Hedge funds have been giving vast sums to academia this last
year. In February Ken Griffin, founder of Chicagobased
hedge fund firm Citadel, donated $150 million to Harvard
College, the biggest single gift to the college ever. Michael
Hintze, head of Londonheadquartered hedge fund firm CQS, donated £1.5 million ($2.5
million) to Oxford University, to help search the universe for
invisible dark matter and dark energy. These followed
Jerseybased hedge fund firm Brevan Howards £20.1 million
donation to Imperial College Business School last year and the
£4.5m to Oxford Universitys Saïd Business
School from Bill Ackman, the activist investor CEO of New York
hedge fund firm Pershing Square Capital Management.
University coffers seem to be awash with hedge fund money.
But more recently there has been a new trend to harness
academic research with investment returns.
In February Capital Fund Management (CFM), one of
Frances largest hedge fund firms, which manages $4.5
billion, announced a formal partnership with Imperial College
London to create the CFM-Imperial Institute of Quantitative
Finance, which will explore new directions in the modeling of
risks in financial markets. To promote academic inquiry into
finance, CFM is funding a postdoctoral fellowship, stipends for
doctorate-level students and a program for visiting
international scholars, as well as a series of seminars and
The project is a solid fit for CFM, the company of which
physicist Jean-Philippe Bouchaud is chair, a leading figure
among quantitative hedge fund firms. Finance is as
important for humans as nuclear science and pharmaceutical
research, says Bouchaud. Academia and finance are
two separate things. But the gap is getting narrower; this
tie-up is proof of that. Its time to stop warring and get
the best of both insights.
As well as overseeing CFM, Bouchaud teaches physics at the
Ecole Polytechnique in Paris and has published several books
and more than 250 scientific papers on physics and finance. He
is also a well-known proponent of econophysics, the study of
economics using statistical theories and methods developed by
physicists. The firms teaching connections have helped
CFM to bring 40 scientists on staff out of its 140 employees,
many of whom have come from the ranks of higher education.
The urge to marry finance and academia is nothing new.
Economics has leaned on physics for a variety of model
equations, such as for earthquake prediction and chaos theory.
Black-Scholes-Merton option pricing formula,which won Myron
Scholes and Robert Merton the 1997 Nobel Memorial Prize in
Economic Sciences, shares its derivation with the heat equation
in physics. (The formula was first published in a 1973 paper
and was co-created by Fischer Black, who died in 1995 and was
thus ineligible for the Nobel.)
But the formalization of recent partnership suggests a
direct route to harnessing science for investment. CFMs
initiative is the latest tie-up of hedge fund firm and science.
Man Group, the worlds largest
publicly traded hedge fund, pledged £13.75 million ($27.5
million using 2007 rates) in 2007 to sponsor the Oxford-Man
Institute (OMI) of Quantitative Finance for a five-year period.
Last year Man Group extended this partnership until 2018. East
Setauket, New Yorkbased hedge fund firm Renaissance
Technologies is known for specifically seeking out job
candidates with science backgrounds for its quantitative
research positions. Longtime quant James Simons, who founded
the firm in 1982, has donated hundreds of millions of dollars
to institutions of higher learning and research, including $60
million to the namesake Simons Institute for the Theory of
Computing at the University of California, Berkeley, and those
on his resident Long Island, including $13 million to the
Brookhaven National Laboratory and $85 million to the State
University of New York at Stony Brook, where he is chair
emeritus of the board of trustees.
For Man Group, the OMI is a way to access and incubate top
talent as well as to procure relevant research.
We have a constant need across Man for high-quality
people, so having a road into one of the top universities is
very helpful, says Tim Wong, executive chair of
Mans AHL fund, which relies on computer algorithms to
spot profitable trends. You have the chance to get to
know the candidates on a much deeper level before you hire
them. You can see how they work, and they have the chance to
see how we work too. It also gives us links into Oxfords
large network across the world.
