Book Review: Inside the black box

Ever since I made the switch from investment bank to hedge fund, my interest in quantitative trading and hedge funds has grown tremendously. At my new firm, there is barely any discretionary trading (almost none). All positions are based on some quantitative model that has been extensively tested prior to going live.

To get myself familiar with the hedge fund industry, I have started reading some related books. The fact that my commute is more than twice as long as it used to be was also a compelling reason for me to read. I figured I would share my thoughts here in case my readers are looking for some book recommendations.

About 3 months ago, I decided to learn the basics of quantitative hedge funds – how they operate, what the different components are, what strategies they use etc. After some research, I decided to buy Inside the Black Box – The Simple Truth About Quantitative Trading by Rishi K Narang (amazon). Ever since I started reading it, I have successfully convinced 3 of my friends to buy the book. Rishi has written a book that lays out the structure of quantitative hedge funds in a simplified manner. Not once was I lost or felt like I had to do some background reading to understand what Rishi was writing. If you are new to hedge fund industry with very little knowledge of the basics, then this book is for you.


The books is divided into three parts:

  1. The Quant Universe
  2. Inside the Black Box
  3. A Practical Guide for Investors in Quantitative Strategies

Part 1 introduces readers to what quant trading is and why it matters. It goes on to highlight the basic structure of a quant trading system which is later explained in detail in the next part.

Part 2 is the juiciest part of the book and the reason why I read it. This part is all about the different components of a hedge fund and how they all work together. These parts are:

  • Alpha Model
  • Risk Model
  • Transaction Cost Model
  • Portfolio Construction Model
  • Execution Model
  • Data

First, we are introduced to the alpha model and the most common types of strategies that are utilized in many hedge funds. Rishi groups the 5 common types of strategies in two groups: Price and Fundamental.

  • Price
    • Trend
    • Reversion
  • Fundamental
    • Yield
    • Growth
    • Quality

Then, Rishi dives into Risk and Transaction Cost Models and how they are important to successfully implementing a model. Later, Rishi discusses how these three models (alpha, transaction cost and risk) lead to portfolio construction model. He not only covers the different ways in which one can build a portfolio but also ways in which one can optimize them. Afterwards, the author talks about the importance of a good execution model and how they are necessary to successfully implement a good alpha strategy. Without an efficient model, you can bleed a lot of money courtesy of high transaction costs, slippage and market impact.

After the author is done covering all the models, he goes on to talk about data and its importance. Without data, a quant cannot do any research and hence, can’t create any of the aforementioned models. I was a little disappointed from the lack of attention given to time-series databases in this section.

Part 3 was the least interesting to me because it’s mainly targeted towards investors and how they should evaluates quants and quantitative strategies. However, this section does have some interesting stuff such as the different types of risks that are inherent to quant strategies.

Overall, I am extremely glad that I picked this book as my introductory book into the hedge fund world. Before reading this book, make sure that you understand that the book only provides a high level overview of how a quantitative hedge fund works.

I would like to wrap up this review by saying that I highly recommend this book. Give it a chance and you won’t regret it. You can buy the book from amazon. Let me know your thoughts if you do end up reading the book.

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