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.

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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.

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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.

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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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).

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• 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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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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.

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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.

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.

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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.

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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.

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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.

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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.

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).

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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.

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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.

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.

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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.

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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?

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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?

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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).

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.

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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.

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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.

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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.

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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.

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.

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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%.

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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.

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.

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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.

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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.

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.

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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.

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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?

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.

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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.

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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.

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.

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“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.

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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.

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.

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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.

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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.

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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.

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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.

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.

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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).

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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.

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).

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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).

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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.

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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.

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., 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.

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).

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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.

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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.

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.

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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.

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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).

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).

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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).

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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.

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.”

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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.

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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.

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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.

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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.

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.

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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.

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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.

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).

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—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.

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. • 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.

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.

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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.

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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.

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.

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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.

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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?

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?

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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?

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.

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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.

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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.

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).

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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.

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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.

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.

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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.

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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.

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.”

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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.

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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.

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.

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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.”

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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.

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.

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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.

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—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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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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.

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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.

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?

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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!”

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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.

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’.

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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 .

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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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.

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(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.

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.

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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.

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“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?

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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%.

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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!

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%.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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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?

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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.

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.

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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.

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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).

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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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)).

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(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.

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.

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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.

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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.

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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?

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**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).

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.

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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.

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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.

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.

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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.

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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.

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.

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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.

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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.

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.

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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

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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.

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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.

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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.

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