McGraw-Hill

P A R T ONE
Selecting Securities
A n active quantitative equity manager expects to benefit from re
turns in excess of those on an underlying benchmark, whether a
broad market index such as the Wilshire 5000, a large-capitalization
index such as the S&P 500, a small-capitalization index such as the.
Russell 2000, or a growth or value subset of the market. Whether
those expectations will be met depends on how well the manager
does at two basic related tasks. The first task is to detect mispriced
securities. The articles here in Part 1 focus primarily on that task.
The articles in Parts 2 and 3 of the book have more to do with the
second task of the manager-combining those securities in portfolios
that preserve the superior returns without incurring undue
Mispriced securities have the potential to provide superior returns
as their prices correct, over time, to fair values. Of course, the
Efficient Market Hypothesis and Random Walk Theory would sa
that mispricing, if it exists at all, is so fleeting or so random as to defy
exploitation. And elegant Ivory Tower theories, such as the Capi
Asset Pricing Model and Arbitrage Pricing Theory, would say tha
any apparent superior returns are merely the investor’s compensation
for bearing various kinds of risk.
Certainly, both research and reality have shown that simple
rules don‘t work. Buying stocks with low price/eamings (P/E) ratios
or high dividend discount model values won’t deliver superi
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