Handbook of Finance: Investment Management and Financial Management

Chapter 37. The Blindness of Hindsight in Finance

PETER L. BERNSTEIN

President, Peter L. Bernstein Inc.

Abstract: Asset management as a profession is the art of making decisions in the face of uncertainty. Measurement crumbles before uncertainty. The only certainty about our work is that the forward-looking markets in which we function are inherently unsteady, fickle, and full of surprises. Disorder and discontinuity are the norm, not anomalies; only the shape and timing of these inevitable disturbances are hidden from us, not their inevitability. Can quantitative modeling, which can be based only on data from the past, perform in a world such as this?

Keywords: quantitative methods, asset management, chaos theory

Can we dare to ask whether quantitative methods are appropriate for portfolio management? Quantitative methods are so widespread in practice today, and so cozily wrapped in the apparatus of financial theory, that the question can have only one obvious response: positive. My purpose in this chapter is to explore the case for a negative response. I do not promise an unqualified conclusion. The asset management field never tolerates unqualified conclusions—but that is precisely what concerns me about quantitative methods. For the sake of argument, and in order to be as provocative as possible, I shall minimize the qualifications of the conclusions, even if the effort leads me into overstating the case.

My line of argument begins with a few illustrations of when and how quantitative ...