I've been working in hedge funds for over a decade, and it's interesting what the variety of opinions is. There's a great deal of secrecy, and good reasons for it, so getting to know how other quants do things has been quite informative.
On the one hand, your arbitrage argument makes sense. If there existed a simple strategy that made money, it would be traded out of existence.
On the other hand, I happen to know how the major quantitative funds allocate their money. It is a simple formula, with a number of small twists. (Yes, people will not believe you if you claim this. Rightly so.)
Now, how can these facts coexist? The answer is that the formula "sort of works". There are long periods where it doesn't work, and periods where the returns are phenomenal. If someone were to start a new fund, they would have a number of issues:
- It is just not quite believable that such a simple formula is profitable. What are those hordes of phds actually doing? (Squeezing a lemon actually). Surely someone else would have found it?
- Institutional investors have all sorts of issues with investing. It's done by committee. They need you to have a long track record. They want all the right boxes checked.
- What happens if you launch and you start with a fallow period?
- Even if a simple formula works, why does it work? Are you happy to trade something that you don't really understand?