diversification

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The Permanent Portfolio by Craig Rowland, J. M. Lawson

Alan Greenspan, Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bear Stearns, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, currency risk, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, junk bonds, low interest rates, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

Before we discuss the Permanent Portfolio's approach to diversification, however, let's discuss how other diversification strategies can run into problems. When Diversification Fails When diversification fails it is normally related to several key factors: 1. The strategy took too much risk in a single asset class. 2. The portfolio held assets that ultimately were exposed to the same types of risk. 3. The strategy was designed based upon false assumptions about asset class correlations. 4. The portfolio held no hard assets. 5. The portfolio had little or no cash reserves. In order to understand what solid diversification involves it is important to gain a better understanding of why these factors are allowed to creep into the design of investment strategies in the first place.

Stocks do not go up because bonds are going down, and stocks do not go down because bonds are going up. These assets move in price for very specific reasons in the economy. To make a conclusion based upon asset class correlations alone is going to eventually lead to a bad outcome when that correlation variable suddenly shifts. Strong diversification is not built by looking at asset class correlation data, but rather through an understanding of how certain assets respond to changing economic conditions. Strong diversification is not built by looking at asset class correlation data, but rather through an understanding of how certain assets respond to changing economic conditions.

Key Concepts Buy All of the Assets Remember that the diversification provided by the Permanent Portfolio comes from having exposure to all four of its asset classes. Those asset classes are: Stocks, Bonds, Cash, and Gold. It is imperative that all four of these assets be held in the portfolio at all times without making any attempts at market timing. Trying to correctly guess when to be in or out of any asset leaves your portfolio exposed to serious risks, and these risks can show up suddenly and without notice. It's also important to stay within the guidelines outlined in the previous chapters for each asset class. Straying outside of those parameters can easily cause an investor to move from investing to speculating, often without even realizing it.


pages: 367 words: 97,136

Beyond Diversification: What Every Investor Needs to Know About Asset Allocation by Sebastien Page

Andrei Shleifer, asset allocation, backtesting, Bernie Madoff, bitcoin, Black Swan, Bob Litterman, book value, business cycle, buy and hold, Cal Newport, capital asset pricing model, commodity super cycle, coronavirus, corporate governance, COVID-19, cryptocurrency, currency risk, discounted cash flows, diversification, diversified portfolio, en.wikipedia.org, equity risk premium, Eugene Fama: efficient market hypothesis, fixed income, future of work, Future Shock, G4S, global macro, implied volatility, index fund, information asymmetry, iterative process, loss aversion, low interest rates, market friction, mental accounting, merger arbitrage, oil shock, passive investing, prediction markets, publication bias, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Feynman, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, robo advisor, seminal paper, shareholder value, Sharpe ratio, sovereign wealth fund, stochastic process, stochastic volatility, stocks for the long run, systematic bias, systematic trading, tail risk, transaction costs, TSMC, value at risk, yield curve, zero-coupon bond, zero-sum game

When no buyers are present, prices crash instantaneously, and correlations across risk assets jump. What about risk factors? The failure of diversification across public and private return-seeking asset classes has led, in part, to the popularity of risk factors. Many authors have argued that risk factor diversification is more effective than asset class diversification.15 Our results indeed revealed that several risk factors (equity value, cross-asset value, equity momentum, currency value, and currency momentum) appear to be more immune to the failure of diversification than are asset classes. Others have pointed out, however, that risk factors aren’t inherently superior building blocks.16 They deliver better diversification than traditional asset classes simply because they allow short positions and often encompass a broader universe of assets.

Others have pointed out, however, that risk factors aren’t inherently superior building blocks.16 They deliver better diversification than traditional asset classes simply because they allow short positions and often encompass a broader universe of assets. For example, the size and value factors in equities are often defined as long-short, security-level portfolios. But if factor definitions are restricted to linear combinations of asset classes, and short positions are allowed across asset classes as well as risk factors, then risk factors do not deliver any efficiency gains over asset classes. In a sense, the argument in favor of risk factor diversification is more about the removal of the long-only constraint and the expansion of the investment universe than anything else.

Estimate the end investors’ risk tolerance accordingly against returns. 4. Use portfolio optimization tools that account directly for left-tail risks. 5. Beware of “diversification free lunches” in privately held asset classes. 6. Evaluate interest rate risk and its impact on stock-bond diversification. 7. Seek asset classes that provide upside “unification”/antidiversification. We’re not arguing against diversification. We’re arguing for better diversification. Active Management Strategies 1. Hedges with put options and proxies 2. Strategies that embed short positions 3. Momentum-based factors or strategies 4.


All About Asset Allocation, Second Edition by Richard Ferri

activist fund / activist shareholder / activist investor, Alan Greenspan, asset allocation, asset-backed security, barriers to entry, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, book value, buy and hold, capital controls, commoditize, commodity trading advisor, correlation coefficient, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, equity risk premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, inverted yield curve, John Bogle, junk bonds, Long Term Capital Management, low interest rates, managed futures, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, selection bias, Sharpe ratio, stock buybacks, stocks for the long run, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve

Potential asset classes for inclusion in your portfolio should have three important characteristics: 1. The asset class is fundamentally different from other asset classes in a portfolio. 2. Each asset class is expected to earn a return higher than the inflation rate over time. 3. The asset class must be accessible with a low-cost diversified fund or product. Fundamentally Different Asset allocation is risk diversification. In order to have risk diversification, each investment in a portfolio must be fundamentally different from other investments. This provides the portfolio with an assortment of unique risk characteristics. The first criterion for selection is that an investment under consideration be quantifiably different from all other investments.

Second, they should select individual investments that best represent those asset classes. The selection of investments to represent asset classes takes a lot of time because there are thousands of investments to choose from. I try to make the investment selection easy in this book. For further reference, I’ve also written other books, including All About Index Funds, 2nd edition, and The ETF Book, 2nd edition. In general, you are looking for investments that have broad asset class representation and low fees. Index mutual funds and ETFs are a perfect fit for this purpose. They give you broad diversification within an asset class at a reasonable cost.

Analyze asset classes and select those that are appropriate based on their unique risk, expected return, past correlation with other asset classes, and tax efficiency, if applicable. 3. Choose securities that best represent each asset class selected in Step 2. Low-cost index funds and select ETFs make good choices because they offer broad diversification and closely track asset-class returns. 4. Implement your asset allocation plan completely. Then rebalance your investments occasionally to control portfolio risk and enhance long-term return. The rest of this book discusses these four steps in detail. Part Two discusses asset class and fund selection in detail. Part Three discusses portfolio management and, in particular, selecting an appropriate level of risk and return and maintaining the investment mix.


Systematic Trading: A Unique New Method for Designing Trading and Investing Systems by Robert Carver

asset allocation, automated trading system, backtesting, barriers to entry, Black Swan, buy and hold, cognitive bias, commodity trading advisor, Credit Default Swap, diversification, diversified portfolio, easy for humans, difficult for computers, Edward Thorp, Elliott wave, fear index, fixed income, global macro, implied volatility, index fund, interest rate swap, Long Term Capital Management, low interest rates, margin call, Market Wizards by Jack D. Schwager, merger arbitrage, Nick Leeson, paper trading, performance metric, proprietary trading, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, survivorship bias, systematic trading, technology bubble, transaction costs, Two Sigma, Y Combinator, yield curve

Top level grouping Across asset classes 40% in bonds (constrained), leaves 60% in equities. 231 Systematic Trading You can see the final weights in table 41. Using these weights, the correlations and the formula on page 297, I get an instrument diversification multiplier of 1.61. TABLE 41: WHAT INSTRUMENT WEIGHTS SHOULD YOU USE FOR THE ETF PORTFOLIO? Within region/sub class Within asset class Across asset classes Final weight US bonds 33.3% 50% 40% 6.67% Euro bonds 33.3% 50% 40% 6.67% UK bonds 33.3% 50% 40% 6.67% EM bonds 100% 25% 40% 10% Inflation bonds 100% 25% 40% 10% Euro Stoxx 50 25% 70% 60% 10.5% S&P 500 25% 70% 60% 10.5% UK equities 25% 70% 60% 10.5% Japan equities 25% 70% 60% 10.5% EM equities 100% 30% 60% 18% The table shows the handcrafted instrument weights for the asset allocating investor.

Narrative fallacy means we have a tendency to see more predictability in historic asset prices than really existed and so we’re naturally drawn to over-fitted trading rules. I’ll return to this problem in chapter three, ‘Fitting’. Second bias, and perhaps the most serious of all: overconfidence. This manifests itself in a lack of diversification. Surveys of individual portfolios find that most amateur investors have relatively few securities in their portfolio, with a bias towards their home country, and also lack diversification across asset classes. You might think that experts, with access to sophisticated quantitative tools, wouldn’t make these mistakes. Unfortunately they often do. This happens when they don’t consider the considerable uncertainty in expected asset returns.

If due to high costs you need to trade this slowly you are probably better trying not to forecast asset prices at all, like an asset allocating investor. The other important implication of the law is that diversification across assets can substantially improve returns. If you can find four assets which have zero correlation then you can double your Sharpe ratio. Whilst this might seem unrealistic a trading strategy with a large number of instruments, covering a group of half a dozen asset classes, the returns of which will be relatively uncorrelated, can have returns which are two to three times those for a single asset. 33. Actually it’s the information ratio, which is identical to the Sharpe ratio except that the numerator is the return relative to a benchmark rather than the risk free rate.


Commodity Trading Advisors: Risk, Performance Analysis, and Selection by Greg N. Gregoriou, Vassilios Karavas, François-Serge Lhabitant, Fabrice Douglas Rouah

Asian financial crisis, asset allocation, backtesting, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, compound rate of return, constrained optimization, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, discrete time, distributed generation, diversification, diversified portfolio, dividend-yielding stocks, financial engineering, fixed income, global macro, high net worth, implied volatility, index arbitrage, index fund, interest rate swap, iterative process, linear programming, London Interbank Offered Rate, Long Term Capital Management, managed futures, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, p-value, Pareto efficiency, Performance of Mutual Funds in the Period, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, stochastic process, survivorship bias, systematic trading, tail risk, technology bubble, transaction costs, value at risk, zero-sum game

Returns-protection diversifiers have relatively high correlations in both the up and down markets with a generic asset class (such as the S&P 500 Index). 2. Returns-enhancing diversifiers possess correlations with the same generic asset class in an up market but are relatively less correlated in a down market. 3. “Ineffective” diversifiers are assets that do not add value, even though they may possess significant correlation coefficients with the generic asset class. CTA Strategies for Returns-Enhancing Diversification 339 To illustrate, a hedge fund strategy that has a negative correlation coefficient in an up-market regime and positive correlation coefficient in a down-market regime provides diversification with no incremental returns.

As a result, distinctions between international and domestic stocks are beginning to fade. This diversification vacuum is one reason why “skill-based” investing has become so popular with investors. Hedge funds and managed futures and other skill-based strategies might be expected to provide greater diversification than international equity investing because the returns are dependent on the special skill of the manager rather than any broad macroeconomic events or trends. However, diversification need not rely solely on active skill-based strategies. Diversification benefits also can be achieved from the passive addition of a new asset class such as commodity futures.

We then blend in hedge funds, managed futures, and commodity futures to see how the distribution changes when these alternative asset classes are added. DESCRIBING DOWNSIDE RISK The greatest concern for any investor is downside risk. If equity and bond markets are indeed becoming increasingly synchronized, international diversification may not offer the protection sought by investors. The ability to protect the value of an investment portfolio in hostile or turbulent markets is the key to the value of any macroeconomic diversification. Within this framework, investment strategies and asset classes distinct from financial assets have the potential to diversify and protect an invest- 222 RISK AND MANAGED FUTURES INVESTING 25 Frequency 20 15 10 5 0 – 8% 8% 7% 9% – 7% 6% – 6% % 4% 3% –5 – 5% 4% – 3% 1% 2% – 2% – 1% 0% 1% – 0% %– −1 2% %– −2 3% %– −3 5% 4% %– −4 %– −5 7% 6% %– −6 %– −7 %– −8 Return FIGURE 11.1 Frequency Distribution, Portfolio with 60/40 Stocks/Bonds ment portfolio from hostile markets.1 Hedge funds, managed futures, and commodity futures are a good choice for downside risk protection.


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Alan Greenspan, Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, behavioural economics, Bernie Madoff, Black Swan, Bob Litterman, bond market vigilante , book value, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, carbon credits, Carmen Reinhart, central bank independence, classic study, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, deal flow, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global macro, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, inverted yield curve, invisible hand, John Bogle, junk bonds, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, low interest rates, managed futures, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, pension time bomb, performance metric, Phillips curve, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, savings glut, search costs, selection bias, seminal paper, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stock buybacks, stocks for the long run, survivorship bias, systematic trading, tail risk, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

It is not clear what will work in the 2010s; I stress the possibility that government bonds will lose their safe haven status. Diversification should not ignore valuations. Especially if many asset classes are overpriced in good times, it seems likely that they may suffer together when bad times hit. The best results arise by combining the general goal of broad diversification with the underweighting of expensive and overcrowded asset classes or strategies. Diversification across strategy styles or risk factors is often more effective than diversification across asset classes (recall the three-dimensional cube in Figure 1.2). Enabling purer style and factor exposures is therefore a key underappreciated benefit of investing in alternative assets (albeit not exclusive to them).

• The strategy style perspective is especially important for understanding the profit potential of popular active-trading approaches. Value, carry, momentum, and volatility styles have outperformed buy-and-hold investments in many asset classes. Styles can also offer better diversification opportunities than asset classes. • Sophisticated investors are increasingly trying to look beyond asset classes and strategies in order to identify the underlying factors driving their portfolio returns. A factor-based approach is also useful for thinking about the primary function of each asset class in a portfolio (stocks for harvesting growth-related premia, certain alternatives for illiquidity premia, Treasuries for deflation hedging, and so on) as well as for diversifying across economic scenarios.

How going for comfort reduces long-run returns Conventional or comfortable approaches to boosting expected returns tend to become overpriced and offer poor reward for risk, maybe even detracting from expected return. Common bad habits include• to avoid (explicit) leverage, overweighting asset classes or strategies with embedded or non-recourse leverage; • to avoid leverage, overweighting the highest volatility assets within an asset class; • to avoid leverage, staying with equity-centric portfolios instead of monetizing gains from diversification into fixed income and other asset classes; • to earn a possible illiquidity premium and avoid mark-to-market volatility, hoarding illiquid asset classes irrespective of valuations; • to boost portfolio yield, buying corporate bonds and structures with embedded options.


pages: 363 words: 28,546

Portfolio Design: A Modern Approach to Asset Allocation by R. Marston

asset allocation, Bob Litterman, book value, Bretton Woods, business cycle, capital asset pricing model, capital controls, carried interest, commodity trading advisor, correlation coefficient, currency risk, diversification, diversified portfolio, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, family office, financial engineering, financial innovation, fixed income, German hyperinflation, global macro, high net worth, hiring and firing, housing crisis, income per capita, index fund, inventory management, junk bonds, Long Term Capital Management, low interest rates, managed futures, mortgage debt, Nixon triggered the end of the Bretton Woods system, passive investing, purchasing power parity, risk free rate, risk-adjusted returns, Robert Shiller, Ronald Reagan, Sharpe ratio, Silicon Valley, stocks for the long run, superstar cities, survivorship bias, transaction costs, Vanguard fund

So does Yale’s loss in 2009 undermine its earlier performance? As David Swensen said in February 2009, Propublica (February 18, 2009). For the period during which we’re in crisis, the hoped-for benefits of diversification disappear. But once the crisis passes, then the fact that these different asset classes are driven by fundamentally different factors will reassert itself, and you’ll get the benefits of diversification. It would be nice if we could always have the benefit of diversification, but life doesn’t work that way. VERDICT ON ALTERNATIVE INVESTMENTS No doubt asset allocation is improved with the addition of alternative investments. The adoption of alternatives will not guarantee Yale-size returns because other investors do not have the advantages of the Yale Endowment.

A correlation of 0.66 is certainly lower than would be found between two types of U.S. stocks, like small-cap and large-cap stocks or value and growth stocks. So it shouldn’t be surprising that diversification into emerging market stocks could lower the risk of an American stock portfolio. But, as shown in later chapters, emerging market stocks do not offer as much diversification as some alternative asset classes. This should not be that surprising given that many emerging market economies depend on exports to P1: a/b c06 P2: c/d QC: e/f JWBT412-Marston T1: g December 8, 2010 17:41 Printer: Courier Westford 108 PORTFOLIO DESIGN TABLE 6.3 Correlations between Emerging Market Stocks and Developed Market Stocks 1989-2009 EAFE MSCI EM 2000-2009 EAFE MSCI EM Correlation with S&P 500 Correlation with EAFE 0.71 0.66 0.68 0.88 0.79 0.88 Data Sources: MSCI and S&P.

This book is based on the sessions that I developed for the CIMA program. The book is designed for investment advisors who want to provide diversified portfolios for their clients, whether they are high net worth private clients or institutional investors. The book examines all of the major asset classes that go into modern portfolios and asks how much they add to portfolio diversification. Besides my participation in the CIMA program, I have taught in many other investment programs at the Wharton School. I have also given investment presentations on behalf of banks, brokerage firms, and insurance companies in more than a dozen countries as well as in conferences and meetings throughout this country.


pages: 490 words: 117,629

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, Benchmark Capital, book value, buy and hold, capital controls, classic study, cognitive dissonance, corporate governance, deal flow, diversification, diversified portfolio, equity risk premium, financial engineering, fixed income, index fund, junk bonds, law of one price, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Savings and loan crisis, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

THE SCIENCE OF PORTFOLIO STRUCTURE Basic financial principles require that long-term investment portfolios exhibit diversification and equity orientation. Diversification demands that each asset class receive a weighting large enough to matter, but small enough not to matter too much. Equity orientation requires that high-expected-return asset classes dominate the portfolio. Begin the portfolio structuring process by considering the issue of diversification, using the six core asset classes. The necessity that each asset class matter indicates a minimum of a 5 or 10 percent allocation. The requirement that no asset class matter too much dictates a maximum of a 25 or 30 percent allocation.

Conventional domestic fixed-income and inflation-indexed securities provide diversification, albeit at the cost of expected returns that fall below those anticipated from equity investments. Exposure to real estate contributes diversification to the portfolio with lower opportunity costs than fixed-income investments. In the portfolio construction process, diversification requires that individual asset-class allocations rise to a level sufficient to have an impact on the portfolio, with each asset-class accounting for at least 5 to 10 percent of assets. Diversification further requires that no individual asset class dominate the portfolio, with each asset class amounting to no more than 25 to 30 percent of assets. The principle of equity orientation induces investors to place the bulk of the portfolio in higher-expected-return asset classes.

Fully 70 percent of assets promise equity-like returns, meeting the requirement of equity orientation. Asset-class weights range from 5 to 30 percent of assets, meeting the requirement of diversification. A portfolio with assets allocated according to fundamental investment principles establishes a strong starting point for individual investment programs. Ultimately, successful portfolios reflect the specific preferences and risk tolerances of individual investors. Understanding the quantitative and qualitative characteristics of asset-class exposure creates a basis for determining which asset classes to include and in which proportions to invest. Chapter 2, Core Asset Classes, offers a primer on those asset classes likely to contribute to investor goals.


pages: 232 words: 70,835

A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan by Ben Carlson

Albert Einstein, asset allocation, backtesting, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, book value, business cycle, buy and hold, buy low sell high, commodity super cycle, corporate governance, delayed gratification, discounted cash flows, diversification, diversified portfolio, do what you love, endowment effect, family office, financial independence, fixed income, Gordon Gekko, high net worth, index fund, John Bogle, junk bonds, loss aversion, market bubble, medical residency, Occam's razor, paper trading, passive investing, Ponzi scheme, price anchoring, Reminiscences of a Stock Operator, Richard Thaler, risk tolerance, Robert Shiller, robo advisor, South Sea Bubble, sovereign wealth fund, stocks for the long run, technology bubble, Ted Nelson, transaction costs, Vanguard fund, Vilfredo Pareto

In the absence of your future self being able to travel back in time to tell you exactly what's going to happen, investors should practice diversification. Diversification is the best way to admit you have no idea what's going to happen in the future. It's how you prepare a portfolio for a wide range of future possibilities and admit your own infallibility. Some might consider diversification a form of ignorance, but one of the best ways to minimize risk in a portfolio is to admit, “I just don't know what's going to happen. I have no idea which asset class is going to perform the best from year to year, therefore I will diversify broadly across the various asset classes and risk factors.” Table 7.2 shows just how difficult it can be to choose the best performing asset class in any given year.

Figuring out that capitulation point is going to be the glue that holds your strategy together, regardless of how many different asset classes, funds, or strategies you employ. When I said that every position, fund, or asset class in your portfolio should serve a purpose, I didn't just mean that from the perspective of diversification and lowering your risk. I meant it from a behavioral perspective as well. Since there's no magical asset allocation to each and every asset class, you have to strike the right balance between sleeping well at night and reaching your long-term goals. The right asset allocation gives you the best chance of staying out of harm's way by making a huge mistake when one piece of your portfolio is lagging the other parts.

Take a look at Table 4.10 to see the power of diversification in action. Had you had all of your eggs in one basket—large-cap U.S. stocks—you would have had miserable performance in that decade. But had you spread your bets to include different subasset classes and geographies you actually would have done pretty well. Table 4.10 A Lost Decade in Stocks?* Asset Class Total Returns Annual Returns S&P 500 –9.1% –1.0% Emerging Markets 162.0% 10.1% Small-Cap Value 158.6% 10.0% Mid-Cap 84.2% 6.3% REITs 169.0% 10.4% Equal-Weighted Portfolio 112.9% 7.2% *2000 to 2009. A simple equal-weighted portfolio of the five asset classes listed in Table 4.10 would have earned an investor 7.2 percent per year.


pages: 332 words: 81,289

Smarter Investing by Tim Hale

Albert Einstein, asset allocation, buy and hold, buy low sell high, capital asset pricing model, classic study, collapse of Lehman Brothers, corporate governance, credit crunch, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, eurozone crisis, fiat currency, financial engineering, financial independence, financial innovation, fixed income, full employment, Future Shock, implied volatility, index fund, information asymmetry, Isaac Newton, John Bogle, John Meriwether, Long Term Capital Management, low interest rates, managed futures, Northern Rock, passive investing, Ponzi scheme, purchasing power parity, quantitative easing, random walk, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, South Sea Bubble, technology bubble, the rule of 72, time value of money, transaction costs, Vanguard fund, women in the workforce, zero-sum game

Growth-oriented equity market diversifiers, such as global commercial property, may help to smooth shorter-term equity market falls, as well as providing some comfort over the long-term, if Siegel’s warning comes true over your investing lifetime. You need to decide if you want to include these asset classes or if you wish to ignore them, sticking with equities and simply reducing the risk you take by diluting your equity exposure with defensive assets. Read up about each in Chapter 12 and make your own mind up. The degree to which each asset class helps to smooth the portfolio returns, i.e. how effective their diversification benefit is, depends on how highly correlated their returns are. If you could find four uncorrelated asset classes with equity-like returns, you could halve the risk of the portfolio without giving up any return.

During two particularly tough periods for investors: 2000–2002 (the Tech Wreck) and 2007–2009 (the Credit Crunch) – as you can see, diversification helped to reduce the cumulative losses incurred over this period. While this illustrates that diversification is an important decision, in periods like the early 1990s, when property fell substantially and global markets fared worse than the UK, it did not pay off; but that does not make it invalid. Investing is an imperfect science. What is interesting to note is that while the risk has been the same, when measured by volatility, it appears that the downside impact of the worst-case periods has been reduced by the diversification into other asset classes. Returns have stood up well.

Returns have stood up well. Diversification is a tool worth using. Smarter investing requires that you simply stack the odds of success in your favour by making sensible decisions along the way. Level 3: Given our expected return and risk assumptions Finally, we can estimate, based on the long-term asset class assumptions that we make about each asset class going forward, (a) its return (i.e. the equity market return from developed markets plus any premia for emerging markets, less healthy (value) companies and smaller companies); (b) the risk of the portfolio, given that the imperfect return correlation between building blocks should help to reduce the portfolio risk below the sum of its parts.


The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William J. Bernstein

asset allocation, backtesting, book value, buy and hold, capital asset pricing model, commoditize, computer age, correlation coefficient, currency risk, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, index arbitrage, index fund, intangible asset, John Bogle, junk bonds, Long Term Capital Management, p-value, passive investing, prediction markets, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, the scientific method, time value of money, transaction costs, Vanguard fund, Wayback Machine, Yogi Berra, zero-coupon bond

This 40/60 stock/bond portfolio is available from DFA, about which more will be said in Chapter 8: ■ 8% U.S. large-cap growth ■ 8% U.S. large-cap value ■ 4% U.S. small-cap growth ■ 4% U.S. small-cap value ■ 4% REIT ■ 4% international large-cap value ■ 2% international small-cap growth ■ 2% international small-cap value ■ 1.2% emerging markets large-cap growth ■ 1.2% emerging markets large-cap value ■ 1.6% emerging markets small-cap growth ■ 15% one-year corporate bonds ■ 15% two-year global bonds ■ 15% five-year U.S. government bonds ■ 15% five-year global bonds First, the complexity of this portfolio should satisfy all but the most exacting portfolio buff, with no less than 15 asset classes. Secondly, it is quite conventional, with a 28/12 domestic/foreign split, and it is much heavier in large-cap than small-cap stocks. This portfolio provides adequate safety and diversification, and yet its return only rarely varies more than a half-dozen percent from a domestic 40/60 S&P 500/T-bill mix. You now have an idea of how the allocation process works. First, decide how many different stock and bond asset classes you are willing to own. Increasing the number of asset classes you employ will improve diversification but will also increase your work load and Optimal Asset Allocations 83 tracking error.

Determine how much complexity you can tolerate. Is keeping track of six different asset classes more than you can handle? Or are you an “asset-class junkie” who craves a portfolio of exotic birds such as Pacific Rim small companies or emerging markets value exposure? For starters, you’ll need at least four asset classes: ■ U.S. large stocks (S&P 500) ■ U.S. small stocks (CRSP 9-10, Russell 2000, or Barra 600) ■ Foreign stocks (EAFE) ■ U.S. short-term bonds If this is all you can handle, fine. The above four classes will provide you with most of the diversification you’ll need. However, if you can tolerate the added complexity, I’d recommend breaking things down a bit further: ■ ■ ■ ■ U.S. large stocks—market and value U.S. small stocks—market, value, and REITs Foreign stocks—Europe, Japan, Pacific Rim, emerging markets, and small cap U.S. short-term bonds Implementing Your Asset Allocation Strategy 145 3.

International Publishing, 1993. 197 This page intentionally left blank Index Active management, 95–99 Alpha, 89–90, 98 American Association of Individual Investors, 177 American Depositary Receipts (ADRs), 78 Annualized return, 2–3, 5 Asset Allocation (Gibson), 176 Asset-allocation funds, 162–164 Asset-allocation strategy, 26, 143–174 asset-allocation funds in, 162–164 bonds in, 151–152 determining allocation, 143–145, 153–154 dynamic, 137–139, 163–164 executing plan for, 154–161 investment resources for, 175–180 key points for, 173–174 retirement accounts and, 153–154 stock indexing in, 145–151 taxes and, 145 Treasury ladders in, 152 (See also Asset classes; Diversification; Optimal asset allocation) Asset classes: 1926–1998, 9–18, 42 1970–1998, 19–21 in asset allocation process, 76–83 correlation coefficients among, 183–186 law of diminishing returns and, 76 standard deviation of annual returns, 6 Asset variance, 109 Autocorrelation, 106–108 Average return, 2–3 Backtesting, 72 Barra indexes, 99, 126 Baruch, Bernard, 52 Behavioral finance, 139–142 defined, 139 overconfidence and, 139–140 recency and, 47–48, 52, 53, 58–59, 140–141 risk aversion myopia and, 141–142 Benchmarking: alpha in, 89–90, 98 with S&P 500, 60, 78, 79, 86, 88–90, 145 Benzarti, Shlomo, 131 Bid-ask spread, 91, 92, 93, 96 Binomial distribution function, 2, 7 Bogle, John, 175–176 Bond funds, 151–152 Bonds: in asset allocation strategy, 151–152 common stock versus, 24 historical returns of, 23, 24 standard deviation of annual returns, 6 Book value (P/B ratio): data on ranges of, 114 in new era of investing, 124 in value investing, 112–113, 120 variation in returns and, 116–117 Brinson, Gary, 176 Buffett, Warren, 118 Calibration, 140 Capital gains capture, 102, 108 Center for Research in Security Prices, 76 Charles Schwab, 100 Clayman, Michelle, 118 Coin-toss option, 1–5, 29–36, 169 Commissions, 90–91, 92, 96, 152 Common Sense on Mutual Funds (Bogle), 175–176 199 200 Index Common stocks: 1926–1998, 4, 13–16, 17, 42–45 discounted dividend method and, 23–24, 26, 127–132 growth, 97, 112, 117 historical returns on, 23–25 large-company, (See Large-company stocks) long bonds versus, 24 risks and returns of, 1–5 small-company (See Small-company stocks) standard deviation of annual returns, 5–8, 63, 65, 96 Company size: variation in returns and, 116–117 (See also Large-company stocks; Small-company stocks) Complex portfolios, 41–62 defined, 41 efficient frontier, 55–59, 64 foreign assets in, 46–53 professional versus small investors, 59–61 rebalancing, 59 return and risk plot, 41–45 risk dilution, 45–46 small versus big stocks in, 53–55, 75 Compound interest, 17 Constant allocation, 58 Contrarian approach, 59, 104 Contrarian Market Strategy (Dreman), 104 Conventionality, in asset allocation process, 78–79 Cooley, Philip L., 169 Corner portfolios, 65–71 Correlation, 36–40 among asset classes, 183–186 autocorrelation, 106–108 calculating, 39 defined, 37 foreign investments and, 46–53, 72–73 imperfect, 37 Correlation (Cont.): negative, 31, 37 overstating of diversification benefits, 71-74 of small stocks and large stocks, 53–55 zero, 31 Cost of capital, 132 Critical-line technique, 65 Currency risk, 132–137 Dimensional Fund Advisors (DFA), 20, 148, 149, 150, 164 analysis of fund performance 1970–1998, 86 bond funds, 152 global large company index, 74–75 moderate balanced strategy, 82 small-cap index, 54–55, 98–99, 100 Discount rate (DR), 127–130 Discounted dividend method: Glassman-Hassett model and, 127–132 nature of, 23–24, 26 Diversification, 19, 21, 144 benefits of, 33–36, 41–45, 71–74 impact on risk and return, 31–36, 63 international, 46–53, 72–75 overstatement of benefits of, 71–74 (See also Optimal asset allocation) Dividend yield: data on ranges of, 114, 115 market declines and, 166–167 in new era of investing, 124 in value investing, 113–115 Dividends: Dow dividend strategy, 116 growth of, 80 reinvesting, 115 REITs and, 145 Dodd, David, 176 Dollar cost averaging (DCA), 154–155, 159 Dow 36,000 (Glassman and Hassett), 127–132 Dow dividend strategy, 116 Dow Jones Industrial Average, 24–25, 26, 80 Index Dreman, David, 104, 117 Dunn’s law, 99–100 Duration risk, 165–167 Dynamic asset allocation, 137–139 defined, 137 market valuation and, 163–164 overbalancing in, 138 EAFE Index, 38, 39, 46–53, 100, 126 Earnings yield, 119 Econometrics of Financial Markets, The (Campbell, Lo, and MacKinlay), 107–108 Edleson, Michael, 155–159, 176 Efficient frontier, 55–59, 64 Efficient market hypothesis, 104–105, 118–119, 120 Efficient Solutions, 65–71, 181–182 Ellis, Charles, 94 Emerging markets, 49–50, 100, 147–148 European bonds, 152 European stocks, 19, 20, 25, 156 efficient frontier and, 55–59 hedging with, 133 mutual funds, 147 Excess risk, 12–13 Exchange traded funds (ETFs), 149, 151 Expense ratio (ER), 90, 91, 92, 96, 146 Expert opinion, 74 Fama, Eugene, 98, 109, 116–117, 120–124, 148 Financial calculators, 5, 168 Fisher, Kenneth, 109 Fixed asset allocation, 109 Forbes, Malcolm, 104 Foreign assets: correlation and, 47, 72–73 EAFE Index, 38, 39, 46–53, 100, 126 hedging with, 132–137 Foreign tax credit, 161 Forward premium, 135 Forward rates, 135–136 Fraud, investment, 4 French, Kenneth, 98, 116–117, 120–124, 126, 148 201 Fund of funds, 161 Future optimal portfolio composition, 64 Gibson, Roger, 176 Glassman, James, 127–132 Global Investing (Ibbotson and Brinson), 176 Goetzmann, William, 49–50 Gold stocks (See Precious metals equity) Graham, Benjamin, 24, 93, 106, 112, 117, 118, 119–120, 125, 176–177 Graham, John, 104 Grant, James, 178 Great Depression, 14, 19, 112, 166 Growth investing: defined, 112, 118 efficient market theory and, 118–119 value investing versus, 117, 118–120 Growth stocks, 97, 112, 117 Harvey, Campbell, 104 Hassett, Kevin, 127–132 Haugen, Robert A., 119, 176 Hedging, 132–137 cost of, 135–136 defined, 132 extent of, 136–137 Historical optimal allocation, 64 Hubbard, Carl M., 169 Hypothetical optimal allocation, 64 Ibbotson, Roger, 176 Ibbotson Associates, 9–10, 23, 41–42, 44, 93, 178 Imperfect correlation, 37 In sample, 87 In Search of Excellence (Peters), 118 Indexing, 94–103 advantages over active management, 95–99 defined, 95 international, 100 mutual funds in, 145–151, 174 202 Index Indexing (Cont.): of small-company stocks, 101, 102, 148–149 theoretical advantage of, 95–96 Inflation, and real return, 80, 168 Institutional investors: evaluation of, 123–124 market-impact costs and, 86–90, 91–92, 96 pension funds, 103 persistence of investment performance, 90 small investors versus, 59–61 (See also Benchmarking; Mutual funds) Intelligent Investor, The (Graham), 106, 176–177 International diversification: case against, 72 correlation and, 46–53, 72–73 with small stocks, 74–75 sovereign risk and, 72 Inverse correlation, 31, 37 Investment climate, 124–127 Investment Company Institute, 103 Investment fraud, 4 Investment newsletters, 104–105 January effect, 92–94 Japanese bonds, 152 Japanese stocks, 19, 20, 25, 38, 39, 40, 48, 55, 56, 57, 59, 160 Jensen, Michael, 86 Jorion, Phillipe, 49–50 Keynes, John Maynard, 18 Lakonishok, Josef, 120 Large-company stocks, 13 indexing advantage with, 96, 97–98 small-company stocks versus, 53–55, 75 Law of diminishing returns, 76 Lehman Long Bond Index, 162 Local return, 133 Long Term Capital Management, 7 Mackay, Charles, 178 Malkiel, Burton, 101–102, 109, 175 Market capitalization, 13 Market efficiency, 85–110 expenses of funds and, 90–92, 96, 146 indexing and, 94–101 investment newsletters and, 104–105 January effect, 92–94 market-impact costs and, 88–90, 91–92, 96 and persistence of investment performance, 85–88 random walk and, 101, 106–108 rebalancing and, 108–109 survivorship bias and, 101–102 taxes and, 102–103 Market-impact costs: extent of, 91, 92, 96 illustration of, 88–90 Market multiple (See P/E ratio) Market risk premium, 121, 122 Market timing, 104–105, 160 Market valuation, 111–115, 163–164, 174 Markowitz, Harry, 64–65, 71, 177–178 Maximum-return portfolios, 69 Mean reversion, 70, 107, 109 Mean-variance analysis, 44–45, 64–71, 181–182 Mean-variance optimizers (MVOs), 64–71, 181–182 Memoirs of Extraordinary Popular Delusions and the Madness of Crowds (Mackay), 178 Miller, Paul, 115 Minimum-variance portfolios, 65–69 Momentum investing, 101, 108, 109, 123 Money managers (See Institutional investors; Mutual funds) Money market, standard deviation of annual returns, 6 Morgan-Stanley Capital Indexes, 19–20, 133, 149 Index Morningstar: long-term returns, 21 Principia database, 61, 96–97, 101–102, 120, 163–164, 177 standard deviation and, 6, 19 MSCI World Index, 162 Multiple (See P/E ratio) Multiple-asset portfolios, 29–40 coin toss and, 36 correlation in, 36–40 diversification and, 31–36 simple portfolios versus, 31–36 Multiple change, 24 Mutual funds: asset-allocation, 162–164 bond, 151–152 exchange traded (ETFs), 149–151 expenses of, 90–92, 96, 146 hedging, 135 indexing with, 145–151, 174 standard deviation and, 6 supermarkets, 148 turnover of, 130–131 Vanguard Group, 97–100, 146–148, 149, 150, 152, 156, 161–163 MVOPlus, 65–71, 181–182 National Association of Real Estate Investment Trusts (NAREIT), 21 Negative correlation, 31, 37 New era of investing: components of, 124–127 Glassman-Hassett model and, 127–132 New Finance: the Case Against Efficient Markets (Haugen), 119, 176 Newsletters, investment, 104–105 Nonsystematic risk, 12–13 Normal distribution, 7 Oakmark Fund, 88–90 Optimal asset allocation, 63–83 asset-allocation funds in, 162–164 asset classes in, 76–78 calculation of, 64–71 conventionality and, 78–79 203 Optimal asset allocation (Cont.): correlation coefficients, 71–74 international diversification with small stocks, 74–75 risk tolerance and, 79–80, 143 three-step approach to, 75–83 Out of sample, 87 Overbalancing, 138 Overconfidence, 139–140 P/B ratio (See Book value) P/E ratio: data on ranges of, 113, 114 earnings yield as reverse of, 119 in new era of investing, 124 in value investing, 112, 119–120 Pacific Rim stocks, 19, 20, 21, 25, 55–59, 147, 156 Pension funds, 103 (See also Institutional investors) Perfectly reasonable price (PRP), 127–128 Performance measurement: alpha in, 89–90, 98 three-factor model in, 123–124 (See also Benchmarking) Perold, Andre, 141 Persistence of performance, 85–88 Peters, Tom, 118 Piscataqua Research, 103 Policy allocation, 59 Portfolio insurance, 141 Portfolio Selection (Markowitz), 177–178 Precious metals stocks, 19–20, 21, 48, 55, 57, 59 Price, Michael, 162 Professional investors (See Institutional investors) Prudent man test, 60 Random Walk Down Wall Street, A (Malkiel), 101–102, 175 Random walk theory, 106–108, 119 positive autocorrelation and, 106–108 204 Index Random walk theory (Cont.): random walk defined, 106 rebalancing and, 109 Raskob, John J., 16–17 Real estate investment trusts (REITs), 38, 40, 100, 145 defined, 19 index fund, 148 returns on, 19, 21, 25 Real return, 26, 80, 168, 170 Rebalancing: frequency of, 108–109 importance of, 32–33, 35–36, 59, 63, 174 and mean-variance optimizer (MVO), 65 overbalancing in, 138 random walk theory and, 109 rebalancing bonus, 74, 159–160 of tax-sheltered accounts, 159–160 of taxable accounts, 160–161 Recency effects, 47–48, 52, 53, 58–59, 140–141 Regression analysis, 89–90 Reinvestment risk, 23 Representativeness, 118 Research expenses, 92, 95 Residual return, 98 Retirement, 165–172 asset allocation for, 153–154 duration risk and, 165–167 shortfall risk and, 167–172 (See also Tax-sheltered accounts) Return: annualized, 2–3, 5 average, 2–3 coin toss and, 1–5 company size and, 116–117 correlation between risk and, 21 dividend discount method, 23–24, 26, 127–132 efficient frontier and, 55–58 expected investment, 26 historical, problems with, 21–27 Return (Cont.): impact of diversification on, 31–36, 63 market, 168 real, 26, 80, 168, 170 return and risk plot, 31–36, 41–45 risk and high, 18 uncorrelated, 29–31 variation in, 116–117 Risk: common stock, 1–5 correlation between return and, 21 currency, 132–137 duration, 165–167 efficient frontier and, 55–58 excess, 12–13 high returns and, 18 impact of diversification on, 31–36, 63 nonsystematic, 12–13 reinvestment, 23 return and risk plot, 31–36, 41–45 shortfall, 167–172 sovereign, 72 systematic, 13 (See also Standard deviation) Risk aversion myopia, 141–142 Risk dilution, 45–46 Risk-free investments, 10, 15, 152 Risk-free rate, 121 Risk time horizon, 130, 131, 143–144, 167 Risk tolerance, 79–80, 143 Roth IRA, 172 Rukeyser, Lou, 174 Rule of 72, 27 Sanborn, Robert, 88–90 Securities Act of 1933, 92–93 Security Analysis (Graham and Dodd), 93, 118, 125, 176 Selling forward, 132–133 Semivariance, 7 Sharpe, William, 141 Shortfall risk, 167–172 Siegel, Jeremy, 19, 136 Index Simple portfolios, 31–36 Sinquefield, Rex, 148 Small-cap premium, 53, 121, 122 Small-company stocks, 13–16, 25 correlation with large-company stocks, 53–55 efficient frontier and, 55–59 indexing, 101, 102, 148–149 international diversification with, 74–75 January effect and, 92–94 large-company stocks versus, 53–55, 75 “lottery ticket” premium and, 127 tracking error of, 75 Small investors, institutional investors versus, 59–61 Solnik, Bruno, 72 Sovereign risk, 72 S&P 500, 13, 38, 39, 55 as benchmark, 60, 78, 79, 80, 86, 88–89, 145 efficient frontier, 56–57 Spiders (SPDRS), 149 Spot rate, 135 Spread, 91, 92, 93, 96 Standard deviation, 5–8 defined, 6, 63 limitations of, 7 of manager returns, 96 in mean-variance analysis, 65 Standard error (SE), 87 Standard normal cumulative distribution function, 7 Stocks, Bonds, Bills, and Inflation (Ibbotson Associates), 9–10, 41–42, 178 Stocks for the Long Run (Siegel), 19, 136 Strategic asset allocation, 58–59 Survivorship bias, 101–102 Systematic risk, 13 t distribution function, 87 Tax-sheltered accounts: asset allocation for, 153–154 rebalancing, 108–109, 159–160 (See also Retirement accounts) 205 Taxable accounts: asset allocation for, 153–154 rebalancing, 160–161 Taxes: in asset allocation strategy, 145 capital gains capture, 102, 108 foreign tax credits, 161 market efficiency and, 102–103 Technological change: historical, impact of, 125 in new era of investing, 125 Templeton, John, 164 Thaler, Richard, 131, 142 Three-factor model (Fama and French), 120–124 Time horizon, 130, 131, 143–144, 167 Tracking error: defined, 75 determining tolerance for, 83, 145 of small-company stocks, 75 of various equity mixes, 79 Treasury bills: 1926–1998, 10–11 returns on, 25–26 as risk-free investments, 10, 15, 152 Treasury bonds: 1926–1998, 11–13, 42–45 ladders, 152 Treasury Inflation Protected Security (TIPS), 80, 131–132, 172 Treasury notes, 11 Turnover, 95, 102, 130–131, 145 Tweedy, Browne, 148–149, 162, 176 Utility functions, 7 Value averaging, 155–159 Value Averaging (Edleson), 176 Value index funds, 145 Value investing, 77, 111–124 defined, 118 growth investing versus, 117, 118–120 measures used in, 112–114 studies on, 115–118 three-factor model of, 120–124 Value premium, 121–123 206 Index VanEck Gold Fund, 21 Vanguard Group, 97–100, 146–148, 149, 150, 152, 156, 161–163 Variance, 7, 108–109 mean-variance analysis, 44–45, 64–71, 181–182 minimum-variance portfolios, 65–69 Variance drag, 69 Walz, Daniel T., 169 Websites, 178–180 Wilkinson, David, 56, 57, 181–182 Williams, John Burr, 127 Wilshire Associates, 120, 147, 162 World Equity Benchmark Securities (WEBS), 149–151 z values, 87 Zero correlation, 31 About the Author William Bernstein, Ph.D, M.D., is a practicing neurologist in Oregon.


pages: 300 words: 77,787

Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, clean tech, compound rate of return, credit crunch, currency risk, diversification, diversified portfolio, equity premium, equity risk premium, estate planning, fixed income, high net worth, implied volatility, index fund, intangible asset, invisible hand, John Bogle, Kenneth Rogoff, low interest rates, market bubble, money market fund, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, selection bias, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

In an ideal (theoretical) world we should own a small slice of all of the world’s assets to maximise diversification and returns. This clearly is not possible in reality, but the rational portfolio is a very good simplification that we can actually implement. Because the asset classes of the rational portfolio have active and liquid markets for the pricing of thousands of individual securities, we don’t need any specific insight to select securities in those markets. And because government bonds, equities and corporate bonds give a very good representation of the world’s assets, a portfolio representing those asset classes is a very good simplification of what we should ideally be striving for in a portfolio.

Figure 7.8 Add diversified corporate bonds to the portfolio Figure 7.9 World corporate debt in $ billions Based on data from Bank for International Settlements, end 2011, www.bis.org Looking to the future, the non-US portion of world corporate debt is likely to increase further and thus augment the importance of getting both the asset class diversification of adding bonds and also the geographic diversification of adding international ones to your rational portfolio.8 When you add corporate bonds to your rational portfolio, consider Figure 7.9 and make sure you diversify internationally. At this time, around 55% of the world’s corporate bonds are non-US, and like the US ones represent thousands of individual bonds of different maturities, industries, geographic areas and credit qualities. Ignoring the great diversification benefits from adding index-tracking ETFs or funds made up of these many thousand foreign bonds to your rational portfolio would be an omission.

The addition of these asset classes further adds diversification to your portfolio and therefore enhances the risk/return profile. Figure 7.1 shows a portfolio including government and corporate bonds, instead of just the minimal risk asset and equities, which gives us higher expected returns. We can expect a better risk/return profile by adding these other government and corporate bonds to the minimal risk asset and world equity portfolio because the correlation between these additional bonds and the equity portfolio is not perfect (they don’t move in step and there are therefore diversification benefits from having some of both).


Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, behavioural economics, Black Monday: stock market crash in 1987, Bob Litterman, book value, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, currency risk, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, price anchoring, price stability, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, seminal paper, Sharpe ratio, short selling, short squeeze, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, tail risk, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

In the 1995 endowment report, he summed it up in a few words: “Yale seeks diversification without the opportunity costs of investing in fixed-income by identifying high-return asset classes that are not highly correlated with domestic marketable securities. . . . [Under these conditions], a portfolio can be constructed that offers both high returns and diversification.” In other words, you can hold plenty of risky assets with high expected returns as long as they f luctuate independently rather than in step with one another. This is nothing more than Markowitz’s theory of diversification. From the very beginning of Swensen’s régime, Yale has consistently aimed for the maximum possible level of diversification while selecting assets with expected rates of return higher than returns available from conventional asset classes.

But second, these alphas will tend to add little or nothing to the volatility of the portfolio as a whole, because the allocation to each is relatively small and the set of assets involved are only weakly correlated with one another—except through their correlation with equities. The combination of small allocations and weak correlations among the alternative asset classes adds the third and equally surprising feature of the analysis: “The benefit from multiasset diversification is to be found not in reduced volatilities, but rather in enhanced fund returns.” Essentially, these enhanced returns are the result of choosing asset classes that produce more return than would be expected merely on the basis of their betas. Assuming, for the sake of example, that returns on REITs have no correlation with equities, moving cash—a zero-beta asset—into REITs has no impact on portfolio volatility, but REITs do have a higher return than cash.

Assuming, for the sake of example, that returns on REITs have no correlation with equities, moving cash—a zero-beta asset—into REITs has no impact on portfolio volatility, but REITs do have a higher return than cash. This example is extreme, but it illustrates Leibowitz’s point that the attraction of multiasset diversification is in higher returns rather than lower volatility. As usual, there are no free lunches. More realistically, if we move from cash to REITs, the volatility of the portfolio is going to increase. Every time you add any asset class from cash, the beta of the portfolio will rise. Investors who wish to add a new asset class but at the same time feel obliged to hold the portfolio volatility constant will have to take some kind of counter-step to get back to the prescribed volatility level.


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

Albert Einstein, AOL-Time Warner, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bear Stearns, Bernie Madoff, Black Swan, bond market vigilante , book value, Bretton Woods, BRICs, British Empire, business cycle, business process, buy and hold, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, commoditize, commodity super cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, equity risk premium, family office, fiat currency, fixed income, follow your passion, full employment, George Santayana, global macro, Greenspan put, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, inverted yield curve, invisible hand, junk bonds, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, market microstructure, Minsky moment, moral hazard, Myron Scholes, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, proprietary trading, purchasing power parity, quantitative easing, random walk, Reminiscences of a Stock Operator, reserve currency, risk free rate, risk tolerance, risk-adjusted returns, risk/return, savings glut, selection bias, Sharpe ratio, short selling, SoftBank, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, stocks for the long term, survivorship bias, tail risk, The Great Moderation, Thomas Bayes, time value of money, too big to fail, Tragedy of the Commons, transaction costs, two and twenty, unbiased observer, value at risk, Vanguard fund, yield curve, zero-sum game

These vehicles largely pay out traditional risk premia that can be found in the public markets through much simpler, more liquid instruments. Many investors do not use diversification efficiently. There are pension funds that have 80 or 90 percent of their assets invested in equities, arguing that in the long term, this will result in higher returns compared to a more traditional portfolio. This cannot be a smart way of constructing a portfolio. Diversification into more asset classes, perhaps using instruments with embedded leverage, can produce the same or even higher returns with less risk. If you are talking about diversification in the endowment model sense, we may have just witnessed a version of what [George] Soros calls “reflexivity,” whereby people’s behavior affects both the real economy and the markets through a feedback loop (see box).

By this I am speaking less about employing efficient stops and more about constructing a safety net. Wait and buy value. Don’t allocate to an asset class just because you feel the need to diversify, to be involved in every asset bucket. I believe it was Warren Buffett who once said, “Diversification, diworsification.” Trying to create a recipe for managing a portfolio is like trying to create a recipe for making someone laugh: it’s impossible. Diversification has evolved such that people use it to absolve themselves of any blame. Because everything is spread around, they don’t have to commit to anything.

Most plans put too much faith in the equity risk premium, when this is but one of the many risk premia that could be assumed. Further, the diversification that managers thought they had in alternative assets was proven mostly a mirage, as many of the “nonequity” assets included in asset mixes—private capital, real estate, and infrastructure, for example—turned out to be very equity-like after all. In hindsight this makes sense, since all three are businesses packaged in an illiquid form, not securities or asset classes, per se. The diversification that most plans had hoped for in their active programs turned out to be just as much of an illusion.


pages: 353 words: 148,895

Triumph of the Optimists: 101 Years of Global Investment Returns by Elroy Dimson, Paul Marsh, Mike Staunton

asset allocation, banking crisis, Berlin Wall, Black Monday: stock market crash in 1987, book value, Bretton Woods, British Empire, buy and hold, capital asset pricing model, capital controls, central bank independence, classic study, colonial rule, corporate governance, correlation coefficient, cuban missile crisis, currency risk, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, European colonialism, fixed income, floating exchange rates, German hyperinflation, index fund, information asymmetry, joint-stock company, junk bonds, negative equity, new economy, oil shock, passive investing, purchasing power parity, random walk, risk free rate, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, stocks for the long run, survivorship bias, Tax Reform Act of 1986, technology bubble, transaction costs, yield curve

Our figures for equity risk are based exclusively on market indexes that represent highly diversified portfolios. Section 4.6 shows that individual stocks tend to be much riskier than this, and demonstrates the importance and power of diversification for equity investors. Finally, in section 4.7 we present risk comparisons both across asset classes and countries. We show that over the long haul, risk and return have gone hand-in-hand. In the chapters that follow, we then examine each asset class in greater detail—bills and inflation in chapter 5, bonds in chapter 6, currencies and common-currency asset returns in chapter 7, international investment in chapter 8, stock returns in chapters 9–11, and the equity risk premium in chapters 12 and 13. 4.1 The US record The United States is today’s financial superpower.

Later, in chapter 8, we explore the benefits of international diversification. Figure 4-12: Selected periods of large losses on equities around the world 0 -20 Real returns (%) -14 -23 -40 -37 -60 -60 -71 -80 -91 -100 US: Sept 11, 2001 US: October 1987 Crash US: 2000–01 bear market US: Wall Street Crash UK: 1973–74 bear market Germany 1945–48 -97 Japan 1944–47 59 Chapter 4 International capital market history 4.7 Risk comparisons across asset classes and countries For the United States, we have seen that for the major asset classes—equities, bonds, and bills—risk and return went hand in hand.

To Helen, Steff, and our parents Contents Preface xi Part One: 101 years of global investment returns 1 Chapter 1 3 Introduction and overview 1.1 Need for an international perspective 3 1.2 The historical record 5 1.3 Inside the markets 7 1.4 The equity premium 1.5 Sixteen countries, one world Chapter 2 8 10 World markets: today and yesterday 11 2.1 The world’s stock markets today 11 2.2 The world’s bond markets today 14 2.3 Why stock and bond markets matter 18 2.4 The world’s markets yesterday 19 2.5 The US and UK stock markets: 1900 versus 2000 23 2.6 Industry composition: 1900 versus 2000 23 2.7 Stock market concentration 28 2.8 Summary 32 Chapter 3 Measuring long-term returns 34 3.1 Good indexes and bad 34 3.2 Index design: a case study 36 3.3 Dividends, coverage, and weightings 38 3.4 Easy-data bias in international indexes 40 3.5 Measuring inflation and fixed-income returns 43 3.6 Summary 44 Chapter 4 International capital market history 45 4.1 The US record 45 4.2 The UK record 48 4.3 Stock market returns around the world 50 4.4 Equities compared with bonds and bills 51 4.5 Investment risk and the distribution of annual returns 54 4.6 Risk, diversification, and market risk 56 4.7 Risk comparisons across asset classes and countries 59 4.8 Summary 61 vii viii Chapter 5 Inflation, interest rates, and bill returns 63 5.1 Inflation in the United States and the United Kingdom 63 5.2 Inflation around the world 65 5.3 US treasury bills and real interest rates 68 5.4 Real interest rates around the world 71 5.5 Summary 72 Chapter 6 Bond returns 74 6.1 US and UK bond returns 6.2 Bond returns around the world 79 6.3 Bond maturity premia 81 6.4 Inflation-indexed bonds and the real term premium 84 6.5 Corporate bonds and the default risk premium 87 6.6 Summary 89 Chapter 7 Exchange rates and common-currency returns 74 91 7.1 Long-run exchange rate behavior 91 7.2 The international monetary system 93 7.3 Long-run purchasing power parity 95 7.4 Deviations from purchasing power parity 96 7.5 Volatility of exchange rates 98 7.6 Common-currency returns on bonds and equities 100 7.7 Summary 103 Chapter 8 International investment 105 8.1 Local market versus currency risk 105 8.2 A twentieth century world index for equities and bonds 108 8.3 Ex post benefits from holding the world index 111 8.4 Correlations between countries 114 8.5 Prospective gains from international diversification 117 8.6 Home bias and constraints on international investment 120 8.7 Summary 123 Chapter 9 Size effects and seasonality in stock returns 124 9.1 The size effect in the United States 124 9.2 The size effect in the United Kingdom 126 9.3 The size effect around the world 129 9.4 The reversal of the size premium 131 9.5 Seasonality and size 135 9.6 Summary 138 ix Chapter 10 Value and growth in stock returns 139 10.1 Value versus growth in the United States 139 10.2 Value and growth investing in the United Kingdom 142 10.3 The international evidence 145 10.4 Summary 148 Chapter 11 Equity dividends 149 11.1 The impact of income 149 11.2 US and UK dividend growth 152 11.3 Dividend growth around the world 154 11.4 Dividend growth, GDP growth, and real equity returns 155 11.5 Dividend yields around the world and over time 157 11.6 Disappearing dividends 158 11.7 Summary 161 Chapter 12 The equity risk premium 163 12.1 US risk premia relative to bills 163 12.2 Worldwide risk premia relative to bills 166 12.3 US risk premia relative to bonds 169 12.4 Worldwide risk premia relative to bonds 171 12.5 Summary 173 Chapter 13 The prospective risk premium 176 13.1 Why the risk premium matters 177 13.2 How big should the risk premium be?


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The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi

asset allocation, backtesting, Bear Stearns, behavioural economics, Bernie Madoff, Black Swan, book value, business cycle, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, diversification, diversified portfolio, financial engineering, fixed income, global macro, high net worth, implied volatility, index fund, interest rate swap, invisible hand, managed futures, market microstructure, merger arbitrage, moral hazard, Myron Scholes, passive investing, Richard Feynman, Richard Feynman: Challenger O-ring, risk free rate, risk tolerance, risk-adjusted returns, risk/return, search costs, selection bias, Sharpe ratio, short selling, statistical model, stocks for the long run, survivorship bias, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve, zero-sum game

Practitioner research generally focuses on a limited number of asset classes (stocks, bonds, cash, real estate; and so forth), largely because these are the asset classes that most practitioners have to sell. As shown during 2008, those asset classes do not provide the range of assets necessary to provide adequate diversification. Moreover, those asset classes do not contain many of the assets or investment approaches that provide today’s investors the ability to manage risk (however you define it). Just as important, many of the historical correlations reported by these asset classes are, in fact, not representative of correlations between many modern asset vehicles in current market environments.

Where a period starts and where it ends can have significant consequences as to whether the performance looks great or whether the risk looks modest. We also examine the behavior of these traditional alternative asset classes in down markets. The focus on down markets is important from the perspective of risk. So long as everyone is making money, there is very little concern about correlations. However, down markets are where the portfolio shock truly takes place and where the diversification decision is truly tested. Throughout this review the chapter focuses within each section on the sources of return and the risks inherent within each asset class. Finally, the book uses this chapter as a starting point for the benchmark issues discussed in Chapter 8. 134 Sources of Risk and Return in Alternative Investments 135 Keep in mind that this chapter focuses on the general performance of each investment area rather than the performance of individual funds or managers.

However, the correlations of private equity with the other nonequity based indices are very low, suggesting that, over the most recent eight-year period, additional diversification benefits could have been achieved by adding private equity to a non-equity based portfolio, but that adding private equity to an equity biased portfolio may offer limited diversification. It can be observed from Exhibit 7.15 that the information ratios for portfolios that include at least a 10% investment in private equity hedge funds failed to dominate those portfolios that do not include an investment 153 Sources of Risk and Return in Alternative Investments EXHIBIT 7.15 Multiple Asset Class Portfolio Performance (2001−2008) Portfolio Annualized Returns Standard Deviation Information Ratio Maximum Drawdown Correlation with Real Estate Portfolio A Portfolio B Portfolio C Portfolio D A B C D 1.7% 1.34% 2.9% 2.4% 7.5% 9.0% 7.2% 8.9% 0.22 0.15 0.39 0.27 −21.0% −27.1% −21.9% −27.8% 0.81 0.84 Equal Weights S&P 500 and BarCap US Aggregate 90% Portfolio A and 10% Private Equity 75% Portfolio A and 25% HF/CTA/Real Estate/Commodities 90% Portfolio C and 10% Private Equity in private equity.


pages: 542 words: 145,022

In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest by Andrew W. Lo, Stephen R. Foerster

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, backtesting, behavioural economics, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, Charles Babbage, Charles Lindbergh, compound rate of return, corporate governance, COVID-19, credit crunch, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, Edward Glaeser, equity premium, equity risk premium, estate planning, Eugene Fama: efficient market hypothesis, fake news, family office, fear index, fiat currency, financial engineering, financial innovation, financial intermediation, fixed income, hiring and firing, Hyman Minsky, implied volatility, index fund, interest rate swap, Internet Archive, invention of the wheel, Isaac Newton, Jim Simons, John Bogle, John Meriwether, John von Neumann, joint-stock company, junk bonds, Kenneth Arrow, linear programming, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, managed futures, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, new economy, New Journalism, Own Your Own Home, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, prediction markets, price stability, profit maximization, quantitative trading / quantitative finance, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, selection bias, seminal paper, shareholder value, Sharpe ratio, short selling, South Sea Bubble, stochastic process, stocks for the long run, survivorship bias, tail risk, Thales and the olive presses, Thales of Miletus, The Myth of the Rational Market, The Wisdom of Crowds, Thomas Bayes, time value of money, transaction costs, transfer pricing, tulip mania, Vanguard fund, yield curve, zero-coupon bond, zero-sum game

However, the marginal benefit of investing a greater proportion of equities internationally was minimal in his opinion: “If you go from 20 percent to 40 percent, and foreign stocks out-perform by two percentage points per year—which would be astonishing—that’s a 0.40 percentage point benefit.”115 Third, the only asset class diversification required is into bonds. No other asset class investments, such as real estate or other alternatives, are required. And fourth, keep it simple. This means considering low-cost investments such as index funds. “There’s no ideal portfolio, no Perfect Portfolio that ignores cost.”116 In other words, regardless of your investment, be it stocks, bonds, or in another asset class, consider the impact that the cost of acquiring and owning an asset is going to have on your ultimate return.

It also means that to the extent that you can find ways of generating returns which are uncorrelated with that portfolio, those are really good returns, those are the ultimate alphas. It was these findings that eventually led to the Endowment Model of Investing: Return, Risk, and Diversification book.”58 This book starts with Markowitz’s mean-variance framework as its foundation. Investors want to form diversified portfolios that maximize their expected return for a particular acceptable level of risk. Within this framework, Leibowitz, Bova, and Hammond built on the earlier Leibowitz-Bova model that measured asset class betas relative to U.S. equities. The asset class returns were then decomposed into equity beta and alpha components that provided returns beyond those from the beta level.

Since equity risk dominated in the typical endowment and pension fund asset allocations (as described earlier in this chapter), their approach diverged from the typical means of reducing portfolio risk through simple portfolio diversification. Their novel suggestion was to reverse the standard asset allocation process of beginning with basic asset classes such as stocks and bonds, then incrementally adding nonstandard assets such as real estate and commodities. They inverted the process by placing nonstandard asset alpha at the core, subject to a fund’s intrinsic constraints on the acceptable sizing of alpha-producing asset classes. Afterward, the traditional stock/bond assets were incorporated as “swing” assets to bring the portfolio to the desired level of beta risk.


pages: 345 words: 87,745

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

Alan Greenspan, asset allocation, backtesting, Benchmark Capital, Bernie Madoff, book value, buy and hold, capital asset pricing model, cognitive dissonance, correlation coefficient, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, intangible asset, John Bogle, junk bonds, Long Term Capital Management, money market fund, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, Ponzi scheme, prediction markets, proprietary trading, prudent man rule, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, survivorship bias, Tax Reform Act of 1986, too big to fail, transaction costs, Vanguard fund, yield curve, zero-sum game

There is no definitive statement in trust law that says how much a portfolio should be diversified, although there is wording that states, “Risk that can be eliminated by adding different stocks (or bonds) is uncompensated risk. The object of diversification is to minimize this uncompensated risk of having too few investments.”1 By definition, index funds provide the most diversification in each asset class and eliminate all uncompensated risk. In contrast, active fund managers rely on less diversification to beat the index. The managers either limit their holdings to a few favorable securities or they avoid unfavorable sectors. In addition, strategic asset allocation maintains broad diversification to many asset classes while tactical asset allocation may have no exposure or limited exposure to one or more major asset classes.

Today, actively managed funds aren’t needed to gain broad diversification in an asset class. Index funds and ETFs perform that function much more efficiently. The costs are lower, diversification is broader, the transparency of fund holdings is superior, and the tax benefit from lower turnover helps investors whose accounts are subject to taxation. The growth of index funds and ETFs across the spectrum of asset classes has put actively managed fund companies on the defensive. Since the actively managed funds are no longer the most efficient way to gain broad diversification at low cost, the active fund industry has had to fashion another reason for being.

Determine a portfolio’s objective by understanding the investor’s income needs, time horizon, tax situation, ability to handle risk, and unique circumstances. 2. Analyze various asset classes to estimate their long-term risks and returns, correlations with other asset classes, and tax efficiency if applicable. 3. Create an appropriate strategic asset allocation that reflects the investment objectives. 4. Choose securities that best represent each asset class. Low-cost index funds and select ETFs make good choices because they offer broad diversification and closely track market indexes. 5. Implement the plan fully and maintain the strategic asset allocation through occasional rebalancing to control portfolio risk and enhance return.


pages: 162 words: 50,108

The Little Book of Hedge Funds by Anthony Scaramucci

Alan Greenspan, Andrei Shleifer, asset allocation, Bear Stearns, Bernie Madoff, business process, carried interest, corporate raider, Credit Default Swap, diversification, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, financial engineering, fixed income, follow your passion, global macro, Gordon Gekko, high net worth, index fund, it's over 9,000, John Bogle, John Meriwether, Long Term Capital Management, mail merge, managed futures, margin call, mass immigration, merger arbitrage, Michael Milken, money market fund, Myron Scholes, NetJets, Ponzi scheme, profit motive, proprietary trading, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, risk/return, Ronald Reagan, Saturday Night Live, Sharpe ratio, short selling, short squeeze, Silicon Valley, tail risk, Thales and the olive presses, Thales of Miletus, the new new thing, too big to fail, transaction costs, two and twenty, uptick rule, Vanguard fund, Y2K, Yogi Berra, zero-sum game

This collected pool of capital—assets under management—enables them to meet the investing threshold of certain hedge funds that have a high level of entry. Unlike a hedge fund, the fund of hedge funds manager does not make direct investments in securities himself. Instead, he invests in a multiple number of actual hedge funds so as to enhance diversification. This blending of different funds—that exhibit different investing strategies and represent multiple asset classes—delivers a more consistent return than any individual fund because it lowers the total risk of the portfolio. As such, a fund of hedge funds’ emphasis is on long-term performance with minimal volatility. So, just how does a fund of hedge funds manager allocate his portfolio?

Then, he constructs a portfolio that thematically and tactically allocates assets among more than 20 hedge fund managers and strategies that are better able to account for global macroeconomic conditions and specific opportunities. In doing so, he focuses on selecting a series of noncorrelated (or low) funds so as to diversify risk exposures. In other words, he targets and selects hedge funds that are fundamentally different from one another. This diversification can be achieved by investing in different asset classes, sectors, or geographic regions. In doing so, he enhances the returns of the portfolio while reducing risk. Along the way, he adds additional value by actively shifting investment exposure to emerging opportunity sets with an attractive risk/reward proposition and correlation characteristics.

For example, for as little as $50,000 a Registered Investment Company (RIC) provides individuals with access through the same aggregation that a fund of funds provides. These types of products put relatively small investors in the catbird seat, benefitting from the aggregation but also from the rigorous analysis and risk management. Diversification = Mitigated Risk As discussed previously, a fund of hedge funds holds a diversified portfolio of various hedge funds that invest in different asset classes, alternative investment styles, and geographic regions. Although there is not a magic number, it is recommended that a fund of hedge funds invest in about 30 to 50 managers, with the typical sweet spot being around 35 to 40 managers.


pages: 407 words: 114,478

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

Alan Greenspan, asset allocation, behavioural economics, book value, Bretton Woods, British Empire, business cycle, butter production in bangladesh, buy and hold, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial engineering, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, Glass-Steagall Act, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Bogle, John Harrison: Longitude, junk bonds, Long Term Capital Management, loss aversion, low interest rates, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, Performance of Mutual Funds in the Period, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Savings and loan crisis, South Sea Bubble, stock buybacks, stocks for the long run, stocks for the long term, survivorship bias, Teledyne, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

So her initial target allocation will be split between just two asset classes—taxable cash and sheltered S&P 500. Each year thereafter, she plans to contribute the maximum allowed in her IRA, placing the excess in her taxable money fund for emergencies. And thanks to the Tax Relief Reconciliation Act of 2001, the amounts that she can contribute to her IRA will increase from $3,000 in 2002 to $5,000 in 2008. At what point does she start to diversify into other asset classes? I’ve already mentioned the tradeoff between diversification and fees; each asset class will provide her with additional diversification, but will also cost her the $10 per year fee for fund accounts of less than $5,000.

The moral remains the same: performance comes and goes, but expenses are forever. Diversification still works in the long run. That, of course, is not what you’re hearing these days, and for good reason. Consider the returns of the following asset classes during the great bear market of 2007–2009: During the most recent market turmoil, there was simply no place to hide; all stocks got hammered, and the further investors strayed from the good old S&P 500, the more they lost. Next, let’s look at the bear market of 2000–2002. Here, diversification seemed to work a bit better. The madness of the preceding 1990s was confined largely to tech stocks and to the largest growth companies, which investors saw as the new wired world’s primary beneficiaries.

Once you’ve answered them, you’re 80% of the way home. If you’re lazy or just plain not interested, you can actually get by with only three asset classes, and thus, three mutual funds: the total U.S. stock market, foreign stocks, and short-term bonds. That’s it—done. However, there are a few relatively simple extra portfolio wrinkles that are worth incorporating into your asset allocation repertoire. We’ve already talked about the extra return offered by value stocks and small stocks. The diversification benefits of small stocks and value stocks are less certain. For example, during the 1973–74 bear market, value stocks did much better than growth stocks; the former lost only 23% versus 37% for the latter.


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The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

asset allocation, behavioural economics, book value, buy and hold, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial engineering, financial independence, financial innovation, high net worth, index fund, John Bogle, junk bonds, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, stocks for the long run, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

It's very difficult to find negatively correlated asset classes that have similar expected returns. The closer the number is to 1.0, the higher the correlation between the two assets, and the lower the number, the less correlation there is between the two investments. So, a correlation figure of 0.71 would mean the two assets are not perfectly correlated, but a fund with a correlation figure of 0.52 would offer still more diversification, since it has an even lower number. Despite what some investors think, simply owning a large number of mutual funds doesn't automatically achieve greater diversification. If a portfolio holds a number of funds that overlap and are highly correlated, there is little benefit.

After careful consideration of all the factors we've discussed here, you and your spouse agree on a portfolio allocation of stocks and bonds that seems about right for you. Congratulations! You've just made your most important portfolio decision. Subdividing Your Stock Allocation It's important for maximum diversification that our stock allocation contain various subcategories. This is because different types of stocks perform differently at different times. No investor wants to own a portfolio that has all of its equity investments in an underperforming asset class. Accordingly, we want to have some exposure to as many different types of stocks as is reasonably practical. Morningstar's Style Box, Table 8.3, is a useful tool that shows how your portfolio's equity holdings are divided between the different styles and sizes.

Real Estate Investment Trusts (REITs) area special type of fund and are sometimes considered a separate asset class from stocks and bonds. This is because REIT funds often behave differently than other stocks. This characteristic of noncorrelation can make them a worthwhile addition to larger portfolios. We suggest that REIT funds not exceed 10 percent of your equity allocation. International Stocks U.S. stocks represent about half the value of world stocks, with foreign stocks representing the other half. Foreign stocks offer diversification and possibly higher returns, but they also carry more risk in the form of political instability, weak regulation, higher transaction costs, and different accounting practices.


pages: 337 words: 89,075

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

accounting loophole / creative accounting, airline deregulation, Alan Greenspan, Andrei Shleifer, asset allocation, Bretton Woods, business cycle, buy and hold, buy low sell high, California energy crisis, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, equity risk premium, financial engineering, fixed income, frictionless, global macro, high net worth, index fund, inflation targeting, invisible hand, John Meriwether, junk bonds, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low cost airline, low interest rates, market bubble, merger arbitrage, money market fund, new economy, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, Phillips curve, price mechanism, purchasing power parity, risk free rate, risk tolerance, risk-adjusted returns, risk/return, rolling blackouts, Ronald Reagan, Savings and loan crisis, selection bias, seminal paper, shareholder value, Sharpe ratio, short selling, statistical arbitrage, stocks for the long run, survivorship bias, systematic bias, Tax Reform Act of 1986, the market place, transaction costs, Y2K, yield curve, zero-sum game

Chapter 6 To Start, a Benchmark 113 But, the results also show the SAA produces a much lower correlation with the market. The diversification in the portfolio seems to produce the highly desirable lower risk outcome without any reduction in returns, something economists call a free lunch. Ideally, one would then search for those asset classes that would add alpha (that is, excess returns to a portfolio) without increasing beta (that is, the risk of the portfolio in relation to the benchmark). Now, let’s apply the Sharpe ratio. Once more, the Sharpe ratio divides a portfolio’s excess returns (returns less risk less Treasury bill returns) by its volatility. In effect, the Sharpe ratio treats each asset class as a separate portfolio, focusing on the standard deviations that measure total risk.

To my surprise, correctly identifying the location (domestic versus international) during the 30-year period would have added 635 basis points over the performance of the large-cap stocks. This result surprises given that international stocks exhibit lower average returns and higher volatilities than large-cap stocks, as well as lower Sharpe ratios within the equity asset classes. The numbers illustrate the power of diversification. A lack of synchronization between the domestic and foreign markets offers a potential upside to an active global strategy. 58 UNDERSTANDING ASSET ALLOCATION The Case for a Cyclical Asset-Allocation Strategy In brief, those are your cycles. Now, let’s draw a few early conclusions.

Figure 6.3 illustrates the SAA produced by my interpretation of the various asset classes’ market weights. Either exchange-traded funds (ETFs), or passively managed low-cost index funds, could fill most buckets in question. ETFs and the low cost-managed index funds are diversified baskets of securities designed to track the performance of well-known indices, proprietary indices or basket of securities. The major differences between the two is that the ETF are traded as individual stocks on major exchanges while the passive funds are subject to the traditional mutual funds-pricing mechanism (that is, at the close of market). They offer diversification or exposure to an entire market index or sector with one security at very low costs (that is, management fees).


pages: 236 words: 77,735

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

affirmative action, Alan Greenspan, asset allocation, backtesting, barriers to entry, Bear Stearns, Bernie Madoff, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fear index, fiat currency, financial engineering, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, Glass-Steagall Act, global macro, High speed trading, housing crisis, index fund, joint-stock company, junk bonds, managed futures, Market Wizards by Jack D. Schwager, Michael Milken, military-industrial complex, money market fund, moral hazard, Myron Scholes, National best bid and offer, off-the-grid, passive investing, Ponzi scheme, power law, price discovery process, proprietary trading, random walk, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, risk/return, Savings and loan crisis, short squeeze, stocks for the long run, stocks for the long term, too big to fail, trade route, Vanguard fund, walking around money

Bar Charts Source: http://upload.wikimedia.org/wikipedia/commons/thumb/b/b4/Piecharts.svg/2000px-Piecharts.svg.png The individual investor is told asset allocation is diversifying a portfolio among different types of asset classes such as stocks, bonds, and cash. Advisers always try to make a big deal out of some assets such as international stocks and commodities because they have become much more in vogue this past decade. asset class Describes the general type of asset in the context of a portfolio. Stocks, bonds, real estate, and commodities are the most common portfolio assets for investors. However, asset classes also include stamp collections, Beanie Babies, and private equity. Usually used by advisers to impress clients with the broad diversification of terms a single asset class can be split up into.

One of the primary reasons for including bonds in a portfolio is the diversification factor, coupled with income generation. That said, how is an investor supposed to commit large allocations of capital in fixed income ETFs with that sinking feeling that this 30-year party may be over? MLPs are neither stock nor bond, but they can be an alternative to a portfolio seeking diversification and income outside of traditional asset classes. If you were thinking of buying higher-volatility bond ETFs like HYG, JNK, or PFD, read on and find another way to capture higher risk return and diversification. In their simplest form, MLPs are publicly traded organizations that are structured as limited partnerships (LP) rather than corporations.

Getting back to my problem back in tech land, when I looked at the portfolios, everything lacked diversification. Just because you owned a software firm, a chipmaker, and a money-losing dot-com retailer didn’t mean you were diversified. Why? It didn’t have anything to do with the fact that these were all Internet or tech-oriented companies. It was that they moved together. This is where Wall Street confuses investors and gets them off their dime. They tell you to diversify, either by way of asset class or sector. For instance, you might be told to buy small-cap stocks to diversify your large-cap holdings, or maybe to have some health care stocks to balance out your energy companies.


The Handbook of Personal Wealth Management by Reuvid, Jonathan.

asset allocation, banking crisis, BRICs, business cycle, buy and hold, carbon credits, collapse of Lehman Brothers, correlation coefficient, credit crunch, cross-subsidies, currency risk, diversification, diversified portfolio, estate planning, financial deregulation, fixed income, global macro, high net worth, income per capita, index fund, interest rate swap, laissez-faire capitalism, land tenure, low interest rates, managed futures, market bubble, merger arbitrage, negative equity, new economy, Northern Rock, pattern recognition, Ponzi scheme, prediction markets, proprietary trading, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, short selling, side project, sovereign wealth fund, statistical arbitrage, systematic trading, transaction costs, yield curve

Selecting the correct number of funds within a portfolio has already been mentioned: too many investments detract from performance, while having too few deters from portfolio diversification. Figure 1.2.5 represents the analysis of a selected portfolio to identify ‘the right level of diversification’. The figures were generated by running 5,000 simulations for each number of funds. Each simulation defines an equally weighted random portfolio. The portfolio is selected from 500 equity funds with data history from 2003 to 2008. The average portfolio volatility is the average volatility observed across the 5,000 simulations. Studies like this show that diversification steadily results in a volatility that is more attributable to the index of the asset class universe and becomes less a function of the fund selection itself.

This therefore becomes an excellent method of longterm capital growth and wealth preservation. Real estate value has experienced historically low volatility. Until recently, UK real estate has shown steady returns over the long term relative to other asset classes. In the context of portfolio diversification, real estate has a low correlation with other asset classes. Real estate has proved to be an effective inflation hedge. Who invests in which type of real estate structure? Generally speaking, the higher the clients’ net worth, the more likely they are to entertain niche funds or investment vehicles and direct real estate investment.

These are unusual characteristics compared with other asset classes, hence offering benefits to many institutional and private investors that are further explained below. Finally, new environmental markets such as carbon credits, biomass and windfarms are rapidly emerging, reinforcing future forestry income and values. Special qualities of forestry investment Portfolio diversification One major feature of forestry investments is that they have been shown to have a non-correlation with stocks and bonds, as evidenced by Table 2.3.1. As a result, forestry is considered to have strong diversification potential and the capability of reducing an investment portfolio’s overall risk.


pages: 250 words: 77,544

Personal Investing: The Missing Manual by Bonnie Biafore, Amy E. Buttell, Carol Fabbri

asset allocation, asset-backed security, book value, business cycle, buy and hold, currency risk, diversification, diversified portfolio, Donald Trump, employer provided health coverage, estate planning, fixed income, Home mortgage interest deduction, index fund, John Bogle, Kickstarter, low interest rates, money market fund, mortgage tax deduction, risk tolerance, risk-adjusted returns, Rubik’s Cube, Sharpe ratio, stocks for the long run, Vanguard fund, Yogi Berra, zero-coupon bond

Manage Your Portfolio 161 Other Ways to Diversify If you’re just starting out in personal investing, you can keep diversification plain and simple, as you learn on page 166. With time and a larger portfolio, you may decide to diversify your investments in several ways: by different-sized companies, by market sectors and industries, or by geographic regions. The following table explains how these types of diversification can help your portfolio. Diversification by Effect Asset class A mixture of stocks, bonds, REITs, and cash offers better overall returns with more dependable year-to-year performance.

For example, high market interest rates mean more income for investors who buy and hold bonds, but high rates drag stock prices down. (That’s because investors would rather buy bonds, which are less risky than stocks, when bonds deliver a return that’s close to that of stocks.) With a mixture of asset classes, your portfolio returns from year to year are more consistent. If you buy individual stocks or bonds, diversification means no one investment can seriously harm your portfolio. Regardless of how thoroughly you research investments, some do better than you expect, some do worse, and most perform about on target. If you own one stock and it drops 50%, you lose 50%.

When you point to a profile, a pie chart shows the suggested asset allocation and provides some details about it, such as the time horizon and the average annual return. To see mutual funds that Schwab suggests for each asset class, click “See sample portfolio” below the pie chart. Manage Your Portfolio 165 Asset Allocation Made Ridiculously Easy In Chapter 5, you learned how index funds are a low-cost way to diversify your portfolio among all sorts of investments. They provide instant diversification, because they own many individual investments within categories like large and small companies, industries and sectors, bonds, and geographical regions. Because they follow indexes, their expenses and turnover are low.


pages: 244 words: 58,247

The Gone Fishin' Portfolio: Get Wise, Get Wealthy...and Get on With Your Life by Alexander Green

Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, backtesting, behavioural economics, borderless world, buy and hold, buy low sell high, cognitive dissonance, diversification, diversified portfolio, Elliott wave, endowment effect, Everybody Ought to Be Rich, financial independence, fixed income, framing effect, hedonic treadmill, high net worth, hindsight bias, impulse control, index fund, interest rate swap, Johann Wolfgang von Goethe, John Bogle, junk bonds, Long Term Capital Management, means of production, mental accounting, Michael Milken, money market fund, Paul Samuelson, Ponzi scheme, risk tolerance, risk-adjusted returns, short selling, statistical model, stocks for the long run, sunk-cost fallacy, transaction costs, Vanguard fund, yield curve

FIGURE 7.1 The Gone Fishin’ Asset Allocation In any given year, these assets will generate returns that may be greater or less than their long-term average. No one can tell you for certain what any of these asset classes will return next year or over the next 10 years. In certain years, the returns for some asset classes will be negative. Going forward, however, it is reasonable to expect that the long-term returns will be close to their historic averages. Furthermore, by combining these assets we can look forward to earning a handsome return without taking the risk of being fully invested in stocks. That’s because these asset classes are not perfectly correlated. In other words, when some zig, others will zag. This reduces the swings in value you’d otherwise see on your statements month to month, and year to year.

WHAT TO TELL THE NAYSAYERS There are some aspects of the Gone Fishin’ strategy that critics—and fee-oriented investment advisors—may find controversial. I want to address those potential objections now. Some, for example, may object to the inclusion of asset classes like gold shares and junk bonds. Others will question the weightings of different asset classes. Still others will question the “one-size-fits-all” nature of this strategy. I’m happy to rebut them all. Unusual Success from Unusual Assets Let’s begin by looking at the reasons for the inclusion of more controversial asset classes like gold shares, foreign stocks (particularly emerging market stocks), and high-yield bonds. In my view, the key to diversifying wisely is including investments that tend to be out of sync with the rest of your holdings.

