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Now a matter of degrees
Julianne Dowling
Just as Professor Richard Florida developed the idea of a creative class, the influx of academia into money management and banking industry research would lead one to think there’s also a smart class – and it’s alive and well in the finance industry.
In the US, some of the top fund and money managers are former and current finance professors (think of Fisher Black and the principals of Dimensional Fund Advisers and Mellon Capital Management). The newest wave of finance theory – behavioural finance – has also been academically inspired.
Professor Bruce Grundy, the Ian Potter Professor of Finance at Melbourne University, is currently visiting Wharton at the University of Pennsylvania in the US, as well as having taught at Stanford. He points out that the interface of academia and money management is not a new phenomenon, especially in the US.
The need for credentials
While that interface is less visible in Australia, the relationships are expanding. And as more finance professors discover the power of business, management teams and boards need to think about how to respond to this sophisticated level of input and, in doing so, broaden their horizons.
Professor Grundy suggests that the new breed of leaders working with finance academia will need detailed quantitative skills. “They have to be able to say ‘you’ve shown me a strategy’s average profitability and the variability of those profits’. I have to know if there’s an underlying economic force or simply chance, because I need to understand the risks inherent in that strategy.”
In order to harness this resource, leaders themselves are going to be better credentialed and better able to understand research, because it’s not uncommon that at a certain point and age, a senior academic will wake up one day and want to join “the main game in town”.
“In the life cycle of an academic, they will come to attack more applied problems in their research, and then they tend to look at the applications and find that sooner or later the only financially rewarding game in town is working with a firm, [and since] firms can’t develop the human capital in-house, they will look outside,” says Grundy.
Also, as banks need to implement more complex models of value-at-risk, they’re forced to go to skilled mathematicians and, says Grundy, it’s much more common to see professors working in the highly quantitative fields of finance.
“In the top finance schools in the world, at least half the full professors are also successful in money management. Within Australia, maybe it hasn’t been as common, and that is in part a reflection that the money management industry hasn’t understood the importance of being at the forefront of research.” However, that’s all changing.
Applying theory to business
Over at the big end of town, banks, funds and investment houses are realising that an academic can bring more to the equation.
There’s also a push by professors to set up their own outfits based on their applied research skills. People like Associate Professor Neville Hathaway, who joined County and still teaches at Melbourne Business School, now runs his own applied research house with Bob Officer, professor of finance at the business school and another highly valued practitioner.
And pathfinders such as Professor Dodd, now at ABN Amro, led the transition of professors to business when he first stepped into the investment banking world via Whitlam Turnbull in the late 1980s.
One discussed virtue of these supernormal types is their ability to devote themselves long-term to a deep problem.
“In business, you have to respond to deadlines, but in academia you can think more deeply and at length about a problem. Business needs people who can get beyond the surface buzzwords of the day to the enduring economic forces, and who are patient and skilled teachers capable of explaining how to use their insight,” says Professor Grundy.
Dr Ron Bewley, Commsec’s gregarious head of quantitative research, is used to thinking about problems. As a former professor of econometrics at the University of NSW, he has previously consulted in a variety of areas, including expert witness work in cases and tribunals (including the landmark case involving Australian Meat Holdings – a first to use econometrics in evidence). He also acted in a number of cases before the Prices Surveillance Authority, such as the CD prices debate lasting some eight years.
Econometrics provides methodologies for bringing together statistics, mathematics, computer programming and economics to draw conclusions about business and government policy decisions. It is widely used in general pricing decisions and reforms.
For example, Bewley’s work on a corporate bond yield curve model, now known as CBASpectrum, is a benchmark in the energy industry after a decision made by the Australian Competition and Consumer Commission.
Econometrics in practice
Bewley says an example of the early application of econometrics to pricing was the work done by 2004 Nobel Laureate Clive Granger during the 1960s. Granger did experimental work on pricing and store placement in supermarkets. “Clive’s work was a breakthrough on the various price points. Now, you can do it by scanners.
