Sunday, December 10, 2017

Harriman’s New Book of Investing Rules

Harriman’s New Book of Investing Rules: The Do’s & Don’ts of the World’s Best Investors, edited by Christopher Parker, contains over 500 pages of wisdom from 64 noted American and British investors. It’s a smorgasbord of ideas from which the reader can pick and choose. Don’t like Brussel sprouts? Here, have some cheesecake. But, said in a cautionary whisper, you’d be better off with the Brussel sprouts.

I hate to think how many years of successful investing experience are encapsulated in this volume. Probably somewhere in the neighborhood of 2,000. There aren’t too many resources that can claim this much collective experience.

Herewith a tiny sampling of some of the rules, minus the often much more insightful explanation that follows each of them.

Diversify, but not to mediocrity.

Concentrate, but not too much.

Hedge when the market’s expensive and falling.

Unless you are a genius use a system.

Don’t rely too heavily on models.

Beware of geeks bearing formulas.

Demographics are destiny.

Price is the paramount trading signal.

Be happy doing nothing.

Question the persistency of anomalies.

Understand your edge and why it is sustainable.

Review past stupidities, but don’t let them make you timid.

Only bet on one variable at a time.

It’s important that your process does not work in every market environment.

Don’t chop and change too much.

Be patient—fortune sometimes take a while to favor the bold.

Time, not timing, is the key to investment success. The best time to invest, therefore, is now.

Always remember that investing is hard.

Wednesday, December 6, 2017

Best books of 2017

Bowing to reader demand, I'm sharing my personal, idiosyncratic choices for the best books of 2017, with links to my reviews.

Eric Barker, Barking Up the Wrong Tree

Richard Bookstaber, The End of Theory

Robert Carver, Smart Portfolios



Michael W. Covel, Trend Following, 5th ed.

Aswath Damodaran, Narrative and Numbers

Diana B. Henriques, A First-Class Catastrophe



Hari P. Krishnan, The Second Leg Down

Bill Martin, The Smart Financial Advisor

Edward O. Thorp, A Man for All Markets


Sunday, December 3, 2017

Brandimarte, An Introduction to Financial Markets

Paolo Brandimarte’s An Introduction to Financial Markets: A Quantitative Approach (Wiley, 2018) is an imposing 750-page book. It is meant as a textbook for students who want a thorough grounding in the mathematics and statistics of finance. It arose out of courses the author offered at Politecnico di Torino, where he is a professor in the department of mathematical sciences, to graduate students in mathematical engineering. Like most textbooks, at the each of each chapter it has a set of problems (the answers to which can be found on the book’s website) and a bibliography.

After an overview of markets and an outline of basic problems in quantitative finance, the author analyzes fixed-income assets, equity portfolios, derivatives, and advanced optimization models. Devoting nearly 150 pages to optimization models may seem a bit eccentric, but Brandimarte is particularly interested in this topic and has done extensive research on it. For instance, in 1995 he co-authored a book titled Optimization Models and Concepts in Production Management. And in 2013 he co-authored a book on distribution logistics, which is essentially an optimization problem.

Zeroing in on the third part of the book, on equity portfolios, we find four chapters that deal with (1) decision-making under uncertainty: the static case, (2) mean-variance efficient portfolios, (3) factor models, and (4) equilibrium models: CAPM and APT. Here I’ll look very briefly, and somewhat telegraphically, at the first problem—decision-making under uncertainty—to give some sense of the book’s approach.

Brandimarte distinguishes between a static decision model and a multistage decision model. In a static model, we assume that we are not “adjusting our decisions along the way, when we observe the actual unfolding of uncertain risk factors.” In a multistage model, we can update our decisions, “depending on the incoming information flow over time.” He is simplifying his discussion by considering only the static case.

If we are trying to choose among a set of lotteries, let’s say, we might use a utility function. Brandimarte spends ten pages on the math involved in explicating and applying these functions. But utility functions have been severely criticized over the years, most notably for mixing objective risk measurement and subjective risk aversion in decision-making. Therefore, academics and practitioners have proposed mean-risk models, using risk measures such as standard deviation and variance and quantile-based risk measures such as V@R and CV@R. (More math.) These “may provide us with a partial ordering of alternatives, as well as a set of efficient portfolios.”

A third alternative framework is the stochastic dominance framework, “resulting in a partial ordering that may be related to broad families of utility functions.” (Math.) Brandimarte finds stochastic dominance “an interesting concept, allowing us to establish a partial ordering between portfolios, which applies to a large range of sensible utility functions. Unfortunately, it is not quite trivial to translate the concept into computational terms, in order to make it suitable to portfolio optimization. Nevertheless, it is possible to build optimization models using stochastic dominance constraints with respect to a benchmark portfolio.” (Two theorem proofs, problems, bibliography, end of chapter.)

Wednesday, November 29, 2017

Mulgan, Big Mind

Geoff Mulgan’s Big Mind: How Collective Intelligence Can Change Our World (Princeton University Press, 2018) is a thoughtful, quasi-philosophical book on a topic where “the stakes could not be higher. Progressing collective intelligence is in many ways humanity’s grandest challenge since there’s little prospect of solving the other grand challenges of climate, health, prosperity, or war without progress in how we think and act together.”

Collective intelligence requires a diversity of elements and capabilities: a live model of the world, observation, focus, memory, empathy, motor coordination, creativity, judgment, and wisdom. It is supported by infrastructures, such as networks. A general theory of collective intelligence also needs to address the dimensionality of choices—not only the number of variables involved but “cognitive dimensionality (how many different ways of thinking, disciplines, or models are necessary to understand the choice), its social dimensionality (how many people or organizations have some power or influence over the decision, and how much are they in conflict with each other), and its temporal dimensionality (how long are the feedback loops).” And this is just the beginning. The lists and requirements keep multiplying. Collective intelligence is complicated.

Mulgan analyzes how collective intelligence (though, in practice, all too often collective stupidity) functions in everyday life—in meetings, in cities and governments, in economies and firms, in universities.

Big Mind is a call to action, even though the author admits that there’s no single path to success. Because of this, we need to nurture people with skills in “intelligence design.”

Sunday, November 26, 2017

Martin, The Smart Financial Advisor

The subtitle of Bill Martin’s The Smart Financial Advisor (Harriman House, 2017) says it all: How Financial Advisors Can Thrive by Embracing Fintech and Goals-Based Investing. Martin, the chief investment officer at INTRUST Bank, beats the drum for goal-based investing since it has so many benefits, for both advisors and clients. For instance, it enables advisors to manage more of their clients’ wealth, it better matches assets and liabilities, it determines the optimal asset allocation, it minimizes taxes, and it increases an advisor’s value. He also advocates using fintech within a goals-based investing framework to efficiently manage, monitor, and report goal progress.

Most investors fall victim to a bevy of investing hazards. They react to external factors, fail to plan, quarantine their portfolios, mismanage risks, rely on alluring stories, ignore taxes, and focus on past performance. Advisors can address these hazards by adopting goals-based investing, identifying and prioritizing client goals, managing client wealth holistically, assessing risk comprehensively, determining the optimal mix of assets and constructing portfolios intelligently, utilizing tax-smart investment strategies, and tracking goal progress.

Goals-based investing is gaining traction among advisors and “finally appears positioned to become the new industry norm in managing wealth.” Historically, from the 1900s to the 1960s investors held concentrated stock portfolios and evaluated their stocks independently. From the 1960s to the 1980s Markowitz’s theory of portfolio selection became the guiding model, then from the 1980s through the 1990s strategic asset allocation took over. Employing Markowitz's model added value to investors' portfolios; strategic asset allocation added more value. Today, in part as a result of the findings of behavioral finance, goals-based investing is beginning to take center stage, and it is adding yet more value.

Martin explains the ins and outs of goals-based investing, step by step, element by element. Although he is writing for financial advisors, I consider his book a must-read for the DIY investor as well. Admittedly, it’s a lot harder for the individual investor to stay on track without the assistance of an advisor, but it’s virtually impossible without a viable, forward-looking plan. If you’re acting as your own advisor, you couldn’t ask for a clearer, more useful book than The Smart Financial Advisor.

Wednesday, November 22, 2017

Bernstein, Secrecy World

Jake Bernstein’s Secrecy World: Inside the Panama Papers Investigation of Illicit Money Networks and the Global Elite (Henry Holt, 2017) is both riveting and dispiriting. Bernstein, a Pulitzer Prize-winning journalist, knows whereof he writes because he was a senior reporter on the International Consortium of Investigative Journalists team that broke the Panama Papers story.

Data siphoned off from the law firm of Mossack Fonseca in Panama “afforded an unprecedented look into the operations of an underground economy through which trillions of dollars flow annually. This river of cash exists in a largely unregulated place known as the secrecy world. It’s an alternate reality available only to those who can afford the trip. In the secrecy world, wealth is largely untouchable by government tax authorities and hidden from the view of criminal investigators. Through the secrecy world, family dynasties are nurtured, their fortunes—often acquired illicitly—laundered and passed on to heirs. It’s a place where capital always triumphs over labor and the well-to-do are free to ignore the laws that govern their fellow citizens.” That’s dispiriting.

But Bernstein’s account of who hid money and how they did it is fascinating. From Vladimir Putin, whose name of course never appeared in the files, only the names of his oldest and most loyal friends, to Donald Trump’s partners and customers, to brashly overconfident Icelanders—people created thousands of shell companies with Mossfon. Some were trying to keep their wealth secret from their spouses, others trying to avoid the tax man, still others were buying and selling art, often to move it to freeports.

Secrecy World is a must-read book for anyone with an interest in, and perhaps a sense of outrage over, how the rich protect their wealth. And, I should note, it’s not just through secret offshore accounts. Delaware and Nevada allow incorporations with virtually no due diligence.

Sunday, November 19, 2017

Arnold, The Deals of Warren Buffett, vol. 1

Glen Arnold, a former academic (professor of investment and professor of corporate finance) turned more or less fulltime investor as well as a prolific author of books on finance, is an unabashed fan of Warren Buffett. He is a Berkshire Hathaway shareholder and regularly travels from England to Omaha for the Berkshire annual meetings.

Arnold set out to discover why Buffett chose the companies he invested in and what lessons individual investors can learn from Buffett’s decisions. Volume 1 of The Deals of Warren Buffett (Harriman House, 2017) covers the period leading to Buffett’s first $100 million in net worth, which he reached in 1978 at the age of 48.

Contrary to myth, Buffett didn’t always have a Midas touch. Apart from his most notable failure, Berkshire Hathaway the textile company, he lost money when he was in his early 20s on Cleveland Worsted Mills and an Omaha gas station he bought together with a friend.

But many of his investments were staggeringly successful, certainly dwarfing the $2,000 he lost on the gas station. Arnold goes through Buffett’s early investments one by one, from lesser known companies such as Rockwood & Co., Sanborn Maps, Dempster Mill, Hochschild-Kohn, and Associated Cotton Shops to such Berkshire staples as American Express, Disney, See’s Candies, and the Washington Post.

Throughout, Arnold stresses Buffett’s investing principles, exemplified in each of these deals, that can withstand the test of time. Among them: Grand principles are more important than a grand plan. Market moods can be incomprehensible to value investors, but stick with sound investing principles in good times and bad. And, re managers, good jockeys will do well on good horses, but not on broken-down nags. And so, in general it’s important to avoid businesses with problems.

Buffett followers will welcome this addition to the already huge Buffett bibliography. Arnold’s book will be even more illuminating to investors who are in search of an overarching rationale for their investing decisions. Why not learn from the best?