The Quants by Scott Patterson

Author:Scott Patterson
Language: eng
Format: mobi, epub
ISBN: 9780307453396
Publisher: Crown Publishing Group
Published: 2010-02-03T15:00:00+00:00

ASNESS

On November 13, 1998, shares of a little-known company called Theglobe.com Inc. debuted on the Nasdaq Stock Market at $9 apiece. Founders of the Web-based social networking site were expecting a strong reaction.

The frenzy that greeted the IPO defied all expectations and common sense. The stock surged like a freight train, hitting $97 at one point that day. Theglobe.com, formed by Cornell students Stephan Paternot and Todd Krizelman, was, for a brief moment, the most successful IPO in history.

A few days earlier, EarthWeb Inc., perhaps feeling the force of gravity, merely tripled in its IPO. Investors gobbled up EarthWeb’s shares despite the following warning in its prospectus: “The company anticipates that it will continue to incur net losses for the foreseeable future.”

A few months before the dot-com IPO frenzy began, LTCM had collapsed. Alan Greenspan and the Federal Reserve swept in, orchestrating a bailout. Greenspan also slashed interest rates to salve the wounds to the financial system left by LTCM’s implosion and flood the system with liquidity. The easy money added fuel to the smoldering Internet fires, which were soon raging and pushing the tech-laden Nasdaq to all-time highs on an almost daily basis.

While minting instant millionaires among dot-com pioneers, this series of unlikely events proved a disaster for AQR, which had started trading in August 1998. Asness’s strategy involved investing in cheap companies with a low price-to-book-value ratio, while betting against companies his models deemed expensive. In 1999, this was the worst possible strategy in the world. Expensive stocks—dot-com babies with no earnings and lots of hot air—surged insanely. Cheap stocks, sleepy financial companies such as Bank of America, and steady-as-she-goes automakers such as Ford and GM were stuck, left in the blazing wake of their futuristic New Economy betters.

AQR and its Goldman golden boys were hammered mercilessly, losing 35 percent in their first twenty months. In August 1999, in the middle of the free fall, Asness married Laurel Fraser, whom he’d met at Goldman, where she was an administrative assistant in the bond division. As AQR’s fortunes plummeted, he complained bitterly to her about the insanity of the market. What is wrong with these people? They are so monumentally stupid. Their stupidity is killing me.

Asness believed his strategy worked because people made mistakes about value and momentum. Eventually they wised up, pushing markets back into equilibrium—the Truth was restored. He made money on the gap between their irrationality and the time it took them to wise up.

Now investors were acting far more stupidly and self-destructively than he could possibly have imagined.

“I thought you made money because people make mistakes,” his wife chided him. “But when the mistakes are too big, your strategy doesn’t work. You want this Goldilocks story of just the right irrationality.”

Asness realized she was right. His Chicago School training about efficient markets had blinded him to the wilder side of human behavior. It was a lesson he’d remember in the future: People could act far more irrationally than he’d realized, and he had better be ready for it.

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