Alpha geeks

More nonlinear returns to brainpower.

This Times article, about Google in China, features Kai-Fu Lee, a CS PhD (speech recognition) who was the subject of a bidding war and lawsuits between Microsoft and Google. He now runs Google's Beijing office (he used to run Microsoft research there).

This WSJ piece profiles Goldman's Global Alpha quant hedge fund. Asness has appeared before on this blog (you can search on the right), both for his research on a modified Fed model for equity valuation, and via a Times magazine profile.

In early 1997, Mark Carhart was an academic at the University of Southern California. His big claim to fame was his doctorate work at the University of Chicago on mutual-fund performance.

Today, the 40-year-old Mr. Carhart and another former Chicago-school colleague run a big, secretive hedge fund at Goldman Sachs Group Inc. which, with an estimated $10 billion in assets, is the Cadillac of a fleet of alternative investments that have boosted the earnings at the blue-chip Wall Street firm. And the two men are making millions themselves.

Known as Global Alpha, the Goldman hedge fund was a leading contributor to a surge in "incentive fees," or performance-related fees, that Goldman reported for the first quarter ended in February. In that period, the incentive fees soared to $739 million from $131 million a year earlier, helping Goldman's earnings rise 64% to $2.48 billion, the biggest first-quarter gain of any major Wall Street firm.

Global Alpha's recent returns have been sizzling. In the 12-month period ended in March, the fund returned more than 48% before some fees, according to Goldman Sachs JBWere, an Australian affiliate of Goldman. It was closed to new investors last year. (On Wall Street, the word alpha refers to investment returns beyond those generated by the market.)

The bearded Mr. Carhart and his colleague, Ray Iwanowski, manage Global Alpha. A 50-member team they lead also offers a menu of services for Goldman clients based on statistical models first developed by a group led by Clifford Asness, another former Chicago student.

The Global Alpha fund was seeded in late 1995 with just $10 million, and in its first full year, 1996, the fund returned 140%, one former group member recalls. Mr. Asness left Goldman in 1997 with seven of the group's 13 members, to form his own hedge-fund business, AQR -- short for Applied Quantitative Research.

...The Global Alpha group's lineage traces to a group of students of Professor Eugene Fama, an influential Chicago finance professor known for a belief in efficient markets. In the early 1990s, his former teaching assistant, Mr. Asness, was recruited to join Goldman by a college friend, and in turn recruited numerous colleagues from Chicago.

One of the group's early assignments was to build quantitatively oriented asset-allocation models. Part of the methodology, which underpinned the strategy of Global Alpha, was to select stocks selling at cheap prices based on their book value, earnings or other metrics, while betting on a decline in stocks selling at higher prices based on their growth prospects.

The Goldman group later used similar methods to choose not only stocks but also bonds, currencies, and entire country markets, former group members say. The models also included a "momentum" factor based on which stocks or markets have recently performed well. Although the models have evolved, the underlying "quant" methodology remains similar.

In addition to Global Alpha, Goldman employees manage two other hedge funds specializing in quantitative stock and bond investments with an estimated $8 billion in assets. While some competitors grumble that Goldman traders could gain an advantage based on possible access to client information, the Goldman funds don't have such access, former group members say.

The Goldman "quants" also offer a product similar to the Global Alpha fund known as global tactical asset allocation, which gives pension funds and other institutions the chance to boost returns using statistical methods. Goldman's 2003 annual report featured a team including Mr. Carhart which invested $1 billion for the General Motors Corp. pension fund using "active alpha investing."

The Goldman team continues to rely on the latest work from academia. Maryland's Mr. Wermers recalled a visit to Goldman about a year ago to discuss a paper he had written on whether the flow of investments into top-performing mutual funds could predict whether stocks they held would rise in price.

When he presented his findings in a boardroom filled with about 20 GSAM employees, Mr. Wermers recalls, "it was kind of a high-pressure event. They asked very, very tough questions."