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Leigh Drogen

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2017-06-13
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2017-06-13
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  1. “And just so much more representative of that expectation. And we also find in all the models more alpha in the mid and small cap stocks. And that's the case for most stuff because the large cap stuff tends to be more efficient. But the coverage is basically, it's like 97% of the market cap of the US universe. We don't do REITs and we don't do community banks. And those are the only two things we really don't do.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  2. “Yeah, so we cover with three or more estimates about 2,100 companies now. And we have about 1,400 companies with 10 plus estimates. And for a name like Apple, we'll have 1,000 estimates. But I think more importantly, so there's this interesting effect that takes place. For large cap names, the sell side will have 30 or 40 analysts covering a name. But for like a mid or small cap name, you might have seven or ten. The relative difference between 40 and 500 is like it matters, but it doesn't matter. There's totally diminishing returns there. And our data set is far more accurate. 70% of the time our consensus number is going to be more accurate in the street. But really where it matters is the street will have seven or ten for like a mid-cap growth name and we'll have like 60. And that is really where the gold is. And there we're going to be like 75, 80% of the time more accurate.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  3. “I believe it's going to trade at some different multiple then. I multiply my fundamental expectation by the multiple, and that's my stock target price. My alpha is the delta between whatever the market is pricing in in terms of consensus and some kind of terminal multiple. But the problem historically is you don't know what that true market consensus is because the sell side stuff, especially going a year out, is like not representative at all. So they come to our platform and the deal we basically make with everybody is we're going to cannibalize the industry by allowing you for free to see everybody else's data.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  4. “Yeah, so that's the billion dollar question here and why I think my background in behavioral economics is specifically relevant to what we do. So historically, the buy side discretionary guys will call around to each other before an earnings report. And this is known as Darling as the whisper number, right? And then they'll call their equity research sales guy, Goldman and Morgan Stanley, and say, hey, what are you hearing from your buy site clients? And this game is just like, I knew guys before I started this thing that would share Google Docs amongst each other at different funds. And all of this is totally against compliance, by the way, of all these funds. It's certainly not illegal, but it's completely against compliance. You're not supposed to be sharing information outside the firm. But they have to. And the reason they have to is the fundamental premise of fundamental-based trading is I believe that a company is going to earn X over the next year. It trades at some Y multiple now.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  5. “The raw expectations data through our own quantitative research process into factor models so that both discretionary and quantitative managers that don't want to use the raw data can get the direct alpha out of it. And those factor models are relatively shorter term kind of days to weeks kind of models. And there are some that are going to be coming out that are more like earnings yield focused, which are longer, quarterly rebalance type stuff.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  6. “Yeah, the concept is basically that if you crowdsource all these expectations from a broad community of buy side independent, non-professional individuals, industry experts, corporate finance professionals, you get a more diverse data set, less bias, less hurting. You get a larger data set relative to the sell side stuff. And it takes out a lot of those inefficiencies and bias associated with that one. And so we collect specifically EPS and revenue estimates for publicly traded US companies. We also do economic reports, so GDP, CPI, oil inventory, stuff like that. And then we do force rank as well, which I talked about a little bit before. And then what we do with that is we run a bunch of models through it. We overweight certain analysts. We score and rank everybody. And then on the back end, we output all the raw data to institutional clients. We have a big front end data visualization platform, a bunch of emails. And then we turn.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  7. “Of change, our platform has changed, the interface has changed, the heuristics associated with how they make the estimates might have changed. And so you want to see if the same thing's there hold up because if they do, you know that there's some inherent quality of their decision making that is at play instead of just some heuristic that we're affecting negatively or positively. So there's a lot of different ways you can do it. We like now to just go for first half, second half.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  8. “You know, at STMize, we keep it pretty simple with our quant research team and our process, and we have enough data now on the core data set, about five and a half years to just do first half, second half. When we were early on and we wanted to figure this stuff out in 14 when we wrote our first white paper, we did chop it up into quarters, and then we took every other quarter, and then we looked back at the other every other quarter. And that worked fine as well. But with some of these data sets, and I think this is stuff that people need to think about these days in crowdsourcing, the panel changes. It's going to grow. It's going to morph different people, different reasons they're there, different types of people. And so it actually is good to go first half, second half to see if the regressions that were run in the first half. And I'm talking not just about alpha generating models, but our select consensus model. How do we overweight and underweight certain analysts and behaviors?”