Friday, August 8, 2014

This is the Opposite of Real Investing

Innovation in finance is designed largely to benefit those who create the complex new products, rather than those who own them. - Jack Bogle 
Earlier this week, I came across an article about "math nerds taking over Wall Street" and thought it must have been republished from 2006 when quantitative strategies were in their heyday

Nope. A few years after the financial crisis broke their old can't-miss algorithims, the quants have returned with a new set of proprietary trading formulas that will work until they don't anymore. 

No one ever said Wall Street had a long memory. 

The article highlights a quantitative software program that "uses historical data and analysis to predict price movements in various assets." 

This line made me think of Buffett's commentary in the 2008 Berkshire letter:
Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas. (my emphasis)
I don't mean to come down too hard on the quants -- they're clearly bright people and there's apparently demand for what they're doing, but their approach is the complete opposite of what we should be trying to do as investors.

Seeking patterns where none exist. (Pi)
Any time you would spend seeking patterns in the newspaper quotes page or developing automatic trading formulas would be much better spent pursuing another type of formula, like the one Buffett outlined in the 1994 Berkshire letter:
We believe that our formula - the purchase at sensible prices of businesses that have good underlying economics and are run by honest and able people - is certain to produce reasonable success. 
This simple formula isn't easy to implement, of course, but it beats using a complex formula that is easy to implement.

What do you think? Let me know on Twitter @toddwenning.

What I've been reading this week:
Cartoon of the week:

Stay patient, stay focused.