Long-term investors need to fight this instinct and think like Ebenezer Scrooge instead. Forget what the hot asset class is doing. You want to buy what’s cheapest for the long-term advantage it confers. As investment great John Templeton has said, “To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greatest reward.” Don’t thwart the power of this strategy by succumbing to the temptation to buy more of your winning funds. Given enough time, each asset class will experience a down cycle. That’s when you’ll add to them. When they’re cheap and out of favor.


pages: 249 words: 77,342

The Behavioral Investor by Daniel Crosby

affirmative action, Asian financial crisis, asset allocation, availability heuristic, backtesting, bank run, behavioural economics, Black Monday: stock market crash in 1987, Black Swan, book value, buy and hold, cognitive dissonance, colonial rule, compound rate of return, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, disinformation, diversification, diversified portfolio, Donald Trump, Dunning–Kruger effect, endowment effect, equity risk premium, fake news, feminist movement, Flash crash, haute cuisine, hedonic treadmill, housing crisis, IKEA effect, impact investing, impulse control, index fund, Isaac Newton, Japanese asset price bubble, job automation, longitudinal study, loss aversion, market bubble, market fundamentalism, mental accounting, meta-analysis, Milgram experiment, moral panic, Murray Gell-Mann, Nate Silver, neurotypical, Nick Bostrom, passive investing, pattern recognition, Pepsi Challenge, Ponzi scheme, prediction markets, random walk, Reminiscences of a Stock Operator, Richard Feynman, Richard Thaler, risk tolerance, Robert Shiller, science of happiness, Shai Danziger, short selling, South Sea Bubble, Stanford prison experiment, Stephen Hawking, Steve Jobs, stocks for the long run, sunk-cost fallacy, systems thinking, TED Talk, Thales of Miletus, The Signal and the Noise by Nate Silver, Tragedy of the Commons, trolley problem, tulip mania, Vanguard fund, When a measure becomes a target

The results for small capitalization stocks, often considered to be less efficiently priced and therefore more favorable to active management, are just as damning: 87.75% of small cap managers were bested by passive approaches. Diversification is likewise rooted in an ethos of, “you can’t be sure of anything so buy everything” and is proof that conceding to uncertainty does not have to mean compromising returns. In fact, broad diversification and rebalancing have been shown to add half a percentage point of performance per year, a number that can seem small until you realize how it is compounded over an investment lifetime. For evidence of the efficacy of diversification and rebalancing take, for example, the case of European, Pacific and US Stocks cited in A Wealth of Common Sense.

Since that time, Apple shares have gone from $74 to $142, but I still hope that the man heeded my advice that day to diversify his position. One of the most important rules of behavioral investing is that results matter less than the process; you can be right and still be a moron. Diversification has become such a broadly accepted good in asset management that it seems many have forgotten the underlying reasons for doing it. Considered from a behavioral lens, diversification is humility made flesh, the embodiment of managing ego risk. Diversification is a concrete nod to the luck and uncertainty inherent in money management and an admission that the future is unknowable. As evidenced by the JP Morgan research in the following table, single stock ownership can indeed be harrowing, with nearly half of all stocks suffering catastrophic losses in their lifetime.

As evidenced by the JP Morgan research in the following table, single stock ownership can indeed be harrowing, with nearly half of all stocks suffering catastrophic losses in their lifetime. But diversification is a lot like medicine (or candy, or children) in the sense that some is good but more is not always better. In fact, diversification can be achieved with fewer holdings than most understand and over-diversification can be an impediment. Catastrophic losses of single stocks Sector Total % of companies experiencing catastrophic loss, 1980–2014 All sectors 40% Consumer Discretionary 43% Consumer Staples 26% Energy 47% Materials 34% Industrials 35% Health Care 42% Financials 25% Information Technology 57% Telecommunication Services 51% Utilities 13% Source: Isaac Presley, ‘How Concentrated is Too Concentrated?


pages: 321

Finding Alphas: A Quantitative Approach to Building Trading Strategies by Igor Tulchinsky

algorithmic trading, asset allocation, automated trading system, backpropagation, backtesting, barriers to entry, behavioural economics, book value, business cycle, buy and hold, capital asset pricing model, constrained optimization, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, currency risk, data science, deep learning, discounted cash flows, discrete time, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial engineering, financial intermediation, Flash crash, Geoffrey Hinton, implied volatility, index arbitrage, index fund, intangible asset, iterative process, Long Term Capital Management, loss aversion, low interest rates, machine readable, market design, market microstructure, merger arbitrage, natural language processing, passive investing, pattern recognition, performance metric, Performance of Mutual Funds in the Period, popular capitalism, prediction markets, price discovery process, profit motive, proprietary trading, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, selection bias, sentiment analysis, shareholder value, Sharpe ratio, short selling, Silicon Valley, speech recognition, statistical arbitrage, statistical model, stochastic process, survivorship bias, systematic bias, systematic trading, text mining, transaction costs, Vanguard fund, yield curve

If the bootstrapped drawdown is controlled, it is safer to believe that the underlying distribution will not produce extreme drawdowns. 108 Finding Alphas CONTROLLING RISKS Diversify When Possible Because different instruments are exposed to different types of risk and volatility scales like the square root of the number of independent variables, the extrinsic and intrinsic risks of an alpha or portfolio can generally be reduced by diversification, as long as the position concentrations are under control. For example, alphas constructed only on the FTSE 100 have lower diversification than alphas constructed on the entire set of UK and European stocks. Diversification can include new instruments, new regions or sectors, and new asset classes. The lower the correlations between the instruments, the better the risk approximates the ideal central limit theorem. However, there are limits to diversification. If the instruments are too diverse, the volatilities may be too heterogeneous to allow all the instruments to contribute meaningfully without excessive concentration risk, or the instruments may simply behave too differently for the same alpha ideas to be relevant.

TAP is really just a tool to organize the complex, multidimensional alpha space. It offers a number of advantages for portfolio diversification. The alpha space is vast, with a high and growing number of degrees of freedom, and there is an almost unlimited number of possible alphas, with each region or cluster of alphas possessing different topographies that require discovery and exploration. A quant has a plethora of choices. She can make predictions to trade over intervals ranging from microseconds to years. She can make predictions on different asset classes, most commonly equities, bonds, commodities, and currencies. But the set of possible elements that a quant can manipulate is growing all the time – more datasets, more parameters, more ideas.

How do I start the search?” Even experienced quants working with many alphas can miss key components required to build a robust, diversified portfolio. For instance, one of the most difficult aspects of alpha portfolio construction is the need to optimize the level of diversification of the portfolio. In automated trading systems, decisions on diversification make up a major area of human intervention. It’s not easy to visualize the many pieces of the portfolio, which contain hundreds or thousands of alphas, and their interactions. TAP emerged from those concerns. When new quants start conducting alpha research, many begin by searching the internet for articles about developing alphas.


pages: 356 words: 51,419

The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns by John C. Bogle

asset allocation, backtesting, buy and hold, creative destruction, currency risk, diversification, diversified portfolio, financial intermediation, fixed income, index fund, invention of the wheel, Isaac Newton, John Bogle, junk bonds, low interest rates, new economy, passive investing, Paul Samuelson, random walk, risk tolerance, risk-adjusted returns, Sharpe ratio, stocks for the long run, survivorship bias, transaction costs, Upton Sinclair, Vanguard fund, William of Occam, yield management, zero-sum game

I wouldn’t dream of consuming valuable pages in this small book with a weighty bibliography, so please don’t hesitate to visit my website. Notes 1 Keep in mind that an index may also be constructed around the bond market, or even “road less traveled” asset classes such as commodities or real estate. Today, if you wish, you could literally hold all your wealth in a diversified portfolio of low-cost traditional index funds representing every asset class and every market sector within the United States or around the globe. 2 Over the past century, the average nominal return on U.S. stocks was 10.1 percent per year. In real terms (after 3.4 percent inflation) the real annual return was 6.7 percent.

“I really love his overall message on staying the course, focusing on dividends, keeping investment costs low, and ignoring stock prices. He also believes in keeping things simple. Bogle is against the widespread practice today of building portfolios that consist of 10–15 asset classes, whose sole purpose is to create complexity to generate fees for greedy asset managers. Keeping it simple means owning stocks and some bonds. It also means not getting too fancy and too carried away by adding fashionable asset classes whose merits are derived from a backtested computer model.” Chapter Seven The Grand Illusion Surprise! The Returns Reported by Mutual Funds Are Rarely Earned by Mutual Fund Investors.

Simply put, the ETF is an index fund designed to facilitate trading in its shares, dressed in the guise of the traditional index fund. If long-term investment was the paradigm for the original TIF designed 42 years ago, surely using index funds as trading vehicles can only be described as short-term speculation. If the broadest possible diversification was the original paradigm, surely holding discrete—even widely diversified—sectors of the market offers far less diversification and commensurately more risk. If the original paradigm was minimal cost, then this is obviated by holding market-sector index funds that carry higher costs, entail brokerage commissions when they are traded, and incur tax burdens if one has the good fortune to trade successfully.


pages: 130 words: 32,279

Beyond the 4% Rule: The Science of Retirement Portfolios That Last a Lifetime by Abraham Okusanya

asset allocation, diversification, diversified portfolio, high net worth, longitudinal study, low interest rates, market design, mental accounting, Paul Samuelson, quantitative easing, risk tolerance, risk-adjusted returns, Robert Shiller, seminal paper, tail risk, The 4% rule, transaction costs, William Bengen

,2007 to Mar., 2009) a) High-yield asset classes such as commercial property/ REITs, equities and high-yield bonds tend to have large drawdowns, particularly during stressful market conditions. Fig. 19 is taken from the Vanguard paper referred to earlier and it shows the total returns of major asset classes, including high-yield ones during the financial crisis of 2008. As you can see, income-yielding asset classes experienced larger losses. b) Overweighting high-yield asset classes invariably increases concentration risk and reduces diversification in the portfolio. c) There’s some empirical evidence to suggest that high dividend stocks tend to outperform over the very long term.

They may sacrifice some upside and residual wealth, but they’ll probably sleep more easily! Commodities and alternatives What about other asset classes? Many people have questioned whether including other asset classes like commercial property and commodities improves withdrawal rates. We can’t make an assertion one way or the other, because historical records for these asset classes don’t go back far enough. Cassaday (2006)50 indicated that adding other asset classes, such as REITs, commodities and international exposures, potentially has a positive impact on sustainable withdrawal rates. However, this research was limited in its scope; the authors only used US historical data since 1972 and assumed 3% static inflation.

However, this research was limited in its scope; the authors only used US historical data since 1972 and assumed 3% static inflation. So, the period covered in the research excluded some of the more severe periods like the early 1900s and 1936. It’s not clear whether these asset classes would add much value under such stressful market conditions. My take on this is that the likely benefit of adding these asset classes to a retirement portfolio are theoretical and at best, modest. These asset classes should only be used sparingly, if at all, (less than 10% of the portfolio allocation) and at very low cost. Impact of alpha on SWR One common question about the SWR framework is what’s the impact of superior investment return, also known as alpha, on sustainable withdrawals?


Mastering Private Equity by Zeisberger, Claudia,Prahl, Michael,White, Bowen, Michael Prahl, Bowen White

Alan Greenspan, asset allocation, backtesting, barriers to entry, Basel III, Bear Stearns, book value, business process, buy low sell high, capital controls, carbon credits, carried interest, clean tech, commoditize, corporate governance, corporate raider, correlation coefficient, creative destruction, currency risk, deal flow, discounted cash flows, disintermediation, disruptive innovation, distributed generation, diversification, diversified portfolio, family office, fixed income, high net worth, impact investing, information asymmetry, intangible asset, junk bonds, Lean Startup, low interest rates, market clearing, Michael Milken, passive investing, pattern recognition, performance metric, price mechanism, profit maximization, proprietary trading, risk tolerance, risk-adjusted returns, risk/return, Savings and loan crisis, shareholder value, Sharpe ratio, Silicon Valley, sovereign wealth fund, statistical arbitrage, time value of money, transaction costs, two and twenty

Family offices and endowment funds have lower liquidity needs and on average make substantial, double-digit allocations to the asset class. Exhibit 18.2 shows PE target allocations as a percentage of AUM for different types of institutional investors over the years. Exhibit 18.2 PE Target Allocation by Investor Type Source: Preqin DIVERSIFICATION: The degree of diversification within a PE portfolio and specific allocation decisions depend on an LP’s risk appetite, its target return for the asset class and the resources available to build and manage a PE portfolio. LPs diversify their PE allocation across a range of factors including manager, investment strategy (venture, growth, buyouts), geography, industry and vintage year.

Exhibit 5.4 provides a simple overview of the two project stages (early stage and mature) and the risk−return characteristics of real estate, infrastructure and natural resources projects. Exhibit 5.4 Real Assets Project Stage Mature real assets provide not only a steady dividend stream but also diversification benefits to any investment portfolio given their historically uncorrelated returns with other asset classes. This has made them an attractive target for large institutional investors with a long-term investment horizon and an appetite for cash distributions to offset regular funding demands from their investment programs. Real asset investments also provide an effective hedge against inflation, as the real asset pricing risk is effectively transferred to the consumer.

payment blockage payment subordination PE see private equity pension plans performance see also key performance indicators performance reporting evaluating performance ILPA article interim performance IRR conundrum public equity portfolios pitch books placement agents plans/planning 100-Day plans compensation plans ESOPs partnerships pension plans PME see public market equivalent approach portfolio companies portfolio management allocations to PE benefits of investing challenges of investing construction of portfolio existing portfolios fund manager selection investing in PE asset class limited partners LP commitment strategies LP portfolio management optimizing exits relative value approach portfolio risk portfolios construction diversification management public equity secondary sale of positioning post-closing deal pricing adjustments post/pre-money valuation PPM see Private Placement Memorandum PPPs see public private partnerships Prahl, Michael preferred shares Preliminary Investment Memorandum pre-marketing fundraising stage pre/post-money valuation presentation, management price/pricing buyouts direct secondaries LP secondaries “price chipping” see also deal pricing primary funds private capital private debt private equity (PE) definition evolution last 45 years overview Private Placement Memorandum (PPM) privatization proactive ESG management program-driven ESG approach proof-of-concept start-up stage proprietary deal flow public equity market risk PE comparison portfolios unrealized value public market equivalent (PME) approach public private partnerships (PPPs) public-to-private (P2P) transactions purchaser protection purchases see sale and purchase agreements questionnaires, DD RCF see revolving credit facility real asset investing real estate realization risk recapitalizations regulations, marketing regulatory pressure regulatory risks reinvestment assumption relative value approach reporting LPAs performance risk reps (representations) and warranties resources responsible investment continuum definition ESG growth markets restructuring returns co-investment corporate governance high returns/risks leveraged buyouts portfolio management time-weighted see also internal rate of return revolving credit facility (RCF) right of first refusal risk co-investment direct investment foreign exchange high returns/risks risk-focused ESG programs risk management asset class risk currency hedging direct investment risk fund manager risk for general partners portfolio risk roll-up strategies sale and purchase agreements (SPAs) buyout debt documentation “clean exit” vs purchaser protection deal pricing sales growth sales multiples scaling up start-up stage screening fund managers second lien term loans secondaries annual volume 2002-2015 deal structuring direct executing transactions LP secondaries transaction types secondary buyouts secondary investments secondary sale of portfolio sellers senior debt debt instruments distressed private equity leveraged buyouts transaction documents shared services shareholder agreements (SHAs) shareholder model shareholders listed PE firms loans minority shareholding structures share transfer restrictions shares, preferred SHAs see shareholder agreements side letters site visits small and medium-sized enterprises (SMEs) social factors see also environmental, social and governance factors sourcing deals Southey Holdings sovereign wealth funds SPAs see sale and purchase agreements special purpose vehicles (SPVs) buyout debt documentation deal structuring secondaries spin-offs spin-outs SPVs see special purpose vehicles standardization of PE standstill periods staple financing stapled secondaries start-up companies accelerators commercialization development incubators proof-of-concept scaling up venture capital see also early-stage companies steady state steady-state end-of-fund life options strategic alignment strategic buyers structural subordination structured secondaries structuring deals style drift subscription process subsequent closings success succession swaps sweet equity syndication tag-along provisions tail-end funds talent attraction Tank & Rast service stations target allocations target returns target valuation buyouts enterprise value growth equity toolkit valuation multiples venture capital tax risks team builders teams deal in-house operating see also management teams telecommunications industry term sheets termination Terra Firma third party sales time-weighted returns top-down reviews top-down valuation total return swaps total-value-to-paid-in (TVPI) track records transaction documentation buyout debt documentation buyout key documents “clean exit” vs purchaser protection equity documentation transaction fees transaction financing transfer restrictions transferability of fund interests transparency trust trusts, liquidating turnaround investing turnover provision TVPI see total-value-to-paid-in two-stage auction process United States (US) compensation plans distressed private equity evolution of PE fundraising see also North America unrealized value value-add strategy value creation growth equity impact of PE LBO investing see also operational value creation value drivers valuation company valuation football field leveraged buyouts LP secondaries multiples venture capital see also target valuation VC see venture capital vendor due diligence (VDD) vendor financing venture capital (VC) characteristics corporate governance corporate VC deal sourcing definition evolution of PE first-time entrepreneurs geographic location high returns/risks investment process management teams staged funding start-up companies term sheets valuation venture capitalists venture philanthropy warranties White, Bowen winding down funds end-of-fund life options GP-led liquidity solutions liquidating funds zombie funds working capital Zeisberger, Claudia zombie funds GP perspectives lifecycle limited partnership agreements LP perspectives monitoring multiple funds review of fund structure WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA.


pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

activist fund / activist shareholder / activist investor, Alan Greenspan, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Black-Scholes formula, book value, Brownian motion, business cycle, buy and hold, buy low sell high, buy the rumour, sell the news, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, currency risk, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, global macro, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, junk bonds, late capitalism, law of one price, Long Term Capital Management, low interest rates, managed futures, margin call, market clearing, market design, market friction, Market Wizards by Jack D. Schwager, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, Phillips curve, price discovery process, price stability, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, Renaissance Technologies, Richard Thaler, risk free rate, risk-adjusted returns, risk/return, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, short squeeze, SoftBank, sovereign wealth fund, statistical arbitrage, statistical model, stocks for the long run, stocks for the long term, survivorship bias, systematic trading, tail risk, technology bubble, time dilation, time value of money, total factor productivity, transaction costs, two and twenty, value at risk, Vanguard fund, yield curve, zero-coupon bond

Its consistent cumulative return is seen in figure 12.3, which illustrates the hypothetical growth of $100 invested in 1985 in the diversified TSMOM strategy and the S&P 500 stock market index, respectively. 12.4. DIVERSIFICATION: TRENDS WITH BENEFITS To understand this strong performance of time series momentum, note first that the average pairwise correlation of these single-asset strategies is less than 0.1 for each trend horizon, meaning that the strategies behave rather independently across markets so one may profit when another loses. Even when the strategies are grouped by asset class or trend horizon, these relatively diversified strategies also have modest correlations. Another reason for the strong benefits of diversification is our equal-risk approach. The fact that we scale our positions so that each asset has the same ex ante volatility at each time means that, the higher the volatility of an asset, the smaller a position it has in the portfolio, creating a stable and risk-balanced portfolio.

Even before you react to losses, you can manage risk prospectively. Prospective risk management comes in several forms, including diversification, risk limits, liquidity management, and tail hedging via options and other instruments. To control risk, a hedge fund often has risk limits, meaning prespecified restrictions on how large a risk the hedge fund will ever take. The risk limit can be at the overall fund level and/or at the more granular level of each asset class or strategy. Hedge funds often also have position limits that restrict the notional exposure (regardless of how low the risk is estimated to be).

For example, a five-year U.S. government bond futures typically exhibits a volatility of around 5% a year, while a natural gas futures typically exhibits a volatility of around 50% a year. If a portfolio holds the same notional exposure to each asset in the portfolio (as some indices and managers do), the risk and returns of the portfolio will be dominated by the most volatile assets, significantly reducing the diversification benefits. The diversified time series momentum strategy has very low average correlations to traditional asset classes. Indeed, the correlation with the S&P 500 stock market index is –0.02, the correlation with the bond market as represented by the Barclays U.S. aggregate index is 0.23, and the correlation with the S&P GSCI commodity index is 0.05. This low average correlation hides the fact that the strategy can at times be highly correlated to the market, but these correlations are offset on average by other times when the strategy is negatively correlated to the market.


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, backtesting, Bear Stearns, beat the dealer, Bernie Madoff, book value, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial engineering, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

Markowitz’s great contribution to investors’ wallets was his demonstration that anything less than perfect positive correlation can potentially reduce risk. His research led to the results presented in the preceding table. As shown, it demonstrates the crucial role of the correlation coefficient in determining whether adding a security or an asset class can reduce risk. DIVERSIFICATION IN PRACTICE To paraphrase Shakespeare, can there be too much of a good thing? In other words, is there a point at which diversification is no longer a magic wand safeguarding returns? Numerous studies have demonstrated that the answer is yes. As shown in the following chart, the golden number for American xenophobes—those fearful of looking beyond our national borders—is at least fifty equal-sized and well-diversified U.S. stocks (clearly, fifty oil stocks or fifty electric utilities would not produce an equivalent amount of risk reduction).

Receipt of a large new contract, the finding of mineral resources, labor difficulties, accounting fraud, the discovery that the corporation’s treasurer has had his hand in the company till—all can make a stock’s price move independently of the market. The risk associated with such variability is precisely the kind that diversification can reduce. The whole point of portfolio theory is that, to the extent that stocks don’t always move in tandem, variations in the returns from any one security tend to be washed away by complementary variation in the returns from others. The chart How Diversification Reduces Risk: Risk of Portfolio (Standard Deviation of Return), similar to The Benefits of Diversification, illustrates the important relationship between diversification and total risk. Suppose we randomly select securities for our portfolio that on average are just as volatile as the market (the average betas for the securities in our portfolio will be equal to 1).

Suppose you were considering combining Ford Motor Company and its major supplier of new tires in a stock portfolio. Would diversification be likely to give you much risk reduction? Probably not. If Ford’s sales slump, Ford will be buying fewer new tires from the tire manufacturer. In general, diversification will not help much if there is a high covariance (high correlation) between the returns of the two companies. On the other hand, if Ford was combined with a government contractor in a depressed area, diversification might reduce risk substantially. If consumer spending is down (or if oil prices skyrocket), Ford’s sales and earnings are likely to be down and the nation’s level of unemployment up.


Trading Risk: Enhanced Profitability Through Risk Control by Kenneth L. Grant

backtesting, business cycle, buy and hold, commodity trading advisor, correlation coefficient, correlation does not imply causation, delta neutral, diversification, diversified portfolio, financial engineering, fixed income, frictionless, frictionless market, George Santayana, global macro, implied volatility, interest rate swap, invisible hand, Isaac Newton, John Meriwether, Long Term Capital Management, managed futures, market design, Myron Scholes, performance metric, price mechanism, price stability, proprietary trading, risk free rate, risk tolerance, risk-adjusted returns, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, the scientific method, The Wealth of Nations by Adam Smith, transaction costs, two-sided market, uptick rule, value at risk, volatility arbitrage, yield curve, zero-coupon bond

A good qualitative starting point is the rudimentary economics of the securities themselves. For example, if you are trading equities, you can assume that in order to achieve a meaningful level of diversification, it will be necessary to hold positions across a number of industries—ideally those that are subject to different business cycles. Similarly, if you are trading commodities, a portfolio of materially different asset classes (e.g., grains and energies) is likely to generate higher levels of diversification than one that is focused in a single set of “substitutable” product types (e.g., wheat and corn). These dynamics also carry forward to the remaining segments of global capital markets, most notably fixed income and foreign exchange.

However, it is still possible for longterm investors to use holding periods as a means of controlling exposures, specifically by increasing and decreasing their position sizes around the anticipated release of economic information that may be pertinent to their position profile, as suggested earlier. DIVERSIFICATION One proven way to control portfolio exposure is through the manipulation of diversification. While the mathematics of this concept are vague at best, the idea itself is intuitive: The more diverse the portfolio, the lower its risk profile. In turn, diversification itself can be diffused into two separate components: (1) the number of securities included in a given portfolio, and (2) the similarity of the pricing characteristics across these securities. As is the case with the other methods to adjust portfolio exposure, diversification can be used as a tool for two-way risk control, allowing investors to adjust their risk profiles upward or downward as the specific situation requires.

., without regard to market direction), a given market-neutral, long/short portfolio with very minimal risk has a higher degree of leverage than one that simply contained the long positions in the same portfolio––in spite of the fact that the latter is likely to be the more risky market profile. Beyond this, leverage statistics have vastly different implications across asset classes and across instrument classes within a given asset class. For example, the use of a specified amount of leverage in a fixed-income portfolio will generally have lessacute impacts than will the same profile in equities, due to the fact that equity markets routinely have higher levels of volatility. For identical reasons, within the fixed-income group, leverage will be more impactful at the long end of the yield curve than it will for short-term trading instruments.


pages: 482 words: 121,672

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition) by Burton G. Malkiel

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, book value, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, equity risk premium, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial engineering, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Salesforce, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, Teledyne, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

Markowitz’s great contribution to investors’ wallets was his demonstration that anything less than perfect positive correlation can potentially reduce risk. His research led to the results presented in the preceding table. As shown, it demonstrates the crucial role of the correlation coefficient in determining whether adding a security or an asset class can reduce risk. DIVERSIFICATION IN PRACTICE To paraphrase Shakespeare, can there be too much of a good thing? In other words, is there a point at which diversification is no longer a magic wand safeguarding returns? Numerous studies have demonstrated that the answer is yes. As shown in the following chart, the golden number for American xenophobes—those fearful of looking beyond our national borders—is at least fifty equal-sized and well-diversified U.S. stocks (clearly, fifty oil stocks or fifty electric utilities would not produce an equivalent amount of risk reduction).

Suppose you were considering combining Ford Motor Company and its major supplier of new tires in a stock portfolio. Would diversification be likely to give you much risk reduction? Probably not. If Ford’s sales slump, Ford will be buying fewer new tires from the tire manufacturer. In general, diversification will not help much if there is a high covariance (high correlation) between the returns of the two companies. On the other hand, if Ford was combined with a government contractor in a depressed area, diversification might reduce risk substantially. If consumer spending is down (or if oil prices skyrocket), Ford’s sales and earnings are likely to be down and the nation’s level of unemployment up.

Still, at least at certain times, some stocks and some classes of assets do move against the market; that is, they have negative covariance or (and this is the same thing) they are negatively correlated with each other. THE CORRELATION COEFFICIENT AND THE ABILITY OF DIVERSIFICATION TO REDUCE RISK Correlation Coefficient Effect of Diversification on Risk +1.0 No risk reduction is possible. +0.5 Moderate risk reduction is possible. 0 Considerable risk reduction is possible. –0.5 Most risk can be eliminated. –1.0 All risk can be eliminated. Now comes the real kicker; negative correlation is not necessary to achieve the risk reduction benefits from diversification. Markowitz’s great contribution to investors’ wallets was his demonstration that anything less than perfect positive correlation can potentially reduce risk.


pages: 263 words: 89,368

925 Ideas to Help You Save Money, Get Out of Debt and Retire a Millionaire So You Can Leave Your Mark on the World by Devin D. Thorpe

asset allocation, buy and hold, call centre, diversification, estate planning, fixed income, Home mortgage interest deduction, index fund, junk bonds, knowledge economy, low interest rates, money market fund, mortgage tax deduction, payday loans, random walk, risk tolerance, Skype, Steve Jobs, transaction costs, women in the workforce, zero-sum game

How Do I Diversify My Retirement Savings Appropriately? Diversification is a key concept in successful investing, especially for retirement. This article will help you understand what diversification really means, why diversification is important for you and your family, and how you can easily create the needed diversification in your investment portfolio. Definition: Diversification refers to spreading your investments around among a variety of both asset classes (stocks, bonds, real estate) and individual investments within those asset classes. Why: Diversification is important because if you are not careful, you can end up with a bunch of different investments that all move in the same direction at the same time with the same result you’d get from just one, more easily managed investment.

By investing in mutual funds or exchange traded funds (ETFs), you get the benefit of diversification at the level of individual investments but you may not be getting diversification at the level of asset classes. A “small cap growth fund,” which invests in smaller growth companies with a bias for technology stocks, for instance, may have dozens of stocks in it, but most will be similar companies that face similar risks and will react in much the same way to changes in the economy or to competition. Invest in multiple funds. In order to improve your diversification, invest in multiple funds, not just one. Don’t invest in five small cap growth funds, spread your money among several funds with different strategies.

For retirees, bonds represent the central pillar of your investment program as they generate income you can spend. Diversification: Do not put your entire stock allocation into one or two stocks. Don’t invest it all in twelve different stocks all from the same industry. The market prices assets as part of a portfolio; when you concentrate your investments you take risk that no one is paying you to take. Investing in a wide range of stocks is called diversification. You should do the same with bonds, too. Funds: The easiest way to get diversification is by buying mutual funds or ETFs (Exchange Traded Funds—always referred to as ETFs).


pages: 433 words: 53,078

Be Your Own Financial Adviser: The Comprehensive Guide to Wealth and Financial Planning by Jonquil Lowe

AltaVista, asset allocation, banking crisis, BRICs, buy and hold, correlation coefficient, cross-subsidies, diversification, diversified portfolio, estate planning, fixed income, high net worth, money market fund, mortgage debt, mortgage tax deduction, negative equity, offshore financial centre, Own Your Own Home, passive investing, place-making, Right to Buy, risk/return, short selling, zero-coupon bond

Source: Financial Ombudsman Service, Ombudsman News, March 2003. M10_LOWE7798_01_SE_C10.indd 294 05/03/2010 09:51 10 n Managing your wealth 295 Diversification At its simplest, diversification means: don’t put all your eggs in one basket. However, underlying this statement is a tricky question: if not one basket, what others should you should use? Diversification can mean choosing a range of investments (see below), a range of asset classes (see p. 299) and also a range of timing (see p. 304). Investment diversification Chapter 9 suggests that, for superior returns over the long term, you need to look at investing in shares (equities).

Even before M10_LOWE7798_01_SE_C10.indd 300 05/03/2010 09:51 10 n Managing your wealth 301 this, investment professionals have been on the hunt for new asset classes and it is variously claimed that gold (see p. 331), art (see p. 332), hedge funds (see p. 328) and a variety of other investments all fit the bill. In practice, it is not always clear that they do provide the benefits of diversification that are claimed. For example, the global crisis cast doubts on the ability of hedge funds to deliver uncorrelated returns. Table 10.1 How asset classes are correlated Asset classes with a relatively low correlation (less than 0.5) are shown in bold. Cash UK government bonds Property UK equities International equities Cash UK government bonds 0.25 Property 0.29 0.02 UK equities –0.03 0.28 0.53 International equities 0.06 0.28 0.44 0.96 Source: Author’s own work based on yearly return data from Money Management (January 1998–December 2009).

Betas calculated relative to different stock-market indices are not comparable. Asset allocation Although investment diversification has been described above in the context of shares, it applies equally to any other type of investment that is traded on a market, such as bonds and even residential property (see the discussion of buy-to-let on p. 330). Diversification also applies across the boundaries of different investments. Just as combining uncorrelated or weakly correlated shares reduces risk for any given level of return, combining different types of investments – called asset classes – also improves the risk-return balance, provided the classes are uncorrelated or only 3 www.advfn.com.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

Affordable Care Act / Obamacare, Alan Greenspan, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, behavioural economics, Black Monday: stock market crash in 1987, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial engineering, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, impact investing, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, low interest rates, margin call, Mark Zuckerberg, McMansion, Minsky moment, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Savings and loan crisis, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, subprime mortgage crisis, tail risk, Thales of Miletus, the long tail, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

The cancer megafund is an idea at the start of its life rather than one that has been thrashed to within an inch of it. Asset classes have to get very big before they can have an impact on the financial system as a whole, let alone potentially require the taxpayer to step in when things go wrong. And even if you do fret about speculative excess, he says, better that investors’ animal spirits are directed toward solving the biggest social issues than to funding the purchase of McMansions. But he is alive to the potential dangers of securitization. For example, the benefits of diversification come about only if assets in the fund genuinely do not all rise and fall together—in the jargon, if they are “noncorrelated.”

This is also an argument for having a megafund devoted to a lot of different diseases, rather than one focused on cancer. But that would bring costs of its own by making it harder for investors to assess the portfolio. And since cancer is itself a collection of many different diseases, with a lot of different potential treatments, there is already plenty of scope for diversification. If diversification is the key to providing a more acceptable mix of risk and reward, then Lo’s proposed megafund needs to hold a lot of assets. The more assets, the more shots on goal, is the way he puts it. That in turn means the funds must be able to attract a lot of capital to fund these assets. And that means they need to be able to attract investors in debt instruments like bonds.

Another is to diversify investors’ portfolios so that a bad outcome for one graduate has more chance of being balanced by a better outcome for another. These two approaches are in some senses at odds: having more investees means greater diversification but also reduces the chance of close interaction. The Lumni model is a fund structure: it offers the benefits of diversification at the cost of knowing the individual students as well, which means the youngsters forgo the benefits of a mentoring relationship. The models adopted in their old incarnations by Pave and Upstart allowed for closer interaction, but investors ended up concentrating their risks on fewer individuals as a result.


Work Less, Live More: The Way to Semi-Retirement by Robert Clyatt

asset allocation, backtesting, buy and hold, currency risk, death from overwork, delayed gratification, diversification, diversified portfolio, do what you love, eat what you kill, employer provided health coverage, estate planning, Eugene Fama: efficient market hypothesis, financial independence, fixed income, future of work, independent contractor, index arbitrage, index fund, John Bogle, junk bonds, karōshi / gwarosa / guolaosi, lateral thinking, Mahatma Gandhi, McMansion, merger arbitrage, money market fund, mortgage tax deduction, passive income, rising living standards, risk/return, Silicon Valley, The 4% rule, The Theory of the Leisure Class by Thorstein Veblen, Thorstein Veblen, transaction costs, unpaid internship, upwardly mobile, Vanguard fund, work culture , working poor, zero-sum game

Here are some simple definitions for common terms and strategies, along with some basic advice for building your own autopilot along Rational Investing principles. Asset classes are types of financial instruments broken into logical groups—for example, small U.S. stocks, large U.S. value stocks, foreign medium-term bonds, commercial real estate, commodities. Diversification means owning different securities within an asset class, as well as owning several different asset classes. When one asset class tends to go up when another generally goes down or sideways, this pair of asset classes are said to be less correlated. Including both in a portfolio will make it less volatile—its value will move more like an ocean liner than a speedboat.

In other cases, such as the private equity, oil and gas, market neutral hedge fund, and even commercial real estate asset classes, the fullest diversification and best returns may come, paradoxically, by moving outside the universe of indexes and funds entirely and making individual, illiquid investments—that is, investments in carefully researched private companies, partnerships, or buildings which cannot be readily sold. Later in the chapter, you will find a list of good choices of index and other funds for each asset class. Choose from among these and compare them to other favorite or new funds as you set about implementing the Rational Investing Method for yourself.

Bonds.........................................................................................333 International Bonds......................................................................................................333 High Yield Bonds............................................................................................................334 GNMA Bonds...................................................................................................................334 Other..........................................................................................................................................335 Oil and Gas........................................................................................................................335 Market Neutral Hedge Funds..................................................................................335 Commodities...................................................................................................................336 Commercial Real Estate..............................................................................................338 Private Equity...................................................................................................................338 330 | Work Less, Live More T his appendix includes a brief description of each of the 16 assets classes that comprise the Rational Investing portfolio outlined in Chapter 3. The portfolio is made up of roughly 40% stocks, 40% bonds, and 20% other asset classes to provide broad diversification, good return, and modest volatility. Stocks Large U.S. Stocks, Value Tilt Large U.S. Stocks make up a big proportion of the world’s stock markets and should be well-represented in your portfolio. By favoring value stocks, you put historical returns on your side, as these shares have tended to outperform the average large stock over time.


pages: 385 words: 128,358

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

Abraham Maslow, Alan Greenspan, Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, business cycle, buy and hold, buy low sell high, capital controls, central bank independence, commoditize, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, currency risk, diversification, diversified portfolio, family office, financial engineering, fixed income, glass ceiling, Glass-Steagall Act, global macro, Greenspan put, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, inverted yield curve, John Meriwether, junk bonds, land bank, Long Term Capital Management, low interest rates, managed futures, margin call, market bubble, Market Wizards by Jack D. Schwager, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, Nixon triggered the end of the Bretton Woods system, oil shale / tar sands, oil shock, out of africa, panic early, paper trading, Paul Samuelson, Peter Thiel, price anchoring, proprietary trading, purchasing power parity, Reminiscences of a Stock Operator, reserve currency, risk free rate, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, tail risk, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, Vision Fund, yield curve, zero-coupon bond, zero-sum game

Because finding high-quality, uncorrelated trades is not easy, the ability to find multiple better-than-average independent bets is what separates a star hedge fund manager from the rest of the herd.To become a star, the notion of diversification must be pushed to an extreme. Diversification in this sense goes far beyond traditional notions of the term. It means diversifying in many different ways, and the flexibility to do so is particularly evident within the global macro style of investing. Global macro managers have the breadth of mandate to look for inefficiencies and opportunities across the spectrum of products, geographic regions, and strategies. Here we’ll briefly examine why global macro is an optimal strategy for building a diversified portfolio. Asset Classes and Products The easiest way for a global macro hedge fund manager to find diversified, independent bets is to trade different asset classes and different investment products within those asset classes.

As such, global macro managers need to watch all asset classes and products all the time with an eye out for such inefficiencies.The mandate of global macro hedge funds affords the latitude to allocate capital to any asset class or product, allowing global macro managers the freedom to exploit a particular inefficiency in the most effective manner. 348 INSIDE THE HOUSE OF MONEY Geography Global macro hedge fund managers also achieve diversification by investing anywhere geographically. By doubling the number of countries a manager can invest in, the number of independent investment opportunities available more than doubles.There are innumerable independent bets that can be made within countries, across countries, within regions, and across regions.

Asset Classes and Products The easiest way for a global macro hedge fund manager to find diversified, independent bets is to trade different asset classes and different investment products within those asset classes. Global macro managers monitor interest rates, equities, currencies, commodities, and real estate, and within each of these categories, managers consider a range of products.Whether it be cash, physical commodities, futures, derivatives, or direct investment, the key is to not limit choice. Better-than-average bets are a rarity and can occur in some products but not others for various fundamental or technical reasons. As such, global macro managers need to watch all asset classes and products all the time with an eye out for such inefficiencies.The mandate of global macro hedge funds affords the latitude to allocate capital to any asset class or product, allowing global macro managers the freedom to exploit a particular inefficiency in the most effective manner. 348 INSIDE THE HOUSE OF MONEY Geography Global macro hedge fund managers also achieve diversification by investing anywhere geographically.


pages: 192 words: 72,822

Freedom Without Borders by Hoyt L. Barber

accounting loophole / creative accounting, Affordable Care Act / Obamacare, Albert Einstein, banking crisis, diversification, El Camino Real, estate planning, fiat currency, financial engineering, financial independence, fixed income, high net worth, illegal immigration, interest rate swap, money market fund, obamacare, offshore financial centre, passive income, quantitative easing, reserve currency, road to serfdom, selective serotonin reuptake inhibitor (SSRI), subprime mortgage crisis, too big to fail

., companies paying respectable dividends and that outpace inflation and taxation, including some well-performing blue chips). • Foreign currencies (e.g., stocks of portfolios, trusts, and funds for currency diversification). A basket of stable and appreciating currencies helps diversify your portfolio, but keep in mind that all currencies are in a soft-money cycle. A goldbacked Bancor could seriously hurt this asset class. • Global opportunities (e.g., stocks of countries with strong economies and currencies, such as we’ve seen with Brazil, Russia, China, and India in recent years; unique stock opportunities overseas; emerging markets and frontier investments).

—Edmund Burke, 1774 18th-century Irish philosopher To ALH & K Contents Preface 1. Logistics of International Diversification xi 1 Asset Preservation Strategies 2 Challenges to Avoiding Taxation Anywhere 4 Structuring Your Personal, Business, and Financial Life 5 The T-8 Tax Havens and Offshore Banking Centers 8 Geopolitical Investment Diversification 10 Expatriating 10 The Great American Tax Loophole 12 Renouncing Your Citizenship 14 Economic Citizenship and Retirement Programs 15 Logistics of International Diversification 19 2. The Best Offshore Structures 20 International Business Corporation (IBC): Belize, Cook Islands, Nevis 21 The Offshore Corporation: Panama Style 23 Limited Liability Company (LLC): Nevis, Panama, Cook Islands 24 viii Contents Asset Protection Trust (APT): Belize, Nevis, Cook Islands 25 The Foundation: Panama 28 The Benefits of Owning Your Own Offshore International Bank 29 Establishing a Tax-Free Offshore Operating Business 30 Flags-of-Convenience: Offshore Ship and Yacht Registration 32 Country Profiles: Belize, Nevis, Panama, Cook Islands 32 3.

. • Hong Kong: Offshore corporations, offshore banking and investing; strong bank secrecy; no TIEA with the United States or Canada. GEOPOLITICAL INVESTMENT DIVERSIFICATION Here is a concept that complements taking your financial life offshore and expatriating, as we’ve discussed, and, to take it a step further, in conjunction with your own personal (private) conservative monetary policy, which we’ll explore in a later chapter. Today, it’s not just having diversified investments but how they are owned and where. Geopolitical investment diversification compartmentalizes your holdings, in the same way a submarine is compartmentalized and built for an unexpected attack.


pages: 305 words: 98,072

How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely by Andrew Craig

Airbnb, Alan Greenspan, Albert Einstein, asset allocation, Berlin Wall, bitcoin, Black Swan, bonus culture, book value, BRICs, business cycle, collaborative consumption, diversification, endowment effect, eurozone crisis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Future Shock, index fund, information asymmetry, joint-stock company, Joseph Schumpeter, Long Term Capital Management, low cost airline, low interest rates, Market Wizards by Jack D. Schwager, mortgage debt, negative equity, Northern Rock, offshore financial centre, oil shale / tar sands, oil shock, passive income, pensions crisis, quantitative easing, Reminiscences of a Stock Operator, road to serfdom, Robert Shiller, Russell Brand, Silicon Valley, smart cities, stocks for the long run, the new new thing, The Wealth of Nations by Adam Smith, Yogi Berra, Zipcar

If you only have property, there is a risk you will fail to become wealthy in your lifetime. To give yourself the best chance of becoming truly wealthy, you need to ensure that you are aware of, and are exposed to, the other asset classes – particularly shares, bonds and commodities. General considerations common to all asset classes Each of the above types of investment vehicle has certain individual characteristics, but the two most important considerations when we look at any of them are: How safe your money is when invested in that asset class. What sort of percentage return you might expect to make. Put another way, when we consider the relative merits of an investment vehicle or financial product, we are concerned with both the return of our money and the return on our money.

If the market or the sector has gone up 20 per cent in two months and your analysis tells you that this might correct, then you might wait a little longer before buying your shares. Fundamental analysis of other asset classes We have just had a very quick look at the idea of using fundamental analysis to find a good company to invest in. It may be obvious to you that the metrics we used to look at shares cannot be applied to the other asset classes. Bonds, property and commodities have their own distinct characteristics and we must evaluate them in a different way as a result. As such, it is worth saying a little bit about how we might perform a fundamental analysis of each of the other asset classes. BONDS We looked at the basics of what a bond is in chapter 7.

Many investment professionals are just like doctors who tell you how bad drinking and smoking are and then nip to the pub for several drinks and a few cigarettes at the end of their day. Over the years, I have lost count of the number of smart City folk I know who have all their money in the one asset class they know about, with the result that they are heavily punished during any bad year for that asset class. At the risk of being a little on the repetitive side, I must reiterate that one of the most successful investing strategies over many years is being properly diversified. This means that you should ensure you own a wide variety of assets rather than just shares or just property, for instance.


pages: 825 words: 228,141

MONEY Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins

"World Economic Forum" Davos, 3D printing, active measures, activist fund / activist shareholder / activist investor, addicted to oil, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, backtesting, Bear Stearns, behavioural economics, bitcoin, Black Monday: stock market crash in 1987, buy and hold, Carl Icahn, clean water, cloud computing, corporate governance, corporate raider, correlation does not imply causation, Credit Default Swap, currency risk, Dean Kamen, declining real wages, diversification, diversified portfolio, Donald Trump, estate planning, fear of failure, fiat currency, financial independence, fixed income, forensic accounting, high net worth, index fund, Internet of things, invention of the wheel, it is difficult to get a man to understand something, when his salary depends on his not understanding it, Jeff Bezos, John Bogle, junk bonds, Kenneth Rogoff, lake wobegon effect, Lao Tzu, London Interbank Offered Rate, low interest rates, Marc Benioff, market bubble, Michael Milken, money market fund, mortgage debt, Neil Armstrong, new economy, obamacare, offshore financial centre, oil shock, optical character recognition, Own Your Own Home, passive investing, profit motive, Ralph Waldo Emerson, random walk, Ray Kurzweil, Richard Thaler, risk free rate, risk tolerance, riskless arbitrage, Robert Shiller, Salesforce, San Francisco homelessness, self-driving car, shareholder value, Silicon Valley, Skype, Snapchat, sovereign wealth fund, stem cell, Steve Jobs, subscription business, survivorship bias, tail risk, TED Talk, telerobotics, The 4% rule, The future is already here, the rule of 72, thinkpad, tontine, transaction costs, Upton Sinclair, Vanguard fund, World Values Survey, X Prize, Yogi Berra, young professional, zero-sum game

His Yale model, also known as the endowment model, was developed with his colleague and former student Dean Takahashi, and is an application of modern portfolio theory. The idea is to divide a portfolio into five or six roughly equal parts and invest each in a different asset class. The Yale model is a long-term strategy that favors broad diversification and a bias toward equities, with less emphasis on lower-return asset classes such as bonds or commodities. Swensen’s position on liquidity has also been called revolutionary—he avoids rather than chases liquidity, arguing that it leads to lower returns on assets that could otherwise be invested more efficiently.

You not only have to diversify between your Security and your Risk/Growth Buckets, but within them as well. As Burton Malkiel shared with me, you should “diversify across securities, across asset classes, across markets—and across time.” That’s how you truly get a portfolio for all seasons! For example, he says you want to invest not only in both stocks and bonds but also in different types of stocks and bonds, many of them from different markets in different parts of the world. (We’ll talk about diversifying across time in chapter 4.4, “Timing Is Everything?”) And, most experts agree, the ultimate diversification tool for individual investors is the low-fee index fund, which gives you the broadest exposure to the largest numbers of securities for the lowest cost.

If you decide to buy an index fund, you are diversified to the maximum extent possible because you own the whole market. That’s one of the beauties of the index fund, and it’s one of the wonderful things Jack Bogle did for investors in America. He gave them the opportunity in a low-cost way to buy the whole market. But from an asset-allocation perspective, when we talk about diversification, we’re talking about investing in multiple asset classes. There are six that I think are really important and they are US stocks, US Treasury bonds, US Treasury inflation-protected securities [TIPS], foreign developed equities, foreign emerging-market equities, and real estate investment trusts [REITs]. TR: Why do you pick those six versus others?


pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

Albert Einstein, asset allocation, asset-backed security, book value, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, fear index, financial engineering, fixed income, Glass-Steagall Act, implied volatility, index fund, intangible asset, interest rate swap, inventory management, inverted yield curve, junk bonds, London Interbank Offered Rate, low interest rates, margin call, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk free rate, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, short squeeze, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

One should think of an investment portfolio as a pie that is divided into pieces of varying sizes that represent a variety of asset classes and/or types of investments to accomplish an appropriate riskadjusted return. For example, a conservative investor may favor a portfolio with large-cap value stocks, broad-based market index 226 The Investopedia Guide to Wall Speak funds, investment-grade bonds, and cash. In contrast, a risk-loving investor may hold small-cap growth stocks, aggressive large-cap growth stocks, some high-yield bonds, international investments, and maybe some alternative investments. Related Terms: • Alpha • Diversification • Modern Portfolio Theory—MPT • Asset Allocation • Style Drift Preferred Stock What Does Preferred Stock Mean?

Related Terms: • Cash Flow • Free Cash Flow—FCF • Net Present Value—NPV • Cash Flow Statement • Internal Rate of Return—IRR 78 The Investopedia Guide to Wall Speak Diversification What Does Diversification Mean? A risk management investment strategy in which a wide variety of investments are mixed within a portfolio; the rationale is that a portfolio of different investments will, on average, yield higher returns and pose a lower risk than any individual investment within the portfolio. Diversification strives to smooth out unsystematic risk in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not correlated.

Therefore, the benefits of diversification will hold only if the securities in the portfolio are not correlated. Investopedia explains Diversification Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks will yield the most cost-effective level of risk reduction. Investing in more securities will yield further diversification benefits, but to a drastically smaller degree. Further diversification benefits can be gained by investing in foreign securities because they tend to be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan’s economy; therefore, Japanese investments could do well when domestic investments perform poorly.


pages: 304 words: 80,965

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

activist fund / activist shareholder / activist investor, Admiral Zheng, banking crisis, Basel III, Bear Stearns, behavioural economics, Bernie Madoff, Black Swan, buy and hold, Carl Icahn, centralized clearinghouse, clean water, compensation consultant, computerized trading, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Glass-Steagall Act, income inequality, index fund, information asymmetry, invisible hand, John Bogle, Kenneth Arrow, Kickstarter, light touch regulation, London Whale, Long Term Capital Management, moral hazard, Myron Scholes, Northern Rock, passive investing, Paul Volcker talking about ATMs, payment for order flow, performance metric, Ponzi scheme, post-work, principal–agent problem, rent-seeking, Ronald Coase, seminal paper, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

The investors were subject to “idiosyncratic risk,” meaning factors that were specific to those companies rather than to the market as a whole. Diversification minimizes idiosyncratic risk, because if you invest in fifty companies, most of your money will still be safe even if one or two go bankrupt. That’s why academics call diversification the “only free lunch” for investors.35 All the free food at the diversification buffet may lead us to ignore a key fact: diversification is no defense against systemic risk, meaning risks to broad swaths of the market. That seems obvious; if the entire market declines, a diversified portfolio will decline, too. What is less obvious is that widespread diversification may actually increase systematic risk.

They began writing noor low-documentation loans in which so little corroboration of information was required of borrowers that the mortgages were commonly known as “liar loans.”38 None of it mattered to the bankers doing the underwriting. They thought they were protected by the magic of diversification; since they sold most of the loans and kept only small tranches of thousands of them, or hundreds of thousands, what could go wrong? If one egg broke, there were others. No one was watching the baskets of eggs. By overrelying on diversification, the bankers actually increased the risk: every basket and every egg were affected. Diversification turned from a prudent strategy to a justification for sloppy lending. Mindless diversification was no substitute for lending standards. Nearly a decade after the collapse of the housing market, we are still feeling its effects.

Because they are loaded with routine assumptions, they are fairly good at predicting the range of everyday, normal price movements. The problem is that the experts try to apply them to situations for which the models are ill suited. Promiscuous Diversification Unfortunately, the world of finance has other examples of taking a good idea and extending it or misapplying it until it becomes a bad one. Diversification is truly one of the great concepts of investing, because it helps reduce risk. The concept is simple: don’t put all your eggs in one basket. Why? Because the basket could fall, the eggs could break, and you would be left with no breakfast.


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Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond: The Innovative Investor's Guide to Bitcoin and Beyond by Chris Burniske, Jack Tatar

Airbnb, Alan Greenspan, altcoin, Alvin Toffler, asset allocation, asset-backed security, autonomous vehicles, Bear Stearns, bitcoin, Bitcoin Ponzi scheme, blockchain, Blythe Masters, book value, business cycle, business process, buy and hold, capital controls, carbon tax, Carmen Reinhart, Clayton Christensen, clean water, cloud computing, collateralized debt obligation, commoditize, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, disintermediation, distributed ledger, diversification, diversified portfolio, Dogecoin, Donald Trump, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, fiat currency, financial engineering, financial innovation, fixed income, Future Shock, general purpose technology, George Gilder, Google Hangouts, high net worth, hype cycle, information security, initial coin offering, it's over 9,000, Jeff Bezos, Kenneth Rogoff, Kickstarter, Leonard Kleinrock, litecoin, low interest rates, Marc Andreessen, Mark Zuckerberg, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Network effects, packet switching, passive investing, peer-to-peer, peer-to-peer lending, Peter Thiel, pets.com, Ponzi scheme, prediction markets, quantitative easing, quantum cryptography, RAND corporation, random walk, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Ross Ulbricht, Salesforce, Satoshi Nakamoto, seminal paper, Sharpe ratio, Silicon Valley, Simon Singh, Skype, smart contracts, social web, South Sea Bubble, Steve Jobs, transaction costs, tulip mania, Turing complete, two and twenty, Uber for X, Vanguard fund, Vitalik Buterin, WikiLeaks, Y2K

The point is not to bash regulators but to show how hard it is to classify a brand-new asset class, especially when it is the first digital native asset class the world has seen. WHAT IS AN ASSET CLASS, ANYWAY? While people accept that equities and bonds are the two major investment asset classes, and others will accept that money market funds, real estate, precious metals, and currencies are other commonly used asset classes,4 few bother to understand what is meant by an asset class in the first place. Robert Greer, vice president of Daiwa Securities, wrote “What Is an Asset Class, Anyway?”5 a seminal paper on the definition of an asset class in a 1997 issue of The Journal of Portfolio Management.

See also The DAO Deloitte, 270 Demographics, 281 Derivatives, 219 Deutsche Bundesbank, 12 Devaluation, 116 Developers, 54 community and, 182 miners and, 112 rewards for, 60 software and, 194–198 Devil Take the Hindmost: A History of Financial Speculation (Chancellor), 138, 157 DigiCash, 34 Digital Asset Holdings, 25 Digital Currency Council, 243 Digital Currency Group (DCG), 231 Digital payment systems decentralization and, 35 ecash as, 34 Dimon, Jamie, 267 Discounting method risk and, 180 valuation and, 179–182 Disruption, xiv, 9 for incumbents, 271 portfolios and blockchains as, 263–277 public blockchains and, 21 resilience to, 65 technology and, 28, 264 Distributed ledger technology (DLT), 266, 269–270, 274 Distribution, 13–14, 42 Diversification cryptoassets and, 102–105 risk and, 101 Divestment, 271 DJIA. See Dow Jones Industrial Average DLT. See Distributed ledger technology DNS. See Domain naming service Documents, 258. See also Articles Dodd, David, 139 Dogecoin, 43–44 Dollar, U. S. (USD), 114 Bitcoin and, 122 Velocity of, 178 Domain naming service (DNS), 39 Domingos, Pedro, 19 Dow Jones Industrial Average (DJIA), 85, 87, 100 Duffield, Evan, 48, 49 Dutch East India Company, 121, 161 shares of, 141–142 Dutch Republic, 141, 143 Economics, 140 asset classes and, 111–120 The Economist, 143 Economy, 32 as global, 37 Internet and, 176 Edelman, Ric, 244–245 Education, 286 Efficient frontier, 71 correlation of returns and, 74–76 Emergency Economic Stabilization Act of 2008, 8 Encryption, 14 Endpoint sensitivity, 84 Enterprise Ethereum Alliance, 273 Equities, 76, 102, 116, 137 as asset class, 108, 110 ETC.

Much of the thinking in this chapter grew out of a collaboration between ARK Invest and Coinbase through late 2015 and into 2016 when the two firms first made the claim that bitcoin was ringing the bell for a new asset class.6 KEY DIFFERENTIATORS BETWEEN ASSET CLASSES In our investigation of economic characteristics, we find the main differences come down to governance, supply schedule, use cases, and basis of value. Beyond economic similarities, asset classes also tend to have similar liquidity and trading volume profiles. Remember that a liquidity profile refers to how deep the order book of the markets is, while trading volume refers to how much is traded daily. Lastly, asset classes differ in their marketplace behavior, the most important of which include risk, reward, and correlation with other assets.


pages: 117 words: 31,221

Fred Schwed's Where Are the Customers' Yachts?: A Modern-Day Interpretation of an Investment Classic by Leo Gough

Albert Einstein, banking crisis, Bernie Madoff, book value, corporate governance, discounted cash flows, disinformation, diversification, fixed income, index fund, John Bogle, junk bonds, Long Term Capital Management, Michael Milken, Northern Rock, passive investing, Ralph Waldo Emerson, random walk, short selling, South Sea Bubble, The Nature of the Firm, the rule of 72, The Wealth of Nations by Adam Smith, transaction costs, young professional

This is of course true, because these funds control millions of pounds which they can spread across a very large number of different companies and, indeed, asset classes. DEFINING IDEA… Wide diversification is only required when investors do not understand what they are doing. ~ WARREN BUFFETT To understand diversification, let’s suppose there is an island with only two businesses, umbrellas and swimwear. When it rains, the umbrella company does well and when it is sunny, the swimwear company does well. The weather is unpredictable, so if you are completely invested in swimwear in a year when it rains all the time, your returns are going to be awful.

What this doesn’t tell us is how much diversification we actually need. More diversification is not necessarily better for us. Suppose you bought a share in every company on a stock exchange, including the secondary markets where small, often iffy, companies are quoted. You would then have a lot of diversification, you might think, but it would cost you a fortune in transaction fees. One celebrated theory, known as Modern Portfolio Theory, tells us that you don’t really need to do this because a holding of as few as 20 shares will give you the diversification you really need. The aim is really to diversify away the risk of something truly awful happening to your portfolio.

So, for example, people who try to diversify by investing in lots of different unit trusts are wasting their time. As long as you have, say, £20,000 to invest, then you can obtain adequate diversification on your own. But if you don’t want the bother of managing your investments yourself, then by all means invest in a few unit trusts or investment trusts – remember, though, that some of them are highly specialised and therefore do not provide good diversification. HERE’S AN IDEA FOR YOU… Some people worry a lot about diversification and then keep all their money in UK shares. That’s not diversification. What about other parts of the world, Such as China and India, whose long term outlook appears to be very rosy?


pages: 368 words: 145,841

Financial Independence by John J. Vento

Affordable Care Act / Obamacare, Albert Einstein, asset allocation, diversification, diversified portfolio, estate planning, financial independence, fixed income, high net worth, Home mortgage interest deduction, low interest rates, money market fund, mortgage debt, mortgage tax deduction, oil shock, Own Your Own Home, passive income, retail therapy, risk tolerance, the rule of 72, time value of money, transaction costs, young professional, zero day

Alternatives include investments in tangibles, such as real estate, art, precious metals and stones, as well as collectibles. Each asset class has a different level of risk as well as potential rate of return. The basic idea is that while one asset class may be increasing in value one or more of the others may be decreasing. Therefore, asset allocation and diversification may help you ride out market fluctuations and protect your portfolio from a major loss in any one asset class. They may also provide you with the staying power and control over your emotions even after a big downturn in the market. However, it is important to understand that asset allocation and diversification do not guarantee against loss.

This is an amazing discovery which goes against the basic premise “the higher the risk, the higher the return.” The beauty of diversification is that when you have a group of asset classes, some of which are negatively correlated, you can reduce the volatility (i.e., risk) of your portfolio and at the same time possibly increase your rate of return. Many financial scholars have come to realize that all investment classes fluctuate in value, but that different asset classes fluctuate differently under different sets of circumstances. It has also been found that many asset classes are not positively correlated and in fact in some cases are inversely correlated.

Distributing your investment risk among different asset classes can help to smooth out your investment return. Diversification is an investment strategy that every investor should use. Diversification is also one of the main reasons I am a big advocate of mutual funds and exchange-traded funds (ETFs) for both novice and experienced investors. Whether you have $1,000 or $10 million to invest, these investment vehicles can provide you with the level of diversification that is essential to maximizing your risk and reward equation.4 4 Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.


pages: 333 words: 76,990

The Long Good Buy: Analysing Cycles in Markets by Peter Oppenheimer

Alan Greenspan, asset allocation, banking crisis, banks create money, barriers to entry, behavioural economics, benefit corporation, Berlin Wall, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, book value, Bretton Woods, business cycle, buy and hold, Cass Sunstein, central bank independence, collective bargaining, computer age, credit crunch, data science, debt deflation, decarbonisation, diversification, dividend-yielding stocks, equity premium, equity risk premium, Fall of the Berlin Wall, financial engineering, financial innovation, fixed income, Flash crash, foreign exchange controls, forward guidance, Francis Fukuyama: the end of history, general purpose technology, gentrification, geopolitical risk, George Akerlof, Glass-Steagall Act, household responsibility system, housing crisis, index fund, invention of the printing press, inverted yield curve, Isaac Newton, James Watt: steam engine, Japanese asset price bubble, joint-stock company, Joseph Schumpeter, Kickstarter, Kondratiev cycle, liberal capitalism, light touch regulation, liquidity trap, Live Aid, low interest rates, market bubble, Mikhail Gorbachev, mortgage debt, negative equity, Network effects, new economy, Nikolai Kondratiev, Nixon shock, Nixon triggered the end of the Bretton Woods system, oil shock, open economy, Phillips curve, price stability, private sector deleveraging, Productivity paradox, quantitative easing, railway mania, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, savings glut, secular stagnation, Shenzhen special economic zone , Simon Kuznets, South Sea Bubble, special economic zone, stocks for the long run, tail risk, Tax Reform Act of 1986, technology bubble, The Great Moderation, too big to fail, total factor productivity, trade route, tulip mania, yield curve

Chapter 4 Asset Returns through the Cycle Chapter 3 looks at how the equity market tends to deliver different returns across the phases of the cycle. It is also possible to illustrate a tendency for equities to vary their pattern of relative returns in comparison to other asset classes through the cycle, and for different asset classes to respond to both growth and inflation in different ways. These characteristics help to make diversification across assets such a useful tool in seeking to reduce risks in an investment portfolio over time. Assets across the Economic Cycle For example, one simple way of thinking about the relative performance of assets as an economic cycle matures is to look at their average monthly real returns in early and late phases of both an economic expansion and contraction (these are shown for the US in exhibit 4.1 in total real terms, adjusted for inflation).

At the time, equities did not look particularly cheap versus bonds, but over the following 5 years they significantly outperformed bonds, although this reflected the onset of the technology bubble. Although valuation is clearly not the only factor driving relative returns, it is nonetheless significant. The Impact of Diversification on the Cycle Because equities and bonds can move in different directions (although they do not always do so), or at least have different risk and volatility profiles, it is often considered wise to combine these two major asset classes when building a portfolio. In this way, the volatility can be reduced by reducing the impact of sharp corrections in equities (even if bond prices fall when equity prices do, they are likely to do so by a smaller degree) but typically aggregate returns would be lower.

Index 100 year bond 34 1920s, United States 148, 154, 157, 160 1945-1968, post-war boom 129–131 1960s ‘Nifty Fifty’ 114, 130–131, 233, 235 structural bear market 130 1970s Dow Jones 131 equity cycle 56 oil crisis 108 1980s bull markets 131–133 Dow Jones 15–16, 131–132 equity cycle 56–57 Japan 114, 148–149, 155–156, 158, 160–161, 162, 164 technology 12–15 1990s 16–17 Asia crisis 108, 133 equity cycle 57 S&P concentration 114 technology bubble 33, 93–94, 149–150, 156–157, 158–159, 161, 164 2000-2007 equity cycle 57 2007-2009 financial crisis 169–174 emerging markets 171–173 forecasting 19–21 growth vs. value company effects 94–96 impact 169–170 phases 171–174 quantitative easing 173–174, 178–179 sovereign debt 170, 171–173 structural bear market 110, 118–119 A accounting, bubbles 163–165 adjustment speed 74, 89–90 Akerflof, G.A. 23 American Telephone and Telegraph (AT&T) 154, 225, 235–236, 238 Asia crisis, 1998 108, 133 ASPF see Association of Superannuation and Pension Funds asset classes across phases 66–68 contractions and expansions 63–65 cyclical 83–89 defensive 83–89 diversification 42, 45–47, 178–179 growth 83–84, 90–96 and inflation 65–66, 70 levels of yield 74–76 relationship through cycle 68–76 returns across cycle 63–79 speed of adjustment 74 structural shifts 76–79 value 83–84, 90–96 see also bonds; commodities; equities Association of Superannuation and Pension Funds (ASPF) 77 AT&T see American Telephone and Telegraph austerity 239 Austria, 100 year bond 34 B bank margins 214–215 bear markets 49, 99–125 1960s 130 characteristics 100–106, 117–118 cyclical 105, 106–107 deflation 109, 113 duration 100–101, 106–111, 117 employment 121–124 event-driven 105, 107–109 false negatives 119–120 financial crisis 118–119 growth momentum 122–123 indicators 106, 108, 109–110, 119–125 inflation 101–103, 109, 121–122 interest rates 106, 111–113 prior conditions 121–124 private sector financial balance 124 profitability 115–117 recovery 101 risk indicator vs MSCI index 124–125 S&P 500 103–105 structural 105 triggers 101–105, 106, 108, 111 valuations 123 yield curve 122 behavioural factors 5, 22–25 Berlin Wall, fall of 133 Bernanke, B. 133 betas 65, 85 ‘Big Bang’ deregulation 12 Bing 237 Black Monday 16, 102, 148 Black Wednesday 16–17 ‘bond-like’ equities 96 bonds, 100 year 34 bond yields across phases 66–68, 72–76 current cycle 95–96, 191–193, 201–220 cyclical vs. defensive companies 87–88 and demographics 215–217 and equity valuations 72–76, 206–208 and growth companies 92–94 historical 43, 202 and implied growth 210–215 and inflation 65, 70 quantitative easing 173–174, 202–205 and risk asset demand 217–220 S&P 500 correlation 72–73 speed of adjustment 74, 89–90 ultra-low 201–220 and value companies 92–94 vs. dividends 78–79 vs. equities 43–45, 68–76, 78–79 Bretton Woods monetary system 102, 130–131 broadcast radio 154, 225 Bubble Act 147, 157 bubbles 143–165 1920s US 148, 154, 157, 160 1980s Japan 114, 148–149, 155–156, 158, 160–161, 162, 164 accounting 163–165 canal mania 152 characteristics 145–146 deregulation 157–159 easy credit 160–161 famous 145 financial innovation 158–159 government-debt-for-equity swaps 151–152 Mississippi Company 147, 151 ‘new eras’ 150–157 personal computers 155 psychology 144–145 radio manufacturing 154 railways 148, 152–154, 157, 160, 163 Shanghai composite stock price index 156 South Sea Company 147, 151, 153 structural bear markets 113 sub-prime mortgages 70, 102, 118, 133, 145, 159 technology, 1990s 33, 93–94, 149–150, 156–157, 158–159, 161, 164 tulip mania 146–147 valuations 161–162 bull markets 49, 127–142 characteristics 127–141 composition 138 cyclical 134–136 disinflation 131–133 duration 136–138, 139–141 equity performance 135–136 Great Moderation 133–134, 187–189 non-trending 138–141 post-war boom 129–131 quantitative easing 134 secular 127–134 United States 136 C canal mania 152 CAPE see cyclically adjusted price-to-earnings ratio capital investment, Juglar cycle 3 CDO see collateralised debt obligations characteristics bear markets 100–109, 111, 117–118 bubbles 145–146 bull markets 127–141 cyclical bear markets 106–107 event-driven bear markets 108–109 structural bear markets 111 China 15, 156 Cold War 14–15, 133 collateralised debt obligations (CDO) 159 commodities across phases 66–68 Kitchin cycle 3 composition of bull markets 138 concentration structural bear markets 115 and technology 238–240 contractions asset performance 63–65 mini cycles 60 see also recessions Cooper, M. 162 corporate debt 65, 110, 114, 160–161 corporate profitability bear markets 107, 115–117 current equity cycle 185–186 monetary policy 239 credit crunch 78–79, 170, 171 crowds, psychology of 21–22, 144–145 cult of the equity 77–78 current equity cycle 57–58, 167–240 bank profitability 214–215 bond yields 191–193 demographic shifts 215–217 drivers 179–180 earnings per share 195–196 employment and unemployment 183–185 equity valuations 206–208 ‘first mile problem’ 226–227 future expectations 246–247 global relative performance 193–196 growth momentum 174–178, 182–183, 227–231 growth and value companies 190–196, 239–240 implied growth 210–215 inflation 180–182, 203–205 interest rates 180–182, 239–240 Japan, lessons from 196–200 lessons from 244–245 market and economy incongruence 174–178 monetary policy 178–179, 201–205 opportunities 230–231 profitability 185–186 quantitative easing 202–205 returns 174–179 risk asset demand 217–220 structural changes 76–79, 93–96, 169–200 technology 189–190, 221–241 term premium collapse 204–205 ultra-low bond yields 201–220 valuations 233–235 volatility 187–189 cycles 1970s 56 asset returns 63–79 cyclical vs. defensive companies 85–89 equities 49–62 growth vs. value companies 90–96 investment styles 81–96 long-term returns 29–47 riding 11–27 sectors 83–85 valuations 53 cyclical bear markets 105, 106–107, 117, 118 vs. event-driven 109 cyclical bull markets 134–136 cyclical companies bond yields 193 inflation 88 sectors 83–84 vs. defensive 85–89 cyclical growth 83–84 cyclically adjusted price-to-earnings ratio (CAPE) 37–38, 44–45 cyclical value 83–84 D DDM see discounted dividend model debt levels bubbles 160–161 structural bear markets 110, 114 decarbonization 13 defensive companies 63–65 bond yields 193 inflation 88 Japan 198 sectors 83–84 vs. cyclical 85–89 defensive growth 83–84 defensive value 83–84 deflation bear markets 109, 113 Volker 102, 131 delivery solutions 226–227 demographics and zero bond yields 215–217 deregulation 12, 132–133, 157–159 derivative markets 158–159 design of policy 25–26 despair phase 50–52, 53, 55–56, 60, 66–68 cyclical vs. defensive companies 86, 88 growth vs. value companies 92 Dice, C. 161 Dimitrov, O. 162 discounted dividend model (DDM) 36, 69 discount rate 68 disinflation 131–133 disruption 1980s 12–15 current equity cycle 189–190, 221–241 electricity 226 historical parallels 222–227 printing press 223–224 railway infrastructure 224–227 telecoms 225–226 divergence, and technology 238–240 diversification 42, 45–47, 178–179 dividends asset yields 38–41, 69 reinvestment 38–40 value of future streams 209 vs. bonds 78–79 Dodd, D. 163, 164 domain registrations 12–13 dominance of technology 231–233 dotcoms 12–13, 33, 93–94, 102, 161, 237 Dow Jones 1970s 131 1980s 15–16, 131 Black Monday 16, 102, 148 Draghi, M. 17, 173 drivers of bull markets 138 current equity cycle 179–180 duration bear markets 100–101, 106–111, 117 bull markets 135–138, 139–141 cyclical bear markets 106–107, 117, 118 cyclical bull markets 135–136 dominance of technology 231–233 event-driven bear markets 108–109, 117–118 non-trending bull markets 139–141 structural bear markets 109–111, 117 term premia 204–205 DVDs 227 E earnings per share (EPS) bear markets 115–117 historical 189 since pre-financial crisis peak 195–196, 209–210 easy credit, and bubbles 160–161 ECB see European Central Bank Economic Recovery Act, 1981 132 efficient market hypothesis 4 electricity 226 email 13 employment 121–124, 183–185 Enron 164 environmental issues 13 EPS see earnings per share equities across phases 66–68 ‘bond-like’ 96 and bond yields 72–73, 74–76, 206–208 bull market performance 135–136 CAPE 37–38, 44–45 dividends 38–41, 69, 78–79, 209 and inflation 65–66, 70 mini/high-frequency cycles 58–61 narrowing and structural bear markets 114–115 overextension 36–37 phases of investment 50–58 quantitative easing 173–174, 178–179 S&P 500 historical performance 42 valuations and future returns 43–45 vs. bonds 43–45, 68–76, 78–79 equity cycle 49–62 1970s 56 1980s 56–57 1990s 57 2000-2007 57 current 57–58, 76–79 historical periods 56–58 length 49 mini/high-frequency 58–61 phases 50–56 structural shifts 76–79 equity risk premium (ERP) 35–38, 69–72, 210 ERM see exchange rate mechanism ERP see equ ity risk premium ESM see European stability mechanism Europe dividends 39–40 exchange rate mechanism 16–17, 111 Maastricht Treaty 17 market narrowing in 1990s 115 privatisation 132 quantitative easing 17, 204–205 sovereign debt crisis 170, 171–173 European Central Bank (ECB) 17, 171, 173 European Recovery Plan 129–131 European stability mechanism (ESM) 173 event-driven bear markets 105, 107–109, 117–118 vs. cyclical 109 excess see bubbles exchange rate mechanism (ERM) 16–17, 111 exogenous shocks 108 expansions, asset performance 63–65 F false negatives, bear markets 119–120 fat and flat markets 128, 139 features see characteristics Federal Reserve 16, 102, 131, 134, 150–151, 157, 203 financial crisis, 2007–2009 169–174 forecasting 19–21 growth vs. value company effects 94–96 impact 169–170 structural bear market 110, 118–119 financial innovation 158–159 ‘first mile problem’ 226–227 Fish, M. 19 fixed costs 84–85, 173–174 fixed income assets 35, 65, 69–70, 205 flat markets 138–141 see also non-trending bull markets forecasting 2008 financial crisis 19–21 bear markets 106, 108, 109–110, 119–125 behavioural aspects 22–25 difficulties of 18–22 future growth 211–212 neuroeconomics 24–25 and policy setting 25–26 recessions 20–21 and sentiment 21–25 short-term 17–18 weather 18–19 France Mississippi Company 147, 151 privatisation 132 Fukuyama, F. 15 future expectations 246–247 G Galbraith, J.K. 160 GATT see General Agreement on Tariffs and Trade General Agreement on Tariffs and Trade (GATT) 129 Germany Bund yield 207 fall of Berlin Wall 133 wage inflation 185 Glasnost 14 Glass-Steagall Act, 1933 132 global growth 182–183 globalisation 14–16 global relative performance 193–196 global sales growth 212 global technology bubble 33, 93–94, 149–150, 156–157, 158–159, 161, 164 Goetzmann, F. 151 ‘Golden Age of Capitalism’ 129–131 Gold Standard 130 see also Bretton Woods monetary system Goobey, G.R. 77 Google 237 Gorbachev, M. 14 Gordon Growth model 209 government-debt-for-equity swaps 151–152 Graham, B. 161, 163, 164 Great Britain South Sea Company 147, 151, 153 see also United Kingdom Great Depression 4 Great Moderation 133–134, 187–189 Greenspan, A. 16, 113, 150–151 gross domestic product (GDP) cyclical vs. defensive companies 87 labour share of 185, 238–239 phases of cycle 52–53 profit share of, US. 186 growth bear markets 122–123 current equity cycle 174–178, 182–183, 227–231 technology impacts 227–231 and zero bond yields 208–210, 210–215 growth companies bond yields 92–94, 191–193 current cycle 190–196 definition 90–91 since financial crisis 94–96 interest rates 92–94 outperformance 239–240 sectors 83–84 vs. value 90–96 growth phase 50–52, 54–56, 67–68 cyclical vs. defensive companies 86 growth vs. value companies 92 Gulf war 102 H herding 21–22, 144–145 high-frequency cycles 58–61 historical performance 10 year bonds, US 43 bonds 43, 202 equities cycles 49, 56–58 S&P 500 38–39, 42 trends 29–31 holding periods 31–34 Holland, tulip mania 146–147 hope phase 50–52, 53–54, 55–56, 66–67 cyclical vs. defensive companies 86 growth vs. value companies 92 housing bubble, US 70, 102, 118, 133, 145, 159 Hudson, G. 163 I IBM 13, 155, 236 IMAP see Internet Message Access Protocol IMF see International Monetary Fund impacts of diversification 42, 45–47 financial crisis, 2007-2009 169–170 technology on current cycle 221–241 ultra-low bond yields 201–220 Imperial Tobacco pension fund 77 implied growth 210–215 income, Kuznets cycle 3 indicators bear markets 106, 108, 109–110, 119–125 cyclical bear markets 106 event-driven bear markets 108 structural bear markets 109–110 industrial revolution 224–226 industry leadership, S&P 500 232–233, 237–238 inflation asset performance 65–66, 70 bear markets 101–103, 109, 121–122 current equity cycle 180–182, 203–205 cyclicals 88 Volker 102, 131 Institute of Supply Management index (ISM) 59–61 bear markets 123 cyclical vs. defensive companies 86–87 interest rates bear markets 106, 111–113 current equity cycle 180–182, 239–240 growth vs. value companies 92–94 structural bear markets 111–113 and yield 69, 74–76 International Monetary Fund (IMF) 129 internet 12–13, 225–227 search 237 see also dotcoms Internet Message Access Protocol (IMAP) 13 inventories 84–85 Kitchin cycle 3 investment, Juglar cycle 3 investment cycle bear markets 122–123 current 57–58, 76–79 historical periods 56–58 lengths 49 mini/high-frequency 58–61 phases 50–56 structural shifts 76–79 see also cycles ISM see Institute of Supply Management index J Japan bubbles 114, 148–149, 155–156, 158, 160–161, 162, 164 defensive companies 198 dividends 39–40 lessons from 196–200 John Crooke and Company 160 Juglar cycle 3 K Kahneman, D. 22–23 Kennedy Slide bear market 102 Keynes, J.M. 22 Kindleberger, C.P. 22 Kitchin cycle 3 Kondratiev cycle 3 Kuznets cycle 3 L labour share of GDP 185, 238–239 land and property bubble, Japan 114, 148–149, 155–156, 158, 160–161, 162, 164 laptop computers 13 largest companies S&P 500 237–238 technology 234–237 light touch regulation 157–159 see also deregulation Live Aid 13–14 Loewenstein, G. 21–22 long-term returns 29–47 M Maastricht Treaty 17 Mackay, C. 21 market forecasts short-term 17–18 see also forecasting market narrowing structural bear markets 114–115 and technology 238–240 markets current equity cycle 174–178 psychology of 21–25, 144–145 see also bear markets; bubbles; bull markets market timing 41–43 market value of technology companies 234, 235–238 Marks, H. 6–7 Marshall Plan 129–131 MBS see mortgage-backed securities Microsoft 12, 236–237 mini cycles 58–61 Mississippi Company 147, 151 monetary policy 157–159, 178–179, 201–205, 239 austerity 239 European Central Bank 17, 171, 173 Federal Reserve 16, 102, 131, 134, 150–151, 157, 203 quantitative easing 17, 70–71, 119, 133–134, 173–174, 178–179, 202–205 Montreal Protocol 13 mortgage-backed securities (MBS) 159 MSCI indices 91 N narrow equity markets 114–115, 238–240 NASDAQ 149–150, 161 negative bond yields 201–220 demographics 215–217 and equity valuations 206–208 and growth 208–210 implied growth 210–215 monetary policy 201–205 quantitative easing 202–205 risk asset demand 217–220 neuroeconomics 24–25 ‘new eras’ 113–114, 150–157 ‘Nifty Fifty’ 114, 233 non-trending bull markets 138–141 nudges 26 O oil 108, 226 opportunities, technology 230–231 optimism phase 50–52, 54–56, 67–68 cyclical vs. defensive companies 86 growth vs. value companies 91–92 output gaps 4 Outright Monetary Transactions (OMT) 171, 173 overextension 36–37 ozone layer 13 P pension funds 77, 218–219 Perestroika 14 Perez, C. 159 performance bull markets 134–136 current equity cycle 174–179 and cycles 53–56 diversification impacts 42, 45–47 dividends 38–41 equities vs. bonds 43–45 factors 41–45 historical trends 29–31 holding periods 31–34 interest rates 69, 74–76 long-term 29–47 market timing 41–43 risks and rewards 35–38 valuations 43–45 volatility 30–31 personal computing introduction 12–13, 155 phases 2007-2009 financial crisis 171–174 asset classes 66–68 bear markets 123 cyclical vs. defensive companies 86 of equities cycle 50–56 growth vs. value companies 91–92 Phillips curve 182 Plaza Accord, 1985 148–149, 158 PMI see purchasing managers’ index policy, design of 25–26 population decline 216 post-financial crisis see current equity cycle post-war boom 129–131 prediction see forecasting price-to-earnings ratio (P/E) 53–56 printing press 223–224 prior conditions to bear markets 121–124 private sector debt 65, 110, 114, 160–161 private sector financial balance 124 privatisation 132 productivity growth 227–230 profit labour share of 185, 238–239 share of GDP, US. 186 profitability banks 214–215 bear markets 107, 115–117 current equity cycle 185–186 property and land bubble, Japan 114, 148–149, 155–156, 158, 160–161, 162, 164 psychology bubbles 144–145 of markets 21–25 policy setting 25–26 public ownership 132 purchasing managers' index (PMI) 59–61, 86–87, 89–90 Q QE see quantitative easing Qualcom 149–150 quality companies 193 quantitative easing (QE) asset returns 70–71, 119, 178–179 bond yields 173–174, 202–205 start of 17, 133–134, 171 United Kingdom 17, 204–205 United States 134, 171, 202–204 R radio, expansion of 154, 225 Radio Corporation of America (RCA) 154 railways bubbles UK 148, 152–153, 157, 163 US 153–154, 160 infrastructure development 224–227 Rau, P. 162 RCA see Radio Corporation of America Reagan, R. 14, 131–132 real assets 68 real estate bubble, US 70, 102, 118, 133, 145, 159 recessions bear markets 101–103 current equity cycle 174–178 forecasting 20–21 recovery bear markets 101 current equity cycle 174–178 reinvestment of dividends 38–40 return on equity (ROE) 43–45 returns bull markets 134–136 current equity cycle 174–179 cycles 53–56 diversification impacts 42, 45–47 dividends 38–41 equities vs. bonds 43–45 factors 41–45 historical trends 29–31 holding periods 31–34 interest rates 69, 74–76 long-term 29–47 market timing 41–43 risks and rewards 35–38 valuations 43–45 volatility 30–31 reverse yield gap 77 risk assets, demand for 217–220 risk-free interest rate 68 risk indicators bear markets 119–125 event-driven bear markets 108 structural bear markets 110–111, 113–114 risk premia equity 35–38, 69 neuroeconomics 25 term premia 204–205 ROE see return on equity Rouwenhorst, G. 151 Russian debt default, 1997 108 S S&P 500 bear markets 103–105 and bond yields 72–73 concentration in 1990s 115 dividends 38–39 historical performance 38–39, 42 industry leadership 232–233, 237–238 and ISM 60 largest companies 237–238 US Treasury yields 206 sales growth 212 savings, current equity cycle 182 Schumpeter, J. 150 search companies 237 ‘search for yield’ 217–220 secondary-market prices 229–230 sectors across the cycle 83–85 dominance 231–233 secular bull market 127–134 disinflation 131–133 Great Moderation 133–134, 187–189 post-war boom 129–131 secular stagnation hypothesis 181 sentiment 5, 21–25 see also bubbles Shanghai composite stock price index 156 Shiller, R.J. 4–5, 23 short-term market forecasts 17–18 skinny and flat markets 139–140 smartphones 226, 229–230 Solow, R. 229 South Sea Company 147, 151, 153 sovereign debt crisis 170, 171–173 Soviet Union 14–15, 133 speed of adjustment 74, 89–90, 122–123 Standard Oil 235 structural bear markets 105, 109–115 1960s 130 bubbles 113 debt levels 110, 114 deflation 113 duration 109–111, 117 financial crisis, 2007 118–119 interest rates 111–113 narrow equity markets 114–115 ‘new eras’ 113–114 risk indicators 110–111, 113–114 triggers 111 volatility 105, 115 structural changes 6 1980s 12–15 current equity cycle 76–79, 93–96, 169–200 sub-prime mortgage bubble 70, 102, 118, 133, 145, 159 Summers, L. 181 Sunstein, C.R. 26 ‘super cycle’ secular bull market 127–134 see also secular bull market T technology 1920s America 154 bubble in 1990s 33, 93–94, 149–150, 156–157, 158–159, 161, 164 current equity cycle 189–190, 221–241 and disruption in 1980s 12–15 dominance 231–233 and growth 227–231 historical parallels 222–227 industrial revolution 224–226 Kondratiev cycle 3 largest companies 234–237 market value 234, 235–238 opportunities 230–231 personal computers 12–13, 155 printing press 223–224 railway bubbles 148, 152–154, 157, 160, 163 railway infrastructure 224–227 and widening gaps 238–240 telecommunications 13, 154, 225, 235–236, 238 telegrams 225 term premium collapse 204–205 TFP see total factor productivity growth Thaler, R.H. 26 Thatcher, M. 14, 132 Tokkin accounts 158 ‘too-big-to-fail’ 133 total factor productivity (TFP) growth 238–240 triggers bear markets 101–105, 106, 108, 111 cyclical bear markets 106 event-driven bear markets 108 structural bear markets 111 tulip mania 146–147 Tversky, A. 22–23 U ultra-low bond yields 201–220 demographics 215–217 and equity valuations 206–208 and growth 208–210 implied growth 210–215 monetary policy 201–205 quantitative easing 202–205 risk asset demand 217–220 UNCTAD see United Nations Conference on Trade and Development unemployment 121–124, 183–185 unexpected shocks 108 United Kingdom (UK) Black Wednesday 16–17 bond yields, historical 202 canal mania 152 deregulation 132 exchange rate mechanism 16–17, 111 privatisation 132 quantitative easing 204–205 railway bubble 148, 152–153, 157, 163 South Sea Company 147, 151, 153 United Nations Conference on Trade and Development (UNCTAD) 129 United States (US) 10 year bond returns 43 Black Monday 16, 102, 148 bull markets 136 credit crunch 78–79, 170, 171 disinflation 132 dividends 38–39 Dow Jones 15–16, 131 equities in current cycle 207–208 housing bubble 70, 102, 118, 133, 145, 159 labour share of GDP 185, 238–239 market narrowing 114 NASDAQ 149–150, 161 ‘Nifty Fifty’ 114, 130–131, 233, 235 post-war boom 129–131 profit share of GDP 186 quantitative easing 133–134, 171, 202–204 radio manufacturing 154, 225 railway bubble 153–154, 160 stock market boom, 1920s 148, 154, 157, 160 vs.


pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

3Com Palm IPO, asset allocation, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Brownian motion, buy and hold, collateralized debt obligation, commodity trading advisor, computerized trading, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, global macro, high net worth, implied volatility, index arbitrage, index fund, Jim Simons, junk bonds, London Interbank Offered Rate, Long Term Capital Management, low interest rates, managed futures, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, merger arbitrage, negative equity, pattern recognition, performance metric, pets.com, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, selection bias, Sharpe ratio, short selling, statistical arbitrage, statistical model, subprime mortgage crisis, survivorship bias, tail risk, transaction costs, two-sided market, value at risk, yield curve

In this light, the distinction between the groups as separate asset classes appears artificial. If anything, it makes more sense to differentiate along strategy approaches, such as systematic macro versus discretionary macro (with each group containing both CTAs and global macro hedge funds), rather than between global macro managers and CTAs. Fund of hedge funds. As the name implies, these funds allocate to other hedge funds. Most funds of funds seek to allocate to a broad mix of hedge fund strategies in order to enhance portfolio diversification. Some funds of funds, however, create thematic portfolios (e.g., long/short equity, credit, managed futures, etc.) for investors seeking exposure to a specific strategy group.

