Recipe For Gains

Harin de Silva's quant strategy minimizes downside risk

It's a good bet you'll never see Harin de Silva on CNBC. "I can't tell a good stock story," concedes the president of Analytic Investors Inc. De Silva, 43, is a "quant" -- an investor who picks stocks using complex mathematical formulas. His strategy, which employs 70 different stock-screening criteria and involves hedging, doesn't translate well to TV. And besides, it isn't designed to produce blowout gains, but rather steady returns with little downside risk.

Perhaps that's why investors have largely ignored his two funds, Analytic Defensive Equity (ANDEX ) and newcomer Analytic Global Long-Short (ANGLX ), which he co-manages with Dennis Bein and Gregory McMurran from their Los Angeles office. The funds have only about $50 million in combined assets -- even though Defensive Equity has beaten the Standard & Poor's 500-stock index in four of the past five years, with about half the S&P's volatility. Moreover, both funds are no-load and have lower-than-average expense ratios -- 0.99% of assets for Defensive Equity and 1.3% for Global Long-Short. Typical equity funds charge 1.5%, and ones that short stocks -- as de Silva's does -- more than 2%.

De Silva, a cooking enthusiast, grew up in Sri Lanka and Britain, and earned a PhD in finance from the University of California at Irvine. He worked as a pension fund consultant before joining Analytic in 1994 -- and observed then that most strategies work well in some markets but poorly in others. "To be successful you have to adapt to the environment," he says. So instead of being, say, a growth manager or a value one -- terms managers usually use to describe themselves -- de Silva sees what's working at the moment and goes with that.

DIFFERENT HEDGES

That's why there are so many different criteria in his stock screens. He isolates which of the 70 are producing the best returns over periods of one month, six months, and a year -- and then ranks stocks that fit those criteria from best to worst. The best he buys; the worst he sells short. Currently his screens favor companies with low price-sales ratios, high leverage, volatile share prices, and strong earnings momentum. During the bear market, he took the opposite tack, buying stocks of corporations that had high dividends, clean balance sheets, and low share-price volatility.

The hedging strategies of the two funds are different. In Defensive Equity, de Silva buys only U.S. stocks and typically shorts no more than 20% of his portfolio. To reduce downside risk further, he sells covered call options -- contracts that let investors purchase a stock at a predetermined price -- which provide income to the fund but reduce its upside. De Silva doesn't use options in Global Long-Short but can short as much as 40% of its portfolio.

Although de Silva has no stock stories to tell, he does have a few quant tales. For instance, he found that companies with the lightest CEOs performed best in 1999. "Younger CEOs tend to weigh less," de Silva says. "And the youngest CEOs all worked in the dot-com industry in 1999." Of course, the thin-CEO screen isn't one de Silva normally uses in his funds, but it might just get him on television.

By Lewis Braham

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