From the May 2007 issue of Research Magazine • Subscribe!

Method to Her Math

Getting an advanced degree in mathematics has become a pretty common path to Wall Street, where math geniuses routinely labor over proprietary trading models, sophisticated derivatives tools and other rocket science products. Leila Heckman says that she gets plenty of resumes from mathematicians hoping to work for Bear Stearns.

But when Heckman was getting her Ph.D. in statistics and operations research from Polytechnic University in 1981, she expected to do what other mathematicians were typically trained to do at the time -- teach. Even though she promptly went to work for Citibank, there was considerable serendipity in the way she got into international asset management. Her job for most of the 1980s was in the credit department of the Bankcard Division, weeding out potential deadbeats.

Then, after getting into investment banking, she heard someone say something about the Bundesbank, the German central bank, cutting its interest rates, which would in turn translate into a rally in the German stock market. Her rigorous mathematical training suggested to her that she should try to quantify such loose talk and to try to determine which variables impacted market performance. Such quantitative market research was at its pioneering stage at the time, but this is what she has been doing for the past 14 years, 10 of which were spent at Salomon Smith Barney.

Active Management

Eventually, her work led to the creation of Active Country Equity -- EAFE Plus, a highly quantitative asset allocation model based on the EAFE benchmark for non-U.S. stocks developed by Morgan Stanley Capital International and covering 21 developed equity markets in Europe, Australasia and the Far East.

Heckman's model perfects the EAFE index by including 12 emerging markets and weighs different markets based on five key performance factors -- valuation, growth, risk, interest rates and momentum. At a time when index tracking has become all the rage, Heckman remains a believer in active asset management. Since its introduction in February 2006 to the end of 2006, EAFE Plus' net returns outperformed MSCI EAFE 21.2 percent to 19 percent. Hypothetical performance in 2002-2005 also shows consistently higher results than the EAFE benchmark.

Heckman describes the model succinctly and precisely, like a true mathematician. But her responsibilities now include marketing the product in the brokerage community, not just conducting research. After leaving Smith Barney in 2002 and prior to joining Bear Stearns in 2005, she and her team set up an independent research operation. Although it is now part of Bear Stearns Asset Management, Heckman Global Advisors retains its brand name and is now managing money based on its model. Its long-only equity portfolio gets its alpha from overweighting or underweighting equity markets around the world; its products are distributed through a variety of channels to institutional investors and high-net-worth individuals.

Looking at a wide range of international markets has become indispensable for any sophisticated investor, says Heckman. She cites several considerations, in addition to portfolio diversification provisions. First of all, while around half of global equity market capitalization is comprised of U.S. stocks, the number of international companies comprising key market indices, such as the Morgan Stanley World Index, is nearly twice as large. Investors who shun foreign markets exclude themselves from a crucial universe of companies.

Second, U.S. companies simply don't provide exposure to the same variety of industries and sectors that foreign companies do. Commodities and the mining industry are one obvious example, but with outsourcing of goods and services to lower labor-cost regions, sectors dominated by foreign players now also includes textiles, high-tech and, increasingly, manufacturing, says Heckman.

Finally, GDP growth in emerging economies is expected to surpass 5 percent this year, while developed economies will average slightly over 2 percent. In studies done by her group going back a couple of decades, there was never a year in which the United States was the strongest performing stock market. However, while greater returns in emerging markets typically go hand in hand with greater volatility, in the case of EAFE Plus risk is mitigated by the inclusion of 20 more stable developed equity markets.

Country Allocation

Heckman says that country allocation is by far the most important factor to consider in an actively managed, diversified international portfolio.

"We conducted a study of international mutual funds performance between 2001 and 2005," says Heckman. "It showed that up to 88 percent of performance variation was directly attributable to geographic allocation, while picking individual stocks had almost no relevance for returns."

The EAFE Plus model is complex and sophisticated. While economic growth is an important factor the model takes into consideration, valuations typically trump growth considerations. The model underweights what it considers over-bought markets. In the late 1990s, when a bubble was building up in the Far East, the model was underweight in Asia, based on valuations as well as additional parameters, such as interest rates and exchange-rate dynamics. This helped the firm to rank either No. 1 or No. 2 for asset allocation in Institutional Investor's Global Equity Poll in the 1999-2002 period.

On the other hand, the model also looks at momentum -- which means that even when bubbles start to develop, EAFE Plus provides for overweighting when stock prices continue to climb. The model also seeks to identify points when unexpected crises depress prices below their fair valuation levels, presenting a buying opportunity.

While devoting time and effort tracking macro indicators, the model pays little attention to sector allocation.

"We don't pick individual companies," says Heckman. In fact, they invest into foreign markets through U.S.-listed exchange traded funds or, when no such index-linked funds are available, by putting together baskets of American Depositary Receipts that emulate the country's main stock market index. This obviates the need -- and expense -- of hedging currency exposure.

Following mathematical prescriptions in asset allocation helps eliminate subjective factors. The model occasionally throws surprising or counterintuitive results, which eventually tend to be borne out by events.

"For nearly a decade, our model continued underweight on Japan," says Heckman. "When it finally went overweight in the early 2000s, we were all a little surprised." But the oversold Japanese market has been one of the best performers in the current stock market recovery.

Heckman readily admits that, without the vigorous discipline of a model, she could have been easily swayed by subjective views, sympathies and interests. Nevertheless, working on a quantitative model does not preclude acute interest in international politics and policy. On the contrary, it may actually encourage it. Heckman's official short bio proudly lists her membership in the Council on Foreign Relations, one of the country's oldest and most prestigious international policy forums.


Who: Leila Heckman, Senior Managing Director, Bear Stearns Asset Management

Where: Branzini, Madison Ave. and 41st Street, New York

On the Menu: Rigatoni, eggplant, tomato, basil, ricotta cheese and active country allocation


Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at His monthly "Global Economy" column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past four years, 2004-2007.

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