In this case, the investor must weigh the trade-off of including second-tier investments versus the benefit of reduced risk provided by diversification. In fact, if carried to an extreme, diversification would guarantee mediocrity by leading to index-like performance. If an index return is desirable, then it can be achieved much more efficiently by investing directly in an index or a fund that benchmarks the index. It follows that insofar as a goal of any investment process is, presumably, to surpass index performance, then diversification must, by definition, be limited. Although diversification is beneficial, if not essential, beyond some point more diversification can be detrimental. Each investor must determine the appropriate level of diversification as an individual decision.

Are There Strategies That Are Not Amenable to Managed Accounts? Evaluating Four Common Objections to Managed Accounts Investment Insights Postscript to Part Two: Are Hedge Fund Returns a Mirage? Part Three: Portfolio Matters Chapter 17: Diversification: Why 10 Is Not Enough The Benefits of Diversification Diversification: How Much Is Enough? Randomness Risk Idiosyncratic Risk A Qualification Investment Insights Chapter 18: Diversification: When More Is Less Investment Insights Chapter 19: Robin Hood Investing A New Test Why Rebalancing Works A Clarification Investment Insights Chapter 20: Is High Volatility Always Bad? Investment Insights Chapter 21: Portfolio Construction Principles The Problem with Portfolio Optimization Eight Principles of Portfolio Construction Correlation Matrix Going Beyond Correlation Investment Insights Epilogue: 32 Investment Observations Appendix A: Options—Understanding the Basics Appendix B: Formulas for Risk-Adjusted Return Measures Sharpe Ratio Sortino Ratio Symmetric Downside-Risk Sharpe Ratio Gain-to-Pain Ratio (GPR) Tail Ratio MAR and Calmar Ratios Return Retracement Ratio Acknowledgments About the Author Index Other Books by Jack D.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

Alan Greenspan, asset allocation, buy and hold, collateralized debt obligation, commoditize, compensation consultant, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Glass-Steagall Act, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, John Bogle, junk bonds, low interest rates, market bubble, market clearing, military-industrial complex, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, Ponzi scheme, post-work, principal–agent problem, profit motive, proprietary trading, prudent man rule, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, seminal paper, shareholder value, short selling, South Sea Bubble, statistical arbitrage, stock buybacks, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, two and twenty, Vanguard fund, William of Occam, zero-sum game

The table below shows one version of how various markets and asset-class managers must perform in order for a pension plan to reach that elusive goal. A Template for DB Returns During the Coming Decade In effect, I present in the chart the very analysis that at least some corporations use—yet without their disclosure of the specific numbers they use. Here’s the Exxon Mobil explanation for the process that underlies the corporation’s expected return assumption of 7.5 percent for its pension plan: “a forward-looking, long-term return assumption for each asset class, taking into account factors such as the expected return for each.”

What’s more, for DB plan managers as a group—competing with one another—zero Alpha is the expected outcome. (In fact, with the typical costs that I’ve assumed, pension managers will, in the aggregate, produce negative Alpha.) Even if our asset class returns for equities and bonds are realized, venture capital and hedge funds would have to earn returns that are far above historical norms. If those asset classes fail to do so, the actual realized return for this example would fall by 2 percentage points, to 6 percent per year. Mark your calendars for 2022, 10 years hence, and see who’s made the best estimate. For me, subjectively, even 6 percent is an ambitious goal.

See also Retirement system design problems with growth in passively managed index funds in simplifying speculative investment options in Delaware Democracy, corporate Derivatives Dimensional Fund Advisors Directors Diversification Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) “Do ETFs Badly Serve Investors?” (Tower and Xie) Domestic equity mutual funds Double-agency society Earnings, managed Econometric techniques “Economic Role of the Investment Company, The” (Bogle) Economics (Samuelson) Economist, The Efficient Market Hypothesis (EMH) Ellis, Charles D. Emerging markets stock funds Employee Retirement Income Security Act (ERISA) Employer, stock of Equity diversification Equity index funds Equity mutual funds. See also Actively managed equity funds assets costs domestic emerging markets expense ratio, average failure of large-cap number of returns small capitalization volatility, increase in Equity ownership, institutional ERISA (Employee Retirement Income Security Act) Essinger, Jesse Estrada, Javier Exchange traded funds (ETFs): assets Economist on future of growth in history of holding periods institutional versus individual investors in managers, leading number of problems with profile focus and selection risk profile of returns as speculation trading volumes traditional index funds versus turnover Vanguard Wall Street Journal listing of Exchange traded notes (ETNs) Executive compensation: average worker’s pay compared to cost of capital and highest increase in ratchet effect reform, progress on reform suggestions as “smoking gun,” tax surcharge on Exile on Wall Street (Mayo) Expectations, investment Expectations market Expenses.


pages: 149 words: 43,747

How I Invest My Money: Finance Experts Reveal How They Save, Spend, and Invest by Brian Portnoy, Joshua Brown

asset allocation, behavioural economics, bitcoin, blockchain, blue-collar work, buy and hold, coronavirus, COVID-19, cryptocurrency, diversification, diversified portfolio, estate planning, financial independence, fixed income, high net worth, housing crisis, index fund, John Bogle, low interest rates, mental accounting, passive investing, prediction markets, risk tolerance, Salesforce, Sharpe ratio, time value of money, underbanked, Vanguard fund

My philosophy about money shapes how I invest. I like to build flexibility and discipline in my investment plan. I try to automate my savings and investment plan. I started participating in my 401(k) plan even before I graduated from college. I have a long-term perspective to investing. I believe that tax diversification is just as important as investment diversification. It is important to have tax-deferred, tax-free and taxable accounts so that you can plan for changes in tax rates. I am not the type of investor who will set it and forget it, nor will I day trade in my account either. Everyone’s portfolio deserves TLC. Financial planning does not mean that you will avert a market downturn, but it does give you certain peace of mind knowing that you can stay the course.

Where to invest Public markets have become so efficient because of the advancements in information technology that it is impossible to achieve any informational advantage (legally). Therefore, I am more interested in investing in markets that are less efficient and where information advantages can be easily and legally gained. Examples of these types of markets are: real estate (all sub-asset classes), privately held operating businesses, venture capital, fine art, fine wine and spirits, watches, collectible automobiles, antiques, antiquities, rare earth metals, and cryptocurrencies. Warren Buffett famously said, “invest in what you know.” I take it one step further and assert “invest in things you love to own and that you are obsessed with researching and gaining knowledge about.”

After you invest in yourself—aka your own business, or businesses, that you have some measure of control in, e.g. a voting Board seat—invest in real estate. In my experience real estate is the second most reliable way to build wealth over the very long term. I personally own outright, or am a limited partner in, a wide range of real estate sub-asset classes. My investments include: single family residential, multi-family residential, farm land, industrial distribution centers, and self-storage. I have made exceptional returns (particularly tax adjusted) in almost all of my real estate investments. Invest in assets you love. In my case I love visual art.


pages: 1,239 words: 163,625

The Joys of Compounding: The Passionate Pursuit of Lifelong Learning, Revised and Updated by Gautam Baid

Abraham Maslow, activist fund / activist shareholder / activist investor, Airbnb, Alan Greenspan, Albert Einstein, Alvin Toffler, Andrei Shleifer, asset allocation, Atul Gawande, availability heuristic, backtesting, barriers to entry, beat the dealer, Benoit Mandelbrot, Bernie Madoff, bitcoin, Black Swan, book value, business process, buy and hold, Cal Newport, Cass Sunstein, Checklist Manifesto, Clayton Christensen, cognitive dissonance, collapse of Lehman Brothers, commoditize, corporate governance, correlation does not imply causation, creative destruction, cryptocurrency, Daniel Kahneman / Amos Tversky, deep learning, delayed gratification, deliberate practice, discounted cash flows, disintermediation, disruptive innovation, Dissolution of the Soviet Union, diversification, diversified portfolio, dividend-yielding stocks, do what you love, Dunning–Kruger effect, Edward Thorp, Elon Musk, equity risk premium, Everything should be made as simple as possible, fear index, financial independence, financial innovation, fixed income, follow your passion, framing effect, George Santayana, Hans Rosling, hedonic treadmill, Henry Singleton, hindsight bias, Hyman Minsky, index fund, intangible asset, invention of the wheel, invisible hand, Isaac Newton, it is difficult to get a man to understand something, when his salary depends on his not understanding it, Jeff Bezos, John Bogle, Joseph Schumpeter, junk bonds, Kaizen: continuous improvement, Kickstarter, knowledge economy, Lao Tzu, Long Term Capital Management, loss aversion, Louis Pasteur, low interest rates, Mahatma Gandhi, mandelbrot fractal, margin call, Mark Zuckerberg, Market Wizards by Jack D. Schwager, Masayoshi Son, mental accounting, Milgram experiment, moral hazard, Nate Silver, Network effects, Nicholas Carr, offshore financial centre, oil shock, passive income, passive investing, pattern recognition, Peter Thiel, Ponzi scheme, power law, price anchoring, quantitative trading / quantitative finance, Ralph Waldo Emerson, Ray Kurzweil, Reminiscences of a Stock Operator, reserve currency, Richard Feynman, Richard Thaler, risk free rate, risk-adjusted returns, Robert Shiller, Savings and loan crisis, search costs, shareholder value, six sigma, software as a service, software is eating the world, South Sea Bubble, special economic zone, Stanford marshmallow experiment, Steve Jobs, Steven Levy, Steven Pinker, stocks for the long run, subscription business, sunk-cost fallacy, systems thinking, tail risk, Teledyne, the market place, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, time value of money, transaction costs, tulip mania, Upton Sinclair, Walter Mischel, wealth creators, Yogi Berra, zero-sum game

Minimizing risk through diversification. An investor can enjoy part ownership of ten to fifteen of the best businesses in existence at any time. Diversification reduces the risk of losing capital entirely, which could happen, for any unfortunate or unforeseen reason, if you own only one business. Because one’s capital is spread across various businesses, this mitigates idiosyncratic (individual company–specific) risk. No matter how well you may know your stocks, every business has unknown risks. Few can know about a Satyam, an Enron, or a Ricoh India in advance. Diversification also protects investors from the risk of ruin as a result of a natural calamity or any other significantly adverse development in one or two businesses.

Risk hasn’t been reduced, it simply has been transferred from one form to another. Diversification of investments is touted as reducing both risk and volatility. Although a diversified portfolio indeed may reduce your overall level of risk, it also may correspondingly reduce your potential level of reward. The more extensively diversified an investment portfolio, the greater the likelihood is that it, at best, mirrors the performance of the overall market. Because many investors aim for better-than-market-average investment returns, it is important to have a clear understanding of diversification versus concentration in portfolio choices. Some level of diversification should be considered in constructing an investment portfolio, but it should not be the main driver.

—Charlie Munger instead, practice sufficient diversification… For an individual investor you want to own at least ten and probably fifteen and as many as twenty different securities. Many people would consider that to be a relatively highly concentrated portfolio. In our view you want to own the best ten or fifteen businesses you can find, and if you invest in low leverage/high-quality companies, that’s a comfortable degree of diversification. —Bill Ackman and structure a concentrated yet diverse portfolio in terms of risk exposures. Most investors think diversification consists of holding many different things, few understand that diversification is effective only if portfolio holdings can be counted on to respond differently to a given development in the environment.


pages: 517 words: 139,477

Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Alan Greenspan, AOL-Time Warner, Asian financial crisis, asset allocation, backtesting, banking crisis, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, Black-Scholes formula, book value, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, currency risk, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, Glass-Steagall Act, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, it's over 9,000, John Bogle, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, machine readable, market bubble, mental accounting, Minsky moment, Money creation, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, proprietary trading, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk free rate, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen, Tyler Cowen: Great Stagnation, uptick rule, Vanguard fund

Long-term correlations between asset returns are significantly lower than short-term correlations. This means that long-term investors should continue to diversify even though such diversification does not lead to significant reductions in the short term volatility of portfolio returns. Decreased Correlations In contrast to commodities, which have increased their correlation with stocks since the financial crisis, there are two notable asset classes whose returns have become significantly less correlated with equities: U.S. Treasury bonds and the U.S. dollar. The price of a dollar in foreign exchange markets is impacted by the strength of the U.S. economy and the safe-haven status that international investors accord the U.S. dollar.

Impact of the Financial Crisis on Asset Returns and Correlations One of the principal conclusions of financial theory is that to attain the best return for a given risk, investors should seek to diversify their holdings not only within an asset class but also among asset classes. For that reason investors put a premium on assets whose prices are negatively correlated with the market, and discount assets that are positively correlated with the market. Figure 3-3 shows the correlations of various asset classes with the S&P 500 over all five-year windows from 1970 through 2012. One can see that the financial crisis had a significant impact on the correlation between asset classes, in most cases accelerating trends that had taken place before the crisis. The correlation between both developed economies’ equity markets (EAFE) and emerging economies’ equity markets (EM) with the U.S. stock market has grown significantly, reaching 0.91 for EAFE and 0.85 for EM.

But this result begets the question: If faster growth is not the reason to buy international stocks, what is? DIVERSIFICATION IN WORLD MARKETS The reason for investing internationally is to diversify your portfolio and reduce risk. Foreign investing provides diversification in the same way that investing in different sectors of the domestic economy provides diversification. It would be poor investment strategy to pin your hopes on just one stock or one sector of the economy. Similarly it is not a good strategy to buy the stocks only in your own country, especially when developed economies are becoming an ever smaller part of the world’s market. International diversification reduces risk because the stock prices of different countries do not rise and fall in tandem, and this asynchronous movement of returns dampens the volatility of the portfolio.


pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

affirmative action, Alan Greenspan, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bear Stearns, Bernie Madoff, Black-Scholes formula, Bob Litterman, business cycle, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, Glass-Steagall Act, global macro, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, John Meriwether, Kickstarter, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, low skilled workers, managed futures, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, Mitch Kapor, money market fund, moral hazard, mortgage debt, Myron Scholes, National best bid and offer, negative equity, Northern Rock, Occupy movement, oil shock, price stability, proprietary trading, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Ronald Reagan, Sam Peltzman, Savings and loan crisis, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, survivorship bias, systematic trading, tail risk, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

Even through one of the hottest bull markets ever, this fixed-income money tree left the S&P 500 in the dust.10 Continue the comparison across a host of major asset classes high-yield bonds, real estate, gold, silver, world bonds, or world equity and the story is the same. The LTCM money tree was the best deal around. More than that, LTCM added diversification to many investors’ holdings. The LTCM portfolio had a low correlation to many standard asset classes that an investor might already hold. Only the HFRI Relative Value Index, which is a diversified index of relative value hedge funds and not really investable, had a Sharpe ratio in the same ballpark as that of LTCM.11 LTCM’s returns from 1994 to 1997 were impressive, but it wasn’t the leverage per se that boosted them above the average.

A portfolio of relative-value hedge funds (HFR RV Index) has a much higher Sharpe ratio than all the selected relative-value funds.8 The JWMP fund provided a much better alternative to standard asset classes over this period. Its Sharpe ratio was nearly double that of the asset class with the highest Sharpe ratio in this table, showing that these other asset classes could not be leveraged to provide the same level of return as JWMP without having much more monthly risk. Even considering their leverage, these hedge funds did better than other asset classes. With success came more assets. By 2007, JWMP managed roughly $3 billion in assets, most of it from fund-of-funds investors. Platinum Grove Asset Management Former LTCM principals Myron Scholes and Chi-Fu Huang, along with three former LTCM employees, Ayman Hindy, Lawrence Ng, and Tong-Sheng Sun, left to start their own hedge fund.

Traders were more likely to take on marginal trades because they believed that the diversified portfolio protected them. When we came into 1998, I didn’t like a lot of our trades. They were very marginal. I didn’t do anything about it. I thought with our diversification, it would come out in the wash. There was a general notion that if these trades were standalone trades, we would not have put them on. Diversification fooled us. —Hans Hufschmid interview, September 30, 2010 Diversification may have also encouraged less experienced, more theoretical traders to make experimental trades. There were only about 4 people at LTCM who had substantial trading instincts, something that got at times lost in a larger group.


pages: 571 words: 105,054

Advances in Financial Machine Learning by Marcos Lopez de Prado

algorithmic trading, Amazon Web Services, asset allocation, backtesting, behavioural economics, bioinformatics, Brownian motion, business process, Claude Shannon: information theory, cloud computing, complexity theory, correlation coefficient, correlation does not imply causation, data science, diversification, diversified portfolio, en.wikipedia.org, financial engineering, fixed income, Flash crash, G4S, Higgs boson, implied volatility, information asymmetry, latency arbitrage, margin call, market fragmentation, market microstructure, martingale, NP-complete, P = NP, p-value, paper trading, pattern recognition, performance metric, profit maximization, quantitative trading / quantitative finance, RAND corporation, random walk, risk free rate, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, Silicon Valley, smart cities, smart meter, statistical arbitrage, statistical model, stochastic process, survivorship bias, transaction costs, traveling salesman

This is Markowitz's curse: The more correlated the investments, the greater the need for diversification, and yet the more likely we will receive unstable solutions. The benefits of diversification often are more than offset by estimation errors. Figure 16.1 Visualization of Markowitz's curse A diagonal correlation matrix has the lowest condition number. As we add correlated investments, the maximum eigenvalue is greater and the minimum eigenvalue is lower. The condition number rises quickly, leading to unstable inverse correlation matrices. At some point, the benefits of diversification are more than offset by estimation errors. Increasing the size of the covariance matrix will only make matters worse, as each covariance coefficient is estimated with fewer degrees of freedom.

In intuitive terms, we can understand the above empirical results as follows: Shocks affecting a specific investment penalize CLA's concentration. Shocks involving several correlated investments penalize IVP's ignorance of the correlation structure. HRP provides better protection against both common and idiosyncratic shocks by finding a compromise between diversification across all investments and diversification across clusters of investments at multiple hierarchical levels. Figure 16.7 plots the time series of allocations for the first of the 10,000 runs. Figure 16.7 (a) Time series of allocations for IVP. Between the first and second rebalance, one investment receives an idiosyncratic shock, which increases its variance.

The values could be tabulated or hierarchical, aligned or misaligned, historical or real-time feeds, etc. Team members are experts in market microstructure and data protocols such as FIX. They must develop the data handlers needed to understand the context in which that data arises. For example, was a quote cancelled and replaced at a different level, or cancelled without replacement? Each asset class has its own nuances. For instance, bonds are routinely exchanged or recalled; stocks are subjected to splits, reverse-splits, voting rights, etc.; futures and options must be rolled; currencies are not traded in a centralized order book. The degree of specialization involved in this station is beyond the scope of this book, and Chapter 1 will discuss only a few aspects of data curation. 1.3.1.2 Feature Analysts This is the station responsible for transforming raw data into informative signals.


How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Bear Stearns, Black-Scholes formula, Bob Litterman, Bonfire of the Vanities, book value, Bretton Woods, Brownian motion, business cycle, business process, butter production in bangladesh, buy and hold, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency risk, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, full employment, George Akerlof, global macro, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, Ivan Sutherland, John Bogle, John von Neumann, junk bonds, linear programming, Loma Prieta earthquake, Long Term Capital Management, machine readable, margin call, market friction, market microstructure, martingale, merger arbitrage, Michael Milken, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Richard Feynman, Richard Stallman, risk free rate, risk-adjusted returns, risk/return, seminal paper, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, subscription business, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

As this debate intensified, I reexamined the BHB methodology and discovered it was specious for reasons other than its reliance on realized returns. I contrived an experiment to demonstrate its fundamental flaw. I hypothesized a world in which all asset classes had the same performance, but within each asset class the performance of individual securities varied significantly. In this hypothetical world, security selection explained 100 percent of the difference in the performance among funds, while asset allocation had no impact whatsoever. I essentially created a world with a single asset class, thus rendering the asset allocation decision irrelevant. I then applied the BHB methodology, and it revealed that asset allocation determined 100 percent of performance and security selection determined none of it—the exact opposite of the truth.15 JWPR007-Lindsey May 7, 2007 17:15 Mark Kritzman 261 The Future for Quants Quantitative analysis has advanced from the fringes of the investment management profession to the mainstream and is well on the way to becoming the dominant paradigm of the investment industry.

For example, an outcome investment product might focus on inflation protection with a bucket of assets that include real assets such as commodities, inflation protected bonds, and real estate. This means that, in the future, asset class lines will blur and become less important. What will be important will be a rigorous design of new products that addresses the new risks for the retired Boomers. This is where quants will continue to excel. These new outcomeoriented products will need a solid analytical design where the relationships across asset classes can be documented, well understood, and made to work together in the most efficient manner possible. Traditional fundamental research will be less important because the goal will not be to find undervalued stocks or bonds, but instead, to focus on financial outcomes.

Olivier had been a quant at Paribas and UBS and brought with him a good deal of experience in both derivatives theory and analytics library design. His vision was to build a new library from scratch that was going to have its own structured products description language, a whole host of modelling frameworks for the various asset classes as well cross-asset class hybrids, and sophisticated numerical pricing engines. It was an exciting project, and he had put together a strong team for the job. I guess it was for most of us the first time that we had been involved in building what amounted to a whole derivatives pricing JWPR007-Lindsey 174 May 18, 2007 21:24 h ow i b e cam e a quant system from scratch.


pages: 229 words: 61,482

The Gig Economy: The Complete Guide to Getting Better Work, Taking More Time Off, and Financing the Life You Want by Diane Mulcahy

Affordable Care Act / Obamacare, Airbnb, Amazon Mechanical Turk, basic income, Clayton Christensen, cognitive bias, collective bargaining, creative destruction, David Brooks, deliberate practice, digital nomad, diversification, diversified portfolio, fear of failure, financial independence, future of work, gig economy, helicopter parent, Home mortgage interest deduction, housing crisis, independent contractor, job satisfaction, Kickstarter, loss aversion, low interest rates, low skilled workers, Lyft, mass immigration, mental accounting, minimum wage unemployment, mortgage tax deduction, negative equity, passive income, Paul Graham, remote working, risk tolerance, Robert Shiller, seminal paper, Silicon Valley, Snapchat, social contagion, TaskRabbit, TED Talk, the strength of weak ties, Uber and Lyft, uber lyft, universal basic income, wage slave, WeWork, Y Combinator, Zipcar

The Risk of Over-Diversification One question to consider when building your portfolio of gigs is, how much is too much? How many gigs should you have? You want to be careful to realize the benefits of diversification but not over-diversify. The easiest way to think about diversification concretely is to use a simple financial example. If you had a total of $25,000 in savings, you wouldn’t invest it all in one company. There are too many reasons, none of which you can control or accurately predict, why the company could perform poorly, leaving you worse off. Lack of diversification is risky. But what happens if you over-diversify the portfolio and invest ten dollars each in 2,500 stocks?

It turns out that over-diversifying can be just as bad; it may constrain your losses, but it also limits your gains. Excess diversification eliminates the risk that any one company’s poor performance will tank the portfolio but also limits the gain you’ll realize from any outperformance. Over-diversified portfolios generate average returns that mirror, rather than outperform, the general market because the performance of any single stock doesn’t meaningfully impact the performance of the whole portfolio. We risk over-diversification if we spread ourselves too thin and do too much. If we over-diversify, we risk achieving less than we hoped and expected.

We underinvest in every activity, which increases our risk of mediocre outcomes. It’s only worth making the investment in an activity if we can invest the right amount of time, energy, and attention to realize a meaningful reward. The challenge for each of us is to find the right level of diversification for ourselves. Can We Diversify and Build Expertise? Diversification has connotations of breadth, but it can also be deployed for depth. Malcolm Gladwell asserts in his book Outliers that it takes at least 10,000 hours of deliberate practice to obtain mastery in a cognitively demanding field.3 But we can stretch out our 10,000 hours over the course of our lives, achieving mastery later in life.


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Monday: stock market crash in 1987, Black Swan, Bonfire of the Vanities, bonus culture, book value, Bretton Woods, buy and hold, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, Cornelius Vanderbilt, corporate governance, Credit Default Swap, cross-subsidies, currency risk, dematerialisation, disinformation, disruptive innovation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial engineering, financial innovation, financial intermediation, financial thriller, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Greenspan put, Growth in a Time of Debt, Ida Tarbell, income inequality, index fund, inflation targeting, information asymmetry, intangible asset, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, it is difficult to get a man to understand something, when his salary depends on his not understanding it, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", Jim Simons, John Meriwether, junk bonds, light touch regulation, London Whale, Long Term Capital Management, loose coupling, low cost airline, M-Pesa, market design, Mary Meeker, megaproject, Michael Milken, millennium bug, mittelstand, Money creation, money market fund, moral hazard, mortgage debt, Myron Scholes, NetJets, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, reality distortion field, regulatory arbitrage, Renaissance Technologies, rent control, risk free rate, risk tolerance, road to serfdom, Robert Shiller, Ronald Reagan, Schrödinger's Cat, seminal paper, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, vertical integration, Washington Consensus, We are the 99%, Yom Kippur War

A fairly small number of securities is enough to provide effective diversification if the risks those securities carry are completely different. On the other hand, even a very long list of securities with similar characteristics provides little real diversification. Investing in companies in different economic sectors and different countries was once an effective route to diversification. But large corporations today operate in many businesses and are global in their scope. They have common sales profiles, so that Pfizer and Glaxo, Exxon and Shell, have fortunes very similar to each other. Not very much diversification is therefore achieved from a portfolio of big multinational companies like these.

The adverse consequences for business, for households and for economic growth and economic policy will be described in later chapters. Diversification Behold, the fool saith, ‘Put not all thine eggs in the one basket’ – which is but a matter of saying, ‘Scatter your money and your attention’; but the wise man saith, ‘Put all your eggs in the one basket and – WATCH THAT BASKET.’ Mark Twain, Pudd’nhead Wilson’s Calendar, 1894 Financial intermediation can facilitate diversification. A small share of several projects is less risky than a large share of a single one. If you toss a coin once, you either win or lose: if you toss a coin thirty times, you will have ten or more wins 98 per cent of the time.

Sharing the risks and rewards of a pool of assets with a group of people with similar objectives means that you can derive the same average return with lower risk of major loss (but correspondingly reduced possibility of substantial gain). Individuals can – and should – use this principle in building their own portfolios. Professional intermediaries can provide a service by offering ready-made diversification, so that savers can acquire a share in a portfolio with the purchase of a single security in a mutual fund or investment company. The coin-tossing game reduces risk effectively because the results of successive throws are independent of each other. Diversification is most effective if the values of the assets in a portfolio are uncorrelated. For example, the risk that interest rates will rise sharply is unrelated to the risk that a cancer drug will fail its clinical trials, or the risk that Apple’s new product range will flop.


pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

Alan Greenspan, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Black Swan, Black-Scholes formula, bonus culture, book value, break the buck, buy and hold, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delayed gratification, diversification, Edmond Halley, facts on the ground, fear index, financial innovation, fixed income, George Akerlof, Glass-Steagall Act, Greenspan put, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, John Meriwether, junk bonds, Kenneth Rogoff, Kickstarter, Long Term Capital Management, margin call, market bubble, money market fund, Myron Scholes, Nick Leeson, Northern Rock, offshore financial centre, Paul Samuelson, price mechanism, proprietary trading, regulatory arbitrage, rent-seeking, Richard Thaler, risk free rate, risk tolerance, risk/return, Ronald Reagan, Salesforce, Savings and loan crisis, seminal paper, shareholder value, short selling, statistical model, subprime mortgage crisis, The Chicago School, Thomas Bayes, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve, zero-sum game

Or as Markowitz put it, “A rule of behavior which does not imply the superiority of diversification must be rejected as a hypothesis and a maxim.”11 Expressed even more simply, if variance was “risk,” then Markowitz proved that diversification was “risk management.” Since this flavor of diversification protects against falls in prices, justifying it requires plenty of historical price data and deft use of statistics.12 Then there is a third type of diversification, the joker in the pack. Behavioral economists call it naive diversification, in part because it seems to be hardwired into the human psyche. Psychological experiments show that when people are not restricted to a single choice on a menu, they will spread their allocation across whatever is available.

In the spring of 2000, the Barclays salesman in Germany, Christian Stoiber, brought Chandra to meet a pair of eager clients: LB Kiel and its sibling, Hamburgische Landesbank. Diversification, Motherhood, and Apple Pie A former LB Kiel executive summed up the bank’s strategy at the time succinctly: “What we were aiming for was diversification, which is a normal way if you manage your portfolio actively. We utilized our credit investment business to diversify our risks away.” In other words, follow the strategy advised by investment professionals everywhere. Doubting the benefit of diversification is the financial equivalent of doubting the goodness of motherhood and apple pie. But what do bankers actually mean by diversification? It turns out that there are three distinct types.

The bank’s board was under pressure to increase returns, but chasing higher returns meant accepting more risk on investments. However, market diversification reduced the overall level of risk. That’s why many finance experts say that for long-term investors, diversification is the closest thing to a free lunch. The problem for LB Kiel was that finding new lending opportunities across the world—the equivalent of additional coins or dice that were independent of what happened in Germany—was intensive, time-consuming work. It involved a lot of due diligence to avoid the seductive trap of naive diversification. That’s why what Barclays offered them seemed so appetizing—it had already done the hard work of scouring the globe and assembling a smorgasbord of hard-to-access assets.


pages: 225 words: 61,388

Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa by Dambisa Moyo

affirmative action, Asian financial crisis, belling the cat, Bob Geldof, Bretton Woods, business cycle, buy and hold, colonial rule, correlation does not imply causation, credit crunch, diversification, diversified portfolio, en.wikipedia.org, European colonialism, failed state, financial engineering, financial innovation, financial intermediation, Hernando de Soto, income inequality, information asymmetry, invisible hand, Live Aid, low interest rates, M-Pesa, market fundamentalism, Mexican peso crisis / tequila crisis, microcredit, moral hazard, Multics, Ponzi scheme, rent-seeking, risk free rate, Ronald Reagan, seminal paper, sovereign wealth fund, The Chicago School, trade liberalization, transaction costs, trickle-down economics, Washington Consensus, Yom Kippur War

The evidence of ten countries suggests that investors made higher returns on bond lending to foreign countries than in safer home governments; despite the former’s wars and recessions, foreign bondholders got a net return premium of 0.44 per cent per annum on all bonds outstanding at any time between 1850 and about 1970. Third, investing in the broader class of emerging markets can enhance portfolio diversification. The notion of portfolio diversification is at the core of asset management. It pertains to the need to spread your risks and rewards across investments. In essence, you diversify a portfolio to garner the same amount of returns for a reduced amount of risk. A very basic example of the diversification concept is illustrated by two separate islands, one that produces umbrellas and another that produces sunscreen. If you were to invest only in the island that produces umbrellas, you would make a fortune when it was unseasonably wet, but you would do poorly when it was a very dry year.

Like the sunscreen and umbrella islands, emerging markets and developed markets are so disparate that the opportunity to enhance a portfolio’s performance by having some exposure to both markets is considerable; smoothing out the risks and enhancing the returns. In the past, research has found that emerging-market debt (broadly as a group, as well as for individual countries) has low (and sometimes even negative) correlations with other major asset classes. To put it simply, emerging-market investments tend to fare well when other asset classes (say, developed-market stocks and bonds) fare less well. Indeed, the correlation of key emerging-market spreads (the difference between the risk-free rate and the rate charged to a riskier concern) and US bond returns is typically negative – moving in the same direction when the global economy is universally bad.

Shortly after the GEMLOC announcement, the bond investment organization PIMCO was selected to fulfil the role of investment manager. Next, Markit, a private-sector data and index firm, was chosen to develop a new independent and transparent bond index, for the emerging-markets local-currency debt asset class. A country’s inclusion in the new index (known as GEMX) is based on a country’s score on investability indicators, such as market size, and a set of criteria developed by the ratings, risk and research firm CRISIL. The index will open the way for a broad range of countries to be considered for investment, as currently less than 2 per cent of local-currency debt is benchmarked against leading market indices, and these include relatively few countries and instruments.


pages: 403 words: 110,492

Nomad Capitalist: How to Reclaim Your Freedom With Offshore Bank Accounts, Dual Citizenship, Foreign Companies, and Overseas Investments by Andrew Henderson

Affordable Care Act / Obamacare, Airbnb, airport security, Albert Einstein, Asian financial crisis, asset allocation, bank run, barriers to entry, birth tourism , bitcoin, blockchain, business process, call centre, capital controls, car-free, content marketing, cryptocurrency, currency risk, digital nomad, diversification, diversified portfolio, Donald Trump, Double Irish / Dutch Sandwich, Elon Musk, failed state, fiat currency, Fractional reserve banking, gentrification, intangible asset, land reform, low interest rates, medical malpractice, new economy, obamacare, offshore financial centre, passive income, peer-to-peer lending, Pepsi Challenge, place-making, risk tolerance, side hustle, Silicon Valley, Skype, too big to fail, white picket fence, work culture , working-age population

And, while US banks are not off limits, limiting yourself to just one country is an investment risk that no savvy business person should be making. The key is to diversify. Most people equate the old saying of ‘never keep all your eggs in one basket’ to diversifying your assets across numerous asset classes, such as growth stocks, blue chip stocks, bonds, and real estate. And that is certainly part of it. Nomad Capitalists add one more factor into their diversification strategy: geography. Many people in the West have never considered diversifying geographically. That does not mean it is a new idea, though. I recently spoke in Shenzhen to a group of entrepreneurs, importers, exporters and Americans doing business in China.

Planting flags as we will discuss in the chapters to come is, in my opinion, the best way to be free. Takeaway: Those of us that live by principles of self-reliance, entrepreneurship, and global diversification will not only prosper, but prosper on a far more consistent basis than those who have tied themselves to one economy. While investing in a foreign stock or mutual fund was enough in the 1990s, Nomad Capitalists operate on an entirely new level of savvy diversification by going where they’re treated best. E ENHANCE YOUR PERSONAL FREEDOM Chapter Three: The Location Independent Lifestyle “Come to Cuenca, Where Flowers Bloom From Your Toilet Water!”

The fact that a few European leaders suggested revoking visa-free travel for US and Canadian citizens in retaliation for their refusal to allow all European Union citizens to visit them visa-free shows you that nothing is off the table in the world we live in today. When it comes to smart diversification, I often look to Chinese culture. I have met so many smart and pragmatic people during my times in China; their outlook on diversification mirrors that of Nomad Capitalists. One of my favorite stories was from a young man’s grandfather who told him to, “Always have a second set of papers and some gold coins in a fast junk in the harbor.” Although I cannot remember how to tie a knot, pitch a tent or shoot a bow and arrow, I do remember one thing as an Eagle Scout: be prepared.


pages: 320 words: 33,385

Market Risk Analysis, Quantitative Methods in Finance by Carol Alexander

asset allocation, backtesting, barriers to entry, Brownian motion, capital asset pricing model, constrained optimization, credit crunch, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, en.wikipedia.org, financial engineering, fixed income, implied volatility, interest rate swap, low interest rates, market friction, market microstructure, p-value, performance metric, power law, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk tolerance, risk-adjusted returns, risk/return, seminal paper, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic bias, Thomas Bayes, transaction costs, two and twenty, value at risk, volatility smile, Wiener process, yield curve, zero-sum game

There are two main applications of optimal capital allocation in finance: • • Global asset management. This is usually regarded as a multi-stage optimization process: first, select the optimal weights to be assigned to different asset classes (such as bonds, equities and cash); then, within each class, allocate funds optimally to various countries; finally, given the allocation to a specific asset class in a certain country, select the individual investments to maximize the investor’s utility. Constraints on allocations may be needed, such as no short sales, or to restrict investments within a certain range such as ‘no more than 10% of the fund is invested in US equities’.

We shall not be concerned here with the manner in which the forecasts of risk and return are constructed. For the purpose of the present chapter it does not matter whether the asset risk and returns forecasts are based on subjective beliefs, historical data with statistical models, or some combination of these.12 I.6.3.1 Portfolio Diversification We illustrate the diversification principle using a simple example of a long-only portfolio with just two assets. We suppose that a proportion w of the nominal amount is invested in asset 1 and a proportion 1 − w is invested in asset 2 with 0 ≤ w ≤ 1. We denote the volatilities of the assets’ returns by 1 and 2 and the correlation of their returns by .

Since the portfolio is long-only, the vector x has non-negative elements, and in this case it can be shown that VR = w Vw = x Cx ≤ 1 C1 (I.6.28) The inequality (I.6.28) is the matrix generalization of the upper bound for the portfolio variance that was derived above for two assets. We have thus proved the principle of portfolio diversification, i.e. that holding portfolios of assets reduces risk, relative to the sum of the risks of the individual positions in the assets. And the lower the correlation between the asset returns, the lower the portfolio risk will be. Maximum risk reduction for a long-only portfolio occurs when correlations are highly negative, but if the portfolio contains short positions we want these to have a high positive correlation with the long positions for the maximum diversification benefit. In a long-only portfolio the weighted average of the asset volatilities provides an upper bound for the portfolio volatility, which is obtained only when the assets are all perfectly correlated.


pages: 272 words: 19,172

Hedge Fund Market Wizards by Jack D. Schwager

asset-backed security, backtesting, banking crisis, barriers to entry, Bear Stearns, beat the dealer, Bernie Madoff, Black-Scholes formula, book value, British Empire, business cycle, buy and hold, buy the rumour, sell the news, Claude Shannon: information theory, clean tech, cloud computing, collateralized debt obligation, commodity trading advisor, computerized trading, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, diversification, diversified portfolio, do what you love, Edward Thorp, family office, financial independence, fixed income, Flash crash, global macro, hindsight bias, implied volatility, index fund, intangible asset, James Dyson, Jones Act, legacy carrier, Long Term Capital Management, managed futures, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, merger arbitrage, Michael Milken, money market fund, oil shock, pattern recognition, pets.com, Ponzi scheme, private sector deleveraging, proprietary trading, quantitative easing, quantitative trading / quantitative finance, Reminiscences of a Stock Operator, Right to Buy, risk free rate, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Rubik’s Cube, Savings and loan crisis, Sharpe ratio, short selling, statistical arbitrage, Steve Jobs, systematic trading, technology bubble, transaction costs, value at risk, yield curve

These were largely the BBB tranches of the mortgage securitization pools that were going into the CDOs Paul Singer had talked about. So he and Charlie had already started to do some work at the MBS level when we became aware of the CDO angle.10 In the past, one important argument that was given to support the value of CDOs was that they provided portfolio diversification—that is, the collateral that went into CDOs was sourced from different asset classes. One could argue that there was a diversification benefit to having credit card receivables, aircraft leases, and various forms of real estate debt in a single structure. By late 2006, however, CDOs were composed almost entirely of the lowest-rated tranches of subprime mortgage securitizations.

You also know that diversification works. That is what the systematic trend-following strategy is built on: markets trend and diversification works. It doesn’t have any economic information. But that leaves open two questions: How do you accurately identify trends without being overly subject to whipsaws, and how have you managed to keep risks so constrained? First, the systematic trend-following strategy trades over 150 markets. Second, the systematic team looks at past correlations in weighting those markets. Currently, because of the whole risk-on/risk-off culture that has developed, diversification is quite hard to get.

Similarly, Greenblatt asserts that value investors must maintain a longer-term perspective and not be swayed by interim losses, providing the fundamentals haven’t changed. For longer-term investors, such as Taylor and Greenblatt, monthly loss constraints would be in conflict with their strategy. 26. The Power of Diversification Dalio calls diversification the “Holy Grail of investing.” He points out that if assets are truly uncorrelated, diversification could improve return/risk by as much as a factor of 5:1. 27. Correlation Can Be Misleading Although being cognizant of correlation between different markets is crucial to avoiding excessive risk, it is important to understand that correlation measures past price relationships.


pages: 357 words: 91,331

I Will Teach You To Be Rich by Sethi, Ramit

Albert Einstein, asset allocation, buy and hold, buy low sell high, diversification, diversified portfolio, do what you love, geopolitical risk, index fund, John Bogle, late fees, low interest rates, money market fund, mortgage debt, mortgage tax deduction, Paradox of Choice, prediction markets, random walk, risk tolerance, Robert Shiller, shareholder value, Silicon Valley, survivorship bias, the rule of 72, Vanguard fund

My friend grew up there, and he told me what he and his buddies used to use as a gang sign: two hands clasping in friendship. I mocked him endlessly for that.) It is important to diversify within stocks, but it’s even more important to allocate across the different asset classes—like stocks and bonds. Investing in only one category is dangerous over the long term. This is where the all-important concept of asset allocation comes into play. Remember it like this: Diversification is D for going deep into a category (for example, buying different types of stocks: large-cap, small-cap, international, and so on), and asset allocation is A for going across all categories (for example, stocks and bonds). 80 YEARS OF AVERAGE ANNUAL RETURNS FOR STOCK AND BONDS * * * The group at Vanguard Investment Counseling & Research recently analyzed eighty years of investment returns to help individual investors understand how to allocate their money.

What if stocks as a whole don’t perform well for a long time? That’s when you need to own other asset classes—to offset the bad times. The Importance of Being Diversified Now that we know the basics of the asset classes (stocks, bonds, and cash) at the bottom of the pyramid, let’s explore the different choices within each asset class. Basically, there are many types of stocks, and we need to own a little of all of them. Same with bonds. This is called diversifying, and it essentially means digging in to each asset class—stocks and bonds—and investing in all their subcategories. As the table on the next page shows, the broad category of “stocks” actually includes many different kinds of stock, including large-company stocks (“large-cap”), mid-cap stocks, small-cap stocks, and international stocks.

I know asset allocation sounds like a B.S. phrase—like mission statement and strategic alliance. But it’s not. Asset allocation is your plan for investing, the way you organize the investments in your portfolio between stocks, bonds, and cash. In other words, by diversifying your investments across different asset classes (like stocks and bonds, or, better yet, stock funds and bond funds), you could control the risk in your portfolio—and therefore control how much money, on average, you’d lose due to volatility. It turns out that the amounts you buy—whether it’s 100 percent stocks or 90 percent stocks and 10 percent bonds—make a profound difference on your returns.


pages: 231 words: 64,734

Safe Haven: Investing for Financial Storms by Mark Spitznagel

Albert Einstein, Antoine Gombaud: Chevalier de Méré, asset allocation, behavioural economics, bitcoin, Black Swan, blockchain, book value, Brownian motion, Buckminster Fuller, cognitive dissonance, commodity trading advisor, cryptocurrency, Daniel Kahneman / Amos Tversky, data science, delayed gratification, diversification, diversified portfolio, Edward Thorp, fiat currency, financial engineering, Fractional reserve banking, global macro, Henri Poincaré, hindsight bias, Long Term Capital Management, Mark Spitznagel, Paul Samuelson, phenotype, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, rent-seeking, Richard Feynman, risk free rate, risk-adjusted returns, Schrödinger's Cat, Sharpe ratio, spice trade, Steve Jobs, tail risk, the scientific method, transaction costs, value at risk, yield curve, zero-sum game

This is so wrong on so many levels—not a terribly insightful comment by me. As Buffett himself has said, “Wide diversification is only required when investors do not understand what they are doing.” What's more, diversification is “a confession that you don't really understand the businesses that you own.” To add insult to injury, I would add that diversification is a confession that you don't care about cost‐effectiveness in your risk mitigation. You just want less risk, no matter the cost. You see, diversification is fundamentally a dilution of risk, not a solution to risk. It is about evading risk. Moreover, the estimation of volatility is conflated as risk.

What's more, the Baltic isn't the Atlantic; there are fewer ships and fewer diversifying routes. And it's pretty naïve to think that old Jack of the Baltic would let a handful of ships sail right by unimpaired, even if separated by days, and choose only one to seize; any diversification value would likely be overstated. (This is an uncanny parallel to the shortcomings of today's financial market diversification, which we will discuss later.) So much for pirate and weather diversification. Our merchant is left hiring a single ship, setting sail at the mercy of Captain Jack and the Baltic. When that ship leaves port, what follows is only one outcome out of all that might happen.

Best to just recognize it for what it is, make some popcorn, and watch. THE DOGMA OF DIVERSIFICATION Our third variety of safe haven imposters, the diworsifier haven is without a doubt the most common form of safe haven imposter. It is pervasive throughout almost all investment portfolios. This is because diversification as a risk‐mitigation strategy is the central pillar to the central paradigm in all of investing: modern portfolio theory. Most, and likely pretty close to all, investors have been led to accept this dogma of diversification. It is considered “the only free lunch in finance.” Recall from Chapter 2 that the credit for this formal concept of diversification actually goes all the way back to eighteenth‐century Basel, Switzerland, where Daniel Bernoulli proposed it as a solution for his hapless Petersburg merchant to get his cargo ship past pirates and across the Baltic Sea: break his cargo up into smaller cargos and send all those smaller cargos on different ships.


pages: 467 words: 154,960

Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel

Albert Einstein, Alvin Toffler, Atul Gawande, backtesting, Bear Stearns, beat the dealer, Bernie Madoff, Black Swan, buy and hold, buy low sell high, California energy crisis, capital asset pricing model, Carl Icahn, Clayton Christensen, commodity trading advisor, computerized trading, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Edward Thorp, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, fiat currency, fixed income, Future Shock, game design, global macro, hindsight bias, housing crisis, index fund, Isaac Newton, Jim Simons, John Bogle, John Meriwether, John Nash: game theory, linear programming, Long Term Capital Management, managed futures, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, Market Wizards by Jack D. Schwager, mental accounting, money market fund, Myron Scholes, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Reminiscences of a Stock Operator, Renaissance Technologies, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, survivorship bias, systematic trading, Teledyne, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, William of Occam, zero-sum game

Now, in reading Trend Following, the do-it-yourselfers might argue that having a book that illustrates these same basic principles takes some of the fun out of it. Actually, Covel, like any good trend follower, has not focused solely on the endpoint. He gives you a deep understanding of the most important part: the path. Unlike so many other books that xv A prudent investor’s best safeguard against risk is not retreat, but diversification. [And] true diversification is difficult to achieve by [simply] spreading an investment among different stocks (or different equity managers), or even by mixing stocks and bonds, because the two are not complementary. David Harding Winton Capital xvi [Trend following firm] Aspect Capital is aptly named. Its group of physics-trained leaders took it from the aspect ratio of plane design, that is, the wider the wing span, the more stable the plane.

He [I]f you’re trying to reduce the volatility or uncertainty of your portfolio as a whole, then you need more than one security. This seems obvious, but you also need securities which don’t go up and down together [reduced correlation]… It turns out that you don’t need hundreds and hundreds of securities [to be diversified]. Much of the effective diversification comes with 20 or 30 wellselected securities. A number of studies have shown that the number of stocks needed to provide adequate diversification are anywhere from 10 to 30. Mark S. Rzepczynski John W. Henry & Co.6 250 Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets is worse off than someone who tries and fails or someone who never had any desire in the first place.

When you look at a breakdown of performance at any given time, losses are typically negated by winners. This is by design because no one ever knows which market will be the one to take off with a big trend that pays for all of the losses—hence the need for diversification. AHL is even more precise about its need for Chapter 10 • Trading Systems 255 diversification in an uncertain world: “The cornerstone of the AHL investment philosophy is that financial markets experience persistent anomalies or inefficiencies in the form of price trends. Trends are a manifestation of serial correlation in financial markets—the phenomenon whereby past price movements inform about future price behavior.


Concentrated Investing by Allen C. Benello

activist fund / activist shareholder / activist investor, asset allocation, barriers to entry, beat the dealer, Benoit Mandelbrot, Bob Noyce, Boeing 747, book value, business cycle, buy and hold, carried interest, Claude Shannon: information theory, corporate governance, corporate raider, delta neutral, discounted cash flows, diversification, diversified portfolio, Dutch auction, Edward Thorp, family office, fixed income, Henry Singleton, high net worth, index fund, John Bogle, John von Neumann, junk bonds, Louis Bachelier, margin call, merger arbitrage, Paul Samuelson, performance metric, prudent man rule, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, shareholder value, Sharpe ratio, short selling, survivorship bias, technology bubble, Teledyne, transaction costs, zero-sum game

The additional gains beyond 30 securities are minimal, and the costs of acquiring and monitoring those securities likely outweigh the benefits of any further risk reduction. When Buffett was asked by business students in 2008 about his views on portfolio diversification and position sizing, he responded that he had “two views on diversification:”13 If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification. If it’s your game, diversification doesn’t make sense. It’s crazy to put money in your twentieth choice rather than your first choice. . . . [Berkshire vice-chairman] Charlie 96 Concentrated Investing [Munger] and I operated mostly with five positions.

He believes that most securities are mostly appropriately valued, but the idea was taken to an unwarranted extreme:25 [T]he people that came up with the efficient market theory weren’t totally crazy, but they pushed their idea too far. The idea is roughly right with exceptions. When Buffett was asked by business students in 2008 about his views on portfolio diversification and position sizing, he responded that he had “two views on diversification:”26 If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, 208 Concentrated Investing participate in total diversification. If it’s your game, diversification doesn’t make sense. It’s crazy to put money in your twentieth choice rather than your first choice. . . . [Berkshire Vice‐Chairman] Charlie [Munger] and I operated mostly with five positions.

(Lowe), 120–121, 213 Davidson, Lorimer, 6–7, 26 Davy Shipbuilding, 135–136 De Angelis, Anthony “Tino,” 89–90 delta-neutral portfolio, 83 Den Norske Bank (DnB), 138, 146–147 Diamon M. Dragon (drill ship), 138–142, 143 Dimson, Elroy, 45 diversification Buffett on diversification versus concentration, 94–96, 95, 207–209 “closet indexers,” 27, 94–104, 95, 99, 100, 102, 103, 104, 123–124 diversification versus concentration, overview, 1–2 Graham on, 106 Keynes on, 62 Munger on diversification versus concentration, 96–97 Simpson on, 19, 27–28 Diversified Retailing, 110, 112 Dodd, David, 45 dollar cost averaging Keynes on, 51 Shannon’s Demon and, 80 Dolphin, 137 Drake, George, 159 Drexel Burnham Lambert, 144 DSND Subsea, 151–153 Durbin Amendment (Dodd-Frank), 192 Dutch auction, 22 Dutton, Gardiner, 160 E earnings yield, 19, 49 EBIDTA (earnings before interest, taxes, amortization, and depreciation), 154 Economic Consequences of Peace, The (Keynes), 40, 41 edge/odds, 76, 209–210 Edgewater Funds, 163 efficient market theory Munger on, 121, 207 overview, 3 Effjohn, 142 Elton, E.


pages: 304 words: 22,886

Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler, Cass R. Sunstein

Al Roth, Albert Einstein, asset allocation, availability heuristic, behavioural economics, call centre, carbon tax, Cass Sunstein, choice architecture, continuous integration, currency risk, Daniel Kahneman / Amos Tversky, desegregation, diversification, diversified portfolio, do well by doing good, endowment effect, equity premium, feminist movement, financial engineering, fixed income, framing effect, full employment, George Akerlof, index fund, invisible hand, late fees, libertarian paternalism, loss aversion, low interest rates, machine readable, Mahatma Gandhi, Mason jar, medical malpractice, medical residency, mental accounting, meta-analysis, Milgram experiment, money market fund, pension reform, presumed consent, price discrimination, profit maximization, rent-seeking, Richard Thaler, Right to Buy, risk tolerance, Robert Shiller, Saturday Night Live, school choice, school vouchers, systems thinking, Tragedy of the Commons, transaction costs, Vanguard fund, Zipcar

If he had invested most of his money in stocks, he would have done a lot better. Markowitz’s strategy can be viewed as one example of what might be called the diversification heuristic. “When in doubt, diversify.” Don’t put all your eggs in one basket. In general, diversification is a great idea, but there is a big difference between sensible diversification and the naïve kind. A special case of this rule of thumb is what might be called the “1/n” heuristic: “When faced with ‘n’ options, divide assets evenly across the options.”3 Put the same number of eggs in each basket. Naïve diversification apparently starts young. Consider the following clever experiment conducted by Daniel Read and George Loewenstein on Halloween night.4 The “subjects” were trick-or-treaters.

ERISA sets forth three fiduciary principles for retirement-plan investments: the exclusive benefit rule, requiring that plans be managed exclusively for the benefit of participants; the prudence rule, requiring that plan assets be invested according to a “prudent investor” standard; and the diversification rule, requiring that plan assets be diversified so as to minimize the risk of large losses. Most notably, company stock is exempted from the diversification requirement in defined-contribution plans—largely because, at the time ERISA was passed, large employers with profit-sharing plans lobbied Congress to exempt them from the diversification requirements imposed on defined-benefit plans.12 Employers are still expected to act prudently, however, in determining whether company stock is a suitable investment.

“Which Is Better: Simultaneous or Sequential Choice?” Organizational Behavior and Human Decision Processes 84 (2001): 54–70. Read, Daniel, and George Loewenstein. “Diversification Bias: Explaining the Discrepancy in Variety Seeking Between Combined and Separated Choices.” Journal of Experimental Psychology: Applied 1 (1995): 34–49. Read, Daniel, George Loewenstein, and Shobana Kalyanarama. “Mixing Virtue and Vice: Combining the Immediacy Effect and the Diversification Heuristic.” Journal of Behavioral Decision Making 12 (1999): 257–73. Read, Daniel, and B. Van Leeuwen. “Predicting Hunger: The Effects of Appetite and Delay on Choice.”


The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals by Daniel R. Solin

Alan Greenspan, asset allocation, buy and hold, corporate governance, diversification, diversified portfolio, index fund, John Bogle, market fundamentalism, money market fund, Myron Scholes, PalmPilot, passive investing, prediction markets, prudent man rule, random walk, risk tolerance, risk-adjusted returns, risk/return, transaction costs, Vanguard fund, zero-sum game

Ellis, Invmmmt Policy Another imponant factor in proper investing-after taking account of COS t S and understanding risk-is asset allocation. Asset allocation refers to the percentage of an investment portfolio held in each of the major asset classes-stocks, bonds and cash. Many academic studies have shown that the vast majo rity of a portfolio's variabili ty in retu rns is accou nted for by asset allocation. Very little is accounted fo r by either market timing or by picking the "right" security within an asset class. Therefore, it is curious that aU the hype you hear from hyperactive bro kers and advisors relates to market timing and stock picking. When is the last time your hyperactive broker called yo u for the sole purpose of discuss ing your asset allocation?

Cash. the term for short-term, highly liquid investmentS, barely keeps up with inflation, bur is very dose to risk-free. 122 The Real Way Smart Investors Beat 95~ of the "Pros" By splitting your portfolio up among these asset classes. you can target the specific level of return you wish to get for the specific level of risk you are willing to take. Economists have very accurately modelled how different balances among these three asset classes affect both return and risk with in a portfolio. Academ ic research has shown that asset allocat ion accounts for 90% or more of the variability of returns from any particular portfolio. T he specific securities held in the portfolio (stOck picking) accounts for about 5%. and digress~ ing fro m the ideal asset allocation to take into account outside influences on the markets (marker riming) accounts fo r about 2%.

No advisor who advocates Smart Investing was the subject of any of these allegations. These advisors do not believe, employ or rely upon stock analysts. Smart Investing advisors make no predictions about the future performance of the market as a whole or about any particular stock. Instead, they focus on asset classes (and their returns), asset allocation, risk management and a solid, academically based belief system that has consistently been demonstrated to outperform hyperactive brokers and advisors over the long term. m~jor 9 " " " "iall: stocK$,boijtisa a company;" loans to a ~ifrt,,,,i3,~+ entity. Cash;is not just ;-'","rO""\1 leqtujnc~c:trtj;l, saVln!


pages: 349 words: 134,041

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, Asian financial crisis, asset-backed security, Bear Stearns, beat the dealer, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business logic, business process, buy and hold, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, commoditize, complexity theory, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, currency risk, disinformation, disintermediation, diversification, diversified portfolio, Edward Thorp, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, financial engineering, financial innovation, fixed income, Glass-Steagall Act, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, John Bogle, John Meriwether, junk bonds, locking in a profit, Long Term Capital Management, low interest rates, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, mega-rich, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mutually assured destruction, Myron Scholes, new economy, New Journalism, Nick Leeson, Nixon triggered the end of the Bretton Woods system, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, Right to Buy, risk free rate, risk-adjusted returns, risk/return, Salesforce, Satyajit Das, shareholder value, short selling, short squeeze, South Sea Bubble, statistical model, technology bubble, the medium is the message, the new new thing, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

Traditionally investors have been content to lose money investing in government bonds, shares and property. They had to be convinced about a new ‘asset class’. Bankers trooped to investors and their masters, the asset consultants. They wailed a new siren song – ‘credit is a new investment asset’. DAS_C10.QXD 5/3/07 282 7:59 PM Page 282 Tr a d e r s , G u n s & M o n e y There was ‘diversification’ – credit did not move together with other asset classes. There was ‘return’ – credit risk gave you a higher return than government bonds. There was ‘volatility’ – risk margins fluctuated. Ford Motor Credit’s risk margins (the spread) had fluctuated between about 1.00% and about 6.00%.

They didn’t seem troubled at all that the volatility may translate into losses, not profits. They, too, ‘knew things’. Then, there were the real reasons. Credit investing took off when all other asset classes showed different degrees of morbidity. In the early 2000s, the equity market’s stellar run was over. Bond yields were at record lows, property prices looked inflated, financed by a flood of money fleeing carnage elsewhere. The only game in town was credit and hedge funds. Investors unsurprisingly discovered ‘credit’. It was, it seemed, a new asset class. The question was how to package up the credit risk for investors. They didn’t like CDS, it was off-balance sheet and didn’t require money initially.

Lack of disclosure means that you don’t know how far the ship is off course until it is on the rocks. Cases of fraud and other common crimes also began to surface. There was every sign that the hedge fund universe was overheated. At the suggestion that there was a ‘bubble’, one manager bristled that hedge funds weren’t an ‘asset class’, therefore there was no ‘bubble’ to burst. Only asset classes experienced bubbles. The semantics weren’t reassuring. Hot tubbing I worked diligently at the case, my expert report was lodged with the court. The other side put on their expert, Sherman, an American ex-academic who had worked briefly at a dealer. In the competitive world of expert work, I sneered that he hadn’t been in markets recently.


pages: 224 words: 13,238

Electronic and Algorithmic Trading Technology: The Complete Guide by Kendall Kim

algorithmic trading, automated trading system, backtesting, Bear Stearns, business logic, commoditize, computerized trading, corporate governance, Credit Default Swap, diversification, en.wikipedia.org, family office, financial engineering, financial innovation, fixed income, index arbitrage, index fund, interest rate swap, linked data, market fragmentation, money market fund, natural language processing, proprietary trading, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, short selling, statistical arbitrage, Steven Levy, transaction costs, yield curve

It comes as little surprise that equity markets were the first ones to adopt this type of trading, but what about other major asset classes such as fixed income, foreign exchange, and commodities? Chapter 11: Electronic and Algorithmic Trading for Different Asset Classes reviews how electronic trading has taken ground depending on the asset class in question, providing some interesting and revealing answers to which classes are most likely to be affected next and how your area in the industry might be changed by it. Of course, every part of the industry, including the new asset classes entering into the electronic trading world, is impacted by regulatory reporting requirements set in place by financial authorities.

Algorithms, which were traditionally associated with one particular asset class, namely equities, are diversifying into other markets that are rapidly evolving toward electronic trading. Participants in other asset classes such as derivatives tend to be comfortable and savvy with technology to begin with, so moving to a more systematic algorithmic approach to some of these classes may not seem as radical. Algorithmic trading may soon find a place in futures, options, and foreign exchange. Fixed-income instruments are most likely to be the last asset class to move into algorithmic trading or rely on electronic communication networks to facilitate order flow.

This page intentionally left blank Chapter 11 Electronic and Algorithmic Trading for Different Asset Classes 11.1 Introduction Web-based technologies have made substantial changes in the financial services industry. Virtual exchanges and extended after-market-hours trading have significantly accounted for transaction volume in stocks. The adoption of electronic trading platforms has transformed the economic landscape of trading, and other market-making possibilities. Current technologies such as algorithmic trading had been most often associated with one particular asset class: equities. Now algorithms, or mathematical models that take over the process of trading decisions and executions, are diversifying into other markets that are rapidly evolving toward electronic trading with more force in markets such as fixed-income instruments, foreign exchange, derivatives, futures, and options.


pages: 199 words: 48,162

Capital Allocators: How the World’s Elite Money Managers Lead and Invest by Ted Seides

Albert Einstein, asset allocation, behavioural economics, business cycle, coronavirus, COVID-19, crowdsourcing, data science, deliberate practice, diversification, Everything should be made as simple as possible, fake news, family office, fixed income, high net worth, hindsight bias, impact investing, implied volatility, impulse control, index fund, Kaizen: continuous improvement, Lean Startup, loss aversion, Paradox of Choice, passive investing, Ralph Waldo Emerson, risk tolerance, Sharpe ratio, sovereign wealth fund, tail risk, The Wisdom of Crowds, Toyota Production System, zero-sum game

The team searches for exceptional managers independent of their asset class or strategy, and sizes positions based on their conviction in the manager, attractiveness of their underlying holdings, quality of their relationship, liquidity, and diversification characteristics of the strategy to the MIT portfolio. The team carefully measures the resulting risks and sets aggregate limits to maintain sufficient diversification.41 Matt Whineray deploys New Zealand’s assets through the lens of risk factors. He begins with the creation of a Reference Portfolio, which is a shadow portfolio of easily replicable, low-cost passive investments. The Reference Portfolio moves away from asset classes, emphasizing underlying economic drivers of growth, inflation, liquidity, and agency.

Jim Williams contends that at the end of the day, there are really only two asset classes – owning and lending. Everything else is a permutation. Scott Malpass reduced Notre Dame’s asset classes from six to three, leaving just public, private, and opportunistic, distinguished primarily by liquidity. These broader categories allow the investment team to search for the best managers and compare the attractiveness of risk and reward across traditional asset classes. Seth Alexander at MIT adopted a manager-centric allocation framework in lieu of asset classes. The team searches for exceptional managers independent of their asset class or strategy, and sizes positions based on their conviction in the manager, attractiveness of their underlying holdings, quality of their relationship, liquidity, and diversification characteristics of the strategy to the MIT portfolio.

Asset allocation may drive performance in retrospect, but few, if any, CIOs profess skill in forecasting asset class returns. Other than their usefulness as familiar communication language with a board, asset classes leave a lot to be desired as an anchor for portfolios. For one, asset classes can create rigid investment buckets. Roz Hewsenian finds “the box approach” to be a disaster. It forces allocators to compromise standards to fill a box and pass on great investments that don’t fit into one. Traditional asset allocation is also more sensitive to the past than to recent market conditions. Matt Whineray finds that asset classes have a life cycle. As more institutional investors get into an asset class, excess returns decline over time.


Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

addicted to oil, Alan Greenspan, asset allocation, backtesting, behavioural economics, Black-Scholes formula, book value, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, it's over 9,000, John Bogle, joint-stock company, Long Term Capital Management, loss aversion, machine readable, market bubble, mental accounting, Money creation, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, proprietary trading, purchasing power parity, random walk, Richard Thaler, risk free rate, risk tolerance, risk/return, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, stock buybacks, stocks for the long run, subprime mortgage crisis, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, uptick rule, Vanguard fund, vertical integration

No single market is always dominant, and the globalization of the world markets affords investors more opportunities for spreading their risk than are available in the domestic markets. 168 PART 2 Valuation, Style Investing, and Global Markets DIVERSIFICATION IN WORLD MARKETS Principles of Diversification It might surprise investors that the principal motivation for investing in foreign stocks is not that foreign countries are growing faster and therefore will provide investors with better returns. We learned in Chapter 8 that faster growth in no way guarantees superior returns. Rather, the reason for investing internationally is to diversify your portfolio and reduce risk.5 Foreign investing provides diversification in the same way that investing in different sectors of the domestic economy provides diversification. It would not be good investment policy to pin your hopes on just one stock or one sector of the economy.

Capital 137 Conclusion 138 CONTENTS CONTENTS ix Chapter 9 Outperforming the Market: The Importance of Size, Dividend Yields, and Price-to-Earnings Ratios 139 Stocks That Outperform the Market 139 Small- and Large-Cap Stocks 141 Trends in Small-Cap Stock Returns 142 Valuation 144 Value Stocks Offer Higher Returns Than Growth Stocks 144 Dividend Yields 145 Other Dividend Yield Strategies 147 Price-to-Earnings (P-E) Ratios 149 Price-to-Book Ratios 150 Combining Size and Valuation Criteria 152 Initial Public Offerings: The Disappointing Overall Returns on New Small-Cap Growth Companies 154 The Nature of Growth and Value Stocks 157 Explanations of Size and Valuation Effects 157 The Noisy Market Hypothesis 158 Conclusion 159 Chapter 10 Global Investing and the Rise of China, India, and the Emerging Markets 161 The World’s Population, Production, and Equity Capital 162 Cycles in Foreign Markets 164 The Japanese Market Bubble 165 The Emerging Market Bubble 166 The New Millennium and the Technology Bubble 167 Diversification in World Markets 168 Principles of Diversification 168 “Efficient” Portfolios: Formal Analysis 168 Should You Hedge Foreign Exchange Risk? 173 Sector Diversification 173 Private and Public Capital 177 x The World in 2050 178 Conclusion 182 Appendix: The Largest Non-U.S.-Based Companies 182 PART 3 HOW THE ECONOMIC ENVIRONMENT IMPACTS STOCKS Chapter 11 Gold, Monetary Policy, and Inflation 187 Money and Prices 189 The Gold Standard 191 The Establishment of the Federal Reserve 191 The Fall of the Gold Standard 192 Postdevaluation Monetary Policy 193 Postgold Monetary Policy 194 The Federal Reserve and Money Creation 195 How the Fed’s Actions Affect Interest Rates 196 Stocks as Hedges against Inflation 199 Why Stocks Fail as a Short-Term Inflation Hedge 201 Higher Interest Rates 201 Nonneutral Inflation: Supply-Side Effects 202 Taxes on Corporate Earnings 202 Inflationary Biases in Interest Costs 203 Capital Gains Taxes 204 Conclusion 205 Chapter 12 Stocks and the Business Cycle 207 Who Calls the Business Cycle?

Two economists tested whether the “monitoring interval” affected the choice between stocks and bonds.26 They conducted a “learning experiment” in which they allowed individuals to see the returns on two unidentified asset classes. One group was shown the yearly returns on stocks and bonds, and other groups were shown the same returns, but instead of annually, the returns were aggregated over periods of 5, 10, and 20 years. The groups were then asked to pick an allocation between stocks and bonds. The group that saw yearly returns invested a much smaller fraction in stocks than the groups that saw returns aggregated into longer intervals. This was because the short-term volatility of stocks dissuaded people from choosing that asset class, even though over longer periods it was clearly a better choice.


pages: 1,042 words: 266,547

Security Analysis by Benjamin Graham, David Dodd

activist fund / activist shareholder / activist investor, asset-backed security, backtesting, barriers to entry, Bear Stearns, behavioural economics, book value, business cycle, buy and hold, capital asset pricing model, Carl Icahn, carried interest, collateralized debt obligation, collective bargaining, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, diversification, diversified portfolio, fear of failure, financial engineering, financial innovation, fixed income, flag carrier, full employment, Greenspan put, index fund, intangible asset, invisible hand, Joseph Schumpeter, junk bonds, land bank, locking in a profit, Long Term Capital Management, low cost airline, low interest rates, Michael Milken, moral hazard, mortgage debt, Myron Scholes, prudent man rule, Right to Buy, risk free rate, risk-adjusted returns, risk/return, secular stagnation, shareholder value, stock buybacks, The Chicago School, the market place, the scientific method, The Wealth of Nations by Adam Smith, transaction costs, two and twenty, zero-coupon bond

Fueled by performance pressures and a growing expectation of low (and inadequate) returns from traditional equity and debt investments, institutional investors have sought high returns and diversification by allocating a growing portion of their endowments and pension funds to alternatives. Pioneering Portfolio Management, written in 2000 by David Swensen, the groundbreaking head of Yale’s Investment Office, makes a strong case for alternative investments. In it, Swensen points to the historically inefficient pricing of many asset classes,10 the historically high risk-adjusted returns of many alternative managers, and the limited performance correlation between alternatives and other asset classes. He highlights the importance of alternative manager selection by noting the large dispersion of returns achieved between top-quartile and third-quartile performers.

Developing innovative sources of ideas and information, such as those available from business consultants and industry experts, has become increasingly important. 9 They did consider the relative merits of corporate control enjoyed by a private business owner versus the value of marketability for a listed stock (p. 372). 10 Many investors make the mistake of thinking about returns to asset classes as if they were permanent. Returns are not inherent to an asset class; they result from the fundamentals of the underlying businesses and the price paid by investors for the related securities. Capital flowing into an asset class can, reflexively, impair the ability of those investing in that asset class to continue to generate the anticipated, historically attractive returns. 11 Nor would they find one in leveraged buyouts, through which businesses are purchased at lofty prices using mostly debt financing and a thin layer of equity capital.

Importantly, while Graham and Dodd emphasized limiting risk on an investment-by-investment basis, they also believed that diversification and hedging could protect the downside for an entire portfolio. (p. 106) This is what most hedge funds attempt to do. While they hold individual securities that, considered alone, may involve an uncomfortable degree of risk, they attempt to offset the risks for the entire portfolio through the short sale of similar but more highly valued securities, through the purchase of put options on individual securities or market indexes, and through adequate diversification (although many are guilty of overdiversification, holding too little of their truly good ideas and too much of their mediocre ones).


pages: 244 words: 79,044

Money Mavericks: Confessions of a Hedge Fund Manager by Lars Kroijer

activist fund / activist shareholder / activist investor, Bear Stearns, Bernie Madoff, book value, capital asset pricing model, corporate raider, diversification, diversified portfolio, equity risk premium, family office, fixed income, forensic accounting, Gordon Gekko, hiring and firing, implied volatility, index fund, intangible asset, Jeff Bezos, Just-in-time delivery, Long Term Capital Management, Mary Meeker, merger arbitrage, NetJets, new economy, Ponzi scheme, post-work, proprietary trading, risk free rate, risk-adjusted returns, risk/return, shareholder value, Silicon Valley, six sigma, statistical arbitrage, Vanguard fund, zero-coupon bond

If they succeeded, the rewards would be massive by any normal standard – probably too big. It was certainly exciting, but not in the way most people seemed to think. The term ‘hedge fund’ is often thrown around as if we all know what it is, or are meant to know. To me, hedge funds constitute investment funds that invest in a very broad array of assets classes, often across multiple geographies, and with very different risk profiles. Sometimes hedge-funds are extremely narrow in their strategy while many engage in multiple strategies within the same fund. Like a mutual fund, the hedge-fund manager charges an annual management fee, but in addition charges a performance fee on profits.

The industry grew as individuals and institutions increasingly opened their eyes to what were seen as uncorrelated returns that would earn them a profit even in a bear market. Asset growth really took off as larger institutions accepted hedge-fund allocations just as they had allocations in private equity or other asset classes. It seemed a good idea to allocate at least some assets in investments that could be expected to do well in falling markets. As some of the earlier hedge funds had stellar returns that appeared uncorrelated to the wider market, the investment opportunity attracted ever-increasing numbers. Obviously, many (including myself) saw this growing investor base as an opportunity to set up new funds to meet the increasing demand.

As the events of autumn 2008 suggest, a large number of hedge funds were indeed long the markets and the value they generated was thus lower. Investors were paying for beta – paying for being long the market – rather than true alpha. It is no coincidence that the growth surge in hedge-fund assets occurred at the same time as a historic bull-market run in equities and other asset classes. There has been a lot of beta (market exposure) sold as alpha, yet how much is perhaps not readily apparent to the end investor until the market starts going down, and even then there are ways to disguise it. Return on investment Speaking from personal experience, it is incredibly hard to generate 10 per cent gross alpha every year.


pages: 572 words: 94,002

Reset: How to Restart Your Life and Get F.U. Money: The Unconventional Early Retirement Plan for Midlife Careerists Who Want to Be Happy by David Sawyer

"World Economic Forum" Davos, Abraham Maslow, Airbnb, Albert Einstein, asset allocation, beat the dealer, bitcoin, Black Monday: stock market crash in 1987, Cal Newport, cloud computing, cognitive dissonance, content marketing, crowdsourcing, cryptocurrency, currency risk, David Attenborough, David Heinemeier Hansson, Desert Island Discs, diversification, diversified portfolio, Edward Thorp, Elon Musk, fake it until you make it, fake news, financial independence, follow your passion, gig economy, Great Leap Forward, hiring and firing, imposter syndrome, index card, index fund, invention of the wheel, John Bogle, knowledge worker, loadsamoney, low skilled workers, Mahatma Gandhi, Mark Zuckerberg, meta-analysis, mortgage debt, Mr. Money Mustache, passive income, passive investing, Paul Samuelson, pension reform, risk tolerance, Robert Shiller, Ronald Reagan, Silicon Valley, Skype, smart meter, Snapchat, stakhanovite, Steve Jobs, sunk-cost fallacy, TED Talk, The 4% rule, Tim Cook: Apple, Vanguard fund, William Bengen, work culture , Y Combinator

Vanguard UK doesn’t offer a property fund (otherwise you could use it as well), swapping iShares Emerging Markets for the Vanguard-equivalent fund. Note the global property securities fund. If you do want to invest in property, a real estate fund (compared with buying property yourself) is a no-hassle risk-diversified way to invest in this asset class. Pros: low-cost, for such specialised funds; safer, because of bonds; globally diversified; targets asset classes that outperform the market historically, eg, small-caps; you can copy Monevator. Cons: UK weighting in line with MSCI World Index at 6%, not the 25% suggested in the RESET portfolio and baked in to Vanguard’s LifeStrategy 100 fund.

During what he calls the “wealth accumulation stage”, he recommends investing in one fund only: the Vanguard Total Stock Market Index fund (VTSAX), arguing because of the large number of worldwide companies that generate more than 50% of their profits from overseas in this fund, this provides all the global diversification you need[395]. Writing in 2011, Pete Adeney recommended a similar approach[396]. RESET View A simple low-cost approach aimed at US investors. The equivalent UK fund is the Vanguard FTSE UK All Share – Acc, which offers similar international diversification. Nevertheless, placing all your eggs in one UK basket – however international the constituent members of the FTSE All Share index – is not recommended. B. Goldberg five funds Another one for the US investors among you: UK readers can find the Vanguard UK-equivalent funds easily enough.

Not true, it’s possible to become a millionaire on a middling, midlife household income of £60,000 before-tax. The stock market is gambling: I know too many people who’ve been burnt. Any money I have left at the end of the month, I put in my savings account. Are you bonkers? Over long periods, the stock market outperforms all other asset classes (savings accounts, gold, property). You just need to know where to put it. Most of the investing suggestions given by the financial independence movement focus on America. That’s why RESET’s here. We’ve got two kids: do you know how much they cost to feed? There’s no denying it, kids cost a small fortune.


pages: 1,544 words: 391,691

Corporate Finance: Theory and Practice by Pierre Vernimmen, Pascal Quiry, Maurizio Dallocchio, Yann le Fur, Antonio Salvi

"Friedman doctrine" OR "shareholder theory", accelerated depreciation, accounting loophole / creative accounting, active measures, activist fund / activist shareholder / activist investor, AOL-Time Warner, ASML, asset light, bank run, barriers to entry, Basel III, Bear Stearns, Benoit Mandelbrot, bitcoin, Black Swan, Black-Scholes formula, blockchain, book value, business climate, business cycle, buy and hold, buy low sell high, capital asset pricing model, carried interest, collective bargaining, conceptual framework, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, currency risk, delta neutral, dematerialisation, discounted cash flows, discrete time, disintermediation, diversification, diversified portfolio, Dutch auction, electricity market, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, eurozone crisis, financial engineering, financial innovation, fixed income, Flash crash, foreign exchange controls, German hyperinflation, Glass-Steagall Act, high net worth, impact investing, implied volatility, information asymmetry, intangible asset, interest rate swap, Internet of things, inventory management, invisible hand, joint-stock company, joint-stock limited liability company, junk bonds, Kickstarter, lateral thinking, London Interbank Offered Rate, low interest rates, mandelbrot fractal, margin call, means of production, money market fund, moral hazard, Myron Scholes, new economy, New Journalism, Northern Rock, performance metric, Potemkin village, quantitative trading / quantitative finance, random walk, Right to Buy, risk free rate, risk/return, shareholder value, short selling, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, stocks for the long run, supply-chain management, survivorship bias, The Myth of the Rational Market, time value of money, too big to fail, transaction costs, value at risk, vertical integration, volatility arbitrage, volatility smile, yield curve, zero-coupon bond, zero-sum game

By varying ρH,C between −1 and +1, we obtain: Proportion of C shares in portfolio (XC) (%) 0 25 33.3 50 66.7 75 100 Return on the portfolio: E(rH,C) (%) 6.0 7.8 8.3 9.5 10.7 11.3 13.0 Portfolio risk σ(rH,C) (%) ρH,C = −1 10.0 3.3 1.0 3.5 8.0 10.3 17.0 ρH,C = −0.5 10.0 6.5 6.2 7.4 10.1 11.7 17.0 ρH,C = 0 10.0 8.6 8.7 9.9 11.8 13.0 17.0 ρH,C = 0.3 10.0 9.7 10.0 11.1 12.7 13.7 17.0 ρH,C = 0.5 10.0 10.3 10.7 11.8 13.3 14.2 17.0 ρH,C = 1 10.0 11.8 12.3 13.5 14.7 15.3 17.0 Note the following caveats: If Criteo and Heineken were perfectly correlated (i.e. the correlation coefficient was 1), then diversification would have no effect. All possible portfolios would lie on a line linking the risk/return point of Criteo with that of Heineken. Risk would increase in direct proportion to Criteo’s stock added. If the two stocks were perfectly inversely correlated (correlation coefficient −1), then diversification would be total. However, there is little chance of this occurring, as both companies are exposed to the same economic conditions. Generally speaking, Criteo and Heineken are positively, but imperfectly, correlated and diversification is based on the desired amount of risk.

Section 19.3 Limits of the CAPM The CAPM assumes that markets are efficient and it is without a doubt the most widely used model in modern finance. But financial analysts are always quick to criticise and thus this section appeases the critics by summarising how the CAPM presents some problems in practice. 1. The limits of diversification The CAPM is a development of portfolio theory and is based on the assumption that diversification helps to reduce risk (to the non-diversifiable risk). A study by Campbell et al. (2001) shows that diversification is increasingly complex and that, whereas in the 1970s a portfolio of 20 stocks reduced risk significantly, today at least 50 are required to achieve the same result. This is due, among other things, to the greater volatility of individual stocks, although markets as a whole are no more volatile.

On the other hand, Kuka’s value will increase if, and only if, Midea’s management allows it to improve its return on capital employed. Purely financial diversification creates no value. Value is created only when the sum of cash flows from the two investments is higher because they are both managed by the same group. This is the result of industrial synergies (2 + 2 = 5), and not financial synergies, which do not exist. The large groups that indulged in a spate of financial diversifications in the 1960s have since realised that these operations were unproductive and frequently loss-making. Diversification is a delicate art that can only succeed if the diversifying company already has expertise in the new business.


pages: 287 words: 62,824

Just Keep Buying: Proven Ways to Save Money and Build Your Wealth by Nick Maggiulli

Airbnb, asset allocation, Big Tech, bitcoin, buy and hold, COVID-19, crowdsourcing, cryptocurrency, data science, diversification, diversified portfolio, financial independence, Hans Rosling, index fund, it's over 9,000, Jeff Bezos, Jeff Seder, lifestyle creep, mass affluent, mortgage debt, oil shock, payday loans, phenotype, price anchoring, risk-adjusted returns, Robert Shiller, Sam Altman, side hustle, side project, stocks for the long run, The 4% rule, time value of money, transaction costs, very high income, William Bengen, yield curve

Because I don’t know your current circumstances, I can’t say which, if any, of the following assets would be a good fit for you. In fact, I have only ever owned four of the asset classes listed below because some of them don’t make sense for me. I advise that you evaluate each asset class fully before adding or removing anything from your portfolio. With that being said, let’s begin with my personal favorite. Stocks If I had to pick one asset class to rule them all, stocks would definitely be it. Stocks, which represent ownership (i.e., equity) in a business, are great because they are one of the most reliable ways to create wealth over the long run.

Most investors rarely venture past stocks and bonds when creating an investment portfolio. And I don’t blame them. These two asset classes are great candidates for building wealth. However, stocks and bonds are just the tip of the investment iceberg. If you are really serious about growing your wealth, you should consider everything that the investing world has to offer. To this end, I have compiled a list of the best income-producing assets that you can use to grow your wealth. For each asset class discussed, I will define what it is, examine the pros and cons of investing in it, and finally tell you how you can actually invest in it as well.

