Monday, November 11, 2013

Capital and Human Capital

According to this study of money managers, PhDs outperform on a risk adjusted basis, as do people who attended high SAT undergraduate institutions. MBAs do not outperform on a risk adjusted basis, but they take more risk.

See also The real big money is run by a physicist , The real smart guysA tale of two geeks.
What a Difference a Ph.D. Makes: More than Three Little Letters (

Abstract: Several hundred individuals who hold a Ph.D. in economics, finance, or others fields work for institutional money management companies. The gross performance of domestic equity investment products managed by individuals with a Ph.D. (Ph.D. products) is superior to the performance of non-Ph.D. products matched by objective, size, and past performance for one-year returns, Sharpe Ratios, alphas, information ratios, and the manipulation-proof measure MPPM. Fees for Ph.D. products are lower than those for non-Ph.D. products. Investment flows to Ph.D. products substantially exceed the flows to the matched non-Ph.D. products. Ph.D.s’ publications in leading economics and finance journals further enhance the performance gap.
An excerpt from the paper:
... The existing literature has explored some aspects of the link between managerial talent and both ability and education in the context of money management. For instance, Chevalier and Ellison (1999) find that mutual fund performance is related to certain educational characteristics of mutual fund managers. In particular, mutual fund managers graduating from undergraduate institutions with higher average SAT scores achieve higher raw fund returns. Similarly, Chevalier and Ellison (1999) also find that raw fund returns achieved by managers with an MBA outperform those without an MBA by 63 basis points per year. However, upon adjustments for risk, only the differential in risk-adjusted performance between the managers graduating from undergraduate institutions with higher average SAT scores and those graduating from undergraduate institutions with lower average SAT scores persists, whereas the risk-adjusted performance differential between funds managed by MBAs and non-MBAs disappears. ...
In this paper, we analyze the relation between investment performance of domestic equity products managed by institutional money manager and a broad spectrum of managers’ demonstrated academic ability. We focus on possession of a Ph.D. degree, as well as managers’ publication records in top outlets in economics and finance). Using gross returns (returns measured gross of fees, but net of transaction costs), we find that the performance of investment products managed by Ph.D.s is superior to the performance of non-Ph.D. products along several metrics widely employed to measure risk-adjusted product performance (objective-adjusted returns, Sharpe ratio, four-factor alpha, information ratio, and manipulation-proof performance measure). The performance differential in gross returns is preserved, even slightly enhanced, once fees are taken into account (fees for Ph.D. products tend to be slightly lower than fees for non-Ph.D. products).

Hiring employees to maximize assets under management is of first-order importance for money management companies. We find that net flows to Ph.D. products substantially exceed net flows to the non-Ph.D. products matched by style, assets under management, and recent performance. This difference is particularly accentuated in the top quintile of past performance. While the underlying cause of the relation between flows and educational attainment may ultimately stem from ability, knowledge, or soft skills, this finding provides a clear economic justification for the aggressive recruitment individuals holding a Ph.D. to serve in key positions in money management companies.

Finally, our analysis reveals that, among Ph.D. firms, a product’s performance is strongly positively related to the firm’s key personnel publication record in the top outlets in economics and finance. This finding indicates the extent to which proven academic ability at the highest percentiles of achievement translates into successful institutional money management.


oregonlocal said...

Most mutual funds do not outperform the market averages. The high-flyers that do (including anti-Black Swan event ones!) experience a catastrophic Black Swan collapse of 50 - 70+% at least once within ten years. The (presumably Phd. holding managers) of these high flyers get fat on their .75% annual management rake but their clients get wiped out 10% of the time. If the fund managers have their own skin in the game then they are bigger fools than their clients.

Hardly something to be proud of, and I might add that Long Tern Capital Investment (replete with Myron Scholes and another half-dozen Phd.s) is the most famous (but hardly the only) example of this. The same catastrophic collapse happened to Princeton Newport Partners managed by my personal hero (and Phd. in Math) Edward O. Thorpe of "Beat The Dealer" fame. It happens to all of them.

The fact is these Phd.s are not heroes but just more of the same Wall Street sharks feeding off the gullible public whether they be individual or corporate entities.

Diogenes said...

so the oracle of omaha was wrong.

he said (i paraphrase), "the investments game isn't one where the guy with a 160 iq beats the guy with a 130 iq."

Diogenes said...

sounds like ressentiment to me.

Kenuto said...

From page 11 of the paper: "Moreover, the analyses focus on actively managed products; accordingly, we exclude index products." Guess that it wasn't important to see how the PhD is doing against Mr. Market. You'd think the authors (all from schools selling PhD degrees) could have mentioned that, but why include critical information? Pun intended.

Cornelius said...

MBAs who go into portfolio management don't normally learn anything beyond the four factor model. I'm not sure what the R^2 is for the four factor model, but it's about .95 for the three factor model vs. a portfolio of stocks. The smart MBAs just use one of those models to construct a portfolio with a particular risk-reward profile. Most MBAs aren't very inquisitive so I wouldn't expect them to go beyond those models.

Many PhDs on the other hand go into finance with very little formal training in financial economics. Even the econ PhDs are trained to push the limits and try to improve on the best models of portfolio risk-reward. It's no surprise that they end up with results better than the best models used by MBAs.

I suspect several of the quant funds have developed models with R^2 significantly above .95.

Bobdisqus said...


Diogenes said...

BUT the rocket scientist have no understanding of accounting or business and their usefulness is limited to ultra high frequency trading, derivatives pricing, and portfolio optimization.

buffet said, "risk comes from not knowing what you're doing." but the rocket scientists think of investments risk in the same way they think of the "irreducibly" random "risks" of qm.

oregonlocal said...

You'll be happy to know I've run a balanced portfolio since the 1980's. That's why I'm rich and you are not.

Diogenes said...

"you are totally wrong about bonds"?

then why do you run a balanced portfolio?

they were a long term short in japan 20 years ago too!

"That's why I'm rich and you are not...You know nothing about money."

you're not even bougeois. your md like income you made by the sweat of your brow.

oregonlocal said...

And my millions in capital by smart investment of that income. BTW, how is that dead end job of your working out?

oregonlocal said...

"then why do you run a balanced portfolio?"

Capital preservation mostly. Plus rebalancing realizes profits where they exist and forces a buy low-sell high strategy.

Diogenes said...

"And my millions in capital exists by smart investment of that income"

then you're smarter than all those guys at ltcm. too bad you missed your calling. you could have made billions as a hedge fund manager.

oregonlocal said...

How so. All I did was save my money and invest it wisely. Fund managers only invest in financial instruments and there are many rules limiting most mutual funds to small percentages in any one stock. Do you think that the multitudes of wealthy people in the US are only involved in the stock market or have to follow mutual fund rules?

And yes, I guess I am smarter than all those guys running ltcm at the time. I haven't gone bankrupt nor did I require a monster government bailout.

You know nothing about money.

Diogenes said...

i'm sure at this point you're senile.

"too bad you missed your calling. you could have made billions as a hedge fund manager."

oregonlocal said...

You're repeating yourself once again. And quoting yourself as you do here is a psychopathology just like your alternate profiles are.

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