Quantitative methods have traditionally been associated with benchmark replication in passive management. As firms apply quantitative methods to active management on a large scale, what, if anything, is changing in the modeling approach?
Passive management tries to replicate a benchmark in the most economic way (i.e., using a smaller number of stocks and minimizing transaction costs). Active management, on the other hand, tries to find subsets of the benchmark that beat the benchmark or that produce positive returns in the absolute. Passive management is often based on sampling techniques that can replicate but not beat the benchmark; what they do is bring down the management costs; active management is based on predictors that allow to identify alpha sources. Active strategies typically accept higher turnover than passive strategies. It is often said that models do not work because the future does not repeat the past. Should the future not repeat the past, no knowledge is possible. That holds for qualitative and quantitative analysis alike. All knowledge is based on the existence of regularities. The problem is: Just what repeats what? Clearly, the future does not repeat the past in a nave sense. Example: if the price
