Harvesting ‘Mistakes’

Three times a day, Acadian Asset Manage-ment calculates the relative attractiveness and expected return of 40,000 stocks around the world. “You may notice we like numbers,” Churchill Franklin says with a laugh. The Acadian CEO is sitting in a conference room at the Boston headquarters of the quantitative investment firm for an interview in early May.

Across the table, Chief Investment Officer John Chisholm says that, in essence, what Acadian does is look for inefficiencies in the pricing of securities. “Investors make certain systematic behavioral errors in the way they make investment decisions,” he says.

Take value. Companies that are cheap in terms of price to earnings tend to generate higher returns over time than expensive companies. One reason: Investors tend to extrapolate from a stretch of strong earnings growth and bid up a company’s price, even when continued growth to support such valuations is improbable. Errors such as that can be tied to certain characteristics of stocks. “‘Factors’ is the quant term for them,” Chisholm says. “We measure empirically what’s the payoff associated with that error.”

Acadian then uses its models to predict, given the current market and macroeconomic environment, what the return associated with that characteristic will be in the near future. “Then we build portfolios that maximize the exposure to those particular factors or inefficiencies in the marketplace,” he says.

Acadian’s approach has worked: Its $8.5 billion Global All-Country Equity strategy, for example, returned 1 percentage point more than its benchmark net of fees from inception in 2003 to June 30. Acadian, which was founded in 1986, manages about $75 billion for institutions in more than 40 strategies. The firm’s $19 billion emerging markets equity strategy, its largest, returned an average of 7.1% a year net of fees from January 1, 1994, through June 30. By comparison, the fund’s benchmark, which since 2001 has been the MSCI Emerging Markets Index (Net), gained an average of 5.1% annually over the period.