“By three methods we may learn wisdom: First, by reflection, which is noblest; Second, by imitation, which is easiest; and third by experience, which is the bitterest.” ― Confucius
It’s Blogger Wisdom week here on Abnormal Returns. As we have done in previous editions we asked an esteemed group of finance bloggers a series of (hopefully) provocative questions. The answers are not edited and the author’s name, blog name and Twitter handles follow. Yesterday’s post touched on the idea of the famous Buffett bet. We hope you enjoy these posts as much as we do putting them together.
Question: Assume you have discovered an equity return factor that is both previously unknown and uncorrelated with other factors. What would you do to monetize that insight? (Answers in no particular order.)
Ben Carlson, A Wealth of Common Sense, @awealthofcs, author of Organizational Alpha: How to Add Value in Institutional Asset Management:
Setting up a hedge fund and leveraging that factor would seem to make sense but that just opens you up to competition. I guess the best thing to do would be to set up an index and license it out to all of the smart beta ETF and mutual fund providers and be the gatekeeper on it.
Call my friend Bill Smalley at Virtus ETF Solutions, make the product, get it out the door asap, and market the hell out of it.
Nothing because I would understand that it would take years of study to validate my research. I would also question how I was able to find such a factor when it has eluded Fama and French, among others!
To maximize personal monetization, I’d launch an ETF. First to market plus a good marketing campaign could easily raise billions of dollars. Even charging just a 0.25% fee would net revenue that would far exceed any profit I could generate leveraging my own net worth. I’d probably also quickly follow it with a long/short hedge fund version that uses some leverage to tap into the institutional crowd looking for non-correlated exposures.
Discovering the factor is just one step. That doesn’t mean it has a trend of any sort, either up or down. Plus, if it’s truly uncorrelated, then it’s only value is at the service of diversification. Personally, I would build an index or ETF to monetize it.
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I would go to the manager of the best quantitative trading firm that I know of and pursue systematic strategies to harvest returns from that factor (as well as the others) across asset classes and regions of the world and rebalance portfolios as needed. Weighting that new factor with the others to achieve optimal returns will require further research.
Tobias Carlisle, The Acquirer’s Multiple, @greenbackd, co-author of Concentrated Investing: Strategies of the World’s Greatest Concentrated Investors:
Patent it. Package it as a 39bp ETF.
Easy – write an opaque white paper about it and then issue crypto tokens through an Initial Coin Offering to access it. Nothing sells like scarcity!
I’d trade on it.
I don’t think I can get scale to the point where I personally would benefit from trading directly on it, so I’d look to sell access to it via auction for exclusive vs non-exclusive rights for some period (3 years)?
I’d keep it all to myself! Seriously, whenever someone says they’ve found a systematic way to beat the market, ask yourself, Why are they offering to help me get rich? Why aren’t they sunning themselves on a luxury island, sipping Martinis, while the algorithm quietly whirs away?
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Keep quiet, and invest using that factor.
A great question, and a difficult one. First, you need to be convinced that you have discovered and tested it properly. Most people – even those who should know better – fool themselves with overfit backtests. Next, you must convince a big investor to try it. They see so many poor tests that they want a five-year track record. This bureaucratic approach relieves them of actually evaluating the research process. You wind up starting small, building your record, and gradually adding investors. Then you hope that it still works when you finally get the size you seek!
First I’d double check my math. Then I’d give it to the 10 smartest people I know and ask them to rip it apart. Cherry picking is rife in the backtest world.
Wesley R. Gray, Ph.D., Alpha Architect, @alphaarchitect, co-author of Quantitative Momentum: A Practitioner’s Guide to Building a Momentum-Based Stock Selection System:
First, I’d sign myself up the nearest data-miners anonymous club.
Second, I’d license the technology to an asset manager focused on throwing spaghetti against the wall.
It depends on the size of the discovered edge. If it is too small, the discovery might not matter much. For some reason, Wall Street is still fascinated with uncorrelated returns. There’s nothing wrong in making a lot of money with highly-correlated strategies. You just need to know when to stop using them. Since different methods work in different markets, timing a strategy is the best form is risk management.
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Well, I’ve been pretty negative about factor investing so it would be pretty damn hypocritical of me to start a factor fund. I am deeply skeptical of the idea that anyone can capture consistent alpha in any factor. And even if factors exist there is solid evidence showing that they tend to disappear once discovered or lapse for such long periods that it can make it impossible to capture the gains in a realistic time horizon. I know I am going against the tide here, but my view is that most factor strategies are the hope of market beating returns in exchange for the guarantee of higher fees. That’s not a bet that tends to work out for most investors. Not to mention the fact that “alpha” is not a financial goal. It’s just something we all want and don’t need.
If I were playing the long game, my goal would be to keep my insight out of reach of other market participants. I would use my own capital, along with capital from some friends and family, to start a track record. If I thought the factor was scalable, I would attempt to use that track record to raise external assets or parlay it into a gig at a (more) lucrative / sizable hedge fund. If I were playing a short game, I would create an index for credibility (sacrificing my secret), market its backtest, and license it out to a “passive” ETF provider hoping to raise assets before its correlations eventually increase and returns decrease.
Raise money through an ICO and launch a 3x leveraged ETF, currency and interest rate hedged, of course.
The way you go about exploiting the factor depends on the scope of the factor. If it’s a massive market-wide factor, there is no better way to monetize it than to raise some money, create a product, and market it to asset managers. You can even challenge Warren Buffett to a million dollar bet to promote the fund! If it’s a smaller edge you keep it a secret for a while and exploit it until it goes away (they all do, unfortunately).
Publish the research, land a consulting job based on my discovery, and book speaking gigs.
I think there would be two choices 1) don’t tell anyone, don’t publish and don’t let anyone else invest in the return factor so the factor return isn’t arbitraged away or 2) create a business to help other people capture the return factor as well. I think one would have to think carefully about which scenario maximizes their personal profit (after all costs including the cost of building a business). I would probably side on not telling anyone and investing only my own money so the factor isn’t arbitraged away.
I’d sell the idea to both Cliff Asness and Rob Arnott, and then enjoy the fireworks as they each argue they’re right.
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Create an organization as fast as I could to bring it to market. Given the interest in quantitative strategies, it wouldn’t be too hard to raise assets, although I would need to find start-up capital. I don’t think that would be hard to find either.
I would set up a new equity strategy for separately managed accounts, and quietly manage it at my small firm. I am skeptical that large, durable new factors will be found, though. It’s difficult to do much with a new factor, though. If you publicize it, people might believe you, but others will take advantage of it as well. If you don’t publicize it, it will be difficult to get investors to come on board. Fortunately, I don’t care that much about AUM, so slow growth would be fine with a secret strategy.
Thanks to everyone for their time and effort. Stay tuned for a new Blogger Wisdom question tomorrow.