“Econometrics could only realistically be used by business with the advent of personal computers in the 1990s. Before that, you only had mainframes and needed experts to do the job. Now, nearly everybody has the software and the skills to do at least basic quantitative applications. As a result, there’s a growing demand for these ‘quant’ research skills to find new ways to store, analyse and interpret data,” Bewley says.
At Combank, Bewley’s team is responsible for advising institutions on equities and credit data. The team also works within the bank on modelling options price data, portfolio construction and risk management, as well as crunching the numbers for the retail market on retirement strategies, asset allocation, property prices and margin lending.
“As an academic, you may have had a better working situation with total freedom on what to research; in corporates, it’s about teams and fitting in. But surprisingly, it’s far more competitive in academia than business. One person’s success can mean another’s failure when you’re vying for the same pool of funding.”
Bewley was previously a consultant for financial institutions before Commsec’s John Beggs hired him; Beggs is also a former academic, and saw a good opportunity to build a team specialising in ‘commercial’ econometrics.
In hiring researchers for his team, Bewley looks for creativity, intuition and team spirit as well as expertise. “It’s not sufficient for someone to just have state of the art methods. Knowing that the problem is more important than the technique matters. And then the researcher needs to explain their skills at the appropriate level for the customer.”
Professor Grundy agrees: “The person who can do the advanced research will intuitively know that it’s an interesting problem and can look at the data in a certain way – that’s a pre-requisite skill for being the complete academic researcher, and is most valuable in the money industry.”
From corporate to classroom
The flip side of the academia interface is when a corporate official signs up to a university teaching staff.
Andrew Rothery has pioneered the management buyout market, and has written a definitive text on the topic. As a director and partner in private equity group Archer Capital, he’s been involved in the buyouts of Tasman Building Products, Repco, John West and, more recently, EMECO.
Rothery was recently invited to become an adjunct Professor of the School of Banking and Finance in the Faculty of Commerce & Economics at the University of NSW. “From our perspective, it allows us to tap into research database and wave the flag with the teaching body and the other constituents, as well as being in contact with some smart people.
“In those quantitative areas of financial services, such as capital markets and traded financial products like options and derivatives, there is definitely a place for theoreticians who can offer value with new ideas about risk management and pricing. But in the less quantitative areas like ours, the opportunities may be fewer.”
Rothery believes time pressures and the short-termism, which he says comes naturally to financial services, may be hard to justify considering “the time and resources required to think deeply about every nuance and detail”.
But competitive advantage flows to those who do the hard thinking. “To the extent that you’re injecting good teachers into the workplace, you can often transmit ideas better. They may be able to better communicate the value of that intellectual property,” he adds.
David Knox, who recently joined Mercer Human Resources Consulting, is a former Professor of Actuarial Studies at Melbourne University and has been involved in the industry’s ongoing education. He has helped organisations like the Association of Superannuation Funds of Australia develop their course at Macquarie University.
He also believes a larger company must have a highly skilled research and development group, and that group “needs to prod and push to stay ahead of the game for the long-term benefit of the company”.
He points out sectors, such as the mining industry, have a longer view on their exploration. In the financial services sector, it may appear to be a short-term focus, but much of the development of product and relationships have a long-term aspect, whether it’s a bank or a superannuation fund.
“You’re looking at products which need to be sustainable over the longer term,” he says.
Commercial realities
Do numbers speak for themselves at all times? And can system dynamics over-ride the ability to model every situation?
Rothery thinks academics sometimes need assistance understanding the subtler realities of the commercial situation they’re studying. For example, it’s easy to discount the role of financial incentives as a key driver of human behaviour.
“Academics can look at data and develop a hypothesis, and then run a series of tests to prove or disprove the hypothesis. But, in doing so, there may be less obvious factors that have driven the data in the first place. So I think good commercial sense can help academics develop the hypothesis to be tested.”
21 July 2005
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