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What Can Quant Firms Learn From Steve Jobs

October 6, 2011

I was very sad to hear the news that Steve Jobs- the  former CEO of Apple Computer– passed away today.  His life was an incredible story of innovation, and the ability to triumph in the face of constant adversity. The legacy that he left cannot possibly be missed– you can’t walk outside or inside for more than a minute without seeing someone use an Apple product. There is literally no other consumer brand in the world that enjoys the same degree of loyalty and enthusiasm as Apple Computer. There is a good reason for that: Steve Jobs was focused on creating the best products with no compromises—even at the expense of delaying a launch in a world driven by quarterly earnings. Furthermore, he furnished these products with  functionality that consumers  didn’t know they needed until it was available. Jobs did not focus on market research and on providing customers with what they wanted, instead he brought them products from his unique vision of the future. It was the act of daring to be different, and focusing on value  instead of money that set Jobs and Apple far away from the competition.

This philosophy extends to all industries, and especially those that are driven by intense competition, technology and innovation. Of course, quantitative investing fits in perfectly within this category. So what can we learn from Steve Jobs? He was a man that wasn’t fond of rules or the status quo. Jobs would run his business based on his vision of how technology would evolve in the future rather than how it actually was in the present. He was willing to risk everything in order to best shape his products with this vision.  If he were in finance he would quickly recognize that greatest rewards will accrue to those that can create innovative algorithms or technology. It is very easy to imagine him seeing the value in a quantitative approach to investing.  Furthermore, Jobs would spend less time studying what others are doing in the field and focus on taking a completely novel approach. He would hire talent and promote risk-taking at every level of the organization. Furthermore he would invest extensively in research and development and avoid using a management accounting approach to evaluating its budget.

In the world of “quant” investing today,there are several major barriers to duplicate this approach: 1) a  true lack of diverse and creative talent 2)a lack of  consistent commitment to an ongoing research and development 3) embedded philosophical barriers to innovation .  The first problem is driven by the type of “left-brained” people that are attracted to and consistently employed in finance:  math, engineering and physics. This makes sense because of the high intellectual and technical barriers that exist in modern quantitative finance. However, the saturation of Phds and math wizards creates a talent pool that often lacks both diversity and creativity. While it is true that creativity can come from any background, it is certainly less likely to come from those that have cognitive wiring that is the polar opposite of those people that are typically artistic and creative.

Another challenge is that it is much more difficult to tangibly measure the value of financial innovation unless one is committed to the process. It is easy to measure the value of programmers or the mathematicians that create core programs. In contrast, adding alpha requires incrementally longer time frames to evaluate accurately as the trading frequency becomes lower. However, evaluation is a critical part of business decisions to increase R&D expenditures. That explains why hedge funds,high frequency firms and investment banks continue to hire top scientists while the rest of the investment industry fails to invest in talent.

A final achilles heel resides in the psychological, political, and philosophical barriers to innovation. In all areas of finance, the cost of miscalculation or being “wrong” is so high that human nature causes us to seek out those who are less likely to screw up the math. Having worked with many Phds and other bright individuals, the fear of being wrong or even doing math that is not conventional is so strong and pervasive that they are psychologically unwilling to break from convention. Of course, the very essence of the creative  process requires risking being incredibly wrong in order to find a better way to do something. This can mean that a quant can lose their job for introducing a novel idea that doesn’t pan out, but will probably keep their job if they use GARCH or Fama-French and mess up. Clearly between the type of employee that gets hired, fear of math mistakes, and  the obvious politics involved, innovation has many hurdles to overcome.

We need to stop worrying about being wrong— in a competitive game there is no alpha in  being conventional and avoiding mistakes. There is no such thing as the “right” way to do anything anymore. In quantum physics we are continually exposed to how little concrete information we truly possess. Why should a vastly more unpredictable field be any different? Determinism and mathematical proofs are rapidly losing their value in finance. There is no fixed reality, and the highly dimensional nature financial problems today require both tremendous statistical skills but also the unique and artistic insights that drive the hypotheses to be tested. The new brand of quant firms that will succeed will integrate both approaches under one roof.

