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.”