Finance in the lab is a lot different from finance on the factory floor. Marcos López de Prado, an executive at fixed-income specialist Guggenheim Partners, knows both venues well. He serves on the editorial board of the Journal of Portfolio Management — Institutional Investor’s (much brainier) sister publication — and in the latest issue heartily critiques how universities are teaching finance.
In an “Invited Editorial Comment,” López de Prado takes higher finance education and academic research to task for operating in a vacuum outside the pragmatic world of industry. Holder of a couple of PhDs himself (financial economics and mathematical finance, both summa cum laude), López de Prado believes the discipline and its practitioners face irrelevancy without implementing major changes. In fact, asset managers are already feverishly competing with one another for ivory tower–raised mathematicians, engineers, and scholars of physics and statistics.
“The presence of financial academia is fading, something that was unthinkable 10 years ago,” writes López de Prado. “The edge is not yet another reincarnation of the capital asset pricing model,” he says. It’s in analyzing untapped data sources, such as satellite images of crops and tunnel traffic, via techniques learned outside the classroom. FinTech, big data, machine learning, and even quantum computing will render formal finance education even more irrelevant, he believes.
Like any savvy executive, having identified a major problem, López de Prado has an answer. Universities should institute apprenticeships, he suggests, so students can gain the real-life practice they need. Students pursuing finance degrees at the University of Chicago or Wharton School of Business may have to dirty their hands in the Wall Street weeds to compete with the graduates MIT and Caltech are churning out. Besides, he writes, many of those quant-nerds are already doing a fine job running hedge funds.
López de Prado, who is also a research affiliate at the Lawrence Berkeley National Laboratory, draws inspiration from the pedagogy behind Germany’s highly skilled engineers. Engineers are often educated at local colleges — some even with the low-brow word technische in their names! — ranked far behind lofty U.S. institutions, where yearly tuition roughly equates to the yearly median household income. Yet technical universities’ curricula include messy factory work during a student’s tenure. Similar apprenticeships could save finance education, argues López de Prado, whom the Spanish government named the best graduate student in the country in 1999. As it is, anybody who wants to get the prestigious Chartered Financial Analyst designation needs four years of financial work experience.
Finance is not a rigorous science on par with physics and biology, where experiments can and must be repeated and independently verified. Markets change with regulations, investors’ behavior, and demographics, and the research tends to be substandard, according to the much-published López de Prado. “Most journals in finance are merely tenure-track vehicles, in which aspiring professors publish articles not in the hope of having their theories tested (which would require an investment firm), but to simply check the mandatory boxes in their job applications,” he writes, biting at the hand that feeds. Academics who have no applied experience complicate that problem.
“Half of the books about finance are written by authors who have not practiced what they teach,” he says in an interview. “They contain extremely elegant mathematics that describe a world that does not exist. The other half of the books are written by authors who offer explanations absent of any academic theory. They misuse mathematical tools to describe actual observations.”
López de Prado is a creature of both, the Venn diagram where PhDs meet profit margins. And he’s far from the first to discover it. “Firms like Renaissance, D.E. Shaw, and PDT have delivered returns of 10 to 30 percent every year,” says another academic who declined to be named. “There’s no academic model that can deliver such returns. That’s industrial research.”