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  9. “You need to have a hypothesis for why a data set is actually some kind of causality. So we start with that. Then we simply take our time series and we split it into two, or we can divide it up into chunks. Simply, we like to, if you have enough data, you just divide it up into two halves. If you have a 10-year data set, five and five, run the regression on the first five, then run the regression on the second five, and then look at the p-values and the p-values are basically like, does the performance from the first half equal the second half roughly? And if those p-values are good, you know that you have not overfit your strategy in sample and your out-of-sample works. And if you're out of sample works, then you can be pretty sure that going forward, it's actually going to perform well. If you don't run that out of sample and you're just like, wow, look, the regression works on the first five years, let's go put it into production. You have zero clue whether this thing's actually going to hold up at all. And I see on the discretionary side, again, that.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  10. “So, first, you need to start with an ex ante hypothesis for something. We can't just go and say, well, let's run a bunch of regressions and see what works. Because if you don't know why it works, you won't know why it stops working. So I think this is one of the biggest mistakes that I see everybody make and why there are certain products in the market right now for discretionary managers, which I will not name that I don't like because they skip the two biggest steps that I think are really important. And the first is the ex-ante hypothesis. Let's just say you want to see what happens when oil goes up 10%, right? And you just start running regressions across the board to different assets and stuff. And you say, oh, wow, look, if oil goes up 10%, then these things go down or whatever. Well, if you didn't start with a, I think if oil goes up, then these things will go down. You won't know why that happens and why it works. And it'll eventually stop working and you won't get out of it.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  11. “Or even doing the thing that we do on this, we have this app called ForceRank, right? And the whole point is it doesn't matter how you get to the decision of saying on a quarterly basis you believe amongst these twenty stocks we do ten, but let's just say 20 in a specific industry, these 10 will outperform the other 10 and you force rank them in order. Doesn't matter what your fundamental inputs or technical inputs to that decision making is, it's just that you rank them. And if you can rank them correctly, well, then just go along the top five and short the bottom five and you're going to generate alpha, but it's just like that portfolio construction and adherence to a model is so hard for some of these guys because they want to be correct more than they want to make money sometimes. And that causes all sorts of perverse things.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  12. “Most of them are availability heuristic. They're going to operate on whatever information is readily in front of their face the most that day. And they just shouldn't be doing that. And that's the difference between a good quantitative strategy based on science and what some of these guys are doing, which simply isn't working anymore.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  13. “Whether it's cancer. And the students are like 70% hit rate. Why? Right? Because the oncologists who are experts don't use their own damn rubric. And we find this is the exact same way in the discretionary trading world where if you ask any of these guys who run a billion dollars in discretionary long, short money, they will tell you exactly how they're supposed to be making decisions and then they just simply won't follow it. I think firms need to seriously codify the flow of decision making from stock selection to position sizing to market timing to risk management to just the whole thing. And I don't see many firms that have actually codified this very well. I'm actually waiting for somebody to put together a good piece of software and sell it to them to like modify the behavioral heuristics that they operate against because man, I mean I could pick like half a dozen off the top of my head that these guys are just so exposed to.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  14. “I mean, that too, but I think it's more just how do you make decisions? Like, what is your decision flow process? And I like to use this really specific story. It's a very famous behavioral study, and it's in Michael Lewis's new book, which is really good if people haven't read it, The On Doing Project. And the story is basically about a study that Thaler did with a colleague where they give a set of x-rays to these very famous oncologists and then give the same set of x-rays to first-year medical students. And they asked the oncologist, how do you determine whether it's cancer or not? And they give them basically a 10-point rubric of how they determine and very quantitative structure of things. And they take that rubric and they give it to the first year of medical students and they say, tell us whether it's cancer. And then they give the same slides to the oncologists. And the oncologists end up being no better than random at guessing.