The application of theoretical physics to what at times can
appear to be the gravity-defying properties of money is one
thing. But where does theory end and practice begin? A
brilliant quantitative mind is not necessarily an alpha
generator. Last year hedge fund manager George Soros argued
that economics had tried to be a hard science like physics but
ignored that society and the thinking of human beings entered
into the course of events, introducing unpredictability into
Mans AHL fund has suffered three straight years of
losses: not exactly the shining display of science working for
There have, of course, been performance challenges in the
trend-following space more broadly, but the industry is rapidly
evolving and diversifying, says Wong. OMI plays a
key role in this commitment.
As evidenced by the failure of models to deal with the
financial crisis, banks have had a rough go of incorporating
quant models in their strategies but havent always had
the patience to see them through. Twenty years ago, we
were stunned by seeing that banks considered a week to be
long-term research, says Bouchaud. You have no time
to research in a week you wont get answers.
Innovation needs long-term research.
Even Isaac Newton lost a bundle investing in the speculative
South Sea bubble in the 18th century, explaining later, I
can calculate the movement of stars, but not the madness of
men. Berkshire Hathaway chair and CEO Warren Buffett
quipped in his 2005 letter to shareholders that if
Newton had not been traumatized by this loss, Sir Isaac
might well have gone on to discover the Fourth Law of Motion:
as a whole, returns decrease as motion increases.
A school of thought holds that far from being physical
systems, markets are based on informational asymmetry and
become difficult to model because there is always something
looking to disrupt order to gain an informational advantage
that is, the traders edge. In a 2010
paper titled Warning: Physics Envy May Be Hazardous to Your
Wealth!, Massachusetts Institute of Technology
academics Andrew Lo and Mark Mueller put it succinctly,
Attempts to understand uncertainty are mere illusions;
there is only suffering.
Bouchaud insists that mathematical models are not the only
factor in trading success. He has criticized the Efficient
Market Hypothesis, the proponent of which, University of
Chicago economist Eugene Fama, and avowed critic, Yale
Robert Shiller, jointly won the 2013 Nobel Memorial Prize
in Economic Sciences (Chicago economist Lars Peter Hansen also
shared the prize). Bouchaud is also not a fan of the
BlackScholes-Merton model, which he believes leads to a
systematic underestimation of risk in options trading.
We are doing a little bit of the math that is needed.
But most of the time you dont need math, he says.
You need intuition and an understanding of what the
numbers mean and how to pull them together. There is a huge
difference between understanding something on an academic level
and looking at implementing it.
So to where does this all lead? Could we really see the next
generation of hedge fund firms being staffed by wonks in ironic
T-shirts splashed with mathematically themed puns? Despite the
riches on offer, the marriage between science and
hedge funds isnt necessarily one from the fairy
The sentiment among many academics is that finance has
kidnapped scientists away from their ivory towers. In a study
for the Bank for International Settlements published in 2012,
BIS economists Stephen Cecchetti and Enisse Kharroubi argue
that the lure of riches during times of plenty literally
bids rocket scientists away from the satellite industry. The
result is that erstwhile scientists, people who in another age
dreamt of curing cancer or flying to Mars, today dream of
becoming hedge fund managers.
Others disagree, stating that the best in science will
generally stay in academia and not jump ship to finance. James
Owen Weatherall, assistant professor of logic and philosophy of
science at the University of California, Irvine, argues in his
book The Physics of Wall Street, published in
February, that mathematical models are the remedy, not the
ailment. One of the cases in point in his book is Simonss
The vast majority of research scientists have gone
into their fields because they want to do research. They have
made great sacrifices, both personal and financial, to be
successful in academia, Weatherall says in an interview.
The Ph.D.s who move to finance tend to be the ones who
decide that a good salary on Wall Street, or elsewhere in
industry, is better than a progression of postdocs and no job
security, or a teaching position with no research