourbon, that the quants in question would find something rather more useful to do, rather than try to predict the future path of the ridiculously complex system that is the global financial system. But quants, anecdotally, are still in demand — I get the feeling that many investors seem to believe that if they’ve blown up once, they’re somehow less likely to blow up again. Which is something for which there is no empirical evidence at all.