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  15. “They will look at the out of sample and they'll look at p-values, and the p-values will be really good, but then maybe the last three or six months of the performance of a 10-year track record will be not quite as good. And they'll be like, well, we want to wait a little bit to put something into production. Like, no, you shouldn't do that. So there is some irrationality on their part when they turn things on, when they turn things off. But really, it's the behavioral aspect on the discretionary side is probably the most important thing right now.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  16. “Yeah, I mean, I think the informational edge is becoming more arbitraged these days. Although it's interesting with more information out there, new data sets like ours, new data sets all across the universe of different types, and we're at a new inflection where you need to be more aggressive about arbitraging that informational edge because, I mean, look, Rentech buys everything. And so if you're not buying some things at least, you're going to not perform well relative to them. The analytical part, there are not enough quants out there to do the research simply. Like we just literally don't have enough of them out there, especially when the discretionary world was attempting to hire them now as well. So yeah, you can have an analytical edge by having a really good team. And then I think the behavioral one is the most important one, especially for the discretionary guys. Quants, we do see some irrationality on their part sometimes where they'll test something.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  17. “So the manager, so this was crazy. The manager at the fund went completely to cash about halfway down in halfway down the crash in 08. And we had made a bunch of money coming out of that turn on the short side. He went completely to cash and I watched him trade index futures for the next six months. Incredibly well too, like by hand, just by feel. And he didn't catch. So we had that the next half of that first big drop and he caught a decent portion of that. Then he was out. He didn't catch the turn because he was completely out. And then he caught the move back up. And then he caught the move back down into March. And then unfortunately shot the fun down. And my mentor eventually passed away from skin cancer shortly after that. And it was just crazy watching him do that in the twilight of his life, just operating so well.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  18. “So at the turn in late 07, when momentum all stopped working because we were coming up the crest of what was going on, everything stopped working for six months. And then it all started working really well again.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  19. “What percentage of the time does the company beat or miss? And then just very simple linear regression models of like what happens if a company beats four quarters in a row by more than a normalized 10%. The next six months, the stock is going to outperform on a momentum basis. Like it absolutely will. And we've known this for a very long time. We know that companies which beat their consensus numbers by a significant amount will see post-earnings drift and you can collect residual return in the three to five days afterwards very easily. We know that revisions are highly correlated.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  20. “So, a lot of the stuff that we did was not necessarily cutting edge. It was just we did it well. And these strategies had been around for, I don't know, the academic research had probably been done 10, 15 years earlier. And so the basis of this is that the cell site analysts are inefficient in how they produce their estimates, largely coming about because of institutional biases, corporate access, investment banking pressures. They also tend to not update their estimates in the last couple weeks before the earnings report, partially because they're lazy, partially just because compliance is really hard to get new research reports out the door. And they also tend to love to allow the companies to beat their estimates because they want to get on the earnings call and be like, ah, great quarter, guys. But like, nobody pays attention to the fact that they move their estimates down 15% in the last five or six weeks. So you can see all of the patterns in this data and the average movement in estimates up or down.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  21. “And what politics is, which is not science, and the not science part kind of frustrated me. And so I started my career at this hedge fund, Geller Capital up in White Plains doing the reverse commute from New York every day, and fell in love with it, you know, just fell in love with the process. And then from there, and we were doing exactly that. We were doing analyst testimony revision models, earnings acceleration, history surprise, beat rates. We were basically attempting to arbitrage the inefficiency in that cell side analyst estimate data set.”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source

  22. “Yeah, so I actually have my educational background is in behavioral economics and war theory. I actually thought I was going to Rand Corp, CIA, like State Department that route. And it was interesting. I got an opportunity to do an internship at a quantitative hedge fund between my sophomore and junior years and loved it. And it was incredible. And at the end of the summer, basically I stayed in New York instead of going back to school and finished up at night at Hunter College here. And that world was so interesting to me mostly because it's all just numbers and letters, right? You don't have to deal with the irrationality of people. You just get to deal with like there's a variable and it's either correlated or it's not. And if you can find that correlation and you backtest it and the out of sample works and the p-values are good, like you have a strategy and you can make money and it's all very kind of straightforward. Look, it's science and it's the difference between science and”

    2017-06-13 · Invest Like the Best · Leigh Drogen - Quant vs Traditional Investors and How Alphas Become Betas - [Invest Like the Best, EP.41] · IDENTIFIED FROM THE TRANSCRIPT · source