Inside the Black Box: The Simple Truth About Quantitative Trading

12.6. HOW QUANTS FIT INTO A PORTFOLIO

Assuming that you find a quant that is worth hiring or investing in, you have to decide how to allocate to this trader. To make this determination, you have to understand how the strategy fits in with the rest of your portfolio. This is largely a question of balancing the levels of various types of exposures. This section details some of the more important kinds of exposures associated with quant investing.

12.6.1. A Portfolio of Alphas

First, it is worth remembering that portfolio construction is about allocating to exposures. A portfolio that contains more kinds of exposures is more diversified than one that is concentrated among a smaller number of exposures. Investors must seek out the appropriate balance of trend, reversion, value/yield, growth, and quality to achieve optimal diversification. A quant doing trend following is not likely to be so incredibly different, from a portfolio construction viewpoint, than a discretionary trader who is seeking to identify trends. To be sure, the tireless vigilance of a computerized trading strategy might find opportunities that the human trader misses. In addition, the human trader might avoid some bad trades that are taken on by the computerized strategy out of naiveté. But, as trend following in general goes, so it is likely that the human and computerized trader both go. So, at a primary level, the investor must diversify among various alpha exposures. In the evaluation process, the investor ...