Wednesday, December 13, 2017

Producing alpha is not easy - The solution to making effective decisions in a uncertain world has not been found


"What I think HBS does and does very well is train people to, in situations of ambiguity, to take imperfect information, uncertain outcomes, and tight deadlines and figure out what to do in the most effective, efficient, and powerful way." - Casey Gerald from The Golden Passport: Harvard Business School, the Limits of Capitalism, and the Moral Failure of the MBA Elite by Duff McDonald 

I cannot say that Harvard has always done a good job meeting that description especially in the world of trading where quant skills and street smarts run supreme, but the comment above may be the most concise way to describe what a good trader should do. We always come back to the key problem for any trader or money manager, how do you make effective decisions in a VUCA world of Volatility, Uncertainty, Complexity and Ambiguity. 

For some, the key to success is building models to force discipline on all decisions. For others, the formula to success is using discretionary judgment through taking in all the information that is available and forming narratives on value and opportunities. Both are specialized skills that are difficult to find or develop.

The decision problem has been the same since trading began. How do you properly risk capital when information is imperfect, there is no certainty with the market model, volatility is constantly changing, the behavior of market players is complex, and market signals are ambiguous. All of these decisions must be made under tight time constraints. 

Of course, investors do not have to play the game, but even diversified portfolios held for the long-run have to face the effects of a VUCA world where wealth can fluctuate with changing risk premiums, fundamentals, and sentiment. The important point is that the skills necessary to be a good money manager/trader are very specialized and rare. Alpha product is not easy and can be fleeting, so care should be taken when measuring this skill.

No comments:

Post a Comment