Principles of Quantitative Fund management

As the semester comes to an end and one is able to catch up on the reading sorely missed under the strain of coursework, I have found and put together a few gems (in my opinion anyway), regarding the underlying strategies or principles when looking at quantitatively managing money.

1. Diversification - the process, made popular by Harry Markowitz,  investing in multiple asset classes, seemingly to reduce risk. While this mitigates non-systematic risk, one is still always exposed to market risk (Beta).

2. Efficient Market Hypothesis - made popular by Eugene Fama at the university of Chicago, a share price is is said to be a reflection of information known about the share and the price can take 3 forms:
    i) Strong Form  Efficiency - where ALL info regarding the share is priced in.
   ii)Semi-Strong Form Efficiency - where all PUBLIC info regarding the share is priced in                                                                         iii)Weak form Efficiency - where the share price is just a reflection of previous prices. 

3. Mean/Variance - arguably the two most important descriptive statistics, managers always want to be able to calculate the expected return (mean), as well as how volatile the returns can be (variance). The more volatile the asset is, the higher risk it poses, which leads us to the final principle...

4. Risk/Return Trade Off - while this makes perfect sense and people have been trading these two variables off for years without officially naming it, The Capital Asset Pricing Model (CAPM) model was introduced by Jack Treynor, William Sharpe, John Lintner and Jan Mossin independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory, introduced the CAPM to show returns should be compensated for a given level of risk. 


A Simple calculation ensues, 

where

•  is the expected return on the capital asset
•  is the risk-free rate of interest such as interest arising from US government bonds
•  (Beta - market risk)
•  is the expected return of the market
•  is also known as the risk premium

The Young Economist