 

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12 Comments leave one →
  1. October 6, 2011 2:13 am

    Excellent article thank you David.

    • david varadi permalink*
      October 7, 2011 9:59 am

      thanks James!
      best
      david

  2. October 6, 2011 3:55 am

    Bravo.

    • david varadi permalink*
      October 7, 2011 9:59 am

      thanks Henry!
      best
      david

  3. jkw permalink
    October 6, 2011 6:08 am

    I’m guessing that you don’t have a PhD. It is the only degree I know of that has creativity as a primary requirement. You can get a BS in any field without ever doing anything that hasn’t been done before. You can also get a master’s degree from many schools and in many fields without doing anything truly new. But a PhD (at least from a real research university) requires you to formulate a new problem and then solve it. Someone without creativity will never finish. Although this is becoming somewhat less true as PhD’s are granted for research that is merely an obvious extension of prior work that simply hasn’t been completed previously due to resource constraints.

    • david varadi permalink*
      October 7, 2011 10:06 am

      hi Jkw, I actually was on track to entering a PhD program many years ago and chose to stay in the industry. so I am not entirely unfamiliar with what is involved. but I do agree that to some extent it is important to be creative to excel in that environment. however, in my experience most people complete a thesis that is merely an extension of previous work. typically a completely novel or unconventional idea is supressed by the supervisor on the grounds of not extending any past research or fitting in with existing theory. of course my experience is from one field and one school and it is difficult to extrapolate.

      best
      david

  4. Zack permalink
    October 6, 2011 2:49 pm

    As a long time reader of your blog, and as a professor of physics, I would like to expand on jkw’s point. The best scientists I know are some of the most creative and risk-taking people I know – and I grew up around the some of the world’s best musicians and stage actors. I will confess, however, that many of the physics students (including Ph.D.s) I know who ended up working for others in finance were the least creative of the bunch. I cannot speak for mathematicians or engineers, as I simply do not have the experience to judge.

    I find it interesting that you feel the finance industry has hit the stagnation phase, where innovation is not rewarded. I, for one, have found your blog over the years to be very rewarding. If I may, let me phrase my reading of your point this way: the portfolio of quantitative research is becoming unbalanced. There needs to be more investment in pushing the next frontier, rather than in maintenance of the existing ideas. Your solution is to bring more balanced people (from whatever field) into finance. I think every field has desires of a similar sort.

    • david varadi permalink*
      October 7, 2011 10:24 am

      hi Zack, I have certainly read about many highly creative scientists (Claude Shannon is a great example) so I do not mean to paint everyone with the same brush. The subject area obviously attracts certain types of personalities and perhaps finance attracts those individuals that have more technical rather than abstract talent in working with numbers due to the far more tangible nature of say pricing derivatives (versus say the area of theoretical physics with is highly abstract ). In either case, I agree with you that innovation and the incentives to be different in the industry have evolved in a way that is completely opposite to the technology space. In reviewing many different academic articles on finance it appears that the “high priesthood” of efficient markets and Fama-French dogma is used automatically as a null hypothesis. Dozens of pages are spent attempting to show that an “anomaly” is not simply a function of priced risk factors that are “well-accepted.” This simple barrier leads to researchers completely avoiding or abandoning certain fruitful research areas. The non-linearity and complexity behind market function makes it highly difficult to evaluate through the lens of one regression equation that is based on flimsy theoretical grounds.

      On a side note, thank you very much for the kind words, and I am glad that you find value in my rants 🙂 I try my best to introduce new ideas even if they have not been thoroughly vetted or validated. My philosophy is that brain-storming should be done separately and uninhibited by the science of evaluation. The combination of the two seems to be the best approach.
      best
      david

  5. October 6, 2011 3:32 pm

    “But a PhD… Someone without creativity will never finish.”

    LOL

  6. John Hall permalink
    October 6, 2011 3:49 pm

    What’s so bad about Garch?

    • david varadi permalink*
      October 7, 2011 10:25 am

      Hi John, nothing is wrong with GARCH—I like it and use it and it was just one example of a widely accepted approach.
      best
      David

  7. October 10, 2011 4:09 am

    Excellent!!!

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