They may also play version of martingale strategy where they pay for higher returns now with increased losses if some rare event in the future happens. This is how very successful hedge funds can beat the market for decades. There is hidden risk somewhere and you better jump off before it is realized.

No, luck cannot be the explanation for what these quant funds do. These funds are run by mathematicians. People with PhD's in probability and physics. They are not being fooled by randomness. They are right, and they are right consistently.

However, they are also at least generally, not making traditional 'investing' decisions. They are making statistical arbitrage bets - they are looking for instances where mispricing exists in the market, and they can make a guaranteed (statistically) profit by buying and selling statistically equivalent securities at different prices. The classical simple example is pairs trading: you notice that coke is always worth 10% more than pepsi, so when you see coke trading at 15% more than pepsi, you short coke and buy pepsi, betting that the gap will close to its traditional norm. Now, what they are doing is obviously substantially more complex and rigorous than that, but that is its flavor.

Wow, this is the height of hubris. Of course luck can play a factor. There's no law of the universe that a correlation you observe over the past century of human activity is going to hold indefinitely. Obviously some quant funds have better models than others and it's not wrong to attribute that to intelligence and skill, but they absolutely can have the rug pulled out from under them by changing market conditions make no mistake.

They trade very, very often. You can be lucky if you buy a couple of stocks and wait around a few years. Someone I know had parents who bought Nokia in the 1980s and sat on it until the mid 200s. That's luck.

You can guess a coin flip 5 times in a row. A few people out of a hundred will do so.

But you cannot get significantly over 50% correct on millions of coin flips. That's not luck.

First of all, I explicitly said that it's not wrong to attribute winners to skill, but you still feel the need to put my argument in a binary box, very well.

Your mistake is treating each trade as an independent event. But in reality all those trades may share a single methodology which can be invalidated by a single unprecedented market change. Yeah, a fund is a perennial winner until it's not. You can call it being unlucky or you can say they went from being smart to stupid. It doesn't really matter what you call it, the point is past performance is no guarantee of future returns.

>>Your mistake is treating each trade as an independent event.

They largely are.

The people who fall under your criticism are the old school stock pickers. For instance, people who've grown up during the long decline of inflation and rates might have hit a wall over the last few years. A lot of those guys were essentially riding the same wave over multiple trades.

But the kind of trading done in stat arb is largely independent of such long term trends. They change around their positions so often that there's hardly any regime that they are biased towards. High vol? Been long and short. Rates going up/down? Been long and short. Economy? Been long and short.

Sure, there might be some hidden regime that we've yet to hear about, that's possible. But there's quite a difference between the quantitatively astute funds and the other long-lived ones.

Sorry, not drinking your koolaid. Any exploitable "stat arb" will go to zero as it's exploited, or if it grows large it will move the market. There are no statistical axioms which are guaranteed to make you money, because if there were it would change once enough people discovered it. Anyone that's far out enough ahead can find these things for a while, but there's no way the average investor ever gets close to it, they're not exactly cold-calling senior citizens with these amazing opportunities.

That's still using the past to predict the future. There's nothing inherent about coke and Pepsi being 10% apart - so they may have that ratio, until they don't.

I had a conversation with a co worker about this. Its basic probability. Lets assume they make at least 1 trade a day and they have been doing this for the past 25 years. Its a simple binomial probability problem. For them to be correct on that many trades and it to be 'luck' would be a probability in the ~0.00001% range.

You're assuming all trades are the same size and have the same upside (and downside) risk.

How do you distinguish between pure luck and actual skills?

That's the argument from A Random Walk for index funds: even if such skills exist, they're indistinguishable from luck, therefore one can't make an informed choice of active fund.

It's impossible to perfectly distinguish them. Anyone that seemed to be skillful could just be incredibly lucky.

But you can get determine a likelihood that they are lucky by monitoring their performance over a long time / lot of games. It's just that if you are evaluating a whole lot of people looking for a rare skillful person, you need a whole lot more time/games to be sure they aren't lucky than if you just had one person to evaluate.

You cut that sentence short...

"How do you distinguish between pure luck, actual skills, and illegal manipulation?"

I believe his point is that you can't, because "actual skills" need not exist. It might ALL be luck, and outliers will exist. And, their existence doesn't prove anything about luck or the lack of it.

Conversely, if the difference between luck and skill is unknowable, everyone who wins might be skillful. As you said, the existence of winners is not revelatory about the existence of skill.

Related: one can be highly skilled and still lose to someone who is highly lucky.

You should see that your candidates will falter as time passes.

Suppose there are 10 funds with the track record of RenTech. In 10 years, you wouldn't expect them all to be as stellar.

You do more MATHS :D

There are models to model the risks and the potential outcomes.

Believe me, Jim Simons didn't rely on luck. He's a mathematics genius and rather creative. You could say he was lucky in that he sort of pioneered the entire algorithmic trading thing and was well ahead of the curve because of that. It was simply low hanging fruit for a long time before others began to catch on.