Find what level of risk you are willing to accept with your concentrated positions and then sell accordingly. In addition to selling a concentrated position, you may also need to sell a losing position at some point in your investment life. Whether your beliefs around an asset class change or one of your concentrated positions keeps going down, sometimes you just have to get out. I experienced this after doing some analysis on gold that made me realize that I shouldn’t own it as a long-term holding. Since my beliefs on the asset class changed based on fundamental analysis (and not emotion), I sold the position. This was true even though my gold holdings had increased in value. While this position wasn’t a losing one on monetary terms yet, I believed it eventually would be, so I sold.


pages: 248 words: 57,419

The New Depression: The Breakdown of the Paper Money Economy by Richard Duncan

Alan Greenspan, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, Ben Bernanke: helicopter money, Bretton Woods, business cycle, currency manipulation / currency intervention, debt deflation, deindustrialization, diversification, diversified portfolio, fiat currency, financial innovation, Flash crash, Fractional reserve banking, Glass-Steagall Act, income inequality, inflation targeting, It's morning again in America, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, low interest rates, market bubble, market fundamentalism, mass immigration, megaproject, Mexican peso crisis / tequila crisis, Money creation, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, Nixon triggered the end of the Bretton Woods system, private sector deleveraging, quantitative easing, reserve currency, risk free rate, Ronald Reagan, savings glut, special drawing rights, The Great Moderation, too big to fail, trade liberalization

Therefore, the $5 trillion invested into the United States by foreign central banks accounted for 10 percent of all the credit extended in the country. Where did those central banks invest so much money? Central banks are conservative. They prefer to invest in government bonds since they are believed to be the safest asset class. The U.S. government, however, simply did not issue enough bonds to satisfy $5 trillion worth of demand from foreign central banks. Exhibit 2.6 illustrates the large gap between the amount of dollars central banks outside the United States accumulated as foreign exchange reserves and the amount of bonds the U.S. government sold.

It leaves the economy frozen in a liquidity trap with high unemployment and no growth. Both would end in disaster for the economy and, therefore, for society. However, the two would impact asset prices very differently. This chapter looks at how very high rates of inflation and extreme deflation would affect the various asset classes. It is not inconceivable that, as this economic calamity plays out over the next decade, the economy could be hit by both. Government policy will determine the outcome. As of now, it remains very uncertain which direction government policy will take. Fire The United States has experienced five episodes of very high rates of inflation.

See Balance of payments Fortune magazine Fractional reserve banking, money creation through Freddie Mac: conservatorship of credit creation and decline in liquidity reserves quantitative easing and U.S. debt guarantees and Friedman, Milton General equilibrium, theory of Germany Glass–Steagall Act Globalization Global savings glut theory, of Bernanke Goldman Sachs Gold reserve requirement, end of and creation of fiat money Government Accountability Office report Government sector: inflation and deflation’s effects on percentage of total credit market debt rational investment option for results of spending cuts in Government-sponsored entities (GSEs): credit supply and GSE-backed mortgage pools inflation and deflation’s effects on quantitative easing and U.S. debt guarantees and Great Depression economic conditions during Friedman’s conclusions about Greece Greenspan, Alan Gross domestic product (GDP): change in value added, by industry debt as percentage of driven by credit equation of exchange and during Great Depression ratio of credit growth to GSE-backed mortgage pools History of Economic Analysis (Schumpeter) Hoover, Herbert Household sector: debt and inflation and deflation’s effects on Human Action (von Mises) Hyperinflation Inflation and deflation credit and inflation derivative regulation and effects on asset classes Fisher’s theory of debt-deflation inflation in 2011 inflation likely in 2012 inflation likely without additional quantitative easing and fiscal stimulus New Great Depression scenarios and protectionism and wealth preservation during Innovation, in Mitchell’s theory of business cycles Interest rates, in U.S.: bond sales and cut by Federal Reserve to encourage credit expansion money supply and quantitative easing and trade balances and International Monetary Fund Ireland Jackson, Andrew Japan Johnson, Lyndon JP Morgan JPMorgan Chase Keynes, John Maynard Korea Labor market, changes in marginal cost of wages in.


pages: 130 words: 11,880

Optimization Methods in Finance by Gerard Cornuejols, Reha Tutuncu

asset allocation, call centre, constrained optimization, correlation coefficient, diversification, financial engineering, finite state, fixed income, frictionless, frictionless market, index fund, linear programming, Long Term Capital Management, passive investing, Sharpe ratio, transaction costs, value at risk

In these problems, the objective is not to choose a portfolio of stocks (or other securities), but to determine the optimal investment among a set of asset classes. Examples of these asset classes are large capitalization stocks, small capitalization stocks, foreign stocks, government bonds, corporate bonds, etc. Since there are many mutual funds focusing on each one of these different asset classes, one can conveniently invest in these asset classes by purchasing the corresponding mutual fund. After estimating the expected returns, variances, and covariances for different asset classes, one can formulate a QP identical to (1.13) and obtain efficient portfolios of these asset classes. The formulation (1.13) we presented above makes several simplifying assumptions and much of the literature on asset allocation/portfolio selection focuses on solving this problem without some of these assumptions.

Here, we assume that Lt ’s are random with known distributions. A typical problem to solve in asset/liability management is to determine which assets (and in what quantities) the company should hold in each period to maximize its expected wealth at the end of period T. We can further assume that the asset classes the company can choose from have random returns (again, with known distributions) denoted by Rit for asset class i in period t. Since the company can make the holding decisions for each period after observing the asset returns and liabilities in the previous periods, the resulting problem can be cast as a stochastic program with recourse: maxx P E[ i xi,T ] P (1 + R )x it i,t−1 − i i xi,t = Lt , t = 1, . . . , T xi,t ≥ 0 ∀i, t.

RETURNS-BASED STYLE ANALYSIS 5.3 63 Returns-Based Style Analysis In two ground-breaking articles, Sharpe described how constrained optimization techniques can be used to determine the effective asset mix of a fund using only the return time series for the fund and a number of carefully chosen asset classes [13, 14]. Often, passive indices or index funds are used to represent the chosen asset classes and one tries to determine a portfolio of these funds/indices whose returns provide the best match for the returns of the fund being analyzed. The allocations in the portfolio can be interpreted as the fund’s style and consequently, this approach has become to known as returns-based style analysis, or RBSA.


pages: 1,202 words: 424,886

Stigum's Money Market, 4E by Marcia Stigum, Anthony Crescenzi

accounting loophole / creative accounting, Alan Greenspan, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, Black-Scholes formula, book value, Brownian motion, business climate, buy and hold, capital controls, central bank independence, centralized clearinghouse, corporate governance, credit crunch, Credit Default Swap, cross-border payments, currency manipulation / currency intervention, currency risk, David Ricardo: comparative advantage, disintermediation, distributed generation, diversification, diversified portfolio, Dutch auction, financial innovation, financial intermediation, fixed income, flag carrier, foreign exchange controls, full employment, Glass-Steagall Act, Goodhart's law, Greenspan put, guns versus butter model, high net worth, implied volatility, income per capita, intangible asset, interest rate derivative, interest rate swap, inverted yield curve, junk bonds, land bank, large denomination, locking in a profit, London Interbank Offered Rate, low interest rates, margin call, market bubble, market clearing, market fundamentalism, Money creation, money market fund, mortgage debt, Myron Scholes, offshore financial centre, paper trading, pension reform, Phillips curve, Ponzi scheme, price mechanism, price stability, profit motive, proprietary trading, prudent man rule, Real Time Gross Settlement, reserve currency, risk free rate, risk tolerance, risk/return, Savings and loan crisis, seigniorage, shareholder value, short selling, short squeeze, tail risk, technology bubble, the payments system, too big to fail, transaction costs, two-sided market, value at risk, volatility smile, yield curve, zero-coupon bond, zero-sum game

In the futures market, this assurance is provided by both the clearing service providers and their clearing member firms. Both act as the counterparty to every futures trade, guaranteeing to make good on all trades even if the counterparty fails on his obligation on the trade. Portfolio diversification is another use for futures. They enable investors to invest in asset classes that are not always easy to access. For example, if an investor wants to invest in foodstuffs, he can do so by utilizing the numerous futures that exist for that industry. The same could be said about foreign currencies, precious metals, energy products, livestock, foreign equity indexes, and many other types of interest-rate futures.

One big issuer estimated that its all-in cost of issuance runs 1 bp. Diversification into Financial Services One important change in direct issuance over the years has been the expansion, especially by the auto finance companies and/or their parent companies, into other related finance services: mortgage servicing, insurance, the thrift business, leasing, and so on. The move toward such diversification made sense on a number of counts: the auto companies had strong earnings and could thus finance acquisitions of firms in financial services; the auto business is cyclical and thus produces profits that swing cyclically; diversification into related financial services appeared to offer the auto companies and their finance subs attractive, stable earnings.

This is acceptable to most, of course, because bond investors generally invest in bonds simply to diversify their portfolio, provide an income stream, and prudently add safety elements to their portfolio. Bond investors are therefore somewhat indifferent to the generally laggard returns on bonds compared to other asset classes. There is, however, a limit to this indifference: when the return on other asset classes far outpaces the returns on fixed-income securities and when it appears that the returns might be sustained, money will almost certainly be channeled away from the bond market. Bond investors won’t pull out en masse, of course, but they will reduce their allocation to bonds to take advantage of better returns elsewhere.


pages: 354 words: 26,550

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, computerized trading, diversification, equity premium, fault tolerance, financial engineering, financial intermediation, fixed income, global macro, high net worth, implied volatility, index arbitrage, information asymmetry, interest rate swap, inventory management, Jim Simons, law of one price, Long Term Capital Management, Louis Bachelier, machine readable, margin call, market friction, market microstructure, martingale, Myron Scholes, New Journalism, p-value, paper trading, performance metric, Performance of Mutual Funds in the Period, pneumatic tube, profit motive, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, tail risk, trade route, transaction costs, value at risk, yield curve, zero-sum game

According to research conducted by Aite Group, equities are the most algorithmically 19 Evolution of High-Frequency Trading 60% 50% Equities Futures Options FX Fixed Income 40% 30% 20% 10% 0% 2004 2005 2006 2007 2008 2009 2010 Year FIGURE 2.7 Adoption of algorithmic execution by asset class. Source: Aite Group. executed asset class, with over 50 percent of the total volume of equities expected to be handled by algorithms by 2010. As Figure 2.7 shows, equities are closely followed by futures. Advances in algorithmic execution of foreign exchange, options, and fixed income, however, have been less visible.

This section summarizes statistical arbitrage applied to triangular arbitrage and uncovered interest rate parity models. Other fundamental foreign exchange models, such as the flexible price 190 HIGH-FREQUENCY TRADING TABLE 13.1 Summary of Fundamental Arbitrage Strategies by Asset Class Presented in This Section Asset Class Fundamental Arbitrage Strategy Foreign Exchange Foreign Exchange Equities Equities Equities Equities Futures and the Underlying Asset Indexes and ETFs Options Triangular Arbitrage Uncovered Interest Parity (UIP) Arbitrage Different Equity Classes of the Same Issuer Market Neutral Arbitrage Liquidity Arbitrage Large-to-Small Information Spillovers Basis Trading Index Composition Arbitrage Volatility Curve Arbitrage monetary model, the sticky price monetary model, and the portfolio model can be used to generate consistently profitable trades in the statistical arbitrage framework.

In 1923, 1 million shares traded per day on the NYSE, while just over 1 billion shares were traded per day on the NYSE in 2003, a 1,000-times increase. 10 HIGH-FREQUENCY TRADING 100% 80% Equities Futures Options FX Fixed Income 60% 40% 20% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year FIGURE 2.2 Adoption of electronic trading capabilities by asset class. Source: Aite Group. Technological advances have also changed the industry structure for financial services from a rigid hierarchical structure popular through most of the 20th century to a flat decentralized network that has become the standard since the late 1990s. The traditional 20th-century network of financial services is illustrated in Figure 2.3.


The Trade Lifecycle: Behind the Scenes of the Trading Process (The Wiley Finance Series) by Robert P. Baker

asset-backed security, bank run, banking crisis, Basel III, Black-Scholes formula, book value, Brownian motion, business continuity plan, business logic, business process, collapse of Lehman Brothers, corporate governance, credit crunch, Credit Default Swap, diversification, financial engineering, fixed income, functional programming, global macro, hiring and firing, implied volatility, interest rate derivative, interest rate swap, locking in a profit, London Interbank Offered Rate, low interest rates, margin call, market clearing, millennium bug, place-making, prediction markets, proprietary trading, short selling, statistical model, stochastic process, the market place, the payments system, time value of money, too big to fail, transaction costs, value at risk, Wiener process, yield curve, zero-coupon bond

Although most organisations arrange trading desks according to asset class, the support and control functions are very often grouped by product type. For instance, there might be separate IT systems for spot, nonlinear and option trades – each one crossing many asset classes. 5.8 TRADE MATRIX Differences in processes arise from: different underlying asset classes different type and complexity of trades. This can be represented as a two-dimensional table with the various asset classes in one dimension and the range of trade types in the other as shown in Table 5.5. Control and support must be provided for every product type in every asset class. This can be done vertically (e.g. equities for every product type), horizontally (e.g. options for every asset class) or with a mixture of both.

However, since the type of vendor, the layout of the store, the delivery mechanism and various other factors are different, we normally view these two acquisitions in different ways. We may say that potatoes are in the asset class of perishable food and washing machines are in the asset class of domestic appliances. So the underlying process is the same but the asset classes are different. The same is true for financial products. Buying shares is intrinsically the same as buying aluminium, sovereign bonds or purchasing dollars in exchange for euros. However, since the people and trading environments of each of these trades are very different, we generally group them into different asset classes. (The examples above corresponding to equities, commodity, fixed income and foreign exchange (FX)).

(The examples above corresponding to equities, commodity, fixed income and foreign exchange (FX)). The processes for dealing with each of these trades will normally depend on the asset class rather than the product itself. As we have seen, some products exist in more than one asset class. Every asset class has a suite of possible products. A financial institution organises its traders, sales staff, middle office and controllers around each asset class rather than around each product. T 17 18 THE TRADE LIFECYCLE A trade is an actual instance of a product. There are two parties to any trade, often referred to as counterparties or counterparts. Many products make reference to other parties or events.


pages: 340 words: 100,151

Secrets of Sand Hill Road: Venture Capital and How to Get It by Scott Kupor

activist fund / activist shareholder / activist investor, Airbnb, Amazon Web Services, asset allocation, barriers to entry, Ben Horowitz, Benchmark Capital, Big Tech, Blue Bottle Coffee, carried interest, cloud computing, compensation consultant, corporate governance, cryptocurrency, discounted cash flows, diversification, diversified portfolio, estate planning, family office, fixed income, Glass-Steagall Act, high net worth, index fund, information asymmetry, initial coin offering, Lean Startup, low cost airline, Lyft, Marc Andreessen, Myron Scholes, Network effects, Paul Graham, pets.com, power law, price stability, prudent man rule, ride hailing / ride sharing, rolodex, Salesforce, Sand Hill Road, seminal paper, shareholder value, Silicon Valley, software as a service, sovereign wealth fund, Startup school, the long tail, Travis Kalanick, uber lyft, VA Linux, Y Combinator, zero-sum game

Now that we’ve got that out of the way, let’s look at how investors consider VC funds to put their money into. Venture Capital as a (Not-Very-Good) Asset Class for Investors In simple terms, an “asset class” is a category of investments to which investors make an allocation. For example, bonds are an asset class, as are public market equities; that is, investors often choose—as part of a balanced portfolio—to invest some portion of their monies into bonds or stocks of publicly traded companies. Hedge funds, VC funds, and buyout funds, among others, are also examples of asset classes. Institutional investors (i.e., professionals who manage large pools of capital) often have a defined asset allocation policy by which they invest.

They might for example choose to invest 20 percent of their assets in bonds, 40 percent in publicly traded equities, 25 percent in hedge funds, 10 percent in buyout funds, and 5 percent in VC funds. There are numerous other asset classes for consideration and x-number of percentage allocations between the assets classes that institutional investors might pursue. As we’ll see when we talk about the Yale University endowment, the objectives of the particular investor will determine the asset allocation strategy. So, if we agree that VC is an asset class, why is it not a “good” one? Simply because the median returns are not worth the risk or the illiquidity that the average VC investor has to put up with.

The final complexity that we ignored—and rightly so, because it is not that common among VC funds (though much more so in buyout funds)—involves the opportunity cost of money. Because LPs have a choice of asset classes in which to invest, they naturally want to know that investing in VC funds will pay them a premium compared to other asset classes. After all, venture capital is risky and has long time horizons during which the LP’s capital is tied up. Instead of investing in a VC fund, an LP could choose to invest in the S&P 500 or some other asset class. To account for this, some LPAs introduce the concept of a “hurdle rate” into the profits calculations. A hurdle rate says that unless the fund generates a return in excess of the hurdle rate (this is a negotiated number, but often around 8 percent), the GP is not entitled to take her carried interest on the profits.


The Unusual Billionaires by Saurabh Mukherjea

Albert Einstein, asset light, Atul Gawande, backtesting, barriers to entry, Black-Scholes formula, book value, British Empire, business cycle, business intelligence, business process, buy and hold, call centre, Checklist Manifesto, commoditize, compound rate of return, corporate governance, dematerialisation, disintermediation, diversification, equity risk premium, financial innovation, forensic accounting, full employment, inventory management, low cost airline, low interest rates, Mahatma Gandhi, Peter Thiel, QR code, risk free rate, risk-adjusted returns, shareholder value, Silicon Valley, Steve Jobs, supply-chain management, The Wisdom of Crowds, transaction costs, upwardly mobile, Vilfredo Pareto, wealth creators, work culture

Now we are moving towards becoming a decor solutions provider to the customer (offering value-added services like colour consultancies),’ recalled Jalaj Dani, member from the promoter family, Asian Paints, in our meeting with him. For the Chokseys, Danis and Vakils, Asian Paints is the single biggest source of their wealth and to give them credit, the promoters have refrained from pushing the company towards major unrelated diversifications. On the contrary, erstwhile paint industry leaders like Jenson and Nicholson saw a steep decline in their market shares during the 1990s due to unrelated diversification into sectors like financial services, weigh bridges, weighing machines and hotels. Asian Paints identified and understood the twin drivers for growth—supply chain efficiencies and brand power—early on and have relentlessly focused on entrenching themselves further in the paints sector using these drivers.

In fact, its dominance of the organized cigarette industry has actually increased over the past decade, with market share in cigarettes rising to 79 per cent in FY15 from 73 per cent in FY07 (see Exhibit 125). In comparison to its track record on unrelated diversifications, ITC’s track record on acquisitions has been more conservative. It has often resorted to making strategic investments in its competitors though, like in its hotel business where it purchased stakes in East India Hotels and Hotel Leelaventure. Its other acquisitions like Technico (biotech) in FY08 have also been carried out for access to technology for its foods business. Despite so many diversifications, including its largest and most sustained one into FMCG, how has ITC still delivered ROCEs of more than 15 per cent every year for the past decade?

**GPI is Godfrey Philip India. Exhibit 126: ITC’s allocation of cash generated over FY05–15 Source: Company, Ambit Capital research. Case Study 2: Asian Paints Asian Paints is another example of diversifications without breaking the company’s balance sheet. Over the years, the company has forayed into international markets and, within India, in home improvement solutions—both of which are diversifications from the company’s large and lucrative domestic paints franchise. In FY15, Asian Paints’s overseas businesses were across the following geographies: The Caribbean (Barbados, Jamaica, Trinidad and Tobago), The Middle East (Egypt, Oman, Bahrain and the UAE), Asia (Bangladesh, Nepal, Sri Lanka, Singapore and Indonesia), The South Pacific (Fiji, Solomon Islands, Samoa, Tonga and Vanuatu), and Africa (Ethiopia).


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

Abraham Wald, Alan Greenspan, Albert Einstein, An Inconvenient Truth, Andrei Shleifer, anti-communist, AOL-Time Warner, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black Monday: stock market crash in 1987, Black-Scholes formula, Blythe Masters, book value, Bretton Woods, British Empire, business cycle, capital asset pricing model, carbon tax, Carl Icahn, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, different worldview, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, Garrett Hardin, George Akerlof, Glass-Steagall Act, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kickstarter, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, military-industrial complex, Minsky moment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Nixon triggered the end of the Bretton Woods system, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Phillips curve, Ponzi scheme, precautionary principle, price discrimination, price stability, principal–agent problem, profit maximization, proprietary trading, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Solow, Ronald Coase, Ronald Reagan, Savings and loan crisis, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, subprime mortgage crisis, tail risk, Tax Reform Act of 1986, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, Tragedy of the Commons, transaction costs, Two Sigma, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

Almost a third of them had FICO scores below 600, indicating serious problems in their credit history. The basic rationale for investing in an RMBS (or a CDO) was that financing loans to several thousand questionable borrowers was much safer than lending to any individual. Why would that be? Wall Street had three answers: diversification, subordination, and the building up of reserves. The argument for diversification was the same one that applies to salting away your retirement savings in mutual funds rather than investing in individual stocks. If you put all of your money in one company and it goes bankrupt, you lose everything; if you invest in five hundred companies, through an index fund, say, and one of them goes out of business, it shouldn’t have much impact on the value of the fund.

A bit more formally, the Nobel-winning financial theorist Harry Markowitz demonstrated back in the 1950s that diversification allows investors to minimize the impact of particular damaging events, or what is often referred to as “idiosyncratic risk.” If the oil price plummets, the oil stocks in your retirement fund will probably go down, but cheaper gas frees up cash that gets spent on other things, and the stock in the sectors that benefit, such as retailers and restaurants, should go up. Losses in one part of the portfolio are made up in another. With mortgage bonds, diversification is based on geography. When home prices are falling in Illinois or Ohio, they might well be going up in New Mexico and Arizona.

In any group of assets, be it a stock, a mutual fund, or an RMBS, the benefits of diversification depend on the assets being truly diverse; in a statistical sense, they need to have a low degree of correlation. The subprime loans that were used in mortgage securitizations weren’t diverse at all. Most of them were situated in bubble areas, such as California, Nevada, and Florida, and the borrowers who had taken them out all had low credit ratings. Combining a hundred 2/28 mortgages from Fort Lauderdale with a hundred 2/28 loans from Las Vegas and another hundred from Orange County didn’t provide any real diversification of risk; it simply joined like with like.


pages: 519 words: 118,095

Your Money: The Missing Manual by J.D. Roth

Airbnb, Alan Greenspan, asset allocation, bank run, book value, buy and hold, buy low sell high, car-free, Community Supported Agriculture, delayed gratification, diversification, diversified portfolio, do what you love, estate planning, Firefox, fixed income, full employment, hedonic treadmill, Home mortgage interest deduction, index card, index fund, John Bogle, late fees, lifestyle creep, low interest rates, mortgage tax deduction, Own Your Own Home, Paradox of Choice, passive investing, Paul Graham, random walk, retail therapy, Richard Bolles, risk tolerance, Robert Shiller, speech recognition, stocks for the long run, traveling salesman, Vanguard fund, web application, Zipcar

On The Money: Don't Put All Your Eggs in One Basket One way investors reduce risk is through diversification, which means not putting all your money into one investment, whether it's a stock or bond or something else altogether. By spreading your money around, you smooth out the market's wild ups and downs while getting a similar return on your investment. You can diversify your investments in several ways, including: Within asset classes. The more different stocks you own, the better your diversification. Same goes for bonds. Among asset classes. In general, the movements of stocks, bonds, commodities (The Tools of Investing), and real estate aren't strongly correlated; for example, just because the stock market is down doesn't mean the real estate market will be down, too.

The same is generally true of the returns on these asset classes—they're normally independent of each other. (But sometimes, as in the recent financial crisis, there's a whole lot of correlation going on!) Over time. "Risk is also reduced for investors who build up a retirement nest egg by putting their money in the market regularly over time," writes Burton Malkiel in The Random Walk Guide to Investing. By using techniques like dollar-cost averaging (see All-in-one funds), you ensure that you're not investing all your money when the market is high. There are other types of diversification, too. For example, when you buy foreign stocks, you're diversifying by geography.

The best way to do this is to invest in the stock market because, over the long-term, stocks offer the best possible return. (When talking about investments, your return is the amount you earn or lose.) How Much Do Stocks Actually Earn? In his book Stocks for the Long Run (McGraw-Hill, 2008), Jeremy Siegel analyzes the historical performance of several types of investments (economists call them asset classes). He tries to answer the question "How much does the stock market actually return?" After crunching lots of numbers, Siegel found that since 1926: Stocks have returned an average of about 10% per year. Over the past 80 years, stocks have produced a real return (meaning an inflation-adjusted return) of 6.8%, which also happens to be their average rate of return for the past 200 years.


pages: 1,373 words: 300,577

The Quest: Energy, Security, and the Remaking of the Modern World by Daniel Yergin

"Hurricane Katrina" Superdome, "World Economic Forum" Davos, accelerated depreciation, addicted to oil, Alan Greenspan, Albert Einstein, An Inconvenient Truth, Asian financial crisis, Ayatollah Khomeini, banking crisis, Berlin Wall, bioinformatics, book value, borderless world, BRICs, business climate, California energy crisis, carbon credits, carbon footprint, carbon tax, Carl Icahn, Carmen Reinhart, clean tech, Climategate, Climatic Research Unit, colonial rule, Colonization of Mars, corporate governance, cuban missile crisis, data acquisition, decarbonisation, Deng Xiaoping, Dissolution of the Soviet Union, diversification, diversified portfolio, electricity market, Elon Musk, energy security, energy transition, Exxon Valdez, facts on the ground, Fall of the Berlin Wall, fear of failure, financial innovation, flex fuel, Ford Model T, geopolitical risk, global supply chain, global village, Great Leap Forward, Greenspan put, high net worth, high-speed rail, hydraulic fracturing, income inequality, index fund, informal economy, interchangeable parts, Intergovernmental Panel on Climate Change (IPCC), It's morning again in America, James Watt: steam engine, John Deuss, John von Neumann, Kenneth Rogoff, life extension, Long Term Capital Management, Malacca Straits, market design, means of production, megacity, megaproject, Menlo Park, Mikhail Gorbachev, military-industrial complex, Mohammed Bouazizi, mutually assured destruction, new economy, no-fly zone, Norman Macrae, North Sea oil, nuclear winter, off grid, oil rush, oil shale / tar sands, oil shock, oil-for-food scandal, Paul Samuelson, peak oil, Piper Alpha, price mechanism, purchasing power parity, rent-seeking, rising living standards, Robert Metcalfe, Robert Shiller, Robert Solow, rolling blackouts, Ronald Coase, Ronald Reagan, Sand Hill Road, Savings and loan crisis, seminal paper, shareholder value, Shenzhen special economic zone , Silicon Valley, Silicon Valley billionaire, Silicon Valley startup, smart grid, smart meter, South China Sea, sovereign wealth fund, special economic zone, Stuxnet, Suez crisis 1956, technology bubble, the built environment, The Nature of the Firm, the new new thing, trade route, transaction costs, unemployed young men, University of East Anglia, uranium enrichment, vertical integration, William Langewiesche, Yom Kippur War

At one point, Alexei Miller, the CEO of Gazprom, told the Europeans, “Get over your fear of Russia, or run out of gas.”16 For their part, Russia and Ukraine had had further standoffs over natural gas pricing. Even the subsequent government of President Viktor Yanukovych, which had better relations with Moscow, still continued to describe its pipeline network as “our national treasure.” DIVERSIFICATION The lasting impact of the gas controversies was to fuel a new campaign of diversification on both sides of the argument. That meant a new round of pipeline politics that was elevated to the geopolitical level. The Russians were determined to get around Ukraine and Poland with a series of new pipelines. Gazprom and ENI had already built Blue Stream, which crosses the Black Sea from Russia to Turkey and is the deepest underwater pipeline in the world.

Development of these resources could provide an alternative to gas imports, whether they come by pipeline from the east or by ship in the form of LNG.18 But it is still early days, and a great deal of effort will be required to develop such resources. Obstacles will range from local opposition and national policy to lack of infrastructure and sheer density of population. Still the imperatives of diversification will likely fuel the development of unconventional gas resources in some parts of Europe, as elsewhere—most notably in Poland and Ukraine. The new supplies will compensate for declining conventional domestic supplies. Moreover, by enhancing the sense of security and diversification around gas supplies, the development of unconventional gas could end up bolstering confidence in relying on expanded gas imports. A FUEL FOR THE FUTURE Natural gas is a fuel of the future.

The first is to start with the recognition of the scale, complexity, and importance of the energy foundations on which a world economy depends, whether it is today’s $65 trillion or $130 trillion two decades from now. There is much to be said for an ecumenical approach that recognizes the contribution of the range of the energy options. Churchill’s famous dictum about supply—“variety, and variety alone”—still resounds powerfully. Diversification of oil resources needs to be expanded to diversification among energy sources—conventional and “new.” This represents a realization that there are no risk-free options and that the risks can come in many forms. Energy efficiency remains a top priority for a growing world economy. Remarkable results have already been achieved, but technologies and tools not available in earlier decades are now at hand.


pages: 432 words: 106,612

Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever by Robin Wigglesworth

Albert Einstein, algorithmic trading, asset allocation, Bear Stearns, behavioural economics, Benoit Mandelbrot, Big Tech, Black Monday: stock market crash in 1987, Blitzscaling, Brownian motion, buy and hold, California gold rush, capital asset pricing model, Carl Icahn, cloud computing, commoditize, coronavirus, corporate governance, corporate raider, COVID-19, data science, diversification, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, fear index, financial engineering, fixed income, Glass-Steagall Act, Henri Poincaré, index fund, industrial robot, invention of the wheel, Japanese asset price bubble, Jeff Bezos, Johannes Kepler, John Bogle, John von Neumann, Kenneth Arrow, lockdown, Louis Bachelier, machine readable, money market fund, Myron Scholes, New Journalism, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, Performance of Mutual Funds in the Period, Peter Thiel, pre–internet, RAND corporation, random walk, risk-adjusted returns, road to serfdom, Robert Shiller, rolodex, seminal paper, Sharpe ratio, short selling, Silicon Valley, sovereign wealth fund, subprime mortgage crisis, the scientific method, transaction costs, uptick rule, Upton Sinclair, Vanguard fund

At least in theory, that should mean that people should invest only in the single security that offered the greatest expected return. But Markowitz knew this would be insanity in practice. Future dividends are inherently uncertain, and investors care about both the risk of their investments and their return. So he thought diversification—spreading the eggs across several baskets—would reduce the risk. Using the volatility of a stock as a proxy for risk, he empirically proved that diversification across a large number of independently moving securities—a “portfolio,” as the finance industry calls a collection of securities—did indeed reduce the risks for investors. In fact, Markowitz suggested that all investors should really care about was how the entire portfolio acted, rather than obsess about each individual security it contained.

And to DFA’s chagrin, after small caps enjoyed a robust year in DFA’s first year of existence, they would then undergo a long, painful seven-year period of trailing dramatically behind the S&P 500.13 DFA managed to keep growing, losing very few clients, partly because it had always stressed to them that stretches like this could happen. But it was an uncomfortable period that led to many awkward conversations with clients. At one point Booth was cornered by the assistant treasurer of one big customer, who angrily grabbed his arm and snarled, “I want you to know you’re the worst performing manager we have in any asset class. Do you still believe that small-cap stocks have higher expected returns?” Booth stuck to the DFA script and replied, “We believe small-cap stocks are riskier than big-cap stocks and risk and return are related. Which part of the argument are you no longer comfortable with?”14 DFA eventually did make it through the lean years, but not without casualties

As of June 2020, only 15 percent of US stock-pickers had cumulatively managed to surpass their benchmark over the last decade. In bond markets, it is a similar tale, albeit varying depending on the flavor of fixed income. The data is more favorable for fund managers in more exotic, less efficient asset classes, such as emerging markets, but on the whole the data is clear that in the longer run most fund managers still underperform their passive rivals after fees. * The section of the letter on passive investing was titled “Comfortably Numb,” a reference to the Pink Floyd song and the approach Singer argued that too many investors are currently taking.


Trade Your Way to Financial Freedom by van K. Tharp

asset allocation, backtesting, book value, Bretton Woods, buy and hold, buy the rumour, sell the news, capital asset pricing model, commodity trading advisor, compound rate of return, computer age, distributed generation, diversification, dogs of the Dow, Elliott wave, high net worth, index fund, locking in a profit, margin call, market fundamentalism, Market Wizards by Jack D. Schwager, passive income, prediction markets, price stability, proprietary trading, random walk, Reminiscences of a Stock Operator, reserve currency, risk tolerance, Ronald Reagan, Savings and loan crisis, Sharpe ratio, short selling, Tax Reform Act of 1986, transaction costs

Although Brinson and his colleagues found that stock selection and other types of decisions were not that significant to the performance, the lotto bias causes many people to continue to think that asset allocation means selecting the right asset class. Yet what’s important is the how-much decision, not the investment selection decision. Let me reemphasize that what’s important about money management or asset allocation is not any of the following: • It is not that part of your system that dictates how much you will lose on a given trade. • It is not how to exit a profitable trade. • It is not diversification. • It is not risk control. • It is not risk avoidance. • It is not that part of your system that tells you what to invest in.

Portfolio managers tend to talk about “asset allocation” as being important for their success. Now think about the words asset allocation. What do they mean to you? Chances are, you think they mean what asset class to select for your assets. This is what it means to most portfolio managers because by charter they must be fully (at least 95 percent) invested. Thus, they think of asset allocation as a decision about which asset class to select. Was this your definition? Brinson and his colleagues defined asset allocation to mean how much of one’s capital was devoted to stocks, bonds, or cash.2 When they defined it that way, they discovered that asset allocation, and not the what-to-buy decision, accounted for 91.5 percent of the performance variability of 82 pension plans over a 10-year period.

This strategy usually involves the simultaneous purchase and sale of related items. asset allocation The procedure by which many professional traders decide how to allocate their capital. Due to the lotto bias, many people think of this as a decision about which asset class (such as energy stocks or gold) to select. However, its real power comes when people use it to tell them “how much” to invest in each asset class. Thus, it is really another word for “position sizing.” average directional movement (ADX) An indicator that measures how much a market is trending. Both bullish and bearish trends are shown by positive movement. average true range (ATR) The average over the last X days of the true range, which is the largest of the following: (1) today’s high minus today’s low; (2) today’s high minus yesterday’s close; or (3) today’s low minus yesterday’s close.


pages: 576 words: 105,655

Austerity: The History of a Dangerous Idea by Mark Blyth

"there is no alternative" (TINA), accounting loophole / creative accounting, Alan Greenspan, balance sheet recession, bank run, banking crisis, Bear Stearns, Black Swan, book value, Bretton Woods, business cycle, buy and hold, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, deindustrialization, disintermediation, diversification, en.wikipedia.org, ending welfare as we know it, Eugene Fama: efficient market hypothesis, eurozone crisis, financial engineering, financial repression, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, Gini coefficient, global reserve currency, Greenspan put, Growth in a Time of Debt, high-speed rail, Hyman Minsky, income inequality, information asymmetry, interest rate swap, invisible hand, Irish property bubble, Joseph Schumpeter, Kenneth Rogoff, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, Long Term Capital Management, low interest rates, market bubble, market clearing, Martin Wolf, Minsky moment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Occupy movement, offshore financial centre, paradox of thrift, Philip Mirowski, Phillips curve, Post-Keynesian economics, price stability, quantitative easing, rent-seeking, reserve currency, road to serfdom, Robert Solow, savings glut, short selling, structural adjustment programs, tail risk, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, Two Sigma, unorthodox policies, value at risk, Washington Consensus, zero-sum game

As per above, government bond purchases by Asian central banks cut the supply of T-bills, and this made CDOs even more attractive. 19. Peter S. Goodman, Past Due: The End of Easy Money and the Renewal of the American Economy (New York: Henry Holt, 2010), chap. 5. 20. Gillian Tett, Fool’s Gold (New York: Free Press, 2009). 21. Or SPV (special purpose vehicle). 22. Diversification is more than “not putting all your eggs in one basket.” Good diversification seeks to add assets that are uncorrelated or negatively correlated with other assets in a portfolio. Uncorrelated assets still must be expected to earn more than one would expect to get by depositing cash in a checking account, to be worth risking money and inclusion in a portfolio.

You can only generate bubbles of this magnitude if there are assets that are either undervalued, or are at least perceived to be undervalued, and that can serve as fuel for the bubble. US equities had been flat for a generation back in the early 1980s. US housing was cheap and patterns of demand were changing. Commodities used to be a niche market. Finance changed all that, pumping and dumping these asset classes and taking profits along the way for twenty-five years. It was a great run while it lasted, but now, after the bust, could it be over? Figure 7.1 The Bubble behind the Bust (1987–2011) Sovereigns are stretched, and eventually liquidity support and zero rates will come to an end on what will be a much weaker underlying economy.

Equities will decline in value, commodities too, as global demand weakens, and housing, outside a few markets, is not going to be increasing in value at 7 to 10 percent a year anytime soon. But deprived of fuel for the asset cycle, all those wonderful paper assets that can be based off these booms—commodity ETFs, interest rate swaps, CDOs and CDSs—to name but a few—will cease to be the great money machine that they have been to date. Having pumped and dumped every asset class on the planet, finance may have exhausted its own growth model. The banks’ business model for the past twenty-five years may be dying. If so, saving it in the bust is merely, and most expensively, prolonging the agony. Anticipating John Quiggin’s Zombie Economics, we may have endured austerity to bring back the nearly dead.


pages: 741 words: 179,454

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", "there is no alternative" (TINA), "World Economic Forum" Davos, affirmative action, Alan Greenspan, Albert Einstein, algorithmic trading, Andy Kessler, AOL-Time Warner, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, book value, Bretton Woods, BRICs, British Empire, business cycle, buy the rumour, sell the news, capital asset pricing model, carbon credits, Carl Icahn, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Daniel Kahneman / Amos Tversky, deal flow, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Dr. Strangelove, Dutch auction, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Fall of the Berlin Wall, financial engineering, financial independence, financial innovation, financial thriller, fixed income, foreign exchange controls, full employment, Glass-Steagall Act, global reserve currency, Goldman Sachs: Vampire Squid, Goodhart's law, Gordon Gekko, greed is good, Greenspan put, happiness index / gross national happiness, haute cuisine, Herman Kahn, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", job automation, Johann Wolfgang von Goethe, John Bogle, John Meriwether, joint-stock company, Jones Act, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, market bubble, market fundamentalism, Market Wizards by Jack D. Schwager, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Michael Milken, Mikhail Gorbachev, Milgram experiment, military-industrial complex, Minsky moment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, National Debt Clock, negative equity, NetJets, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Phillips curve, planned obsolescence, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, proprietary trading, public intellectual, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, Reminiscences of a Stock Operator, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Thaler, Right to Buy, risk free rate, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, short squeeze, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, stock buybacks, survivorship bias, tail risk, Teledyne, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, two and twenty, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

UBS Asset Management and Blackstone now manage trillions of dollars. As size made it difficult to enter and exit markets quickly without affecting prices, indexation or core-satellite approaches grew. Diversification encouraged new asset classes—emerging markets, currencies, commodities, infrastructure, insurance risk, and even fine arts. As long as the investment offered returns and did not move together with other asset classes held by the investor, adding them to a portfolio improved return with lower risk. The success of the unorthodox investment philosophy of David Swensen and the Yale Endowment showed the potential of hedge funds and private equity to generate alpha.

Black remained equivocal about the replication approach: “Merton’s derivation relies on stricter assumptions, so I don’t think it’s really robust.”13 Slow and Quick Money Initially, the ideas did not find acceptance among practitioners. The professors could point to no practical experience or track record. Baron Rothschild once observed that only three people understood the meaning of money and none had very much of it.14 Diversification to reduce risk was contrary to the ethos of stock picking. While successfully managing the portfolios of an insurance company and the King’s College endowment, Keynes insisted that diversification was flawed: To suppose that safety...consists in having a small gamble in a large number of different [stocks] where I have no information...as compared with a substantial stake in a company where one’s information is adequate, strikes me as a travesty of investment policy.15 Mark Twain’s Pudd’nhead Wilson agreed: “Put all your eggs in one basket, and watch that basket.”

His remaining 24 percent stake was valued at almost $8 billion, placing him near Rupert Murdoch and Steve Jobs on the list of richest people. In 2006, Schwarzman earned $398 million, around double the combined pay of the five largest American investment bank CEOs. Amateur Hour A leaked internal memo written by Carlyle’s William Conway dated January 31, 2007 showed that that the boom was almost over: “most investors in most assets classes are not being paid for the risks being taken...the longer it lasts the worst it will be when it ends...if the excess liquidity ended tomorrow I would want as much flexibility as possible.”14 Shortly after the Blackstone IPO, U.S. subprime problems overflowed into a general credit crunch, and the debt markets ground to a halt.


file:///C:/Documents%20and%... by vpavan

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, Alan Greenspan, AOL-Time Warner, asset allocation, Bear Stearns, Berlin Wall, book value, business cycle, buttonwood tree, buy and hold, Carl Icahn, corporate governance, corporate raider, currency risk, disintermediation, diversification, diversified portfolio, Donald Trump, estate planning, financial engineering, fixed income, index fund, intangible asset, interest rate swap, John Bogle, junk bonds, Larry Ellison, margin call, Mary Meeker, money market fund, Myron Scholes, new economy, payment for order flow, price discovery process, profit motive, risk tolerance, shareholder value, short selling, Silicon Valley, Small Order Execution System, Steve Jobs, stocks for the long run, stocks for the long term, tech worker, technology bubble, transaction costs, Vanguard fund, women in the workforce, zero-coupon bond, éminence grise

After deciding how much to allocate to stocks and to bonds, make sure that you diversify within those asset classes so that you aren't overexposed to one particular industry. The sudden downturn in the high-tech sector, for example, took many 401(k) participants by surprise in 2000 because they were not properly diversified. When you own mutual funds, the intellectual work involved in making sure you are diversified is done for you. Well, mostly. Diversification means balancing the high-risk, high-return potential of a small-cap stock fund with the steady-as-she-goes growth of a blue-chip fund, though even blue chips can lose value, as we have seen in recent years. Diversification means that if you own a fund that specializes in stocks that appear to be undervalued— so-called value stocks— you might want to balance that with a fund that looks for stocks likely to generate above-average earnings— so-called growth stocks.

A fiduciary has a legal obligation to make investment decisions that benefit the recipient. Because such contributions are strictly voluntary, Congress never brought them under the protective arm of ERISA. It also did not subject 401(k)s to diversification rules that traditional, defined-benefit plans must follow. In such plans, company stock cannot exceed 10 percent of total assets. Companies in the past have fought such diversification rules, arguing that it's good policy to align their employees' interests with those of the company, and the best way to do that is to require employees to own stock in the company. Some companies also have argued that matching funds are not required by law, so Congress shouldn't restrict the form or the amount of those contributions.

Diversification means that if you own a fund that specializes in stocks that appear to be undervalued— so-called value stocks— you might want to balance that with a fund that looks for stocks likely to generate above-average earnings— so-called growth stocks. Because fund names can be misleading, it's important to review the underlying stocks that make up a mutual fund to make sure it's doing what its name advertises. If you are investing in a bond fund, diversification means choosing bonds that have different interest rates and maturity dates. Remember: diversification helps you reduce risk by balancing investments that perform poorly with those that produce solid earnings. Stocks versus Bonds: How Do I Decide Between Them? Historically, stocks have outperformed bonds. As I explained earlier, the stocks that make up the S&P 500 have achieved an average annual return of 10.7 percent since 1926.


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The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Alan Greenspan, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bear Stearns, Bernie Madoff, book value, Bretton Woods, business process, call centre, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, financial engineering, fixed income, global macro, high net worth, high-speed rail, impact investing, interest rate derivative, Isaac Newton, Jim Simons, junk bonds, Long Term Capital Management, managed futures, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Michael Milken, Myron Scholes, NetJets, oil shock, pattern recognition, Pershing Square Capital Management, Ponzi scheme, proprietary trading, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Savings and loan crisis, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, stock buybacks, systematic bias, systematic trading, tail risk, two and twenty, zero-sum game

Bridgewater called its first optimal alpha strategy Pure Alpha, and it would be an integral step in the process for every investment made across the fund. So, toward the end of the 2006 Bridgewater sent letters to clients about the “constrained” nature of those alpha-generating strategies, which didn’t permit the firm to move freely among asset classes. Bridgewater announced that henceforth clients would use Pure Alpha in conjunction with its bond or currency accounts; those unwilling to make the transfer would be resigned within 12 months. Once among the largest traditional global bond and currency managers in the world, Bridgewater today uses Pure Alpha only in conjunction with its actively managed accounts.

When Loeb started Third Point, he had a strong background in high-yield credit, distressed debt, and risk arbitrage, but necessity pushed him to expand his areas of expertise. “We’ve never defined ourselves as one kind of firm,” he says, “and we’ve never really deviated from that kind of flexible approach. Instead, we’ve deepened our research process, and hired people who brought us expertise in different geographies, different industries, and different asset classes. Our philosophy is to be opportunistic all the way across the capital structure from debt to equity, across industries and different geographies. We invest wherever we see some kind of special situation element, an event that will either help create the investment opportunity or help to realize the opportunity.”

Dalio knew that in order to protect downside risk and promote alpha generation, he’d need to convince the World Bank to let him transition from traditional asset management practices, where a portfolio manager would peg his hedges and positions to a benchmark, to an active manager that could take a variety of alpha positions around the benchmark. “I always wanted diversified alpha. So I encouraged the World Bank to give me greater leeway, saying there’s no reason you should be giving me a domestic bond account because you’re getting much less diversification.” Bridgewater pursued a similar strategy in currency markets—managing “hedge portfolios” for clients based on their international equity exposure, but then deviating from that hedge portfolio in all currency markets. For example, a U.S. client could own a portfolio of European equities and hire Bridgewater to hedge his euro/U.S. dollar exposure, and, to add value, Bridgewater would trade all the major currency pairs globally long and short.


Hedgehogging by Barton Biggs

activist fund / activist shareholder / activist investor, Alan Greenspan, asset allocation, backtesting, barriers to entry, Bear Stearns, Big Tech, book value, Bretton Woods, British Empire, business cycle, buy and hold, diversification, diversified portfolio, eat what you kill, Elliott wave, family office, financial engineering, financial independence, fixed income, full employment, global macro, hiring and firing, index fund, Isaac Newton, job satisfaction, junk bonds, low interest rates, margin call, market bubble, Mary Meeker, Mikhail Gorbachev, new economy, oil shale / tar sands, PalmPilot, paradox of thrift, Paul Samuelson, Ponzi scheme, proprietary trading, random walk, Reminiscences of a Stock Operator, risk free rate, Ronald Reagan, secular stagnation, Sharpe ratio, short selling, Silicon Valley, transaction costs, upwardly mobile, value at risk, Vanguard fund, We are all Keynesians now, zero-sum game, éminence grise

A long-only manager sourly said something along the lines of the following: “The golden age for hedge funds is about over, and it will end with a bang, not a whimper.The larger capital and the bigger talent pool now being deployed by hedge funds mean that the pricing of everything from asset classes to individual securities is under intense scrutiny by manic investors, who stare at screens all day, have massive databases, and swing large amounts of money with lightning speed. This has the effect of bidding up the prices and reducing the returns of all mispriced investments. Obvious anomalies now disappear, almost instantly. In effect, the alpha available for capture by hedge funds has to be spread over more funds with bigger money, resulting in lower returns on invested capital for hedge funds as an asset class. Risks will also rise as hedge funds have to take larger, more concentrated positions.

His record over the past 20 years is spectac- ccc_biggs_ch08_95-118.qxd 11/29/05 7:02 AM Page 109 Hedgehogs Come in All Sizes and Shapes 109 ular, although, of course, like everyone else, sometimes he gets it wrong. His fund is now around $5 billion, and he does the macro overlay. He has maybe seven or eight asset class (like biotech, Asia, junk bonds, Europe, emerging markets, etc.) portfolio managers who each run anywhere from $400 million to $100 million, depending on what Jake’s view of their sector is. Jake creates performance by allocating between the asset classes, and, in theory, the other guys add additional alpha by doing even better than their sector index. Sometimes Jake buys or sells an index to hedge them out. If one of his managers fails to perform, he or she gets cut.

David doesn’t believe that the lows of this bear market have been made. He thinks the principal asset classes, ranging from domestic marketable securities (both equity and fixed income) to private equity, are still overvalued, that the public hasn’t learned its lesson, and that the returns from stocks and bonds, particularly in the United States, will be paltry over the next 5 to 10 years.As a result,Yale’s allocation to domestic marketable securities has fallen from more than 75% in 1984 to 22.5% today. By contrast, the average U.S. educational institution has 54.3%. Instead, Yale uses diversifying asset classes like absolute-returnoriented hedge funds, capable of grinding out consistent 8% to 9% returns.Timberland and emerging market equities are the asset classes he is emphasizing now.


pages: 447 words: 104,258

Mathematics of the Financial Markets: Financial Instruments and Derivatives Modelling, Valuation and Risk Issues by Alain Ruttiens

algorithmic trading, asset allocation, asset-backed security, backtesting, banking crisis, Black Swan, Black-Scholes formula, Bob Litterman, book value, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delta neutral, discounted cash flows, discrete time, diversification, financial engineering, fixed income, implied volatility, interest rate derivative, interest rate swap, low interest rates, managed futures, margin call, market microstructure, martingale, p-value, passive investing, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk/return, Satyajit Das, seminal paper, Sharpe ratio, short selling, statistical model, stochastic process, stochastic volatility, time value of money, transaction costs, value at risk, volatility smile, Wiener process, yield curve, zero-coupon bond

Figure 14.5 Z-scores calculation 14.1.4 Performance contribution and attribution This sub-section aims to answer the following question: what are the explanatory factors of a performance? Performance Contribution The return of a portfolio P can be usefully analyzed per invested asset or, more commonly, per sub-sets, for example on a sector basis, or a country basis, or per currency. For an asset or asset class i (portfolio of assets or asset classes 1, …, i, …, n) of weight wi, having achieved a return ri, If we denote by rP the global portfolio return, above contributions are such as Example. A portfolio (all in $) invested in 3-month rolled-over futures contracts, made of 45% of S&P 500, 20% of Nasdaq 100 and 35% of Nikkei 225 (in $), the performance and contributions for 2005 were as shown in Figure 14.6.

As a conclusion to the Markowitz model, to be optimized, an efficient portfolio must be situated on the efficient frontier, which implies it needs to be: diversified, by combining various stocks presenting a low pair-wise correlation; and optimized in weights. Diversification has its limits, however. Understandably, more or less correlated stocks are affected by whole market movements, so that the benefit of such diversification is actually restricted to what is called the specific3 risk (specific to each individual stock), but the global market risk remains as a whole. In other words, by increasing the number n of diversified stocks, the benefit in terms of risk reduction diminishes progressively, up to an asymptotical risk level of pure market risk (see Figure 4.8).

Performance Attribution Performance attribution aims to evidence the portfolio (or fund) manager's skill about the portfolio performance track record. On the contrary to the “performance contribution”, which is only based on portfolio data, the performance attribution needs to refer to a benchmark, to assess the portfolio manager's skill. It analyzes how and to what extent, each of the assets, or more realistically, each asset class, is representing a part of the portfolio global excess return vis-à-vis the benchmark. The Case of Stocks Portfolios As a first step, we have to precise things about the excess return measure. Let us consider the above portfolio, that is destined to outperform a basket of 50% of SP 500, 25% of Nasdaq 100 and 25% of Nikkei 225 (in $), as its benchmark.


pages: 461 words: 128,421

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

"Friedman doctrine" OR "shareholder theory", Abraham Wald, activist fund / activist shareholder / activist investor, Alan Greenspan, Albert Einstein, Andrei Shleifer, AOL-Time Warner, asset allocation, asset-backed security, bank run, beat the dealer, behavioural economics, Benoit Mandelbrot, Big Tech, Black Monday: stock market crash in 1987, Black-Scholes formula, book value, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, card file, Carl Icahn, Cass Sunstein, collateralized debt obligation, compensation consultant, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, democratizing finance, Dennis Tito, discovery of the americas, diversification, diversified portfolio, Dr. Strangelove, Edward Glaeser, Edward Thorp, endowment effect, equity risk premium, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Glass-Steagall Act, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Bogle, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, market bubble, market design, Michael Milken, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, power law, prediction markets, proprietary trading, prudent man rule, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, rolodex, Ronald Reagan, seminal paper, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, Skinner box, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, statistical model, stocks for the long run, tech worker, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, Two Sigma, Tyler Cowen, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

Parts of the piece sounded an awful lot like what would become standard advice a half century hence: The individual investor should be wary of “pitting his unaided judgment against the collective intelligence of the pools of professional traders,” Fisher warned, but there was safety in diversification. “The more unsafe the investments are, taken individually, the safer they are collectively, to say nothing of profitableness, provided that the diversification is sufficiently increased,” he wrote. Fisher admitted that neither he nor anyone else he knew of had “definitely formulated” this principle (that would have to wait until Harry Markowitz in 1952). But then Fisher twisted his reasonably sound advice into a distinctly dodgy apologia for high stock prices: Because so many investors now held well-diversified portfolios, they were willing to venture into risky stocks that previously would have interested only speculators.

Less than two decades after Milton Friedman scandalized liberal readers of the New York Times with his argument that the job of corporations was to make money, union pension funds and liberal state politicians were joining hands to pressure CEOs to…make more money. Years later, as pension funds heeded their consultants’ calls to diversify into new asset classes, many even began investing in the funds of 1980s corporate raiders that had rebranded themselves as “private equity” firms. Unruh died in 1987, but Dale Hanson—hired away from Wisconsin’s state pension fund that year to run Calpers—proved a more than capable successor as a shareholder activist.

Second, Fisher admitted that he hadn’t understood how deeply indebted Americans were—which led to disaster when the market crash and price deflation made it impossible for borrowers to pay back their loans.37 Fisher’s theories of what caused the Depression were given little credence at the time, but they have become widely accepted among economists. His own investing behavior, though, was harder to explain away. Despite his talk of diversification, his own portfolio was tilted toward Remington Rand and a few start-ups. He held on to his Remington Rand stock as it dropped from $58 to $1, averting bankruptcy by borrowing from his still-wealthy sister-in-law, which seriously endangered her financial health as the market continued to tank in 1930 and 1931.


pages: 414 words: 101,285

The Butterfly Defect: How Globalization Creates Systemic Risks, and What to Do About It by Ian Goldin, Mike Mariathasan

air freight, air traffic controllers' union, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, barriers to entry, Basel III, Bear Stearns, behavioural economics, Berlin Wall, biodiversity loss, Bretton Woods, BRICs, business cycle, butterfly effect, carbon tax, clean water, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, connected car, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, digital divide, discovery of penicillin, diversification, diversified portfolio, Douglas Engelbart, Douglas Engelbart, Edward Lorenz: Chaos theory, energy security, eurozone crisis, Eyjafjallajökull, failed state, Fairchild Semiconductor, Fellow of the Royal Society, financial deregulation, financial innovation, financial intermediation, fixed income, Gini coefficient, Glass-Steagall Act, global pandemic, global supply chain, global value chain, global village, high-speed rail, income inequality, information asymmetry, Jean Tirole, John Snow's cholera map, Kenneth Rogoff, light touch regulation, Long Term Capital Management, market bubble, mass immigration, megacity, moral hazard, Occupy movement, offshore financial centre, open economy, precautionary principle, profit maximization, purchasing power parity, race to the bottom, RAND corporation, regulatory arbitrage, reshoring, risk free rate, Robert Solow, scientific management, Silicon Valley, six sigma, social contagion, social distancing, Stuxnet, supply-chain management, systems thinking, tail risk, TED Talk, The Great Moderation, too big to fail, Toyota Production System, trade liberalization, Tragedy of the Commons, transaction costs, uranium enrichment, vertical integration

The concentration of U.S. automobile manufacturing in the Detroit area or of microchip and semiconductor production in flood-prone regions of Thailand or Taiwan may serve these industries well during normal times but ensure that the repercussions of any local hiccup or catastrophe are especially harsh when things go wrong. A systemic approach recommends diversification, but local authorities have strong incentives to attract specialized businesses. The “diversification of strategy” is thus an important imperative for the global governance of supply chains, and one that equally applies for reforming financial regulation. Lesson 2: Negative externalities such as counterparty risk need to be recognized and addressed We have argued that the financial system is characterized by a number of externalities that prevent socially optimal outcomes and inevitably trigger financial crises.

This includes using policy levers to distribute not only airports and energy generation and distribution systems but also the necessary backup capacity. The lessons of the Japanese tsunami, Hurricane Sandy’s devastating impact on the U.S. East coast, and the Icelandic volcano need to be learned. These include, for example, the need for geographic diversification of backup routes, the stress testing of contingency plans well beyond historic experience, and diversification in fuel, communication, and other critical systems so no one source or node becomes uniquely critical for millions of people. Lesson 4: Global cooperation is required to protect the integrity of the Internet and tackle cybercrime The risk of hardware failures due to dependence on critical server systems and cables has been emphasized in this chapter.

Herding behavior in this model is a simultaneous ex ante decision of banks to undertake correlated investments and thus gives rise to correlations among the banks’ portfolios.71 The different forms of systemic risk are not independent of each other, and a bank default does not happen instantaneously. During the buildup to the default, the bank will start deleveraging and selling assets. This may cause fire sales in certain asset classes and exacerbates the problems of the bank. At the same time, rumors about the bank and similar banks will spread in the markets, causing market participants to tighten their liquidity provision. Because the first bank already is struggling, this tightened liquidity can lead to default of this bank.


pages: 483 words: 141,836

Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

Abraham Wald, activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, Bear Stearns, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, book value, business cycle, capital asset pricing model, carbon tax, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, currency risk, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, fail fast, fear index, financial engineering, financial innovation, global macro, illegal immigration, implied volatility, independent contractor, index fund, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, managed futures, margin call, market clearing, market fundamentalism, market microstructure, Money creation, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, power law, pre–internet, proprietary trading, quantitative trading / quantitative finance, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, stock buybacks, stocks for the long run, tail risk, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve

Loosely speaking, that means however many stocks you add to your portfolio, you can’t get its standard deviation much below 40 percent (0.40 is the square root of 0.16) of the average standard deviation of the stocks in it. If you stick to large-capitalization U.S. stocks, the correlation is even higher. That also means that if you pick stocks at random you get 90 percent of the diversification benefit of holding the entire market by buying just 20 stocks. What it doesn’t say, but is true, is that if you pick stocks cleverly to have low or even negative correlation with each other, you can get the diversification benefit of the market with four to eight stocks. These are the kinds of portfolios we would expect investors to hold under IGT CAPM; and until MPT CAPM pushed investors to huge portfolios, typical portfolio sizes were eight to 40 stocks, even among professional managers.

The portfolio is what results from this process. IGT is clearly a better description of the world. No investors used a top-down approach when Markowitz wrote. People have tried it since, inspired by what MPT said they should do, but it has never been popular or conspicuously successful. When it is used, it is generally only at the asset-class level rather than to select individual positions—that is, it is used to decide how much to allocate to each of stocks, bonds, real estate, commodities, and other assets, but not which stocks or which bonds to buy—and it is constrained tightly to force a result similar to preconceived ideas. IGT also seems to be a better description of investor thought processes.

In the real world, with all investors doing the same thing, we saw consolidation of investment management services, with huge funds managed by huge fund management companies. In the IGT world, with every investor different, you would expect to see far more small funds and companies. Belief in MPT CAPM helped make the markets more efficient cross-sectionally; that is, returns on different asset classes over the same time periods aligned pretty well with their respective risk levels. But, at least arguably, MPT CAPM contributed toward prices diverging from fundamental value. Index fund investors don’t ask what something is worth; they want to hold it in proportion to its price. Among other things, it guarantees that they are overinvested in anything overpriced, and underinvested in anything underpriced.


pages: 289 words: 95,046

Chaos Kings: How Wall Street Traders Make Billions in the New Age of Crisis by Scott Patterson

"World Economic Forum" Davos, 2021 United States Capitol attack, 4chan, Alan Greenspan, Albert Einstein, asset allocation, backtesting, Bear Stearns, beat the dealer, behavioural economics, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, bitcoin, Bitcoin "FTX", Black Lives Matter, Black Monday: stock market crash in 1987, Black Swan, Black Swan Protection Protocol, Black-Scholes formula, blockchain, Bob Litterman, Boris Johnson, Brownian motion, butterfly effect, carbon footprint, carbon tax, Carl Icahn, centre right, clean tech, clean water, collapse of Lehman Brothers, Colonization of Mars, commodity super cycle, complexity theory, contact tracing, coronavirus, correlation does not imply causation, COVID-19, Credit Default Swap, cryptocurrency, Daniel Kahneman / Amos Tversky, decarbonisation, disinformation, diversification, Donald Trump, Doomsday Clock, Edward Lloyd's coffeehouse, effective altruism, Elliott wave, Elon Musk, energy transition, Eugene Fama: efficient market hypothesis, Extinction Rebellion, fear index, financial engineering, fixed income, Flash crash, Gail Bradbrook, George Floyd, global pandemic, global supply chain, Gordon Gekko, Greenspan put, Greta Thunberg, hindsight bias, index fund, interest rate derivative, Intergovernmental Panel on Climate Change (IPCC), Jeff Bezos, Jeffrey Epstein, Joan Didion, John von Neumann, junk bonds, Just-in-time delivery, lockdown, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, Mark Spitznagel, Mark Zuckerberg, market fundamentalism, mass immigration, megacity, Mikhail Gorbachev, Mohammed Bouazizi, money market fund, moral hazard, Murray Gell-Mann, Nick Bostrom, off-the-grid, panic early, Pershing Square Capital Management, Peter Singer: altruism, Ponzi scheme, power law, precautionary principle, prediction markets, proprietary trading, public intellectual, QAnon, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Nader, Ralph Nelson Elliott, random walk, Renaissance Technologies, rewilding, Richard Thaler, risk/return, road to serfdom, Ronald Reagan, Ronald Reagan: Tear down this wall, Rory Sutherland, Rupert Read, Sam Bankman-Fried, Silicon Valley, six sigma, smart contracts, social distancing, sovereign wealth fund, statistical arbitrage, statistical model, stem cell, Stephen Hawking, Steve Jobs, Steven Pinker, Stewart Brand, systematic trading, tail risk, technoutopianism, The Chicago School, The Great Moderation, the scientific method, too big to fail, transaction costs, University of East Anglia, value at risk, Vanguard fund, We are as Gods, Whole Earth Catalog

If that’s so, Schatzker asked, why do so many investors devote so much time and energy to making predictions? The problem isn’t so much the predictions, Spitznagel said, it’s the way many investors attempt to protect themselves from the unpredictable—through diversification. “This is the Kool-Aid that we’re drinking from modern finance, diversification, lowering the volatility of our portfolio is going to somehow protect us from things like this. But in fact, it doesn’t. What it’s doing is just making us poor at the end of the day—it doesn’t provide enough protection when we need it.” Later that day, Spitznagel and Yarckin dropped by a class Taleb was hosting for his annual Real World Risk Institute, or RWRI (commonly pronounced rew-ree by acolytes), a group of some one thousand people from all walks of life—medicine, the military, policy-making, venture capital, banking, complexity theory, psychology, etc.

An investor with that allocation would have lost about 8 percent overall in 2008—far better than the 39 percent gutting of the S&P. Copycats plunged into what the Wall Street press had taken to calling “black swan funds.” A strategy that hadn’t existed before Taleb and Spitznagel launched Empirica in 1999 was suddenly one of the financial world’s hottest products. It was flattering. The two iconoclasts had created a new asset class. How many traders could say that? It was also vexing. Now Spitznagel had to compete with fund managers he was certain were less than competent at trading but perhaps more adept at one of Wall Street’s more primary skills: salesmanship. Of course, Universa wasn’t the only hedge fund to make billions during the Global Financial Crisis.

The young German insurance executive was the CEO and founder of Ryskex, a new kind of insurance company that focused solely on systemic disasters. The hurricane that takes out a company’s supply chain. The deadly crash that grounds an airline’s fleet. The cyberattack that destroys a company’s reputation. The virus that decimates a workforce. Using artificial intelligence and blockchain, Schmalbach had created an entirely new, tradeable asset class: systemic risk. With Ryskex, hedge funds and banks could buy and sell systemic risk like a bushel of corn. Fortune 500 companies could use it to protect themselves against calamitous shocks. In the late 2010s, it remained a fledgling effort. At the start, much like Mark Spitznagel in the early days of Universa, Schmalbach had few takers for his highly unique and strange offering.


pages: 807 words: 154,435

Radical Uncertainty: Decision-Making for an Unknowable Future by Mervyn King, John Kay

Airbus A320, Alan Greenspan, Albert Einstein, Albert Michelson, algorithmic trading, anti-fragile, Antoine Gombaud: Chevalier de Méré, Arthur Eddington, autonomous vehicles, availability heuristic, banking crisis, Barry Marshall: ulcers, battle of ideas, Bear Stearns, behavioural economics, Benoit Mandelbrot, bitcoin, Black Swan, Boeing 737 MAX, Bonfire of the Vanities, Brexit referendum, Brownian motion, business cycle, business process, capital asset pricing model, central bank independence, collapse of Lehman Brothers, correlation does not imply causation, credit crunch, cryptocurrency, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, DeepMind, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, Donald Trump, Dutch auction, easy for humans, difficult for computers, eat what you kill, Eddington experiment, Edmond Halley, Edward Lloyd's coffeehouse, Edward Thorp, Elon Musk, Ethereum, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, fear of failure, feminist movement, financial deregulation, George Akerlof, germ theory of disease, Goodhart's law, Hans Rosling, Helicobacter pylori, high-speed rail, Ignaz Semmelweis: hand washing, income per capita, incomplete markets, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Jeff Bezos, Jim Simons, Johannes Kepler, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Snow's cholera map, John von Neumann, Kenneth Arrow, Kōnosuke Matsushita, Linda problem, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, market bubble, market fundamentalism, military-industrial complex, Money creation, Moneyball by Michael Lewis explains big data, Monty Hall problem, Nash equilibrium, Nate Silver, new economy, Nick Leeson, Northern Rock, nudge theory, oil shock, PalmPilot, Paul Samuelson, peak oil, Peter Thiel, Philip Mirowski, Phillips curve, Pierre-Simon Laplace, popular electronics, power law, price mechanism, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, railway mania, RAND corporation, reality distortion field, rent-seeking, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Solow, Ronald Coase, sealed-bid auction, shareholder value, Silicon Valley, Simon Kuznets, Socratic dialogue, South Sea Bubble, spectrum auction, Steve Ballmer, Steve Jobs, Steve Wozniak, Suez crisis 1956, Tacoma Narrows Bridge, Thales and the olive presses, Thales of Miletus, The Chicago School, the map is not the territory, The Market for Lemons, The Nature of the Firm, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Davenport, Thomas Malthus, Toyota Production System, transaction costs, ultimatum game, urban planning, value at risk, world market for maybe five computers, World Values Survey, Yom Kippur War, zero-sum game

An off-model event – the elopement of Shylock’s daughter Jessica – leads the vengeful moneylender to seek enforcement of the bond despite the intervention of a lender of last resort with ample liquidity. Third, a further off-model event, the intervention of Portia, resolves the issue in Antonio’s favour. But heedless of radical uncertainty, and over-influenced by his own probabilistic model, Antonio puts his life in danger. The narrative captures the essence of the model of diversification. And diversification is central to risk management in the face of radical uncertainty. The meaning of risk and risk aversion One of the authors attended a meeting between some business people representing major defence contractors, and a group of Treasury economists who had recently studied economics and finance before graduating from leading universities.

And all ignore – are even contemptuous of – the corpus of finance theory based on portfolio theory, the capital asset pricing model and the efficient market hypothesis. Indeed that corpus of knowledge implies that they could not have succeeded as they have. These financial models emphasise points of which all investors should be aware – the benefits of diversification, the extent to which different assets offer genuine opportunities for diversification, and the degree to which information is incorporated in securities prices. But the lesson of experience is that there is no single approach to financial markets which makes money or explains ‘what is going on here’, no single narrative of ‘the financial world as it really is’.

If your concept of risk is very different from that of the market as a whole, you can minimise your risk at other people’s expense. Broad diversification becomes ‘a free lunch’ reducing risk without cost. Once you recognise that day-to-day price movements are not an indication of risk but a measure of meaningless noise in markets, you can achieve your longer-term objectives at lower cost by learning to ignore such fluctuations. There can be reward – not without risk, but with little risk – through building a diversified portfolio, turning off your computer, and thinking hard, though not necessarily frequently, about ‘what is going on here’. Broad diversification, involving building a portfolio which will be robust and resilient to unpredictable events, is the best protection against radical uncertainty, because most radically uncertain events will have a significant long-run effect on only some of the assets which you own.


pages: 194 words: 59,336

The Simple Path to Wealth: Your Road Map to Financial Independence and a Rich, Free Life by J L Collins

asset allocation, Bernie Madoff, Black Monday: stock market crash in 1987, buy and hold, compound rate of return, currency risk, diversification, financial independence, full employment, German hyperinflation, index fund, inverted yield curve, John Bogle, lifestyle creep, low interest rates, money market fund, Mr. Money Mustache, nuclear winter, passive income, payday loans, risk tolerance, side hustle, The 4% rule, Vanguard fund, yield curve

Here’s the thing: if you want to survive and prosper as an investor you have two choices. You can follow the typical advice we examined in Chapter 1 and seek out broad diversification with extensive asset allocations. Your hope is this will smooth the ride, even as it reduces your long-term returns. Screw that! You’re young, aggressive and here to build wealth. You’re out to build your pot of F-You Money ASAP. You’re going to focus on the best performing asset class in history: Stocks. You’re going to “get your mind right,” toughen up and learn to ride out the storms. You’ve heard the expression, “Don’t keep all your eggs in one basket.”

The Escape Artist www.theescapeartist.me “Jim enjoys a financially independent lifestyle while sharing money and life lessons through his blog. His Stock Series introduced passive index investing to a wide audience. Now you can get the same wisdom, distilled in book form. Jim tells you how to avoid common investing fears, misperceptions and mistakes. He teaches about diversification, asset classes, asset allocation and the best way to use retirement plans. This is a simple, proven path to investment success from a guy who actually did it. If you’re new to investing, don’t miss this crash course in the essentials!” Darrow Kirkpatrick Retired at 50 www.caniretireyet.com “I came of age in the midst of the Great Recession.

Over your investing career you’ll experience many of them. But if you are mentally tough enough you can simply ignore them. So now if we agree that we can “get our minds right,” what shall we choose for riding out the storm? Clearly we want the best performing asset class we can find. Just as clearly that’s stocks. If you look at all asset classes from bonds to real estate to gold to farmland to art to racehorses to whatever, stocks provide the best performance over time. Nothing else even comes close. Let’s take a moment to review why this is true. Stocks are not just little slips of traded paper.


pages: 426 words: 115,150

Your Money or Your Life: 9 Steps to Transforming Your Relationship With Money and Achieving Financial Independence: Revised and Updated for the 21st Century by Vicki Robin, Joe Dominguez, Monique Tilford

asset allocation, book value, Buckminster Fuller, buy low sell high, classic study, credit crunch, disintermediation, diversification, diversified portfolio, fiat currency, financial independence, fixed income, fudge factor, full employment, Gordon Gekko, high net worth, index card, index fund, intentional community, job satisfaction, junk bonds, Menlo Park, money market fund, Parkinson's law, passive income, passive investing, profit motive, Ralph Waldo Emerson, retail therapy, Richard Bolles, risk tolerance, Ronald Reagan, Silicon Valley, software patent, strikebreaker, The Theory of the Leisure Class by Thorstein Veblen, Thorstein Veblen, Vanguard fund, zero-coupon bond

A very low-cost index is going to beat a majority of the professionally managed money.” Best-selling author Larry Swedroe from his book, What Wall Street Doesn’t Want You to Know: “Regardless of the asset class [see below], use only index or passive asset class funds. Active management is a loser’s game. Diversify across many asset classes. This will reduce portfolio risk and probably increase returns as well.” Designing Your Own ʺENOUGH . . . AND THEN SOMEʺ FI3 Portfolio Your “portfolio” is a fancy way of saying the sum of your investments across “asset classes”—which simply means types of investment vehicles such as cash, bonds, stocks, real estate, foreign currency and commodities.

Asset allocation is the art and science of distributing your nest egg across various classes to balance risk and reward. Instead of putting all your eggs in one basket, you are wisely limiting your market risk by spreading your money across various asset classes. This is a smart, sensible and time-tested strategy. By using index funds, you can allocate your capital across various asset classes. This enables you to reduce volatility without giving up investment performance. Beyond Index Funds: The Simplest Kind of Mutual Fund— Lifestyle Funds The FI investment program was designed to be easy to implement as well as simple to manage.

That is why index funds, with their low fees and ability for diversification, can work well for the FI investment program. At its core, index fund investing means you are using an approach and strategy that seeks to track the investment returns of a specified stock or bond market benchmark or index. One of the most popular index funds today is the S&P 500 Index Fund, which attempts to replicate the investment results of this specific target index. There is no attempt to use traditional “active” money management or to make “bets” on individual stocks. Indexing is a passive investment approach emphasizing broad diversification and low portfolio trading activity.


pages: 276 words: 59,165

Impact: Reshaping Capitalism to Drive Real Change by Ronald Cohen

"World Economic Forum" Davos, asset allocation, benefit corporation, biodiversity loss, carbon footprint, carbon tax, circular economy, commoditize, corporate governance, corporate social responsibility, crowdsourcing, decarbonisation, diversification, driverless car, Elon Musk, family office, financial independence, financial innovation, full employment, high net worth, housing crisis, impact investing, income inequality, invisible hand, Kickstarter, lockdown, Mark Zuckerberg, microbiome, minimum viable product, moral hazard, performance metric, risk-adjusted returns, risk/return, Silicon Valley, sovereign wealth fund, Steve Ballmer, Steve Jobs, tech worker, TED Talk, The Wealth of Nations by Adam Smith, transaction costs, zero-sum game

It sounds like an indefinable concept, and it used to be considered unmeasurable, but the academic community eventually found ways to standardize its measurement across all forms of investment; by the end of the twentieth century, everyone was talking about and measuring it in the same way. The measurement of risk has had profound implications for the investment community. It introduced new theories like portfolio diversification, which gave rise to new asset classes that came with a higher level of risk, but also disproportionately improved returns. These new asset classes included venture capital, which funded the Tech Revolution, private equity and hedge funds. It also allowed new investment themes to take hold, like investment in emerging markets, which funded globalization. If we fast-forward to the present day, we see that the same revolution that risk brought is now being brought by impact.

From Measuring Risk to Measuring Impact The measurement of risk, which began in the second half of the twentieth century,9 had a profound effect on investment portfolios across the world. The new notion of risk-adjusted returns led investors to include higher-risk investment categories in their investment portfolios, when the expected return was sufficiently high. This thinking brought the idea of portfolio diversification, which in turn opened the door to new higher risk and return asset classes, including venture capital, private equity and investment in emerging countries. As a consequence of risk measurement, risk thinking brought higher levels of return than previously, when investment was limited to the stocks and bonds of one’s own country, as had been the general practice until the 1970s.

Now, more than a decade later, I believe that impact thinking will bring about as great a change as that brought by the Tech Revolution. Impact thinking is changing our investment behavior, just as innovative thinking about measuring risk did 50 years ago. Risk thinking resulted in portfolios whose risk is diversified across many different asset classes, allowing them to capture the high returns of higher-risk investments like venture capital and investment in emerging markets. Impact thinking will now transform our economies and reshape our world. For me, the breakthrough in impact thinking came in September 2010, when for the first time we linked the measurement of social impact to financial return.


Financial Statement Analysis: A Practitioner's Guide by Martin S. Fridson, Fernando Alvarez

Bear Stearns, book value, business cycle, corporate governance, credit crunch, discounted cash flows, diversification, Donald Trump, double entry bookkeeping, Elon Musk, financial engineering, fixed income, information trail, intangible asset, interest rate derivative, interest rate swap, junk bonds, negative equity, new economy, offshore financial centre, postindustrial economy, profit maximization, profit motive, Richard Thaler, shareholder value, speech recognition, statistical model, stock buybacks, the long tail, time value of money, transaction costs, Y2K, zero-coupon bond

Hunger for growth, along with the quest for cyclical balance, is a prime motivation for the corporate strategy of diversification. Diversification reached its zenith of popularity during the conglomerate movement of the 1960s. Up until that time, relatively little evidence had accumulated regarding the actual feasibility of achieving high earnings growth through acquisitions of companies in a wide variety of growth industries. Many corporations subsequently found that their diversification strategies worked better on paper than in practice. One problem was that they had to pay extremely high price-earnings multiples for growth companies that other conglomerates also coveted.

Tice Associates Death duties Debt: management's attitude toward return on equity and total, constitution of total-debt-to-cash-flow ratio Debt restriction disclosures Declining growth, rationalizations: diversification, mature markets and growth back on track, new products and year-over-year comparisons distorted Defaulting on debt Default risk models Deferred profit plan: accounting discrepancies background on from bad to worse lessons learned Deferred taxes, capital and Denari, Stephen Depreciation schedules Derivatives Dex One Corporation Dilution Disclosure/audits: artful deal death duties generally systematic problems, auditing and Discount rate Discretionary uses of cash Diversification Dividend discount model: dividends and future appreciation earning or cash flow future dividends/present stock price growing company, valuing Dividends Dooner, John J.

Inconsistent valuations can also undermine the integrity of an enterprise's balance sheet without involvement of outside parties such as private equity firms. An inquest into the September 2008 bankruptcy of Lehman Brothers found that each trading desk within the investment bank had its own methodology for pricing assets. Methodologies differed even within a single asset class, and the Product Control Group, which was supposed to enforce standardization in valuation, was understaffed for the task. Incidentally, some of the methodologies employed at Lehman Brothers were dubious, to say the least. For example, the investment bank based its second-quarter 2008 prices for one group of assets on a Morgan Stanley research note published in the first quarter of that year.4 INSTANTANEOUS WIPEOUT OF VALUE Because the value of many assets is so subjective, balance sheets are prone to sudden, arbitrary revisions.


pages: 511 words: 151,359

The Asian Financial Crisis 1995–98: Birth of the Age of Debt by Russell Napier

Alan Greenspan, Asian financial crisis, asset allocation, bank run, banking crisis, banks create money, Berlin Wall, book value, Bretton Woods, business cycle, Buy land – they’re not making it any more, capital controls, central bank independence, colonial rule, corporate governance, COVID-19, creative destruction, credit crunch, crony capitalism, currency manipulation / currency intervention, currency peg, currency risk, debt deflation, Deng Xiaoping, desegregation, discounted cash flows, diversification, Donald Trump, equity risk premium, financial engineering, financial innovation, floating exchange rates, Fractional reserve banking, full employment, Glass-Steagall Act, hindsight bias, Hyman Minsky, If something cannot go on forever, it will stop - Herbert Stein's Law, if you build it, they will come, impact investing, inflation targeting, interest rate swap, invisible hand, Japanese asset price bubble, Jeff Bezos, junk bonds, Kickstarter, laissez-faire capitalism, lateral thinking, Long Term Capital Management, low interest rates, market bubble, mass immigration, means of production, megaproject, Mexican peso crisis / tequila crisis, Michael Milken, Money creation, moral hazard, Myron Scholes, negative equity, offshore financial centre, open borders, open economy, Pearl River Delta, price mechanism, profit motive, quantitative easing, Ralph Waldo Emerson, regulatory arbitrage, rent-seeking, reserve currency, risk free rate, risk-adjusted returns, Ronald Reagan, Savings and loan crisis, savings glut, Scramble for Africa, short selling, social distancing, South China Sea, The Wealth of Nations by Adam Smith, too big to fail, yield curve

This forced almost all these investors to pay huge attention to the composition of this index when they allocated their capital to what was called Asia, but was actually a small section of what any layperson would call Asia. When I wrote about this in May 1996, I called it “the tyranny of benchmarks” and that is a phrase that seems to have stuck as a description of how it impacts investment decisions. What made it into this index and what weightings determined what investors called the Asian equity ‘asset class’? This asset class comprised equities of some of the world’s poorest countries, but also some of the world’s richest. It spread from Pakistan in the west to South Korea in the east, and from China in the north to Indonesia in the south. These countries, their peoples and their economies had very little in common, but they were not in Europe or the Middle East, or Africa or the Americas, so they were lumped together in an index of equities for Asia.

Had economic problems developed in ‘Asia’ 434 years ago, would we have been so certain that that entire region would be simultaneously contaminated? The Solid Ground Daily has been boring readers for years with the concept that ‘Asian’ equities are not an asset class. ‘Asia’ is an agglomeration of economies at different stages of development operating different types of economic systems at different stages of their economic development. In recent years the export-orientated economies of Southeast Asia have added to the illusion of an Asian asset class by their blind pursuance of US dollar currency policies. These days, too, have passed. The operation of these currency policies in Southeast Asia has led them into the current trap where they cannot reduce interest rates without creating a fall in the value of their currencies.

These insiders, whom I was sure knew more about what was going on in Asia than I did, were well informed, but they were also intoxicated with success and the mutual affirmations of others. They too were part of the crowd. It is a lesson that has remained with me that it is always essential to get the opinions of an outsider on any investment proposition. Those whose job it is to follow a particular asset class can very easily form a crowd and crowds are full of feedback loops that create, for those in the crowd, a view of the future for asset prices that an outsider often finds divorced from fact or analysis. It is the easiest thing in the world to assume that it is the insiders who know more about the facts in any given situation.


pages: 348 words: 82,499

DIY Investor: How to Take Control of Your Investments & Plan for a Financially Secure Future by Andy Bell

asset allocation, bank run, Bear Stearns, Black Monday: stock market crash in 1987, buy and hold, collapse of Lehman Brothers, credit crunch, currency risk, diversification, diversified portfolio, estate planning, eurozone crisis, fixed income, high net worth, hiring and firing, Isaac Newton, junk bonds, Kickstarter, lateral thinking, low interest rates, money market fund, Northern Rock, passive investing, place-making, quantitative easing, selection bias, short selling, South Sea Bubble, technology bubble, transaction costs, Vanguard fund

The key point about pound-cost averaging is that you invest small amounts on a regular basis. So, when prices are high your monthly investment will buy fewer shares or units, but when prices are low your investment buys more shares or units. Diversification. Different types of asset tend to rise and fall in value at different times in the market cycle. So, by diversifying your portfolio across different geographies, asset classes and even across different sectors within an asset class, you can dampen much of the market’s volatility out of your portfolio. Use fund managers. While you still need to choose a fund manager, this is a lot easier and less risky than choosing individual investments.

The more complex ones are generally designed for high net-worth individuals with a lot of money. As long as you get a decent level of diversification, across three or four sectors, your portfolio will be in the right ballpark. These portfolios, constructed from equities, ETFs, OEICs, investment trusts, bonds and gilts, are suitable for your core investment holdings. Once you have your bedrock investments in place in a balanced portfolio, you may start to feel adventurous and experiment with less mainstream asset classes. Medium-term investing If you are investing over the medium term, say 5 to 10 years, you should be considering a high proportion of equities, but you should not be investing as aggressively as long-term investors.

Correlation When looking at different asset classes and sectors, it is helpful to understand how they may be correlated. Some are positively correlated – that is, they tend to move in the same direction. Others are negatively correlated, where a fall in the value of one asset class is normally accompanied by a rise in the other. Correlation is measured on a continuous scale between −1, a perfect negative correlation, 0 where there is no correlation and 1 where there is perfect positive correlation. Figure 18.2 shows the correlation between some of the major asset classes. figure 18.2 Correlation between major asset classes between July 2004 and June 2007 Source: Shares Magazine You will see that UK equities and global equities have the highest positive correlation, whereas UK equities and UK gilts have the largest negative correlation.


pages: 289 words: 113,211

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

affirmative action, Albert Einstein, asset allocation, backtesting, beat the dealer, behavioural economics, Black Swan, Black-Scholes formula, Bonfire of the Vanities, book value, butterfly effect, commoditize, commodity trading advisor, computer age, computerized trading, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, Edward Thorp, family office, financial engineering, financial innovation, fixed income, frictionless, frictionless market, Future Shock, George Akerlof, global macro, implied volatility, index arbitrage, intangible asset, Jeff Bezos, Jim Simons, John Meriwether, junk bonds, London Interbank Offered Rate, Long Term Capital Management, loose coupling, managed futures, margin call, market bubble, market design, Mary Meeker, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shock, Paul Samuelson, Pierre-Simon Laplace, proprietary trading, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Solow, rolodex, Saturday Night Live, selection bias, shareholder value, short selling, Silicon Valley, statistical arbitrage, tail risk, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, UUNET, William Langewiesche, yield curve, zero-coupon bond, zero-sum game

The problem with this sort of classification, based as it is strictly on the trading style or strategy type, is that it has to be revised over time as new strategies emerge and existing ones fail. An alternative classification matrix, which I developed in 2001, attempts to overcome this problem, but in so doing reveals the existential issue for hedge funds.1 This approach classifies hedge funds by five characteristics: 1. Asset class. The broadest category, it defines the market in which the fund operates. These include fixed income, equities, currencies, and commodities. There can also be a “multiclass” to capture “none or some of the above,” and this specifically includes global macro funds. 245 ccc_demon_243-254_ch11.qxd 2/13/07 A DEMON 1:47 PM OF Page 246 OUR OWN DESIGN 2.

If this is an effective categorization framework for hedge funds/alternative investments, what is the categorization framework for the alternative to this al- 246 ccc_demon_243-254_ch11.qxd 2/13/07 1:47 PM Page 247 HEDGE FUND EXISTENTIAL ternative? The answer is, there is none. This categorization for hedge funds actually is a categorization for all investment strategies. After all, what investment strategy is not typified by some direction (especially since “neutral” is one choice), operating on some general asset class, and focused on some geographic region? The same question arises when we consider hedge funds as a subject of study and research. I know of at least two institutes that are focused on the study of alternative investments. One is at the London School of Business, the other at the University of Massachusetts, Amherst.

A 1-percent-and-20-percent fee structure leads to the same ballpark return for the hedge fund manager as a 100-basis-point fee will for the manager of a larger but unlevered long-only fund. WILL HEDGE FUNDS TAKE OVER THE INVESTMENT WORLD? Hedge funds are the unconstrained version of traditional investment funds in that they do not have restrictions on shorting, levering, or expanding to innovative asset classes. They can do everything a traditional manager can do and then some. Because of this, hedge funds should dom- 252 ccc_demon_243-254_ch11.qxd 2/13/07 1:47 PM Page 253 HEDGE FUND EXISTENTIAL inate the traditional funds in generating returns. Looking at it another way, any traditional investment manager who finds himself passing up an opportunity to improve returns because he cannot get short exposure, cannot lever his exposure to a trade idea, or cannot take on a promising position because it lies outside of his allowable universe will be left behind by an equally talented counterpart who is following an identical investment method in a hedge fund.


pages: 229 words: 75,606

Two and Twenty: How the Masters of Private Equity Always Win by Sachin Khajuria

"World Economic Forum" Davos, affirmative action, bank run, barriers to entry, Big Tech, blockchain, business cycle, buy and hold, carried interest, COVID-19, credit crunch, data science, decarbonisation, disintermediation, diversification, East Village, financial engineering, gig economy, glass ceiling, high net worth, hiring and firing, impact investing, index fund, junk bonds, Kickstarter, low interest rates, mass affluent, moral hazard, passive investing, race to the bottom, random walk, risk/return, rolodex, Rubik’s Cube, Silicon Valley, sovereign wealth fund, two and twenty, Vanguard fund, zero-sum game

And there were deal fees for making the investments, fees for financing or refinancing assets, monitoring fees for participating in board meetings and working on the business plans of investee companies, and deal fees for exiting the investments. Often, the infrastructure investments were sold to a similar set of local pension fund investors who had backed the investment vehicle itself at the start. The establishment of infrastructure as an asset class for private capital has had another benefit for private equity—the development of a new analytical lens for investment professionals to use when looking at a potential target, even if the opportunity is outside the infrastructure sector. When looking at private equity deals or at distressed debt, the infrastructure know-how acquired by firms empowers deal teams to ask about the hard assets that are in—or could be added to—the target perimeter, to think differently about the barriers to market entry and customer switching, to consider the reliance of clients, and to scrutinize the security and stability of revenues and cash flow, including the structure of client contracts and renewal options.

Trust us: Hand it over. This premise is in striking contrast to the modus operandi of other asset managers. The masters of private equity do not pick stocks or bonds in liquid markets and hope to ride a rising wave of positive sentiment. They do not spread their investors’ money thinly around to achieve diversification across the financial markets. They aren’t long some stocks and short others. They are not seeking to replicate the S&P 500 index. There are no chartists or research gurus. Investing passively in an ETF, like those managed by BlackRock or Vanguard, might mean paying a yearly management fee equivalent to ten basis points (0.1 percent)—if that—and you keep all of the investment performance for yourself; it is not typically shared with the asset manager.

This gift of almost a trillion dollars of freshly printed cash from the Fed alone will lift stock and debt markets to the point that investors will forget the jagged falls and crashes that have been torturing them in recent months. To be blunt, things will not stay cheap for long. It is an excellent time to buy a good business. General Insurance’s operational diversification is also a clear plus. There are ninety different lines in the book, from standard home insurance in one part of the world to hurricane reinsurance somewhere else, and these lines are largely non-correlated. In other words, they are distinct and separate risks. A failure in one business is not likely to trigger failure elsewhere.


pages: 819 words: 181,185

Derivatives Markets by David Goldenberg

Black-Scholes formula, Brownian motion, capital asset pricing model, commodity trading advisor, compound rate of return, conceptual framework, correlation coefficient, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, en.wikipedia.org, financial engineering, financial innovation, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, law of one price, locking in a profit, London Interbank Offered Rate, Louis Bachelier, margin call, market microstructure, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, price mechanism, random walk, reserve currency, risk free rate, risk/return, riskless arbitrage, Sharpe ratio, short selling, stochastic process, stochastic volatility, time value of money, transaction costs, volatility smile, Wiener process, yield curve, zero-coupon bond, zero-sum game

This has the positive effect of diversifying away some of the avoidable risk of individual stocks. However, we also know from portfolio analysis that there are limits to diversification. You can’t diversify away the non-diversifiable (market) risks of your portfolio. We also know that the maximum effect of diversification occurs when we add perfectly negatively correlated assets to our portfolio. So, the alternative ways to hedge your position are: 1. (Naive) Diversification: add securities to form a portfolio with BAC. This gets you the diversification effect. 2. Synthetically create negative correlation: find another type of security that is highly positively correlated with BAC stock and short it!

Of course, it may be very hard to find such a security in the real world, because by diversifying the mutual fund you may have already exhausted your diversification possibilities. This was the situation facing mutual fund managers prior to 1982. Then stock index futures contracts were introduced. This allowed investors to further ‘diversify away’ the systematic risk of their portfolios by hedging in stock index futures. In other words, hedging is just another kind of portfolio diversification–based on synthesizing the correlation that drives the diversification effect in the extreme case. If the resulting zero risk portfolio does not have a return equal to the actual (non-synthetic) risk-free rate, then there is an arbitrage opportunity using the synthetic risk-free asset and the actual risk-free asset (US Treasury bill)

Now, looking forward to financial futures in Chapter 7, we will shift the focus away from agricultural commodities like wheat to financial ‘commodities’ like stock indexes and stock index futures contracts as their hedging vehicles. FIGURE 6.1 Long vs. Short Positions 6.1 HEDGING AS PORTFOLIO THEORY You are a mutual fund manager, which means that you manage a diversified portfolio. However, even after diversifying, market volatility remains. You don’t want to jump around between asset classes attempting to execute a risky and questionably profitable market timing strategy. We will call this the Wall Street Journal strategy. Instead, you want to maintain your position in the portfolio, but you also want to protect it against adverse price movements. The basic alternatives available to you are described in Figure 6.2.


pages: 228 words: 68,315

The Complete Guide to Property Investment: How to Survive & Thrive in the New World of Buy-To-Let by Rob Dix

buy and hold, diversification, diversified portfolio, driverless car, Firefox, low interest rates, Mr. Money Mustache, risk tolerance, TaskRabbit, transaction costs, young professional

The only real cause for concern with this strategy is that you might end up without appropriate diversification after selling whatever is necessary to shift the mortgage balances. Being left with just one or two properties that cover your expenses is nice and simple from a management point of view, but also risky: non-paying tenants in one of your properties would cut your “pension” in half until the situation is resolved. Liquidate It could be that in your old age, you want nothing to do with property at all. In that case, there’s nothing to stop you from selling the lot and investing the proceeds in another asset class. No, it’s not particularly tax-efficient because of capital gains tax, but there’s more to life than paying as little tax as possible.

No, it’s not particularly tax-efficient because of capital gains tax, but there’s more to life than paying as little tax as possible. In terms of diversification, this isn’t a terrible idea. If you could make roughly the same net return from a couple of unencumbered properties or a globally diversified portfolio of stocks and bonds, the latter might give you better peace of mind. Restructure The options above are all totally valid strategies, but the best option of all is likely to be a mix-and-match of all of them, depending on your risk tolerance and income requirements. For example, you could: Sell a couple of properties to raise cash to put into stocks and bonds for diversification. Sell another to reduce your loan-to-value.

Gross and net yield have their uses, but neither of them captures the entire investment equation. What we really need is a calculation that takes everything into account – and which we can use not just to compare different properties, but also to compare our return from a property investment to the returns we could get if we invested in a different asset class entirely. That calculation is Return on investment (ROI) – calculated as the annual rental profit divided by the money you put in. If you buy wholly in cash, the money you put in is the same as the cost of acquiring the asset, so your ROI and net yield will be identical. But if you use a mortgage, your ROI will be higher than your net yield.


pages: 543 words: 147,357

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

Abraham Maslow, Alan Greenspan, Andrei Shleifer, asset-backed security, bank run, banking crisis, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, bread and circuses, Bretton Woods, business cycle, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, Cornelius Vanderbilt, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, disinformation, diversification, double helix, Edward Glaeser, financial deregulation, financial engineering, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, general purpose technology, George Akerlof, Gini coefficient, Glass-Steagall Act, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, Japanese asset price bubble, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, language acquisition, Large Hadron Collider, liberal capitalism, light touch regulation, Long Term Capital Management, long term incentive plan, Louis Pasteur, low cost airline, low interest rates, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, meritocracy, Mikhail Gorbachev, millennium bug, Money creation, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, plutocrats, power law, price discrimination, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, Right to Buy, rising living standards, Robert Shiller, Ronald Reagan, Rory Sutherland, Satyajit Das, Savings and loan crisis, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, systems thinking, tail risk, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, three-masted sailing ship, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, work culture , working poor, world market for maybe five computers, zero-sum game, éminence grise

There is no easy solution. However, Britain has certainly been far too biased in favour of total shareholder freedom. Our finanical sector has always stressed the importance of liquidity – of being able to realise assets quickly for cash. But over the 1990s and 2000s company shares became just another asset class that leveraged banks, hedge funds and investment houses held on a short-term basis for yield or capital gain before selling as soon as the anticipated profits had been made. The number of investors committed to long-term share ownership consistently fell as the number of short-term funds consistently rose.

Over the seven years to March 2008, global foreign currency reserves jumped by $4,900 billion, with China’s reserves alone up by $1,500 billion.19 Each of these elements contributed to the fiasco; and now all of them need to be unravelled if Britain and the world economy are to generate a sustained recovery. Banking is vital but dangerous The fundamental attribute of finance is its capacity to make money from money. Financiers have three avenues to riches that are not available to non-financial entrepreneurs: the laying off of risk through diversification; the extra capital gains to be won through leverage; and the capacity to borrow short and lend long. Economies need bankers to spread their risk, offer credit and confront the existential challenge of offering depositors their money back on demand while simultaneously lending it over the longer term.

Central banking and regulation are societies’ two defences against this, but in the 2000s they were hoodwinked. One of the first principles of banking and insurance is that one default or pay-out can be safely absorbed as long as it occurs among many successful loans or insurance contracts. For diversification to work, though, the risks must be both genuinely spread and, as far as possible, independent of each other. Thus, for example, a prudent banker lends to both a manufacturer of umbrellas and a manufacturer of suntan oil: whatever the weather, at least one of the companies will prosper and pay back the loan with interest.


pages: 505 words: 142,118

A Man for All Markets by Edward O. Thorp

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", 3Com Palm IPO, Alan Greenspan, Albert Einstein, asset allocation, Bear Stearns, beat the dealer, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, Black-Scholes formula, book value, Brownian motion, buy and hold, buy low sell high, caloric restriction, caloric restriction, carried interest, Chuck Templeton: OpenTable:, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, Garrett Hardin, George Santayana, German hyperinflation, Glass-Steagall Act, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Bogle, John Meriwether, John Nash: game theory, junk bonds, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, low interest rates, margin call, Mason jar, merger arbitrage, Michael Milken, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, PalmPilot, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, power law, price anchoring, publish or perish, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, risk-adjusted returns, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, Stanford marshmallow experiment, statistical arbitrage, stem cell, stock buybacks, stocks for the long run, survivorship bias, tail risk, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Tragedy of the Commons, uptick rule, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

It was only in January 1945—after more than fifteen years and most of World War II—that, on a month-end basis, large-company stocks finished above their August 1929 all-time high. Again, an investment in corporate bonds more than doubled on average over this period and long-term US government bonds almost did so, showing that diversification into asset classes other than equities, though possibly sacrificing long-term return, can preserve wealth in bad times. To prevent a repeat of 1929, the Securities Exchange Act of 1934 empowered the board of governors of the Federal Reserve System to prescribe the part of the purchase price the investor has to put up to purchase a listed security.

Whether or not you try to beat the market, you can do better by properly managing your wealth, which I talk about next. Chapter 27 * * * ASSET ALLOCATION AND WEALTH MANAGEMENT Private wealth in the industrially advanced countries is spread among major asset classes such as equities (common stocks), bonds, real estate, collectibles, commodities, and miscellaneous personal property. If investors choose index funds for each asset class in which they wish to invest, their combined portfolio risk and return will depend on how they allocate among asset classes. This also is true for investors who don’t index. Table 8 gives a rough overview of the asset categories. Investment assets held by mutual funds, hedge funds, foundations, and employee benefit funds are not included, since their underlying assets have already been counted.

Derivative securities, which include warrants, options, convertible bonds, and many later complex inventions, derive their value—as we have seen—from that of an “underlying” security such as the common stock of a company. Instead of listing them separately, they’re understood to be included as part of their underlying asset class. How are your assets divided among the categories in table 8? The big three for most investors are equities, interest rate securities, and real estate. Each accounts for about a quarter of the total net worth of US households, though the proportions fluctuate, particularly when an asset class experiences a boom or a bust. Table 8: Major Asset Classes and Subdivisions EQUITIES Common Stock Preferred Stock Warrants and Convertibles Private Equity INTEREST RATE SECURITIES Bonds US Government Corporate Municipal Convertibles Cash US Treasury Bills Savings Accounts Certificates of Deposit Mortgage-Backed Securities REAL ESTATE Residential Commercial COMMODITIES Agricultural Industrial Currencies Precious metals COLLECTIBLES (Art, gems, coins, autos, etc.)


pages: 543 words: 157,991

All the Devils Are Here by Bethany McLean

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, Bear Stearns, behavioural economics, Black-Scholes formula, Blythe Masters, break the buck, buy and hold, call centre, Carl Icahn, collateralized debt obligation, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, diversification, Dr. Strangelove, Exxon Valdez, fear of failure, financial innovation, fixed income, Glass-Steagall Act, high net worth, Home mortgage interest deduction, interest rate swap, junk bonds, Ken Thompson, laissez-faire capitalism, Long Term Capital Management, low interest rates, margin call, market bubble, market fundamentalism, Maui Hawaii, Michael Milken, money market fund, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, Savings and loan crisis, shareholder value, short selling, South Sea Bubble, statistical model, stock buybacks, tail risk, Tax Reform Act of 1986, telemarketer, the long tail, too big to fail, value at risk, zero-sum game

Multisector CDOs were “highly diversified kitchen sinks,” as one FP trader put it, that included everything from student loans to credit card debt to prime commercial real estate mortgage-backed securities to a smattering of subprime residential mortgage-backed securities. The theory, as always, was that diversification would protect against losses; the different asset classes in a multisector CDO were supposed to be uncorrelated. A Yale economist named Gary Gorton was hired to work up the risk models, which showed—naturally!—that the possibility of losses reaching the super-senior tranches was so tiny as to be nearly nonexistent. To FP’s executives, wrapping the super-seniors felt like free money.

Perhaps because of his long experience, he was always less willing to accept uncritically many of the arguments made for mortgage-backed securities. When underwriters began reducing their credit enhancements, claiming that the securities had proven themselves with their good performance, Adelson didn’t buy it. The fact that an asset class like housing had performed well in the past said nothing about how the same asset class was going to perform in the future, he believed. For a very long time, Moody’s backed Adelson, for which he would always be grateful. But his skepticism was out of sync with both the market and the new Moody’s. “My view wasn’t the most widely held one at Moody’s,” he says now.

Having studied at the feet of Rubin, Summers, and Greenspan, it was perhaps inevitable that he would share their mind-set about the virtues of the market. As the guidance was being discussed within the government, there were bank supervisors who were arguing that the Fed needed to clamp down on both mortgage lending and commercial real estate practices, especially given the rapid growth of both asset classes since 2000. But there were, shall we say, alternate concerns, which were expressed by Geithner and others who shared his views. What would the effect be on the mortgage and housing market if the Fed were heavy-handed? What would the effect be on the bottom lines of banks? “The Fed slowed down the guidance,” says one person.


pages: 294 words: 82,438

Simple Rules: How to Thrive in a Complex World by Donald Sull, Kathleen M. Eisenhardt

Affordable Care Act / Obamacare, Airbnb, Apollo 13, asset allocation, Atul Gawande, barriers to entry, Basel III, behavioural economics, Berlin Wall, carbon footprint, Checklist Manifesto, complexity theory, Craig Reynolds: boids flock, Credit Default Swap, Daniel Kahneman / Amos Tversky, democratizing finance, diversification, drone strike, en.wikipedia.org, European colonialism, Exxon Valdez, facts on the ground, Fall of the Berlin Wall, Glass-Steagall Act, Golden age of television, haute cuisine, invention of the printing press, Isaac Newton, Kickstarter, late fees, Lean Startup, Louis Pasteur, Lyft, machine translation, Moneyball by Michael Lewis explains big data, Nate Silver, Network effects, obamacare, Paul Graham, performance metric, price anchoring, RAND corporation, risk/return, Saturday Night Live, seminal paper, sharing economy, Silicon Valley, Startup school, statistical model, Steve Jobs, TaskRabbit, The Signal and the Noise by Nate Silver, transportation-network company, two-sided market, Wall-E, web application, Y Combinator, Zipcar

According to this rule of thumb, “a man should always place his money, one third in land, a third into merchandise, and keep a third in hand.” The general extension of this Talmudic advice is the 1/N principle, whereby total available funds are prioritized with equal ranking across the total number of asset classes. The 1/N rule ignores a lot of data and relationships that the Markowitz model captures, such as each asset’s historical returns, risk, and correlation with other asset classes. In fact, the 1/N rule ignores everything except for the number of investment alternatives under consideration. It is hard to imagine a simpler investment rule. And yet it works. One recent study of alternative investment approaches pitted the Markowitz model and three extensions of his approach against the 1/N rule, testing them on seven samples of data from the real world.

One surprising follower of the 1/N rule is Markowitz himself. While working at the Rand Corporation, Markowitz had to allocate his retirement fund across investment opportunities. According to his own theory, he should have calculated the correlations between different asset classes to draw an efficient frontier and rank the asset classes accordingly. Instead, as he later confessed to a financial journalist, he allocated his retirement funds evenly between stocks and bonds and called it a day. Prioritizing rules are particularly common in business settings, as we will discuss in chapter 5. They are especially powerful when applied to a bottleneck, an activity or decision that keeps individuals or organizations from reaching their objectives.

. [>] Markowitz went on: “This Year’s Laureates Are Pioneers in the Theory of Financial Economics and Corporate Finance,” NobelPrize.org, press release, October 16, 1990, http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1990/press.html. [>] According to this rule: Ran Duchin and Haim Levy, “Markowitz Versus the Talmudic Portfolio Diversification Strategies,” Journal of Portfolio Management 35, no. 2 (2009): 71–74. [>] This research ran: Jun Tu and Guofu Zhou, “Markowitz Meets Talmud: A Combination of Sophisticated and Naive Diversification Strategies,” Journal of Financial Economics 99, no. 1 (2011): 204–15. See table 6 for summary of tests of rules against real data sets. [>] The 1/N rule earned: Ibid. When provided with twenty years of data, the financial models did a bit better, beating the 1/N rule just over one-third of the time. [>] Other studies have run: Victor DeMiguel, Lorenzo Garlappi, and Raman Uppal, “Optimal Versus Naïve Diversification: How Inefficient Is the 1/N Portfolio Strategy,” Review of Financial Studies 22, no. 5 (2007): 1915–53; Victor DeMiguel et al., “A Generalized Approach to Portfolio Optimization: Improving Performance by Constraining Portfolio Norms,” Management Science 55, no. 5 (2009): 798–812; Michael Gallmeyer and Marcel Marekwica, “Heuristic Portfolio Trading Rules with Capital Gains Tax,” Social Science Research Network, May 18, 2013, http://ssrn.com/abstract=2172396. [>] Instead, as he later confessed: Jason Zweig, “Investing Experts Urge ‘Do as I Say, Not as I Do,’” Wall Street Journal, January 3, 2009. [>] When choosing a mate: Oliver M.


pages: 614 words: 168,545

Rentier Capitalism: Who Owns the Economy, and Who Pays for It? by Brett Christophers

"World Economic Forum" Davos, accounting loophole / creative accounting, Airbnb, Amazon Web Services, barriers to entry, Big bang: deregulation of the City of London, Big Tech, book value, Boris Johnson, Bretton Woods, Brexit referendum, British Empire, business process, business process outsourcing, Buy land – they’re not making it any more, call centre, Cambridge Analytica, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, cloud computing, collective bargaining, congestion charging, corporate governance, data is not the new oil, David Graeber, DeepMind, deindustrialization, Diane Coyle, digital capitalism, disintermediation, diversification, diversified portfolio, Donald Trump, Downton Abbey, electricity market, Etonian, European colonialism, financial deregulation, financial innovation, financial intermediation, G4S, gig economy, Gini coefficient, Goldman Sachs: Vampire Squid, greed is good, green new deal, haute couture, high net worth, housing crisis, income inequality, independent contractor, intangible asset, Internet of things, Jeff Bezos, Jeremy Corbyn, Joseph Schumpeter, Kickstarter, land bank, land reform, land value tax, light touch regulation, low interest rates, Lyft, manufacturing employment, market clearing, Martin Wolf, means of production, moral hazard, mortgage debt, Network effects, new economy, North Sea oil, offshore financial centre, oil shale / tar sands, oil shock, patent troll, pattern recognition, peak oil, Piper Alpha, post-Fordism, post-war consensus, precariat, price discrimination, price mechanism, profit maximization, proprietary trading, quantitative easing, race to the bottom, remunicipalization, rent control, rent gap, rent-seeking, ride hailing / ride sharing, Right to Buy, risk free rate, Ronald Coase, Rutger Bregman, sharing economy, short selling, Silicon Valley, software patent, subscription business, surveillance capitalism, TaskRabbit, tech bro, The Nature of the Firm, transaction costs, Uber for X, uber lyft, vertical integration, very high income, wage slave, We are all Keynesians now, wealth creators, winner-take-all economy, working-age population, yield curve, you are the product

Just during the decade beginning in 1995, mortgage lending increased by over 500 per cent.25 Needless to say, the growth of mortgage securitization, enabling lenders to access the vast funding capacity provided by wholesale markets, was integral to this history.26 Nonetheless, securitization – of mortgages and (almost) everything else – is not the only way in which financial deregulation and liberalization have fostered the massive diversification and accumulation of financial assets in the UK since the 1970s. Derivatives have been another obvious and much-debated focal point of financial innovation and expansion. I will say more in due course about the nature of the rents earned on these various asset classes (both new and old), but it is worth noting here that, in many cases today, the rents are literal. Assets are, in effect, hired out – like an apartment, they are lent by their owners to third parties, the latter paying the former a fee for the temporary use of the asset.

While UK-based banks were never solely the simple deposit-taking, loan-making intermediaries of popular lore, and had already somewhat reduced their traditional reliance on interest income by the time of the Big Bang, their expansion of non-interest-based activities gathered pace thereafter, and it picked up a powerful head of steam once interest rates began their secular decline in the 1990s. The modern-day revival of the financial rentier in the UK would not have been anything like as strong as it has been had it not been for this income diversification, which has been under-written by the growth in financial assets, itself driven by a different kind of diversification – the proliferation of derivatives, mortgage-backed debt securities, reverse repos, and so on. In 1984, non-interest income accounted for only a little over a third (35.6 per cent) of the total net income of UK-based banks; by 1990, this proportion had increased to 38.7 per cent; and by 1995, it was 42.7 per cent.68 As Figure 1.4 demonstrates, growth then went into overdrive, with the share of non-interest income peaking at just under two-thirds (64.6 per cent) in 2006, before the financial crisis precipitated something of a return to business staples as interest income’s share recovered to around the 50 per cent mark.

Nonetheless, it is worth noting that the increase in wealth inequality in the UK since the early 1980s has not been as substantial as in some other countries, such as the United States, Russia and China. The reason for this appears to have been to do with housing. In the UK, property prices have increased particularly sharply, and the distribution of housing is notably different from other asset classes. It accounts for only a relatively small proportion of total wealth at the top end; meanwhile, the mass conversion of social housing to owner-occupied dwellings over the past four decades has served to distribute significant amounts of property wealth across several wealth deciles. Thus, as Gabriel Zucman has noted, house price increases in the UK have ‘tended to boost the wealth share of the middle class, since most [of] its wealth is invested in housing, while upper groups mostly own financial assets’.78 Or, as Facundo Alvaredo, Tony Atkinson and Salvatore Morelli note of the UK: ‘housing wealth has moderated a definite tendency for there to be a rise in recent years in top shares in total wealth apart from housing’.79 But that is not quite the end of our account of the headline political-economic consequences of UK rentierization.


pages: 237 words: 50,758

Obliquity: Why Our Goals Are Best Achieved Indirectly by John Kay

Andrew Wiles, Asian financial crisis, Bear Stearns, behavioural economics, Berlin Wall, Boeing 747, bonus culture, British Empire, business process, Cass Sunstein, computer age, corporate raider, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, discovery of penicillin, diversification, Donald Trump, Fall of the Berlin Wall, financial innovation, Goodhart's law, Gordon Gekko, greed is good, invention of the telephone, invisible hand, Jane Jacobs, junk bonds, lateral thinking, Long Term Capital Management, long term incentive plan, Louis Pasteur, market fundamentalism, Myron Scholes, Nash equilibrium, pattern recognition, Paul Samuelson, purchasing power parity, RAND corporation, regulatory arbitrage, shareholder value, Simon Singh, Steve Jobs, Suez canal 1869, tacit knowledge, Thales of Miletus, The Death and Life of Great American Cities, The Predators' Ball, The Wealth of Nations by Adam Smith, ultimatum game, urban planning, value at risk

The most widely used template in the banking industry was called “value at risk” (VAR) and elaborated by JPMorgan. The bank published the details and subsequently spun off a business, RiskMetrics, which promotes it still.2 These risk models are based on analysis of the volatility of individual assets or asset classes and—crucially—on correlations, the relationships among the behaviors of different assets. The standard assumptions of most value-at-risk models are that the dispersion of investment returns follows the normal distribution, the bell curve that characterizes so many natural and social phenomena, and that future correlations will reproduce past ones.

To a degree incomprehensible to Americans, Saint-Gobain must move through a veritable jungle of blood ties and corporate ties while carrying the dead weight of dozens of intra-company empires and three centuries of tradition.”6 History has not served Dr. H. Igor Ansoff well. TRW, Singer and Litton all pursued similar strategies of poorly managed diversification that subsequently fell apart. Litton’s legendary reputation survived the publication of Dr. Ansoff’s work by less than a year. Singer and Litton are no longer independent companies and TRW is, once again, an automotive parts supplier of modest scale and ambition. Saint-Gobain, by contrast, is one of the most successful industrial companies in France and globally, with two hundred thousand employees worldwide.7 As Dr.

Welfare is something which is always changing its opportunities and demands—because human nature and general circumstances are always changing.”1 Marks and his colleagues had a rather general vision of the business they wanted to build but were constantly adaptive in decision making. Their chief method of market research was to put goods on the shelves and see if they sold. Or not: Most of the company’s diversifications failed, with one unexpected success—a food department. As a result, from the 1950s to the 1990s, fear of Marks & Spencer was at the front of the mind of every other UK retailer. But like ICI and Boeing, Marks & Spencer would sacrifice that status during the rationalist 1990s in the—ultimately unsuccessful—pursuit of growth in earnings per share.2 As at ICI and Boeing, the oblique approach built shareholder value and the direct approach destroyed it.


pages: 246 words: 74,341

Financial Fiasco: How America's Infatuation With Homeownership and Easy Money Created the Economic Crisis by Johan Norberg

accounting loophole / creative accounting, Alan Greenspan, bank run, banking crisis, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, business cycle, capital controls, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Brooks, diversification, financial deregulation, financial innovation, Greenspan put, helicopter parent, Home mortgage interest deduction, housing crisis, Howard Zinn, Hyman Minsky, Isaac Newton, Joseph Schumpeter, Long Term Capital Management, low interest rates, market bubble, Martin Wolf, Mexican peso crisis / tequila crisis, millennium bug, money market fund, moral hazard, mortgage tax deduction, Naomi Klein, National Debt Clock, new economy, Northern Rock, Own Your Own Home, precautionary principle, price stability, Ronald Reagan, savings glut, short selling, Silicon Valley, South Sea Bubble, The Wealth of Nations by Adam Smith, too big to fail

If things look good, they are going to get worse. "Investors said, `I don't want to be in equities anymore, and I'm not getting any return in my bond positions,"' explains a financier who is the author of many financial innovations: "Two things happened. They took more and more leverage, and they reached for riskier asset classes. Give me yield, give me leverage, give me return."" It's the Deficit, Stupid U.S. households were not alone in opening wide their pocketbooks and bankbooks: The U.S. government did the same. By 2002, the Bush administration had turned a $127 billion surplus into a $158 billion deficit. This was not only the effect of the general economic downturn but also the result of conscious policy choices.

Moody's, which used to be a bit sulky in its outward behavior, suddenly began to spend a lot of time with its customers on numerous golfing trips and karaoke nights. The number one growth industry at that time was the securitization of mortgages. Moody's held out for a long time, sticking to its principle that no CDO consisting solely of mortgages could get a top rating since there was too little diversification of risk-a national fall in home prices would have a devastating effect on its value. But other rating agencies were making out like bandits by awarding top grades to such securities, even though some of the people working there were already suspicious. One S&P employee warned in an internal e-mail that the CDO market they were creating was a "monster," concluding, "Let's hope we are all wealthy and retired by the time this house of cards falters."26 The CEO of Moody's explained the development much later at an internal meeting: "It was a slippery slope.

What happened in 2004 and 2005 with respect to subordinated tranches [the riskiest bits of CDOs] is that our competition, Fitch and S&P, went nuts. Everything was investment grade."27 The conservative rating agency must have felt an overwhelming temptation to go a little crazy itself: Moody's abandoned its diversification requirement in 2004 and started bringing out its Aaa stamp when customers came calling with mortgage-backed securities. From a business point of view, this was exactly the right thing to do. A single rating assignment could earn the company more than $200,000, and it did not have to take more than a day and could sometimes be done in a few hours.


pages: 364 words: 101,286

The Misbehavior of Markets: A Fractal View of Financial Turbulence by Benoit Mandelbrot, Richard L. Hudson

Alan Greenspan, Albert Einstein, asset allocation, Augustin-Louis Cauchy, behavioural economics, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Black-Scholes formula, British Empire, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, electricity market, Elliott wave, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, financial engineering, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John Meriwether, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, Myron Scholes, new economy, paper trading, passive investing, Paul Lévy, Paul Samuelson, plutocrats, power law, price mechanism, quantitative trading / quantitative finance, Ralph Nelson Elliott, RAND corporation, random walk, risk free rate, risk tolerance, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, Vilfredo Pareto, volatility smile

The Wall Street mantra is asset allocation: Deciding how to divide your portfolio among cash, bonds, stocks, and other asset classes is far more important than the specific stocks or bonds you pick. A typical broker’s recommendation, based on Markowitz-Sharpe portfolio theory, is 25 percent cash, 30 percent bonds, and 45 percent stocks. But, according to a study by the Organization for Economic Cooperation and Development, most people do not think that way. Japanese households keep 53 percent of their financial assets in cash, and barely 8 percent in shares (the balance is in other asset classes). Europeans keep 28 percent in cash, 13 percent in shares. For Americans, it is 13 percent cash and 33 percent stocks.

It argued that, to estimate a stock’s value, you start by forecasting how much in dividends it will pay; then adjust the prediction for inflation, foregone interest, and other factors that make the forecast uncertain. A straightforward rule. But surely, Markowitz thought to himself, real investors do not think that way. They do not look only at their potential profit; if they did, most people would buy just one stock, their best pick, and wait for the winnings to roll in. Instead, people also think about diversification. They judge how risky a stock is, how much its price bounces around compared to other stocks. They think about risk as well as reward, fear as well as greed. They buy many stocks, not one. They build portfolios. “Don’t put all your eggs in one basket”: It was an idea as old as investing itself.

He and some colleagues published some information about it in a 1998 scholarly paper; they called it “tail chiseling”: Under conventional portfolio theory, based on all the old assumptions of Brownian motion in prices, you build a portfolio by laboriously calculating how all the assets in a portfolio vary against each other; good diversification would mean some stocks zig when others zag. But Bouchaud’s method takes it as given that prices exhibit long-term dependence, have fat tails, and scale by a power law. He focuses, then, only on the odds for a crash—sharp, catastrophic price drops. After all, it is not small declines that wipe an investor out, it is the crashes.


pages: 311 words: 99,699

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe by Gillian Tett

"World Economic Forum" Davos, accounting loophole / creative accounting, Alan Greenspan, asset-backed security, bank run, banking crisis, Bear Stearns, Black-Scholes formula, Blythe Masters, book value, break the buck, Bretton Woods, business climate, business cycle, buy and hold, collateralized debt obligation, commoditize, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, easy for humans, difficult for computers, financial engineering, financial innovation, fixed income, Glass-Steagall Act, housing crisis, interest rate derivative, interest rate swap, inverted yield curve, junk bonds, Kickstarter, locking in a profit, Long Term Capital Management, low interest rates, McMansion, Michael Milken, money market fund, mortgage debt, North Sea oil, Northern Rock, Plato's cave, proprietary trading, Renaissance Technologies, risk free rate, risk tolerance, Robert Shiller, Satyajit Das, Savings and loan crisis, short selling, sovereign wealth fund, statistical model, tail risk, The Great Moderation, too big to fail, value at risk, yield curve

The common assumption was that even if one region suffered a housing bust, the property market would never collapse across the country as a whole. But by the autumn of 2007, it had become clear that this diversification theory wasn’t working in the subprime mortgage world. Defaults were rising in all regions. The problem of cash flow was particularly vexing for those managing what had become an especially popular type of CDO during 2005 and 2006, those known as “mezzanine CDO of ABS.” These were made up out of only mezzanine notes—or those rated around BBB. Bankers liked to claim that there was still a high level of diversification in these structures because the mezzanine notes were linked to the loans of a vast pool of different households.

The industry was rapidly adjusting to a new reality that banks needed to be big and offer a full range of services in order to compete at all. As institutions merged, financial activity broke through long-standing barriers. The art of trading corporate bonds had always been siloed off from the business of extending loans and underwriting equities. Now investors began hopping across assets classes, not to mention national borders, with abandon. Aggressive and high-risk hedge funds exploded onto the scene, some growing so large that they were competing in earnest with the new banking behemoths. The financial world was becoming “flat,” morphing into one seething, interlinked arena for increasingly free and fierce competition.

However, as Basel’s BIS noted at the time, the “striking feature of financial market behavior” in the twenty-first century was “the low level of price volatility over a wide range of financial assets and markets.” The prices of almost all assets were rising, while the cost of borrowing was flat or falling. One troubling result, policy makers feared, was an increasing correlation among the prices of many different asset classes, which would mean that a downturn would also be widespread. Most policy makers and bankers had never seen such eerily calm markets in their careers, and they were uncertain and divided about what—if anything—they should do. At one end of the intellectual spectrum stood senior American officials, who mostly assumed that the pattern was benign.


pages: 346 words: 102,625

Early Retirement Extreme by Jacob Lund Fisker

8-hour work day, active transport: walking or cycling, barriers to entry, book value, buy and hold, caloric restriction, caloric restriction, clean water, Community Supported Agriculture, delayed gratification, discounted cash flows, diversification, dogs of the Dow, don't be evil, dumpster diving, Easter island, fake it until you make it, financial engineering, financial independence, game design, index fund, invention of the steam engine, inventory management, junk bonds, lateral thinking, lifestyle creep, loose coupling, low interest rates, market bubble, McMansion, passive income, peak oil, place-making, planned obsolescence, Plato's cave, Ponzi scheme, power law, psychological pricing, retail therapy, risk free rate, sunk-cost fallacy, systems thinking, tacit knowledge, the scientific method, time value of money, Tragedy of the Commons, transaction costs, wage slave, working poor

This is unlike most people where one skill completely dominates all others--for example, one may be paid $25,000/year for one activity (one's job) but less than $25/year for one's next highest source of income, which is very likely to be the interest from a savings account. With proper diversification, if one income-generating module fails, it doesn't cause shockwaves through the rest of the system because the external coupling to other modules is weak. In addition, if the external couplings connect to different modules, rather than connecting to the same module, this lack of centralization protects the system from disruptions and cascading failures. Furthermore, the wider the diversification, the greater the likelihood of taking advantage of opportunities in the unique environment you reside in, or which you may find yourself residing in due to changing circumstances--this is the quintessence of adaptability.

Then after a decade of trending stock markets, which moved up no matter what people owned, it was decided that the managers weren't needed and index funds came into fashion--why do you need a manager if markets go up all on their own? At that point nobody wanted to own gold. In the past 10 years the market has been in a trading range and now gold is more expensive than ever, so who knows what the future will bring? My suggestion is not to presume that one can pick an asset class and then stick with it forever. Despite this, there are a few established principles in the art of investing. Reward is often correlated with risk, where risk can either be quantified as volatility or qualified as uncertainty (lack of knowledge). This means that the higher the return rate, the higher the risk of loss of capital.

The aggregate effect of workers investing in this manner is to turn the stock market into an elaborate demographical Ponzi scheme, where the value of investments depends on how many people are retiring and how many people are entering the labor market. In particular, it depends on the level of confidence that the most recent entrant has in the system, and hence this becomes a policy matter. Diversification doesn't prevent the effects of something as systemic as this. Instead, it reinforces the problem, as everybody behaves the same. If stocks are supplied and demanded according to how many are entering and leaving the workforce, then market price becomes dependent on demographics. The consequence of retirement accounts and the reliance on automatic savings in equity markets is a large class of people who have very little equity ownership compared to their level of consumption.


pages: 274 words: 81,008

The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything by Jason Kelly

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, antiwork, barriers to entry, Bear Stearns, Berlin Wall, call centre, Carl Icahn, carried interest, collective bargaining, company town, corporate governance, corporate raider, Credit Default Swap, diversification, eat what you kill, Fall of the Berlin Wall, family office, financial engineering, fixed income, Goldman Sachs: Vampire Squid, Gordon Gekko, housing crisis, income inequality, junk bonds, Kevin Roose, late capitalism, margin call, Menlo Park, Michael Milken, military-industrial complex, Occupy movement, place-making, proprietary trading, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Rubik’s Cube, San Francisco homelessness, Sand Hill Road, Savings and loan crisis, shareholder value, side project, Silicon Valley, sovereign wealth fund, two and twenty

The Private Equity Growth Capital Council, the industry’s chief lobbyist, estimated in 2011 that there were roughly 2,400 private-equity firms headquartered in the United States.17 “As we’ve seen what’s happened in the market, the model has changed, and you have two kinds of players: public and diversified and private and focused,” Colony’s Tom Barrack said. Managers at the firms where private equity remains the main, or only, business argue that they’re the only ones who can generate the sort of returns that the industry originally delivered and has promised ever since. “This asset class is not going away,” said Thomas Lister, co-managing partner of Permira. “There will be people who continue to make 20 percent IRRs off a reasonable pool of capital. I’m not a believer in just making 5 points over the S&P. I believe in 2.5 times your money and 25 percent returns.” Private-equity guys talk a lot about alpha, a Greek letter that’s taken on many meanings in the modern world, especially in finance.

In 2010, Carlyle took a $500 million loan from Mubadala in large part to pay a dividend to the owners, including the founders and the California Public Employees’ Retirement System. Carlyle repaid the loan in late 2011 and early 2012, a move that helped avoid Mubadala converting the debt to equity at a discount to the IPO price. Mubadala was a key tenet of establishing the firm as global in its approach. Carlyle’s founders argued their version of diversification—geographic—put them on that path before any of their competitors, including Blackstone. That view was crucial to Carlyle’s pitch for one of its most important deals, the long-mulled initial public offering. The founders, all headed toward their sixties at the time, seriously contemplated going public back when Schwarzman got his deal done and Kravis got as far as filing an S-1, in 2007.

Blackstone also offered the chance at times to hang on to a slice of the unit being divested, helping the selling CEO avoid potential embarrassment of selling too cheap and watching Blackstone reap huge profits down the line. It’s undeniable that the biggest private-equity firms today stand as financial behemoths given what they own and their expansion into areas beyond buying companies with borrowed money. Blackstone is the furthest along in that regard, and it was a strategy in part born of fear. Diversification is Blackstone’s long-term business plan, executives there say, in part because of the terror of watching Lehman Brothers collapse around them—the first time, in the mid-1980s. Peterson, who had come to hold various positions at Lehman Brothers including the top job, had lost a series of nasty battles with Lew Glucksman over the future of the firm that ultimately led to Peterson’s departure.


pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

Admiral Zheng, Alan Greenspan, An Inconvenient Truth, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Bear Stearns, Black Monday: stock market crash in 1987, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, business cycle, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, classic study, collateralized debt obligation, colonial exploitation, commoditize, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, equity risk premium, financial engineering, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, Future Shock, German hyperinflation, Greenspan put, Herman Kahn, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, iterative process, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", John Meriwether, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour mobility, Landlord’s Game, liberal capitalism, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, Modern Monetary Theory, Money creation, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, Naomi Klein, National Debt Clock, negative equity, Nelson Mandela, Nick Bostrom, Nick Leeson, Northern Rock, Parag Khanna, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, risk free rate, Robert Shiller, rolling blackouts, Ronald Reagan, Savings and loan crisis, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, stocks for the long run, structural adjustment programs, subprime mortgage crisis, tail risk, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Malthus, Thorstein Veblen, tontine, too big to fail, transaction costs, two and twenty, undersea cable, value at risk, W. E. B. Du Bois, Washington Consensus, Yom Kippur War

In the words of Bill Gross, who runs the world’s largest bond fund at the Pacific Investment Management Company (PIMCO), ‘bond markets have power because they’re the fundamental base for all markets. The cost of credit, the interest rate [on a benchmark bond], ultimately determines the value of stocks, homes, all asset classes.’ From a politician’s point of view, the bond market is powerful partly because it passes a daily judgement on the credibility of every government’s fiscal and monetary policies. But its real power lies in its ability to punish a government with higher borrowing costs. Even an upward move of half a percentage point can hurt a government that is running a deficit, adding higher debt service to its already high expenditures.

In 2006, 717 ceased to trade; in the first nine months of 2007, 409.103 It is not widely recognized that large numbers of hedge funds simply fizzle out, having failed to meet investors’ expectations. The obvious explanation for this hedge fund population explosion is that they perform relatively well as an asset class, with relatively low volatility and low correlation to other investment vehicles. But the returns on hedge funds, according to Hedge Fund Research, have been falling, from 18 per cent in the 1990s to just 7.5 per cent between 2000 and 2006. Moreover, there is increasing scepticism that hedge fund returns truly reflect ‘alpha’ (skill of asset management) as opposed to ‘beta’ (general market movements that could be captured with an appropriate mix of indices).104 An alternative explanation is that, while they exist, hedge funds enrich their managers in a uniquely alluring way.

Markets have short memories. Many young traders today did not even experience the Asian crisis of 1997-8. Those who went into finance after 2000 lived through seven heady years. Stock markets the world over boomed. So did bond markets, commodity markets and derivatives markets. In fact, so did all asset classes - not to mention those that benefit when bonuses are big, from vintage Bordeaux to luxury yachts. But these boom years were also mystery years, when markets soared at a time of rising short-term interest rates, glaring trade imbalances and soaring political risk, particularly in the economically crucial, oil-exporting regions of the world.


pages: 218 words: 62,889

Sabotage: The Financial System's Nasty Business by Anastasia Nesvetailova, Ronen Palan

Alan Greenspan, algorithmic trading, bank run, banking crisis, barriers to entry, Basel III, Bear Stearns, Bernie Sanders, big-box store, bitcoin, Black-Scholes formula, blockchain, Blythe Masters, bonus culture, Bretton Woods, business process, collateralized debt obligation, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, critique of consumerism, cryptocurrency, currency risk, democratizing finance, digital capitalism, distributed ledger, diversification, Double Irish / Dutch Sandwich, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, gig economy, Glass-Steagall Act, global macro, Gordon Gekko, high net worth, Hyman Minsky, independent contractor, information asymmetry, initial coin offering, interest rate derivative, interest rate swap, Joseph Schumpeter, junk bonds, Kenneth Arrow, litecoin, London Interbank Offered Rate, London Whale, Long Term Capital Management, margin call, market fundamentalism, Michael Milken, mortgage debt, new economy, Northern Rock, offshore financial centre, Paul Samuelson, peer-to-peer lending, plutocrats, Ponzi scheme, Post-Keynesian economics, price mechanism, regulatory arbitrage, rent-seeking, reserve currency, Ross Ulbricht, shareholder value, short selling, smart contracts, sovereign wealth fund, Thorstein Veblen, too big to fail

Existing banks compete fiercely with one another and face challenges from new entrants to the sector: all major supermarkets today offer a range of financial services and products that were traditionally the prerogative of the banks. Geographically, too, the breakdown of national regulations and the rise of emerging market economies has widely expanded the number and the range of financial institutions, with the majority now operating across several jurisdictions, time zones and asset classes. In 1997 Paul Volcker, formerly the chairman of the Federal Reserve, reflected on this heightened competition. Even in the face of the intense and growing pressures of competition, Volcker noted, ‘The industry never has been so profitable’. The noted anomaly would later become known as Volcker’s paradox, and would refer to the seemingly strange coexistence of intense competition and historically high profit rates in commercial banking.4 Why was this a puzzle for one of the leading economic figures of his generation?

., ‘Bitcoin might make tax havens obsolete’, Motherboard, Vice, 22 June 2016, https://motherboard.vice.com/en_us/article/wnxzpy/bitcoin-might-make-tax-havens-obsolete. Benston, G. J., W. C. Hunter and L. D. Wall, ‘Motivations for Bank Mergers and Acquisitions: Enhancing the Deposit Insurance Put Option versus Earnings Diversification’, Journal of Money, Credit and Banking, vol. 27, 1995, pp. 777–88, https://doi.org/10.2307/2077749. Berstein, P., Against the Gods: The Remarkable Story of Risk, John Wiley and Sons, 1998. Binham, C., ‘RBS unit memo told staff to let clients “hang themselves”’, Financial Times, 17 January 2018.

Puri, ‘Commercial Banks in Investment Banking: Conflict of Interest or Certification Role?’, Journal of Financial Economics, vol. 40, 1996, pp. 373–401; G. J. Benston, W. C. Hunter and L. D. Wall, ‘Motivations for Bank Mergers and Acquisitions: Enhancing the Deposit Insurance Put Option versus Earnings Diversification’, Journal of Money, Credit and Banking, vol. 27, 1995, pp. 777–88. 27. J. Spindler, ‘Conflict or Credibility: Research Analyst Conflicts of Interest and the Market for Underwriting Business,’ Journal of Legal Studies, vol. 35, no. 2, June 2006, pp. 303–25. 28. The recently introduced MIFID 2 directive prohibits free advice in the financial sector.


pages: 430 words: 140,405

A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers by Lawrence G. Mcdonald, Patrick Robinson

"World Economic Forum" Davos, Alan Greenspan, AOL-Time Warner, asset-backed security, bank run, Bear Stearns, Black Monday: stock market crash in 1987, book value, business cycle, Carl Icahn, collateralized debt obligation, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, diversification, fixed income, Glass-Steagall Act, high net worth, hiring and firing, if you build it, they will come, it's over 9,000, junk bonds, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, naked short selling, negative equity, new economy, Ronald Reagan, Savings and loan crisis, short selling, sovereign wealth fund, value at risk

I’d seen those beady-eyed analyst guys operate at close quarters, and I had enormous faith in them. With my courage high, I straightened up to sell these convertible bonds that had been given the green light from Merrill Lynch. I’d already noticed this type of bond was beginning to outperform on a risk-adjusted basis every other kind of asset class, even residential property and gold. I also sensed the coming high-tech revolution, and I had visions of being carried directly into Wall Street on a wave of flying electronic sparks, flickering screens, and cyberspace mysticism. I was not that far wrong, either. But first I needed to establish a business within the confines of Merrill Lynch in Hyannis.

It was not what you might describe as a perfectly straightforward answer. Indeed, David’s opening sentence was as close to unadulterated gibberish as anything I’ve ever heard: “You know, again, our mortgage platform in the U.S. as well as in Europe and Asia is predicated on a diversified set of products and a diversified set of regions, and with that diversification it has led to, you know, resiliency overall. As Chris [Chris O’Meara, the recently appointed CFO of Lehman] mentioned in his formal remarks, the overall securitization volume is slightly down; however, there was a slight mix shift this quarter, more going toward Europe; our small lending platform basically had a couple of large securitizations.”

Instead of the vast army of struggling homeowners, this derivative, the CMBS, offered the backing of major corporations in the form of cash flow paid by rents to those who owned the buildings. And so far as Dick and Joe were concerned, this was perfect: a hedge against the residential real estate, a safe diversification. Except that in the current global asset bubble, no one was diversified, nothing was safe. They simply did not understand that Lehman was concentrated, that commercial real estate was equally as vulnerable as residential property. Just another top-of-the market illusion of solidarity. Christine Daley understood this, understood we were heading for trouble.


pages: 348 words: 83,490

More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) by Michael J. Mauboussin

Alan Greenspan, Albert Einstein, Andrei Shleifer, Atul Gawande, availability heuristic, beat the dealer, behavioural economics, Benoit Mandelbrot, Black Swan, Brownian motion, butter production in bangladesh, buy and hold, capital asset pricing model, Clayton Christensen, clockwork universe, complexity theory, corporate governance, creative destruction, Daniel Kahneman / Amos Tversky, deliberate practice, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, dogs of the Dow, Drosophila, Edward Thorp, en.wikipedia.org, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, fixed income, framing effect, functional fixedness, hindsight bias, hiring and firing, Howard Rheingold, index fund, information asymmetry, intangible asset, invisible hand, Isaac Newton, Jeff Bezos, John Bogle, Kenneth Arrow, Laplace demon, Long Term Capital Management, loss aversion, mandelbrot fractal, margin call, market bubble, Menlo Park, mental accounting, Milgram experiment, Murray Gell-Mann, Nash equilibrium, new economy, Paul Samuelson, Performance of Mutual Funds in the Period, Pierre-Simon Laplace, power law, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, Richard Florida, Richard Thaler, Robert Shiller, shareholder value, statistical model, Steven Pinker, stocks for the long run, Stuart Kauffman, survivorship bias, systems thinking, The Wisdom of Crowds, transaction costs, traveling salesman, value at risk, wealth creators, women in the workforce, zero-sum game

But extremely low portfolio turnover (less than 20 percent) may not provide sufficient flexibility to capture the market’s dynamics. In addition, faster clockspeed suggests the need for greater diversification. If competitive advantages are coming and going faster than ever, investors need to cast a wider net in order to assure that their portfolios reflect the phenomenon. (Ideally, of course, investors would only focus on the winners and avoid the losers. This is practically very difficult.) The data show evidence for this increased diversification. Finally, the rate of change in the business world demands that investors spend more time understanding the dynamics of organizational change.

Said differently, investors pay attention to the narrow frame.3 If prospect theory does indeed explain investor behavior, the probabilities of a stock (or portfolio) rising and the investment-evaluation period become paramount. I want to shine a light on the policies regarding these two variables. Explaining the Equity-Risk Premium One of finance’s big puzzles is why equity returns have been so much higher than fixed-income returns over time, given the respective risk of each asset class. From 1900 through 2006, stocks in the United States have earned a 5.7 percent annual premium over treasury bills (geometric returns). Other developed countries around the world have seen similar results.4 In a trailblazing 1995 paper, Shlomo Benartzi and Richard Thaler suggested a solution to the equity risk premium puzzle based on what they called “myopic loss aversion.”

However, if price changes are not normally distributed, standard deviation can be a very misleading proxy for risk.2 The research, some done as far back as the early 1960s, shows that price changes do not follow a normal distribution. Exhibit 31.1 shows the frequency distribution of S&P 500 daily returns from January 1, 1978, to March 30, 2007, and a normal distribution derived from the data. Exhibit 31.2 highlights the difference between the actual returns and the normal distribution. Analyses of different asset classes and time horizons yield similar results.3 The figures show that:• Small changes appear more frequently than the normal distribution predicts • There are fewer medium-sized changes than the model implies (roughly 0.5 to 2.0 standard deviations) • There are fatter tails than what the standard model suggests.


pages: 422 words: 113,830

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

"World Economic Forum" Davos, Alan Greenspan, algorithmic trading, asset-backed security, bank run, banking crisis, Bear Stearns, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, buy and hold, collateralized debt obligation, computer age, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial engineering, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, Glass-Steagall Act, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, junk bonds, Kenneth Rogoff, large denomination, Long Term Capital Management, low interest rates, market bubble, Martin Wolf, Menlo Park, Michael Milken, military-industrial complex, Minsky moment, mobile money, money market fund, Monroe Doctrine, moral hazard, mortgage debt, Myron Scholes, new economy, oil shale / tar sands, oil shock, old-boy network, peak oil, plutocrats, Ponzi scheme, profit maximization, prosperity theology / prosperity gospel / gospel of success, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Ronald Reagan, Satyajit Das, Savings and loan crisis, shareholder value, short selling, sovereign wealth fund, stock buybacks, subprime mortgage crisis, The Chicago School, Thomas Malthus, too big to fail, trade route

Petersburg Stock Exchange. 65 In light of government signals that Russian companies should trade through the exchange, Western analysts assumed that Putin’s unspoken goal was to see 10 to 20 percent of world oil and gas trade—some of it in Europe—become ruble-denominated. In the meantime, observers disagreed on which tactics—diversification of central bank reserves, depegging from the dollar, or repricing oil to be paid for with a broader currency mix—held the biggest threat for the greenback or for the overall interests of the United States. Several experts partially exonerated central bank diversification sales, blaming “real money” managers (pension funds, insurance companies, and corporate treasurers) or funds. Mansoor Mohi-uddin, head of foreign-exchange strategy at UBS, suggested that the main threats “come not from central banks but real money or sovereign wealth funds fueled by very high oil prices selling the dollar aggressively.”66 Without some kind of currency magic, the fireworks were just beginning.

Yale economist Robert Shiller, fearful that in some parts of the United States home prices could fall by as much as 50 percent, emphasized the usual prominence of housing slumps leading into U.S. recessions.22 Merrill Lynch chief economist David Rosenberg, predicting a nationwide fall in housing prices of 15 or even 20 percent, explained a double underpinning. By 2007, a $23 trillion asset class was involved, and “there is nothing on the planet as big as that.” Moreover, he said, “there has never been a real estate deflation in this country that failed to end in a destabilizing recession.” 23 Martin Feldstein, president of the National Bureau of Economic Research, which declares and measures recessions in the United States, told the important August 31 conference sponsored by the Kansas City Federal Reserve Bank that the sort of collapse already visible in new home construction had been “ a precursor to eight of the past 10 recessions,” so that there was “a significant risk of a very serious downturn.”24 Speaking at the same conference, Professor Edward Leamer, of UCLA’s Anderson School of Management, set out his own theory, that the U.S. economy was guided not by a business cycle but by a consumer cycle particularly driven by housing.

By mid-2007, in turn, five of the ten markets projected by Moody’s Economy.com to undergo the largest peak-to-bottom home price declines were in California—Stockton, Modesto, Fresno, Oxnard-Ventura, and Sacramento.26 If anything, the earlier explosive growth shown in the figure hinted at the possibility of a decline of a related magnitude. FIGURE 4.4 The Tripling of California Home Prices, 1995-2006 Source: California Association of Realtors. But back in 2000-2001, as the NASDAQ stock market bubble was bursting, an appreciation of housing’s enormous national weight—besides being a $20 trillion asset class, it was also the principal wealth repository for most American families—may well have spurred a new strategy on the part of the Federal Reserve Board and the President’s Working Group on Financial Markets. Several specific motivations have been bandied about. First, the Working Group logically went into high gear to stimulate the U.S. economy after 9/11.


pages: 239 words: 60,065

Retire Before Mom and Dad by Rob Berger

Airbnb, Albert Einstein, Apollo 13, asset allocation, Black Monday: stock market crash in 1987, buy and hold, car-free, cuban missile crisis, discovery of DNA, diversification, diversified portfolio, en.wikipedia.org, fixed income, hedonic treadmill, index fund, John Bogle, junk bonds, mortgage debt, Mr. Money Mustache, passive investing, Ralph Waldo Emerson, robo advisor, The 4% rule, the rule of 72, transaction costs, Vanguard fund, William Bengen, Yogi Berra, Zipcar

Let’s begin with what we want our investment portfolio to look like. Our Goal We have just four goals to keep in mind as we decide how to invest. Diversification: We don’t want to put all of our eggs in one basket. We have no idea whether U.S. stocks or foreign stocks will do better over the next few decades. The same is true for big or small companies. How will REITs perform? I have no idea. Because we don’t know the future, we want to cover all of our bases. We do that by investing in different asset classes. As you’ll see, that’s very easy to do. Equities: History tells us that stocks outperform bonds over the long term.

Well, bonds have time limits too, ranging from just days to decades to even centuries (yep, some bonds mature 100 years after they are issued). Stock and Bond Markets So far, we’ve considered stocks and bonds of a single company or government. Now let’s consider the entire market of stocks and bonds. If we look at how each of these Asset Classes (a term that refers to different categories of investments) has performed over the last 100 years or so, we learn two very important things: First, stocks have performed better than bonds. Let’s imagine that in 1928 we had $300 to invest. That’s a lot of money today, but it was a small fortune in 1928.

If your 401(k) is anything like mine, it can be intimidating. My current employer runs its 401(k) through Fidelity. In my account, I see 29 investment options. Here’s what the first few look like: Name/Inception Date Asset Class 1 Year 3 Year 5 Year 10 Year/LOF* AF GRTH FUND AMER R6 (RGAGX) Stock Investments 6.92% 12.73% 11.63% 14.96% FID 500 INDEX (FXAIX) Stock Investments 6.26% 12.15% 11.11% 14.31% FID CONTRAFUND K (FCNKX) Stock Investments 6.62% 12.82% 11.76% 15.14% FID DIVERSIFD INTL K (FDIKX) Stock Investments -9.15% 2.73% 2.41% 8.36% Now what do we do?


pages: 413 words: 117,782

What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences by Steven G. Mandis

activist fund / activist shareholder / activist investor, algorithmic trading, Bear Stearns, Berlin Wall, Bob Litterman, bonus culture, book value, BRICs, business process, buy and hold, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, commoditize, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, diversification, eat what you kill, Emanuel Derman, financial innovation, fixed income, friendly fire, Glass-Steagall Act, Goldman Sachs: Vampire Squid, high net worth, housing crisis, junk bonds, London Whale, Long Term Capital Management, merger arbitrage, Myron Scholes, new economy, passive investing, performance metric, proprietary trading, radical decentralization, risk tolerance, Ronald Reagan, Saturday Night Live, Satyajit Das, shareholder value, short selling, sovereign wealth fund, subprime mortgage crisis, systems thinking, The Nature of the Firm, too big to fail, value at risk

While discussing Goldman’s success with me, a widely respected consultant, who has experience working with many firms, explained that Goldman is exceptionally good at looking at overall risk and firmwide risk and understanding the aggregate size of the risk and correlations across the firm. He believes that Goldman had so many different proprietary desks in so many different asset classes with so many different correlations that it benefits from a diversification effect. When the corporate credit or equities businesses are doing poorly, then foreign exchange or interest rate businesses may be doing well. No other bank had invested as much in sophisticated, computer-driven quantitative systems to reveal the signals.

No nonpartner employees were allowed to sell shares before the first vesting period, three years after the IPO. 2 I remember a partner sheepishly telling me he decided to sell the maximum he was allowed to in the special offering for “diversification reasons,” almost seeking or expecting some sort of understanding or reassurance that it was ok. At the time a group of my peers discussed that the partners who retired before the IPO did not have the “diversification” option and that the current employees did not have the option to sell after one year. And based on conversations with those more senior to me at the time, some of my peers were certainly not the only ones who were questioning the timing of the sales.

The SEC fines Goldman $40 million for allegedly trying to pump up the prices of IPOs. Goldman pays the fine without admitting or denying wrongdoing. Peter Weinberg, son of Jimmy Weinberg and nephew of John L. Weinberg, leaves Goldman and cofounds a competing firm the next year. In a push to pool knowledge across asset classes, Goldman merges its corporate bond and credit area with its equity counterparts (O). Goldman reportedly changes its compensation policy in sales and trading areas to be more quantitative and transparent (O, C). 2006: Invited, along with four other investment banks, to make a pitch to defend BAA against a possible take-over, Goldman proposes buying a chunk of BAA itself, in what sounds to BAA like another take-over bid.


pages: 202 words: 58,823

Willful: How We Choose What We Do by Richard Robb

activist fund / activist shareholder / activist investor, Alvin Roth, Asian financial crisis, asset-backed security, Bear Stearns, behavioural economics, Bernie Madoff, Brexit referendum, capital asset pricing model, cognitive bias, collapse of Lehman Brothers, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, delayed gratification, diversification, diversified portfolio, effective altruism, endowment effect, Eratosthenes, experimental subject, family office, George Akerlof, index fund, information asymmetry, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, lake wobegon effect, loss aversion, market bubble, market clearing, money market fund, Paradox of Choice, Pareto efficiency, Paul Samuelson, Peter Singer: altruism, Philippa Foot, principal–agent problem, profit maximization, profit motive, Richard Thaler, search costs, Silicon Valley, sovereign wealth fund, survivorship bias, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, trolley problem, ultimatum game

The billionaire tech entrepreneur, sniffing a profit, will pounce. Institutional investors manage funds more or less in accordance with a common formula. A board of trustees approves a policy that a chief investment officer (CIO) then implements. The policy usually splits the fund into “buckets,” “sectors,” or “asset classes.” Sectors can include domestic public equity, global equity, credit, illiquid credit, private equity, cash, absolute return (hedge funds), and the like. The CIO assigns specialists to look after each sector. Equity managers handle equity; credit managers handle credit. For the public equities sector, some CIOs farm out stock selection to outside managers, and others invest passively in an index fund to hold down costs.

See also mercy ambiguity effect, 24 American Work-Sports (Zarnowski), 191 Anaximander, 190 anchoring, 168 angel investors, 212–213n1 “animal spirits,” 169 Antipater of Tarsus, 134–135, 137 “anxious vigilance,” 73, 82 arbitrage, 70, 78 Aristotle, 200, 220n24 Asian financial crisis (1997–1998), 13 asset-backed securities, 93–95 asset classes, 75 astrology, 67 asymmetric information, 96, 210n2 authenticity, 32–37, 114 of challenges, 176–179 autism, 58, 59 auto safety, 139 Bank of New York Mellon, 61 Battle of Waterloo, 71, 205 Bear Stearns, 85 Becker, Gary, 33, 108–109 behavioral economics, 4, 10, 198–199 assumptions underlying, 24 insights of, 24–25 rational choice complemented by, 6 Belgium, 191 beliefs: attachment to, 51 defined, 50 evidence inconsistent with, 54, 57–58 formation of, 53, 92 persistence of, 26–28, 54 transmissibility of, 92–93, 95–96 Bentham, Jeremy, 127, 197–198 “black swans,” 62–64 blame aversion, 57, 72 brain hemispheres, 161 Brexit, 181–185 “bull markets,” 78 capital asset pricing model, 64 care altruism, 38, 104, 108–114, 115, 120, 135, 201 Casablanca (film), 120, 125 The Cask of Amontillado (Poe), 126–127 challenges, 202–203 authenticity of, 176–179 staying in the game linked to, 179–181 changes of mind, 147–164 charity, 40, 45–46, 119, 128 choice: abundance of, 172–174 intertemporal, 149–158, 166 purposeful vs. rational, 22–23 Christofferson, Johan, 83, 86, 87, 88 Cicero, 133–134 Clark, John Bates, 167 cognitive bias, 6, 23, 51, 147–148, 167, 198–199 confirmation bias, 200 experimental evidence of, 10–11, 24 for-itself behavior disguised as, 200–201 gain-loss asymmetry, 10–11 hostile attribution bias, 59 hyperbolic discounting as, 158 lawn-mowing paradox and, 33–34 obstinacy linked to, 57 omission bias, 200 rational choice disguised as, 10–11, 33–34, 199–200 salience and, 29, 147 survivor bias, 180 zero risk bias, 24 Colbert, Claudette, 7 Columbia University, 17 commitment devices, 149–151 commodities, 80, 86, 89 commuting, 26, 38–39 competitiveness, 11, 31, 41, 149, 189 complementary skills, 71–72 compound interest, 79 confirmation bias, 57, 200 conspicuous consumption, 31 consumption planning, 151–159 contrarian strategy, 78 cooperation, 104, 105 coordination, 216n15 corner solutions, 214n8 cost-benefit analysis: disregard of, in military campaigns, 117 of human life, 138–143 credit risk, 11 crime, 208 Dai-Ichi Kangyo Bank (DKB), 12–14, 15, 17, 87, 192–193 Darwin, Charles, 62–63 depression, psychological, 62 de Waal, Frans, 118 Diogenes of Seleucia, 134–135, 137 discounting of the future, 10, 162–164 hyperbolic, 158, 201 disjunction effect, 174–176 diversification, 64–65 divestment, 65–66 Dostoevsky, Fyodor, 18 drowning husband problem, 6–7, 110, 116, 123–125 effective altruism, 110–112, 126, 130, 135–136 efficient market hypothesis, 69–74, 81–82, 96 Empire State Building, 211–212n12 endowment effect, 4 endowments, of universities, 74 entrepreneurism, 27, 90, 91–92 Eratosthenes, 190 ethics, 6, 104, 106–108, 116, 125 European Union, 181–182 experiential knowledge, 59–61 expert opinion, 27–28, 53, 54, 56–57 extreme unexpected events, 61–64 fairness, 108, 179 family offices, 94 Fear and Trembling (Kierkegaard), 53–54 “felicific calculus,” 197–198 financial crisis of 2007–2009, 61, 76, 85, 93–94, 95 firemen’s muster, 191 flow, and well-being, 201–202 Foot, Philippa, 133–134, 135 for-itself behavior, 6–7, 19, 21, 27, 36, 116, 133–134, 204–205, 207–208 acting in character as, 51–53, 55–56, 94–95, 203 acting out of character as, 69, 72 analyzing, 20 authenticity and, 33–35 charity as, 39–40, 45–46 comparison and ranking lacking from, 19, 24, 181 consequences of, 55–64 constituents of, 26–31 defined, 23–24 difficulty of modeling, 204 expert opinion and, 57 extreme unexpected events and, 63–64 flow of time and, 30 free choice linked to, 169–172 in groups, 91–100 incommensurability of, 140–143 in individual investing, 77–78 in institutional investing, 76 intertemporal choice and, 168, 175, 176 job satisfaction as, 189 mercy as, 114 misclassification of, 42, 44, 200–201 out-of-character trading as, 68–69 purposeful choice commingled with, 40–43, 129, 171 rationalizations for, 194–195 in trolley problem, 137 unemployment and, 186 France, 191 Fuji Bank, 14 futures, 80–81 gain-loss asymmetry, 10–11 Galperti, Simone, 217n1 gambler’s fallacy, 199 gamifying, 177 Garber, Peter, 212n1 Germany, 191 global equity, 75 Good Samaritan (biblical figure), 103, 129–130, 206 governance, of institutional investors, 74 Great Britain, 191 Great Depression, 94 Greek antiquity, 190 guilt, 127 habituation, 201 happiness research (positive psychology), 25–26, 201–202 Hayek, Friedrich, 61, 70 hedge funds, 15–17, 65, 75, 78–79, 93, 95 herd mentality, 96 heroism, 6–7, 19–20 hindsight effect, 199 holding, of investments, 79–80 home country bias, 64–65 Homer, 149 Homo ludens, 167–168 hostile attribution bias, 59 housing market, 94 Huizinga, Johan, 167–168 human life, valuation of, 138–143 Hume, David, 62, 209n5 hyperbolic discounting, 158, 201 illiquid markets, 74, 94 index funds, 75 individual investing, 76–82 Industrial Bank of Japan, 14 information asymmetry, 96, 210n2 innovation, 190 institutional investing, 74–76, 82, 93–95, 205 intergenerational transfers, 217n1, 218n4 interlocking utility, 108 intertemporal choice, 149–159, 166 investing: personal beliefs and, 52–53 in start-ups, 27 Joseph (biblical figure), 97–99 Kahneman, Daniel, 168 Kantianism, 135–136 Keynes, John Maynard, 12, 58, 167, 169, 188–189 Kierkegaard, Søren, 30, 53, 65, 88 Knight, Frank, 145, 187 Kranton, Rachel E., 210–211n2 labor supply, 185–189 Lake Wobegon effect, 4 lawn-mowing paradox, 33–34, 206 Lehman Brothers, 61, 86, 89, 184 leisure, 14, 17, 41, 154, 187 Libet, Benjamin, 161 life, valuation of, 138–143 Life of Alexander (Plutarch), 180–181 Locher, Roger, 117, 124 long-term vs. short-term planning, 148–149 loss aversion, 70, 199 lottery: as rational choice, 199–200 Winner’s Curse, 34–36 love altruism, 104, 116, 123–125, 126, 203 lying, vs. omitting, 134 Macbeth (Shakespeare), 63 MacFarquhar, Larissa, 214n6 Madoff, Bernard, 170 malevolence, 125–127 Malthus, Thomas, 212n2 manners, in social interactions, 104, 106, 107, 116, 125 market equilibrium, 33 Markowitz, Harry, 65 Marshall, Alfred, 41, 167 Mass Flourishing (Phelps), 189–191 materialism, 5 merchant’s choice, 133–134, 137–138 mercy, 104, 114–116, 203 examples of, 116–120 inexplicable, 45–46, 120–122 uniqueness of, 119, 129 mergers and acquisitions, 192 “money pump,” 159 monks’ parable, 114, 124 Montaigne, Michel de, 114, 118 mortgage-backed securities, 93 Nagel, Thomas, 161 Napoleon I, emperor of the French, 71 neoclassical economics, 8, 10, 11, 22, 33 Nietzsche, Friedrich, 21, 43, 209n5 norms, 104, 106–108, 123 Norway, 66 Nozick, Robert, 162 observed care altruism, 108–112 Odyssey (Homer), 149–150 omission bias, 200 On the Fourfold Root of the Principle of Sufficient Reason (Schopenhauer), 209n5 “on the spot” knowledge, 61, 70, 80, 94, 205 Orico, 13 overconfidence, 57, 200 “overearning,” 44–45 The Palm Beach Story (film), 7 The Paradox of Choice (Schwartz), 172 parenting, 108, 141, 170–171 Pareto efficiency, 132–133, 136, 139–140 Peirce, Charles Sanders, 53–54, 67, 94 pension funds, 66, 74–75, 93, 95 permanent income hypothesis, 179 Pharaoh (biblical figure), 97–99 Phelps, Edmund, 17, 189–191 Philip II, king of Macedonia, 181 planning, 149–151 for consumption, 154–157 long-term vs. short-term, 148–149 rational choice applied to, 152–158, 162 play, 44–45, 167, 202 pleasure-pain principle, 18 Plutarch, 180–181 Poe, Edgar Allan, 126 pollution, 132–133 Popeye the Sailor Man, 19 portfolio theory, 64–65 positive psychology (happiness research), 25–26, 201–202 preferences, 18–19, 198 aggregating, 38–39, 132, 164 altruism and, 28, 38, 45, 104, 110, 111, 116 in behavioral economics, 24, 168 beliefs’ feedback into, 51, 55 defined, 23 intransitive, 158–159 in purposeful behavior, 25, 36 risk aversion and, 51 stability of, 33, 115, 147, 207, 208 “time-inconsistent,” 158, 159, 166, 203 present value, 7, 139 principal-agent problem, 72 Principles of Economics (Marshall), 41 prisoner’s dilemma, 105 private equity, 75 procrastination, 3, 4, 19, 177–178 prospect theory, 168 protectionism, 185–187 Prussia, 191 public equities, 75 punishment, 109 purposeful choice, 22–26, 27, 34, 36, 56, 133–134, 204–205 altruism compatible with, 104, 113–114, 115–116 commensurability and, 153–154 as default rule, 43–46 expert opinion and, 57 extreme unexpected events and, 62–63 flow of time and, 30 for-itself behavior commingled with, 40–43, 129, 171 mechanistic quality of, 68 in merchant’s choice, 135, 137–138 Pareto efficiency linked to, 132 rational choice distinguished from, 22–23 regret linked to, 128 social relations linked to, 28 stable preferences linked to, 33 in trolley problem, 135–136 vaccination and, 58–59 wage increases and, 187.

See also mercy ambiguity effect, 24 American Work-Sports (Zarnowski), 191 Anaximander, 190 anchoring, 168 angel investors, 212–213n1 “animal spirits,” 169 Antipater of Tarsus, 134–135, 137 “anxious vigilance,” 73, 82 arbitrage, 70, 78 Aristotle, 200, 220n24 Asian financial crisis (1997–1998), 13 asset-backed securities, 93–95 asset classes, 75 astrology, 67 asymmetric information, 96, 210n2 authenticity, 32–37, 114 of challenges, 176–179 autism, 58, 59 auto safety, 139 Bank of New York Mellon, 61 Battle of Waterloo, 71, 205 Bear Stearns, 85 Becker, Gary, 33, 108–109 behavioral economics, 4, 10, 198–199 assumptions underlying, 24 insights of, 24–25 rational choice complemented by, 6 Belgium, 191 beliefs: attachment to, 51 defined, 50 evidence inconsistent with, 54, 57–58 formation of, 53, 92 persistence of, 26–28, 54 transmissibility of, 92–93, 95–96 Bentham, Jeremy, 127, 197–198 “black swans,” 62–64 blame aversion, 57, 72 brain hemispheres, 161 Brexit, 181–185 “bull markets,” 78 capital asset pricing model, 64 care altruism, 38, 104, 108–114, 115, 120, 135, 201 Casablanca (film), 120, 125 The Cask of Amontillado (Poe), 126–127 challenges, 202–203 authenticity of, 176–179 staying in the game linked to, 179–181 changes of mind, 147–164 charity, 40, 45–46, 119, 128 choice: abundance of, 172–174 intertemporal, 149–158, 166 purposeful vs. rational, 22–23 Christofferson, Johan, 83, 86, 87, 88 Cicero, 133–134 Clark, John Bates, 167 cognitive bias, 6, 23, 51, 147–148, 167, 198–199 confirmation bias, 200 experimental evidence of, 10–11, 24 for-itself behavior disguised as, 200–201 gain-loss asymmetry, 10–11 hostile attribution bias, 59 hyperbolic discounting as, 158 lawn-mowing paradox and, 33–34 obstinacy linked to, 57 omission bias, 200 rational choice disguised as, 10–11, 33–34, 199–200 salience and, 29, 147 survivor bias, 180 zero risk bias, 24 Colbert, Claudette, 7 Columbia University, 17 commitment devices, 149–151 commodities, 80, 86, 89 commuting, 26, 38–39 competitiveness, 11, 31, 41, 149, 189 complementary skills, 71–72 compound interest, 79 confirmation bias, 57, 200 conspicuous consumption, 31 consumption planning, 151–159 contrarian strategy, 78 cooperation, 104, 105 coordination, 216n15 corner solutions, 214n8 cost-benefit analysis: disregard of, in military campaigns, 117 of human life, 138–143 credit risk, 11 crime, 208 Dai-Ichi Kangyo Bank (DKB), 12–14, 15, 17, 87, 192–193 Darwin, Charles, 62–63 depression, psychological, 62 de Waal, Frans, 118 Diogenes of Seleucia, 134–135, 137 discounting of the future, 10, 162–164 hyperbolic, 158, 201 disjunction effect, 174–176 diversification, 64–65 divestment, 65–66 Dostoevsky, Fyodor, 18 drowning husband problem, 6–7, 110, 116, 123–125 effective altruism, 110–112, 126, 130, 135–136 efficient market hypothesis, 69–74, 81–82, 96 Empire State Building, 211–212n12 endowment effect, 4 endowments, of universities, 74 entrepreneurism, 27, 90, 91–92 Eratosthenes, 190 ethics, 6, 104, 106–108, 116, 125 European Union, 181–182 experiential knowledge, 59–61 expert opinion, 27–28, 53, 54, 56–57 extreme unexpected events, 61–64 fairness, 108, 179 family offices, 94 Fear and Trembling (Kierkegaard), 53–54 “felicific calculus,” 197–198 financial crisis of 2007–2009, 61, 76, 85, 93–94, 95 firemen’s muster, 191 flow, and well-being, 201–202 Foot, Philippa, 133–134, 135 for-itself behavior, 6–7, 19, 21, 27, 36, 116, 133–134, 204–205, 207–208 acting in character as, 51–53, 55–56, 94–95, 203 acting out of character as, 69, 72 analyzing, 20 authenticity and, 33–35 charity as, 39–40, 45–46 comparison and ranking lacking from, 19, 24, 181 consequences of, 55–64 constituents of, 26–31 defined, 23–24 difficulty of modeling, 204 expert opinion and, 57 extreme unexpected events and, 63–64 flow of time and, 30 free choice linked to, 169–172 in groups, 91–100 incommensurability of, 140–143 in individual investing, 77–78 in institutional investing, 76 intertemporal choice and, 168, 175, 176 job satisfaction as, 189 mercy as, 114 misclassification of, 42, 44, 200–201 out-of-character trading as, 68–69 purposeful choice commingled with, 40–43, 129, 171 rationalizations for, 194–195 in trolley problem, 137 unemployment and, 186 France, 191 Fuji Bank, 14 futures, 80–81 gain-loss asymmetry, 10–11 Galperti, Simone, 217n1 gambler’s fallacy, 199 gamifying, 177 Garber, Peter, 212n1 Germany, 191 global equity, 75 Good Samaritan (biblical figure), 103, 129–130, 206 governance, of institutional investors, 74 Great Britain, 191 Great Depression, 94 Greek antiquity, 190 guilt, 127 habituation, 201 happiness research (positive psychology), 25–26, 201–202 Hayek, Friedrich, 61, 70 hedge funds, 15–17, 65, 75, 78–79, 93, 95 herd mentality, 96 heroism, 6–7, 19–20 hindsight effect, 199 holding, of investments, 79–80 home country bias, 64–65 Homer, 149 Homo ludens, 167–168 hostile attribution bias, 59 housing market, 94 Huizinga, Johan, 167–168 human life, valuation of, 138–143 Hume, David, 62, 209n5 hyperbolic discounting, 158, 201 illiquid markets, 74, 94 index funds, 75 individual investing, 76–82 Industrial Bank of Japan, 14 information asymmetry, 96, 210n2 innovation, 190 institutional investing, 74–76, 82, 93–95, 205 intergenerational transfers, 217n1, 218n4 interlocking utility, 108 intertemporal choice, 149–159, 166 investing: personal beliefs and, 52–53 in start-ups, 27 Joseph (biblical figure), 97–99 Kahneman, Daniel, 168 Kantianism, 135–136 Keynes, John Maynard, 12, 58, 167, 169, 188–189 Kierkegaard, Søren, 30, 53, 65, 88 Knight, Frank, 145, 187 Kranton, Rachel E., 210–211n2 labor supply, 185–189 Lake Wobegon effect, 4 lawn-mowing paradox, 33–34, 206 Lehman Brothers, 61, 86, 89, 184 leisure, 14, 17, 41, 154, 187 Libet, Benjamin, 161 life, valuation of, 138–143 Life of Alexander (Plutarch), 180–181 Locher, Roger, 117, 124 long-term vs. short-term planning, 148–149 loss aversion, 70, 199 lottery: as rational choice, 199–200 Winner’s Curse, 34–36 love altruism, 104, 116, 123–125, 126, 203 lying, vs. omitting, 134 Macbeth (Shakespeare), 63 MacFarquhar, Larissa, 214n6 Madoff, Bernard, 170 malevolence, 125–127 Malthus, Thomas, 212n2 manners, in social interactions, 104, 106, 107, 116, 125 market equilibrium, 33 Markowitz, Harry, 65 Marshall, Alfred, 41, 167 Mass Flourishing (Phelps), 189–191 materialism, 5 merchant’s choice, 133–134, 137–138 mercy, 104, 114–116, 203 examples of, 116–120 inexplicable, 45–46, 120–122 uniqueness of, 119, 129 mergers and acquisitions, 192 “money pump,” 159 monks’ parable, 114, 124 Montaigne, Michel de, 114, 118 mortgage-backed securities, 93 Nagel, Thomas, 161 Napoleon I, emperor of the French, 71 neoclassical economics, 8, 10, 11, 22, 33 Nietzsche, Friedrich, 21, 43, 209n5 norms, 104, 106–108, 123 Norway, 66 Nozick, Robert, 162 observed care altruism, 108–112 Odyssey (Homer), 149–150 omission bias, 200 On the Fourfold Root of the Principle of Sufficient Reason (Schopenhauer), 209n5 “on the spot” knowledge, 61, 70, 80, 94, 205 Orico, 13 overconfidence, 57, 200 “overearning,” 44–45 The Palm Beach Story (film), 7 The Paradox of Choice (Schwartz), 172 parenting, 108, 141, 170–171 Pareto efficiency, 132–133, 136, 139–140 Peirce, Charles Sanders, 53–54, 67, 94 pension funds, 66, 74–75, 93, 95 permanent income hypothesis, 179 Pharaoh (biblical figure), 97–99 Phelps, Edmund, 17, 189–191 Philip II, king of Macedonia, 181 planning, 149–151 for consumption, 154–157 long-term vs. short-term, 148–149 rational choice applied to, 152–158, 162 play, 44–45, 167, 202 pleasure-pain principle, 18 Plutarch, 180–181 Poe, Edgar Allan, 126 pollution, 132–133 Popeye the Sailor Man, 19 portfolio theory, 64–65 positive psychology (happiness research), 25–26, 201–202 preferences, 18–19, 198 aggregating, 38–39, 132, 164 altruism and, 28, 38, 45, 104, 110, 111, 116 in behavioral economics, 24, 168 beliefs’ feedback into, 51, 55 defined, 23 intransitive, 158–159 in purposeful behavior, 25, 36 risk aversion and, 51 stability of, 33, 115, 147, 207, 208 “time-inconsistent,” 158, 159, 166, 203 present value, 7, 139 principal-agent problem, 72 Principles of Economics (Marshall), 41 prisoner’s dilemma, 105 private equity, 75 procrastination, 3, 4, 19, 177–178 prospect theory, 168 protectionism, 185–187 Prussia, 191 public equities, 75 punishment, 109 purposeful choice, 22–26, 27, 34, 36, 56, 133–134, 204–205 altruism compatible with, 104, 113–114, 115–116 commensurability and, 153–154 as default rule, 43–46 expert opinion and, 57 extreme unexpected events and, 62–63 flow of time and, 30 for-itself behavior commingled with, 40–43, 129, 171 mechanistic quality of, 68 in merchant’s choice, 135, 137–138 Pareto efficiency linked to, 132 rational choice distinguished from, 22–23 regret linked to, 128 social relations linked to, 28 stable preferences linked to, 33 in trolley problem, 135–136 vaccination and, 58–59 wage increases and, 187.


pages: 381 words: 101,559

Currency Wars: The Making of the Next Gobal Crisis by James Rickards

"World Economic Forum" Davos, Alan Greenspan, Asian financial crisis, bank run, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, borderless world, Bretton Woods, BRICs, British Empire, business climate, buy and hold, capital controls, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-border payments, currency manipulation / currency intervention, currency peg, currency risk, Daniel Kahneman / Amos Tversky, deal flow, Deng Xiaoping, diversification, diversified portfolio, Dr. Strangelove, Fall of the Berlin Wall, family office, financial innovation, floating exchange rates, full employment, game design, German hyperinflation, Gini coefficient, global rebalancing, global reserve currency, Great Leap Forward, guns versus butter model, high net worth, income inequality, interest rate derivative, it's over 9,000, John Meriwether, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, Long Term Capital Management, low interest rates, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, Money creation, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, Network effects, New Journalism, Nixon shock, Nixon triggered the end of the Bretton Woods system, offshore financial centre, oil shock, one-China policy, open economy, paradox of thrift, Paul Samuelson, power law, price mechanism, price stability, private sector deleveraging, proprietary trading, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, Ronald Reagan, short squeeze, sovereign wealth fund, special drawing rights, special economic zone, subprime mortgage crisis, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, time value of money, too big to fail, value at risk, vertical integration, War on Poverty, Washington Consensus, zero-sum game

To increase velocity, the Fed must instill in the public either euphoria from the wealth effect or fear of inflation. The idea of the wealth effect is that consumers will spend more freely if they feel more prosperous. The favored route to a wealth effect is an increase in asset values. For this purpose, the Fed’s preferred asset classes are stock prices and home prices, because they are widely known and closely watched. After falling sharply from a peak in mid-2006, home prices stabilized during late 2009 and rose slightly in early 2010 due to the policy intervention of the first-time home buyer’s tax credit. By late 2010, that program was discontinued and home prices began to decline again.

An individual can have current income from a job and have various forms of debt, yet still maintain some savings for future use or a rainy day. These savings can be invested in stocks and commodities or just left in the bank. A country has the same choices with its reserves. It can use a sovereign wealth fund to invest in stocks or other asset classes, or it can keep a portion in liquid instruments or gold. The liquid instruments can involve bonds denominated in a number of different currencies, each called a reserve currency, because countries use them to invest and diversify their reserves. Since Bretton Woods in 1944, the dollar has been by far the leading reserve currency; however, it has never been the sole reserve currency.

Each player could participate as much or as little as she liked while the entire stream-of-consciousness digital scroll was preserved for future evaluation by Pentagon planners. The China brief was predictably boring given the proclivities of the team and my failure to excite much interest in gold-backed currency. We meekly accepted the scripted Russia-Japan energy deal but made some comment about accelerating China’s efforts to increase energy diversification. Russia went next. The brief started with some happy talk about continuing to work with China on a joint venture pipeline, but then veered into the announcement about demanding gold-backed currency for future energy shipments. An official summary of the war game prepared much later referred to this move as “aggressive” and “threatening,” but the immediate response was more in keeping with the absurd style of Dr.


pages: 318 words: 99,524

Why Aren't They Shouting?: A Banker’s Tale of Change, Computers and Perpetual Crisis by Kevin Rodgers

Alan Greenspan, algorithmic trading, bank run, banking crisis, Basel III, Bear Stearns, Berlin Wall, Big bang: deregulation of the City of London, bitcoin, Black Monday: stock market crash in 1987, Black-Scholes formula, buy and hold, buy low sell high, call centre, capital asset pricing model, collapse of Lehman Brothers, Credit Default Swap, currency peg, currency risk, diversification, Fall of the Berlin Wall, financial innovation, Financial Instability Hypothesis, fixed income, Flash crash, Francis Fukuyama: the end of history, Glass-Steagall Act, Hyman Minsky, implied volatility, index fund, interest rate derivative, interest rate swap, invisible hand, John Meriwether, latency arbitrage, law of one price, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, Minsky moment, money market fund, Myron Scholes, Northern Rock, Panopticon Jeremy Bentham, Ponzi scheme, prisoner's dilemma, proprietary trading, quantitative easing, race to the bottom, risk tolerance, risk-adjusted returns, Silicon Valley, systems thinking, technology bubble, The Myth of the Rational Market, The Wisdom of Crowds, Tobin tax, too big to fail, value at risk, vertical integration, Y2K, zero-coupon bond, zero-sum game

Rinse and repeat over and over and over again and the option price – and Greeks to feed into our risk management system – would emerge. Aided by ever more powerful hardware, the Monte Carlo method’s mighty computational hammer was used to crack the obdurate index option nut. Thus did advances in computer power allow investors access to leverage in a new, alternative asset class in ways that would have been impossible only a few years previously. But for all this business’s growth, it was a sideshow compared to the credit markets, where similar, but much larger and more important developments were taking place. Alphabet Soup One such development was the headlong progress of the credit default swap or CDS market.

Leverage, driven by competition, would, I’m sure, have been taken to the limit again. Where the eventual trigger for the next Minsky moment would have occurred, and how many years it would have taken to get to it, is a matter of pure speculation. Would it have been another property-related crash? It is tempting to think so, since property is a gigantically important asset class. If you are lucky enough to have accumulated any wealth in your lifetime it is likely that a large part of it is stored in the value of your home: the total market value of housing in the US in 2014 was around $22–4 trillion, the same order of magnitude as the value of all privately held paper financial assets, or approximately 150 per cent of GDP.30 Ratios are higher in other countries, such as the UK.

It was, indeed, shocking. With a VaR of $100 million, according to the maths this loss should never have happened – it was statistically impossible. But the models were at fault. The past was no guide to the present. The elaborate correlation matrix and p99 bumps were completely wrong – there was now no benefit to diversification. Every risky position was being dumped in unison, and banks, which had copied LTCM’s biggest trades, were unwinding them ahead of the fund. LTCM could not get out – they were too big. On a grander and gigantically more dangerous scale, the fund was experiencing the same sick sense of being trapped that Darren and I had felt in October 1997 – they couldn’t exit positions without pushing the market even more decisively against themselves.


pages: 516 words: 157,437

Principles: Life and Work by Ray Dalio

Alan Greenspan, Albert Einstein, asset allocation, autonomous vehicles, backtesting, Bear Stearns, Black Monday: stock market crash in 1987, cognitive bias, currency risk, Deng Xiaoping, diversification, Dunning–Kruger effect, Elon Musk, financial engineering, follow your passion, global macro, Greenspan put, hiring and firing, iterative process, Jeff Bezos, Long Term Capital Management, margin call, Market Wizards by Jack D. Schwager, microcredit, oil shock, performance metric, planetary scale, quantitative easing, risk tolerance, Ronald Reagan, Silicon Valley, Steve Jobs, transaction costs, yield curve

As the Holy Grail chart showed, an equity manager could put a thousand 60 percent-correlated stocks into their portfolios and it wouldn’t provide much more diversification than if they’d picked only five. It would be easy to beat those guys by balancing our bets in the way the chart indicated. Thanks to my process of systematically recording my investment principles and the results they could be expected to produce, I had a large collection of uncorrelated return streams. In fact, I had something like a thousand of them. Because we traded a number of different asset classes, and within each one we had programmed and tested lots of fundamental trading rules, we had many more high-quality ones to choose from than a typical manager who was tracking a smaller number of assets and was probably not trading systematically.

At the time (and still today), most investment managers did not take advantage of this. They managed investments in a single asset class: equity managers managed equities, bond managers managed bonds, and so on. Their clients gave them money with the expectation that they would receive the overall return of the asset class (e.g., the S&P 500 stock market index) plus some added returns from the bets managers took by over- and under-weighting particular assets (e.g., buying more Microsoft stock than was in the index). But individual assets within an asset class are generally about 60 percent correlated with each other, which means they go up or down together more than half the time.

Because Pure Alpha didn’t have any betas, it didn’t have any bias to go up or down along with any market. Its returns depended only on how good we were in outperforming others. Our totally new “alpha overlay” approach allowed investors to receive the return of their chosen asset class (the S&P 500 stock market, a bond index, commodities—whatever) plus the return from the portfolio of bets that we were making across all asset classes. As unprecedented as our approach was, we explained our logic carefully, showing why it was actually much less risky than traditional approaches. We also showed them how we expected the cumulative performance to unfold and what the expected range of performance around that would be.


pages: 261 words: 70,584

Retirementology: Rethinking the American Dream in a New Economy by Gregory Brandon Salsbury

Alan Greenspan, Albert Einstein, asset allocation, Bear Stearns, behavioural economics, buy and hold, carried interest, Cass Sunstein, credit crunch, Daniel Kahneman / Amos Tversky, diversification, estate planning, financial independence, fixed income, full employment, hindsight bias, housing crisis, loss aversion, market bubble, market clearing, mass affluent, Maui Hawaii, mental accounting, mortgage debt, mortgage tax deduction, National Debt Clock, negative equity, new economy, RFID, Richard Thaler, risk tolerance, Robert Shiller, side project, Silicon Valley, Steve Jobs, the rule of 72, Yogi Berra

As the last few years have taught us, markets and the overall economy can be volatile and hard to predict. Investing all your assets in one place or in one type of investment vehicle is closer to gambling than it is to prudent investing. By spreading your assets across multiple asset classes, you reduce the overall risk associated with just one asset class. An appropriate asset allocation also takes into consideration your risk tolerance, your financial resources, and your timeframe. The way you view or frame your portfolio can also help you diversify it. View your portfolio in the broad sense as a whole, rather than in a narrow sense, in pieces and parts.

Periodically Evaluate Your Plan and Strategy Over time, it’s easy to get off course as your financial journey unfolds. You should periodically evaluate your direction to see if changes are needed. You may want to rebalance your portfolio from time to time to make sure that it represents the risk and diversification you desire. It’s very unlikely that your financial resources and financial burdens and responsibilities will follow a nice, neat linear path to retirement. There will be windfalls and there will be setbacks. For this reason, it is important to reevaluate your financial plan on no less than an annual basis.

Additionally, Roth IRAs are not subject to required minimum distributions (RMDs), so an investor who does not need income can allow their legacy to continue growing and pass income tax free to heirs. Roth conversions have been available since the introduction of Roth IRAs over a decade ago, but significant tax policy changes in 2010 may result in a surge of popularity for this tax strategy. With the nation facing unprecedented financial challenges, the tax-hedge and tax-diversification advantage of Roth IRAs and future tax-free income may be particularly appealing. If you think income tax rates will rise in the future, paying taxes now to receive tax-free income in the future is worth consideration. By working with an adviser or using the Roth income calculator on a financial planning website, you can measure the impact on your net income in retirement with and without a Roth conversion.


pages: 466 words: 127,728

The Death of Money: The Coming Collapse of the International Monetary System by James Rickards

"World Economic Forum" Davos, Affordable Care Act / Obamacare, Alan Greenspan, Asian financial crisis, asset allocation, Ayatollah Khomeini, bank run, banking crisis, Bear Stearns, Ben Bernanke: helicopter money, bitcoin, Black Monday: stock market crash in 1987, Black Swan, Boeing 747, Bretton Woods, BRICs, business climate, business cycle, buy and hold, capital controls, Carmen Reinhart, central bank independence, centre right, collateralized debt obligation, collective bargaining, complexity theory, computer age, credit crunch, currency peg, David Graeber, debt deflation, Deng Xiaoping, diversification, Dr. Strangelove, Edward Snowden, eurozone crisis, fiat currency, financial engineering, financial innovation, financial intermediation, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, G4S, George Akerlof, global macro, global reserve currency, global supply chain, Goodhart's law, Growth in a Time of Debt, guns versus butter model, Herman Kahn, high-speed rail, income inequality, inflation targeting, information asymmetry, invisible hand, jitney, John Meriwether, junk bonds, Kenneth Rogoff, labor-force participation, Lao Tzu, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, low interest rates, mandelbrot fractal, margin call, market bubble, market clearing, market design, megaproject, Modern Monetary Theory, Money creation, money market fund, money: store of value / unit of account / medium of exchange, mutually assured destruction, Nixon triggered the end of the Bretton Woods system, obamacare, offshore financial centre, oil shale / tar sands, open economy, operational security, plutocrats, Ponzi scheme, power law, price stability, public intellectual, quantitative easing, RAND corporation, reserve currency, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Satoshi Nakamoto, Silicon Valley, Silicon Valley startup, Skype, Solyndra, sovereign wealth fund, special drawing rights, Stuxnet, The Market for Lemons, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, too big to fail, trade route, undersea cable, uranium enrichment, Washington Consensus, working-age population, yield curve

If these data then guide the next dose of policy, the central banker has entered a wilderness of mirrors in which false signals induce policy, which induces more false signals and more policy manipulation and so on, in a feedback loop that diverges further from reality until it crashes against a steel wall of data that cannot easily be manipulated, such as real income and output. A case in point is the so-called wealth effect. The idea is straightforward. Two asset classes—stocks and housing—represent most of the wealth of the American people. The wealth represented by stocks is highly visible; Americans receive their 401(k) account statements monthly, and they can check particular stock prices in real time if they so choose. Housing prices are less transparent, but anecdotal evidence gathered from real estate listings and water-cooler chatter is sufficient for Americans to have a sense of their home values.

The low interest rates offered by the banks, a type of financial repression also practiced in the United States, make Chinese savers susceptible to higher-yielding investments. Foreign markets are mostly off-limits because of capital controls, and China’s own stock markets have proved highly volatile, performing poorly in recent years. China’s bond markets remain immature. Instead, Chinese savers have been attracted by two asset classes—real estate and structured products. The bubble in Chinese property markets, especially apartments and condos, is well known, but not every Chinese saver is positioned to participate in that market. For them, the banking system has devised trust structures and “wealth management products” (WMPs).

A rapid price rise from the $1,500-per-ounce level to the $2,500-per-ounce level will not be a bubble but rather a sign that a physical buying panic has commenced and that official shorting operations are not producing the desired dampening effect. Conversely, if gold moves to the $800-per-ounce level or lower, this is a good sign of severe deflation, potentially devastating to leveraged investors in all asset classes. Gold’s continued acquisition by central banks. Purchases by China in particular are a second sign of the dollar’s demise. The announcement by China in late 2014 or early 2015 that it has acquired over 4,000 tonnes of gold will be a landmark in this larger trend and a harbinger of inflation.


pages: 435 words: 127,403

Panderer to Power by Frederick Sheehan

Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Bear Stearns, book value, Bretton Woods, British Empire, business cycle, buy and hold, California energy crisis, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, Glass-Steagall Act, Greenspan put, guns versus butter model, inflation targeting, interest rate swap, inventory management, Isaac Newton, John Meriwether, junk bonds, low interest rates, margin call, market bubble, Mary Meeker, McMansion, Menlo Park, Michael Milken, money market fund, mortgage debt, Myron Scholes, new economy, Nixon triggered the end of the Bretton Woods system, Norman Mailer, Northern Rock, oil shock, Paul Samuelson, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, Robert Solow, rolodex, Ronald Reagan, Sand Hill Road, Savings and loan crisis, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, stock buybacks, stocks for the long run, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War, zero-sum game

That’ll Be $250,000 . . .”New York Post, February 9, 2006. 301 criticism: “I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.”4 He was also well paid for his private advice. Deutsche Bank, Pimco, the worlds largest bond manager, and John Paulson, a hedge fund manager who profited magnificantly from the real estate crash, all hired Greenspan as an advisor. THE PEAK All asset classes were inflating. This worldwide credit bubble developed after the stock market crash in 2000. Now, stock markets around the world, and also bonds, commodities, and art (of all periods), were rising.5 As markets rose and credit spreads shrank, there seemed to be one explanation: liquidity. This is a word with several meanings.

Of course, there had to be a willing buyer and there was no shortage of purchasers for the most dubious of assets. (Home-equity loans was bundled and sold. They were backed by rising house prices. Thus, the word liquidity: assets flowed like a river after a monsoon. In 2005, U.S. house prices stalled. In 2006, prices fell. “Illiquidity” followed. Many of the other asset classes (if not all the others) were supported by the higher level of collateral and credit that spilled back from elevating house prices. When house prices peaked, so did the collateral. But credit kept rising. Banks and brokerages borrowed to lend. By 2007, brokerage firms were leveraged at 30:1 and 40:1.

.… The excess credit which the Fed pumped into the economy spilled over into the stock market—triggering a fantastic speculative boom.… As a result, the American economy collapsed.… The world economies plunged into the Great Depression of the 1930’s.” Money pouring into speculation in the 1920s went not only into the stock market, it also went into an asset class that probably received more speculative funds than the stock market: real estate. Speculative real estate lending then bore a sickening resemblance to the present. But by the late 1920s, New York banks lent to commercial builders long after they should have stopped. The city’s office space rose 92 percent in the last half of the 1920s and by another 56 percent after the stock market crash.13 One notable growth story was the Bank of United States.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

activist fund / activist shareholder / activist investor, Alan Greenspan, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, Black Swan, bond market vigilante , bonus culture, Bretton Woods, business climate, business cycle, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, Cornelius Vanderbilt, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial engineering, financial innovation, financial intermediation, Fractional reserve banking, full employment, Glass-Steagall Act, God and Mammon, Golden arches theory, Gordon Gekko, greed is good, Hyman Minsky, income inequality, industrial research laboratory, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, plutocrats, price stability, principal–agent problem, profit motive, proprietary trading, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

Easy money, the growing demand for food in emerging markets such as China and India, instability in oil-producing countries in the Middle East, extreme weather conditions and subsidies for ethanol may have been more powerful influences on prices than speculation when President Sarkozy was sounding off. That said, there is a growing body of evidence that financial speculation is causing extreme price movements as investment banks and pension funds treat commodities as a specific asset class that supposedly offers the benefits of diversification. These movements may also be exacerbated by the activities of high-frequency traders, who use computerised algorithms to analyse market data and trade frenetically in milliseconds or even microseconds. There is also an arguable case against short selling in banking when confidence is fragile, because a collapsing share price may encourage a run on the deposits of a solvent bank, thereby precipitating its collapse.

It is possible to put a case that manufacturing can shrink too far if international specialisation causes economies to suffer from a lack of diversity. That was the case with Britain, which was seriously under-diversified when the credit crunch struck in 2007. Back then, it derived more than 9 per cent of GDP from financial services. Yet it is also possible to suffer from a lack of diversification by dint of excessive exposure to manufacturing, as was the case with Germany at the same time. The Germans’ over-reliance on exports to drive economic growth meant that the collapse in world trade after the bankruptcy of Lehman Brothers in 2008 resulted in a greater percentage loss of output than in the US, which was the epicentre of the financial crisis.

Wilson) 1, 2 Alberti, Leon Battista 1 Alessandri, Piergiorgio 1 Allen, Maurice 1 Ambassadors, The (Henry James) 1 Americans for Tax Reform 1 Anatomy of Change-Alley (Daniel Defoe) 1 Angell, Norman 1 Anglosphere 1, 2 Arab Spring 1 Aramaic 1 arbitrage 1 Argentina 1 Aristotle 1, 2, 3, 4, 5, 6, 7, 8, 9 art 1 Asian Tiger economies 1 Atlas Shrugged (Ayn Rand) 1 Austen, Jane 1 Austrian school 1 aviation 1 Babbitt (Sinclair Lewis) 1 Bair, Sheila 1 Balloon Dog (Orange) (sculpture) 1 Balzac 1 Bank for International Settlements 1, 2, 3, 4, 5, 6 Bank of England 1, 2, 3, 4, 5 bank runs 1 bankers 1, 2 bankruptcy laws 1, 2 Banks, Joseph 1 Banksy 1 Barbon, Nicholas 1, 2, 3 Bardi family 1 Barings 1 Baruch, Bernard 1, 2 base metal, transmutation into gold 1 Basel regulatory regime 1, 2, 3 Baudelaire, Charles 1 Baum, Frank 1 behavioural finance 1 Belgium 1, 2 Bell, Alexander Graham 1 Benjamin, Walter 1 Bernanke, Ben 1, 2, 3 Bi Sheng 1 Bible 1 bimetallism 1 Bismarck, Otto von 1 Black Monday (1987) 1 black swans 1 Blake William 1, 2, 3 Bloch, Marcel 1 Bloomsbury group 1, 2 Boccaccio 1 bond market 1 bonus culture 1 Bootle, Roger 1 Boston Tea Party 1 Boswell, James 1 Boulton, Matthew 1 Bowra, Maurice 1 Brandeis, Louis 1 Bretton Woods conference 1 British Land (property company) 1 British Rail pension fund 1 Brookhart, Smith 1, 2 Brunner, Karl 1 Bryan, William Jennings 1 Bubble Act (Britain 1720) 1 bubbles 1, 2, 3 Buchanan, James 1 Buffett, Warren 1, 2, 3 Buiter, Willem 1 Burdett, Francis 1 van Buren, Martin 1 Burke, Edmund 1, 2 Burns, Robert 1 Bush, George W. 1, 2 Butler, Samuel 1 Candide (Voltaire) 1 Carlyle, Thomas 1, 2, 3 Carnegie, Andrew 1 Carville, James 1 cash nexus 1 Cash Nexus, The (Niall Ferguson) 1 Cassel, Ernest 1, 2 Catholic Church 1, 2, 3 Cecchetti, Stephen 1 Centre for the Study of Capital Market Dysfunctionality, (London School of Economics) 1 central bankers 1 Cervantes 1 Chamberlain, Joseph 1 Chancellor, Edward 1 Chapter 11 bankruptcy 1 Charles I of England 1, 2 Charles II of England 1 Chaucer 1 Cheney, Dick 1 Chernow, Ron 1 Chicago school 1, 2 Child & Co. 1 China 1, 2 American dependence on 1, 2 industrialisation 1, 2, 3 manufacturing 1 paper currency 1 Christianity 1, 2, 3, 4, 5 Churchill, Winston 1 Cicero 1, 2 Citizens United case 1 Cleveland, Grover 1 Clyde, Lord (British judge) 1 Cobden, Richard 1, 2, 3, 4 Coggan, Philip 1 Cohen, Steven 1 Colbert, Jean-Baptiste 1, 2 Cold War 1 Columbus, Christopher 1 commodity futures 1 Companies Act (Britain 1862) 1 Condition of the Working Class in England (Engels) 1 Confucianism 1, 2, 3 conquistadores 1 Constitution of Liberty, The (Friedrich Hayek) 1 Coolidge, Calvin 1, 2, 3 Cooper, Robert 1 copyright 1 Cort, Cornelis 1 Cosimo the Elder 1 crash of 1907 1 crash of 1929 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 creative destruction 1, 2 credit crunch (2007) 1, 2, 3 cum privilegio 1 Cyprus 1, 2 Dale, Richard 1, 2 Dante 1 Darwin, Erasmus 1 Das Kapital (Karl Marx) 1 Dassault, Marcel 1 Daunton, Martin 1 Davenant, Charles 1, 2, 3 Davies, Howard 1 debt 1 debt slavery 1 Decameron (Boccaccio) 1 Defoe, Daniel 1, 2, 3, 4, 5, 6, 7, 8 Dell, Michael 1 Deng Xiaoping 1, 2 derivatives 1 Deserted Village, The (Oliver Goldsmith) 1, 2, 3 Devil Take the Hindmost (Edward Chancellor) 1 Dickens, Charles 1, 2, 3, 4, 5, 6, 7, 8, 9 portentously named companies 1 Die Juden und das Wirtschaftsleben (Werner Sombart) 1 A Discourse of Trade (Nicholas Barbon) 1 Ding Gang 1 direct taxes 1, 2 Discorsi (Machiavelli) 1 diversification 1 Dodd–Frank Act (US 2010) 1, 2, 3 ‘dog and frisbee’ speech 1 dot.com bubble 1, 2, 3, 4 Drayton, Harley 1 Dumas, Charles 1, 2 Dürer, Albrecht 1 Duret, Théodore 1, 2 Dutch East India Company 1 Duttweiler, Gottlieb 1 Dye, Tony 1 East of Eden (film version) 1 Economic Consequences of the Peace (Keynes) 1, 2 Edison, Thomas 1, 2 efficient market hypothesis 1 electricity 1 Eliot, T.


pages: 285 words: 58,517

The Network Imperative: How to Survive and Grow in the Age of Digital Business Models by Barry Libert, Megan Beck

active measures, Airbnb, Amazon Web Services, asset allocation, asset light, autonomous vehicles, big data - Walmart - Pop Tarts, business intelligence, call centre, Clayton Christensen, cloud computing, commoditize, crowdsourcing, data science, disintermediation, diversification, Douglas Engelbart, Douglas Engelbart, future of work, Google Glasses, Google X / Alphabet X, independent contractor, Infrastructure as a Service, intangible asset, Internet of things, invention of writing, inventory management, iterative process, Jeff Bezos, job satisfaction, John Zimmer (Lyft cofounder), Kevin Kelly, Kickstarter, Larry Ellison, late fees, Lyft, Mark Zuckerberg, Mary Meeker, Oculus Rift, pirate software, ride hailing / ride sharing, Salesforce, self-driving car, sharing economy, Silicon Valley, Silicon Valley startup, six sigma, software as a service, software patent, Steve Jobs, subscription business, systems thinking, TaskRabbit, Travis Kalanick, uber lyft, Wall-E, women in the workforce, Zipcar

As a business model, network orchestration is highly differentiated because it is the only model in which the company enables and allows the network to serve itself (participants serving other participants) instead of the company trying to serve all the network’s needs on its own. As you consider each network’s needs, keep in mind the four asset classes. Network platforms can help facilitate the creation and exchange of any of the four types: Physical capital: access to physical assets that are related to your products, value proposition, or industry. Examples: Airbnb, Uber Human capital: expertise related to your products, processes, or industry.

A slash-and-burn approach will only create chaos. What we recommend instead is conscious, incremental, deliberate, ongoing openness and adaptation. Openness will allow you to develop a portfolio of useful practices that will make your organization more adaptable and valuable in the digital network age. Just as financial portfolios require diversification and balance, your organization should leverage a mix of new ideas and methods, including tangible and intangible assets, employees and freelancers, accounting and big data analytics, and so on. You can develop this degree of openness even within a single core business—by using different approaches to serving the same customer need.

See also mindset action by network leaders and evolution of, 192–194 as barriers in strategy shifts, 50 of boards, 106, 108 breaking habits and, 198 mentoring for, 198–199 move to intangible assets and, 46 of network orchestrators, 194–195 new stories needed for, 198 Pinpointing in PIVOT process, 137–139 reinforcing, to realize change, 197–199 mentors, 108, 162, 198–199 Microsoft, 76, 80, 133 millennials, 8, 89, 90, 130, 155, 199 mindset, 28, 113–120 diversification of new ideas and methods in, 115 examples of companies using, 118–119 General Motors’ example of change in, 113–114 move from closed to open in, 115–118, 120, 186 network orchestrators and, 114–115, 118, 202 openness to change and, 114–115 organizational culture supporting, 117–118 questions to ask about, 117 scoring your company on, 121–122 minorities, and board membership, 105, 108 mission, 67, 92, 103–104, 118, 119, 140, 163 mission statement, 117 mobile technology customers’ use of, 156 examples of companies using, 36, 53, 70, 110, 191, 197 as key technology, 32 network orchestrators and, 148 platform choice and, 162 multiplier (price/revenue) market valuation comparison among business models using, 18–19 performance comparison among business models using, 16 use of term, 17–18 Myatt, Mike, 90 NASA, 73 Netflix, 46, 82–83, 196 Net Promoter Score (NPS), 65, 83 network capital business model based on, 15, 132 inventory of, 126, 145, 146, 149–151 mental model values on, 138 network orchestrators’ use of, 16 network platforms and, 160 Network Challenge, The (Kleindorfer, Wind, and Gunther), 7 network leader on teams, 169–170, 178, 179 network leaders in organizations, 189–203 core beliefs of, 192 digital technology changes and, 190 guiding principles of, 192–193 mental model evolution of, 192–194 network orchestrators as, 202 new thinking needed by, 189 responses to rapid pace of change by, 190–191 network orchestrators as allocators, 51, 54 boards and, 106–107 digital platforms used by, 33, 36–37 economic advantages of, 15–16 evaluating organization’s performance as, 135–136 examples of, 14 financial services and, 130 identifying organization’s characteristics related to, 133–135 industry sector adoption comparison for, 22–23 intangible assets and, 42, 44 leadership and, 56, 58–59, 60, 61, 62–63 market valuation comparison for, 17–19 measurement used by, 97 mental models of, 21, 194–195 mindset openness and, 114–115, 118, 202 network capital used by, 15 as network leaders, 202 number of companies analyzed for, 13 number of companies using, 22 overview description of, 14 performance comparison for, 16 PIVOT assessment of business models with, 132–133 possible situations behind slow adoption of, 23 scalability characteristics of, 15–17 tracking network and platform metrics for, 178–179 value creation comparison for, 19–20 Visualizing business model for, in PIVOT process, 157–158 networks best practices of legacy firms compared with companies using, 20 boards and, 104–106, 110–111 customer groups within, 149–150 intangible needs met by, 21 law of increasing returns and, 12 open organizations’ use of, 116 power of, 8, 12, 24, 28 subscription model using, 80 network sentiment, 44, 97, 98, 100, 150, 179, 180 Nickell, Jake, 68 Nike, 53, 70, 82, 160, 161, 171 Nike+, 53, 161, 171 Nordstrom, 76 Ocean Tomo, 97 Oculus VR, 36 online forums, 70, 72, 162 OpenMatters, business models research of, 131 OpenMatters website additional resources and support on, 128, 131, 203 business model resources on, 121 digital tools on, 10, 131 mental model assessment on, 138 survey of organization’s characteristics on, 135 openness examples of companies with, 118–119 mindset with, 114–115, 120 open organizations diverse initiatives and business units in, 116–117 examples of, 118–119 innovation pipeline in, 116 move from closed organization to, 115–118, 120, 186 organizational culture supporting, 117–118 questions to ask about, 117 talent in, 117 Operate step in PIVOT, 126, 127, 169–176, 186 creating platform in, 170–172 Enterprise Community Partners example for, 175–176 goal of, 169 management plan for, 174–175 management practices in, 172–174 selecting network leader and team in, 169–170, 173 organizational culture, and openness, 117–118 Page, Larry, 118, 119 Palmisano, Sam, 50 partners customer contributors as, 34, 58, 59 independent workers as, 89, 90–92, 93 performance business model comparison for, 18–19 Pinpointing in PIVOT process, 135–136 Phone Case of the Month, 81 physical capital business model based on, 15, 132 inventory of, 126, 145, 146, 163 mental model values on, 138 network platforms and, 159 Pinpoint step in PIVOT, 126, 130–141, 185 assessing current business model in, 131–132 defining current business model in, 132–133 defining mental model in, 137–139 Enterprise Community Partners example for, 140–141 goal of, 130–131 identifying organization’s characteristics in, 133–135 reviewing economic performance in, 135–136 Pinterest, 44 PIVOT, 123–186 additional resources and support for, on OpenMatters website, 128, 131 change leader in, 132 Enterprise Community Partners example for, 127 five steps of, 126–127 introduction to, 125–128 Pixar, 68 plans for big data use, 99–100 for filling technology, talent, and capital gaps in platforms, 171–172 for growth, on OpenMatters website, 10 for network management, 174–175 for reallocating capital, 157–158 PricewaterhouseCoopers, 106 principles for network orchestration, 25–122 as challenges and levers for change, 27 list of, 27–28 research identifying, 21, 28 scoring your company on, 121–122 Principles of Economics (Mankiw), 49 Project Loon, 167 Red Hat, 133 referrals, 78, 79, 175, 183 Reichheld, Fred, 65 relationships with customers data collection in, 81–82 as intangible asset, 42 leaders affected by changes in, 56–58 personalized approach to, 82 in subscription model (see subscription model) revenues, 28, 75–83 advantages of subscription models for, 77–78 data acquired with, 78, 81–82 move from transaction to subscription in, 78, 79–82 Netflix versus Blockbuster example in, 82–83 nonrevenue activities in subscription model and, 78–79 recurring, in subscription model, 75–77 scoring your company on, 121–122 reverse mentoring, 108, 162, 199 ride-sharing services, 44, 85, 113, 155, 197 Rouse, Jim, 127, 128, 165, 184 Rouse, Patty, 127 Russell Reynolds, 107 Salesforce.com, 176 scalability advantages of, 31 business model comparison for, 15–17, 132 cloud technology and, 32 costs with, 12, 16, 17, 19, 33, 63, 139 digital technology enabling, 3, 33, 41, 44, 162 economics of scale contrasted with, 17 global access and, 31 of network lodging options, 156 network orchestrators and, 172, 202 Threadless example of, 69 scale economics, 17 service providers evaluating organization’s performance as, 135–136 examples of, 14 human capital used by, 15 identifying organization’s characteristics related to, 133–135 industry sector adoption comparison for, 22 market valuation comparison for, 18–19 number of companies analyzed for, 13 overview description of, 14 performance comparison for, 16 PIVOT assessment of business models with, 132–133 scalability characteristics of, 16, 17 value creation comparison for, 19–20 services as intangible asset, 41 subscription model using, 80 shared vision, and co-creators, 61 sharing-economy companies, 44, 85, 113, 155, 197 show-rooming, 45 Sidecar, 44 Sitaram, Pradip, 140, 152, 164, 175–176, 183, 184 skills assessment, 138 smartphones, 29–30, 32 social media, 29 boards’ use of, 107 CEOs’ use of, 199 customer data from, 97, 98, 101 examples of companies using, 53–54, 143, 180 interactions with companies using, 58, 80, 107, 202 as key technology, 32 leveraging for marketing and communication, 34 network sentiment tracked on, 180 platform choice and, 33, 162 public relations problems from customers’ use of, 42–43 subscription model using, 77–78, 80 Softlayer, 48 software subscription model, 76, 80 Spencer Stuart, 105 Sprint, 81 Stanford University, 107 Starbucks, 53, 109, 143, 190, 191 Starwood Hotels, 4, 43–44 strategy, 27, 47–54 barriers to changing, 48–49, 50 best practices of allocators in, 52–53 capital allocation as focus of, 49–51 IBM as example of shift in, 47–48, 50 move from operator to allocator in, 51–52 Nike-Apple partnership as example of, 53–54 questions to ask about, 52 scoring your company on, 121–122 subscription model advantages of, 77–78 customer contributors and, 77 data acquired in, 78, 81–82 examples of companies using, 75–76 moving customers from transactors to subscribers in, 78, 79–80 Netflix versus Blockbuster example in, 82–83 nonrevenue activities in, 78–79 personalized approach in, 82 recurring revenue from, 76–77 surprising and delighting the customer in, 81 themes in implementing, 80–82 types of offerings in, 80 talent big data collection and, 100 customer contribution of, 69 for digital platform operation, 170–171 experience in digital technologies needed by, 35 innovation and, 168 in open organizations, 117 tangible assets as financial liabilities in, 43–44 market valuation of intangible versus, 40, 46 move to intangible assets from, 44–45 Target, 76 TaskRabbit, 15, 159 Team of Teams: New Rules of Engagement for a Complex World (McChrystal), 55 technology, 27, 29–37 advantages of using, 31 business models incorporating, 30–31 embracing “digital everything” in, 30–31 essential aspect of, 29–30 importance of understanding and using, 30 management practices for intangible assets related to, 42 mentorships for, 199 move from physical to digital in, 34–37 platforms and, 33–34 questions to ask about, 35 scoring your company on, 121–122 talent needed for, 35 understanding five key technologies in, 32–33 technology creators evaluating organization’s performance as, 135–136 examples of, 14 identifying organization’s characteristics related to, 133–135 industry sector adoption comparison for, 22 intellectual capital used by, 15 market valuation comparison for, 18–19 number of companies analyzed for, 13 overview description of, 14 technology creators (continued) performance comparison for, 16 PIVOT assessment of business models with, 132–133 scalability characteristics of, 16, 17 value creation comparison for, 19–20 Tesla, 114 Threadless, 68–70, 72, 73, 78, 79, 81 3M, 91, 190 Thrun, Sebastian, 168 Topsy, 98 Track step in PIVOT, 126, 127, 177–184, 186 Amazon example of, 177–178 Enterprise Community Partners example for, 183–184 goal for, 178 network and platform metrics for, 178–179 network dimensions used in, 179–180 ongoing experimentation with, 182–183 platform dimensions used in, 180–181 team dimensions used in, 181–182 Trader Joe’s, 78 transactors, customers as, 78, 79–80 TripAdvisor, 10, 14, 44, 159, 174 Trunk Club, 76 Twitter, 42, 59, 60, 66, 72, 78, 79, 89, 97, 100, 107, 148, 171, 180, 199 Uber, 3, 4, 44, 66, 70, 81, 85, 91, 114, 155, 159, 160, 174, 197 United Healthcare, 133 US Board Index, 105 US interstate highway system, 11–12 Upwork, 12, 15, 43 value creation business model comparison for, 19–20 co-creators and, 61, 62–63 mental model beliefs on, 138–139 nonemployees and, 91 values assessment, 138 van Kralingen, Bridget, 47, 48 Verizon, 81 virtual reality (VR) technology, 36 Visa, 133 vision, and co-creators, 61 Visualize step in PIVOT, 126, 127, 156–165, 186 analyzing possible contribution to networks in, 160–161 beginning step for, 157–158 choosing platform in, 162–163, 170 Enterprise Community Partners example for, 163–165 goal of, 156–157 identifying potential networks in, 159–160 network orchestrator business model in, 157–158 overview of process in, 158–159 selecting network for, 161–162 team in, 158 VRBO, 156 Walmart, 4, 14, 76, 110, 133, 144 Wealthfront, 130 Weatherup, Craig, 110 WeChat, 4 Welch, Jack, 108, 199 Werhane, Charlie, 140, 164, 184 Wikipedia, 8, 46 Wind, Jerry, 6, 7 women, and board membership, 105, 108, 109 workforce.


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Magic Internet Money: A Book About Bitcoin by Jesse Berger

Alan Greenspan, barriers to entry, bitcoin, blockchain, Bretton Woods, Cambridge Analytica, capital controls, carbon footprint, correlation does not imply causation, cryptocurrency, diversification, diversified portfolio, Ethereum, ethereum blockchain, fiat currency, Firefox, forward guidance, Fractional reserve banking, George Gilder, inflation targeting, invisible hand, Johann Wolfgang von Goethe, liquidity trap, litecoin, low interest rates, Marshall McLuhan, Metcalfe’s law, Money creation, money: store of value / unit of account / medium of exchange, moral hazard, Network effects, Nixon shock, Nixon triggered the end of the Bretton Woods system, oil shale / tar sands, planned obsolescence, price mechanism, Ralph Waldo Emerson, rent-seeking, reserve currency, ride hailing / ride sharing, risk tolerance, Robert Metcalfe, Satoshi Nakamoto, the medium is the message, Vitalik Buterin

In the backdrop of an economy whose central banks have clearly demonstrated that their only solution to any forthcoming systemic difficulties is unabashed currency devaluation, and whose governments’ only response is more inequitable fiscal largesse, there is a very reasonable case for insuring against fiat fallibility. As its own new asset class and alternative money, Bitcoin can fulfill this role. It improves portfolio diversification, reducing unsystematic risk, and as the sound centerpiece of its own economy that functions irrespective of the legacy system, it is also a hedge against systematic risk. As a monetary phenomenon with a unique risk profile that is secured by its own independent network, Bitcoin can accurately measure prices, withstand the rigors of time, foster economic efficiencies, and be a magnet for value.

When investing in the pursuit of wealth, it is impossible to completely eliminate risk or guarantee reward, but it is practical to manage them. As such, every investor must strategically evaluate all risks in order to minimize losses and maximize gains. Bitcoin, as its own new monetary system and asset class, offers an unparalleled risk and reward profile. The key to understanding the opportunity it represents requires putting risk in context. 4.4.2 Calculated Risk: Expect the Unexpected “People think I got into bitcoin because I have a high risk tolerance ... actually I got in because I have a low risk tolerance for worst case scenarios.”

The key to understanding the opportunity it represents requires putting risk in context. 4.4.2 Calculated Risk: Expect the Unexpected “People think I got into bitcoin because I have a high risk tolerance ... actually I got in because I have a low risk tolerance for worst case scenarios.” Jill Carlson, Co-Founder of Open Money Initiative Generally speaking, there are two major risk categories to consider when investing in anything – unsystematic and systematic risk. Unsystematic risks are specific to a particular company, industry, or asset class, with narrow impacts typically associated with factors of productivity, such as land, labor, and physical and intellectual capital. Systematic risk, also known as “market risk,” is more comprehensive, with global implications resulting from macro-economic forces such as inflation, interest rates, exchange rates, taxes, or political and social instabilities.


pages: 360 words: 85,321

The Perfect Bet: How Science and Math Are Taking the Luck Out of Gambling by Adam Kucharski

Ada Lovelace, Albert Einstein, Antoine Gombaud: Chevalier de Méré, beat the dealer, behavioural economics, Benoit Mandelbrot, Bletchley Park, butterfly effect, call centre, Chance favours the prepared mind, Claude Shannon: information theory, collateralized debt obligation, Computing Machinery and Intelligence, correlation does not imply causation, diversification, Edward Lorenz: Chaos theory, Edward Thorp, Everything should be made as simple as possible, Flash crash, Gerolamo Cardano, Henri Poincaré, Hibernia Atlantic: Project Express, if you build it, they will come, invention of the telegraph, Isaac Newton, Johannes Kepler, John Nash: game theory, John von Neumann, locking in a profit, Louis Pasteur, Nash equilibrium, Norbert Wiener, p-value, performance metric, Pierre-Simon Laplace, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, Richard Feynman, Ronald Reagan, Rubik’s Cube, statistical model, The Design of Experiments, Watson beat the top human players on Jeopardy!, zero-sum game

As Bloomberg columnist Matthew Klein put it, “If I find a guy who is good at sports betting and is willing to bet with my money in exchange for a fee, he is, for all intents and purposes, a hedge fund manager.” Rather than putting money into established asset classes such as shares or commodities, investors now have the option of sports betting as an alternative asset class. Betting might seem somewhat distant from other types of investment, but that is one of its selling points. During the 2008 financial crisis, many asset prices fell sharply. Investors often try to build a diverse portfolio to protect against such shocks; for example, they might hold stocks in several different companies in a range of industries.

According to sports journalist Chad Millman, it is not just established gamblers who would be well positioned to profit from law changes. During a visit to MIT in March 2013, Millman got talking to Mike Wohl, an MBA student at the university’s business school. For his study project, Wohl had considered gambling as “the missing asset class.” Wohl had a background in finance, and his analysis—along with his personal experience of betting—suggested that sports wagers could produce as good a trade-off between risk and return as investing in stocks could. Millman pointed out that there are two extremes to the gambling spectrum. At one end are professional sports bettors, the so-called sharps who regularly place successful bets.

According to Tobias Preis, a researcher in complex systems at the University of Warwick, stocks can behave in a similar way when a financial market hits a rough period. Preis and colleagues analyzed share prices in the Dow Jones Industrial Average between 1939 and 2010 and found that stocks would go down together as the market came under more stress. “The diversification effect which should protect a portfolio melts away in times of market losses,” they noted, “just when it would most urgently be needed.” The problem isn’t limited to stocks. In the run-up to the 2008 crisis, more and more investors began to trade “collateralized debt obligations.” These financial products gathered together outstanding loans such as home mortgages, making it possible for investors to earn money by taking on some of the lenders’ risk.


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

Alan Greenspan, asset-backed security, bank run, banking crisis, Bernie Madoff, bond market vigilante , bonus culture, Bretton Woods, business cycle, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, deal flow, disintermediation, diversification, fiat currency, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, foreign exchange controls, Francis Fukuyama: the end of history, George Santayana, global reserve currency, Greenspan put, Home mortgage interest deduction, inverted yield curve, Isaac Newton, joint-stock company, junk bonds, Kickstarter, liquidity trap, London Interbank Offered Rate, long peace, low interest rates, margin call, market clearing, mass immigration, Money creation, money market fund, moral hazard, mortgage tax deduction, Nixon triggered the end of the Bretton Woods system, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, Phillips curve, plutocrats, Ponzi scheme, profit maximization, proprietary trading, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, Suez canal 1869, systems thinking, tail risk, The Great Moderation, the long tail, the new new thing, the payments system, too big to fail, value at risk, very high income, War on Poverty, We are all Keynesians now, Y2K, yield curve

The problem is that really rich people often get that way by having all their eggs in one basket (think of Bill Gates) or a few big 51 52 FINANCIAL MARKET MELTDOWN holdings in which they have some clout over management (think Warren Buffett). So diversification may actually reduce your upside. In a real, full-bore market panic like the Fall of 2008, almost all stocks and classes of stock tank, so diversification offers little if any shelter. IRRATIONAL MARKETS Sometimes it’s better to be lucky than to be good. The stock market is not rational. You have probably seen data and charts produced by financial advisors showing that equities have outperformed bonds by a significant margin over the last century or more. From this, you might conclude they represent a fundamentally better ‘‘asset class’’ for growing your money.

Bond Trading That is why the real profits in the bond markets (and the real losses) come from trading bonds. Bonds of all sorts, mostly issued by governments and their agencies, are by far the biggest pool of financial instruments in most national financial markets and in the world as a whole. In finance-speak, bonds are by far the biggest ‘‘asset class.’’ They are the epitome of a ‘‘contract in a box’’ because they are a simple, fixed-interest contract of debt. Only the name of the issuer, their rating, the tenor, the currency, and the coupon need to be specified for any bond issued in any country to find a market price. They are easy to trade precisely because the players in the bond market need so little specific information. 45 46 FINANCIAL MARKET MELTDOWN The motive behind all the trading in the bond market is simple.


pages: 263 words: 79,016

The Sport and Prey of Capitalists by Linda McQuaig

anti-communist, Bernie Sanders, carbon footprint, carbon tax, clean water, Cornelius Vanderbilt, diversification, Donald Trump, energy transition, financial innovation, Garrett Hardin, green new deal, Kickstarter, low interest rates, megaproject, Menlo Park, Money creation, Naomi Klein, neoliberal agenda, new economy, offshore financial centre, oil shale / tar sands, Paris climate accords, payday loans, precautionary principle, profit motive, risk/return, Ronald Reagan, Sidewalk Labs, Steve Jobs, strikebreaker, Tragedy of the Commons, union organizing

As city councillor Gord Perks put it, “Rather than wasting time chasing after a pot of gold at the end of that rainbow, we should get on and do what we know does work: build it with public dollars.”21 But high-tech companies and Wall Street firms are likely to persist in their quest to score big profits through the privatization of infrastructure development. A 2015 BlackRock paper aimed at investors notes that “infrastructure has emerged as a distinct asset class” and that “institutional investors are increasingly keen to finance it.” Titled Infrastructure Rising, the paper describes the explosive growth in worldwide infrastructure investment since the “watershed event” of the global financial crisis really kicked things off. And Wall Street has been there every step of the way, coming up with a range of innovative methods of packaging infrastructure assets.

Jordan Press, Andy Blatchford, “Documents Suggest Taxpayers Poised for Bigger Risk in Infrastructure Bank,” Globe and Mail, May 31, 2017. 20. Advisory Council on Economic Growth, Unleashing Productivity, p. 15. 21. Quoted in Tara Deschamps, “Sidewalk Toronto Faces Growing Opposition, Calls to Cancel Project,” Financial Post, February 18, 2019. 22. BlackRock, Infrastructure Rising: An Asset Class Takes Shape, April 2015, pp. 2–4. 23. Heather Whiteside, “Austerity Infrastructure: Financializing, Offshoring, and Tax Sheltering Public-Private Partnership Funds,” paper prepared for Austerity and Its Alternatives, SSHRC Partnership Development Grant Workshop, McMaster University, Hamilton, ON, December 14–15, 2016.

By 1950 Rogers Majestic had sold the former Crown corporation’s manufacturing facilities to multinational electronics giant Philips. For several years, Philips manufactured lighting products at two Canadian factories, but by 2003 both these factories had closed. Nothing was left of Research Enterprises, or of any of the ambitious diversification possibilities once described in the Parliament of Canada. C.D. Howe was a towering figure during the war, and he has been credited with transforming Canada from a largely agriculture-based society into an industrial one. His legacy lives on today — somewhat ironically — through the C.D. Howe Institute, a business-funded think tank that has consistently promoted pro-market ideas.


pages: 253 words: 79,214

The Money Machine: How the City Works by Philip Coggan

activist fund / activist shareholder / activist investor, algorithmic trading, asset-backed security, Bear Stearns, Bernie Madoff, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, bond market vigilante , bonus culture, Bretton Woods, call centre, capital controls, carried interest, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, disintermediation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, endowment effect, financial deregulation, financial independence, floating exchange rates, foreign exchange controls, Glass-Steagall Act, guns versus butter model, Hyman Minsky, index fund, intangible asset, interest rate swap, inverted yield curve, Isaac Newton, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", joint-stock company, junk bonds, labour market flexibility, large denomination, London Interbank Offered Rate, Long Term Capital Management, low interest rates, merger arbitrage, Michael Milken, money market fund, moral hazard, mortgage debt, negative equity, Nick Leeson, Northern Rock, pattern recognition, proprietary trading, purchasing power parity, quantitative easing, reserve currency, Right to Buy, Ronald Reagan, shareholder value, South Sea Bubble, sovereign wealth fund, technology bubble, time value of money, too big to fail, tulip mania, Washington Consensus, yield curve, zero-coupon bond

The beneficiaries of the funds (future pensioners) will use the money they receive to buy goods and services in the UK, so it makes sense for the fund to have a significant UK element. Many UK companies already receive a large proportion of their income from abroad, so investors can get a reasonable amount of diversification without leaving the London stock market. The overseas diversification of funds used to come under some criticism from the left but with the increasingly free flow of international capital, the complaints have died down. There is little evidence that UK companies are short of capital and US and European investors are active in the UK market.

As share prices fell, many defined benefit pension funds went into deficit, forcing the companies that sponsored them to cough up more cash. In the aftermath of the 2000–2002 bear market, many pension funds decided they had staked too much on the success of the stock market. They decided to diversify into alternative asset classes such as commodities, hedge funds and private equity. The hope is that a diversified mix of such assets can deliver better returns than government bonds, but with less volatility than equities. The spare cash of the investment institutions goes into the money markets. Although their immediate outgoings are usually met by the premiums and contributions, the institutions still need liquid funds to meet any disparities.

In the early 1990s, when the UK did slip into recession, private equity suffered from a very difficult periods as buyouts of retail outfits like Magnet and MFI got into trouble. In the US, the best-known deal of the era, the takeover of tobacco-and-food group RJR Nabisco, delivered very poor returns for its backer KKR. That episode reveals another potential problem for private equity funds – the feast-or-famine problem. When the asset class is popular, the funds have lots of money to invest. But when those conditions occur, the funds end up bidding against each other for control of attractive groups. That forces prices higher and future returns down. Conversely, when economic times are hard and share valuations lower, investors are less enthusiastic about giving money to private equity managers.


pages: 497 words: 144,283

Connectography: Mapping the Future of Global Civilization by Parag Khanna

"World Economic Forum" Davos, 1919 Motor Transport Corps convoy, 2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, 9 dash line, additive manufacturing, Admiral Zheng, affirmative action, agricultural Revolution, Airbnb, Albert Einstein, amateurs talk tactics, professionals talk logistics, Amazon Mechanical Turk, Anthropocene, Asian financial crisis, asset allocation, autonomous vehicles, banking crisis, Basel III, Berlin Wall, bitcoin, Black Swan, blockchain, borderless world, Boycotts of Israel, Branko Milanovic, BRICs, British Empire, business intelligence, call centre, capital controls, Carl Icahn, charter city, circular economy, clean water, cloud computing, collateralized debt obligation, commoditize, complexity theory, continuation of politics by other means, corporate governance, corporate social responsibility, credit crunch, crony capitalism, crowdsourcing, cryptocurrency, cuban missile crisis, data is the new oil, David Ricardo: comparative advantage, deglobalization, deindustrialization, dematerialisation, Deng Xiaoping, Detroit bankruptcy, digital capitalism, digital divide, digital map, disruptive innovation, diversification, Doha Development Round, driverless car, Easter island, edge city, Edward Snowden, Elon Musk, energy security, Ethereum, ethereum blockchain, European colonialism, eurozone crisis, export processing zone, failed state, Fairphone, Fall of the Berlin Wall, family office, Ferguson, Missouri, financial innovation, financial repression, fixed income, forward guidance, gentrification, geopolitical risk, global supply chain, global value chain, global village, Google Earth, Great Leap Forward, Hernando de Soto, high net worth, high-speed rail, Hyperloop, ice-free Arctic, if you build it, they will come, illegal immigration, income inequality, income per capita, industrial cluster, industrial robot, informal economy, Infrastructure as a Service, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Internet of things, Isaac Newton, Jane Jacobs, Jaron Lanier, John von Neumann, Julian Assange, Just-in-time delivery, Kevin Kelly, Khyber Pass, Kibera, Kickstarter, LNG terminal, low cost airline, low earth orbit, low interest rates, manufacturing employment, mass affluent, mass immigration, megacity, Mercator projection, Metcalfe’s law, microcredit, middle-income trap, mittelstand, Monroe Doctrine, Multics, mutually assured destruction, Neal Stephenson, New Economic Geography, new economy, New Urbanism, off grid, offshore financial centre, oil rush, oil shale / tar sands, oil shock, openstreetmap, out of africa, Panamax, Parag Khanna, Peace of Westphalia, peak oil, Pearl River Delta, Peter Thiel, Philip Mirowski, Planet Labs, plutocrats, post-oil, post-Panamax, precautionary principle, private military company, purchasing power parity, quantum entanglement, Quicken Loans, QWERTY keyboard, race to the bottom, Rana Plaza, rent-seeking, reserve currency, Robert Gordon, Robert Shiller, Robert Solow, rolling blackouts, Ronald Coase, Scramble for Africa, Second Machine Age, sharing economy, Shenzhen special economic zone , Shenzhen was a fishing village, Silicon Valley, Silicon Valley startup, six sigma, Skype, smart cities, Smart Cities: Big Data, Civic Hackers, and the Quest for a New Utopia, South China Sea, South Sea Bubble, sovereign wealth fund, special economic zone, spice trade, Stuxnet, supply-chain management, sustainable-tourism, systems thinking, TaskRabbit, tech worker, TED Talk, telepresence, the built environment, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, Tim Cook: Apple, trade route, Tragedy of the Commons, transaction costs, Tyler Cowen, UNCLOS, uranium enrichment, urban planning, urban sprawl, vertical integration, WikiLeaks, Yochai Benkler, young professional, zero day

The next growth wave will come from cost savings from low commodities prices and low interest rates enabling investment from continents of legacy infrastructure such as North America to regions seeking to harness their human masses such as Southeast Asia. Now is the time both to build markets and to connect them. Connectivity is the most important asset class of the twenty-first century. For investors looking to capitalize on cheap credit and to commit assets to the real economy rather than phony financial derivatives, there is nothing more concrete than infrastructure. Infrastructure is an asset class capable of generating higher returns than fixed income and less volatility than equities. Though it requires debt in the short term, there is no long-term growth without it.

A new terminology is emerging to describe massive yet diffuse entities such as BlackRock, whose $4.5 trillion in assets come from a globally diversified base: They are now called “alternative asset management conglomerates” or “diversified financial institutions” that manage pools of permanent capital they can invest across any asset class such as government debt in emerging markets. They constantly scan markets for trophy real estate assets, underpriced equities, fee-generating infrastructure such as airports and toll roads, or technology start-ups. By making direct investments in foreign countries and establishing joint ventures, global asset managers become one with local partners, getting around investment restrictions to receive better treatment.

While the world rural population is in absolute decline, some Western countries are witnessing a mild amount of de-urbanization. In America, several thousand eco-conscious youth (including many college graduates) have returned to farming (not just marijuana), injecting life into otherwise defunct towns. Indeed, agriculture is one of the best performing asset classes in terms of both operational cash yields and asset appreciation. Japan’s elderly farmers have been joined by some urban youth as well, who bring essential new mechanization technologies to keep agricultural output strong as the world’s oldest country drifts into the sunset. A noble organic food movement has also demonstrated how natural planting of diverse crops at smaller scale can produce high-quality yields.


pages: 319 words: 106,772

Irrational Exuberance: With a New Preface by the Author by Robert J. Shiller

Alan Greenspan, Andrei Shleifer, asset allocation, banking crisis, benefit corporation, Benoit Mandelbrot, book value, business cycle, buy and hold, computer age, correlation does not imply causation, Daniel Kahneman / Amos Tversky, demographic transition, diversification, diversified portfolio, equity premium, Everybody Ought to Be Rich, experimental subject, hindsight bias, income per capita, index fund, Intergovernmental Panel on Climate Change (IPCC), Joseph Schumpeter, Long Term Capital Management, loss aversion, Mahbub ul Haq, mandelbrot fractal, market bubble, market design, market fundamentalism, Mexican peso crisis / tequila crisis, Milgram experiment, money market fund, moral hazard, new economy, open economy, pattern recognition, Phillips curve, Ponzi scheme, price anchoring, random walk, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, Small Order Execution System, spice trade, statistical model, stocks for the long run, Suez crisis 1956, survivorship bias, the market place, Tobin tax, transaction costs, tulip mania, uptick rule, urban decay, Y2K

However, in fact, the typical investor’s actual decision about how much to allocate to the stock market overall, and into other asset classes such as bonds, real estate, or other investments, tends not to be based on careful calculations. Investors are not often assembling forecasts for these different asset class returns and weighing these against measured risks. Part of the reason they are not is that investors more often feel that experts have little or no idea what to expect of future price changes for these asset classes, or how much risk there is in each. After all, experts disagree all the time, and one might easily conclude that there is no great loss in ignoring what they are currently saying about the outlook for any given asset class.

After all, experts disagree all the time, and one might easily conclude that there is no great loss in ignoring what they are currently saying about the outlook for any given asset class. Investors must therefore base their judgments on basic principles on which most experts seem always to agree. The evidence used by experts to predict the relative returns on broad asset classes has little immediacy for most people. Experts talk about the potential actions of the Federal Reserve Board in Washington, about shifts in the Phillips curve, or about distortions on aggregate earnings caused by inflation and conventional accounting procedures. Most individuals have little interest in such esoterica.

The theory that the Baby Boom drives the market up owing to Boomers’ demand for goods would seem to imply that the market is high because earnings are high; it would not explain today’s high priceearnings ratios. If life-cycle savings patterns (the first effect) alone were to be the dominant force in the markets for savings vehicles, there would tend to be strong correlations in price behavior across alternative asset classes, and strong correlations over time between asset prices and demographics. When the most numerous generation feels P RE CIP ITATIN G FACTO RS 27 they need to save, they would tend to bid up all savings vehicles: stocks, bonds, and real estate. When the most numerous generation feels they need to draw down their savings, their selling would tend to force down the prices of all these vehicles.


pages: 358 words: 106,729

Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

"World Economic Forum" Davos, accounting loophole / creative accounting, Alan Greenspan, Andrei Shleifer, Asian financial crisis, asset-backed security, assortative mating, bank run, barriers to entry, Bear Stearns, behavioural economics, Bernie Madoff, Bretton Woods, business climate, business cycle, carbon tax, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency risk, diversification, Edward Glaeser, financial innovation, fixed income, floating exchange rates, full employment, Glass-Steagall Act, global supply chain, Goldman Sachs: Vampire Squid, Greenspan put, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kaizen: continuous improvement, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, longitudinal study, low interest rates, machine readable, market bubble, Martin Wolf, medical malpractice, microcredit, money market fund, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, Phillips curve, price stability, profit motive, proprietary trading, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, Savings and loan crisis, school vouchers, seminal paper, short selling, sovereign wealth fund, tail risk, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

At Lehman, for example, fixed-income traders started selling these securities short, even while the real estate and mortgage unit loaded up on them.5 Clearly, any unit that is focused on creating and holding a certain kind of asset is naturally reluctant to declare an end to the boom it has ridden. The unit’s size, power, and reputation become too closely related to the asset class, and its head becomes an interested booster. For Lehman’s mortgage unit to declare an end to the mortgage boom would have been to sign its own death warrant. But knowing that those close to the action may become unreliable in assessing the associated risks, a firm’s risk managers should step in to curtail further investment.

Moreover, any individual subprime homebuyer would have a high propensity to default, certainly higher than the level of risk with which a conservative private investor would be comfortable. This is where the sophisticated U.S. financial sector stepped in. Securitization dealt with many of these concerns. If the mortgage was packaged together with mortgages from other areas, diversification would reduce the risk. Furthermore, the riskiest claims against the package could be sold to those who had the capacity to evaluate them and had an appetite for the risk, while the safest, AAA-rated portions could be sold directly to the foreign dentist or her bank. The U.S. financial sector thus bridged the gap between an overconsuming and overstimulated United States and an underconsuming, understimulated rest of the world.

Suppose further that the investment bank structuring the deal issues two securities against the package—a junior security with face value of $1 that bears the brunt of losses until they exceed $1, and a senior security that bears losses after that. The senior security suffers losses only if both mortgages default. If mortgage defaults occur independently (that is, they are uncorrelated), then the senior security defaults only 1 percent of the time. This is the magic of combining diversification with tranching the liabilities—that is, creating securities of different seniority. Put a sufficient number of subprime mortgages together from different parts of the country and from different originators, issue different tranches of securities against them, and it is indeed possible to convert a substantial quantity of the subprime frogs into AAA-rated princes, provided the correlation between mortgage defaults is low.


pages: 337 words: 96,666

Practical Doomsday: A User's Guide to the End of the World by Michal Zalewski

accounting loophole / creative accounting, AI winter, anti-communist, artificial general intelligence, bank run, big-box store, bitcoin, blockchain, book value, Buy land – they’re not making it any more, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carrington event, clean water, coronavirus, corporate governance, COVID-19, cryptocurrency, David Graeber, decentralized internet, deep learning, distributed ledger, diversification, diversified portfolio, Dogecoin, dumpster diving, failed state, fiat currency, financial independence, financial innovation, fixed income, Fractional reserve banking, Francis Fukuyama: the end of history, Haber-Bosch Process, housing crisis, index fund, indoor plumbing, information security, inventory management, Iridium satellite, Joan Didion, John Bogle, large denomination, lifestyle creep, mass immigration, McDonald's hot coffee lawsuit, McMansion, medical bankruptcy, Modern Monetary Theory, money: store of value / unit of account / medium of exchange, moral panic, non-fungible token, nuclear winter, off-the-grid, Oklahoma City bombing, opioid epidemic / opioid crisis, paperclip maximiser, passive investing, peak oil, planetary scale, ransomware, restrictive zoning, ride hailing / ride sharing, risk tolerance, Ronald Reagan, Satoshi Nakamoto, Savings and loan crisis, self-driving car, shareholder value, Silicon Valley, supervolcano, systems thinking, tech worker, Ted Kaczynski, TED Talk, Tunguska event, underbanked, urban sprawl, Wall-E, zero-sum game, zoonotic diseases

Remember: it’s not about how much you spend or don’t spend; it’s about how you make every transaction count. Portfolio Design Strategies With the discussion of risks and asset classes out of the way, the final phase of safeguarding wealth is to construct a robust, diversified portfolio that will stand the test of time. The right approach to this problem depends on many factors, including the size of your rainy-day fund, prevailing market conditions, and your familiarity with each of the aforementioned asset classes (heeding the Mr. Market parable from Graham’s book). In normal inflationary environments, a solid starting point may be to keep around three to four months’ worth of savings in cash or in the bank, and then start putting what’s left in a diversified portfolio of around 10 to 20 value stocks, but only up until the equity positions represent about 50 percent of your total emergency funds.

In addition, bonds have fairly complex second-order dynamics tied to interest rates, which are set by the regulators to implement inflation policy goals. Without getting too deep into the woods, this means they can behave in rather undesirable ways, such as bond valuations decreasing just as consumer prices are going up. Simple Currency Hedges Having talked about the asset classes vulnerable to inflation and monetary crises, we can now pivot to instruments that help offset the risk. Perhaps the most straightforward option are simple currency positions that are expected to hold value or appreciate whenever the purchasing power of the rest of our savings goes down. By far the most familiar and purest example of this are loans.

In other words, if your plan is to avoid taxes by keeping things hush-hush with your numerous business partners, you might also want to brush up on prison slang. The final tax-related observation is that some assets used for business purposes—including rental property—can be gradually depreciated for wear and tear, offsetting the income that the business manages to generate on other fronts. On the flip side, real estate is one of the few asset classes subject to a direct wealth tax. As most homeowners know, your state will send you a hefty annual tax bill for the privilege of owning property, even if it’s an off-the-grid cabin in the woods. * Naturally, inflation can have many causes. For example, prices can rise if there’s a reduction in the availability of raw materials used to manufacture goods.


Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game by Walker Deibel

barriers to entry, Blue Ocean Strategy, book value, Clayton Christensen, commoditize, deal flow, deliberate practice, discounted cash flows, diversification, drop ship, Elon Musk, family office, financial engineering, financial independence, high net worth, intangible asset, inventory management, Jeff Bezos, knowledge worker, Lean Startup, Mark Zuckerberg, meta-analysis, Network effects, new economy, Peter Thiel, risk tolerance, risk/return, rolodex, software as a service, Steve Jobs, subscription business, supply-chain management, Y Combinator

It’s “adjusted” because it adds back any non-cash expenses, one-time expenses, or direct Owner Benefits, such as salary, benefits, auto expense, and so on. 21 By nature, 50 percent fail to achieve this and simply die to the law of averages. 22 https://www.forbes.com/sites/bradthomas/2015/04/22/understandin g- cap-rates-the-answer-is-nine/#59a6862e5c32 23 $216,000 in SDE, which is comparable to the “net operating income” of a real estate investment, divided by $891,200, the value of the company ($691,200 purchase price + $200,000 in inventory and working capital). 24 https://seekingalpha.com/article/4108577-high-risk-high-rewardthink 292 25 http://www.investopedia.com/terms/m/marginofsafety.asp 26 https://www.sba.gov/sites/default/files/Finance-FAQ2016_WEB.pdf 27 https://paynet.com/issues-and-solutions/all-paynet-products/smallbusiness-delinquency-index-sbdi/ 28 Sources: National Association of Realtors, Zillow, The Economist 29 http://www.bizbuysell.com/news/media_insight.html 30 31 SBA rates are typically floating at prime plus 2 percent, but for the illustration we’ll pick a fixed rate of 6 percent for ease. $216,000 in SDE divided by twelve months. 32 It’s an unfair comparison because real estate has a cash flow component as well as equity build up, but the point illustrated here is that the value that can be built in your own privately owned business is not limited like other asset classes. 33 Carol Dweck, What Having a ”Growth Mindset” Actually Means, Harvard Business Review, January, 2016. 34 Chad H. Van Iddekinge, Herman Aguinis, Jeremy D. Mackey, Philip S. DeOrtentiis, “A Meta-Analysis of the Interactive, Additive, and Relative Effects of Cognitive Ability and Motivation on Performance” Journal of Management, January, 2018. 293 35 36 37 David Dunning, Chip Heath, and Jerry M.

It’s easy to think about new technologies moving in and eating market share, such as cell phones overtaking landlines or tablets eating away at laptops. I try to consider the offering at the highest level; for example, television and books both provide home entertainment, so understanding the trend surrounding substitutes at this level could prove insightful, and perhaps enough to develop a strategy around diversification, if it made sense. BUYER POWER Consider the power customers have to drive prices down. This will show you how much “buyer power” exists in an industry. If there are a few large buyers and many fragmented suppliers, this gives particular strength to the buyers to put suppliers in direct competition against each other in a race to the lowest price.

What is the “special sauce”? GROWTH OR MARKET STRATEGY Market strategy outlines the path to growth. Often, market strategy will address the desire to increase market share, even at the expense of short term earnings. (Think Amazon.) Growth strategy typically pulls from one (or many) of four broad plays: diversification, product development, market penetration, and market development. This is the “how we plan to sell more stuff” part. 196 WHAT DRIVES VALUE? What is the one thing that drives revenue? If there was one metric that could measure the overall performance of the company, what would it be? How can you accelerate or multiply what drives revenue?


pages: 135 words: 26,407

How to DeFi by Coingecko, Darren Lau, Sze Jin Teh, Kristian Kho, Erina Azmi, Tm Lee, Bobby Ong

algorithmic trading, asset allocation, Bernie Madoff, bitcoin, blockchain, buy and hold, capital controls, collapse of Lehman Brothers, cryptocurrency, distributed ledger, diversification, Ethereum, ethereum blockchain, fiat currency, Firefox, information retrieval, litecoin, margin call, new economy, passive income, payday loans, peer-to-peer, prediction markets, QR code, reserve currency, robo advisor, smart contracts, tulip mania, two-sided market

If you want to trade Synths but don’t want to take on Debt or mint your own Synths, you can actually buy it on the sETH Uniswap Pool. The sETH pool on Uniswap is currently the largest Pool on Uniswap with over 35,000 ETH (~$80mm @ $200 ETH) in liquidity). ~ What Assets do Synths Support? At the point of writing, Synths support the following 4 major asset classes (full list): (i) Cryptocurrencies: Ethereum (ETH), Bitcoin (BTC), Binance Coin (BNB), Tezos (XTZ), Maker (MKR), Tron (TRX), Litecoin (LTC), and Chainlink (LINK) (ii) Commodities: Gold (XAU) and Silver (XAG) (iii) Fiat Currencies: USD, AUD, CHF, JPY, EUR, and GBP (iv) Indexes: CEX and DEFI ~ Index Synths One of the interesting Synths available on Synthetix is the Index Synths.

At the time of writing, there are 2 different Index Synths, namely sCEX and sDEFI. Index Synths provide traders with exposure to a basket of tokens without the need to purchase all the tokens. The index will mirror the overall performance of the underlying tokens. Index Synths allow for exposure to particular segments of the industry as well as diversification of risks without the need to actually hold and manage various tokens. sCEX sCEX is an Index Synth designed to give traders exposure to a basket of Centralized Exchange (CEX) tokens roughly approximating their weighted market capitalization. The current sCEX index consists of Binance Coin (BNB), Bitfinex’s LEO Token (LEO), Huobi Token (HT), OKEx Token (OKB) and KuCoin Shares (KCS).


pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, banks create money, Bear Stearns, book value, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial engineering, financial innovation, fixed income, friendly fire, full employment, Glass-Steagall Act, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, junk bonds, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, McMansion, Minsky moment, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, Paul Volcker talking about ATMs, price mechanism, proprietary trading, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, vertical integration, working-age population, yield curve, Yogi Berra

First, the mortgage twins were allowed to operate with extremely high leverage and under a pretty light regulatory regime. At the end of 2007, as the housing crash was gathering steam, Fannie and Freddie were leveraged about 75 to 1. Yes, that meant that a mere 1.4 percent loss on their assets would have left both of them insolvent. Second, by charter, Fannie and Freddie were not allowed to diversify into other asset classes. Mortgages, mortgage guarantees, and mortgage-related securities constituted roughly 100 percent of their earning assets. In some sense, these three were the same assets in different guises. Thus, in words that no one ever used, Fannie and Freddie were actually designed to fail if the proverbial 100-year flood ever swallowed up the housing market.

One “bad apple” can make the whole group guilty until proven innocent, with unsettling results on financial markets and, much more important, on economies. Some aspects of financial contagion are rational. If a bank fails, that may leave its counterparties holding the (empty) bag—as happened with Lehman Brothers and was feared in the cases of Bear Stearns and AIG. If the prices of a certain asset class (e.g., houses, stocks, or subprime mortgages) plummet, the resulting capital losses may imperil a large number of institutions. Those linkages are obvious. Other bases for rational contagion are less so. For example, in 2008 a number of big Wall Street firms operated with the same business model as Bear Stearns’: combining high leverage with heavy reliance on very short-term debt.

We will pay you cash immediately, which you can lend out to other borrowers. We’ll then combine your mortgages with others from around the country, and package them all into well-diversified mortgage-backed securities. The MBS will be less risky than the underlying mortgages because of geographical diversification. Then we will spread the risk around by selling pieces of the security to investors all over the world.” FIB is not proposing an act of altruism, of course. It stands to earn handsome fees for its services. On the surface, this little bit of financial engineering seems to make good sense. RBC is relieved of a substantial risk that could threaten its very existence.


Unknown Market Wizards by Jack D. Schwager

3D printing, algorithmic trading, automated trading system, backtesting, barriers to entry, Black Monday: stock market crash in 1987, Brexit referendum, buy and hold, commodity trading advisor, computerized trading, COVID-19, cryptocurrency, diversification, Donald Trump, eurozone crisis, family office, financial deregulation, fixed income, forward guidance, index fund, Jim Simons, litecoin, Long Term Capital Management, margin call, market bubble, Market Wizards by Jack D. Schwager, Nick Leeson, performance metric, placebo effect, proprietary trading, quantitative easing, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, Sharpe ratio, short squeeze, side project, systematic trading, tail risk, transaction costs

Generally, I will have roughly 60% of the portfolio in long positions—a percentage that can vary up or down, depending on how cheap or expensive I think the general market is—with the remaining portfolio utilized for short-term trading and the occasional longer-term biotech short. To use an analogy to the typical 60/40 long equity/long bond portfolio, where the bond position is used for diversification, in my 60/40 portfolio, short-term trading provides the diversification. What percent of your short-term trading is from the short side? About 70%. How do you select the stocks in the long position portion of your portfolio? My long book can be broken into two parts: large-cap stocks, which I buy when they are getting hammered on what I consider indiscriminate selling, and small-cap stocks with high revenue growth.

The Fed’s motivation for buying other types of assets, such as mortgage-backed securities, was to mitigate the meltdown in these other sectors during the financial panic. The Fed’s first quantitative easing move occurred in November 2008 when, to support the mortgage and housing market, it purchased mortgage-related government agency assets and private mortgage-backed securities, a financial asset class for which buyer demand had virtually disappeared. At that point, the Fed had still not applied quantitative easing to the purchase of longer-term Treasurys, although there was speculation that it would at some point. Your trading history contains many days with exceptional gains. I counted 34 days in which you made a return above 15%, 15 days with returns above 25%, and five days with returns above 50%.

Although my main focus was on technical analysis, I was still making fundamental trades, and those trades accounted for almost all the gains. Were you more attracted to technical trading than fundamental trading? Initially, I was. Why? I thought the firm wanted us to focus on becoming good technical traders. Was that because they didn’t want people to duplicate the same trades? Yes, it was because they wanted more diversification among their traders. So, was your initial focus on technical analysis a matter of trying to please your bosses? I think so. Also, because I was so naïve, I thought that if my boss could trade this way, so could I. He had a gift for intraday technical trading, which I didn’t. Did the firm give you an amount of money to trade?


pages: 354 words: 105,322

The Road to Ruin: The Global Elites' Secret Plan for the Next Financial Crisis by James Rickards

"World Economic Forum" Davos, Affordable Care Act / Obamacare, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Bayesian statistics, Bear Stearns, behavioural economics, Ben Bernanke: helicopter money, Benoit Mandelbrot, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bitcoin, Black Monday: stock market crash in 1987, Black Swan, blockchain, Boeing 747, Bonfire of the Vanities, Bretton Woods, Brexit referendum, British Empire, business cycle, butterfly effect, buy and hold, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, cellular automata, cognitive bias, cognitive dissonance, complexity theory, Corn Laws, corporate governance, creative destruction, Credit Default Swap, cuban missile crisis, currency manipulation / currency intervention, currency peg, currency risk, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, debt deflation, Deng Xiaoping, disintermediation, distributed ledger, diversification, diversified portfolio, driverless car, Edward Lorenz: Chaos theory, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, fiat currency, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, Fractional reserve banking, G4S, George Akerlof, Glass-Steagall Act, global macro, global reserve currency, high net worth, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Isaac Newton, jitney, John Meriwether, John von Neumann, Joseph Schumpeter, junk bonds, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, Long Term Capital Management, low interest rates, machine readable, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, Minsky moment, Money creation, money market fund, mutually assured destruction, Myron Scholes, Naomi Klein, nuclear winter, obamacare, offshore financial centre, operational security, Paul Samuelson, Peace of Westphalia, Phillips curve, Pierre-Simon Laplace, plutocrats, prediction markets, price anchoring, price stability, proprietary trading, public intellectual, quantitative easing, RAND corporation, random walk, reserve currency, RFID, risk free rate, risk-adjusted returns, Robert Solow, Ronald Reagan, Savings and loan crisis, Silicon Valley, sovereign wealth fund, special drawing rights, stock buybacks, stocks for the long run, tech billionaire, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transfer pricing, value at risk, Washington Consensus, We are all Keynesians now, Westphalian system

At the CIA, the potential to apply Bayesian probability to forecasting in capital markets was obvious. Intelligence analysis involves forecasting events based on scarce information. If information were plentiful, you would not need spies. Investors face the same problem in allocating portfolios among asset classes. They lack sufficient information as prescribed by normal statistical methods. By the time they do have enough data to achieve certainty, the opportunity to profit has been lost. Bayes’ theorem is messy, but still it’s better than nothing. It’s also better than Wall Street regressions that miss the new and unforeseen.

The most sensational snowflake may be a publicized failure to deliver physical gold by a prominent bank. This will shock markets the way mortgage fund defaults did in 2007. A gold-buying panic, super-spike in gold prices, and ripple effects in other markets are predictable outcomes of such a failure. Gold is the world’s least understood asset class. Confusion arises because gold is traded like a commodity, yet gold is not a commodity, it is money. Countries with tens of thousands of tons of gold in their vaults are happy to obscure this distinction. Central banks know gold is money; they just don’t want you to know. Still, the presence of 35,000 tons of gold in government vaults, about 15 percent of all the gold mined in history, testifies to gold’s monetary role despite official denials.

A few more mega-asset aggregators—MetLife, Prudential, and BlackRock—are also in the government’s crosshairs. The fact that their clients’ wealth is digital makes confiscation and control for reasons of state even easier. The next financial crisis will not be merely a bigger version of the 1998 and 2008 crises. It will be qualitatively different. It will encompass multiple asset classes on a global scale. It will exhibit inflation not seen since the 1970s, insolvency not seen since the 1930s, and exchange shutdowns not seen since 1914. State power will be summoned to contain panic. Liquidity will come from the IMF as directed by the G20, including a large voice for China. Capitalism will be discredited once and for all.


pages: 197 words: 53,831

Investing to Save the Planet: How Your Money Can Make a Difference by Alice Ross

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, An Inconvenient Truth, barriers to entry, British Empire, carbon footprint, carbon tax, circular economy, clean tech, clean water, coronavirus, corporate governance, COVID-19, creative destruction, decarbonisation, diversification, Elon Musk, energy transition, Extinction Rebellion, family office, food miles, Future Shock, global pandemic, Goldman Sachs: Vampire Squid, green transition, Greta Thunberg, high net worth, hiring and firing, impact investing, Intergovernmental Panel on Climate Change (IPCC), Jeff Bezos, lockdown, low interest rates, Lyft, off grid, oil shock, passive investing, Peter Thiel, plant based meat, precision agriculture, risk tolerance, risk/return, sharing economy, Silicon Valley, social distancing, sovereign wealth fund, TED Talk, Tragedy of the Commons, uber lyft, William MacAskill

The divestment debate outside of equities So far, much of our discussion has focused on divesting from equities. But a growing number of investors think that divestment has far more effect if it takes place in other asset classes, like bonds. They take the view, discussed earlier in this chapter, that divestment won’t harm share prices, believing that more concrete action needs to be taken in other asset classes. Cambridge University, for example, has not divested its £8bn endowment fund despite plenty of pressure to do so from students and faculty members alike. Dr Ellen Quigley, an adviser on responsible investment to the university’s chief financial officer, argues that divestment from public equity – in shares that anyone can buy and sell – is a waste of time when it comes to affecting company behaviour.

Dr Ellen Quigley, an adviser on responsible investment to the university’s chief financial officer, argues that divestment from public equity – in shares that anyone can buy and sell – is a waste of time when it comes to affecting company behaviour. Worse than that, she argues, it can be harmful. Most divestment, she says, only concerns share portfolios rather than other asset classes, so it can be little more than a box-ticking exercise for trustees to feel that they have done their environmental due diligence. She warns: ‘Divestment concentrates on public equity on the secondary market which doesn’t matter as the company already raised the money. Very few funds apply divestment to other asset classes where it matters – so we’re just rearranging deckchairs on the Titanic. People think job done and don’t think about it any more: it actually keeps people from being useful so it’s worse than nothing.’

‘The most direct impact an investor can make is to invest in green infrastructure of some kind,’ says Mark Fulton, chair of the research council at think tank Carbon Tracker. ‘That can be achieved by capital recycling from high-carbon to low-carbon across asset classes.’ James Purcell, head of ESG at Quintet, a Swiss private bank, says: ‘All these companies issued their capital decades ago and as retail investors we just move around pieces of paper that were issued decades ago. We’re merely passing it around in a circle.’ The asset class where it really matters, Quigley believes, is the bond market. There are other ways to harm a company financially beyond selling its shares, and a key way is to cut off its access to financing.


pages: 303 words: 84,023

Heads I Win, Tails I Win by Spencer Jakab

Alan Greenspan, Asian financial crisis, asset allocation, backtesting, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, book value, business cycle, buy and hold, collapse of Lehman Brothers, correlation coefficient, crowdsourcing, Daniel Kahneman / Amos Tversky, diversification, dividend-yielding stocks, dogs of the Dow, Elliott wave, equity risk premium, estate planning, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, fear index, fixed income, geopolitical risk, government statistician, index fund, Isaac Newton, John Bogle, John Meriwether, Long Term Capital Management, low interest rates, Market Wizards by Jack D. Schwager, Mexican peso crisis / tequila crisis, money market fund, Myron Scholes, PalmPilot, passive investing, Paul Samuelson, pets.com, price anchoring, proprietary trading, Ralph Nelson Elliott, random walk, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, Robert Shiller, robo advisor, Savings and loan crisis, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, subprime mortgage crisis, survivorship bias, technology bubble, transaction costs, two and twenty, VA Linux, Vanguard fund, zero-coupon bond, zero-sum game

If you boost the rate of return, then even more astronomical sums are possible over shorter periods. The Economist magazine wrote a story in 2000 about Felicity Foresight, a fictional investor born at the turn of the twentieth century who started with one dollar and put her money into the single best-performing asset class in the world each year. A trillionaire by her thirties, she had a fictional fortune of $9,607,190,781,673,150,000 ($9.6 quintillion) at age one hundred. What if someone had the reverse Midas touch? Choosing the single worst investment each year would get you down to some fraction of a cent pretty quickly, of course, but how about mere bad timing?

The typical cost of a fee-only advisor—one whose interests should be aligned with yours in growing your nest egg—is 1 percent of assets annually. Whoever does it for you, and as attractive as an optimized portfolio sounds, there’s often a catch when you think you’re getting something for nothing. At times of severe market stress such as the 2008 financial crisis such attempts at diversification were dubbed “de-worse-ification” as market panic became an equal-opportunity destroyer of assets. People and institutions under the impression that they were insulated from wild market gyrations suffered with everyone else and often sold near the bottom, whether out of necessity or panic. Stocks aren’t quite the magical money machine that the Dow 36,000 authors make them out to be.

., 219–20, 229 Pagel, Michaela, 217 PalmPilots, 185 Parness, Michael, 210–13, 215 passive investing, 23, 41, 56, 115, 158–60, 166, 180, 219–20, 256–57 Paulson, John, 235 pension funds, 158, 174, 187–88 Pentagon, 145–46 pharmaceutical companies, 85–87, 89, 188 Philip Morris, 189–89 Phillips, Don, 152 portfolios, 12, 22–23, 56, 96, 191, 195 advice on, 27, 52–53, 62–64, 81–84 and cash, 50, 52, 63, 117 diversification of, 81–84, 95 equal-weighted, 136, 224–25 growth of, 38, 63–64, 76, 83 and market decline, 50, 52–54, 76 monitoring of, 217–18, 229 “monkey,” 106–9, 112, 225 randomly picked, 108, 225–26 rebalancing of, 38, 62–64, 74, 78–79, 82, 94–95, 249–50, 257 and risk taking, 74, 76, 156, 257 “robo,” 250 volatility of, 62–63, 81, 220 PowerShares FTSE RAFI US 1000, 223–24 Prechter, Robert, 124–25, 128, 143 price-to-book value, 193, 195 price-to-earnings (P/E) ratio, 89–95, 139–40, 145, 193, 219–20.


pages: 205 words: 55,435

The End of Indexing: Six Structural Mega-Trends That Threaten Passive Investing by Niels Jensen

Alan Greenspan, Basel III, Bear Stearns, declining real wages, deglobalization, disruptive innovation, diversification, Donald Trump, driverless car, eurozone crisis, falling living standards, fixed income, full employment, Greenspan put, income per capita, index fund, industrial robot, inflation targeting, job automation, John Nash: game theory, liquidity trap, low interest rates, moral hazard, offshore financial centre, oil shale / tar sands, old age dependency ratio, passive investing, Phillips curve, purchasing power parity, pushing on a string, quantitative easing, regulatory arbitrage, rising living standards, risk free rate, risk tolerance, Robert Solow, secular stagnation, South China Sea, total factor productivity, working-age population, zero-sum game

Such a simplistic approach would imply that those asset classes that have risen the most in value will also fall the most, but things are not that simple. Which distinctly British asset class do you think has offered the most attractive returns over the past decade? Central London property? Not even close, even if it has done rather well. UK farmland is the answer, having more than tripled in value over the last decade which will otherwise not be remembered for its outsized returns. The simplistic approach referred to above would therefore imply that British farmland is the most exposed asset class there is. However, as I pointed out in chapter 6, the rise of the East will most likely lead to a massive increase globally in the demand for food products, which could benefit farmland prices in the UK.

As far as the US is concerned, the median family owns next to no bonds and only a limited amount of equities, so the only asset class that matters to them in terms of establishing how wealthy they are is the value of the family home. This picture varies from country to country but, at least as far as the UK is concerned, I wouldn’t reach a dramatically dissimilar conclusion. That doesn’t at all imply that bonds and equities don’t matter. Of course they do, but falling bond and equity prices will only have a limited impact on the average American or British family, whereas falling property prices will do significant damage. This becomes important in the context of how I expect those three asset classes to respond to my expected drive towards mean reversion of wealth-to-GDP.

In the first few years following the Global Financial Crisis, many investors also looked to hedge funds to bail them out, but hedge funds have mostly disappointed. The combination of low returns and high fees has been a major turnoff for many. Consequently, equities have become the only game in town for many investors, driving ever larger pools of capital to this asset class, and that has obviously had an impact on equity valuations. One could therefore – with some right – argue that, as things stand (i.e. with interest rates as low as they are), using past valuation comparisons as your starting point is not necessarily valid when making a call on current valuations.


pages: 402 words: 110,972

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

"World Economic Forum" Davos, AI winter, Alan Greenspan, algorithmic trading, AOL-Time Warner, Apollo 11, asset allocation, banking crisis, barriers to entry, Bear Stearns, Big bang: deregulation of the City of London, Bob Litterman, book value, business cycle, butter production in bangladesh, butterfly effect, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Charles Babbage, citizen journalism, collateralized debt obligation, Cornelius Vanderbilt, corporate governance, Craig Reynolds: boids flock, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, electricity market, Emanuel Derman, en.wikipedia.org, experimental economics, fake news, financial engineering, financial innovation, fixed income, Ford Model T, Gordon Gekko, Hans Moravec, Herman Kahn, implied volatility, index arbitrage, index fund, information retrieval, intangible asset, Internet Archive, Ivan Sutherland, Jim Simons, John Bogle, John Nash: game theory, Kenneth Arrow, load shedding, Long Term Capital Management, machine readable, machine translation, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, Metcalfe’s law, military-industrial complex, moral hazard, mutually assured destruction, Myron Scholes, natural language processing, negative equity, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Metcalfe, Ronald Reagan, Rubik’s Cube, Savings and loan crisis, semantic web, Sharpe ratio, short selling, short squeeze, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, stock buybacks, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, tontine, too big to fail, transaction costs, Turing machine, two and twenty, Upton Sinclair, value at risk, value engineering, Vernor Vinge, Wayback Machine, yield curve, Yogi Berra, your tax dollars at work

Structural Ideas for the Economic Rescue 309 A Capital Market for Home Equity Fractional Interest Securities The HEFI security represents a passive investor interest in a home— just as a share of stock represents a passive investment in a company. Institutional investors such as pension and endowment funds would be interested in HEFIs to achieve diversification beyond stocks and bonds. The single-family, owner-occupied (SFOO) equity asset class is as large as the entire U.S. stock market, around $10 trillion. To be properly diversified, institutional investors should hold about as much in the SFOO equity asset class as they do in stocks. Institutional investors acknowledge interest in these assets. Right now there is no practical way for institutional investors to invest in SFOO equity; HEFIs and a HEFI trading market would change this unhappy situation by creating a practical way for them to take part in this market.

Figure 8.3 revisits the idea of maximizing predictability introduced in Chapter 5 and is a high-level perspective on maximizing predictability in finance.4 To expand on the previous discussion, the key point is that there are three central decisions to make in financial prediction: 1. What to predict. You can choose to predict the returns to an asset class, such as a broad market or industry group, an exchange rate, interest rates, or returns to individual securities of many types. Financial and Economic Data WHAT we predict WITH Figure 8.3 Prediction Method Returns, Spreads HOW we predict WHAT we predict Maximizing Predictability: Three Places to Look Perils and Pr omise of Evolutionary Computation on Wall Str eet 191 There is also money to be made by predicting the return differences (spreads) between individual securities or groups of securities.

For example, a manager who outperformed the S&P index by between 2 percent and 3 percent year in and year out, with very little variation from year to year, would have a much better information ratio than another manager with the same average +2.5 percent performance, but with large differences from year to year. The diversification provided by the larger numbers of stocks in the portfolios of quantitatively managed funds often results in a higher information ratio than their traditionally managed counterparts. A Gentle Intr oduction to Computerized Investing 117 What Do Quantitative Managers Do? What are these people with the computers doing if they haven’t gone and kicked the tires and had lunch with the CEO?


pages: 935 words: 267,358

Capital in the Twenty-First Century by Thomas Piketty

accounting loophole / creative accounting, Asian financial crisis, banking crisis, banks create money, Berlin Wall, book value, Branko Milanovic, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, carbon tax, central bank independence, centre right, circulation of elites, collapse of Lehman Brothers, conceptual framework, corporate governance, correlation coefficient, David Ricardo: comparative advantage, demographic transition, distributed generation, diversification, diversified portfolio, European colonialism, eurozone crisis, Fall of the Berlin Wall, financial intermediation, full employment, Future Shock, German hyperinflation, Gini coefficient, Great Leap Forward, high net worth, Honoré de Balzac, immigration reform, income inequality, income per capita, index card, inflation targeting, informal economy, invention of the steam engine, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Arrow, low interest rates, market bubble, means of production, meritocracy, Money creation, mortgage debt, mortgage tax deduction, new economy, New Urbanism, offshore financial centre, open economy, Paul Samuelson, pension reform, power law, purchasing power parity, race to the bottom, randomized controlled trial, refrigerator car, regulatory arbitrage, rent control, rent-seeking, Robert Gordon, Robert Solow, Ronald Reagan, Simon Kuznets, sovereign wealth fund, Steve Jobs, Suez canal 1869, Suez crisis 1956, The Nature of the Firm, the payments system, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, trade liberalization, twin studies, very high income, Vilfredo Pareto, We are the 99%, zero-sum game

Furthermore, property taxes in some countries (such as the United States) rely on fairly sophisticated assessment procedures with automatic adjustment to changing market values, procedures that ought to be generalized and extended to other asset classes. In some European countries (including France, Switzerland, Spain, and until recently Germany and Sweden), there are also progressive taxes on total wealth. Superficially, these taxes are closer in spirit to the ideal capital tax I am proposing. In practice, however, they are often riddled with exemptions. Many asset classes are left out, while others are assessed at arbitrary values having nothing to do with their market value. That is why several countries have moved to eliminate such taxes. it is important to heed the lessons of these various experiences in order to design an appropriate capital tax for the century ahead.

When comparing very different societies and periods, we must avoid trying to sum everything up with a single figure, for example “the standard of living in society A is ten times higher than in society B.” When growth attains levels such as these, the notion of per capita output is far more abstract than that of population, which at least corresponds to a tangible reality (it is much easier to count people than to count goods and services). Economic development begins with the diversification of ways of life and types of goods and services produced and consumed. It is thus a multidimensional process whose very nature makes it impossible to sum up properly with a single monetary index. Take the wealthy countries as an example. In Western Europe, North America, and Japan, average per capita income increased from barely 100 euros per month in 1700 to more than 2,500 euros per month in 2012, a more than twentyfold increase.10 The increase in productivity, or output per hour worked, was even greater, because each person’s average working time decreased dramatically: as the developed countries grew wealthier, they decided to work less in order to allow for more free time (the work day grew shorter, vacations grew longer, and so on).11 Much of this spectacular growth occurred in the twentieth century.

Over a period of thirty to sixty years, there are significant differences between a growth rate of 0.1 percent per year (3 percent per generation), 1 percent per year (35 percent per generation), or 3 percent per year (143 percent per generation). It is only when growth statistics are compiled over very long periods leading to multiplications by huge factors that the numbers lose a part of their significance and become relatively abstract and arbitrary quantities. Growth: A Diversification of Lifestyles To conclude this discussion, consider the case of services, where diversity is probably the most extreme. In theory, things are fairly clear: productivity growth in the service sector has been less rapid, so that purchasing power expressed in terms of services has increased much less.


pages: 195 words: 63,455

Damsel in Distressed: My Life in the Golden Age of Hedge Funds by Dominique Mielle

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", activist fund / activist shareholder / activist investor, airline deregulation, Alan Greenspan, banking crisis, Bear Stearns, Black Monday: stock market crash in 1987, blood diamond, Boris Johnson, British Empire, call centre, capital asset pricing model, Carl Icahn, centre right, collateralized debt obligation, Cornelius Vanderbilt, coronavirus, COVID-19, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, family office, fear of failure, financial innovation, fixed income, full employment, glass ceiling, high net worth, hockey-stick growth, index fund, intangible asset, interest rate swap, John Meriwether, junk bonds, Larry Ellison, lateral thinking, Long Term Capital Management, low interest rates, managed futures, mega-rich, merger arbitrage, Michael Milken, Myron Scholes, Northpointe / Correctional Offender Management Profiling for Alternative Sanctions, offshore financial centre, Paul Samuelson, profit maximization, Reminiscences of a Stock Operator, risk free rate, risk tolerance, risk-adjusted returns, satellite internet, Savings and loan crisis, Sharpe ratio, Sheryl Sandberg, SoftBank, survivorship bias, Tesla Model S, too big to fail, tulip mania, union organizing

Being a good listener and open-minded, capable of boiling down complicated facts into simple explanations, negotiating and multitasking—that is what brings investors to coalesce around a plan of reorganization and out of bankruptcy. What goes for distressed investing, which was my primary specialty, goes for investing in general. Over the years, I invested in risk arbitrage, equities, interest rates, municipal bonds—you name the asset class, other than currencies and commodities. My conviction is that the job of investing is highly creative and that the qualities it requires are imagination, ingenuity, and guts. All qualities that women have in equal quantity with men. “Coopetition” During my first three years at Canyon, I was an executor rather than an investor, a position that I tolerated with the patience of a type A, top-of-her-class overachiever: poorly.

Chapter 5 Swimming in Opportunities I would not recommend throwing a novice hedge fund analyst into a devastating financial crisis, the sort that ruins industries, disrupts capital markets’ order, bankrupts countries, and threatens decades-old political systems. I merely encourage it. It builds character, polishes a contrarian mind, and sheds a completely new light on the meaning of downside. Ask any junior analyst to quantify the risk of a trade—any trade—that he is pitching, and regardless of the asset class, industry, market direction, hedging strategy, or economic stage, the answer you will get is, in my experience, 10 percent. Always. The human mind cannot conceive, and the human body cannot stomach, the pain of losing more than that. If you live through one or more economic earthquakes, however, you learn that it is a miracle to lose only that.

As a relative sense of measure, the average annual bankruptcy asset pool from 2003 to 2007 went back down almost ninefold to $75 billion. At the time, hedge funds were relatively small (the number of hedge funds grew from three thousand when I started to approximately twenty thousand today), and distressed funds as an asset class, were even smaller. Total hedge fund assets in 2001 were only $371 billion ($455 billion in 2002) while, by most accounts, merely $15 billion of those assets was dedicated to distressed hedge fund strategies. To put it another way, in 2002 there were sixteen times more assets in bankruptcy than investors able to rummage through them.


Alpha Trader by Brent Donnelly

Abraham Wald, algorithmic trading, Asian financial crisis, Atul Gawande, autonomous vehicles, backtesting, barriers to entry, beat the dealer, behavioural economics, bitcoin, Boeing 747, buy low sell high, Checklist Manifesto, commodity trading advisor, coronavirus, correlation does not imply causation, COVID-19, crowdsourcing, cryptocurrency, currency manipulation / currency intervention, currency risk, deep learning, diversification, Edward Thorp, Elliott wave, Elon Musk, endowment effect, eurozone crisis, fail fast, financial engineering, fixed income, Flash crash, full employment, global macro, global pandemic, Gordon Gekko, hedonic treadmill, helicopter parent, high net worth, hindsight bias, implied volatility, impulse control, Inbox Zero, index fund, inflation targeting, information asymmetry, invisible hand, iterative process, junk bonds, Kaizen: continuous improvement, law of one price, loss aversion, low interest rates, margin call, market bubble, market microstructure, Market Wizards by Jack D. Schwager, McMansion, Monty Hall problem, Network effects, nowcasting, PalmPilot, paper trading, pattern recognition, Peter Thiel, prediction markets, price anchoring, price discovery process, price stability, quantitative easing, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, reserve currency, risk tolerance, Robert Shiller, secular stagnation, Sharpe ratio, short selling, side project, Stanford marshmallow experiment, Stanford prison experiment, survivorship bias, tail risk, TED Talk, the scientific method, The Wisdom of Crowds, theory of mind, time dilation, too big to fail, transaction costs, value at risk, very high income, yield curve, you are the product, zero-sum game

(SPREAD) X (NUMBER OF UNITS) = TRANSACTION COST If AAPL is trading 350.00 / 350.08, the spread is eight cents. This is often expressed either as a percentage of the mid-price103 or in basis points: = 0.08 / 350.04 = 0.029% = 2.9bps104 2.9bps is one of the tightest bid/offer spreads you will see. Spreads vary dramatically by asset class and by product within an asset class. In FX, spreads in EURUSD (the most liquid pair) are often less than 1/10 of spreads in USDTRY (Turkish lira). The bid/ask in a small cap or microcap stock can be 50X the AAPL bid/ask. Gold trades way tighter than palladium. Spreads in credit are generally wider than spreads in fixed income.

Know the enemy and know yourself. SUN TZU I like that Sun Tzu quote for Chapter One of a book about trading because it has a cool circularity. In trading, the enemy and the self are one. You will not succeed in trading without self-awareness and discipline. The biggest challenge in trading is not choosing what asset class to trade, or when to buy and sell, or what percentage of your capital to risk on each trade. The biggest challenge in trading is to manage your self. You are a bundle of emotions, memories, history, knowledge, and bias. You can be smart and do stupid things. You can make a hard job impossible by making irrational and compulsive decisions.

As Daniel Boorstin once said: “I write to discover what I think.” 57 Sit down and do a deep dive into your trading journal every month or so. See if you can find meaningful takeaways. For example: Do you stick to your plan? Does your risk/reward at inception come close to your actual risk/reward. If not, why? Are there any consistent features of your good or bad trades? » Time horizon » Asset class » Conviction level Did you hit your stop loss more often than usual? This might be a sign that your positions are too big or the volatility regime has changed and you have not adapted. Once you have your takeaways, set one goal (or two at most) to address a leak or issue you have discovered.


pages: 669 words: 210,153

Tools of Titans: The Tactics, Routines, and Habits of Billionaires, Icons, and World-Class Performers by Timothy Ferriss

Abraham Maslow, Adam Curtis, Airbnb, Alexander Shulgin, Alvin Toffler, An Inconvenient Truth, artificial general intelligence, asset allocation, Atul Gawande, augmented reality, back-to-the-land, Ben Horowitz, Bernie Madoff, Bertrand Russell: In Praise of Idleness, Beryl Markham, billion-dollar mistake, Black Swan, Blue Bottle Coffee, Blue Ocean Strategy, blue-collar work, book value, Boris Johnson, Buckminster Fuller, business process, Cal Newport, call centre, caloric restriction, caloric restriction, Carl Icahn, Charles Lindbergh, Checklist Manifesto, cognitive bias, cognitive dissonance, Colonization of Mars, Columbine, commoditize, correlation does not imply causation, CRISPR, David Brooks, David Graeber, deal flow, digital rights, diversification, diversified portfolio, do what you love, Donald Trump, effective altruism, Elon Musk, fail fast, fake it until you make it, fault tolerance, fear of failure, Firefox, follow your passion, fulfillment center, future of work, Future Shock, Girl Boss, Google X / Alphabet X, growth hacking, Howard Zinn, Hugh Fearnley-Whittingstall, Jeff Bezos, job satisfaction, Johann Wolfgang von Goethe, John Markoff, Kevin Kelly, Kickstarter, Lao Tzu, lateral thinking, life extension, lifelogging, Mahatma Gandhi, Marc Andreessen, Mark Zuckerberg, Mason jar, Menlo Park, microdosing, Mikhail Gorbachev, MITM: man-in-the-middle, Neal Stephenson, Nelson Mandela, Nicholas Carr, Nick Bostrom, off-the-grid, optical character recognition, PageRank, Paradox of Choice, passive income, pattern recognition, Paul Graham, peer-to-peer, Peter H. Diamandis: Planetary Resources, Peter Singer: altruism, Peter Thiel, phenotype, PIHKAL and TIHKAL, post scarcity, post-work, power law, premature optimization, private spaceflight, QWERTY keyboard, Ralph Waldo Emerson, Ray Kurzweil, recommendation engine, rent-seeking, Richard Feynman, risk tolerance, Ronald Reagan, Salesforce, selection bias, sharing economy, side project, Silicon Valley, skunkworks, Skype, Snapchat, Snow Crash, social graph, software as a service, software is eating the world, stem cell, Stephen Hawking, Steve Jobs, Stewart Brand, superintelligent machines, TED Talk, Tesla Model S, The future is already here, the long tail, The Wisdom of Crowds, Thomas L Friedman, traumatic brain injury, trolley problem, vertical integration, Wall-E, Washington Consensus, We are as Gods, Whole Earth Catalog, Y Combinator, zero-sum game

As legendary hedge fund manager Ray Dalio told Tony Robbins (page 210): “It’s almost certain that whatever you’re going to put your money in, there will come a day when you will lose 50% to 70%.” It pays to remember that if you lose 50%, you need a subsequent 100% return to get back to where you started. That math is tough. So, how to de-risk your portfolio? Many investors “rebalance” across asset classes to maintain certain ratios (e.g., X% in bonds, Y% in stocks, Z% in commodities, etc.). If one asset class jumps, they liquidate a part of it and buy more of lower performing classes. There are pros and cons to this, but it’s common practice. From 2007 to 2009, during the Real-World MBA that taught me to angel invest (page 250), less than 15% of my liquid assets were in startups.

A lot of it is just how you look at the world, but most of it is really the process of diversification. I’m not going to worry about losing one friend if I have a hundred, but if I have two friends I’m really going to be worried. I’m not going to worry about losing my job because my one boss is going to fire me, because I have thousands of bosses at newspapers everywhere. One of the ways to not worry about stress is to eliminate it. I don’t worry about my stock picks because I have a diversified portfolio. Diversification works in almost every area of your life to reduce your stress.” Dilbert Hardware—What Scott Draws On Wacom Cintiq tablet The Logic of the Double or Triple Threat On “career advice,” Scott has written the following, which is slightly trimmed for space here.

In Money: Master the Game, Ray Dalio elaborated for Tony: “When people think they’ve got a balanced portfolio, stocks are three times more volatile than bonds. So when you’re 50/50, you’re really 90/10. You really are massively at risk, and that’s why when the markets go down, you get eaten alive. . . . Whatever asset class you invest in, I promise you, in your lifetime, it will drop no less than 50% and more likely 70% at some point. That is why you absolutely must diversify.” Contribution: “And the last one that I found: almost all of them were real givers, not just givers on the surface . . . but really passionate about giving. . . .


pages: 209 words: 53,175

The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by Morgan Housel

airport security, Amazon Web Services, Bernie Madoff, book value, business cycle, computer age, Cornelius Vanderbilt, coronavirus, discounted cash flows, diversification, diversified portfolio, do what you love, Donald Trump, financial engineering, financial independence, Hans Rosling, Hyman Minsky, income inequality, index fund, invisible hand, Isaac Newton, It's morning again in America, Jeff Bezos, Jim Simons, John Bogle, Joseph Schumpeter, knowledge worker, labor-force participation, Long Term Capital Management, low interest rates, margin call, Mark Zuckerberg, new economy, Paul Graham, payday loans, Ponzi scheme, quantitative easing, Renaissance Technologies, Richard Feynman, risk tolerance, risk-adjusted returns, Robert Gordon, Robert Shiller, Ronald Reagan, side hustle, Stephen Hawking, Steven Levy, stocks for the long run, tech worker, the scientific method, traffic fines, Vanguard fund, WeWork, working-age population

Confronted with the argument that few investors are prepared for rising interest rates because they’ve never experienced them—the last big period of rising interest rates occurred almost 40 years ago—he argued that it didn’t matter, because experiencing or even studying what happened in the past might not serve as any guide to what will happen when rates rise in the future: So what? Will the current rate hike look like the last one, or the one before that? Will different asset classes behave similarly, the same, or the exact opposite? On the one hand, people that have been investing through the events of 1987, 2000 and 2008 have experienced a lot of different markets. On the other hand, isn’t it possible that this experience can lead to overconfidence? Failing to admit you’re wrong?

Then pay attention to Google’s current product sales cycles and whether we’ll have a bear market. Are you a day trader? Then the smart price to pay is “who cares?” because you’re just trying to squeeze a few bucks out of whatever happens between now and lunchtime, which can be accomplished at any price. When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different. Take the dot-com bubble in the 1990s. People can look at Yahoo! stock in 1999 and say “That was crazy! A zillion times revenue! The valuation made no sense!”

Benjamin Graham is known as one of the greatest investors of all time, the father of value investing and the early mentor of Warren Buffett. But the majority of Benjamin Graham’s investing success was due to owning an enormous chunk of GEICO stock which, by his own admission, broke nearly every diversification rule that Graham himself laid out in his famous texts. Where does the thin line between bold and reckless fall here? I don’t know. Graham wrote about his GEICO bonanza: “One lucky break, or one supremely shrewd decision—can we tell them apart?” Not easily. We similarly think Mark Zuckerberg is a genius for turning down Yahoo!’


Manias, Panics and Crashes: A History of Financial Crises, Sixth Edition by Kindleberger, Charles P., Robert Z., Aliber

active measures, Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, Boeing 747, Bonfire of the Vanities, break the buck, Bretton Woods, British Empire, business cycle, buy and hold, Carmen Reinhart, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, Corn Laws, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cross-border payments, currency peg, currency risk, death of newspapers, debt deflation, Deng Xiaoping, disintermediation, diversification, diversified portfolio, edge city, financial deregulation, financial innovation, Financial Instability Hypothesis, financial repression, fixed income, floating exchange rates, George Akerlof, German hyperinflation, Glass-Steagall Act, Herman Kahn, Honoré de Balzac, Hyman Minsky, index fund, inflation targeting, information asymmetry, invisible hand, Isaac Newton, Japanese asset price bubble, joint-stock company, junk bonds, large denomination, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low interest rates, margin call, market bubble, Mary Meeker, Michael Milken, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, new economy, Nick Leeson, Northern Rock, offshore financial centre, Ponzi scheme, price stability, railway mania, Richard Thaler, riskless arbitrage, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, special drawing rights, Suez canal 1869, telemarketer, The Chicago School, the market place, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, very high income, Washington Consensus, Y2K, Yogi Berra, Yom Kippur War

The shocks in Japan in the 1980s were rapid increases in the supplies of money and of credit and financial liberalization that enabled the banks to increase their real estate loans at a rapid rate. The shock in the Nordic countries in the 1980s was financial liberalization, which permitted the domestic banks to borrow in the offshore market. One of the shocks the preceded the Asian financial crisis was the discovery of ‘emerging market equities as a new asset class’ which led to sharp increases in the purchases of these securities by mutual funds and pension funds headquartered in the United States, Britain, and other industrial countries. The shock in the United States in the 1990s was the revolution in information technology and the sharp declines in the costs of communication.

The East Asian economic miracle and the bubble in emerging-market equities Four innovations contributed to the surge in property prices and real estate prices in Mexico, Thailand, and other emerging-market countries in the early 1990s. The funding of the overhang of bank loans into Brady bonds, which effectively removed these countries from their bankruptcy – and they were re-christened as emerging markets. The discovery of ‘emerging market equities as a new asset class’, index-based mutual funds and pension funds began to acquire these stocks. The expectation was that these countries would industrialize at a rapid rate, and corporate profits would surge. Privatization of government-owned firms in resource extraction, communications, manufacturing, and other industries led to a surge in money inflows.

Many of the once-developing countries were re-labeled emerging-market countries in the early 1990s after the overhang of past-due bank loans were funded into long-term bonds under the Brady plan. Some bright investment banker came up with the very profitable idea that emerging market equities were a new ‘asset class’. Every pension fund and every mutual fund that was following an index fund approach toward developing a global portfolio believed it had to acquire stocks that were available in these countries; the sales spiel was that the rates of return would be higher than the rates of return on equities available in the industrial countries because their rates of economic growth were higher.


pages: 241 words: 81,805

The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis by Tim Lee, Jamie Lee, Kevin Coldiron

active measures, Alan Greenspan, Asian financial crisis, asset-backed security, backtesting, bank run, Bear Stearns, Bernie Madoff, Bretton Woods, business cycle, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, currency risk, debt deflation, disinformation, distributed ledger, diversification, financial engineering, financial intermediation, Flash crash, global reserve currency, implied volatility, income inequality, inflation targeting, junk bonds, labor-force participation, Long Term Capital Management, low interest rates, Lyft, margin call, market bubble, Money creation, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, negative equity, Network effects, Ponzi scheme, proprietary trading, public intellectual, purchasing power parity, quantitative easing, random walk, rent-seeking, reserve currency, rising living standards, risk free rate, risk/return, sharing economy, short selling, short squeeze, sovereign wealth fund, stock buybacks, tail risk, TikTok, Uber and Lyft, uber lyft, yield curve

The expansion of carry trades always increases liquidity; the reduction or closing of carry trades leads to liquidity contraction. “Liquidity” can be a slippery concept, and the word is typically used in two ways. From a trading perspective, liquidity refers to the ease of transacting. An asset that is liquid can be traded quickly and cheaply and in sizable amounts. When carry trading expands in a certain asset class, that asset becomes, or at least appears to become, more liquid. There is also a volume perspective; from this perspective, liquidity refers to the amount of money or money-like instruments in 4 THE RISE OF CARRY an economy. From this viewpoint, liquidity is related to the ease of obtaining credit and the availability of money in the economy, which is a fundamental driver of economic growth over the business cycle.

The risk-return trade-off appears good, but the strategy does not generate high enough levels of absolute returns. The “solution” is often to apply more leverage. This can generate higher abso- THE RISE OF CARRY 50 lute returns but, of course, comes with the trade-off of potentially much higher risk. In order to provide a set of returns that we can compare with familiar asset classes, we chose a leverage level of 1,000 percent ($5 short and $5 long for every $1 of capital). This produces an annualized risk of around 15 percent, similar to what has been experienced for the S&P 500. While this level of leverage might seem high, it is certainly achievable in currency markets given typical collateral requirements for currency forwards.

However, the later extended period of flat returns combined with a great deal more attention to the strategy might be making some practitioners reconsider currency carry’s long-term viability. Losses Occur During Bad Times An underlying theme of this book is that carry strategies have grown in size, spreading from the currency markets to other asset classes. Because carry 52 THE RISE OF CARRY strategies are short volatility and because spikes in volatility happen during financial crises, losses from carry strategies will occur in large scale and at very inopportune times. This history of currency carry therefore gives us an opportunity to look in more detail at the pattern of returns that carry portfolios generate.


pages: 586 words: 159,901

Wall Street: How It Works And for Whom by Doug Henwood

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, affirmative action, Alan Greenspan, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, bond market vigilante , book value, borderless world, Bretton Woods, British Empire, business cycle, buy the rumour, sell the news, capital asset pricing model, capital controls, Carl Icahn, central bank independence, computerized trading, corporate governance, corporate raider, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, currency risk, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, disinformation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial engineering, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, Glass-Steagall Act, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, information asymmetry, interest rate swap, Internet Archive, invisible hand, Irwin Jacobs, Isaac Newton, joint-stock company, Joseph Schumpeter, junk bonds, kremlinology, labor-force participation, late capitalism, law of one price, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, long and variable lags, Louis Bachelier, low interest rates, market bubble, Mexican peso crisis / tequila crisis, Michael Milken, microcredit, minimum wage unemployment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, oil shock, Paul Samuelson, payday loans, pension reform, planned obsolescence, plutocrats, Post-Keynesian economics, price mechanism, price stability, prisoner's dilemma, profit maximization, proprietary trading, publication bias, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Savings and loan crisis, selection bias, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, stock buybacks, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

Treasury bond and buying shares of Matsushita in its place, or between a multinational corporation's taking its profits in German marks and shipping them back to headquarters in London. Now, however, hedge funds, pension funds, and other institutional investors have increasingly been treating foreign exchange as an asset class in itself, separate from any underlying stock or bond (Bank for International Settlements 1993, p. 7). That means that trading in money itself, rather than monetary claims on underlying real assets, is now one of the most fashionable strategies available to big-time plungers. Trade in foreign currencies is ancient — and not only in coins and bills, but in financial exotica.

African, stocks vs. bonds, various kinds of stocks (by industrial sector, by size of underlying company, by various financial measures like price/earnings ratios) or bonds (government vs. corporate, high-quality corporate vs. low-, long-term vs. short-), and so on. Over the very long term stocks greatly outperform any other asset class, but most people don't care about the long term; they want to be in today's hot sector, the day after tomorrow be damned. While stocks do outperform over the very long term, it's not really clear why; their performance can't be explained by most conventional financial models (Mehra and Prescott 1985; Siegel 1992).

Wall Street apologists might point to attempts to ride emerging long-term trends — biotech, the Internet — with both great risk and promise, but the Street is often wrong about these things; they're far more passions of the moment than ENSEMBLE they are serious, detached prognostications. Talk of structural transformations is often just part of the sales rhetoric, a way to hawk a fresh asset class or defend a favored old one. Few people pay as much attention to the business cycle as Wall Streeters — understandable, given the chart patterns around cyclical turning points. But understanding the cycle isn't enough; it's also tempting to catch deviations from the cycle — "growth recesssions," "soft landings," and the like.


pages: 464 words: 117,495

The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management by Alexander Elder

additive manufacturing, Atul Gawande, backtesting, behavioural economics, Benoit Mandelbrot, buy and hold, buy low sell high, Checklist Manifesto, computerized trading, deliberate practice, diversification, Elliott wave, endowment effect, fear index, loss aversion, mandelbrot fractal, margin call, offshore financial centre, paper trading, Ponzi scheme, price stability, psychological pricing, quantitative easing, random walk, Reminiscences of a Stock Operator, risk tolerance, short selling, South Sea Bubble, systematic trading, systems thinking, The Wisdom of Crowds, transaction costs, transfer pricing, traveling salesman, tulip mania, zero-sum game

Their commissions are similar to those for regular contracts, taking a proportionately bigger bite from each trade. Their slippage tends to be bigger due to lower volumes. The exceptions are stock index futures, where mini contracts have higher volumes than regular ones. ■ 47. Forex The currency market is the largest asset class in the world by trading volume, with a turnover of over $4 trillion per day. Currencies trade around the clock—from 20:15 GMT on Sunday to 22 GMT on Friday, stopping only on weekends. While some currency trades serve the hedging needs of importers and exporters, most transactions are speculative.

These actions reveal that something very positive or negative is about to happen. A stock is likely to rise if three insiders buy in one month and to fall if three insiders sell within a month. Clusters of insider buying tend to have a better predictive value than clusters of selling. That's because insiders are willing to sell a stock for many reasons (diversification, buying a second home, sending a kid to college) but they are willing to buy for one main reason—they expect their company's stock to go up. Short Interest While the numbers of futures and options contracts held long and short is equal by definition, in the stock market there is always a huge disparity between the two camps.

A few days later, stock B hits its stop. Stock E still looks attractive. May he buy it? No, since he already lost 2% on stock B and has a 4% exposure to risk in stocks C and D. Adding another position at this time would expose him to more than 6% risk per month. Three open trades isn't a lot of diversification. If you wish to make more trades, set your risk per trade at less than 2%. For example, if you risk only 1% of your account equity on any trade, you may open up to six positions before maxing out at the 6% limit. In trading a large account, I use the 6% Rule but tighten the 2% Rule to well under 1%.


pages: 459 words: 118,959

Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff by Christine S. Richard

activist fund / activist shareholder / activist investor, Alan Greenspan, Asian financial crisis, asset-backed security, banking crisis, Bear Stearns, Bernie Madoff, Blythe Masters, book value, buy and hold, Carl Icahn, cognitive dissonance, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, electricity market, family office, financial innovation, fixed income, forensic accounting, glass ceiling, Greenspan put, Long Term Capital Management, market bubble, money market fund, moral hazard, old-boy network, Pershing Square Capital Management, Ponzi scheme, profit motive, Savings and loan crisis, short selling, short squeeze, statistical model, stock buybacks, subprime mortgage crisis, white flight, zero-sum game

The fund manager from Neuberger Berman was long gone, and the building was nearly deserted on that summer evening. Ackman talked with Gold about the company’s business of guaranteeing collateralized-debt obligations (CDOs), a business that Budnick described as “booming.” CDOs were Wall Street’s favorite new asset class. The securities are built out of pools of securities rather than pools of loans. Otherwise, CDOs work on the same waterfall principle as simpler asset-backed bonds. MBIA was backing lots of CDOs at what it called “super-senior levels,” the most senior or highest levels of a CDO securitization. These super-senior exposures were considered better than triple-A because they had a greater cushion to absorb losses than what the rating companies believed was necessary to achieve triple-A performance.

The Open Source Model produced performance projections for all 524 ABS CDOs created between 2005 and 2007, indicating they would result in probable losses for the entire market of $231 billion, with super-senior tranches alone losing $92 billion. This disastrous outcome was the result of a basic flaw in the assumptions used to securitize mortgages. Credit-rating companies insisted on diversification: a range of loan originators and servicers, wide geographical distribution, and various loan sizes. Ideally, the diversity protected investors from being exposed to loans that would all come under pressure for the same reason. What the credit-rating companies had overlooked was the time frame, or the so-called vintage, in which the loans were made.

Vintage turned out to be the single most important factor in the performance of many loans. Loans made in 2006 and 2007 were made to people who borrowed as much as they could to purchase houses they couldn’t afford when prices were peaking. The credit-rating companies and bond insurers mistakenly assumed that even more diversification was created when mortgage-backed securities were pooled into CDOs. Yet the CDOs were backed by securities all created around the same time, containing mortgages that all originated around the same time. The CDOs perfectly captured the risk that had spread across the housing market of inflated home values and borrowers lying to get into mortgages they couldn’t afford.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

Alan Greenspan, Alvin Roth, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, benefit corporation, Bernie Madoff, buy and hold, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, democratizing finance, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial engineering, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, Great Leap Forward, Ida Tarbell, income inequality, information asymmetry, invisible hand, John Bogle, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Myron Scholes, Nelson Mandela, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, Right to Buy, road to serfdom, Robert Shiller, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, social contagion, Steven Pinker, tail risk, telemarketer, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, zero-sum game, Zipcar

Suppose they each package part of their mortgages into AAA securities and swap the securities with one another: each thus holds mortgages that the other originated—in the new, securitized form. You might think that nothing essential has changed. But think again. Because capital requirements are based on risk-weighted assets, and because the securities fall into a di erent asset class than the underlying mortgages, the e ect is to loosen regulation and allow the banks to lend more. You might ask, how could regulators be so stupid as not to see the potential for disaster here? They were not stupid. But they were operating on the assumption that the rating agencies were infallible—an assumption that they did not feel it was within their purview to examine, as they did not regulate the rating agencies.

Chevalier and Ellison (1999). 8. Li et al. (2008). 9. That is, among the individuals inducted into the army between 1982 and 2001, those who had higher IQ scores had higher Sharpe ratios for their 2000 portfolios, controlling for other factors, re ecting greater exposure to small-cap and value stocks and better diversification. Grinblatt et al. (2011). 10. Kat and Menexe (2003). 11. Kaplan and Schoar (2005). 12. Berk and Green (2004). 13. Bogle (2009): 47. 14. Levine (1997). 15. French (2008). 16. Goetzmann et al. (2002). 17. Dugan et al. (2002). 18. Dugan (2005). 19. Acharya et al. (2010). 20. Kaufman (2005): 313. 21.

See also financial institutions investment managers: choosing, 29; compensation, 28, 32–34; competition among, 30–32; deceptive games, 34–36; definition of, 27; fees, 28, 34; integrity, 35, 36–37; intelligence, 31; performance, 28–29, 30–32, 34–35; personal portfolios, 28; public hostility toward, 28; regulation of, 35–36; responsibilities, 27–28, 225; risks taken, 34, 35; social benefits, 36; trustees, 119–20; university endowments, 31. See also mutual funds investments: broadening ownership, 214–15; diversification, 28, 29; foreign direct, 229; liquidity, 144; moral hazard, 40–41 investors: information available to, 41–42; institutional, 25, 43; limited liability, 174–75; in mutual funds, 29; venture capital firms, 24–25 Iowa Electronic Markets, 61 IPOs. See initial public offerings Islamic law, 157 Israel, lawyers in, 82, 83 Ives, Charles, 136 Ives & Myrick, 136 Japan: accounting regulators, 101; lawyers, 83; mortgage securitization, 245n6 (Chapter 5) Jayachandran, Seema, 158 Jayadev, Arjun, 12 Jewish law, 83, 157 JOBS Act, 48 John Muir & Co., 137–38 Joseph, Jane E., 140 Jung, Jeeman, 185–86 Kahneman, Daniel, 160, 161 Kaplan, Steven N., 31 Kat, Harry, 31 Kaufman, Henry, 36 Keloharju, Matti, 31 Kelso, Louis O., 215–16 Kendall, Maurice, 169 Keynes, John Maynard, 169, 172 kidney transplants, market for, 69–70 kiva.org, 44 Kleiner, Morris M., 95 Koons, Jeff, 136–37 Korobov, Vladimir, 166, 193 Kranton, Rachel E., 215 Kremer, Michael, 71, 158 Krueger, Alan B., 95 Kuznets, Simon, 94 labor unions.


pages: 268 words: 64,786

Cashing Out: Win the Wealth Game by Walking Away by Julien Saunders, Kiersten Saunders

barriers to entry, basic income, Big Tech, Black Monday: stock market crash in 1987, blockchain, COVID-19, cryptocurrency, death from overwork, digital divide, diversification, do what you love, Donald Trump, estate planning, financial independence, follow your passion, future of work, gig economy, glass ceiling, global pandemic, index fund, job automation, job-hopping, karōshi / gwarosa / guolaosi, lifestyle creep, Lyft, microaggression, multilevel marketing, non-fungible token, off-the-grid, passive income, passive investing, performance metric, ride hailing / ride sharing, risk tolerance, Salesforce, side hustle, TaskRabbit, TED Talk, Uber and Lyft, uber lyft, universal basic income, upwardly mobile, Vanguard fund, work culture , young professional

This means investment opportunities such as cryptocurrencies, IPOs, and individual stock holdings can and should occupy a greater percentage of your total wealth. As we explained in chapter 3, once your income has fulfilled its purpose of providing flexibility, a good rule of thumb is to begin allocating 5 percent of your net worth to invest in emerging or riskier asset classes. This approach to diversification can accelerate you into financial independence sooner, and from there you have the option to reallocate even further. richuals Think of investing like financial hygiene. Consistency matters. If you’re a reasonably clean person, it’s safe to assume you wake up and brush your teeth and perform a long list of other grooming habits.

Think of the people you see selling water on the sidewalk outside a stadium on a hot day. In a digital world, arbitrage could mean buying locally sourced goods on Craigslist and reselling them on eBay, or buying an existing product wholesale and selling it on Amazon. Arbitrage opportunities exist everywhere, in all asset classes. From hawking a pair of kicks or upselling baseball cards, to trading stocks or offering vacation rentals, you have many opportunities to make considerable profits. The upside with arbitrage is its scalability. Unlike a gig opportunity, arbitrage can start as a side hustle and become something that generates full-time income without you needing to work around the clock.


pages: 586 words: 160,321

The Euro and the Battle of Ideas by Markus K. Brunnermeier, Harold James, Jean-Pierre Landau

"there is no alternative" (TINA), Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, banking crisis, battle of ideas, Bear Stearns, Ben Bernanke: helicopter money, Berlin Wall, Bretton Woods, Brexit referendum, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, collective bargaining, credit crunch, Credit Default Swap, cross-border payments, currency peg, currency risk, debt deflation, Deng Xiaoping, different worldview, diversification, Donald Trump, Edward Snowden, en.wikipedia.org, Fall of the Berlin Wall, financial deregulation, financial repression, fixed income, Flash crash, floating exchange rates, full employment, Future Shock, German hyperinflation, global reserve currency, income inequality, inflation targeting, information asymmetry, Irish property bubble, Jean Tirole, Kenneth Rogoff, Les Trente Glorieuses, low interest rates, Martin Wolf, mittelstand, Money creation, money market fund, Mont Pelerin Society, moral hazard, negative equity, Neil Kinnock, new economy, Northern Rock, obamacare, offshore financial centre, open economy, paradox of thrift, pension reform, Phillips curve, Post-Keynesian economics, price stability, principal–agent problem, quantitative easing, race to the bottom, random walk, regulatory arbitrage, rent-seeking, reserve currency, risk free rate, road to serfdom, secular stagnation, short selling, Silicon Valley, South China Sea, special drawing rights, tail risk, the payments system, too big to fail, Tyler Cowen, union organizing, unorthodox policies, Washington Consensus, WikiLeaks, yield curve

Central banks have two degrees of freedom in their collateral policy: First, they can decide which kind of assets they accept as collateral. And, second, they can set the haircuts they apply to the different assets that they do accept. The ECB, for example, throughout the crisis, decided to lend against a wide range of collateral and reduce haircuts for particular asset classes. The list of specific changes is too long to elaborate here, but to gain a rough understanding of the ECB’s actions, it suffices to note that the credit threshold for most assets to qualify as collateral was over time reduced from A– to BBB–. In particular, the policy changes were designed to make it easier for banks to use asset-backed securities as collateral for borrowing.

Banks of course benefited from this relaxation of collateral rules, as they could borrow money more cheaply from the ECB, and at the same time saw the value of any asset eligible as collateral boosted. A common thread running through all these interventions is that they also spill over to other asset classes. Assets differ in their risk profiles, and so, if the central bank’s actions make a particular asset less attractive to hold, investors will partially substitute it with other assets. Lender of Last Resort Policy As argued famously by Walter Bagehot in Lombard Street, part of a central bank’s responsibility should be to accommodate banks’ demand for funds in times of crisis (at a penalty rate).

Bernanke famously claimed that “The problem with QE is it works in practice, but it doesn’t work in theory.”55 Many channels are at work. The most frequently mentioned is the portfolio rebalancing channel. When the central bank buys long-term debt, it gives cash to portfolio managers and creates an incentive for them to buy other riskier assets. In this way, long-term rates tend to decrease over a wide spectrum of financial asset classes. If this rebalancing takes place toward foreign assets, the exchange rate depreciates and that would stimulate exports through the exchange rate channel. Interestingly, a very large fraction of bonds were purchased from foreign sellers allowing foreigners to sell their holdings at an enhanced price.


pages: 215 words: 55,212

The Mesh: Why the Future of Business Is Sharing by Lisa Gansky

"World Economic Forum" Davos, Airbnb, Amazon Mechanical Turk, Amazon Web Services, banking crisis, barriers to entry, Bear Stearns, bike sharing, business logic, carbon footprint, carbon tax, Chuck Templeton: OpenTable:, clean tech, cloud computing, credit crunch, crowdsourcing, diversification, Firefox, fixed income, Google Earth, impact investing, industrial cluster, Internet of things, Joi Ito, Kickstarter, late fees, Network effects, new economy, peer-to-peer lending, planned obsolescence, recommendation engine, RFID, Richard Florida, Richard Thaler, ride hailing / ride sharing, sharing economy, Silicon Valley, smart grid, social web, software as a service, TaskRabbit, the built environment, the long tail, vertical integration, walkable city, yield management, young professional, Zipcar

It is one of the many thriving p2p financial ventures, including the first of such marketplaces, Zopa, which is based in the U.K. and has expanded to Italy and Japan. All facilitate individual loans and offer significantly higher rates of return than traditional banks. In a recent article, American Banker, a notable trade journal, acknowledged this advantage in recommending p2p lending as a compelling asset class for diversification of investment portfolios. Other p2p financial companies, such as Lending Club, SmartyPig, BigCarrot, GreenNote, Kisskissbankbank, auxmoney, and smava, have entered the field, often focused on a particular geography or type of customer. The p2p funding tree is growing fast. The company will direct him to crafters with llama wool products, including those who raise llamas and spin and hand dye their own wool.


pages: 500 words: 145,005

Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

3Com Palm IPO, Alan Greenspan, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, behavioural economics, Berlin Wall, Bernie Madoff, Black-Scholes formula, book value, business cycle, capital asset pricing model, Cass Sunstein, Checklist Manifesto, choice architecture, clean water, cognitive dissonance, conceptual framework, constrained optimization, Daniel Kahneman / Amos Tversky, delayed gratification, diversification, diversified portfolio, Edward Glaeser, endowment effect, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, George Akerlof, hindsight bias, Home mortgage interest deduction, impulse control, index fund, information asymmetry, invisible hand, Jean Tirole, John Nash: game theory, John von Neumann, Kenneth Arrow, Kickstarter, late fees, law of one price, libertarian paternalism, Long Term Capital Management, loss aversion, low interest rates, market clearing, Mason jar, mental accounting, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, PalmPilot, Paul Samuelson, payday loans, Ponzi scheme, Post-Keynesian economics, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, risk free rate, Robert Shiller, Robert Solow, Ronald Coase, Silicon Valley, South Sea Bubble, Stanford marshmallow experiment, statistical model, Steve Jobs, sunk-cost fallacy, Supply of New York City Cabdrivers, systematic bias, technology bubble, The Chicago School, The Myth of the Rational Market, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, ultimatum game, Vilfredo Pareto, Walter Mischel, zero-sum game

Gradually this practice was recognized as silly, and these organizations adopted a more sensible rule, such as to spend a given percentage (say 5%) of a three-year moving average of the value of the endowment, allowing them to choose investments based on their long-term potential rather than their cash payouts. This change in policy allowed endowments to invest in new asset classes such as venture capital funds, which often do not pay any returns for many years. 18 Anomalies An important aspect of Thomas Kuhn’s model of scientific revolutions, which came up at the end of the Chicago conference, is that paradigms change only once experts believe there are a large number of anomalies that are not explained by the current paradigm.

If you form a portfolio composed of a bunch of highly risky stocks whose prices bounce around a lot, the portfolio itself will not be especially risky if the price movements of each of the component stocks are independent of one another, because then the movements will on average cancel out. But if the returns on the stocks are positively correlated, meaning they tend to go up and down together, then a portfolio of volatile stocks remains pretty risky; the benefits of diversification conferred by holding a portfolio of the stocks are not as great. In this way, according to the CAPM, the correct measure of the riskiness of a stock is simply its correlation with the rest of the market, a measure that is called “beta.”† Roughly speaking, if a stock has a beta of 1.0, then its movements are proportional to the overall market.

“Distribution of Incomes of Corporations Among Dividends, Retained Earnings, and Taxes.” American Economic Review 46, no. 2: 97–113. ———. 1965a. “The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets.” Review of Economics and Statistics 47, no. 1: 13–37. ———. 1965b. “Security Prices, Risk, and Maximal Gains from Diversification.” Journal of Finance 20, no. 4: 587–615. List, John A. 2011. “The Market for Charitable Giving.” Journal of Economic Perspectives 25, no. 2: 157–80. Loewenstein, George. 1992. “The Fall and Rise of Psychological Explanations in the Economics of Intertemporal Choice.” In George Loewenstein and Jon Elster, eds., Choice Over Time,. 3–34.


pages: 515 words: 132,295

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

"Friedman doctrine" OR "shareholder theory", "World Economic Forum" Davos, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, Alan Greenspan, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, Bear Stearns, behavioural economics, Big Tech, bonus culture, Bretton Woods, British Empire, business cycle, buy and hold, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carl Icahn, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, data science, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, electricity market, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial engineering, financial intermediation, Ford Model T, Frederick Winslow Taylor, George Akerlof, gig economy, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Greenspan put, guns versus butter model, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, James Carville said: "I would like to be reincarnated as the bond market. You can intimidate everybody.", John Bogle, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Kickstarter, knowledge economy, labor-force participation, London Whale, Long Term Capital Management, low interest rates, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, proprietary trading, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Ronald Reagan, Satyajit Das, Savings and loan crisis, scientific management, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, Steve Jobs, stock buybacks, subprime mortgage crisis, technology bubble, TED Talk, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, Tragedy of the Commons, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, vertical integration, zero-sum game

Although Wall Street has long bought and sold commodities futures and swaps, the combination of purely financial trading and ownership of physical commodities was a trend that began to accelerate around 2000, thanks to deregulation and a torrent of pension money that began to flow into commodities as an asset class. Only financial institutions have this ability to both make the market and be the market—to trade the products they own, hoarding or even manipulating them if they like, to raise or lower prices at will. They are the fox in the henhouse—except they also designed and built the henhouse, and they get to butcher the hens, and sell the eggs if they want.

Byrne, The Whiz Kids: The Founding Fathers of American Business—and the Legacy They Left Us (New York: Doubleday, 1993), 36. 27. Ibid., 50; Abraham Zaleznik, “The Education of Robert S. McNamara, Secretary of Defense, 1961–1968,” Revue Française de Gestion 6, no. 159 (2005). 28. David R. Jardini, “Out of the Blue Yonder: The RAND Corporation’s Diversification into Social Welfare Research, 1946–1968” (PhD diss., Carnegie Mellon University, 1996); Gabor, The Capitalist Philosophers, 136. 29. E. J. Barlow, “Preliminary Proposal for Air Defense Study,” RAND Archives D(L)-816-2, October 1950, quoted in Jardini, “Out of the Blue Yonder,” 67. 30. Halberstam, The Best and the Brightest, 229–30. 31.

Bogle, “Big Money in Boston: The Commercialization of the Mutual Fund Industry,” Journal of Portfolio Management 40, no. 4 (2013): 135. 12. Knut A. Rostad, ed., The Man in the Arena: Vanguard Founder John C. Bogle and His Lifelong Battle to Serve Investors First (Hoboken, NJ: Wiley, 2013), 124–25. 13. Bogle, The Clash of the Cultures, 111. 14. Ian Ayres and Quinn Curtis, “Beyond Diversification: The Pervasive Problem of Excessive Fees and ‘Dominated Funds’ in 401(k) Plans,” Yale Law Journal 124, no. 5 (March 2015): 1501. 15. Bogle, “Big Money in Boston,” 142. 16. Author interview with John Shaw Sedgwick, the son of R. Minturn Sedgwick, for this book. 17. R. Minturn Sedgwick, “The Record of Conventional Investment Management: Is There Not a Better Way?”


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Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Alan Greenspan, Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, bitcoin, Bob Litterman, Bonfire of the Vanities, bonus culture, break the buck, Brexit referendum, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, carbon tax, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, confounding variable, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, democratizing finance, Diane Coyle, diversification, diversified portfolio, do well by doing good, double helix, easy for humans, difficult for computers, equity risk premium, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, information security, interest rate derivative, invention of the telegraph, Isaac Newton, it's over 9,000, James Watt: steam engine, Jeff Hawkins, Jim Simons, job satisfaction, John Bogle, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, language acquisition, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, megaproject, merger arbitrage, meta-analysis, Milgram experiment, mirror neurons, money market fund, moral hazard, Myron Scholes, Neil Armstrong, Nick Leeson, old-boy network, One Laptop per Child (OLPC), out of africa, p-value, PalmPilot, paper trading, passive investing, Paul Lévy, Paul Samuelson, Paul Volcker talking about ATMs, Phillips curve, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, proprietary trading, public intellectual, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Solow, Sam Peltzman, Savings and loan crisis, seminal paper, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, subprime mortgage crisis, survivorship bias, systematic bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, uptick rule, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

The more troubling issue is this: if you don’t even want one project because it only has a 5 percent chance of success, why would you want 150 of them? The key is diversification. Even though each individual project has a 5 percent chance of success, the more projects you hold in your portfolio, the more chance at least one of them will succeed. If you have fourteen projects, you have better than a fifty-fifty chance. It turns out that, through the power of diversification, the chances of getting at least three successes out of 150 independent projects is an amazing 98 percent. With three successes, this portfolio would be worth at least 3 times $12.3 billion, or about $37 billion dollars.

Hedge funds used to be almost completely unregulated, but under the Dodd-Frank Act of 2010, hedge funds are now required to register with the Securities and Exchange Commission (SEC) and provide a certain amount of information to the government. Even so, there are still very few restrictions on what a hedge fund can or can’t do. They can take on all sorts of investment opportunities across different asset classes, in different countries, buying long, selling short, at lightning speed or more slowly, and so on. Hedge funds also charge high fees—a fixed fee, typically 1 to 2 percent of the assets under management, and an incentive fee, typically 20 percent of the profit—but hedge funds may also provide high performance.

Using statistical estimates derived from Principle 2 and the CAPM, portfolio managers can construct diversified long-only portfolios of financial assets that offer investors attractive risk-adjusted rates of return at low cost. Principle 4: Asset Allocation. Choosing how much to invest in broad asset classes is more important than picking individual securities, so the asset allocation decision is sufficient for managing the risk of an investor’s savings. Principle 5: Stocks for the Long Run. Investors should hold mostly equities for the long run. Principle 1 is straightforward: the only way investors would willingly take on a higher-risk asset is if they’re given an incentive for doing so, and that incentive comes in the form of higher expected return.


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Infonomics: How to Monetize, Manage, and Measure Information as an Asset for Competitive Advantage by Douglas B. Laney

3D printing, Affordable Care Act / Obamacare, banking crisis, behavioural economics, blockchain, book value, business climate, business intelligence, business logic, business process, call centre, carbon credits, chief data officer, Claude Shannon: information theory, commoditize, conceptual framework, crowdsourcing, dark matter, data acquisition, data science, deep learning, digital rights, digital twin, discounted cash flows, disintermediation, diversification, en.wikipedia.org, endowment effect, Erik Brynjolfsson, full employment, hype cycle, informal economy, information security, intangible asset, Internet of things, it's over 9,000, linked data, Lyft, Nash equilibrium, Neil Armstrong, Network effects, new economy, obamacare, performance metric, profit motive, recommendation engine, RFID, Salesforce, semantic web, single source of truth, smart meter, Snapchat, software as a service, source of truth, supply-chain management, tacit knowledge, technological determinism, text mining, uber lyft, Y2K, yield curve

Until that time, both public and private companies could disclose what they wanted, however they wanted. This lack of consistency was blamed in-part for investor confusion leading to the market crash. Part of these new standards included homogenizing the set of recognized asset classes to be reported. Information was not one of these asset classes. It wasn’t until some fif-teen years later that the inklings of the Information Age emerged when the accounting firm, Arthur Andersen, computerized the payroll system for a General Electric plant. Only then was the idea hatched that information could be an item separable from its physical manifestation—the paper (e.g., book, magazine, ledger) it was printed upon.

Carey School of Business Infonomics easily provides the clearest thought leadership for companies on the true economic value of information. In time, textbooks will be rewritten and balance sheets recalculated to account for the monetary value of information. Doug is pioneering the establishment of this new asset class with inspiring examples, useful metrics, and sound logic. —Brandon Thomas, Chief Data Officer, Zions Bank Doug Laney makes a compelling case for accounting for information as a corporate asset. Infonomics expertly guides organizations to uncover their hidden treasures and realize economic benefits from information assets.

When considering how to put information to work for your organization, it’s essential to go beyond thinking and talking about information as an asset, to actually valuing and treating it as one. The discipline of infonomics provides organizations a foundation and methods for quantifying information asset value and formal information asset management practices. Infonomics posits that information should be considered a new asset class in that it has measurable economic value and other properties that qualify it to be accounted for and administered as any other recognized type of asset—and that there are significant strategic, operational, and financial reasons for doing so. Infonomics provides the framework businesses and governments need to value information, manage it, and wield it as a real asset.


pages: 231 words: 76,283

Work Optional: Retire Early the Non-Penny-Pinching Way by Tanja Hester

Affordable Care Act / Obamacare, Airbnb, anti-work, antiwork, asset allocation, barriers to entry, buy and hold, crowdsourcing, diversification, estate planning, financial independence, full employment, General Magic , gig economy, hedonic treadmill, high net worth, independent contractor, index fund, labor-force participation, lifestyle creep, longitudinal study, low interest rates, medical bankruptcy, mortgage debt, Mr. Money Mustache, multilevel marketing, obamacare, passive income, post-work, remote working, rent control, ride hailing / ride sharing, risk tolerance, robo advisor, side hustle, stocks for the long run, tech worker, Vanguard fund, work culture

These actively managed funds often tout market-beating returns in the short term, but the companies that offer them are generally less forthcoming about the fact that the high management fees or expense ratios of 1–2% necessary to pay the fund managers a hefty salary erode a large portion of your gains. Because of that, almost no actively managed funds beat or even match the overall market average over the long term. In addition, because mutual funds generally focus on one asset class, they are usually not well diversified, and it’s necessary to own several different mutual funds to manage risk across your portfolio. Some mutual funds known as target date funds manage risk by moving toward more conservative investments as the target date approaches, but these funds have management fees averaging 0.84% according to Morningstar, which is still high enough to erode your gains over the long term.

For example, when stock markets are down, bond values tend to rise as investors seek out more stable assets. When housing prices increase in big cities, that sometimes means housing prices drop in small towns and rural areas, as people leave those places for the better economic opportunities in the urban areas. You want to ensure that you’re not too heavily invested in one sector, asset class, or geographic region, so that you aren’t tying your livelihood to too small a slice of the economy as a whole. That means diversifying your magic money–generating assets, whether you’re investing in the markets or real estate. If you choose to invest in index funds, they are automatically diversified for you.

That’s why bonds are generally thought of as safer than stocks, because their value is guaranteed. However, since the 2008 financial crisis, bond yields have often been lower than the rate of inflation, reintroducing inflationary risk. Despite that risk, most financial experts still advise keeping a mix of stocks and bonds in your portfolio—what’s called diversification, which we’ll discuss in chapter 9—with the idea that you can sell bonds in periods when stocks are down and use the stocks to drive your portfolio growth the rest of the time. As a further benefit, many bonds issued by state and local governments are tax-free and thus are not subject to capital gains tax, which helps offset some of their low yield.


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The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders by Kate Kelly

"Hurricane Katrina" Superdome, Alan Greenspan, Bakken shale, bank run, Bear Stearns, business cycle, commodity super cycle, Credit Default Swap, diversification, fixed income, Gordon Gekko, index fund, light touch regulation, locking in a profit, London Interbank Offered Rate, Long Term Capital Management, margin call, oil-for-food scandal, paper trading, peak oil, Ponzi scheme, proprietary trading, risk tolerance, Ronald Reagan, side project, Silicon Valley, Sloane Ranger, sovereign wealth fund, supply-chain management, the market place

Glancing around the room, Currie noted that the collective assets under management were the lowest they had been in the decade or so that commodity-focused hedge funds had even existed. No wonder, he thought, when the average commodity fund that year was on track to lose almost 3 percent. In fairness, Currie thought it wasn’t all the managers’ fault. “It’s not so much that the commodities story itself is over,” he said after the London meeting, “as it is that the other asset classes,” or groups of investment instruments, like stocks or bonds, “have a better outlook.” Currie had prepared a chart showing that the era of cash, oil, and gold as favored trades had effectively ended. Despite the commodity supercycle, a theory still being thrown around at the time that argued for a protracted period of high commodity prices, he felt that the potential for returns was now far better in stocks.

Brett Olsher, the Goldman banker who tried to bring order to a raucous merger process, is on the left, and Bill Vereker, the Nomura banking chief who advised Xstrata’s independent shareholders, is on the right. Bloomberg/Getty Images Jeff Currie, Goldman’s chief commodities analyst, realized at a fall 2012 meeting of London hedge-fund managers that the popularity of his asset class had finally fizzled. Goldman Sachs ACKNOWLEDGMENTS What you have just read is the result of a three-year undertaking that was made possible by an array of sources, associates, and friends who are too many in number to name here. The shortlist follows. My job at CNBC introduced me to the commodities world with stories on key players in natural gas, agriculture, and crude-oil trading.

An array of new securities that traded like stocks but tracked precious metals like gold and silver had made commodity investing easier for regular people than ever before, and the commodity market’s inexorable upward movement meant that they’d be crazy not to buy in. “Wall Street did a nice job of marketing the value of having the diversification of commodities in your portfolio,” says Jeff Scott, chief investment officer of the $74 billion financial firm Wurts & Associates. “I don’t mean that sarcastically. And there is value to having certain commodities in your portfolio. Unfortunately, the return composition changed.” In other words, at a certain point the money wagon stopped rolling along.


pages: 367 words: 110,161

The Bond King: How One Man Made a Market, Built an Empire, and Lost It All by Mary Childs

Alan Greenspan, asset allocation, asset-backed security, bank run, Bear Stearns, beat the dealer, break the buck, buy and hold, Carl Icahn, collateralized debt obligation, commodity trading advisor, coronavirus, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, diversification, diversified portfolio, Edward Thorp, financial innovation, fixed income, global macro, high net worth, hiring and firing, housing crisis, Hyman Minsky, index card, index fund, interest rate swap, junk bonds, Kevin Roose, low interest rates, Marc Andreessen, Minsky moment, money market fund, mortgage debt, Myron Scholes, NetJets, Northern Rock, off-the-grid, pneumatic tube, Ponzi scheme, price mechanism, quantitative easing, Robert Shiller, Savings and loan crisis, skunkworks, sovereign wealth fund, stem cell, Steve Jobs, stocks for the long run, The Great Moderation, too big to fail, Vanguard fund, yield curve

Leverage … Finance loves the Greek alphabet, and Brynjo was vaguely familiar with it. “What about ‘Lambda Cash’?” Because Lambda also started with an L. The Investment Committee approved. Just Lambda Cash could add 0.25 percent, 0.4 percent a year—which, in fixed income, is everything. And Pimco could do it forever. In any asset class, that’s how you win: if you just don’t lose all your money on some big, dumb trade gone wrong; if, instead, you steady-eddy along, eventually you’ll be number one in the long-term rankings. “Strategic mediocrity,” Pimco’s self-deprecating junk bond manager Ben Trosky used to call it, his own plan never to be number one in a given year, but also never to blow up.

American International Group, the insurance giant, was next to wobble, but having seen the destruction in Lehman’s wake, the government wouldn’t take the chance this time. On September 16, the Federal Reserve bailed AIG out, lending it $85 billion in exchange for 79.9 percent ownership of the company. Even so, the fear and uncertainty continued to spiral, infecting every market, every asset class. Those eye twitches across Manhattan worsened; traders parked in front of blinking Bloomberg Terminals with an IV drip of Diet Coke and growing piles of emptied snack wrappers and takeout containers. Rumors raced around the Street: someone had punched Dick Fuld, the Lehman CEO, in the face while he was running on a treadmill, knocking him out cold.

Like the time he ran a straight 125 miles, from San Francisco to Carmel, over six days, on a dare, the last five miles running with a ruptured kidney. That was extraordinary. Driving a brand-new market for trading bonds, when no one else was interested, or building Pimco in that unlikely, boring asset class; being the greatest bond trader who ever lived: extraordinary. Now he was exceptional. Almost forty years after inventing active bond trading, almost forty years of outperforming the next guy, he’d irrefutably demonstrated it, was still demonstrating it. And here, onstage at the Morningstar conference, standing before his rapt subjects, the industry was recognizing him for it.


pages: 523 words: 143,139

Algorithms to Live By: The Computer Science of Human Decisions by Brian Christian, Tom Griffiths

4chan, Ada Lovelace, Alan Turing: On Computable Numbers, with an Application to the Entscheidungsproblem, Albert Einstein, algorithmic bias, algorithmic trading, anthropic principle, asset allocation, autonomous vehicles, Bayesian statistics, behavioural economics, Berlin Wall, Big Tech, Bill Duvall, bitcoin, Boeing 747, Charles Babbage, cognitive load, Community Supported Agriculture, complexity theory, constrained optimization, cosmological principle, cryptocurrency, Danny Hillis, data science, David Heinemeier Hansson, David Sedaris, delayed gratification, dematerialisation, diversification, Donald Knuth, Donald Shoup, double helix, Dutch auction, Elon Musk, exponential backoff, fault tolerance, Fellow of the Royal Society, Firefox, first-price auction, Flash crash, Frederick Winslow Taylor, fulfillment center, Garrett Hardin, Geoffrey Hinton, George Akerlof, global supply chain, Google Chrome, heat death of the universe, Henri Poincaré, information retrieval, Internet Archive, Jeff Bezos, Johannes Kepler, John Nash: game theory, John von Neumann, Kickstarter, knapsack problem, Lao Tzu, Leonard Kleinrock, level 1 cache, linear programming, martingale, multi-armed bandit, Nash equilibrium, natural language processing, NP-complete, P = NP, packet switching, Pierre-Simon Laplace, power law, prediction markets, race to the bottom, RAND corporation, RFC: Request For Comment, Robert X Cringely, Sam Altman, scientific management, sealed-bid auction, second-price auction, self-driving car, Silicon Valley, Skype, sorting algorithm, spectrum auction, Stanford marshmallow experiment, Steve Jobs, stochastic process, Thomas Bayes, Thomas Malthus, Tragedy of the Commons, traveling salesman, Turing machine, urban planning, Vickrey auction, Vilfredo Pareto, Walter Mischel, Y Combinator, zero-sum game

The Upside of Heuristics The economist Harry Markowitz won the 1990 Nobel Prize in Economics for developing modern portfolio theory: his groundbreaking “mean-variance portfolio optimization” showed how an investor could make an optimal allocation among various funds and assets to maximize returns at a given level of risk. So when it came time to invest his own retirement savings, it seems like Markowitz should have been the one person perfectly equipped for the job. What did he decide to do? I should have computed the historical covariances of the asset classes and drawn an efficient frontier. Instead, I visualized my grief if the stock market went way up and I wasn’t in it—or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions fifty-fifty between bonds and equities. Why in the world would he do that?

brains try to minimize the number of neurons: Using this neurally inspired strategy (known as “sparse coding”), researchers have developed artificial neurons that have properties similar to those found in the visual cortex. See Olshausen and Field, “Emergence of Simple-Cell Receptive Field Properties.” groundbreaking “mean-variance portfolio optimization”: The work for which Markowitz was awarded the Nobel Prize appears in his paper “Portfolio Selection” and his book Portfolio Selection: Efficient Diversification of Investments. “I split my contributions fifty-fifty”: Harry Markowitz, as quoted in Jason Zweig, “How the Big Brains Invest at TIAA–CREF,” Money 27(1): 114, January 1998. “less information, computation, and time”: Gigerenzer and Brighton, “Homo Heuristicus.” more than quadrupled from the mid-1990s to 2013: From Soyfoods Association of North America, “Sales and Trends,” http://www.soyfoods.org/soy-products/sales-and-trends, which in turn cites research “conducted by Katahdin Ventures.”

An Essay on the Principle of Population. London: J. Johnson, 1798. Marcus, Gary. Kluge: The Haphazard Evolution of the Human Mind. New York: Houghton Mifflin Harcourt, 2009. Markowitz, Harry. “Portfolio Selection.” Journal of Finance 7, no. 1 (1952): 77–91. ______. Portfolio Selection: Efficient Diversification of Investments. New York: Wiley, 1959. Martin, Thomas Commerford. “Counting a Nation by Electricity.” Electrical Engineer 12, no. 184 (1891): 521–530. McCall, John. “Economics of Information and Job Search.” Quarterly Journal of Economics 84 (1970): 113–126. McGrayne, Sharon Bertsch. The Theory That Would Not Die: How Bayes’ Rule Cracked the Enigma Code, Hunted Down Russian Submarines, & Emerged Triumphant from Two Centuries of Controversy.


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The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

air freight, Alan Greenspan, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Bear Stearns, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, break the buck, Bretton Woods, business cycle, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, currency risk, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, foreign exchange controls, forward guidance, Fractional reserve banking, full employment, Glass-Steagall Act, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, Les Trente Glorieuses, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, low interest rates, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, Minsky moment, Modern Monetary Theory, Money creation, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, proprietary trading, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, subprime mortgage crisis, tail risk, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen, Tyler Cowen: Great Stagnation, vertical integration, very high income, winner-take-all economy, zero-sum game

But the view that this was the principal cause is entirely unconvincing, for four reasons.66 First, Keith Hennessey, Douglas Holtz-Eakin and Bill Thomas, also Republican nominees to the Financial Crisis Inquiry Commission, note, in their own dissenting comment: The report largely ignores the credit bubble beyond housing. Credit spreads declined not just for housing, but also for other asset classes like commercial real estate. This tells us to look to the credit bubble as an essential cause of the U.S. housing bubble. It also tells us that problems with U.S. housing policy or markets do not by themselves explain the U.S. housing bubble. There were housing bubbles in the United Kingdom, Spain, Australia, France and Ireland, some more pronounced than in the United States.

Between 1970 and 1989, the median annual growth of emerging economies was only 1.5 per cent; between 1990 and 2007, it reached 3.4 per cent.10 Between 1970 and 1989, the median growth rate of low-income countries had been a calamitous minus 0.1 per cent; in the subsequent period, it reached 1.5 per cent – low, but still a huge improvement.11 The variability of growth also fell substantially between the two periods.12 An optimistic view is that the ability of many emerging and developing countries to cope with the biggest financial crisis since the 1930s reflects improvements in policies and changes in economies, particularly diversification of the composition and direction of trade, of the sources of inflows of capital and of their entire economies. A pessimistic view is that recent growth has been supported by capital inflows, strong credit growth, booming commodity markets and, in the crucial case of China, an unsustainable growth of poor-quality investment.

The aims of these proposals were to help insulate domestic retail banking from external financial shocks, facilitate resolution of a banking group in difficulty, and make it more credible that the government would not back trading activities. At the same time, the Commission rejected the idea of a full split, rather than a ring fence, arguing that the diversity of businesses within a large group and the diversification of their assets might improve stability in a crisis. The UK government subsequently brought in legislation in line with the Commission’s proposals, with the strong support of the Parliamentary Commission on Banking Standards. The Banking Reform Act based on these proposals was passed into law in late 2013.


The Future of Money by Bernard Lietaer

agricultural Revolution, Alan Greenspan, Alvin Toffler, banks create money, barriers to entry, billion-dollar mistake, Bretton Woods, business cycle, clean water, complexity theory, corporate raider, currency risk, dematerialisation, discounted cash flows, diversification, fiat currency, financial deregulation, financial innovation, floating exchange rates, full employment, geopolitical risk, George Gilder, German hyperinflation, global reserve currency, Golden Gate Park, Howard Rheingold, informal economy, invention of the telephone, invention of writing, John Perry Barlow, Lao Tzu, Lewis Mumford, low interest rates, Mahatma Gandhi, means of production, microcredit, Money creation, money: store of value / unit of account / medium of exchange, Norbert Wiener, North Sea oil, offshore financial centre, pattern recognition, post-industrial society, price stability, Recombinant DNA, reserve currency, risk free rate, Ronald Reagan, San Francisco homelessness, seigniorage, Silicon Valley, South Sea Bubble, The Future of Employment, the market place, the payments system, Thomas Davenport, trade route, transaction costs, trickle-down economics, two and twenty, working poor, world market for maybe five computers

Sometimes inflation can get really out of hand, with devastating consequences for the societies, which experience them (see sidebar). Managing savings intelligently therefore boils down to allocating cash between the three classical major asset classes: real estate, bonds, and stocks. Over the past decade, another major asset class has appeared that is of particular interest to us: currencies. A few words about the changing role of each asset class over time puts this development into perspective. Real Estate From the beginning of the Agricultural Revolution until last century, real estate, particularly land, was the dominant form of savings available in the world.

Jekyll turned into Mr Hyde, so the blip on a computer screen can change the nature of a derivative position at the drop of a hat. Capitalism’s central nervous system It is insufficient to look at currencies as just another asset class. A country's currency is indeed also much more. It plays the role of the central nervous system that commands the values of all asset classes in that country. This becomes clearer when we look at how all the other three traditional asset classes are affected directly by what happens to money. We have seen already that bonds are an attractive investment only to the extent that the currency in which they are denominated keeps its value (i.e. when inflation is low or falling).

It has now become a significant factor in most professional investors' portfolios. Something extraordinary has been happening over the past decade: the currency market has become the biggest single market in the world. Foreign exchange transactions purchases and sales of currencies) today dwarf the trading volume of all other asset classes, even of the entire global economy. As a result, currency markets are becoming vitally important to almost everyone for the first time in recorded history - although it is probable that the majority of people are still quite unaware of this. If you have travelled anywhere abroad, you have dealt in the foreign exchange market.


pages: 831 words: 98,409

SUPERHUBS: How the Financial Elite and Their Networks Rule Our World by Sandra Navidi

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Alan Greenspan, Anthropocene, assortative mating, bank run, barriers to entry, Bear Stearns, Bernie Sanders, Black Swan, Blythe Masters, Bretton Woods, butterfly effect, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, commoditize, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, digital divide, diversification, Dunbar number, East Village, eat what you kill, Elon Musk, eurozone crisis, fake it until you make it, family office, financial engineering, financial repression, Gini coefficient, glass ceiling, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Google bus, Gordon Gekko, haute cuisine, high net worth, hindsight bias, income inequality, index fund, intangible asset, Jaron Lanier, Jim Simons, John Meriwether, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Roose, knowledge economy, London Whale, Long Term Capital Management, longitudinal study, Mark Zuckerberg, mass immigration, McMansion, mittelstand, Money creation, money market fund, Myron Scholes, NetJets, Network effects, no-fly zone, offshore financial centre, old-boy network, Parag Khanna, Paul Samuelson, peer-to-peer, performance metric, Peter Thiel, plutocrats, Ponzi scheme, power law, public intellectual, quantitative easing, Renaissance Technologies, rent-seeking, reserve currency, risk tolerance, Robert Gordon, Robert Shiller, rolodex, Satyajit Das, search costs, shareholder value, Sheryl Sandberg, Silicon Valley, social intelligence, sovereign wealth fund, Stephen Hawking, Steve Jobs, subprime mortgage crisis, systems thinking, tech billionaire, The Future of Employment, The Predators' Ball, The Rise and Fall of American Growth, too big to fail, Tyler Cowen, women in the workforce, young professional

Financiers generally believe that compensation is purely performance based and, because it is measurable in terms of profits, well deserved. However, in the complex and opaque world of finance, objective performance measurement is challenging. There are many unknown variables beyond executive control, such as the blowup of a previously hailed asset class, like energy, or the bursting of a bubble like the Internet. A systemic financial crisis may even reveal that all asset classes are in fact negatively correlated. The application of performance metrics has been questioned in view of the recent billion-dollar losses and fines ranging in the hundreds of millions. Yet, CEOs still receive rising pay. Proponents argue that winner-takes-all compensation is simply the result of market forces and freely agreed contracts, and that competitive salaries are necessary to obtain and retain top talent.

Speeches of senior policy makers are the highlights of any commercial event, yet another manifestation of how various different networks—in this case public and private ones—interact and reinforce each other. Since 2008, central banks have pumped trillions of dollars into the global financial system to give politicians time to create more fundamental solutions. They now rank among the biggest investors in world markets.2 Central banking has become a quasi “asset class in and of itself” as they move global markets with their decisions. Because of their independence from politics, central banks are relatively unconstrained with regard to their actions as long as they maneuver within their mandate. In contrast to political institutions, they can make quick decisions and execute them.

Such outsized returns were only possible with extremely high leverage, which magnified the returns. However, when the tide turned, the debt also magnified the losses. LTCM hedged itself within a known range of volatility based on past data, but its financial models failed to consider close correlations between a variety of asset classes. When in 1998 Russia defaulted and sent markets tumbling, the value of LTCM’s investments fell steeply. Within a couple of months, the fund lost over 50 percent of its value. Alarmed by its dramatic losses, the New York Fed intervened—although technically the fund was not within their purview—because many Wall Street counterparties, among them countless banks and investors such as pension funds, were intertwined with LTCM and in danger of failing.


pages: 620 words: 214,639

House of Cards: A Tale of Hubris and Wretched Excess on Wall Street by William D. Cohan

Alan Greenspan, asset-backed security, Bear Stearns, book value, call centre, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, deal flow, Deng Xiaoping, diversification, Financial Instability Hypothesis, fixed income, Glass-Steagall Act, Hyman Minsky, Irwin Jacobs, Jim Simons, John Meriwether, junk bonds, Long Term Capital Management, low interest rates, margin call, merger arbitrage, Michael Milken, money market fund, moral hazard, mortgage debt, mutually assured destruction, Myron Scholes, New Journalism, Northern Rock, proprietary trading, Renaissance Technologies, Rod Stewart played at Stephen Schwarzman birthday party, Savings and loan crisis, savings glut, shareholder value, sovereign wealth fund, stock buybacks, too big to fail, traveling salesman, uptick rule, vertical integration, Y2K, yield curve

Then there was the fall in housing prices, which, as Paul Friedman explained, started “to crack on a surprisingly broad basis across the country” and opened a window into “just how bad the 2006 vintage of subprime and Alt-A mortgages were and how much fraud was embedded in the loans.” People also began to realize that, as Friedman described it, “one of the bedrock concepts of the whole subprime securitization model, diversification”—the theory that a broad pool of borrowers provided inherent protection from price declines and defaults—“was fundamentally flawed. In fact, when we had declines around the country it became obvious that if you had a big pool of borrowers who had identical characteristics you really didn't have any diversification at all.” This problem, too, was made worse by the behavior of the ratings agencies—Standard & Poor's, Moody's, and Fitch—that provided the desired ratings on the securities, for a fee paid by the investment banks, to allow the securities to be sold to investors around the world.

Goldstone's explanation of what was happening at his company was merely a heavily lawyered version of what Sedacca referred to as the “ultimate Roach Motel.” A vicious cycle of downward pressure on the value of mortgage securities, which had begun at least a year earlier, was reaching a crescendo and affecting the entire asset class, not just the most junior and riskiest mortgages—so-called subprime mortgages—but also the more secure, performing mortgages. The very word “mortgage” was now a synonym for “toxic waste,” or, as one wag wrote, “Financial Ebola.” To be sure, other firms were having serious mortgage-related problems, too.

One is the large and unprecedented series of credit market disruptions, still unfolding, that was precipitated by declining house prices and severe problems with subprime mortgages. The other is the slowdown in the economy, which has begun to generate a noticeable decline in credit quality in a number of asset classes. The combination of these forces has strained the resources of many of the national banks we regulate.” Whether Dugan's office made these calls or not—and a spokesman from the comptroller's office, Dean DeBuck, had “no comment” but did not expressly deny that the calls had been made— the tempest that raged as a result of the presumption that they were made was of historic proportions.


pages: 349 words: 102,827

The Infinite Machine: How an Army of Crypto-Hackers Is Building the Next Internet With Ethereum by Camila Russo

4chan, Airbnb, Alan Greenspan, algorithmic trading, altcoin, always be closing, Any sufficiently advanced technology is indistinguishable from magic, Asian financial crisis, Benchmark Capital, Big Tech, bitcoin, blockchain, Burning Man, Cambridge Analytica, Cody Wilson, crowdsourcing, cryptocurrency, distributed ledger, diversification, Dogecoin, Donald Trump, East Village, Ethereum, ethereum blockchain, Flash crash, Free Software Foundation, Google Glasses, Google Hangouts, hacker house, information security, initial coin offering, Internet of things, Mark Zuckerberg, Maui Hawaii, mobile money, new economy, non-fungible token, off-the-grid, peer-to-peer, Peter Thiel, pets.com, Ponzi scheme, prediction markets, QR code, reserve currency, RFC: Request For Comment, Richard Stallman, Robert Shiller, Sand Hill Road, Satoshi Nakamoto, semantic web, sharing economy, side project, Silicon Valley, Skype, slashdot, smart contracts, South of Market, San Francisco, the Cathedral and the Bazaar, the payments system, too big to fail, tulip mania, Turing complete, Two Sigma, Uber for X, Vitalik Buterin

There were more Bitcoin ETFs in the pipeline, and it was only a matter of time before the SEC approved at least one of them, or so the thinking was at the time. The wait for the ETF approval fueled the theme that “institutional money is coming” to crypto, which became a constant in 2017.2 By the end of May the entire crypto market had grown more than four times, to $80 billion. The fledgling asset class added over $60 billion in just five months. Many of the big names in crypto gathered at the Marriott Marquis in Times Square, New York, for the third-annual Consensus, a conference organized by CoinDesk, one of the longest-standing trade publications covering the burgeoning industry. With over 100 speakers and more than 2,700 attendees, half of which CoinDesk advertised were “C-level,” it was the crypto Super Bowl.3 The price of bitcoin rallied in anticipation of the event, breaking its previous 2013 record and crossing $2,000.

The entire stock market was reaching new highs. The S&P 500 climbed to a new record in July 2017, as optimism about technology stocks pushed the S&P’s tech index over its dot-com-boom-fueled record in 2000 for the first time. Easy monetary policy spread across the globe, as central banks continued to prop up limping economies, pushing all asset classes, but especially riskier securities, higher. It’s been proven time and time again that there is no correlation between cryptocurrencies and other assets, including stocks, gold, and bonds. That means that it doesn’t matter whether traditional assets are moving up or down, crypto will dance to its own tune.

The cherry on top for the institutional interest narrative came in late December when Bloomberg News, citing unidentified sources, reported that Goldman Sachs was getting ready to set up a trading desk to make markets in digital currencies by the first half of 2018.1 While the actual level of institutional investor interest remained to be seen, it was clear cryptocurrency buyers had evolved from the anarchist cypherpunks and hackers buying crypto to protest against the financial establishment. Cryptocurrencies were now increasingly viewed as a separate asset class, and dedicated funds started popping up accordingly. The number of digital-currency-focused hedge funds and venture funds exploded in 2017. More than two hundred funds were created that year; that’s more than four times the number of funds launched in the previous year. They offered everything from market-weighted investment on the top ten cryptos to more sophisticated algorithmic trading.2 Meanwhile, Ming was in Mexico leading the organization for what would be Ethereum’s biggest event yet, Devcon3.


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Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America by Matt Taibbi

addicted to oil, affirmative action, Affordable Care Act / Obamacare, Alan Greenspan, Bear Stearns, Bernie Sanders, Bretton Woods, buy and hold, carried interest, classic study, clean water, collateralized debt obligation, collective bargaining, computerized trading, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, desegregation, diversification, diversified portfolio, Donald Trump, financial innovation, Glass-Steagall Act, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Greenspan put, illegal immigration, interest rate swap, laissez-faire capitalism, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, medical malpractice, military-industrial complex, money market fund, moral hazard, mortgage debt, Nixon triggered the end of the Bretton Woods system, obamacare, passive investing, Ponzi scheme, prediction markets, proprietary trading, prudent man rule, quantitative easing, reserve currency, Ronald Reagan, Savings and loan crisis, Sergey Aleynikov, short selling, sovereign wealth fund, too big to fail, trickle-down economics, Y2K, Yom Kippur War

The Prudent Investor Act was something of a financial version of the Clear Skies Act or the Healthy Forests Restoration Act, a sweeping deregulatory action with a cheerily Orwellian name that actually meant close to the opposite of what it sounded like. The rule now said that there was no one-size-fits-all industry standard of prudence and that trusts were not only not barred from investing in certain asset classes, they were actually duty bound to diversify as much as possible. “It made diversification a presumptive responsibility” of the trust manager, Langbein said proudly, adding, “It abolished all categoric prohibitions on investment types.” This revolution in institutional investment laws on the state level coincided with similar actions on the federal level—including yet another series of very quiet changes to the rules in 2003 by the CFTC, which for the first time allowed pension funds (which are regulated not by the states but by the federal government) to invest in, among other things, commodity futures.

Coupled with the new interpretation of prudence—this notion that institutional investors not only could diversify into other types of investments, but should or had to—there was suddenly a huge inpouring of money into the commodity futures market. “Once upon a time, you had to be an accredited investor, and commodities weren’t considered an asset class,” says Pat McHugh, a trader in natural gas futures who has spent upwards of twenty years watching changes in the market. “Now all of a sudden commodities, it was like it was something you had to have.” Now, with all these changes, the massive pools of money sitting around in funds like CalPERS (the California state employees pension funds) and other state-run pension plans were fair game for the salesmen of banks like Goldman Sachs looking to pitch this exciting new class of investment as a way of complying with what Langbein, the Yalie professor, called the “powerful duty to diversify broadly.”


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The 100-Year Life: Living and Working in an Age of Longevity by Lynda Gratton, Andrew Scott

"World Economic Forum" Davos, 3D printing, Airbnb, asset light, assortative mating, behavioural economics, carbon footprint, carbon tax, classic study, Clayton Christensen, collapse of Lehman Brothers, creative destruction, crowdsourcing, deep learning, delayed gratification, disruptive innovation, diversification, Downton Abbey, driverless car, Erik Brynjolfsson, falling living standards, financial engineering, financial independence, first square of the chessboard, first square of the chessboard / second half of the chessboard, future of work, gender pay gap, gig economy, Google Glasses, indoor plumbing, information retrieval, intangible asset, Isaac Newton, job satisfaction, longitudinal study, low skilled workers, Lyft, Nelson Mandela, Network effects, New Economic Geography, old age dependency ratio, pattern recognition, pension reform, Peter Thiel, Ray Kurzweil, Richard Florida, Richard Thaler, risk free rate, Second Machine Age, sharing economy, Sheryl Sandberg, side project, Silicon Valley, smart cities, Stanford marshmallow experiment, Stephen Hawking, Steve Jobs, tacit knowledge, The Future of Employment, uber lyft, warehouse robotics, women in the workforce, young professional

The run-down in vitality assets brings to mind the curse of Ondine and an exhausted and zombie-like existence driven by money. A longer third stage of retirement may sound attractive, but can only be supported by significant financial accumulation and savings in the second stage, and could even turn into tedium if not managed properly. 3. A new asset class: Transformational assets If achieving a balance of tangible and intangible assets over a 100-year life within a three-stage model is challenging, then a natural consequence is the emergence of a multi-stage life. We cannot know exactly what this multi-stage life will look like, but there are some broad predictions we can make.

To avoid knowledge stocks hitting zero, fitness and motivation disappearing, and friends and family disconnecting, most people will want to split their career into various stages, each with its own character and purpose. Technological innovations and sectoral shifts will bring flux, and being able to refresh and reskill at more points than Jack will become crucial. So if a multi-stage life is the way to achieve balance between tangibles and intangibles, then it will require the development of a new asset class. We call these transformational assets and they reflect the capacity and motivation to successfully achieve change and transitions. What sort of transitions will you face? Some transitions will be forced upon you by external circumstances: your skills could become technologically obsolete or the business you work for could close.

Take mortgage products, for example: a longer working life means that mortgage repayments can be spread out, but the fluctuations in this longer life require a measure of flexibility in contribution payments. A longer life also creates more time in which to take risks and more time to recover if these go wrong. This means that portfolio diversification and risk taking will alter with a longer life, and this will inevitably result in major structural changes in the industry. Focus on the costs Like any industry where consumers know a lot less than producers, it’s easy for consumers to make financial decisions they will look back on and regret.


pages: 479 words: 113,510

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America by Danielle Dimartino Booth

Affordable Care Act / Obamacare, Alan Greenspan, asset-backed security, bank run, barriers to entry, Basel III, Bear Stearns, Bernie Sanders, Black Monday: stock market crash in 1987, break the buck, Bretton Woods, business cycle, central bank independence, collateralized debt obligation, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, financial deregulation, financial engineering, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, Glass-Steagall Act, greed is good, Greenspan put, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, junk bonds, liquidity trap, London Whale, Long Term Capital Management, low interest rates, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, Navinder Sarao, negative equity, new economy, Northern Rock, obamacare, Phillips curve, price stability, proprietary trading, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, stock buybacks, tail risk, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

At the FOMC meeting on January 29–30, 2008, Dudley sounded an alarm regarding the Fed’s lack of information about the shadow banking system, though he didn’t call it that. He mentioned problems with monoline insurers like AIG. But the New York Fed had no direct dialogue with them. “Unfortunately, there is not much transparency as to the counterparty exposures of the guarantors on a firm-by-firm, asset-class-by-asset class, or security-by-security basis,” Dudley said. Little did the committee realize the bomb Dudley had just dropped inside the conference room. But there was no call to arms, no explanation that in early 2008, the shadow banking system, at $20 trillion, dwarfed the $12 trillion conventional banking system.

Although the market for subprime car loans is nowhere near the size of the subprime mortgage market, it hurts the same people who can ill afford such hardships. Of course there are those who love zero interest rates. In five thousand years of record keeping, debt has never been cheaper. Stocks, bonds, real estate, yachts, planes, blue diamonds, you name it—Fed policies have fueled skyrocketing valuations across the full spectrum of asset classes. And bankers have happily issued debt against them all. Paradoxically, though returns on risky investments have been consistently strong, fewer average Americans are comfortable with the risk of owning the most common of the pack—stocks. The percentage of U.S. adults invested in the stock market fell from 65 percent in 2007 to 52 percent by the spring of 2016, a twenty-year low.

As for those mom-and-pop investors who remain in the market, they have little chance of escaping Fed policy because their assets are tied up in expensive and rigid 401(k) plans that emphasize index funds. The Fed’s artificially low interest-rate level has distorted the relationship between stocks and bonds. Rather than one providing cover when the other is in distress, asset classes have increasingly moved in concert. And though portfolio advisers make it sound safe, index investing will prove disastrous when markets finally correct. The one true growth industry? That would be all that high cotton harvested in high finance. Since 2007, world debt has grown by about $60 trillion, enriching legions of investment bankers one bond deal at a time.


pages: 444 words: 86,565

Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions by Joshua Rosenbaum, Joshua Pearl, Joseph R. Perella

accelerated depreciation, asset allocation, asset-backed security, bank run, barriers to entry, Benchmark Capital, book value, business cycle, capital asset pricing model, collateralized debt obligation, corporate governance, credit crunch, discounted cash flows, diversification, equity risk premium, financial engineering, fixed income, impact investing, intangible asset, junk bonds, London Interbank Offered Rate, performance metric, risk free rate, shareholder value, sovereign wealth fund, stocks for the long run, subprime mortgage crisis, technology bubble, time value of money, transaction costs, yield curve

As D&A is a non-cash expense, it is added back to EBIAT in the calculation of FCF (see Exhibit 3.4). Hence, while D&A decreases a company’s reported earnings, it does not decrease its FCF. Depreciation Depreciation expenses are typically scheduled over several years corresponding to the useful life of each of the company’s respective asset classes. The straight-line depreciation method assumes a uniform depreciation expense over the estimated useful life of an asset. For example, an asset purchased for $100 million that is determined to have a ten-year useful life would be assumed to have an annual depreciation expense of $10 million per year for ten years.

Systematic risk is the risk related to the overall market, which is also known as nondiversifiable risk. A company’s level of systematic risk depends on the covariance of its share price with movements in the overall market, as measured by its beta (β) (discussed later in this section). By contrast, unsystematic or “specific” risk is company- or sector-specific and can be avoided through diversification. Hence, equity investors are not compensated for it (in the form of a premium). As a general rule, the smaller the company and the more specified its product offering, the higher its unsystematic risk. The formula for the calculation of CAPM is shown in Exhibit 3.15. EXHIBIT 3.15 Calculation of CAPM where: rf = risk-free rate βL = levered beta rm = expected return on the market rm - rf = market risk premium Risk-Free Rate (rf) The risk-free rate is the expected rate of return obtained by investing in a “riskless” security.


pages: 397 words: 112,034

What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale

"World Economic Forum" Davos, affirmative action, Alan Greenspan, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Berlin Wall, biodiversity loss, Black Swan, Bretton Woods, business cycle, capital controls, carbon credits, carbon tax, Cass Sunstein, central bank independence, classic study, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, currency risk, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial engineering, financial innovation, floating exchange rates, foreign exchange controls, full employment, Gini coefficient, Glass-Steagall Act, global macro, global reserve currency, global village, high net worth, high-speed rail, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), inverted yield curve, invisible hand, Just-in-time delivery, Kenneth Rogoff, Long Term Capital Management, low interest rates, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, military-industrial complex, Money creation, money market fund, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, precautionary principle, price stability, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Ronald Reagan, Savings and loan crisis, sovereign wealth fund, special drawing rights, subprime mortgage crisis, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Tragedy of the Commons, Washington Consensus, Westphalian system, WikiLeaks, women in the workforce, yield curve

Again, this “contango” may reflect the markets’ capacity to price a worrisome combination of accelerated field depletion, geopolitical turmoil, and self-inflicted political constraints in key producer countries, or it may merely illustrate the irrelevance of “future prices” in predicting the future price of oil. While the near-term economic horizon is currently dominated by an uneven economic recovery process and a reduced appetite for commodities as an asset class, a longer-term time horizon is needed to make sense of market behaviors that fail to be fully determined by the present supply-demand balance. Let us reflect, therefore, on what has been learned since the financial crisis of 2008–2009 regarding the longer-term market determinants. We shall begin with the move toward a post-oil economy that some think could be imposed by geological limits—“peak oil” and the assumed twilight in the desert1—or by concerns for climate change.

Paper Barrels The forecasts above assume that the speculative demand for oil will not get out of hand one way or another. Demand for “paper barrels” will continue to exercise an autonomous influence on oil prices. In the recent past, this took the form of massive investments in the futures markets in pursuit of large-scale gains as oil, and commodities more generally, turned into a major asset class for hedge fund and other investment fund portfolio managers. The sum of open interests on the NYMEX and ICE futures market jumped from 950,000 contracts (equivalent to just under 1 billion barrels of oil) in 2004 to 2.7 million contracts (2.7 billion barrels of oil) in 2008. According to LCM Research, adding exchange-traded options and futures contracts to the latter figure represents no less than seven billion barrels of oil.

As observed by LCM Research, the spike in oil prices of late October 2009—during which time oil prices crossed what had been for five months a firm upper limit of $75—can only be explained by the weakening in what had been a negative relationship between gold and the dollar and by the role that oil played, at least for a few months, as “an asset class of choice for dollar refugees.”41 If sustained for a long enough period, a significant weakening of the dollar could test not only this emerging coupling of currencies and oil markets, but possibly the manner in which Saudi Arabia defines what is presently an upper limit of $80 for the range of acceptable oil prices.


pages: 492 words: 118,882

The Blockchain Alternative: Rethinking Macroeconomic Policy and Economic Theory by Kariappa Bheemaiah

"World Economic Forum" Davos, accounting loophole / creative accounting, Ada Lovelace, Adam Curtis, Airbnb, Alan Greenspan, algorithmic trading, asset allocation, autonomous vehicles, balance sheet recession, bank run, banks create money, Basel III, basic income, behavioural economics, Ben Bernanke: helicopter money, bitcoin, Bletchley Park, blockchain, Bretton Woods, Brexit referendum, business cycle, business process, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, cashless society, cellular automata, central bank independence, Charles Babbage, Claude Shannon: information theory, cloud computing, cognitive dissonance, collateralized debt obligation, commoditize, complexity theory, constrained optimization, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-border payments, crowdsourcing, cryptocurrency, data science, David Graeber, deep learning, deskilling, Diane Coyle, discrete time, disruptive innovation, distributed ledger, diversification, double entry bookkeeping, Ethereum, ethereum blockchain, fiat currency, financial engineering, financial innovation, financial intermediation, Flash crash, floating exchange rates, Fractional reserve banking, full employment, George Akerlof, Glass-Steagall Act, Higgs boson, illegal immigration, income inequality, income per capita, inflation targeting, information asymmetry, interest rate derivative, inventory management, invisible hand, John Maynard Keynes: technological unemployment, John von Neumann, joint-stock company, Joseph Schumpeter, junk bonds, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, knowledge economy, large denomination, Large Hadron Collider, Lewis Mumford, liquidity trap, London Whale, low interest rates, low skilled workers, M-Pesa, machine readable, Marc Andreessen, market bubble, market fundamentalism, Mexican peso crisis / tequila crisis, Michael Milken, MITM: man-in-the-middle, Money creation, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, natural language processing, Network effects, new economy, Nikolai Kondratiev, offshore financial centre, packet switching, Pareto efficiency, pattern recognition, peer-to-peer lending, Ponzi scheme, power law, precariat, pre–internet, price mechanism, price stability, private sector deleveraging, profit maximization, QR code, quantitative easing, quantitative trading / quantitative finance, Ray Kurzweil, Real Time Gross Settlement, rent control, rent-seeking, robo advisor, Satoshi Nakamoto, Satyajit Das, Savings and loan crisis, savings glut, seigniorage, seminal paper, Silicon Valley, Skype, smart contracts, software as a service, software is eating the world, speech recognition, statistical model, Stephen Hawking, Stuart Kauffman, supply-chain management, technology bubble, The Chicago School, The Future of Employment, The Great Moderation, the market place, The Nature of the Firm, the payments system, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, trade liberalization, transaction costs, Turing machine, Turing test, universal basic income, Vitalik Buterin, Von Neumann architecture, Washington Consensus

We’re trying to gather that information, clean that data and reassemble ledgers… and we’ll be doing that for a long time to come…” --------------------------------------------------------------------------------------- “… the world is divided into regulatory regimes by natio-state as well as by asset class…for example, we at the CFTC have the responsibility for credit default indices, while the SCC has the responsibility for CDS ....two products that trade in tandem in the real world but are separated in the regulatory world. The point is [because of this separation] we will be assembling data, cleaning it, and trying to reassemble trading ledgers forever, I think, without really being able to see what it is (and here’s the point) that potentially the Blockchain can provide for us.

Sometimes a trading book that we see may look terribly unbalanced because it might show cleared swaps on the ledger but not the uncleared swaps. With the remaining information it might be a much more balanced portfolio… We are trying to assemble trading ledgers between parties…” “What the potential of the Blockchain is to see real ledgers in real time, across markets (and) across asset classes. That is a tremendous step forward. That would be information that we didn’t have during the crisis. That would be information that, in the event of a future crisis, would allow regulators to be more precise and calibrated in their response to the crisis conditions. It does not necessarily avoid a failure…. but it would give them the transparency into the issues in question in order to make a decision whether to allow that firm to fail or prevent it from failing….”

She is also the creator of ‘Threadneedle’, an experimental tool for simulating fractional reserve banking systems. 31Constant Proportion Portfolio Insurance (CPPI)- CPPI is a method of portfolio insurance in which the investor sets a floor on the value of his portfolio and then structures asset allocation around that decision. The two asset classes are classified as a risky asset (usually equities or mutual funds), and a riskless asset of either cash or Treasury bonds. The percentage allocated to each depends on how aggressive the investment strategy is. Appendix A: Bibliography and References Bibliography Chapter 1 Basel Committee on Banking Supervision. (2016).


pages: 311 words: 90,172

Nothing But Net by Mark Mahaney

Airbnb, AltaVista, Amazon Web Services, AOL-Time Warner, augmented reality, autonomous vehicles, Big Tech, Black Swan, Burning Man, buy and hold, Cambridge Analytica, Chuck Templeton: OpenTable:, cloud computing, COVID-19, cryptocurrency, discounted cash flows, disintermediation, diversification, don't be evil, Donald Trump, Elon Musk, financial engineering, gamification, gig economy, global pandemic, Google Glasses, Jeff Bezos, John Zimmer (Lyft cofounder), knowledge economy, lockdown, low interest rates, Lyft, Marc Andreessen, Mark Zuckerberg, Mary Meeker, medical malpractice, meme stock, Network effects, PageRank, pets.com, ride hailing / ride sharing, Salesforce, Saturday Night Live, shareholder value, short squeeze, Silicon Valley, Skype, Snapchat, social graph, Steve Jobs, stocks for the long run, subscription business, super pumped, the rule of 72, TikTok, Travis Kalanick, Uber and Lyft, uber lyft

But Facebook didn’t look like a juggernaut in the year after its IPO, when its stock corrected from over $40 to $17 on the perception that it didn’t have a mobile strategy. Yet FB has been a fifteen-bagger—up 1,441% through the end of 2020. The Big Long indeed. WHAT THIS BOOK IS NOT . . . AND WHAT IT IS This book is not about investing across asset classes—equities, bonds, commodities, REITs, currencies. My experience has been almost entirely focused on equities. And it’s not a book about investing across all equity groups—high growth, cyclicals, slow growth, turnarounds, asset plays. I have only covered high-growth companies. Or better put, companies that compete in the high-growth sector that is the Internet.

The founders of Lyft (John Zimmer and Logan Green) were actively involved in running Lyft, which was a distinct positive, but I also had confidence in the management capabilities of Uber CEO Dara “Dog’s Breakfast” Khosrowshahi, which I thought somewhat mitigated the fact that Uber’s founders were no longer actively involved. Finally, I believed that Uber’s diversification into online food delivery was a distinct positive and would help generate premium revenue growth. Within a year of their respective IPOs, Covid-19 crushed these companies’ growth rates. After 68% revenue growth in 2019, Lyft reported a 35% decline in 2020. Uber posted 26% revenue growth in 2019 and then a 15% decline in 2020.


pages: 829 words: 186,976

The Signal and the Noise: Why So Many Predictions Fail-But Some Don't by Nate Silver

airport security, Alan Greenspan, Alvin Toffler, An Inconvenient Truth, availability heuristic, Bayesian statistics, Bear Stearns, behavioural economics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Monday: stock market crash in 1987, Black Swan, Boeing 747, book value, Broken windows theory, business cycle, buy and hold, Carmen Reinhart, Charles Babbage, classic study, Claude Shannon: information theory, Climategate, Climatic Research Unit, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, computer age, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, Daniel Kahneman / Amos Tversky, disinformation, diversification, Donald Trump, Edmond Halley, Edward Lorenz: Chaos theory, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, everywhere but in the productivity statistics, fear of failure, Fellow of the Royal Society, Ford Model T, Freestyle chess, fudge factor, Future Shock, George Akerlof, global pandemic, Goodhart's law, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), Internet Archive, invention of the printing press, invisible hand, Isaac Newton, James Watt: steam engine, Japanese asset price bubble, John Bogle, John Nash: game theory, John von Neumann, Kenneth Rogoff, knowledge economy, Laplace demon, locking in a profit, Loma Prieta earthquake, market bubble, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, Monroe Doctrine, mortgage debt, Nate Silver, negative equity, new economy, Norbert Wiener, Oklahoma City bombing, PageRank, pattern recognition, pets.com, Phillips curve, Pierre-Simon Laplace, Plato's cave, power law, prediction markets, Productivity paradox, proprietary trading, public intellectual, random walk, Richard Thaler, Robert Shiller, Robert Solow, Rodney Brooks, Ronald Reagan, Saturday Night Live, savings glut, security theater, short selling, SimCity, Skype, statistical model, Steven Pinker, The Great Moderation, The Market for Lemons, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, Timothy McVeigh, too big to fail, transaction costs, transfer pricing, University of East Anglia, Watson beat the top human players on Jeopardy!, Wayback Machine, wikimedia commons

The other 10 percent of the time, the noise traders dominate—and they can go a little haywire.97 One way to look at this is that markets are usually very right but occasionally very wrong. This, incidentally, is another reason why bubbles are hard to pop in the real world. There might be a terrific opportunity to short a bubble or long a panic once every fifteen or twenty years when one comes along in your asset class. But it’s very hard to make a steady career out of that, doing nothing for years at a time. The Two-Track Market Some theorists have proposed that we should think of the stock market as constituting two processes in one.98 There is the signal track, the stock market of the 1950s that we read about in textbooks.

In this scenario, your risks are well diversified: if a carpenter in Cleveland defaults on his mortgage, this will have no bearing on whether a dentist in Denver does. Under this scenario, the risk of losing your bet would be exceptionally small—the equivalent of rolling snake eyes five times in a row. Specifically, it would be 5 percent taken to the fifth power, which is just one chance in 3,200,000. This supposed miracle of diversification is how the ratings agencies claimed that a group of subprime mortgages that had just a B+ credit rating on average38—which would ordinarily imply39 more than a 20 percent chance of default40—had almost no chance of defaulting when pooled together. The other extreme is to assume that the mortgages, instead of being entirely independent of one another, will all behave exactly alike.

., terrorism prevention by, 273 defensive range, 96 de Groot, Adriaan, 272 Denver, Colo., 150 Denver Post, 176 depth, breadth vs., 271–73 determinism, 112, 113, 241, 242, 249, 448 Detroit Tigers, 77, 88, 94 difference engine, 263 Discover, 160 discrimination, calibration vs., 474 disease, see infectious disease diversification, 27 “Divine Benevolence” (Bayes), 241, 242 Djokovic, Novak, 496 Dodger Stadium, 79 Dokhoian, Yuri, 282 Domodedovo Airport, 440 dot-com boom, 346–48, 361 Dow Jones Industrial Average, 37, 339, 340, 343, 498, 503 Doyle, Arthur Conan, 307 Drake equation, 488 Druckenmiller, Stanley, 356 Dukakis, Michael, 68 Duke University, 359 Dutch book, 256n Dwan, Tom, 308–11, 313, 315, 318, 324, 328 dynamic systems, 16, 118, 120, 194 E*Trade, 339, 363, 498 earthquake forecasting, 149–54, 230 computers in, 289 failure of, 7, 11, 143, 147–49, 158–61, 168–71, 174, 249, 253, 346, 389 overfitting and, 168–71, 185 short-term, 174 time-dependent, 154 earthquakes, 16, 142–75, 476, 512 aftershocks to, 154, 161, 174, 476–77 in Anchorage, 149 causes of, 162 distribution across time and space of, 154–57, 155, 427 foreshocks to, 144, 154, 155–57, 476 Great Sumatra, 161, 171 in Haiti, 147n, 155–56, 156, 224 in Japan, 154, 155, 168–71, 172 in L’Aquila, 142–44, 148, 154–55, 157, 173 Lisbon, 145 list of deadliest, 147 Loma Prieta, 160 magnitude vs. frequency of, 151–53, 152, 153, 368n, 427, 432, 437–38, 441 near Reno, 156–57, 157 in New Zealand, 174 earthquake swarm, 143n, 173 Earth System Science Center, 408 East Germany, 52 eBay, 353 Ecclesiastes, 459 economic data, noise in, 193–94, 198 economic growth, 6, 6, 186n economic progress, 7, 112, 243 economics, predictions in, 33, 176–77, 230 actual GDP vs., 191–93, 192, 193, 194 Big Data and, 197 computers in, 289 consensus vs. individual, 197–98, 335 context ignored in, 43 an ever-changing economy, 189–93 economics, predictions in (Cont.)


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The Quants by Scott Patterson

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, automated trading system, Bear Stearns, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Monday: stock market crash in 1987, Black Swan, Black-Scholes formula, Blythe Masters, Bonfire of the Vanities, book value, Brownian motion, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Carl Icahn, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Dr. Strangelove, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial engineering, Financial Modelers Manifesto, fixed income, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, Jim Simons, job automation, John Meriwether, John Nash: game theory, junk bonds, Kickstarter, law of one price, Long Term Capital Management, Louis Bachelier, low interest rates, mandelbrot fractal, margin call, Mark Spitznagel, merger arbitrage, Michael Milken, military-industrial complex, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Robert Mercer, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Savings and loan crisis, Sergey Aleynikov, short selling, short squeeze, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

In the coming years, it would only get better, making everyone even richer. Especially Peter Muller. ASNESS When Cliff Asness took a full-time job at Goldman in late 1994, he wasn’t sure what his job was supposed to be. He was given the task of building quantitative models to forecast returns on multiple asset classes, a broad mandate. Essentially, Goldman was taking a gamble on the young phenom from Chicago, trying to see if his ivory tower schooling would pay off in the real world. Goldman had made one of its first wagers on book smarts with Fischer Black in the 1980s. By the early 1990s, it was the go-to bank for bright mathletes from universities around the country.

If the selling had continued—which likely would have happened if Goldman Sachs hadn’t bailed out its GEO fund—the results could have been catastrophic, not only for the quants but for everyday investors, as the sell-off spilled into other sectors of the market. Just as the implosion of the mortgage market triggered a cascading meltdown in quant funds, the losses by imploded quant funds could have bled into other asset classes, a crazed rush to zero that could have put the entire financial system in peril. The most terrifying aspect of the meltdown, however, was that it revealed hidden linkages in the Money Grid that no one had been aware of before. A collapse in the subprime mortgage market triggered margin calls in hedge funds, forcing them to unwind positions in stocks.

One reason why banks engage in securitization is to spread around risk like jelly on toast. Instead of lumping the jelly on one small piece of the toast, leaving all the reward (or risk that it falls off the toast) for one bite, it’s evenly distributed, making for lots more tasty bites—and, through the quant magic of diversification (spreading the jelly), less risk. If an investor buys a single subprime mortgage worth $250,000, that investor bears the entire risk if that mortgage goes into default, certainly possible given the fact that subprime mortgages usually go to the least creditworthy borrowers. But if a thousand subprime mortgages, each worth about $250,000, were pooled together and turned into a single security with a collective value of $250 million, the security could be divided into some number of shares.


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The Costs of Connection: How Data Is Colonizing Human Life and Appropriating It for Capitalism by Nick Couldry, Ulises A. Mejias

"World Economic Forum" Davos, 23andMe, Airbnb, Amazon Mechanical Turk, Amazon Web Services, behavioural economics, Big Tech, British Empire, call centre, Cambridge Analytica, Cass Sunstein, choice architecture, cloud computing, colonial rule, computer vision, corporate governance, dark matter, data acquisition, data is the new oil, data science, deep learning, different worldview, digital capitalism, digital divide, discovery of the americas, disinformation, diversification, driverless car, Edward Snowden, emotional labour, en.wikipedia.org, European colonialism, Evgeny Morozov, extractivism, fake news, Gabriella Coleman, gamification, gig economy, global supply chain, Google Chrome, Google Earth, hiring and firing, income inequality, independent contractor, information asymmetry, Infrastructure as a Service, intangible asset, Internet of things, Jaron Lanier, job automation, Kevin Kelly, late capitalism, lifelogging, linked data, machine readable, Marc Andreessen, Mark Zuckerberg, means of production, military-industrial complex, move fast and break things, multi-sided market, Naomi Klein, Network effects, new economy, New Urbanism, PageRank, pattern recognition, payday loans, Philip Mirowski, profit maximization, Ray Kurzweil, RFID, Richard Stallman, Richard Thaler, Salesforce, scientific management, Scientific racism, Second Machine Age, sharing economy, Shoshana Zuboff, side hustle, Sidewalk Labs, Silicon Valley, Slavoj Žižek, smart cities, Snapchat, social graph, social intelligence, software studies, sovereign wealth fund, surveillance capitalism, techlash, The Future of Employment, the scientific method, Thomas Davenport, Tim Cook: Apple, trade liberalization, trade route, undersea cable, urban planning, W. E. B. Du Bois, wages for housework, work culture , workplace surveillance

Today, what we have is a different version of the same fundamental move: the collection of cheap social data, an abundant “natural” resource. We can see this rationalization operating in the metaphors used to describe data extraction. A World Economic Forum report stated that “personal data will be the new ‘oil’—a valuable resource of the 21st century. It will emerge as a new asset class touching all aspects of society.”11 The allusion to petroleum seemed to be particularly evocative in the early 2010s, as evidenced by the number of times it was employed by CEOs and analysts. The CEO of Tresata said, “Just like oil was a natural resource powering the last industrial revolution, data is going to be the natural resource for this industrial revolution.”12 The vice president of the European Commission responsible for the Digital Agenda claimed that “data is a precious thing. . . .

The New York Times, April 28, 2010. http://www.nytimes.com/2010/05/02/magazine/02self-measurement-t.html. Wong, Julie Carrie. “Social Media Is Ripping Society Apart.” Guardian, December 12, 2017. Wood, Allen W. Hegel’s Ethical Thought. Cambridge, UK: Cambridge University Press, 1990. World Economic Forum. Personal Data: The Emergence of a New Asset Class. Geneva, CH: We Forum, January 2011. http://www3.weforum.org/docs/WEF_ITTC_PersonalDataNewAsset_Report_2011.pdf. Wright, Joshua D., and Douglas H. Ginsburg. “Behavioral Law and Economics: Its Origins, Fatal Flaws, and Implications for Liberty.” Northwestern University Law Review 106, no. 3 (2012): 1–58.

For instance, India’s data centers, which provide server hosting and colocation services to companies all over the world, are supported by the government through land allotments and tax rebates; furthermore, the IT sector and the government work closely on national data-management projects such as census or citizen-identification programs.61 Also, India’s immense population constitutes an equally enormous market for both foreign and domestic firms, with the digital economy in India soon poised to represent a trillion-dollar market.62 This is why financers and corporations in Asia and the United States are racing to fund start-ups and acquire companies in India; 63 as of this writing, Walmart is suspected of wanting to buy e-commerce giant Flipkart to compete with Amazon, and Alibaba plans to enter the game through its acquisition of Paytm.64 The most comprehensive example of internal colonization is, of course, China, a Cloud Empire in and of itself that is as advanced as the West’s and could in the near future surpass it. In fact, it is already extending to other parts of the world not just through hardware but also through cloud computing, financial services, and artificial intelligence.65 Companies such as Baidu, Alibaba, and Tencent are sizeable conglomerates with more diversification than their Western counterparts. If we take early 2018 values as our vantage point (but note Tencent’s subsequent loss of approximately $150 billion), the panorama looks as follows: Baidu, with a market value of $87 billion, focuses on searches and ads but also provides services such as maps, games, tools for small business, food delivery, and electronic wallets.


pages: 417 words: 97,577

The Myth of Capitalism: Monopolies and the Death of Competition by Jonathan Tepper

"Friedman doctrine" OR "shareholder theory", Affordable Care Act / Obamacare, air freight, Airbnb, airline deregulation, Alan Greenspan, bank run, barriers to entry, Berlin Wall, Bernie Sanders, Big Tech, big-box store, Bob Noyce, Boston Dynamics, business cycle, Capital in the Twenty-First Century by Thomas Piketty, citizen journalism, Clayton Christensen, collapse of Lehman Brothers, collective bargaining, compensation consultant, computer age, Cornelius Vanderbilt, corporate raider, creative destruction, Credit Default Swap, crony capitalism, diversification, don't be evil, Donald Trump, Double Irish / Dutch Sandwich, Dunbar number, Edward Snowden, Elon Musk, en.wikipedia.org, eurozone crisis, Fairchild Semiconductor, Fall of the Berlin Wall, family office, financial innovation, full employment, gentrification, German hyperinflation, gig economy, Gini coefficient, Goldman Sachs: Vampire Squid, Google bus, Google Chrome, Gordon Gekko, Herbert Marcuse, income inequality, independent contractor, index fund, Innovator's Dilemma, intangible asset, invisible hand, Jeff Bezos, Jeremy Corbyn, Jevons paradox, John Nash: game theory, John von Neumann, Joseph Schumpeter, junk bonds, Kenneth Rogoff, late capitalism, London Interbank Offered Rate, low skilled workers, Mark Zuckerberg, Martin Wolf, Maslow's hierarchy, means of production, merger arbitrage, Metcalfe's law, multi-sided market, mutually assured destruction, Nash equilibrium, Network effects, new economy, Northern Rock, offshore financial centre, opioid epidemic / opioid crisis, passive investing, patent troll, Peter Thiel, plutocrats, prediction markets, prisoner's dilemma, proprietary trading, race to the bottom, rent-seeking, road to serfdom, Robert Bork, Ronald Reagan, Sam Peltzman, secular stagnation, shareholder value, Sheryl Sandberg, Silicon Valley, Silicon Valley billionaire, Skype, Snapchat, Social Responsibility of Business Is to Increase Its Profits, SoftBank, Steve Jobs, stock buybacks, tech billionaire, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, undersea cable, Vanguard fund, vertical integration, very high income, wikimedia commons, William Shockley: the traitorous eight, you are the product, zero-sum game

He created the world's first retail index fund at Vanguard in 1974. Buffett has called him a hero for helping the average investor. Jack humbly responded, “I'm not a hero, I'm an ordinary guy … who gave a damn about the people investing and wanted to make sure they got a fair shake.” Bogle never could have anticipated the incredible inflows into this asset class. The appetite has been insatiable, and money has steadily flowed out of active funds and into passive over the last few years. Passive funds now own 40% of all US assets, and would own 100% by 2030 if this immense growth trajectory continued (Figure 9.2). Figure 9.2 Share of Passively Managed Assets in US Markets SOURCE: Atlas; Data: Pictet, Morningstar.15 Vanguard started with $11 million back in 1975 and has skyrocketed to over $5.1 trillion under management today.

Warren Buffett claims that investors have “wasted” upwards of $100 billion paying useless wealth managers high management fees.14 He is a proponent of what's known as passive investing, or investing in index funds. These funds do not try to beat the market, but mimic a performance of a particular index like the S&P, Russell 500, and so forth. They do not have to be managed, so they are much less expensive than active funds, and they help investors lessen risk through diversification. Passive investing has brought great benefits for average, middle-class investors. It has been somewhat of a Robin Hood story in finance. Small investors who had been paying absurdly high fees to Wall Street investment managers suddenly got access to a low-cost product that democratized investing.


pages: 1,066 words: 273,703

Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze

"there is no alternative" (TINA), "World Economic Forum" Davos, Affordable Care Act / Obamacare, Alan Greenspan, Apple's 1984 Super Bowl advert, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bear Stearns, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bond market vigilante , book value, Boris Johnson, bread and circuses, break the buck, Bretton Woods, Brexit referendum, BRICs, British Empire, business cycle, business logic, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, company town, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, currency risk, dark matter, deindustrialization, desegregation, Detroit bankruptcy, Dissolution of the Soviet Union, diversification, Doha Development Round, Donald Trump, Edward Glaeser, Edward Snowden, en.wikipedia.org, energy security, eurozone crisis, Fall of the Berlin Wall, family office, financial engineering, financial intermediation, fixed income, Flash crash, forward guidance, friendly fire, full employment, global reserve currency, global supply chain, global value chain, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, high-speed rail, housing crisis, Hyman Minsky, illegal immigration, immigration reform, income inequality, interest rate derivative, interest rate swap, inverted yield curve, junk bonds, Kenneth Rogoff, large denomination, light touch regulation, Long Term Capital Management, low interest rates, margin call, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, military-industrial complex, mittelstand, money market fund, moral hazard, mortgage debt, mutually assured destruction, negative equity, new economy, Nixon triggered the end of the Bretton Woods system, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shale / tar sands, old-boy network, open economy, opioid epidemic / opioid crisis, paradox of thrift, Peter Thiel, Ponzi scheme, Post-Keynesian economics, post-truth, predatory finance, price stability, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, race to the bottom, reserve currency, risk tolerance, Ronald Reagan, Savings and loan crisis, savings glut, secular stagnation, Silicon Valley, South China Sea, sovereign wealth fund, special drawing rights, Steve Bannon, structural adjustment programs, tail risk, The Great Moderation, Tim Cook: Apple, too big to fail, trade liberalization, upwardly mobile, Washington Consensus, We are the 99%, white flight, WikiLeaks, women in the workforce, Works Progress Administration, yield curve, éminence grise

It died, because doubts about its business led it to be cut out of wholesale funding markets. Then something even worse began to happen. The uncertainty spread from individual weak banks to the entire system. First in the spring of 2008 and then in June, the haircuts on bilateral repo took a severe step up across the board, for all asset classes, for all parties.15 This meant that the amount of capital that was required to hold the outstanding stock of bonds leaped upward, across the entire banking system. Repo in US Treasurys and GSE-backed mortgage-backed securities was the least badly affected. As top-quality collateral they were reserved mainly for use in triparty repo overseen by JPMorgan Chase and Bank of New York Mellon.

The average maturity of US Treasurys held by the MMFs declined from ninety-five days in January 2010 to only seventy days at the end of July 2011.71 Meanwhile, financial engineers began to contemplate the need for something no one had contemplated before—credit default swaps against US Treasurys.72 Prior to 2008 the market for US Treasury CDS had not existed. What would have been the point of insuring the risk-free asset class on which the entire global financial system rested? In the wildly improbable event of a US default, the general destabilization would be such that it was unclear whether any private financial entity would still be in a position to act as a reliable counterparty. Who would be left standing to pay out on insurance against the end of the world?

But it also exposed them to serious risks. Huge, aggressively managed funds crowded into tight markets. As the IMF pointed out, given that the largest five hundred asset management companies had more than $70 trillion in their portfolios, a 1 percent reallocation implied a flow in or out of an asset class of $700 billion. This was enough either to swamp or to starve the emerging markets. The withdrawal of funds that had caused such stress in 2008 around the periphery of the world economy had amounted to only $246 billion. The unprecedented inflow that transformed the outlook of those same economies in 2012 was $368 billion.9 This disproportion created risk for the borrowers.


pages: 801 words: 209,348

Americana: A 400-Year History of American Capitalism by Bhu Srinivasan

activist fund / activist shareholder / activist investor, American ideology, AOL-Time Warner, Apple II, Apple's 1984 Super Bowl advert, bank run, barriers to entry, Bear Stearns, Benchmark Capital, Berlin Wall, blue-collar work, Bob Noyce, Bonfire of the Vanities, British Empire, business cycle, buy and hold, California gold rush, Carl Icahn, Charles Lindbergh, collective bargaining, commoditize, Cornelius Vanderbilt, corporate raider, cotton gin, cuban missile crisis, Deng Xiaoping, diversification, diversified portfolio, Douglas Engelbart, Fairchild Semiconductor, financial innovation, fixed income, Ford Model T, Ford paid five dollars a day, global supply chain, Gordon Gekko, guns versus butter model, Haight Ashbury, hypertext link, Ida Tarbell, income inequality, information security, invisible hand, James Watt: steam engine, Jane Jacobs, Jeff Bezos, John Markoff, joint-stock company, joint-stock limited liability company, junk bonds, Kickstarter, laissez-faire capitalism, Louis Pasteur, Marc Andreessen, Menlo Park, Michael Milken, military-industrial complex, mortgage debt, mutually assured destruction, Norman Mailer, oil rush, peer-to-peer, pets.com, popular electronics, profit motive, punch-card reader, race to the bottom, refrigerator car, risk/return, Ronald Reagan, Sand Hill Road, self-driving car, shareholder value, side project, Silicon Valley, Silicon Valley startup, Steve Ballmer, Steve Jobs, Steve Wozniak, strikebreaker, Ted Nelson, The Death and Life of Great American Cities, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, trade route, transcontinental railway, traveling salesman, Upton Sinclair, Vannevar Bush, Works Progress Administration, zero-sum game

The federal government’s total expenditure for 1859 was $69 million—at this scale, even forty years of the entire annual federal budget would not have covered the market value of the slaves. Despite the rising tide of industry in the North, the numbers are beyond dispute: Slaves were the single most valuable asset class in America. Preservation of principal, not principle, formed the basis of every argument ever made in defense of slavery. And the next year, 1860, slave prices went up even further—newspapers dubbed the speculative climate “Negro Fever”—making the institution worth defending at all costs all the more.

These English privateering syndicates were anything but swashbuckling men with parrots and eye patches; the accounting statements of individual ventures made careful note of ship tonnage, capital invested, men involved, and number of ships in each operation—from which Sir Francis Drake’s twenty-one ships and 1,932 men stood out with invested capital of £57,000. In his thorough examination of the era’s joint-stock companies, W. R. Scott suggested that the flexibility of the corporate structure lent itself to the virtues of diversification and spreading risk, particularly in matters of piracy. From privateering’s tolerance for large losses emerged the basic principle of modern venture capital. Suppose, for instance, a capitalist was prepared to adventure 2000 Pounds in privateering, he could only fit out one ship of about 200 tons or two smaller ones.

The success of Intel’s IPO, which proved that the time frame from start-up to IPO could be compressed to three years, gave rise to a new formalized vehicle dedicated to investing in multiple start-ups: the venture capital fund. The investors in the venture capital funds received the benefits of diversification, where the staggering gains from one hit would ostensibly offset losses from a handful of others. It helped that the venture capital firms that managed the funds were themselves entrepreneurial—the firms raised money from outside investors to invest in start-ups—with the firm usually entitled to 20 percent of the investment gains for finding, screening, and nurturing start-ups.


Americana by Bhu Srinivasan

activist fund / activist shareholder / activist investor, American ideology, AOL-Time Warner, Apple II, Apple's 1984 Super Bowl advert, bank run, barriers to entry, Bear Stearns, Benchmark Capital, Berlin Wall, blue-collar work, Bob Noyce, Bonfire of the Vanities, British Empire, business cycle, buy and hold, California gold rush, Carl Icahn, Charles Lindbergh, collective bargaining, commoditize, Cornelius Vanderbilt, corporate raider, cotton gin, cuban missile crisis, Deng Xiaoping, diversification, diversified portfolio, Douglas Engelbart, Fairchild Semiconductor, financial innovation, fixed income, Ford Model T, Ford paid five dollars a day, global supply chain, Gordon Gekko, guns versus butter model, Haight Ashbury, hypertext link, Ida Tarbell, income inequality, information security, invisible hand, James Watt: steam engine, Jane Jacobs, Jeff Bezos, John Markoff, joint-stock company, joint-stock limited liability company, junk bonds, Kickstarter, laissez-faire capitalism, Louis Pasteur, Marc Andreessen, Menlo Park, Michael Milken, military-industrial complex, mortgage debt, mutually assured destruction, Norman Mailer, oil rush, peer-to-peer, pets.com, popular electronics, profit motive, punch-card reader, race to the bottom, refrigerator car, risk/return, Ronald Reagan, Sand Hill Road, self-driving car, shareholder value, side project, Silicon Valley, Silicon Valley startup, Steve Ballmer, Steve Jobs, Steve Wozniak, strikebreaker, Ted Nelson, The Death and Life of Great American Cities, the new new thing, The Predators' Ball, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, trade route, transcontinental railway, traveling salesman, Upton Sinclair, Vannevar Bush, Works Progress Administration, zero-sum game

The federal government’s total expenditure for 1859 was $69 million—at this scale, even forty years of the entire annual federal budget would not have covered the market value of the slaves. Despite the rising tide of industry in the North, the numbers are beyond dispute: Slaves were the single most valuable asset class in America. Preservation of principal, not principle, formed the basis of every argument ever made in defense of slavery. And the next year, 1860, slave prices went up even further—newspapers dubbed the speculative climate “Negro Fever”—making the institution worth defending at all costs all the more.

These English privateering syndicates were anything but swashbuckling men with parrots and eye patches; the accounting statements of individual ventures made careful note of ship tonnage, capital invested, men involved, and number of ships in each operation—from which Sir Francis Drake’s twenty-one ships and 1,932 men stood out with invested capital of £57,000. In his thorough examination of the era’s joint-stock companies, W. R. Scott suggested that the flexibility of the corporate structure lent itself to the virtues of diversification and spreading risk, particularly in matters of piracy. From privateering’s tolerance for large losses emerged the basic principle of modern venture capital. Suppose, for instance, a capitalist was prepared to adventure 2000 Pounds in privateering, he could only fit out one ship of about 200 tons or two smaller ones.

The success of Intel’s IPO, which proved that the time frame from start-up to IPO could be compressed to three years, gave rise to a new formalized vehicle dedicated to investing in multiple start-ups: the venture capital fund. The investors in the venture capital funds received the benefits of diversification, where the staggering gains from one hit would ostensibly offset losses from a handful of others. It helped that the venture capital firms that managed the funds were themselves entrepreneurial—the firms raised money from outside investors to invest in start-ups—with the firm usually entitled to 20 percent of the investment gains for finding, screening, and nurturing start-ups.


pages: 375 words: 105,067

Pound Foolish: Exposing the Dark Side of the Personal Finance Industry by Helaine Olen

Alan Greenspan, American ideology, asset allocation, Bear Stearns, behavioural economics, Bernie Madoff, buy and hold, Cass Sunstein, Credit Default Swap, David Brooks, delayed gratification, diversification, diversified portfolio, Donald Trump, Elliott wave, en.wikipedia.org, estate planning, financial engineering, financial innovation, Flash crash, game design, greed is good, high net worth, impulse control, income inequality, index fund, John Bogle, Kevin Roose, London Whale, longitudinal study, low interest rates, Mark Zuckerberg, Mary Meeker, money market fund, mortgage debt, multilevel marketing, oil shock, payday loans, pension reform, Ponzi scheme, post-work, prosperity theology / prosperity gospel / gospel of success, quantitative easing, Ralph Nader, RAND corporation, random walk, Richard Thaler, Ronald Reagan, Saturday Night Live, Stanford marshmallow experiment, stocks for the long run, The 4% rule, too big to fail, transaction costs, Unsafe at Any Speed, upwardly mobile, Vanguard fund, wage slave, women in the workforce, working poor, éminence grise

All too many of us thrilled to stock tips and swooned at sensible strategies for using dollar-cost averaging to invest in everything from the latest hot tech company to sensible no-load mutual funds. We believed it when experts told us we too could become the millionaire next door if we saved and invested just right, whether that was the right mix of asset classes and stock picks or the perfect undervalued house that, with a fresh coat of paint and a couple of other inexpensive fixes, could be quickly flipped at a profit. But it all came down to the same thing. Buy stocks! Buy houses! Buy and hold, my friends! Time the markets! Seize the financial day! But the ability of the vast majority of people to seize the financial day was increasingly constrained by a third trend: our salaries were not, for the most part, keeping up with the rest of the economy.

Mikelann Valterra: http://www.seattlemoneycoach.com; author interview. It’s the sort of mindset: John Pelletier, “College Grads: Think About Your Retirement Now,” MarketWatch, April 16, 2012, http://articles.marketwatch.com/2012-04-16/finance/31345646_1_retirement-fund-switch-jobs-investment-diversification. Saundra Davis, financial coach: author interview. http://www.sagemoney.org/index.php?option=com_content&view=article&id=94&Itemid=53. There are efforts like the Family Independence: David Bornstein, “Out of Poverty, Family Style,” New York Times, July 14, 2011, http://opinionator.blogs.nytimes.com/2011/07/14/out-of-poverty-family-style.


pages: 421 words: 128,094

King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone by David Carey

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, asset allocation, banking crisis, Bear Stearns, Bonfire of the Vanities, business cycle, Carl Icahn, carried interest, collateralized debt obligation, corporate governance, corporate raider, credit crunch, deal flow, diversification, diversified portfolio, financial engineering, fixed income, Future Shock, Gordon Gekko, independent contractor, junk bonds, low interest rates, margin call, Menlo Park, Michael Milken, mortgage debt, new economy, Northern Rock, risk tolerance, Rod Stewart played at Stephen Schwarzman birthday party, Sand Hill Road, Savings and loan crisis, sealed-bid auction, Silicon Valley, sovereign wealth fund, Teledyne, The Predators' Ball, éminence grise

Many industry insiders predicted that, collectively, private equity funds raised in the mid-2000s would not break even, performing even worse than funds raised at the end of the 1990s that were invested during the last market high. The push by some firms like Apollo, KKR, and Carlyle to diversify away from LBOs into other asset classes by launching business development companies and publicly traded debt funds also proved calamitous. A $900 million mortgage debt fund that Carlyle raised on the Amsterdam exchange, shortly after KKR launched its $5 billion equity fund, was leveraged with more than $22 billion of debt and capsized in 2008 when its lenders issued margin calls and seized all its assets.

It emerged with most of its capital intact while commercial and investment banks were hobbled by astronomical losses on mortgage products and derivatives. The buyout funds raised in 2005 to 2007 may end up delivering disappointing returns, just as many funds raised at the peaks of the market at the end of the eighties and nineties did. But the real test for private equity will be how it performs as an asset class against other investments. Notwithstanding the risks of leverage and the private equity–backed companies that went under, private equity funds have beaten the overall average returns at major pension funds over the last three, five, and ten years. For pension managers who need to make up for losses in stocks and real estate in 2007 to 2009, private equity will seem very tempting.

Each of the great conglomerates—Litton Industries, Textron, Teledyne, and Gulf and Western Industries—had its own eclectic mix, but the modus operandi was the same: Buy, buy, buy. Size and diversity became grail-like goals. Unlike companies that grow big by acquiring competitors or suppliers to achieve economies of scale, the rationale for conglomerates was diversification. If one business had a bad year or was in a cyclical slump, others would compensate. At bottom, however, the conglomerate was a numbers game. In the 1960s, conglomerates’ stocks sometimes traded at multiples of forty times earnings—far above the historical average for public companies. They used their overvalued stock and some merger arithmetic to inflate their earnings per share, which is a key measure for investors.


pages: 448 words: 142,946

Sacred Economics: Money, Gift, and Society in the Age of Transition by Charles Eisenstein

Albert Einstein, back-to-the-land, bank run, Bernie Madoff, big-box store, bread and circuses, Bretton Woods, capital controls, carbon credits, carbon tax, clean water, collateralized debt obligation, commoditize, corporate raider, credit crunch, David Ricardo: comparative advantage, debt deflation, degrowth, deindustrialization, delayed gratification, disintermediation, diversification, do well by doing good, fiat currency, financial independence, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, full employment, global supply chain, God and Mammon, happiness index / gross national happiness, hydraulic fracturing, informal economy, intentional community, invisible hand, Jane Jacobs, land tenure, land value tax, Lao Tzu, Lewis Mumford, liquidity trap, low interest rates, McMansion, means of production, megaproject, Money creation, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, multilevel marketing, new economy, off grid, oil shale / tar sands, Own Your Own Home, Paul Samuelson, peak oil, phenotype, planned obsolescence, Ponzi scheme, profit motive, quantitative easing, race to the bottom, Scramble for Africa, special drawing rights, spinning jenny, technoutopianism, the built environment, Thomas Malthus, too big to fail, Tragedy of the Commons

I won’t offer definitions here—you can look them up yourself—except for the most relevant, the zero-risk interest premium. That is equivalent to the rate on short-term U.S. government securities (T-bills), which have essentially zero risk and full liquidity. One might say that there is risk here too, but if things unravel to the point where the U.S. government is incapable of printing money, then no asset class would be safe. 5. The new means of keeping interest rates above growth is the Fed’s new power to offer interest on bank reserves. Currently at near zero, the Fed plans to raise these rates when the economy starts growing (see, e.g., Keister and McAndrews, “Why Are Banks Holding So Many Excess Reserves?”).

In times of extreme crisis, governments typically confiscate private gold holdings—Hitler, Lenin, and Roosevelt all did so. If even the government falls apart, then people with guns will come and take your gold or any other store of wealth. I sometimes read the financial website Zero Hedge for its remarkable insight into the pretenses and machinations of the financial power elite. In that website’s dim view, no asset class except physical gold and other physical commodities is safe today. I agree with its logic as far as it goes, but it does not go far enough. If the system breaks down to the point of hyperinflation, then the institution of property—as much a social convention as money is—will break down too. In times of social turmoil, I can’t imagine anything more dangerous than possessing a few hundred ounces of gold.

Obviously, the word “recession” has negative connotations today, though it really just means a time of receding. I am most emphatically not saying that we must make some sacrifices to our quality of life for the good of the planet. Rather, we need but reduce the role of money. If our future includes a diversification in the modes of human sharing, then economic growth no longer has the same meaning it has today. We don’t need to become more altruistic and self-sacrificing, forgoing our own benefit for the good of others. How tightly we hold to the equation of money and self-interest! But it shall be so no longer.


pages: 477 words: 144,329

How Money Became Dangerous by Christopher Varelas

activist fund / activist shareholder / activist investor, Airbnb, airport security, barriers to entry, basic income, Bear Stearns, Big Tech, bitcoin, blockchain, Bonfire of the Vanities, California gold rush, cashless society, corporate raider, crack epidemic, cryptocurrency, discounted cash flows, disintermediation, diversification, diversified portfolio, do well by doing good, Donald Trump, driverless car, dumpster diving, eat what you kill, fiat currency, financial engineering, fixed income, friendly fire, full employment, Gordon Gekko, greed is good, initial coin offering, interest rate derivative, John Meriwether, junk bonds, Kickstarter, Long Term Capital Management, low interest rates, mandatory minimum, Mary Meeker, Max Levchin, Michael Milken, mobile money, Modern Monetary Theory, mortgage debt, Neil Armstrong, pensions crisis, pets.com, pre–internet, profit motive, proprietary trading, risk tolerance, Saturday Night Live, selling pickaxes during a gold rush, shareholder value, side project, Silicon Valley, Steve Jobs, technology bubble, The Predators' Ball, too big to fail, universal basic income, zero day

At the time, a single Salomon bond trader might move more in dollar volume of US Treasury securities per day than the value of all collective shares of equity traded on the New York Stock Exchange. In 1990, the US bond market had a value of more than $7.5 trillion—dwarfing most other markets. As the largest, safest, and most stable asset class in the entire global financial system, these bonds were indispensable financial instruments to every investment bank, commercial bank, insurance company, and money manager—pretty much every firm in the financial world of any material size. Mozer and his traders at Salomon Brothers understood that high demand, so they mastered the art of the squeeze—dominating certain auctions by purchasing the majority of bonds on offer, then sitting back to wait for the other investment banks to come begging.

He only cared about bringing the truth. If Mike hadn’t gone into the securities business, he could have led a religious revival movement.” Once Drexel uncaged Milken from the back office, put him on special projects, and cautiously began allowing him more and more capital to work with, he created an entirely new asset class, multiplying those funds with paranormal results. Soon it seemed that he was indeed leading a religious revival movement. Converts and followers flocked to him, as Milken became the financial prophet that drove Drexel’s revenue, culture, and operations. In the emergence of hostile takeovers and corporate raiders to the forefront of the American business landscape, Milken was the messiah.

One use of Blockchain that will have a dramatic impact on wealth management and the way we look at value will be the ability to divide an asset into as many parts as desired and sell those to third parties. Any asset, in theory—including your house or even your future earnings potential—would be eligible to be parsed and sold, creating a world in which partial ownership across existing and potential new asset classes would likely be the norm. How will that change our view of and relationship to value when we no longer own an entire asset but only a piece? Will we be as invested in the viability and success of the whole? As much as any other evolution in the world of money, one of the most influential has been the gradual diminishment of human contact.


pages: 364 words: 112,681

Moneyland: Why Thieves and Crooks Now Rule the World and How to Take It Back by Oliver Bullough

Alan Greenspan, banking crisis, Bernie Madoff, bitcoin, blood diamond, Bretton Woods, Brexit referendum, BRICs, British Empire, capital controls, central bank independence, corporate governance, cryptocurrency, cuban missile crisis, dark matter, diversification, Donald Trump, energy security, failed state, financial engineering, Flash crash, Francis Fukuyama: the end of history, full employment, Global Witness, high net worth, if you see hoof prints, think horses—not zebras, income inequality, joint-stock company, land bank, liberal capitalism, liberal world order, mass immigration, medical malpractice, Navinder Sarao, offshore financial centre, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, rent-seeking, Richard Feynman, risk tolerance, Sloane Ranger, sovereign wealth fund, Suez crisis 1956, WikiLeaks

For example, in London 60 percent of houses costing over four million pounds are now sold to non-Brits.’ After the financial crisis, these nomadic Moneylanders inherited the earth. There are a lot of banks like Citigroup, and those banks employ a lot of analysts, and those analysts produce a lot of reports, and those reports describe a lot of asset classes – stocks, bonds, commodities, land, anything else that can yield a profit. The vast majority of the reports vanish after a couple of days, having served their rather limited purpose. Kapur’s plutonomy papers have lasted longer, however. Reuters ran a long article based on his first report within a week of its publication, and was followed by most of the world’s most prestigious media outlets.

And, I have to say, to the credit of the then-PM, he saw the point, and the choice was relatively simple.’ At the time, people looking to buy a St Kitts passport could either buy government bonds or invest in a property development. Kalin suggested a third option: give money to the government, which it would put in a transparently managed Sugar Industry Diversification Foundation, (SIDF) which would act like a national trust fund. The government would get some money, the investor would feel virtuous, the world community would be satisfied that the money was not being embezzled, and the investor would gain access to a whole new travel document. To satisfy other countries’ security concerns, he proposed bringing in private sector companies to do background checks on all the applicants.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

Affordable Care Act / Obamacare, Alan Greenspan, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bear Stearns, Bernie Madoff, book value, break the buck, centre right, collapse of Lehman Brothers, collateralized debt obligation, commoditize, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Future Shock, Glass-Steagall Act, government statistician, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, junk bonds, light touch regulation, Long Term Capital Management, low earth orbit, low interest rates, mega-rich, money market fund, moral hazard, mortgage debt, negative equity, Neil Armstrong, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, plutocrats, Ponzi scheme, price anchoring, price stability, proprietary trading, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Ronald Reagan, tail risk, too big to fail, trickle-down economics, value at risk, yield curve

As far as he was concerned, the amount of money he had at risk was the amount he’d lent to Joe Schmoe minus the amount that Joe had repaid. The only risk to which Jefferson Smith was exposed was that some idiot in the office might not be able to do simple arithmetic. The situation is utterly different today. For all that securities are designed to be tradable‌—‌a commoditized asset class using largely standardized legal language, conferring the same rights no matter which investor owns the security‌—‌they oftentimes don’t trade much at all. Sometimes that doesn’t matter too much. If you own an A-rated corporate bond, and you’ve done your homework and reckon that the A-rating is appropriate for the borrower in question, you can get a pretty good idea of the price your bond will trade at simply by looking at the prices at which other A-rated bonds are traded today.

A currency is likely to appreciate in value if its government operates sound finances and sound money; if it has a strong economy with good growth prospects, a strong and stable housing market, and perhaps especially if it has abundant natural resources. Those things are not, alas, true of very many countries today, but exceptions do exist: Canada and the Scandinavian states, for example. A natural diversification for American investors would be to switch some US dollar assets into Canadian dollars. North of the border, you have a government with sound money, untroubled banks, and huge natural resources. That’s a wonderful recipe for a steadily appreciating currency. The Australian and New Zealand dollars look attractive for similar reasons.


pages: 424 words: 121,425

How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy by Mehrsa Baradaran

access to a mobile phone, affirmative action, Alan Greenspan, asset-backed security, bank run, banking crisis, banks create money, barriers to entry, Bear Stearns, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, cashless society, credit crunch, David Graeber, disintermediation, disruptive innovation, diversification, failed state, fiat currency, financial innovation, financial intermediation, Glass-Steagall Act, Goldman Sachs: Vampire Squid, housing crisis, income inequality, Internet Archive, invisible hand, junk bonds, Kickstarter, low interest rates, M-Pesa, McMansion, Michael Milken, microcredit, mobile money, Money creation, moral hazard, mortgage debt, new economy, Own Your Own Home, Paul Volcker talking about ATMs, payday loans, peer-to-peer lending, price discrimination, profit maximization, profit motive, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, Ronald Reagan: Tear down this wall, Savings and loan crisis, savings glut, subprime mortgage crisis, the built environment, the payments system, too big to fail, trade route, transaction costs, unbanked and underbanked, underbanked, union organizing, W. E. B. Du Bois, white flight, working poor

Put simply, the U.S. markets became flooded by foreign money seeking a high return on investment. While these funds would usually have bought up U.S. Treasury bonds, the large demand for them lowered Treasury yields and the pool of money flowed toward Wall Street, seeking a better return. The next safest asset class after U.S. treasuries was asset-backed securities, or home mortgages. Wall Street banks, trying to meet investor demand, sold and resold as many of these securities as they could through bundling and creating new “structured products,” but the demand was practically insatiable. So they originated more mortgage loans.

However, the question of whether a certain bank action would benefit the public morphed into an inquiry about bank profitability. For example, the Federal Reserve approved another case because of the public benefit of “[providing] Applicant greater resources for expansion and greater flexibility for diversification of business activities … [which would] allow Applicant to continue to compete effectively with other large Rhode Island financial organizations.”108 Bank “efficiency” and “profits” slowly became the proxy for “public benefit.” Additionally, the banks themselves underwent a coinciding cultural shift from acting as caretakers or fiduciaries for their customers to exploiting them.


pages: 400 words: 121,988

Trading at the Speed of Light: How Ultrafast Algorithms Are Transforming Financial Markets by Donald MacKenzie

algorithmic trading, automated trading system, banking crisis, barriers to entry, bitcoin, blockchain, Bonfire of the Vanities, Bretton Woods, Cambridge Analytica, centralized clearinghouse, Claude Shannon: information theory, coronavirus, COVID-19, cryptocurrency, disintermediation, diversification, en.wikipedia.org, Ethereum, ethereum blockchain, family office, financial intermediation, fixed income, Flash crash, Google Earth, Hacker Ethic, Hibernia Atlantic: Project Express, interest rate derivative, interest rate swap, inventory management, Jim Simons, level 1 cache, light touch regulation, linked data, lockdown, low earth orbit, machine readable, market design, market microstructure, Martin Wolf, proprietary trading, Renaissance Technologies, Satoshi Nakamoto, Small Order Execution System, Spread Networks laid a new fibre optics cable between New York and Chicago, statistical arbitrage, statistical model, Steven Levy, The Great Moderation, transaction costs, UUNET, zero-sum game

It is a sensitive topic, because HFT firms quite often fail financially, and my impression is that the most common way in which they do so is not by losses in trading but when revenues from trading are swamped by expenses. Nevertheless, there seems to be some consensus among interviewees that 0.05–0.1 cents per share traded (or its rough equivalent in other asset classes) is a healthy rate of profits net of expenses. Even if that is an underestimate (and it may not be), it does indicate the narrowness of the economic difference in HFT between success—regular tiny profits on huge volumes of trades do add up26—and failure: the inability to earn revenues that exceed a firm’s expenses.

“The Microgeographies of Global Finance: High-Frequency Trading.” Environment and Planning 49/1: 121–140. Zuckerman, Ezra W. 1999. “The Categorical Imperative: Securities Analysts and the Illegitimacy Discount.” American Journal of Sociology 104/5: 1398–1438. ________. 2000. “Focusing the Corporate Product: Securities Analysts and De-Diversification.” Administrative Science Quarterly 45/3: 591–619. Zuckerman, Gregory. 2019. The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution. London: Penguin. INDEX 50 Broad Street, 1, 2f Abbott, Andrew, 16 Abolafia, Mitchel, 19 actor-network theory, 14 advertising, online, 236–37 Aldrich, Eric, 229 Aldrich, Eric, and Seung Lee, 248nn23 and 27 algorithms, 4, 172–205, 213–17; defined, 12–13; volume-participation, 230–31 Amazon, 236 Angel, James, 225 Anova, 155, 156, 159–60, 253n12 AOptics, 159–60 application-specific integrated circuits (ASICs), 254n23 Aquilina, Matteo, 183–84, 223, 256n13 Aquis, 225 arb, 43 arbitrage, 175; statistical, 243n5 Archipelago, 91, 96, 255n7 asterisk, battle of, 219–20, 222 Aurora, 50, 52 Automated Trading Desk (ATD), 28, 29, 66–69, 77–80, 82–84, 90, 101–4, 176, 210–11; staff roles, 84f banks, 5, 103 Barclays Bank, 197 BATS (Better Alternative Trading System), 96, 97 Biais, Bruno, and Richard Green, 110 bigs and littles, 54–55 bilateral relationships, 227–28 Birch, Kean, 246n32 bird droppings, 160 bitcoin, 234–35 Bloomberg FIT (Fixed-Income Trading), 106–7, 110 Borch, Christian, 10–11, 231, 241 Brogaard, Jonathan, 240 broker groups, 46–47 BrokerTec, 105–6, 110, 113, 114, 115t, 165 Budish, Eric, 23, 223–24, 225–26, 240 C++, 167 cabling, 139–47, 165–66 Callon, Michel, 243n17 Cantor Fitzgerald, 111–13 Carlson, Ryan, 60, 247nn5 and 6 Cermak, 135–37, 136f Chicago Board of Trade, 33, 35f, 36f, 37, 59–60 Chicago Board Options Exchange (CBOE), 203–4 Chicago Mercantile Exchange (CME), 29, 32, 33, 37, 63–64, 232–33 Chi-X, 99–101, 240, 256n21 Christie, William, and Paul Schultz, 94 circuit breakers, 261n26 Citadel, 4, 104, 233, 260n16 Citigroup, 103–4 Citron, Jeffrey, 85, 250n17 Clackatron, 3f, 128 clearing and settlement, 209 CLOBs (consolidated limit order books), 71–72, 97, 178, 218, 219 clock synchronization, 11, 187 coils, 258n34 Commodity Exchange Authority, 39 Commodity Futures Trading Commission (CFTC), 41–42, 133 cookies, 261n36 Coombs, Nathan, 242 Copenhagen Business School, 231, 241 coronavirus, 10 Cowan, Ruth Schwartz, 14 cryptocurrencies, 234–35 Cummings, Dave, 3–4, 29, 92 dark pools, 19–20, 116, 251n24 datacenters, 6–8, 135–39, 138f, 162–71 Datek, 85 dealers, 105–8, 110f, 119 decimalization, 101, 198, 199, 252n12 Deutsche Terminbörse, 57, 58 digital economy, 235–37 Direct Match, 114–16, 209 Dodd-Frank Act 2010, 221, 259n16 Dourish, Paul, 243n18 Einstein, Albert, 11 Electronic Broking Services (EBS), 126–28, 198, 199, 200–201 E-Mini, 51f, 54, 55, 56 equities triangle, 7f, 8 ES, 55, 56, 61, 183, 247n27 eSpeed, 112, 113, 114 ethereum, 234, 235 Eurex, 59, 62, 164, 165, 168–69, 244n13, 254n22 EuroMTS, 120 exchange-traded funds (ETFs), 61 Exegy, 9 Facebook, 235, 237 fees, 20–21, 223 fiber-optic cable, 253n9 fiber tail, 152–53, 158, 208 field theory, 14–15, 16, 222 fill messages, 163–65, 209 FINRA (Financial Industry Regulatory Authority), 259nn8 and 15 Fixed Income Clearing Corporation (FICC), 116 Flash Boys, 142, 239 flash crashes, 228–30 foreign exchange trading, 123–31, 134, 196–201, 213, 214 Foucault, Michel, 217 FPGAs (field programmable gate arrays), 30, 169–71, 170f, 233 fragmentation, 97t, 132–34, 154, 211 futures, 37–38, 40–43, 69, 131, 209, 210; defined, 8, 32–33 futures lead, 43, 61–65, 92, 97t, 132–33, 211, 249n30 Galison, Peter, 11 geodesics, 9 Getco (Global Electronic Trading Co.), 55, 232 Ginsey, 247n8 Globex, 49–53, 55, 56, 61 Godechot, Oliver, 17 gold line, 140–41, 209, 252n6 Google, 235–36, 237 governmentality, 217–18 Guardian, 236 Gutterman, Burt, 50, 52 Hackers, 87–88 Harris, Lawrence, and Venkatesh Panchapagesan, 19 Hawkes, James, 67–68 Hendershott, Terrence, 262n2 high-frequency trading, 23–29; defined, 4 hinges, 16, 20–21, 93–98, 210, 224–25; in Europe, 99–101 Hobson, John, and Leonard Seabrooke, 245n23 Hotspot, 129, 130 IEX, 202–3, 202f, 204, 258n36 information, politics of, 210–13 Instinet, 67, 76–77, 78–79, 96 Intercontinental Exchange (ICE), 62, 257n30 Intermarket Sweep Orders (ISOs), 179–81, 215–16, 217, 255n10 Intermarket Trading System (ITS), 72–73, 91 interviewees, 24–28, 25t, 246n34 inverted exchanges, 257n32 Island, 1–3, 4, 29, 56, 85–93, 96, 201, 243n10, 257n31 Itch, 89 jitter, 232–33, 248n25 Johnson, Neil, 230 journalism, 236 Jump Trading, 55, 153 Knight Capital, 232 Lange, Ann-Christina, 6 lasers, 159–60 last look, 196–97 Latour, Bruno, 202, 243n17 Latour Trading LLC, 255n11 Laughlin, Gregory, 20, 244nn12 and 14 Laumonier, Alexandre, 147, 242 Law, John, and Annemarie Mol, 14 Lehmann Brothers, 3f, 128 Lenglet, Marc, 242 leverage, 63 Levine, Josh, 85, 87, 89, 250nn16, 17, and 18 Levy, Stephen, 87–88 Lewis, Michael, 142, 239 LIFFE (London International Financial Futures Exchange), 48–49, 57, 58, 59, 62, 248n14 light, speed of, 4, 11–12 liquidity, stickiness of, 27, 63, 249n28 Liquidity Edge, 117–18 liquidity-taking, 30.


pages: 444 words: 124,631

Buy Now, Pay Later: The Extraordinary Story of Afterpay by Jonathan Shapiro, James Eyers

Airbnb, Alan Greenspan, Apple Newton, bank run, barriers to entry, Big Tech, Black Lives Matter, blockchain, book value, British Empire, clockwatching, cloud computing, collapse of Lehman Brothers, computer age, coronavirus, corporate governance, corporate raider, COVID-19, cryptocurrency, delayed gratification, diversification, Dogecoin, Donald Trump, Elon Musk, financial deregulation, George Floyd, greed is good, growth hacking, index fund, Jones Act, Kickstarter, late fees, light touch regulation, lockdown, low interest rates, managed futures, Max Levchin, meme stock, Mount Scopus, Network effects, new economy, passive investing, payday loans, paypal mafia, Peter Thiel, pre–internet, Rainbow capitalism, regulatory arbitrage, retail therapy, ride hailing / ride sharing, Robinhood: mobile stock trading app, rolodex, Salesforce, short selling, short squeeze, side hustle, Silicon Valley, Snapchat, SoftBank, sovereign wealth fund, tech bro, technology bubble, the payments system, TikTok, too big to fail, transaction costs, Vanguard fund

Elon Musk, rapper Snoop Dogg and former porn star Mia Khalifa encouraged their followers to buy one called Dogecoin, which was created not to be taken too seriously. The price went up 800 per cent. There was a lot of money to be made. Serious investors could make money by latching themselves onto millennial trends, and the most lucrative was cryptocurrencies. Increasingly, institutional investors became converts, and pitched the asset class to their clients. Mark Carnegie, who had spent the pandemic in a bolthole in New Zealand, told the AFR that investors should allocate 1 to 2 per cent of their net worth to crypto as a hedge against inflation risk. Carnegie had never invested in Afterpay, even though the 22-year-old Molnar had sat in his office and developed Ice Online and its payments plan right under his nose.

Other brokers were jockeying to help the Afterpay founders place some of their stock in the market. And if the market wasn’t fully alert to the possibility that Eisen and Molnar would soon be free to sell their shares, Hancock’s April 2018 update spelt it out. ‘Subject to share price and general market conditions, Anthony and Nick, for asset diversification purposes, may sell up to 10 per cent of their underlying individual shareholdings over the next 12 months,’ the statement said. The trading update was enough to give Ashwini Chandra at Goldman Sachs cold feet as he downgraded the Afterpay share price target to neutral. Once he crunched the numbers, he said, he realised that the company’s sales growth had declined over the quarter.


pages: 823 words: 220,581

Debunking Economics - Revised, Expanded and Integrated Edition: The Naked Emperor Dethroned? by Steve Keen

accounting loophole / creative accounting, Alan Greenspan, banking crisis, banks create money, barriers to entry, behavioural economics, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, book value, business cycle, butterfly effect, capital asset pricing model, cellular automata, central bank independence, citizen journalism, clockwork universe, collective bargaining, complexity theory, correlation coefficient, creative destruction, credit crunch, David Ricardo: comparative advantage, debt deflation, diversification, double entry bookkeeping, en.wikipedia.org, equity risk premium, Eugene Fama: efficient market hypothesis, experimental subject, Financial Instability Hypothesis, fixed income, Fractional reserve banking, full employment, Glass-Steagall Act, Greenspan put, Henri Poincaré, housing crisis, Hyman Minsky, income inequality, information asymmetry, invisible hand, iterative process, John von Neumann, Kickstarter, laissez-faire capitalism, liquidity trap, Long Term Capital Management, low interest rates, mandelbrot fractal, margin call, market bubble, market clearing, market microstructure, means of production, minimum wage unemployment, Money creation, money market fund, open economy, Pareto efficiency, Paul Samuelson, Phillips curve, place-making, Ponzi scheme, Post-Keynesian economics, power law, profit maximization, quantitative easing, RAND corporation, random walk, risk free rate, risk tolerance, risk/return, Robert Shiller, Robert Solow, Ronald Coase, Savings and loan crisis, Schrödinger's Cat, scientific mainstream, seigniorage, six sigma, South Sea Bubble, stochastic process, The Great Moderation, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, total factor productivity, tulip mania, wage slave, zero-sum game

This growth in bank income and debt is in turn dependent on the willingness of borrowers to incur debt. If this is based solely on their income, then the ‘hard budget constraint’ that households and firms face will put a limit on the amount of debt they will take on. If, however, a Ponzi scheme develops in some asset class – so that people are willing to borrow money in the expectation of future capital gain – then the amount of borrowing will no longer be constrained by incomes. While capital gains are made, the borrowers also operate with a soft budget constraint: any deficiency of revenue over costs can be covered by selling an asset whose price has been inflated by the increase in leverage.

At this time, his confidence in the soundness of the American economy was complete’ (Barber 1997). 9 Barber observed that among the other reasons was the fact that ‘In the 1930s, his insistence on the urgency of “quick fix” solutions generated frictions between Fisher and other professional economists’ (ibid.). 10 Almost 90 percent of the over 1,200 citations of Fisher in academic journals from 1956 were references to his pre-Great Depression works (Feher 1999). 11 Strictly speaking, this was supposed to be anything in which one could invest, but practically the theory was applied as if the investments were restricted to shares. 12 Since diversification reduces risk, all investments along this edge must be portfolios rather than individual shares. This concept is important in Sharpe’s analysis of the valuation of a single investment, which I don’t consider in this summary. 13 In words, this formula asserts that the expected return on a share will equal the risk-free rate (P), plus ‘beta’ times the difference between the overall market return and the risk-free rate.


pages: 1,009 words: 329,520

The Last Tycoons: The Secret History of Lazard Frères & Co. by William D. Cohan

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", activist fund / activist shareholder / activist investor, Alan Greenspan, AOL-Time Warner, bank run, Bear Stearns, book value, Carl Icahn, carried interest, cognitive dissonance, commoditize, computer age, corporate governance, corporate raider, creative destruction, credit crunch, deal flow, diversification, Donald Trump, East Village, fear of failure, financial engineering, fixed income, G4S, Glass-Steagall Act, hiring and firing, interest rate swap, intermodal, Joseph Schumpeter, junk bonds, land bank, late fees, Long Term Capital Management, Marc Andreessen, market bubble, Michael Milken, offshore financial centre, Ponzi scheme, proprietary trading, Ralph Nader, Ralph Waldo Emerson, rolodex, Ronald Reagan, shareholder value, short squeeze, SoftBank, stock buybacks, The Nature of the Firm, the new new thing, Yogi Berra

He took to wearing contact lenses instead of the preposterous eyeglasses that had been one of his goofy sartorial trademarks. Some of his studied schlumpiness appeared to recede. Ash introduced him to hip young artists and their work. But by all accounts, for Bruce art seems to be nothing more than another asset class with which to display his investment prowess. Under Ash's influence, he bought work by many of the artists in the Gagosian stable: Salle, Warhol, Serra, Halley, and Lichtenstein. Before he met Ash, he bought a few Impressionist paintings by Monet and Matisse. Art "is just another acquisition for Bruce," a friend observed.

Conglomerates will promise anything for your people (if your stock sells for a lower multiple of earnings and has a faster earnings growth than theirs), but once in the fold your company goes through the homogenizer along with their other acquisitions of the week, and all the zeal and most of the good people leave." For ITT, the $53.1 million deal for Avis was its first successful diversification. In 1965, some 54 percent of ITT's revenue and 60 percent of its consolidated net income derived from overseas, with the bulk of its European sales being telecommunications equipment. With Avis, ITT had taken the important first step toward becoming the more U.S.-focused conglomerate Geneen envisioned.


J.K. Lasser's Your Income Tax 2022: For Preparing Your 2021 Tax Return by J. K. Lasser Institute

accelerated depreciation, Affordable Care Act / Obamacare, airline deregulation, anti-communist, asset allocation, bike sharing, bitcoin, business cycle, call centre, carried interest, collective bargaining, coronavirus, COVID-19, cryptocurrency, distributed generation, distributed ledger, diversification, employer provided health coverage, estate planning, Home mortgage interest deduction, independent contractor, intangible asset, medical malpractice, medical residency, mortgage debt, mortgage tax deduction, passive income, Ponzi scheme, profit motive, rent control, ride hailing / ride sharing, Right to Buy, sharing economy, TaskRabbit, Tax Reform Act of 1986, transaction costs, zero-coupon bond

For listed property, use Part V of Form 4562. Election out of bonus depreciation. Unlike regular depreciation, you are not required to use bonus depreciation and have the option of electing out of its use. If eligible for bonus depreciation, you can elect not to use it. The election out is made on a per-asset-class basis. Thus, for example, you can opt out of bonus depreciation for all five-year property while claiming it for seven-year property. To make the election out of claiming bonus depreciation, attach a statement to your return specifying the class of property for which the election not to claim additional depreciation is being made.

Rul. 81-275, 1981-2 CB 75 Extension of 60-day period for frozen assets IRC §402(c)(7) Rollover by surviving spouse IRC §402(c)(9) Section 641(f)(3) of EGTRRA 2001 (averaging barred for amounts rolled over by surviving spouse after 2001 to same plan) Nonspouse beneficiary may make rollover to inherited IRA IRC §402(c)(11)(A), as amended by the Worker, Retiree, and Employer Recovery Act of 2008 Diversification of rollover permitted Rev. Rul. 79-265, 1979-2 CB 186 7.7 ROLLOVER OF PROCEEDS FROM SALE OF PROPERTY Rollover of sales proceeds IRC §402(a)(6)(D) Designation of cash IRC §402(a)(6)(D)(iii)(II) Designation of employee contributions IRC §402(a)(6)(D)(iii)(I) Allocation methods IR-2086, February 6, 1979 7.8 DISTRIBUTION OF EMPLOYER STOCK OR OTHER SECURITIES * IRS Publication 575 Unrealized appreciation due to employee's contributions IRC §402(e)(4) Reg. §1.402(a)-1(b) Reg. §1.402(a)-1(a)(9)(B) Unrealized appreciation due to employer's contributions IRC §402(e)(4) Reg. §1.402(a)-1(b) Reg. §1.402(a)-1(a)(9)(B) Reg. §1.401(e)-2(d)(2) Waiving tax-free treatment IRC §402(e)(4)(B) Shares valued below your cost Rev.

. §1.408-3 Loss on surrender of IRA annuity nondeductible Rev. Rul. 80-268, 1980-2 CB 141 Flexible premiums IRC §408(b)(2) Reg. §1.408-3(b)(6) Endowment contract issued after November 6, 1978 Reg. §1.408-3(e) Broker restrictions Special Ruling, August 24, 1983 Tax treatment of distribution IRC §408(d) Reg. §1.408-4 Diversification of investment permitted Rev. Rul. 79-265, 1979-2 CB 186 Collectibles investments restricted IRC §408(m)(3) Bullion investment allowed if in trustee's possession IRC §408(m)(3) * Letter Ruling 200217059 Time for making contributions IRC §219(f)(3) Prohibited transaction terminates an IRA Lawrence F.