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Move over, black boxes: brains are back

Date: Monday, May 25, 2009
Author: WSJ.com

Quantitative fund managers, who use computer models rather than human judgment to pick securities, have seen their world turned upside down by the credit crisis.

The first generation of managers and their models have moved on: Their inheritors are having to accommodate a changed landscape full of skeptical investors. In reaction, quant managers have spent 2008 making adjustments to their models, finding new sources of data and tightening secrecy.

Asset managers, in general, are facing tough times, but stock-picking is at least familiar … The so-called black boxes…, on the other hand, are increasingly out of favor with investors...

A few years ago, they were heralded as a way around the biases and irrationality of humans. They could analyze value metrics, such as earnings information in company accounts, in a systematic, scientific fashion and make impassive judgments to build the best portfolios. In a smoothly rising market, they were efficient at picking out the best of the bunch, and exploiting sometimes small differentials ruthlessly. Goldman Sachs Group Inc.'s quantitative Alpha fund, posted stellar performance in the mid-2000s, swelling to about $12 billion in size at its peak in 2007….

Goldman Sachs's Global Alpha fund had shrunk by about 80% from its peak to the end of last year, thanks to a combination of client withdrawals and negative market returns.

Some computer models have performed well. Managed futures funds, hedge funds that rely on computers to spot trends in financial markets and use derivatives to bet on them, made 14.1% last year, according to data provider BarclayHedge.