Tuesday, April 24, 2007

Financial Academics as Wall Street Fund Managers

"Those who can't do, teach."

That's an old adage from my youth. However, Saturday's Wall Street Journal featured an article concerning academics who teach finance at our nation's universities, and also have developed and/or run asset strategies via hedge or mutual funds.

My initial question is, why would you think finance professors should necessarily know more about developing hedge or mutual funds that outperform the market than anyone else? If they did, and they knew it, wouldn't they be doing it already? Or, perhaps, have done it, become wealthy, and then retired to teach finance at a major university?

Unlike bygone eras before 1990 or so, when universities often had data, computational resources, and a collection of talent that was unmatched elsewhere, it's unclear what competitive edge would exist nowadays in the academic world. What is it that university finance professors have that is now unique? The days of University of Chicago's CRISP data base being unique, or Wharton's Rodney White Center having some edge, are gone. I can't imagine any leading trading or investing operation, let alone an exchange, releasing data in that manner anymore.

Would universities have better research resources, such as people? Probably not. Funds and investment banks with fund management shops are chockablock with young, eager twenty somethings on the make. In fact, my partner and I even pause when offered an opportunity to meet with some financial services concerns, because we don't see benefits to speaking to a room full of young, inexperienced analysts, all of whom are looking for some edge with which to make partner at their firm.

Computing power is cheap and plentiful now. That is not likely to be a source of advantage for a finance professor nowadays

How about innovative concepts? Perhaps the leading finance professors think better thoughts about investing strategies. The article mentions Wharton's Jeremy Siegel, Yale's Robert Shiller, and Princeton's Burton Malkiel. It neglects to name Robert Merton and Myron Scholes, co-recipients of the 1997 Nobel Prize in Economics, who assisted Long Term Capital Management in causing self-immolation, and the loss of $4.6B, back in 1998. Neither does it discuss Robert Haugen, a UCLA finance professor who applied the theories from his book, The New Finance, to mutual funds in the 1980s. As it happens, my colleagues at a hedge fund worked with Haugen in the late 1980s, using his data and models, and were unable to effect any significantly superior returns from the effort.

The article also omits any mention of Fisher Black's and Richard Roll's track records at Goldman Sachs, back in the 1980s and '90s. Black, of course, was hired for his part in the now-famous Black-Scholes options model (he died while at Goldman, so LTCM had to settle for his partner, Scholes), while Roll was instrumental in the application of a rather garden-variety statistical technique, factor analysis, to portfolio management, which was renamed Arbitrage Pricing Theory, or APT.

Whatever asset management vehicles other famous finance professors, such as Eugene Fama, and/or his research colleague, Ken French, have created, are also omitted.

If anything, finance professors may be more likely to be hidebound, since they must teach what has already been vetted. Or, if it's cutting-edge, what they teach becomes the market behavior. You'd expect to find the more successful asset management strategists out of the limelight, and certainly not prostyletizing their concepts to the masses in MBA and PhD programs.

As an example of this, several years ago, I worked with a wealthy private investor who desired to develop his own hedge fund complex. He told me that he and his colleague, Burton Malkiel, managed the money of some associates.

Did they employ some abstruse black-box econometrically-based model? No. Did they engage in esoteric hedging strategies across currencies, durations, and asset classes? They did not.

Their approach was almost comically simple. It used the yield on Treasuries, and a simply-derived proxy of yield for the S&P500 from its forecasted earnings and PE multiple. They then simply moved client funds between two publicly-available, pure index funds based upon the relative values of the two forward-looking yields.

Hardly rocket science.

However, my comments are hypotheses. Anecdotal, if you will.

What we really need to know, in order to determine whether ex- or current finance professors are uniquely talented asset managers, is whether, as a group, finance professors have outperformed their non-academic peers in the marketplace with their hedge, mutual fund, and/or private account strategies. Did they also outperform the average comparable fund or account? How about the S&P500 index, for equities, or other relevant indices for other asset classes?

This would be fascinating work for some financial media company, such as the Wall Street Journal, Barrons, Forbes, or CNBC to undertake or commission. Just using a few high-profile names and some anecdotes isn't sufficient to demonstrate or conclude anything.

For example, as noted above, Long Term Capital Management blew up, losing billions of investor dollars, with the help of two ex-academic, Nobel Laureates. Siegel's strategies, somewhat disingenuously called 'index funds,' have been off to a rocky start at Wisdom Tree, according to a recent Journal article.

There's no clear sense in the literature as to whether academics have done a better job consistently outperforming their respective market indices, or non-academic asset management peers. From that perspective, the Wall Street Journal article is an intriguing start on this topic, but by no means the final word.

No comments: