Wall Street WARZONE

Proprietary Secrets: How Quants & Behavioral Scientists Make Mega-Billions for Wall Street Insiders

by Paul B Farrell, JD, PhD
| | 4/7/2010

Main Street can’t compete—the awesome Wall Street Machine is already using lucrative consulting contracts, grants, non-disclosure, non-compete and other iron-clad employment agreements to lock up the best’n'brightest talent in behavioral economics, behavioral finance, neuroeconomics, investment psychology, neuro-marketing, physics, computer science and other key areas of the neurosciences working in the leading academic research institutes, think-tanks and business. Wall Street has discovered that this talent can generate huge returns for them in the stock market—for example, with financial innovations like securitizing subprime mortgages, collateralized debt obligations, HFTrading algorithms, etc—while helping Wall Street control the minds of Main Street masses. Wall Street’s War Machine needs a steady stream of new players, new weapons and new strategies in its arsenal, so recruiting has become as important for Wall Street as it is for a major league sports team signing stars.

In the past decade we’ve see a powerful wave come surging through Wall Street, reminding us of the government’s Second World War mobilization. Back then, with incredible speed we brought together the best minds to quickly develop the atomic bomb in the top-secret Manhattan Project, while also retooling American industrial capacity for a major war and recruiting and training a huge army. Similarly, today, Wall Street Machine is in the midst of an enormous recruiting effort to hire the best and brightest quants to develop new psych-ops weapons for Wall Street’s “War to Control the American Investors Mind.” The Wall Street Journal wrote about it in “More Professors are Lured Out of Ivory Tower to Street.” That was the first wave. They were talking about names like Princeton Professor Malkiel, author of Random Walk Down Wall Street, Yale Professor Robert Schiller, Irrational Exuberance, and Wharton Professor Jeremy Siegel, Stocks for the Long Run.

The Journal article’s subtitle made it clear why this trend was rapidly accelerating: “Demand for New Funds Offers a Chance to Test Theories, Make Money.” Noticeably important: They highlighted the lucrative “six-figure payoffs.” And of very special interest, they were working for and paid by Wall Street insiders, not some independent investor advocacy groups. Similarly, last year in a Fortune magazine feature story “The Man Who’s Beaten the Market 15 Years Running,” we read about “Bill Miller’s Brainiacs,” the “deep thinkers” who were helping him continue winning as the portfolio manager of the $11 billion Legg Mason Value Primary Fund. The brainiacs included:

Gregory Burns: Brain imagery technology, Emory University
Laurence Gonzales: Deep Survival: Who Lives, Dies & Why
Norman Johnson: Expert in Problem-Solving & Diversity, Los Alamos
Robert Sapolsky: Biology and Neurology, Standford University
Steven Strogatz: Nonlinear Science Researcher, Cornell University
Duncan Watts: Science of ‘Six Degrees of Separation,’ Columbia Univ.
Elke Weber: Risk & Uncertainty Expert, Columbia Business School
Geoffrey West: Research on Biology and Physics, Santa Fe Institute

Once again: Remember, Miller and Legg Mason were not working with these behavioral finance experts to develop tools that would help America’s 95 million Main Street investors beat the market. Quite the opposite, portfolio managers are now hiring behavioral experts so they can outwit, beat and dominate Main Street investors. In short, the behavioral sciences are now being used against us, to manipulate and control America’s 95 million individual investors.

Best & brightest contracted to manipulate investor’s mind

These experts were on board to give Miller’s fund an edge in three fronts of its ongoing war: First, in competing in the stock market against the other roughly 7,000 equity funds. Second; in finding ways to increase its company profits (and his personal income) which come directly off the top of the investors gross returns. And third; in doing whatever’s necessary to hold onto Legg Mason’s own investors, by manipulating and control them, as well as attracting new investors. Remember the obvious, the more assets under management the more fees are generated, the bigger a pay check to the fund managers. Ironically, in the 2008 meltdown their fund tumbled much as its competition.

Another benchmark of the Wall Street Machine’s aggressive efforts to lock up the best and the brightest minds in its war to control the investors mind was detailed in an early 2007 BusinessWeek special report by Anthony Bianco, “Outsmarting the Market: Behind Barclays’ quest to build a world-class team of academic quants that systematically do the impossible.” Wall Street firms are competing with one and other to aggressively lock up the best minds in an effort to dominate the markets and individual investors. BusinessWeek says:

“It came as no great surprise that Richard G. Sloan took a leave from his tenured position at the University of Michigan’s business school last summer to join an investment firm. Wall Street has stepped up its hiring of academics in recent years, and the 42-year-old Sloan is one of accounting’s bona fide stars. “But Sloan’s explanation of why he left academia for Barclays Global Investors (BGI) is startling. ‘I just felt that BGI was getting ahead of me,’ he says. ‘I came here because this is where the leading edge in my area of research is now.’ “As one of more than 100 PhDs in BGI’s employ, Sloan reinforces a cadre of highly credentialed brainpower that no university finance or economics department in the land can match … enthroning it above State Street, Fidelity and Vanguard as America‘s largest money manager.”

The best and the brightest brains want to be where the action (and the money) is, and it isn’t in some philanthropic or government institution developing tools to help Main Street investors beat Legg Mason, Fidelity or the day-trading market on Ameritrade and E*Trade. Big money also has a big incentive: They will make money for themselves by helping Wall Street’s War Machine gain more power and increase its revenues. So, as with Malkiel, Schiller and Siegel, a new generation of Sloans, all the leading behaviorists and quants in America are attracted to BGI and all the other Wall Street competitors playing these new psychological war games, because this really is the new frontier, for talent and big bucks.

Main Street investors are totally outgunned, cannot win

Whether it’s BGI, Legg Mason or some other member of Wall Street’s War Machine, BusinessWeek says a “deep look into the workings of the planet’s largest quant shop abounds with informative lessons for the average investor,” and it adds up to a very simple bottom line for Main Street:

“This simple, humbling imperative: Get thee to an index fund. Now. You and I can no more hope to do what BGI does than we can to rival such famously heroic stock-picking personalities as Warren Buffett and Peter Lynch. Quant investing BGI-style requires fluency in applied mathematics as well as access to the prodigious computing power needed to continuously crunch the numbers for 10,000 stocks and 2,500 debt issues and execute thousands of trades a day. With 2,640 employees spread among 11 offices around the world, BGI is the largest quant manager by a wide margin … what chance do the rest of us have to top the averages?”

This is one ‘David versus Goliath” battle that the little guy is guaranteed to lose—if he tries to fight by his opponents rules. Goliath has home field advantage, fixes the odds, controls the tables and runs the casinos, and as you can see from this portrait of GBI, he is just one of many Goliaths in the game.

Airtight contracts keep new research as trade secrets

Moreover, BGI has a clear advantage, it “uses its connections at the top universities to get a look at promising academic research before it starts to circulate.” For example, they hired Sloan after developing a relationship over a long eleven-year courtship. “Like other quants, BGI regards its investment signals as trade secrets and guards them accordingly. Here, the traditional academic imperative of publish or perish has been turned on its head: If you publish (or otherwise spill the beans), you will perish.” So all of Wall Street contracts in effect silence the quants in order to protect their proprietary trade secrets for the sole use of the Barclays, Legg Masons or any other Wall Street money managers who pay top dollar for their secrets, strategies, weapons and talents.

Sorry, you won’t see ‘em coming—until it’s too late!

And as you might guess, the vast majority of Main Street investors (as well as competing Wall Street insiders!) will never know what’s really going on behind the walls of secrecy surrounding BGI or any other quant operations. Their code of secrecy is harder to crack than the Mafia’s or CIA‘s.

My image of this kind of extreme secrecy comes from the final scene in Stephen Spielberg’s original Raiders of the Lost Ark. After the sacred “Ark of the Covenant” is finally extracted from the Nazis in an Egyptian desert and sent to the Pentagon, it is simply hidden in a locked box, taken to a secret underground warehouse and stored with other locked boxes, another cold case—and as the camera slowly pans back, you see a vast endless dimly-light chamber filled with tens of thousand of other sealed boxes piled high, one on top of the other. All left alone. Similarly, today’s investors will never see the quant’s new weapons coming, until it’s too late, thanks to non-disclosure contracts. But investors will surly feel their impact when the weapons come cruising silently under the radar from behind the wall of secrecy protecting Wall Street’s War Machine.

FirstPubDate: Nov’06

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