Those who can, do, and those who cannot, teach, as the saying goes. But investing may be an exception, according to Morningstar’s Vice President of Research John Rekenthaler.
Despite evidence of academics’ poor track records—Long-Term Capital Management’s Myron Scholes and Robert Merton, for example— Rekenthaler’s latest column argued finance and economics professors are not as bad as people think.
“No doubt Irving Fisher flubbed the Great Depression, but John Maynard Keynes navigated it (and the subsequent rebound) very well, thanks much,” he wrote.
Furthermore, Rekenthaler said academic-led fund companies such as Eugene Fama’s Dimensional Fund Advisors and Cliff Asness’ AQR “have not suffered for their PhDs.”
“No doubt Irving Fisher flubbed the Great Depression, but John Maynard Keynes navigated it (and the subsequent rebound) very well, thanks much.”However, in addition to IQ, market knowledge, and theories, the columnist added professors would do well to have “adaptability, practicality, and flexibility” for instances when economics theories fail.
Quantitative managers with math, computer science, and engineering backgrounds likewise have some gaps.
According to Rekenthaler, quants are plagued with overconfidence. “There’s no money to be made by outthinking the masses,” he wrote. “Being very good gets a quantitative investor precisely nowhere.”
In addition, numerically gifted investors could stray too far from theories, sometimes leaving them in “no position to understand why their models had worked in the past and how that might change in the future,” he argued.
If an investment formula fails, quants could re-run the numbers and modify their models—“a form of blind reckoning”—which does to connect cause with effect.
Finally, quants struggle in game theory, the columnist said, failing to see “second-level concern of interactive effects.”
“The ability to consider others’ actions in forming one’s own strategy is critical to succeeding in multiplayer games—and I suspect, in investing as well,” he said.