McGraw-Hill

10 Inh’oduction
and underlying benchmark risk-return guidelines helps to immunize
the manager from cognitive errors. Still better, engineered
strategies can be designed to exploit the cognitive biases that can
lead traditional active managers astray.
Furthermore, the discipline imposed by engineering portfolios
to benchmark standards ensures portfolio integrity. Properly constructed
quantitative active portfolios be can combined without fear
that the combination will result in dilution or distortion of expected
performance. Most importantly, portfolio integrity offers some con
sistency of benchmark-relative expected return and risk. The investor
faced with the task of having to select managers (portfolios) to
meet overall fund objectives can have more certainty of the contributions
likely to be made by quantitative, as opposed to traditional,
active managers. Manager selection can thus be more systematic
and overall fund performance more predictable.
Of course, passive portfolios offer even more certainty of
benchmark-relative performance, because they are designed to
track underlying benchmarks closely. But passive portfolios offer
no opportunity for superior performance. Only active quantitative
management has the potential for both breadth and of depth analysis,
as well as the imposed discipline, to deliver outperformance o
a consistent basis.
ATTAINING INSIGHTS
While at the asset management arm of Prudential Insurance Company
of America, we worked extensively with commercially available
systems for measuring and controlling risk. These systems
drew on earlier models for pricing risk, including the Capital Asse
Pricing Model and Arbitrage Pricing Theory, and covered multiple
risk factors, based on accounting and economic data. They pro
us and other portfolio managers with tools for constructing portfo
lios that could meet quantitative risk control goals.
These systems were risk-oriented, not return-oriented. Their
value came from the control of overall portfolio risk, rather than the
enhancement of stock selection. But superior portfolio performance
requires insights that can deliver returns, as well as tools for controlling
risk. We felt we could develop return-oriented proprietary
systems having the power to deliver significant value added.